Federal Register, Volume 75 Issue 202 (Wednesday, October 20, 2010)

[Federal Register Volume 75, Number 202 (Wednesday, October 20, 2010)]
[Rules and Regulations]
[Pages 64786-64862]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-24616]

[[Page 64785]]

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Part II

National Credit Union Administration

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12 CFR Parts 702, 703, 704, et al.

Corporate Credit Unions; Final Rule

Federal Register / Vol. 75 , No. 202 / Wednesday, October 20, 2010 /
Rules and Regulations

[[Page 64786]]

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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 702, 703, 704, 709, and 747

RIN 3133-AD58

Corporate Credit Unions

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule.

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SUMMARY: NCUA is issuing final amendments to its rule governing
corporate credit unions. The major revisions involve corporate credit
union capital, investments, asset-liability management, governance, and
credit union service organization (CUSO) activities. The amendments
establish a new capital scheme, including risk-based capital
requirements; impose new prompt corrective action requirements; place
various new limits on corporate investments; impose new asset-liability
management controls; amend some corporate governance provisions; and
limit a corporate CUSO to categories of services preapproved by NCUA.
In addition, this rulemaking contains conforming amendments to rules
governing Prompt Corrective Action (for natural person credit unions);
Investments and Deposit Activities (for federal credit unions);
Administrative Actions, Adjudicative Hearings, Rules of Practice and
Procedure, and Investigations; and Involuntary Liquidation of Federal
Credit Unions and Adjudication of Creditor Claims Involving Federally
Insured Credit Unions. These amendments will strengthen individual
corporates and the corporate credit union system as a whole.

DATES: This rule is effective January 18, 2011, except that the
amendments to 12 CFR 702.105(a), 703.14(b), 704.2, 704.3, 704.4, and
subpart M of 12 CFR part 747, are effective October 20, 2011.

FOR FURTHER INFORMATION CONTACT: David Shetler, Deputy Director, Office
of Corporate Credit Unions, at telephone (703) 518-6640, National
Credit Union Administration, 1775 Duke Street, Alexandria, Virginia
22314; Ross Kendall, Staff Attorney, Office of General Counsel, at the
address above or telephone (703) 518-6540; or Paul Peterson, Associate
General Counsel, at the address above or telephone (703) 518-6540.

SUPPLEMENTARY INFORMATION:

I. Background

In January 2009, NCUA solicited public comment on whether
comprehensive changes to the structure of the corporate credit union
(corporate) system were warranted. 74 FR 6004 (Feb. 4, 2009). This
corporate Advanced Notice of Proposed Rulemaking (ANPR) sought comment
on how best to define and structure the role of corporates in the
credit union system, whether to modify the level of required capital
for corporates, whether to modify or limit the range of permissible
investments for corporates, whether to impose new standards and limits
on asset-liability management (ALM) and credit risk, and whether to
make modifications in the area of corporate governance. NCUA received
some 445 comments in response to the ANPR. NCUA reviewed these public
comments closely and considered them carefully.
On November 19, 2009, the NCUA Board issued a Notice of Proposed
Rulemaking (NPR) containing extensive, specific proposed revisions to
NCUA's rule governing corporate credit unions (corporates) and related
rule provisions. 74 FR 65210 (Dec. 9, 2009). The proposed revisions
covered corporate capital, prompt corrective action (PCA), investments,
ALM, CUSOs, and governance. Briefly summarized, the major provisions in
the proposal would have:
Imposed new minimum capital ratios, new risk based capital
calculations, and new elements of capital, all in general accordance
with the Basel I capital requirements imposed by the banking regulators
on banks.
Required that retained earnings (RE) constitute a certain
portion of corporate capital, and that corporates build retained
earnings over time.
Eliminated the current prohibition on conditioning
membership, the receipt of services, or the pricing of services upon
the purchase of paid-in capital.
Added new PCA provisions similar to those currently
applicable to banks.
Prohibited investments in collateralized debt obligations
(CDOs) and net interest margin (NIM) securities.
Toughened the capital requirements for expanded investment
authority, and restricted the credit ratings for investments purchased
by such corporates to a minimum of ``A-.''
Required that a corporate examine every available
Nationally Recognized Statistical Rating Organization (NRSRO) rating
for a particular security and only employ the lowest of those ratings,
and that at least 90 percent of a corporate's investments be rated by
at least two NRSROs.
Tightened the existing single obligor concentration limit
and imposed new sector concentration limits.
Placed limits on subordinated positions in structured
securities.
Imposed new limits on the maximum difference between the
estimated average life of the asset cash flows and the average life of
the liability cash.
Restricted the weighted average life (WAL) of a
corporate's cash-flowing assets to two years.
Limited a corporate's aggregate borrowing to the lesser of
10 times capital or 50 percent of shares and capital; and further
restrict secured borrowing to maximum maturities of 30 days and only
for liquidity purposes.
Prohibited a corporate from accepting investments or loans
from any one entity that exceed ten percent of the corporate's assets.
Required that a corporate CUSO only engage in categories
of services preapproved by NCUA, including, initially, brokerage and
investment advisory services.
Required that a corporate CUSO agree with the corporate by
contract to permit NCUA access to the CUSO's books, records, personnel,
equipment, and facilities.
Required that all corporate board members hold either a
CEO, CFO, or COO position at a member credit union or other member
entity.
Generally limited corporate board members to no more than
six years of service.
Required that a majority of a corporate's board members be
representatives of natural person credit unions (NPCUs).
Required that each corporate annually disclose to its
members the compensation of each senior executive officer and director.
Required a merging federally-chartered corporate
affirmatively disclose to both NCUA and its members any material,
merger-related increase in compensation for any senior executive or
director.
Prohibited parties affiliated with a corporate from
receiving 1) indemnification in connection with administrative or civil
proceedings instituted by NCUA or a state regulatory authority where
the party is ultimately found liable and 2) golden parachute payments.
The preamble to the NPR included an extensive discussion of the
crisis in the corporates giving rise to the need for regulatory reform,
followed by a discussion of the nature of, and justification for, each
proposed revision. Id. at 65211-65255.

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The public comment period for the NPR closed on March 9, 2010. NCUA
received 815 public, written comments letters totaling more than 2,600
pages of comments. In addition, NCUA held several town halls and
webinars during the comment period during which NCUA both answered
questions about the proposed rulemaking and listened to oral comments
about the proposal.
Most commenters liked some portions of the proposed rule and
disliked other portions. The most common comment on the overall
rulemaking was support for the proposed stronger capital requirements;
increased limits on single obligors; concentration limits on certain
investment sectors; and prohibitions on certain high risk securities--
but also serious reservations about other portions of the proposal,
including certain ALM, investment, CUSO, and corporate governance
provisions.
Of those commenters who expressed a general opinion on the overall
rulemaking, many, including some trade groups and various larger NPCUs
(i.e., over $1.2 billion in assets), generally support the rule. Many
more commenters, however, generally oppose the proposed rule, among
them many small and medium-sized NPCUs ranging up to over $1 billion in
assets. Many of the commenters in opposition believed that the various
investment and ALM restrictions in the proposed rule would cause major
changes in corporate operations; that these changes would threaten the
ability of corporates to provide liquidity and other valuable services
to NPCUs; and that these changes might force NPCUs to turn to banks
(their competitors) for services--considered by the commenters as a
more expensive and less reliable alternative to today's corporate
system. The comments that pertain to specific, proposed revisions are
discussed in more detail in the section-by-section analysis below.
The NCUA Board has now determined to issue final revisions based on
the proposal and the comments received. Generally, these revisions will
become effective 90 days following the publication in the Federal
Register, but the effective date for many of the revisions will be
delayed beyond 90 days.
The remainder of this preamble contains four sections: A summary of
the significant revisions in the final rule, a section-by-section
analysis of all the revisions, an analysis of how the final investment,
credit risk, and asset liability provisions might affect a corporate's
ability to achieve its capital requirements, and a discussion of the
regulatory procedures affecting this rulemaking.

II. Summary of Significant, Final Revisions

A. Overview

Ultimately, the primary purposes of this extensive rulemaking were
twofold. First, NCUA wanted to design a corporate rule that would
prevent the catastrophic losses that occurred in the corporate system
beginning in 2007 from ever recurring. Second, NCUA wanted to allow for
the survival of some form of a well-run corporate system that could
provide necessary services, including payments systems services, to its
members, and build and attract sufficient capital.
The Board believes this final rule accomplishes these two purposes.
First, and as discussed in more detail below, the 2007 losses
resulted almost entirely from private label residential mortgage backed
securities (RMBS), with many of the worst performing of these
securities being subordinated RMBS. The final rule prohibits corporates
from purchasing either private label RMBS, or subordinated-type
securities, going forward. In the most specific sense, then, the rule
will make it impossible for corporates to repeat what happened in 2007.
Of course, the next financial crisis may not be a credit or mortgage
crisis, so the final rule includes a series of other investment, credit
risk, ALM, liquidity, and capital measures that together should greatly
reduce the systemic risk posed by the corporates regardless of the
source of the next crisis.
Second, the Board believes that a well-run corporate should be able
to operate within the confines of the new rule and construct a business
model, and an investment portfolio, that permits it to attract capital
and grow retained earnings going forward. Again, this is discussed and
demonstrated in some detail in Section IV. of the preamble below.
Affected Sections of NCUA's Rules and Regulations
The final revisions affect part 704, Corporate Credit Unions, and
several other sections of NCUA's regulations. The following chart lists
the affected sections. It also summarizes the applicability dates for
each section and, in some cases, the applicability dates for particular
paragraphs or individual definitions.

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Delayed applicability
date? (e.g., ``+12
months'' means
delayed 12 months
Current rule provision Amended? following date of
publication of final
rule in Federal
Register)
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704.1 Scope................... No............... Not applicable (N/A).
704.2 Definitions............. Yes. Removed and First replacement of
replaced twice. 704.2. +90 days.
Second Second replacement of
replacement 704.2. +12 months.
introduces Adjusted core
capital and PCA capital.
definitions.
--deduct PCC or
NCA at another
corporate. +12
months
--deduct certain
excess PCC. +72
months to +120
months
--deduct PCC in
excess of
retained
earnings. +120
months
Permanent leverage
ratio. +36 months
704.3 Corporate credit union Yes.............. Current 704.3
capital. replaced. +12
months.
704.3(a)(3): If RE
ratio less than
0.45, must submit
REAP. +36 months.
704.3(f)(4):
Corporate with
unconverted MCAs
must notify MCA
holders of account
status. +14 months.
704.4 Board responsibilities.. Yes. The current Current 704.4
Board replaced with PCA
responsibilities section. +12 months.
is redesignated
as 704.13. New
704.4 Prompt
corrective
action (PCA)
added.
704.5 Investments............. Yes.............. +90 days.
704.6 Credit risk management.. Yes.............. +90 days.
704.7 Lending................. No............... N/A.

