[Federal Register Volume 73, Number 147 (Wednesday, July 30, 2008)]
[Proposed Rules]
[Pages 44197-44201]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-17415]
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NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Parts 702 and 704
RIN 3133-AD43
Prompt Corrective Action; Amended Definition of Post-Merger Net
Worth
AGENCY: National Credit Union Administration (NCUA).
ACTION: Proposed rule.
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SUMMARY: NCUA requests public comment on a proposed rule implementing a
statutory amendment to the definition of a natural person credit
union's ``net worth'' that applies solely to NCUA's system of
regulatory capital standards, known as ``prompt corrective action.''
The amendment expands the definition of ``net worth'' to allow the
acquiring credit union, in a merger of natural person credit unions, to
include the merging credit union's retained earnings with its own to
determine the acquirer's post-merger ``net worth.'' In a merger of
corporate credit unions, the proposed rule similarly redefines
corporate credit union capital to allow an acquiring credit union to
include with its capital the retained earnings of the merging credit
union to determine the acquirer's post-merger capital.
DATES: Comments must be received on or before September 29, 2008.
ADDRESSES: You may submit comments by any of the following methods
(Please send comments by one method only):
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
NCUA Web Site: http://www.ncua.gov/RegulationsOpinionsLaws/proposed_regs/proposed_regs.html. Follow the
instructions for submitting comments.
E-mail: Address to [email protected]. Include ``[Your
name]--
Comments on Notice of Proposed Rulemaking for Parts 702 and 704''
in the e-mail subject line.
Fax: (703) 518-6319. Use the subject line described above
for e-mail.
Mail: Address to Mary Rupp, Secretary of the Board,
National Credit Union Administration, 1775 Duke Street, Alexandria,
Virginia 22314-3428.
Hand Delivery/Courier: Same as mail address.
FOR FURTHER INFORMATION CONTACT: Technical: Karen Kelbly, Chief
Accountant, Office of Examination and Insurance, at the above address
or by telephone: 703/518-6389; Legal: Steven W. Widerman, Trial
Attorney, Office of General Counsel, at the above address or by
telephone: 703/518-6557.
SUPPLEMENTARY INFORMATION:
A. Background
1. Natural Person Credit Unions
a. Prompt Corrective Action. In 1998, Congress enacted the Credit
Union Membership Access Act (``CUMAA''), Public Law 105-219, 112 Stat.
913 (1998). CUMAA amended the Federal Credit Union Act to mandate a
system of regulatory capital standards called ``prompt corrective
action'' (``PCA'' or ``regulatory capital'') consisting of
[[Page 44198]]
minimum capital standards and corresponding remedies to improve the net
worth of federally-insured ``natural person'' credit unions. 12 U.S.C.
1790d et seq. In 2000, the NCUA Board implemented a comprehensive
system of PCA primarily under part 702.\1\ 12 CFR 702 et seq.
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\1\ Since it was first adopted, part 702 has been amended four
times. The first amendment incorporated limited technical
corrections. 65 FR 55439 (Sept. 14, 2000). The second amendment
deleted sections made obsolete by adoption of a uniform quarterly
schedule for filing Call Reports. 67 FR 12459 (March 19, 2002). The
third amendment incorporated a series of revisions and adjustments
to improve and simplify the implementation of PCA. 67 FR 71078 (Nov.
29, 2002). Finally, the fourth amendment added a third risk-
weighting tier to the standard risk-based net worth component for
member business loans. 68 FR 56537, 56546 (Oct. 1, 2003). A proposal
to modify the criteria for filing a net worth restoration plan, 67
FR 7113 (Nov. 29, 2002), was never adopted.
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A credit union's ``net worth ratio'' determines its classification
among five statutory net worth categories. 12 U.S.C. 1790d(c); 12 CFR
702.102. As a credit union's classification among these categories
declines, it is subject to an expanding range of PCA remedies to
restore its net worth. These remedies consist of four mandatory
supervisory actions prescribed by statute, 12 U.S.C. 1790d(e)-(g), and
a series of discretionary supervisory actions developed by NCUA. 12 CFR
702.204(b).