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704.8 Asset and liability Yes.............. Generally, +90 days.
management. 704.8(k): Prohibition
on a corporate
receiving more than
15 percent of
business from one
member or credit
union. +30 months.
704.9 Liquidity management.... Yes.............. +90 days.
704.10 Investment action plan. No............... N/A.
704.11 Corporate CUSOs........ Yes.............. Generally, +90 days.
704.11(e)(1):
Requirement for NCUA
approval of
corporate CUSO
activities. +180
days.
704.11(e)(2):
Requirement that
corporate divest
from CUSO engaged in
unapproved
activities. +12
months.
704.12 Permissible services... No............... N/A.
704.13 [Reserved]............. Yes.............. The current 704.4
Board
responsibilities
redesignated as
704.13. +90 days.
704.14 Representation......... Yes.............. Generally, +90 days.
704.14(a)(2):
Requirement that
only CEO, CFO, or
COO may seek
election to
corporate board.
+120 days.
704.14(a)(9):
Requirement that at
least a majority of
each corporate's
directors be
representatives of
NPCUs. +36 months.
704.15 Audit requirements..... No............... N/A.
704.16 Contract/written No............... N/A.
agreements.
704.17 State-chartered No............... N/A.
corporate credit unions.
704.18 Fidelity bond coverage. No............... N/A.
704.19 Wholesale corporate Yes.............. Current 704.19
credit unions. removed, and new
704.19, Disclosure
of executive and
director
compensation, added.
+90 days.
704.20 None................... Yes.............. New 704.20, Golden
parachute and
indemnification
payments, added. +90
days.
Appendix A Model forms........ Yes.............. Amended and renamed
Capital
Prioritization and
Model Forms. +90
days.
Appdx A, Part I:
Corporates may
determine that newly
contributed capital
has priority over
existing capital.
+90 days.
Appendix B Expanded Yes.............. Generally, +90 days.
Authorities and Requirements. Part I(e): Substitute
``leverage ratio''
for ``capital
ratio.'' +12 months.
Appendix C None............... Yes.............. New Appendix C, Risk-
Based Capital Cred-
it Risk-Weight
Categories, added.
+12 months.
702.105....................... Yes.............. Conforming amendment
(to substitute new
capital terms). +12
months.
703.14(b)..................... Yes.............. Conforming amendment
(to substitute new
capital terms). +12
months.
709.5(b)...................... Yes.............. Conforming amendment
(to substitute new
capital terms). +90
days.
Part 747, subpart M........... Yes.............. Add new subpart M on
due process for PCA
actions. +12 months.
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Third Party Evaluation of Proposed Rulemaking
NCUA commissioned an outside consultant, Kamakura, Inc., to provide
NCUA with an assessment of the proposed corporate rule. Kamakura issued
its final report, entitled Impact Analysis--Proposed Modification of 12
Code of Federal Regulations Part 704--National Credit Union
Administration (the ``Kamakura Report''), on July 12, 2010. Interested
parties can download a copy of the Kamakura Report from NCUA's Web site
at http://www.ncua.gov. As discussed throughout the following preamble,
NCUA carefully considered the Kamakura Report when finalizing the
investment and ALM provisions of this rulemaking.
Legacy Assets
The ability of some corporates to comply with the provisions of
this final rule depends on managing certain ``legacy assets'' on their
balance sheet. These legacy assets are securities, generally private
label RMBS, that continue to carry significant credit risk and market
values far below their intrinsic values.
NCUA has been working for some time on a plan to isolate such
legacy assets in those corporates where the exposure represents the
greatest risk to the insurance fund. In general, these cases represent
corporate credit unions where expected future credit losses exceed the
corporate's total capital, and recapitalization would not occur without
agency assistance. NCUA has, as promised, released its plans for
dealing with those corporates' legacy assets. Information about the
plans can be obtained from NCUA's Web site at http://www.ncua.gov.
Some corporates have lesser positions in RMBS assets where NCUA
does not expect the associated credit losses to exceed the corporate's
total capital. They may also have other assets with long WALs,
positions that are concentrated beyond the prescribed diversification
limits, or other portfolios that otherwise inhibit compliance with new
rule. NCUA expects these institutions to develop business plans and
take action to become compliant with the rule. Generally, NCUA will
want these corporates to sell these legacy assets as soon as possible
so as to come into compliance with the corporate rule. If the corporate
decides an alternative approach to selling the legacy assets is sound
and supportable, the corporate will have to submit a draft investment
action plan to NCUA for its approval under Sec. 704.10 and other
provisions of the corporate rule, such as Sec. 704.8(j)(2)(i). For
example, NCUA will consider approval of an action plan that includes
retention of these legacy assets while they amortize if the corporate
can

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document that the expected future credit losses on these assets are
significantly less than the losses the corporate would take if the
investments were sold at current market prices. Depending on the
circumstances of the corporate, an NCUA-approved action plan might
permit the corporate to operate temporarily outside the WAL limitations
and other applicable investment, credit risk, or ALM limitations in the
corporate rule. In addition, NCUA might grant these corporates a waiver
of time to build the retained earnings required by this regulation--but
only to the extent of documented losses flowing from legacy assets
identified in an approved action plan. 12 CFR 704.1(b).
Effect of the Dodd-Frank Act on the Use of Credit Ratings
Just recently, on July 21, 2010, Congress enacted the Dodd-Frank
Wall Street Reform and Consumer Protection Act (DFA). The DFA, which
contains 848 pages divided into 16 separate Titles, has multiple
impacts on NCUA, its regulations, and its enforcement authority. The
Board is carefully considering the implications of the DFA and the
actions NCUA is required to take under the DFA.
Section 939A of the DFA is likely to affect NCUA's regulations,
including the corporate credit union regulation. Both NCUA's current
and revised corporate rules include references to NRSRO credit ratings.
As stated in section 939A, NCUA has one year to review all its
regulations and modify them to remove such references and ``substitute
in such regulations such standard of credit-worthiness as [the Board]
shall determine to be appropriate.'' Until the Board completes that
review and modification, however, corporates will be expected to comply
with all the provisions of the corporate rule that make reference to
NRSRO ratings.
Section 704.2 contains a definition of small business related
securities, and that definition refers to the definition of the same
term in Section 3(a)(53) of the Securities Exchange Act of 1934 (SEA).
The Dodd Frank Act, however, changed the SEA definition, and the Board
determined that it wanted to continue to use the older definition.
Accordingly, this final rule revises the Sec. 704.2 definition of
small business related securities to remove the reference to the SEA
definition.
Section 939(e)(2) the DFA, however, eliminates the reference to
NRSRO ratings in Section 3(a)(53), and substitutes a reference to
``meets standards of credit-worthiness established by the [Securities
and Exchange] Commission (SEC).'' Again, until such time as either the
SEC or NCUA can provide some content to the latter phrase, NCUA
believes that the definition of small business related security in
Sec. 704.2 should remain unchanged.

B. Capital

Summary of Current Capital Provisions
Currently, corporates have only one mandatory minimum capital
requirement: they must maintain total capital (i.e., retained earnings
(RE), paid-in capital, and membership capital accounts) in an amount
equal to or greater than 4 percent of their moving daily average net
assets.\1\ Failure by a corporate to meet this minimum capital ratio
triggers the requirement to file a capital restoration plan with NCUA
and may cause NCUA to issue a capital restoration directive and take
other administrative action.
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\1\ Corporates have other capital-related requirements, such as
a core capital ratio and a retained earnings ratio, but failure to
meet these requirements only triggers future earnings retention
requirements and does not trigger a capital restoration plan
requirement or other particular supervisory actions.
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The current rule allows a corporate to issue Paid in Capital (PIC)
to both members and nonmembers, while Membership Capital Accounts
(MCAs) may only be issued to members. The current rule also prohibits a
corporate from conditioning membership, the receipt of services, or the
pricing of services upon the purchase of PIC.
Summary of Proposed Capital Revisions (November 2009)
The proposal contains a capital scheme based on the Basel I capital
regimes of the other banking regulators. The proposal renames PIC as
Perpetual Contributed Capital (PCC), and makes certain changes to the
MCA requirements and labels those MCAs as Nonperpetual Capital Accounts
(NCAs). The proposal then seeks to replace the one existing total
capital ratio with three minimum capital ratios, including two Risk
Based Capital (RBC) ratios. These RBC ratio calculations involve credit
risk-weighting the corporate's assets and off balance sheets activities
to produce a moving daily average net risk-weighted assets (MDANRA).
The three new proposed ratios are described in the following chart:

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Minimum level Minimum level
Ratio Numerator \2\ Denominator (adequate cap.) (well cap.)
(percent) (percent)
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Leverage Ratio................... RE + PCC............ MDANA.............. 4 5
Tier-One RBC Ratio............... RE + PCC............ MDANRA............. 4 6
Total RBC Ratio.................. RE + PCC + NCAs..... MDANRA............. 8 10
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The proposal also requires that, in the leverage ratio and Tier 1
RBC ratio, the corporate may only count PCC to the extent that it does
not exceed the corporate's RE. That results in the corporate needing
200 basis points (BP) of RE to reach a 4 percent leverage ratio and so
be adequately capitalized, and 250 BP to be well-capitalized. This RE
requirement, and the various other proposed capital measures, are
phased-in over a ten-year time period, as discussed below.
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\2\ These numerator formulas are simplifications. The proposal
actually contains certain adjustments to each capital calculation,
and those proposed adjustments that received comments are discussed
below.
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Summary of Proposed Phase-In of Capital Provisions
The proposal contains a multi-step, multi-year phase-in of the new
capital requirements:
Year one. None of the new capital requirements would apply
during the first year following publication of the final rule. During
this period the current total capital ratio would remain in effect, as
well as the revised capital order, and associated waivers, issued by
the NCUA Board on April 29, 2010.\3\
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\3\ The Net Economic Value (NEV) limitations that exist in the
current rule have not changed under this final rule. 12 CFR
704.8(d). Thus, these NEV limits continue to be in effect and no
implementation delay for these NEV limits is warranted.
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Years two and three. The two new risk based capital ratios
would come into effect on the first anniversary of the publication of
the final rule. Corporates

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would be required to meet a minimum 4 percent Tier 1 RBC ratio and a
minimum 8 percent Total RBC ratio. In addition, corporates would be
required to satisfy an interim leverage ratio, defined almost
identically to the existing total capital ratio. Because NCUA should
have resolved the legacy assets at this point, and most corporates will
have very low-risk weighted assets, neither of the two RBC ratios will
likely dictate the amount of capital corporates need at this point.
Instead, actual minimum capital requirement will likely be dictated by
the interim leverage ratio, meaning a corporate will need 200 BP in
PCC/RE and another 200 BP in NCAs.
Years four through six. At the third anniversary of the
publication of the final rule, the 4 percent minimum leverage ratio
goes into effect. In addition, any corporate that does not have at
least 45 BP of RE on the third anniversary must file a retained
earnings action plan (REAP) with the NCUA illustrating how it is going
to achieve the upcoming RE requirements at the sixth and tenth
anniversaries of the final rule.
Years seven through ten. At the sixth anniversary of the
publication of the final rule, a corporate must have at least 100 BP of
RE to be considered adequately capitalized.
Year eleven and after. At the tenth anniversary of the
publication of the final rule, a corporate must have at least 200 BP of
RE to be considered adequately capitalized.
Overview of Significant Capital Revisions in This Final Rule
Most of the public comments on the capital provisions, including
comments received from corporate credit unions, were supportive of the
new proposed Basel I capital requirements, including the use of risk-
based capital measures. Some of these commenters specifically supported
the use of Basel I standards over Basel II, stating that Basel I was
adequate and less complex.
The Board agrees with these commenters, and has generally adopted,
with some modifications, the minimum capital ratios, risk based capital
calculations, and new elements of capital, as set forth in the proposed
rule. As in the proposed, the final revisions will require that RE
constitute a certain portion of capital. For example, to be adequately
capitalized, a corporate must have at least 100 BP of RE after six
years, and 200 BP of RE after ten years. Other elements of the new
capital provisions will also be phased in over time, beginning one year
after publication of this final rulemaking. The final revisions
eliminate the current prohibition on conditioning membership, services,
or the pricing of services upon the purchase of paid-in capital.
Details about each final revision are contained in the section-by-
section analysis below.
Some commenters, including NPCUs, questioned whether corporates
need any capital. Other commenters stated that NCUA should not require
any contributed capital, and that corporates should be given sufficient
time to ``earn'' their way to adequate capitalization.
The Board is concerned that NCUA's extraordinary actions to
stabilize and protect the corporate system over the past few years have
been misunderstood by some of these commenters. Because of NCUA's
actions, including the Temporary Corporate Credit Union Share Guarantee
Program (TCCUSGP) and the Temporary Corporate Credit Union Liquidity
Guarantee Program (TCCULGP), many corporates have been able to operate
as going concerns with artificially low levels of capital. Measures
like the TCCUSGP and TCCULGP are, however, temporary measures. In the
future, NCUA will wind down and terminate these measures, and
corporates will have to function on their own. Further, corporates and
their members cannot expect to ever again receive such extraordinary
government support, either explicitly or implicitly, from NCUA or any
other government entity.\4\ In fact, it is NCUA's intention with the
various revisions in this final rule to ensure that the corporates,
going forward, never again present the sort of systemic risk to the
entire credit union system that requires such extraordinary
intervention. And this means that, without building adequate capital
going forward, corporates will not be able to function.
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\4\ Except, of course, for the standard federal share insurance
of up to $250,000, as mandated by the Federal Credit Union Act.
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Inadequate levels of capital introduce unacceptable moral hazards.
When the owners of an entity have significant amounts of their own
capital at stake, they have incentive to ensure that the entity is
prudently operated and does not engage in overly risky activity,
because the risk of loss is born by the capital owners. However, when
the owners have little or no capital at stake, they have the incentive
to overlook, or even encourage, risky behavior by the entities'
management. We observed some of this risky behavior at certain
corporates in the recent past--and this behavior was likely fueled by
contributed capital levels that were too low for the risks undertaken,
as well as the fact that some member owners of these corporates did not
fully understand the nature and extent of their potential capital
losses and so were not actively engaged in the oversight of their
corporates. NCUA will not permit corporates to operate with low capital
levels that encourage risky behavior. Accordingly, NCUA intends with
this rulemaking to ensure corporates have adequate capital levels going
forward to mitigate such moral hazard.\5\
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\5\ The Board also believes that all NPCUs now understand the
nature of any capital commitment to a corporate and the need to be
involved in the direction and management of their corporates.
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In addition to introducing unacceptable moral hazards, low capital
levels have negative, direct effects on an entity's ability to
function. For example, potential creditors would not likely lend to any
corporate that does not have capital sufficient to absorb losses,
because the creditors will have legitimate fears that any operating
losses in the corporate will keep the creditors from getting repaid.
Likewise, potential third-party vendors would not do business with
corporates that do not have capital available to absorb operating
losses, because these vendors would be afraid that any losses would
have negative effects on the corporate's ability to pay the vendors'
invoices.\6\
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\6\ As indicated above, after the TCCUSGP and the TCCULGP have
served their purposes and been terminated NCUA will no longer
provide corporates with extraordinary support. NCUA will disabuse
the public, the members, any potential creditors of a corporate, and
any potential vendors of a corporate, of the idea that NCUA will
again intervene to protect insolvent corporates.
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In sum, going forward corporates must survive on their own and
without continued government assistance--and that means corporates must
have their own adequate capital.
In response to the other comments, NCUA is not requiring that any
of a corporate's capital be contributed capital. NCUA will not,
however, continue its extraordinary support of the corporate system
over the time it would take to build sufficient capital just through RE
growth alone. For example, to achieve a 4 percent capital ratio just
through RE growth could take 20 years or longer. It is inappropriate
for the NCUA, which is a government entity, to provide the necessary
guarantees and other assistance that would enable a corporate to
survive that long with such low levels of capital. And that means that,
to survive as a going concern without continued government assistance,
a corporate must solicit and achieve sufficient capital in the form of
contributed capital. Any corporate that

[[Page 64791]]

is unable to obtain the requisite levels of capital in a timely manner
may have to be liquidated or merged.
Some commenters questioned the need for any minimum RE requirement.
One corporate stated that, from a NCUSIF standpoint, contributed
capital acts in the same capacity as RE. This commenter believes that
the building of RE is typically a decision made by the organization's
Board and so does not believe that the portion of capital that is RE
should be designated within the regulation. Another corporate
commenter, however, recognized the need for a minimum RE requirement.
As discussed at length in the preamble to the proposed rule, NCUA
believes that, eventually, some part of a corporate's capital must
consist of RE. This is the only form of corporate capital that, when
depleted, does not result in losses that flow downstream to NPCUs.
Without some RE, the corporates would be a continued source of
instability to the credit union system as a whole.
A few commenters stated that NCUA needed to look at other sources
besides credit unions to recapitalize the corporate system, without
specifying which sources. The Board is unaware of any other logical
sources of capital. Corporates are member-owned cooperatives
established to serve their member NPCUs, so logically the primary
source of a corporate's contributed capital should be its member-owner
NPCUs. Still, corporates have always been free to sell paid-in capital
to nonmembers, including non-credit union nonmembers, but to date have
been either unwilling or unable to do so. The proposal, and these final
revisions, permit corporates to sell all forms of contributed capital,
including nonperpetual capital, to nonmembers at the corporate's
discretion. To the extent, however, that some commenters might believe
that NCUA or the federal government can donate capital to corporates,
that is neither legally possible nor a good idea as a policy matter. As
stated above, credit unions in general, and corporates in particular,
cannot depend on continued government assistance to survive.
Some commenters thought the proposed capital requirements were
overly complex. The NCUA Board disagrees. Corporates are complex
financial entities and so require some detail and nuance in their
regulation. The Board notes that the Basel I standards, and associated
regulations, are no more complex than those capital standards imposed
on banking entities with similarly complex operations and activities.
A few commenters that generally opposed the new capital standards
stated that the NCUA's basic rationale for the proposed changes is that
the permanence of capital and a risk-based capital standard would have
mitigated the losses at Corporates in the past two years. This is not a
correct statement. NCUA has long been considering amendments to improve
corporate capital standards, even before the credit crisis of 2007. The
new capital standards, as proposed and finalized here, are intended to
help protect the corporates, their members, and the NCUSIF from future
losses, whether or not those future losses are related to credit risk
in the mortgage markets (as in 2007) or are caused by other factors.
A few commenters questioned why NCUA was imposing capital
requirements on corporates that were similar to banking capital
requirements while at the same time imposing ALM and investment
requirements that were different from those imposed on banks. The Board
believes that while many corporates engage in activities and take on
risks similar to banks, and thus should have a capital regime similar
to banks, the risks that corporates pose to NPCUs are systemic risks,
and thus different than the risks posed by one bank to another bank. It
is true that a few very large banks may present systemic risks to the
banking system, but the Basel I standards contained in this rulemaking
are different than the Basel II advanced standards that very large
banks are subject to.
Several NPCU commenters were concerned that the likelihood of
ongoing corporate consolidation, combined with factors in the proposal
such as the lengthening of the MCA three year requirement to five years
and the requisite NCUA approval for any return of PCC, all increased
the possibility that an NPCU might find itself stuck with significant
capital in a corporate to which that NPCU did not want to belong.
Natural person credit unions will have to decide, going forward, what
services they want from corporates. As part of that decision, they will
have to decide if they are willing to contribute capital to one or more
corporates. If they decide to contribute capital, they will have to
take into account the possibility that the corporate may then
consolidate or merge with another corporate. If that should happen, and
the NPCU no longer desires services from the continuing corporate, the
NPCU does have several options. First, it may ask the corporate to
redeem the capital. If such redemption complies with NCUA's
regulations, and NCUA approves the redemption, the corporate may redeem
the capital. Second, the member NPCU can attempt to transfer (sell) the
capital to another member. And, third, the member NPCU can attempt to
transfer the capital to a nonmember.
A few commenters believe the proposed capital phase-in period is
appropriate, and one NPCU labeled it as generous. Many commenters,
however, believe that the proposal provides too short a time period for
the phase-in of the proposed new capital requirements.
The Board believes that the final capital phase-in, which mirrors
the proposed phase-in, is both appropriate and feasible. As discussed
in the preamble to the proposed rule, the phase-in period balances the
need for corporates to (1) quickly achieve sufficient capital, and wean
themselves from government assistance, through solicitations of
contributed capital and growth of RE, while (2) providing for an
adequate opportunity to make that solicitation and achieve that growth.
The proposed rule was issued ten months ago, and corporates have
had some time since then to consider the ramifications of the proposal.
Further, none of the new capital provisions will be effective until the
first anniversary of the publication of this final rulemaking in the
Federal Register. This one year period gives corporates ample
opportunity to analyze the elements of this final rule, perfect their
business plans, convince their members of the validity of their
business plans, and solicit contributed capital.\7\ Corporates that are
well-run should be able to make an effective solicitation so as to
garner sufficient contributed capital by the first anniversary.
---------------------------------------------------------------------------

\7\ Some corporates may not even need additional capital on the
first anniversary.
---------------------------------------------------------------------------

Under the final rule, the first specific RE target (e.g. 45 BP of
accumulated RE) does not go into effect until the third anniversary of
publication, and the first specific RE requirement (100 BP) does not go
into effect until the sixth anniversary of publication. As discussed in
the sections below on the asset liability management provisions of the
final rule, the final investment and ALM provisions permit corporate
credit unions a bit more leeway in the mismatch of their assets and
liability cash flows than in the proposed rule, and the Board believes
this should help corporate credit unions generate additional earnings
on their assets. As also discussed below, NCUA has modeled various
investment portfolios that corporates could purchase under provisions
of the final corporate rule, and the Board has concluded that a well-
run corporate can, in fact, generate

[[Page 64792]]

45 BP of earnings in the first three years and 100 BP of earnings in
the first six years as required by the capital phase-in.
Other, more specific comments on capital are discussed in the
section-by-section analysis below.