CUMMA defines a natural person credit union's ``net worth ratio''
as the ratio of its net worth to its total assets. 12 U.S.C.
1790d(o)(3). For regulatory capital purposes,\2\ it expressly limits a
credit union's net worth to ``the retained earnings balance of the
credit union, as determined under generally accepted accounting
principles [``GAAP''].'' 12 U.S.C. 1790d(o)(2)(A) (1998).\3\ ``Not
anticipating the consequences this rule addresses, the CUMAA net worth
definition thus incorporated GAAP by reference generally, subject to
future amendments and interpretations; it did not incorporate GAAP as a
snapshot that preserved what GAAP then prescribed or how it was then
interpreted.
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\2\ In contrast, for financial reporting purposes, CUMMA
requires credit unions to adhere to GAAP in the Call Reports
required to be filed with the NCUA Board. 12 U.S.C.
1782(a)(6)(C)(i).
\3\ In contrast to NCUA, Congress gave the other federal
financial institution regulators the latitude to prescribe the
``relevant capital measures'' of their institutions. 12 U.S.C.
1831o(c)(1). As a result, the ``core capital'' of banks and thrifts
is defined to include virtually all GAAP equity components, 12 CFR
325.2(v), whereas credit union capital is limited by law to the
``retained earnings'' component of equity. 12 CFR 702.2(f).
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b. Financial Reporting of Mergers Between Mutual Enterprises. GAAP
pertaining to credit union mergers were originally embodied in the
financial reporting rules for business combinations established by the
Accounting Principles Board's (``APB'') Opinion No. 16, Business
Combinations (1970) (``Opinion 16''). At the time CUMAA mandated PCA,
the predominant practice for financial reporting of a credit union
merger, whether of natural person or corporate credit unions, was to
apply the ``pooling method.'' That method required an acquiring or
continuing credit union (``acquiring credit union'') to combine with
its own financial statement components the like components of the
merging credit union. Consistent with the limited statutory definition
of net worth, that method allowed an acquiring credit union to combine
its own retained earnings with that of the merging credit union for
purposes of measuring the acquirer's post-merger net worth ratio. The
``pooling method'' presumed that the retained earnings of the merging
credit union flowed forward to the acquirer's financial statement, thus
qualifying it as retained earnings of the acquirer.
The ``pooling method,'' in conjunction with the statutory
definition of net worth, provided an incentive to merge because it
allowed the acquiring credit union to combine the merging credit
union's retained earnings, thus enhancing the acquirer's post-merger
net worth. From a regulatory standpoint, the acquisition of an
operationally troubled credit union by one that will be well
capitalized as a result is a preferable alternative to conserving or
liquidating the troubled credit union.
In 2001, the Financial Accounting Standards Board (``FASB'')--
successor to the APB--replaced Opinion 16 as the source of GAAP for
business combinations other than those between mutual enterprises with
its Financial Accounting Statement No. 141, Business Combinations
(2002) (``FAS 141''). FAS 141 replaced the ``pooling method'' of
financial reporting of business combinations with the ``purchase
method'' effective in June 30, 2001.
c. Deferment of ``Acquisition Method'' for Mutual Combinations. For
mergers between mutual enterprises (``mutual combinations'') such as
credit unions, FASB deferred the 2001 effective date of FAS 141 pending
the outcome of its project on Combinations Between Mutual Enterprises,
which explored a ``differences-based approach'' to mutual combinations.
FAS 141 at ] 60. While the FAS 141 deferment for mutual combinations is
pending, Opinion 16 continues to apply, and credit unions continue to
use the ``pooling method'' of financial reporting of credit union
mergers. But that deferment will expire at the end of 2008.