C. Prompt Corrective Action (PCA)

Although prompt corrective action (PCA) applies to natural person
credit unions (NPCUs) and to banking entities, PCA does not currently
apply to corporates. The proposed rule contained a PCA regime similar
to what the other banking regulators, and the Federal Deposit Insurance
Act, impose on banks.
The final rule adopts the proposed PCA provisions substantially as
proposed. Each corporate will be assigned to one of five capital
categories: Well-capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized. The
potential consequences of failing to meet capital standards include
restrictions on activities, restrictions on investments and asset
growth, restrictions on the payment of dividends, restrictions on
executive compensation, requirements to elect new directors or dismiss
management, and possible conservatorship. The final rule does include
some due process enhancements beyond those contained in the proposed
rule.

D. Corporate Investments, Credit Risk, and Asset-Liability Management
(ALM)

Summary of Current Investment, Credit Risk, and ALM Provisions
The current Part 704 generally prohibits certain types of
investments, including derivatives, stripped mortgage backed securities
(MBS), mortgage servicing rights, and residual interests in asset
backed securities (ABS). The rule specifies, for permissible investment
types, that investments must be rated no lower than AA- by at least one
NRSRO at time of purchase. Corporates that qualify for Part I expanded
authority, however, have additional investment authority, including the
purchase of investments rated down to A-. Corporates that qualify for
Part II expanded authority may purchase investments rated down to
BBB(flat). Corporates that qualify for Part III expanded authority may
invest in certain foreign obligations; corporates that qualify for Part
IV expanded authority may engage in derivatives transactions for
certain specified purposes; and corporates with Part V expanded
authority may engage in certain loan participations.
The current rule requires that corporates maintain an internal
investment policy that includes ``reasonable and supportable
concentration limits'' including limits by ``investor type and
sector.'' The current rule limits the aggregate of all investments in
any single obligor to the greater of 50 percent of capital or $5
million, but includes no regulatory sector limits. The rule does not
limit investments that are structured to be subordinate, in terms of
potential credit losses, to other securities.
Summary of Significant Proposed Investment, Credit Risk, and ALM
Provisions
NCUA developed the proposed changes to the investment, credit risk,
and ALM provisions based on lessons learned from both the recent
experience with corporate investment portfolios and their associated
losses and comments received from the ANPR.
NCUA determined that three major risk conditions were the primary
contributors to the current losses in the corporate system: (1)
Excessive investment sector concentrations, particularly private label
RMBS; (2) excessive average-life mismatches between assets and
liabilities; and (3) excessive concentrations in subordinated
securities, including mezzanine securities. The proposed revisions to
the investment and asset-liability provisions of the corporate rule
control these risk conditions in the aggregate through the use of
limits, many of which are tied to a corporate credit union's capital.
The proposal provided a framework that allowed for a level of risk-
taking necessary to support the profitability of a corporate but which
would also be continuously and adequately protected by the corporate's
capital.
The proposed rule established new prohibitions for investments in
collateralized debt obligations (CDOs) and net interest margin (NIM)
securities.
The proposal also required that a corporate examine the NRSRO
rating from every NRSRO that publicly rates a particular investment and
only employ the lowest of those ratings and required that at least 90
percent of a corporate's investments be rated by at least two NRSROs.
The proposal eliminated Part II expanded authority, thus making ``A-''
the lowest possible rating for an NRSRO-rated investment purchased by a
corporate with expanded investment authority. To qualify for Parts I
and II (i.e., the current Parts I and III) expanded investment
authority, the proposal required a corporate achieve and maintain
higher capital levels, that is, a minimum six percent capital ratio.
The proposal generally reduced the single obligor limits from 50
percent of capital to 25 percent of capital, with slightly higher
limits for investments in mutual funds and repurchase agreements. The
proposal also imposed specific concentration limits by investment
sector. Sectors included residential mortgage backed securities (RMBS),
commercial mortgage backed securities (CMBS), student loan asset backed
securities (ABS), automobile loan/lease asset backed securities, credit
card asset backed securities, other asset backed securities, corporate
debt obligations, municipal securities, and money market mutual funds,
and an ``all others'' category to account for the development of new
investment types. The proposed sector limits were, generally, (1) the
lower of 500 percent of capital/25 percent of assets, or (2) the lower
of 1000 percent of capital/50 percent of assets (for the less risky
sectors).
The proposal excluded certain assets entirely from both the single
obligor concentration limit in Sec. 704.6(b) and the sector
concentration limits in Sec. 704.6(c). The excluded assets include
fixed assets, loans, investments in CUSOs, investments issued by the
United States or its agencies or its government sponsored enterprises,
and investments fully guaranteed or insured as to principal and
interest by the United States or its agencies. Investments in other
federally-insured credit unions, deposits in other depository
institutions, and investment repurchase agreements would also be
excluded from the sector concentration limits but not the single
obligor concentration limit. Investments in CUSOs, while excluded from
both the Sec. 704.6 concentration limits, would still be subject to
the investment limits in the corporate CUSO rule, Sec. 704.11(b).
The proposal limited subordinated positions in a structured
security to the lesser of 100 percent of capital/5 percent of assets in
any given sector class and the lesser of 400 percent of capital/20
percent of assets in the aggregate.
The proposal generally limited a corporate's Part III (renumbered
from Part IV) derivatives activity to derivatives used for the purposes
of reducing the corporate's overall risk.
Summary of Significant Investment, Credit Risk, and ALM Revisions From
the Proposed to the Final Rule
Based on comments received and further review, the NCUA Board
adopted most of the proposed

[[Page 64793]]

provisions but also made some significant changes. The most significant
changes in the final rule were the removal of the two ALM provisions
designed to limit cash flow mismatches between assets and liabilities.
In place of these tests, the final rule substitutes an alternative
weighted average life extension test on the corporate's investments
along with specific prohibitions on private label RMBS and subordinated
securities.
The effect of these changes is to create the following, final set
of investment, credit risk, and ALM hurdles through which a corporate
must run any contemplated investment purchase:
NRSRO ratings screen. The final rule uses NRSRO ratings as
a screening tool. The final NRSRO screen is tougher than the current
rule provides. For example, to get by the ratings screen the corporate
has to look at all available NRSRO ratings (not just one rating), and
the corporate has to take the lowest of all the ratings (i.e., it can't
cherry pick ratings). This ratings screen is exclusionary, not
inclusionary. Even if a security gets by the ratings screen, there are
still six additional hurdles (listed below) each security must pass
before the corporate can buy the security.
Prohibition of certain highly complex and leveraged
securities. NCUA is adding to the list of outright prohibited
securities in part 704 that are overly complex and/or leveraged. So a
corporate cannot buy the security if it is:
[cir] A Collateralized debt obligation (CDO), or
[cir] A Net Interest Margin security (NIM), or
[cir] A Private label RMBS, or
[cir] A security subordinated to any other securities in the
issuance.
Single obligor limit. The final rule tightens the existing
limit from 50% of capital to 25% of capital. So if the corporate wanted
to buy, say, a highly rated student loan asset backed security (ABS)
issued by ``Mainstreet Bank,'' but the corporate has already reached
the 25% of capital limit in investments issued by the same Mainstreet
Bank trust, the corporate can't buy that additional ABS within the same
trust.
Sector concentration limits. Assuming the corporate still
wants to buy that Mainstreet Bank ABS, and it has not reached its
single obligor limit with Mainstreet Bank, the corporate must then
apply the sector limits for these ABS. If the purchase of the
Mainstreet Bank ABS would put the corporate over the private label
student loan ABS sector limit (generally, the lower of 500% of capital
or 25% of assets), the corporate can't buy the ABS.
Portfolio WAL not to exceed two years. If the corporate
got the Mainstreet Bank ABS past all those hurdles above, there are
still more hurdles to overcome. The corporate cannot buy the ABS if it
would put the weighted average life (WAL) of the corporate's loan and
investment portfolio over two years in length.
Portfolio WAL (assuming prepayment slowdown of 50%) not to
exceed 2.25 years. The corporate must then test the Mainstreet Bank ABS
for extension risk. The corporate cannot buy the ABS if it would put
the weighted average life of the corporate's loan and investment
portfolio, assuming the portfolio prepayment speeds slow by 50%, out
over 2.25 years in length.
Interest rate risk shock test. This IRR test is in the
current rule, and the final rule does not change this test. Assuming
that the Mainstreet Bank ABS is floating rate, and its liabilities
reset rates in similar fashion, it would likely not be affected at all
by this particular test. But if its liabilities did not reprice
similarly to the ABS (e.g., the floating rate ABS was funded by fixed
rate liabilities), its addition to the portfolio could not cause the
corporate's NEV to decline by more than 15 percent when the portfolio
as a whole is shocked by 300 BP.\8\
---------------------------------------------------------------------------

\8\ Assuming the corporate was operating under Base level
investment authority.
---------------------------------------------------------------------------

These final revisions provide for a simpler rule that still
accomplishes NCUA's goal of reducing or eliminating various risks while
allowing for sufficient potential for growth in a corporate's RE.
Investment Action Plans for Prohibited Investments
Most of the new investment prohibitions and other credit and ALM
requirements go into effect 90 days after publication of the final
rule. Some corporates may hold investments that are in violation of one
or more of these new prohibitions, and these investments will be
subject to the investment action plan provisions of Sec. 704.10. For
example, if a corporate holds a subordinated security prohibited by the
revised paragraph 704.5(h)(8), and determines not to sell that
security, it must, within 30 calendar days of the effective date of the
704.5(h)(8) prohibition prepare and submit to the OCCU Director an
investment action plan. 12 CFR 704.10(a). If the plan is not approved
by the OCCU Director, the corporate must comply with the ``Director's
directed course of action.'' 12 CFR 704.10(c).

E. Liquidity

Summary of Current Rule
The current rule generally requires a corporate evaluate its
liquidity needs and plan for appropriate liquidity. It also provides
that a corporate credit union may borrow up to the greater of 10 times
capital or 50 percent of capital and shares (excluding shares created
by the use of member reverse repurchase agreements).
Summary of Significant Revisions
The proposal restricted a corporate's borrowing to the lower of 10
times capital or 50 percent of capital and shares (excluding shares
created by the use of member reverse repurchase agreements). The
proposal also added a sublimit for secured borrowings. The final rule
adopts the proposal without changes.

F. Corporate Governance Provisions

Summary of Current Rule
The current Part 704 places limitations on board representation,
including limits on the number of trade organization representatives.
The current rule does not, however, place any experience or knowledge
requirements on individual corporate directors; limit the
representation of corporate managers and officials on the boards of
other corporates; provide for term limits; require any disclosure of
senior executive compensation to the members of a corporate; or place
any limits on ``golden parachute'' severance packages for corporate
senior executives.
Summary of Significant Governance Revisions
The final revisions require that all corporate board members hold
either a CEO, CFO, or COO position at their member credit union or
other member entity. The final rule will, for clarity, add the
positions of Manager and Treasurer, as these are often the equivalent
of CEO or CFO at smaller credit unions. The revisions also require that
a majority of a corporate's board members be representatives of NPCU
members. The proposal also included a six year term limit on board
service, but this mandatory term limit has been removed from the final
rule.
The final revisions require that each corporate annually prepare,
and provide to its members, a document that discloses the compensation
of certain employees. For corporates with 41 or more employees, the
disclosure must include the top five compensated employees. For
corporate with 31 to 40 employees, the disclosure must include

[[Page 64794]]

the top four compensated employees. For corporates with 30 or fewer
employees, the disclosure must include the top three compensated
employees.
With respect to any corporate merger, the final revisions require a
merging federally-chartered corporate affirmatively disclose to both
NCUA and its members any material, merger-related increase in
compensation (i.e., an increase of more than 15 percent of annual
compensation or $10,000, whichever is greater) for any senior executive
or director. A state-chartered corporate must also make the merger-
related disclosure, but only to NCUA unless state law requires
otherwise.
The final revisions prohibit golden parachutes, that is, payments
made to an institution affiliated party (IAP) that are contingent on
the termination of that person's employment and received when the
corporate making the payment is either troubled, undercapitalized, or
insolvent. The revisions also generally prohibit a corporate,
regardless of its financial condition, from paying or reimbursing an
IAP's legal and other professional expenses incurred in administrative
or civil proceedings instituted by NCUA or a state regulatory authority
where the IAP is ultimately found liable.

G. Corporate CUSOs

Summary of Current Rule
The current corporate CUSO provisions do not specify the particular
services that corporate CUSOs may offer, but does provide that the CUSO
must ``primarily serve credit unions'' and ``restrict its services to
those related to the normal course of business of credit unions.'' The
current rule requires the CUSO agree to allow the corporate's auditor,
the corporate's board, and also NCUA access to the CUSO's ``books,
records, and any other pertinent documentation.''
Summary of Significant CUSO Revisions
The final revisions will retain the existing 704.11 requirements,
and further require that a corporate CUSO may only engage in categories
of services preapproved by NCUA. Brokerage services and investment
advisory services will be preapproved in the rule, and NCUA will
approve additional categories of services on an ad hoc basis. Once
approved, however, NCUA may only remove a category of service through a
rulemaking. The final rule provides extra time for a CUSO to seek NCUA
approval of a service category, and extra time for a corporate to
extricate itself from a CUSO that is engaged in activities not
preapproved by NCUA.
The final revisions further require a CUSO agree to permit the
corporate and NCUA to access the books, records, personnel, equipment,
and facilities of the CUSO.

H. Delay of Effective Dates

None of these final revisions will take effect until 90 days
following publication of this final rulemaking in the Federal Register.
This delay in the effective dates will generally provide the
corporates, and their NPCU members, some time to analyze and adapt to
the final rule and to observe how NCUA is moving forward on resolution
of the legacy asset problem.
Some provisions of this final rule, including the capital and PCA
provisions, will have delays in their effective dates that are much
longer than 90 days. Those delays will be discussed below.

III. Section-by-Section Analysis

This section, which provides a section-by-section analysis of the
final revisions, generally follows the organization of part 704, that
is, starting with the proposed capital (Sec. 704.3) and PCA (Sec.
704.4) amendments, then investments (Sec. 704.5) and credit risk
(Sec. 704.6), then asset and liability management (Sec. 704.8), then
corporate board representation (Sec. 704.14), and then the new
sections relating to disclosure of executive and director compensation
(Sec. 704.19) and golden parachutes and indemnification (Sec.
704.20).
Many of the final revisions require new definitions that appear in
Sec. 704.2, and the discussion of these definitions generally appears
with the discussion of the associated substantive change to the
corporate rule. This rulemaking revises Appendices A and B, and adds a
new Appendix C. Since Appendix B relates to investment authority, the
revisions to that appendix are discussed as part of the discussion of
Sec. 704.5. Since Appendices A and C (on model forms and the risk-
weighting of assets, respectively) relate to corporate capital, the
changes to these appendices are discussed immediately following the
discussion of Sec. 704.3. The new subpart L to part 747 provides the
due process associated with the new PCA provisions in Sec. 704.4, and
so is discussed following the Sec. 704.4 discussion.
The revisions to capital terminology in part 704 also necessitate
conforming amendments to parts 702, 703, and 709, as discussed below.

A. Part 702 Prompt Corrective Action

Part 702 sets forth PCA for NPCUs. The proposal contained a
conforming amendment to paragraph 702.105(d) changing references to
paid-in capital and membership capital to perpetual capital and
nonperpetual capital accounts, respectively. The final 702.105(d) is
adopted as proposed.

B. Part 703 Investments and Deposit Activities

Part 703 sets forth the permissible investment and deposit
activities generally applicable to federal credit unions. The proposal
contained a conforming amendment to paragraph 703.14(b) changing
references to paid-in capital and membership capital to perpetual
capital and nonperpetual capital accounts, respectively. The final
703.14(b) is adopted as proposed.

C. Part 704 Corporate Credit Unions

Section 704.2 Definitions
New and modified definitions in Sec. 704.2 are discussed below in
the section where the defined word or phrase appears.
Section 704.3 Capital
Section 704.3 establishes the capital requirements for corporates.
The final 704.3 contains six paragraphs (a) through (f). Paragraph (a)
covers the basic capital requirements. Paragraph (b) contains the
requirements for nonperpetual capital accounts (NCAs) and paragraph (c)
contains the requirements for perpetual contributed capital (PCC).
Paragraph (d) contains the requirements and procedures for establishing
different minimum capital requirements for a particular corporate.
Paragraph (e) contains certain other reservations of authority to the
NCUA Board. Paragraph (f) explains the treatment of certain former
capital accounts under the old corporate rule (i.e., membership capital
accounts) that are not converted to the new forms of capital (i.e.,
either NCAs or PCCs).
As discussed previously, this new 704.3 capital section will not
become effective until October 20, 2011, and some elements of this
section, and associated definitions, have applicability dates that are
delayed beyond October 20, 2011.

704.3(a) Capital Requirements

The proposed 704.3(a), along with associated definitions in 704.2,
established a new leverage ratio, new Tier 1 risk based capital ratio
(T1RBC ratio), and a new total risk based capital ratio (Total RBC
ratio). The proposal established minimum of 4 percent for

[[Page 64795]]

the leverage ratio, 4 percent for the T1RBC ratio, and 8 percent for
the Total RBC ratio. The proposal required a corporate develop goals,
objectives, and strategies to ensure adequacy of capital. The proposal
required that a corporate attempt to build RE to a level of 0.45
percent of its moving daily average net assets (DANA) within 36 months
of publication of the final rule, and submit a RE accumulation plan
(REAP) to NCUA if it fails to do so.
The final rule generally adopts 704.3(a), and the associated
definitions, as proposed. Some commenters, however, sought
clarification about certain provisions, as discussed below.

704.3(a)(1)(i) and 704.2 Definitions of Leverage Ratio

A few commenters expressed confusion about the effective date of
the new leverage ratio, and whether that date was actually 12 months
following publication of the final rule, or 36 months as stated in the
preamble. In fact, the permanent leverage ratio will become effective
36 months after publication, but the rule does contain an interim
leverage ratio to bridge the gap between the general effective date of
the capital provision (i.e., 12 months after publication) and the
permanent leverage ratio.
The proposal, between 12 months and 36 months following publication
of the final rule, requires a minimum 4 percent interim leverage ratio,
which was defined as the adjusted total capital divided by moving DANA.
The proposed definition of ``total capital'' included RE, PCC, and
NCAs, while the proposed definition of ``adjusted total capital'' then
excluded all NCAs in excess of the amount of PCCs. This result would
have limited the use of NCAs to only 200 BP toward the 400 BP necessary
to achieve the minimum leverage ratio.
Two corporate commenters suggested that corporates be allowed to
use NCAs, without limit to satisfy their interim leverage ratio (that
is, until the 36 month point). One stated that the current calculation
of interim leverage ratio will result in NCAs not being an effective
capital tool. This commenter believes that under the proposal as
drafted corporates will immediately solicit PCC following publication
of the final rule so as to be in compliance with the interim leverage
ratio at the 12 month mark. This commenter suggests, instead, that NCUA
redefine the numerator of leverage ratio from ``adjusted total
capital'' to ``total capital,'' thus allowing for unrestricted use of
NCAs in the numerator until at least the third anniversary of
publication of the final rule. This commenter states this will give
NPCUs additional time to decide whether they want to stay in the
corporate system and invest permanently in the corporates through PCCs,
and will also improve the corporate's ability to grow RE in the first
three years, as NCAs are less expensive than PCCs.
The Board agrees with these commenters. Accordingly, in the final
rule the numerator of the interim leverage ratio includes all elements
of capital and permits the use of any one element without limitation.
Hence, a corporate could use just NCAs, if it desires, to satisfy the 4
percent interim leverage ratio requirement. Thirty six months after
publication of the final rule, the proposal defined, and this final
rule adopts, the permanent leverage ratio to be defined as adjusted
core capital divided by moving DANA. Core capital, in turn, is limited
to Tier 1 capital (i.e., RE and PCCs). Accordingly, NCAs will not count
at all toward the permanent leverage ratio when it becomes effective
after 36 months. The final rule also adds clarifying statements at the
end of each of the two definitions, that is ``[T]his is the interim
leverage ratio,'' and ``[T]his is the permanent leverage ratio,'' so
that those who read the definitions will understand that these are two
distinct definitions.