In December 2007, FASB decided that its revised method of financial
reporting for business combinations should apply equally to mutual
combinations and to combinations between other for-profit enterprises.
Financial Accounting Statement No. 141(R), Business Combinations (2007)
(``FAS 141(R)'') at ] 74. FAS 141(R) will apply to mutual combinations
that take place in fiscal years beginning after December 15, 2008. In
conjunction with the limited statutory definition of net worth, the net
effect of FAS 141(R) is to mandate the ``purchase method'' of financial
reporting--which it renamed the ``acquisition method''--for credit
union mergers, resulting in the exclusion of a merging credit union's
retained earnings from the post-merger net worth of an acquiring credit
union.
d. Acquisition Versus Pooling Method of Financial Reporting. The
``acquisition method'' of financial reporting for credit unions would
require the fair value of the net assets acquired in a merger to be
classified as a direct addition to the acquirer's equity, not as an
addition to its retained earnings. FAS 141(R) at ] A67. Because credit
unions cannot count additions of equity in their net worth--which is
limited by definition to GAAP retained earnings--an acquirer's net
worth will not increase as the result of a merger. Moreover, the
``acquisition method'' may well reduce an acquirer's post-merger net
worth because, as a ratio of total assets, it will be diluted by the
addition and fair valuation of assets (i.e., the denominator of the
ratio) acquired in the merger.
Whereas the ``pooling method'' of financial reporting, when applied
in conjunction with the statutory definition of net worth, provided an
incentive to merge, the ``acquisition method'' would have exactly the
opposite effect. The acquiring credit union's net worth ratio not only
would not increase as a result of a merger, it probably would decline.
The risk of being demoted to a lower PCA net worth category, and in
turn being exposed to the mandatory and discretionary supervisory
actions of PCA, would naturally discourage interest in mergers, thus
limiting their availability to rescue troubled credit unions.
e. Statutory Expansion of Net Worth Definition. Concerned that FAS
141(R), in conjunction with the statutory limitation on net worth,
would stifle credit union mergers, Congress enacted the Financial
Services Regulatory Relief Act, Public Law 109-351, 120 Stat. 1966
(``2006 Relief Act'') in 2006. Section 504 of the 2006 Relief Act
expanded the
[[Page 44199]]
original PCA definition of a natural person credit union's ``net
worth'' to include ``any amounts that were previously retained earnings
of any other credit union with which [it] has combined.'' 12 U.S.C.
1790d(o)(2)(A) (2006). The express purpose of section 504 is to allow
the acquiring credit union ``to follow the new FASB rule while still
allowing the capital of both credit unions to flow forward as
regulatory capital and thus preserve the incentive for desirable credit
union mergers.'' Staff of Senate Comm. on Banking, Housing and Urban
Affairs, 109th Cong., Section-By-Section Analysis of Financial Services
Regulatory Relief Act of 2006 (Comm. Print 2006) at 3.\4\ To conform to
the effective date of FAS 141(R), the modifications to part 702
implementing section 504 must take effect in final form on December 31,
2008, so that they will apply to natural person credit union mergers
taking place after that date.
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\4\ Available at: http://banking.senate.gov/public/_files/RegRel_summary.pdf.
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The following table compares the financial reporting and regulatory
capital consequences of a credit union merger under present GAAP (pre-
FAS 141(R)) and under new GAAP (post-FAS 141(R)) both with and without
the proposed modifications to part 702:
[GRAPHIC] [TIFF OMITTED] TP30JY08.037
2. Corporate Credit Unions
Corporate credit unions are exempt from PCA, 12 U.S.C. 1790d(m),
but they are subject to a minimum ``capital ratio'' and to a
requirement to calculate their ``retained earnings ratio'' on a monthly
basis, both as provided by regulation.