704.2 Definition of ``Core Capital''

The proposal defines core capital as the sum of the corporate
credit union's RE, paid-in capital, and the RE of any acquired credit
union, or of an integrated set of activities and assets, calculated at
the point of acquisition, if the acquisition was a mutual combination.
Upon the first anniversary of the publication of the final rule, the
new Basel I capital provisions and ratios become effective. On that
date, the proposal adjusts the definition of core capital to make a
nomenclature change (i.e., replace PIC with PCC) and to add to capital
the minority interests in the equity accounts of CUSOs that are fully
consolidated with the corporate.

704.2 Definition of ``Adjusted Core Capital''

The permanent leverage ratio and the Tier 1 risk based capital
ratio use adjusted core capital as the numerator. The proposal defined
adjusted core capital as core capital modified by six different
deductions.
The proposed deductions required when adjusting core capital
include the amount of the corporate's investments in consolidated
CUSOs. Some commenters objected to this deduction, arguing that such a
deduction varies from the Basel I standards. The Board agrees that this
proposed deduction, as worded in the proposed, did not accurately
reflect the Basel I standard. The deduction should be for investments
in CUSOs that are not consolidated with the corporate, as described in
the Basel I Accord:

It has been concluded that the following deductions should be
made from the capital base for the purpose of calculating the risk-
weighted capital ratio. The deductions will consist of: * * *
investments in subsidiaries engaged in banking and financial
activities which are not consolidated in national systems. The
normal practice will be to consolidate subsidiaries for the purpose
of assessing the capital adequacy of banking groups. Where this is
not done, deduction is essential to prevent the multiple use of the
same capital resources in different parts of the group. The
deduction for such investments will be made against the total
capital base. The assets representing the investments in subsidiary
companies whose capital had been deducted from that of the parent
would not be included in total assets for the purposes of computing
the ratio.\9\

\9\ International Convergence of Capital Measurement and Capital
Standards (July 1988, updated to April 1998), Section I(c),
paragraph 24(ii) (emphasis added). See also 12 CFR part 3, Appendix
A, Sec. 2(c)(7)(i) (Office of the Comptroller of the Currency
deductions from capital), and 12 CFR part 208, Appendix A, Sec.
II.B.(ii) (Federal Reserve Board deductions from capital).

The Board has amended the final definition of adjusted total
capital to required deduction of investments in unconsolidated CUSOs.
The proposed definition of adjusted core capital also requires that
corporates should deduct from their own capital any capital they have
contributed to other corporates. Specifically, the proposal stated:

If the corporate credit union, on or after (the first
anniversary of the final rule), contributes new capital or renews an
existing capital contribution to another corporate credit union,
deduct an amount equal to the aggregate of such new or renewed
capital * * *.

Some NPCU commenters specifically agreed with this deduction,
noting that cross-corporate capitalization can inflate capital levels
and exposes NPCU members of the contributor corporate to the problems
of another corporate.
One commenter asked for clarification about the meaning of ``renew
an existing capital contribution.'' The only capital placed in another
corporate that is exempt from this required deduction is existing PIC
that is converted directly to PCC on the first anniversary of the
publication of the final rule or unconverted MCAs that are amortizing
under the provisions of paragraph 704.3(f). All other PCC, and all
NCAs,

[[Page 64796]]

must be deducted. The Board has amended the final version of the rule
text to clarify that if the corporate credit union contributes any PCC,
or maintains any NCAs, at another corporate credit union, it may deduct
an amount equal to that PCC or NCA.
Another commenter said NCUA should consider an exception for de
minimus member capital contributions between corporates. The Board
considered this last comment, but does not believe a de minimus
exception is necessary.
One commenter objected to this proposed deduction, stating that it
seemed to indicate that NCUA would consider any capital deposits made
by NPCUs into corporates to have a 100 percent risk weighting, if and
when NPCUs might fall under a risk-weighted capital system, and this
would further hinder corporate recapitalization. The Board does not
believe that NPCU's should equate capitalization by NPCUs of retail
corporates with cross-capitalization of corporates for purposes of PCA.
One commenter stated that the definition of core capital should
include NCAs. The Board disagrees. Adding NCAs to the definition of
core capital would undermine the permanent nature of core capital and
the associated capital protection provided by the minimum leverage
ratio.

704.2 Definition of ``Supplementary Capital''

The proposed definition of supplementary capital included NCAs, a
portion of the corporates allowance for loan and lease losses, and a
portion of the unrealized gains on available for sale equity securities
with readily determinable fair values. The term, which is synonymous
with Tier 2 capital, is used in the numerator of the total risk based
capital ratio. One commenter suggested that all of the unrealized gains
on equity securities should count as supplementary capital. The Board
disagrees, as this approach would be inconsistent with the Basel I
regulations of the other banking regulators.\10\ The Board also notes
that corporates are not likely to have much in the way of equity
securities, as they are generally impermissible investments for
corporates.
---------------------------------------------------------------------------

\10\ See, e.g.,12 CFR part 208, Appendix A, Sec. II.A.2.(e)
(Federal Reserve supplementary capital elements).
---------------------------------------------------------------------------

704.2 Definition of ``Fair Value''

The final rule also refines the definition of fair value to be
consistent with Financial Accounting Standard 157.

704.2 Definition and Use of ``Moving Monthly Average Net Risk-Weighted
Assets''

The proposal defined the denominator of both new risk based capital
ratios as ``Moving Daily Average Net Risk-Weighted Assets'' (MDANRA).
Some commenters questioned the burden of daily risk weighting to
produce the MDANRA figure. The Board agrees that a daily calculation is
not necessary and could be quite burdensome for some corporates.
Accordingly, the final rule replaces the denominator of both risk based
capital ratios with a new moving monthly average net risk-weighted
assets (MMANRA), defined to mean the average of the net risk-weighted
assets for the month being measured and the previous eleven (11)
months. The definition also requires that MMANRA measurements be taken
on the last day of each month.

704.2 Definition of ``Retained Earnings''

The final rule amends the definition of retained earnings to create
a cross reference to GAAP: ``Retained earnings means retained earnings
as defined under Generally Accepted Accounting Principles (GAAP).''

704.3(a)(3) RE Accumulation Target and REAP

Some commenters incorrectly characterized the proposal as
establishing a ``requirement'' for 45 BP of RE after three years, and
questioned the feasibility of reaching that target under the proposed
ALM and investment restrictions (discussed elsewhere). In fact, the
proposal does not require 45 BP after three years, but, rather, calls
for the submission of a RE accumulation plan (REAP) if the 45 BP target
is not met.
Many commenters, including both NPCUs and corporates, thought that
the multi-step RE phase-in (i.e., target of 45 BP after three years,
and a requirement for 100 BP after six years, and then 200 BP after
ten) was too difficult for corporates to achieve. Commenters thought
this was too difficult because of the current interest rate
environment; the fact that most corporate income comes from
investments, and not loans; and the limitations imposed by the proposed
ALM and investment requirements (discussed elsewhere). One of these
commenters stated this RE timetable was likely to encourage aggressive
strategies to accumulate RE or cause a corporate ``to solicit high cost
capital,'' and that corporates ``must not be unnecessarily forced into
a survival mode while rebuilding capital.'' Many of these same
commenters suggested that these milestones be changed from three, six,
and ten years to four, eight, and twelve years, respectively. One of
these commenters asked that these milestones be changed to five, seven,
and twelve years, respectively. One corporate commenter, however, did
state its belief that these RE targets and requirements were
achievable.
The Board disagrees with those commenters who believe the proposed
time line is not achievable. The proposed timeline, which the Board has
adopted in the final, provides the necessary balance between permitting
a well-run corporate time to solicit capital and grow retained
earnings, while ensuring that there is pressure on the corporate to
achieve adequate capital levels.
Of the commenters who specifically thought requiring 100 BP of RE
by year six was too aggressive, one asked that NCUA make public its
third-party review of this requirement, along with the assumptions used
during the review. As discussed above, NCUA has made public the
Kamakura report, and has made changes in response to portions of the
report. Overall, NCUA believes these changes will make it easier for a
corporate to achieve the necessary RE growth, as discussed in more
detail below.
One commenter stated that the proposal should require a state
chartered corporate submit any REAP to both NCUA and the relevant state
regulator, and that NCUA consult with the state regulator on the
evaluations of the REAP. The NCUA Board agrees that it should consult
with the relevant state regulator in these circumstances, and has
amended the final regulation accordingly.
Except as described above, the Board adopts the final paragraph
704.3(a), and associated capital definitions in Sec. 704.2, as
proposed.

704.3(b) Requirements for Nonperpetual Capital Accounts (NCAs)

The proposal replaced membership capital accounts (MCAs) with
nonperpetual capital accounts (NCAs). NCAs must be either term or
notice accounts, with a minimum maturity or notice period of five
years. Under the proposal, adjustable balance NCAs were not permitted.
Two commenters stated that five-year notice is more appropriate
than three-year notice, since ``this three year time period is short in
relation to the term of some corporate assets.'' These commenters,
however, believe that all

[[Page 64797]]

contributed capital should be five-year notice and that there is no
need for perpetual contributed capital. The Board believes it is
important to have some element of perpetual capital in corporates. This
is consistent with Basel I and with the fact that, going forward,
corporates cannot expect any future extraordinary government
intervention.
One NPCU stated that NCUA should continue to permit accounts that
adjust with credit union balance sheets. This commenter stated that
such adjustable accounts are ``necessary for the system and in times of
tight liquidity allows credit unions to have flexibility.'' The Board
disagrees. Capital must have a sense of permanence. Capital accounts
that adjust based on measures that can be manipulated by the member
lack this permanence.
One commenter asked that, with regard to the new NCAs, the word
``original'' be placed in front of the phrase ``minimum term.'' The
Board agrees and has made this clarification.
Two commenters recommended that, for ``nonmaturity'' or ``notice''
NCAs, the withdrawal notice be changed from five years to three years
if the NCAs have been in existence at the corporate for at least two
years. The Board believes this change would be confusing to implement,
would undermine the stability of NCAs, and would be inconsistent with
the Basel standards. Accordingly, the Board is not adopting this
recommendation.
A few commenters objected to the proposed change from three years
to five and said MCA maturity should stay at three years; and one
billion dollar NPCU stated that the proposed extension to five years
could cause some credit unions to leave the corporate network. A few
NPCUs stated that if NCUA wanted NPCUs to recapitalize corporates, it
would shorten the term of MCAs instead of lengthening the term, and one
of these NPCUs suggested a term of one to two years. The Board believes
that the importance of having solid, perpetual capital, consistent with
the international Basel I standards, outweighs these concerns.
Another commenter stated that credit unions will need the
flexibility to withdraw or change to another corporate credit union
that meets their needs without having to wait three to five years to
withdraw a capital deposit. The Board disagrees. Capital by its very
nature must be stable and not subject to easy withdrawal. As discussed
above, potential creditors and vendors of a corporate will not do
business with the corporate absent a strong capital regime that is
available to absorb losses ahead of these third parties.