a. Minimum Capital Ratio. A corporate credit union's ``capital
ratio'' is defined as its capital (numerator) divided by its ``moving
daily average net assets'' (denominator). 12 CFR 704.2. Its ``capital''
consists of the sum of its retained earnings, paid-in capital, and
membership capital. Id. Of these, retained earnings and paid-in capital
constitute ``core capital.'' Id. A corporate credit union is required
to maintain a minimum capital ratio of four percent (4%) calculated at
least monthly. 12 CFR 704.3(d). When its capital ratio falls and
remains below that minimum, the corporate credit union is subject to
remedies that resemble some of the mandatory and discretionary
supervisory actions of PCA (e.g., ``capital restoration plan,''
earnings retention requirement, and ``capital directives''). 12 CFR
704.2(g), (h) and (i).
b. Retained Earnings Ratio. A corporate credit union's ``retained
earnings ratio'' is defined as its retained earnings divided by its
moving daily average net assets. 12 CFR 704.2. A corporate credit union
is required to
[[Page 44200]]
calculate its ``retained earnings ratio'' on a monthly basis. 12 CFR
704.3(i). If the retained earnings ratio is less than 2 percent, the
credit union becomes subject to an earnings retention requirement. Id.
3. Issues for Comment
NCUA welcomes public comment on this proposed rule. To facilitate
consideration of the public's views, we ask commenters to organize and
identify their comments by credit union type (natural person or
corporate) or regulation (part 702 or part 704) and by corresponding
topic or definition. General comments, if any, should be included in a
separately identified section. Please recognize that NCUA does not
establish GAAP, does not oversee FASB, does not have the power to
reinstate the ``pooling method,'' and does not have the authority to
override or expand limitations and definitions prescribed by law.
Therefore, this rulemaking will not address comments advocating any of
these actions.
B. Discussion of Proposed Modifications
1. Part 702--Natural Person Credit Union's Post-Merger Net Worth
The 2006 Relief Act's redefinition of ``net worth'' for natural
person credit unions is implemented through Part 702's PCA definitions.
The present definition of ``net worth,'' 12 CFR 702.2(f), is
reorganized into subsections and includes the following new subsection:
(3) For a credit union that acquires another credit union in a
mutual combination, net worth also includes the retained earnings of
the acquired credit union, or of an integrated set of activities and
assets, at the point of acquisition. A mutual combination is a
transaction in which a credit union acquires either another credit
union, or an integrated set of activities and assets that is capable
of being conducted and managed as a credit union for the purpose of
providing a return in the form of economic benefits directly to
owner members.
In the first sentence, proposed subsection (3) adds to an acquiring
credit union's net worth an amount equal to the merging credit union's
retained earnings balance at the point it was acquired, yielding a
regulatory capital measure that approximates the net worth previously
obtainable under the ``pooling method.'' \5\
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\5\ The result approximates, but does not duplicate, that of the
``pooling method'' because CUMAA does not authorize a corresponding
exclusion of intangibles from the ``total assets'' denominator of
the net worth ratio.
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Proposed subsection (3) is not limited in scope to the acquisition
by merger of a credit union as an intact legal entity. FAS 141(R) at
]3d. The definition of ``mutual combination'' in the second sentence
incorporates the GAAP definition of a ``business'' and a ``business
combination.'' FAS 141(R) at ]]3d-e. This allows subsection (3) to
apply to transactions (e.g., certain purchase and assumptions) that
convey substantially all of the components of a credit union, even
though the components together no longer legally constitute a credit
union.
The net effect of the modifications to part 702 is to apply FAS
141(R) to natural person credit union mergers for financial reporting
purposes, while for PCA purposes replicating the post-merger net worth
that would have resulted under the ``pooling method.'' These
modifications affect only the measurement of a credit union's post-
merger regulatory capital under PCA; financial reporting in its Call
Report still must adhere to GAAP (i.e., acquirer's retained earnings
balance must be reported consistent with GAAP). 12 U.S.C.
1782(a)(6)(C)(i).
2. Part 704--Corporate Credit Union's Post-Merger Capital
The proposed rule modifies part 704 [Corporate Credit Unions] to
expand the definitions associated with corporate credit union capital
to correspond with the statutory expansion of net worth for natural
person credit unions. As such, the definition of the ``capital'' and
``core capital'' of a corporate credit union that acquires another
credit union by merger is modified to include ``the retained earnings
of the acquired credit union, or of an integrated set of activities and
assets, at the point of acquisition.'' The same modification is made to
the definition of a corporate credit union's ``retained earnings
ratio.'' Further, to encompass not only the acquisition of a credit
union as an intact legal entity, but also as a group of credit union
components that together are no longer legally constituted as such, the
proposed rule adds a separate definition of ``mutual combination''
that, like proposed section 702.2(f)(3), incorporates the GAAP
definition of ``business'' and ``business combination.''
The NCUA Board has greater flexibility to define corporate credit
union capital than the 2006 Relief Act allows for the net worth of
natural person credit unions. 12 U.S.C. 1766(a). Therefore, to more
closely approximate the regulatory capital result of the ``pooling
method,'' identifiable and unidentifiable intangibles are excluded from
the definition of a corporate credit union's ``moving daily average net
assets'' (``MDANA'')--the denominator of the capital ratio.
Identifiable intangibles could include existing member relationships
(i.e., core deposit intangibles) and unserved portions of a field of
membership; unidentifiable intangibles include predominantly goodwill.
The purpose of excluding intangibles from the MDANA denominator of the
capital ratio is to approximate the denominator of the capital ratio
under the ``pooling method.'' That denominator did not reflect the
merging credit union's intangibles, nor the increased valuation of its
tangible assets. This approach resembles the approach followed by other
Federal banking regulators.
Even though the statutory definition of net worth does not permit
natural person credit unions to exclude intangibles, allowing corporate
credit unions to do so approximates for regulatory capital purposes the
result that would have been achieved under the ``pooling method.'' The
Board welcomes public comment on whether this approach adequately
addresses the risk of devaluation and possible loss to the National
Credit Union Share Insurance Fund.
The net effect of the modifications to part 704 is to apply FAS
141(R) to financial reporting of corporate credit union mergers while
replicating the post-merger capital, capital ratio and retained
earnings that would have resulted under the ``pooling method.'' These
modifications to part 704 must take effect in final form on December
31, 2008, to parallel the effective date of the modifications to part
702 that implement the expanded definition of ``net worth.''
Regulatory Procedures
Regulatory Flexibility Act
The Regulatory Flexibility Act requires NCUA to prepare an analysis
describing any significant economic impact a proposed regulation may
have on a substantial number of small credit unions (primarily those
under $10 million in assets). The proposed rule implements an Act of
Congress expanding the definition of a natural person credit union's
net worth. 12 U.S.C. 1790d(o)(2)(A) (2006). The rule affects the
calculation of the post-merger net worth of an acquiring credit union,
the vast majority of which exceed $10 million in assets. Accordingly,
the proposed rule, if adopted, will not have a significant economic
impact on a substantial number of small credit unions. The NCUA Board
invites comment on this issue.
[[Page 44201]]
Paperwork Reduction Act
NCUA has determined that the proposed rule would not increase
paperwork requirements under the Paperwork Reduction Act of 1995 and
regulations of the Office of Management and Budget. Control number
3133-0154 has been issued for part 702 and control number 3133-0129 has
been issued for part 704. Both will be displayed in the table at 12 CFR
part 795.
Executive Order 13132
Executive Order 13132 encourages independent regulatory agencies to
consider the impact of their regulatory actions on State and local
interests. NCUA, an independent regulatory agency as defined in 44
U.S.C. 3502(5), voluntarily adheres to the fundamental federalism
principles addressed by the executive order. This proposed rule would
apply to all federally-insured credit unions, including State-chartered
credit unions, and thus may raise some federalism implications.