704.3(b)(6), (c)(5) Permitting the Transfer of Contributed Capital
Accounts (NCA and PCC) to Third Parties

The proposal would permit members to freely transfer their NCAs
(704.3(b)(6)) and PCCs (704.3(c)(5)) to third parties, regardless of
membership status.
One NPCU commenter stated that free transferability of capital was
good, as it helped enforce market discipline. A few commenters,
however, stated that there should be limits on the ability of a member
to unilaterally sell or transfer their contributed capital to any other
member or a nonmember. These commenters believe that a corporate credit
union's board must be empowered to preapprove any proposed transfer of
capital funds (other than in a merger or liquidation). One of these
commenters would restrict transfers to other entities in the field of
membership, and another commenter stated that:

It does not appear that the corporate credit union would have
any ability to control the transfer of or the ultimate ownership of
its capital shares. This lack of control could lead to the required
registration of capital shares as public securities. Such a
registration could be required despite the wishes of the corporate
and the majority of its members. Registration would dramatically
increase the cost and complexity of operating a corporate. In
addition, the free transfer of capital shares could allow
manipulation including enabling natural person credit unions to cut
their capital exposure to a corporate by selling shares rather than
by putting them on notice. Alternatively, a prospective member
credit union could buy shares rather than contributing capital
directly to a corporate. This regulation would hamper the objective
of building committed corporate capital.

The Board agrees that there should be additional limits on the
transferability of NCAs and PCCs to mitigate the possibility of
securities laws violations. PCC and NCAs are generally subject to the
securities laws because they meet the general definition of
``security.''\11\ Securities issued by corporate credit unions are
exempt from registration under the Securities Act of 1933 (SA),\12\ and
since it is unlikely that either members or corporates would engage in
activities involving PCC or NCAs that would trigger the application of
broker/dealer provisions of the Securities and Exchange Act of 1934
(SEA), the risk of securities law violations is minimal. Still, the
anti-fraud provisions of SEA Sec. 10(b) and SEC Rule 10b-5 would apply
to any transfer, so that members should not withhold, or misstate, any
available financial information about the corporates when making such a
transfer and should also ensure that the potential transferees have
some sophistication.\13\
---------------------------------------------------------------------------

\11\ See, e.g., 15 U.S.C. 77b(a)(1), 15 U.S.C. 77c(a)(10).
\12\ See 15 U.S.C. 77c(a)(5), and Securities and Exchange
Commission (SEC) Release No. 33-6758, Regulation D Revisions, 53 FR
7866, note 10 (March 3, 1988).
\13\ See 15 U.S.C. 78j(b).
---------------------------------------------------------------------------

Accordingly, the final rule requires a corporate member wishing to
transfer PCC or NCAs to a non-credit union third party must ensure the
potential transferee obtains appropriate financial information about
the corporate. To ensure the proper flow of information, the rule
provides that the member must notify the corporate at least 14 days
before consummating the transaction, and the corporate must then
provide both the member and the potential transferee all financial
information about the corporate available to the members or the public,
including any call report data submitted by the corporate to NCUA but
not yet posted by NCUA.
The final rule also limits such transfer to nonnatural persons.
This serves a consumer protection function and is also consistent with
NCUA's rules on the sale of secondary capital at low income credit
unions.

704.2 Definition of ``Aavailable To Cover Losses That Exceed Retained
Earnings''

NCAs must be ``available to cover losses that exceed retained
earnings and perpetual contributed capital.''\14\ The quoted phrase is
defined in proposed 704.2, and the definition provided that ``[t]o the
extent that contributed capital funds are used to cover losses, the
corporate credit union must not restore or replenish the affected
capital accounts under any circumstances.'' Some commenters believe
that this is a new requirement. In fact, it is not a new requirement,
but simply a clarification of an existing requirement. The proposal
also provided that contributed capital that is used to cover losses in
a fiscal year previous to the year of liquidation has no claim against
the liquidation estate. To avoid the ambiguity associated with
different possible fiscal years, the final rule replaces ``fiscal
year'' with ``calendar year.'' The entire final definitions now read as
set forth in the regulatory text of this rule.\15\
---------------------------------------------------------------------------

\14\ And PCCs must be ``available to cover losses that exceed
retained earnings.'' 12 CFR 704.2.
\15\ The final revisions to the corporate rule contain two
different versions of the definitions section (Sec. 704.2): A
temporary version that goes into effect with the bulk of the
revisions 90 days after publication in the Federal Register, and a
permanent version that goes into effect one year after publication
on the effective date of the capital and PCA provisions. The
definition of Available to cover losses that exceed retained
earnings set forth following amendatory instruction 7 of this rule
is the permanent version of the definition. The temporary version
following amendatory instruction 6 of this rule refers to PIC and
MCAs, not PCC and NCAs.

---------------------------------------------------------------------------

[[Page 64798]]

Except as discussed above, the Board adopts the final paragraph
704.3(b), and associated definitions in Sec. 704.2, as proposed.

704.3(c) Requirements for Perpetual Contributed Capital (PCC)

The proposal renamed paid in capital (PIC) as perpetual contributed
capital (PCC). Generally, the proposed terms and conditions for PCC
tracked those of the existing PIC, with the following exceptions.
The existing rule permits a corporate to call PIC if the corporate
would meet its minimum levels of capital and NEV ratios after
redemption; the proposal requires NCUA's prior approval for any such
redemption. The proposal permits the free transferability of PCC to
certain nonmember third parties, under the same conditions as NCAs may
be transferred (as discussed above). The proposal also eliminated the
existing prohibition on conditioning membership, services, or prices
for services on a member's ownership of PIC (now to be renamed PCC).

704.3(c)(3) Callability of PCC

Many commenters objected to the 704.3(c)(3) proposal that NCUA must
preapprove a corporate's determination to call, or redeem, PCC. Some of
these commenters believe NCUA preapproval is overreaching and
unnecessary in light of other provisions in the proposed regulation.
Some of these commenters stated that the corporate should be free to
permit redemption of PCC, without NCUA preapproval, so long as the
corporate would continue to meet its minimum capital requirements. Two
commenters stated that this prohibition might discourage members from
contributing PCC. One stated that over time RE will replace much of the
PCC, and that should reduce NCUA's concerns with PCC redemption.
PCC will fulfill a central role in corporate capital structures for
many years to come. The Board wishes to ensure that, before a corporate
lets any PCC go through redemption, the corporate truly does meet its
minimum capital and NEV levels, and is likely to maintain those levels
into the foreseeable future. Accordingly, the final rule retains the
proposed requirement for NCUA preapproval of any PCC redemption.

704.3(c)(6) Conditioning Membership, Services, and Prices of Services
on Purchase of PCC

Many commenters recommended that NCUA not eliminate the current
prohibition on a corporate conditioning membership, services, or prices
for service on a credit union's ownership of PIC (PCC going forward).
One of these commenters stated that granting the corporates the ability
to condition payment services or other services on ``membership'' could
force only those NPCUs who have no other alternative to place more
capital at risk and out of their control. Another NPCU commenter stated
that it learned from the Capital Corporate collapse in the 1990s and
has avoided buying capital shares, and does not want to be forced to
contribute capital going forward.
Many other commenters, however, including many NPCU commenters,
supported the full elimination of this prohibition. Most of these
commenters believe this sort of decision on requiring capital
contributions is appropriately left to the board and management of the
corporate credit union. One commenter stated that lifting this
prohibition was necessary to protect against free riders, noting that
because of this prohibition the current distribution of losses among
members of corporate was unfair.
A few NPCU commenters even thought a corporate should require
member capital to receive services. Some of these commenters thought
that the requirement should be linked to the amount of the NPCU's
deposits at the corporate, and others to an NPCU's asset size, and some
stated that larger NPCUs should not be permitted to subscribe to lesser
amounts of capital as a percentage of asset size.
In the Board's view, corporates are designed to service NPCUs, and
NPCUs own the corporates and the associated risks and rewards of such
ownership. If NPCUs believe that corporates provide some valuable or
essential service, then NPCUs will need to capitalize the corporates.
Accordingly, the Board believes it is appropriate that a corporate be
given the option of conditioning its membership, services, or the
prices for services, on the purchase of PCC. This authority helps the
corporate protect itself from free riders, that is, those NPCUs and
other entities that want the benefits of the corporate without taking
on any risks. The Board does not believe that NCUA should, by rule,
require some minimum amount of capital contribution, but does believe
that the corporate's board should have the authority to do so.
Several commenters stated, however, that if this prohibition is
eliminated, the regulation should make clear that corporates cannot
change their policies so as to threaten immediate termination of
essential services absent immediate PCC contributions. Many of these
commenters suggested that an NPCU that refuses to meet a new demand for
contributed capital be given at least 12 months to find another service
provider.
The Board appreciates the concern of these commenters. Corporate
members should be given adequate time to look for alternatives should
they find any particular, proposed conditions on membership, services,
or the prices for services too onerous. The Board believes, however,
that six months to find an alternative service provider should be
appropriate. Accordingly, the final paragraph 704.3(c)(6) provides that
a corporate must give a member at least six months written notice of
(i) the requirement to purchase PCC, including specific amounts; and
(ii) the effects of a failure to purchase the requisite PCC on the
pricing of services or on the member's access to membership or
services.
One NPCU commenter stated that if corporates are permitted to
require capital contributions as a condition of membership or services,
the NCUSIF should insure the capital contribution. Another NPCU
commenter stated that capital should be ``portable,'' meaning that if
an NPCU wishes to move to another corporate because they may not be
satisfied with the services being offered, then the NPCU should be free
to shift its existing capital to the new corporate without any
conditions or time constraints. Again, these commenters misunderstand
the fundamental nature of capital. Capital is a buffer to ensure that
creditors and vendors of a corporate will not be first in line to
absorb operating losses. If NCUA insured the capital, that would be
transferring the risk from the member-owner to the entire universe of
insured credit unions, and that is not appropriate. Further, if NCUA
permitted capital to be ``portable,'' it would undermine this primary
role of capital as assuring potential creditors and vendors of the
corporate of the continued availability of that capital to absorb
operating losses.

704.2 Definition of Tier 2 Capital Includes Certain PCC

Paragraphs (5) and (6) of the proposed definition of adjusted core
capital excludes certain PCC that exceeds certain levels of RE. The
purposes of

[[Page 64799]]

these exclusions is to force corporates to build up their RE for
inclusion in adjusted core capital and inclusion in the corresponding
leverage ratio and Tier 1 risk based capital ratios. The effect of
these provisions, however, was to also exclude the excess PCC from all
capital calculations, including Tier 2 capital ratios.
Some commenters stated that all PCC should continue to count as
capital. They ask that some other method be used to encourage RE growth
but, if not, then in the alternative that excess PCC should continue to
count as at least Tier 2 capital (i.e., and count toward the total RBC
ratio). These commenters understood that the proposal intends to push
corporates toward building RE growth, but they argue that any existing
excess PCC still protects the corporate from losses. Two commenters
stated that to the extent PCC does not count as capital it should be
returned to the members.
The Board agrees that excess PCC should continue to count as Tier 2
capital. Accordingly, in the final rule the Board amends the definition
of Tier 2 capital to include ``any perpetual capital deducted from
adjusted core capital.''