However, the proposal is unlikely to have a direct effect on the
States, on the relationship between the national government and the
States, or on the distribution of power and responsibilities among the
various levels of government because it facilitates, rather than
diminishes, the ability of state-chartered credit unions to combine
with other credit unions.
Treasury and General Government Appropriations Act, 1999
NCUA has determined that the proposed rule will not affect family
well-being within the meaning of section 654 of the Treasury and
General Appropriations Act, 1999, Public Law 105-277, 112 Stat. 2681
(1998).
List of Subjects in 12 CFR Parts 702 and 704
Credit unions, Reporting and recordkeeping requirements, Surety
bonds.
By the National Credit Union Administration Board on July 24,
2008.
Mary Rupp,
Secretary of the Board.
For the reasons set forth above, NCUA proposes to amend 12 CFR
parts 702 and 704 as follows:
PART 702--PROMPT CORRECTIVE ACTION
1. The authority citation for part 702 continues to read as
follows:
Authority: 12 U.S.C. 1766(a), 1790d.
2. Amend Sec. 702.2 by revising paragraph (f) to read as follows:
Sec. 702.2 Definitions.
* * * * *
(f) Net Worth means--
(1) The retained earnings balance of the credit union at quarter-
end as determined under generally accepted accounting principles,
subject to paragraph (f)(3) of this section. Retained earnings consists
of undivided earnings, regular reserves, and any other appropriations
designated by management or regulatory authorities;
(2) For a low income-designated credit union, net worth also
includes secondary capital accounts that are uninsured and subordinate
to all other claims, including claims of creditors, shareholders and
the NCUSIF; and
(3) For a credit union that acquires another credit union in a
mutual combination, net worth includes the retained earnings of the
acquired credit union, or of an integrated set of activities and
assets, at the point of acquisition. A mutual combination is a
transaction in which a credit union acquires another credit union, or
acquires an integrated set of activities and assets that is capable of
being conducted and managed as a credit union for the purpose of
providing a return in the form of economic benefits directly to owner
members.
* * * * *
PART 704--CORPORATE CREDIT UNIONS
1. The authority citation for part 704 continues to read as
follows:
Authority: 12 U.S.C. 1766(a), 1781, 1789.
2. Amend Sec. 704.2 by:
a. Revising the current definitions of Capital, Core capital,
Moving daily average net assets and Retained earnings ratio to read as
set forth below; and
b. Adding the definition of Mutual combination following the
revised definition of Moving daily average net assets, to read as
follows:
Sec. 704.2 Definitions.
* * * * *
Capital means the sum of a corporate credit union's retained
earnings, paid-in capital, and membership capital. For a corporate
credit union that acquires another credit union in a mutual
combination, capital includes the retained earnings of the acquired
credit union, or of an integrated set of activities and assets, at the
point of acquisition.
* * * * *
Core capital means the sum of a corporate credit union's retained
earnings, and paid-in capital. For a corporate credit union that
acquires another credit union in a mutual combination, core capital
includes the retained earnings of the acquired credit union, or of an
integrated set of activities and assets, at the point of acquisition.
* * * * *
Moving daily average net assets means the average of daily average
net assets exclusive of identifiable and unidentifiable intangibles for
the month being measured and the previous eleven (11) months.
Mutual combination means a transaction or event in which a
corporate credit union acquires another credit union, or acquires an
integrated set of activities and assets that is capable of being
conducted and managed as a credit union for the purpose of providing a
return in the form of economic benefits directly to owner members.
* * * * *
Retained earnings ratio means the corporate credit union's retained
earnings divided by its moving daily average net assets. For a
corporate credit union that acquires another credit union in a mutual
combination, the numerator of the retained earnings ratio also includes
the retained earnings of the acquired credit union, or of an integrated
set of activities and assets, at the point of acquisition.
* * * * *
[FR Doc. E8-17415 Filed 7-29-08; 8:45 am]
BILLING CODE 7535-01-P