704.2 Definition of Equity Investments

The proposal uses the term equity investments as a deduction for
purposes of calculating adjusted core capital, and defines the term in
704.2 to include only investments in real property and equity
securities. One commenter pointed out that equity investments can also
take the form of investments in partnerships or limited liability
companies. Accordingly, the final rule adds those investments to the
definition.
Accordingly, and except as described above, the Board adopts the
final paragraph 704.3(c), and associated definitions in Sec. 704.2, as
proposed.

704.3(d) Individual Minimum Capital Requirements

Proposed paragraph 704.3(d) gave NCUA the authority to require
higher minimum capital requirements of individual corporate credit
unions. The proposal provided the corporate with notice and an
opportunity to respond in writing before imposition of the new capital
requirements.
Many commenters opposed this paragraph as giving too much
discretionary power to NCUA and NCUA examiners. Some of these
commenters mistakenly believe that the proposal delegates this
authority to the OCCU Director or some other ``individual.'' In fact,
the proposal provides this authority to the ``NCUA,'' meaning the
``NCUA Board'' (unless further delegated by the Board). The Board
believes that this provision gives the Board powers it needs to ensure
the health of the corporate system and the credit union system as a
whole. The Board does agree that some additional due process may be
appropriate, as discussed below.

704.3(d)(4) Standards for Determination of New Minimum Capital
Requirement

Some commenters objected to the language in proposed 704.3(d)(3)
stating that ``levels for an individual corporate cannot be determined
solely through the application of a rigid mathematical formula or
wholly objective criteria. The decision is necessarily based in part on
subjective judgment grounded in agency experience.'' These commenters
thought this language was too subjective, and that it departed from the
models of the other banking regulators that NCUA was purporting to
follow. In fact, this statement is true. Further, the same language
does appear in the regulations of the other banking regulators. See,
e.g., 12 CFR 3.11 (OCC Regulation). Accordingly, the final rule retains
this language.

704.3(d)(4) Procedures for Imposing New Minimum Capital Requirement

The proposal does provide the corporate due process, that is,
notice and an opportunity to respond in writing. The proposal generally
provides that a corporate will have 30 days to respond to the notice,
but that NCUA may shorten this period for good cause, and two
commenters stated that the corporate should have at least a minimum
time of 15 days to respond. One of these commenters stated that such
powers should be exercised only by the NCUA Board, and not be
delegable. Another commenter stated that, for state chartered
corporates, the regulation should require the NCUA Board obtain the
concurrence of the state regulator before exercising this authority.
The Board agrees that additional due process may be warranted in
some cases. Accordingly, the final rule includes a new paragraph
704.3(d)(4)(vi) that permits a corporate to request an informal
hearing. The corporate must make the request in writing, and NCUA must
receive the request no later than 10 days following the initial notice
of NCUA's intent to establish a different minimum capital requirement.
Upon receipt of the request for hearing, NCUA will conduct an informal
hearing and render a decision using the procedures described in
paragraphs (d), (e), and (f) of Section 747.3003.
Some of these commenters also objected to the statement that the
NCUA decision on this matter represents ``final agency action.''
However, this statement is true as there is no administrative appeal
from NCUA's decision in this matter. Accordingly, the final rule
retains this language.
Except as described above, the Board adopts the final 704.3(d) as
proposed.

704.3(e) Reservation of Authority

The proposed paragraph 704.3(e) provided for various reservations
of authority to NCUA.
Proposed paragraph 704.3(e)(2) gave NCUA the authority to require a
corporate to use period end assets, instead of moving DANA, for
purposes of calculating capital ratios. One corporate commenter
objected to this proposed authority, stating that month-end assets can
be more than 10 percent higher than DANA for the month. This commenter
suggested NCUA adopt an objective standard for the use of this
authority, such as where month-end assets are at least 125 percent of
DANA for three consecutive months. Another commenter stated that
corporates should be given the option of using average or period end
assets, as NPCUs are permitted to do under the PCA regime. The Board
disagrees, and refuses to put such limits on its authority to require
the use of period-end assets in appropriate cases.
Proposed paragraph 704.3(e)(3) gave NCUA authority to discount a
particular asset or capital component of a particular corporate from
the computation of capital. Some commenters opposed this as giving too
much power to NCUA, the OCCU Director, and NCUA examiners. One
commenter stated that no corporate should be treated differently from
others just because of the examiner. The provision, however, only
empowers the NCUA Board, not the OCCU Director or NCUA examiners
(unless the Board delegates its authority).
A few commenters correctly noted that the proposal does not provide
for any particular due process before NCUA acts. Another commenter
believes that there should be some stated time for the corporate to
correct the deficiency that gave rise to the unsatisfactory rating.
The Board agrees that there should be some due process associated
with its reservations of authority under paragraph 704.3(e), and the
final rule adds a new paragraph 704.3(e)(5) setting forth such due
process. Before taking any action under paragraph (e), NCUA will
provide the corporate with written

[[Page 64800]]

notice of the intended action and the reasons for such action. The
corporate will have seven days to provide NCUA with a written response,
and NCUA will consider the response before taking the action. Upon the
timely request of the corporate credit union, and for good cause, NCUA
may extend the seven-day response period.

704.3(f) Former Capital Accounts

Many commenters suggested that three-year MCAs that are not
converted to five-year NCAs be permitted to count as capital, and some
stated that they should count on a two-year declining basis. These
commenters argued that MCAs were available for some loss protection
until such time as they were converted or returned and so should count
in some way toward the corporate's capital requirements. One commenter
asked whether NCUA would permit the corporate to return to its members
three-year MCAs that were not converted to five-year NCAs.
The Board agrees that some corporate members may refuse to convert
their existing three-year MCAs to the new five-year NCA or to perpetual
PCC prior to the effective date of the new capital rules (i.e., the
first anniversary of the publication of the final rule in the Federal
Register). The Board also agrees that the entire balance of these
accounts is available to absorb losses until the account is closed, and
that these unconverted MCAs should count, at least partially, as Tier 2
capital. Accordingly, the final rule adds a new paragraph 704.3(f) that
provides, effective on the first anniversary of publication of the
final rule, unconverted MCAs will be treated as follows:
For ``adjustable balance'' MCAs, the corporate will
immediately put those accounts on notice of withdrawal (if they are not
already on notice). The corporate will continue to adjust the balances
of the MCA account in accordance with the original terms of the account
until the entire notice period has run and then return the remaining
balance, less any losses, to the member. Until the expiration of the
notice period, the entire adjusted balance will be available to cover
losses that exceed RE and certain contributed capital. The corporate
may count the unconverted MCAs as Tier 2 capital on an amortizing
basis, using the amortization method described in proposed
704.3(b)(3).\16\ Corporates will also be required, on the first
anniversary of the publication of the final rule, to provide members
who hold unconverted MCAs a one-time disclosure about the status of
their MCA accounts.
---------------------------------------------------------------------------

\16\ This amortization method reduces the amount that counts
towards capital to zero when one year is remaining on the notice
period or term. This amortization method also assumes that the
adjustment is determined based on a relatively permanent measure,
such as the member's assets, and not on some impermanent measure,
such as the member shares at the corporate.
---------------------------------------------------------------------------

For three-year term MCAs, the corporate will return the
MCAs at the expiration of the three-year term. Again, until the
expiration of three-year term, the entire account balance will be
available to cover losses that exceed RE and certain other contributed
capital. The corporate may count the unconverted MCAs as Tier 2 capital
on an amortizing basis, using the amortization method described in
proposed 704.3(b)(3). Corporates will also be required, on the first
anniversary of the publication of the final rule, to provide members
who hold unconverted MCAs a one-time disclosure about the status of
their MCA accounts.

Part 704, Appendix A--Capital Prioritization and Model Forms

The current Appendix A to part 704, entitled Model Forms, contains
forms that members provide the corporate on an annual basis
acknowledging the terms and conditions of the members' PIC and MCA
accounts. The proposal renamed Appendix A as Capital Prioritization and
Model Forms.
The proposed Appendix A had two parts. Part I, which is new,
provided the corporate's board of directors an option to give entities
that contribute new capital to the corporate priority--in terms of
availability to absorb losses and payout in liquidation--over existing
capital contributions. New capital in this context was defined as any
capital contributed more than 60 days following the publication of the
final rule. The purpose of this provision is to provide a tool to the
corporate for facilitating capital growth. Part II contained amended
model disclosure forms that cover MCAs, PIC, NCAs, and PCCs. The forms
included variable disclosures depending on whether the corporate
exercises the option described in Part I.
NCUA received very few comments on Appendix A, but the final rule
does include two minor changes from the proposed.
Consistent with the proposed clarifying amendments to Sec. 709.5,
Model Form A in Appendix A of the proposal included disclosure language
that depleted capital has no claim against the liquidation estate for
claims filed beyond the fiscal year of depletion. For clarity and to
reduce the potential ambiguity associated with ``fiscal year,'' the
final rule substitutes ``calendar year'' for ``fiscal year.'' The final
rule also contains a similar revision to the payout priority paragraphs
709.5(b)(7) (for NCAs) and (b)(9) (for PCC holders).
Also, since the effective date of the final rule will generally be
ninety days following the date of publication, the final rule modifies
the definition of new contributed capital for purposes of Part I,
changing if from capital contributed more than 60 days following
publication to capital contributed more than 90 days following
publication.
Accordingly, and other than as described above, the final rule
adopts Appendix A as proposed.
Part 704, Appendix B relates closely to the investment (Sec.
704.5), credit risk (Sec. 704.6) and asset-liability (Sec. 704.8)
provisions of the corporate rule, and is discussed below in connection
with those provisions.

Part 704, Appendix C--Risk Weighting of Assets for Risk Based Capital
Calculations

The current corporate rule has no risk weighted capital ratios or
provisions. The proposal included two new minimum capital ratios
defined in terms of risk-weighted assets and activities. Proposed
Appendix C contained the detailed instructions for assigning risk
weights, including:
Assets that appear on the corporate's balance sheet will,
generally, be risk-weighted at zero percent, 20 percent, 50 percent, or
100 percent, with less risky assets (e.g., treasury bills) given lower
percentages, and more risky assets (e.g., loans) given higher
percentages.
Activities that involve risk but that may not appear on a
corporate's balance sheet (e.g., an interest rate swap, or a guaranteed
line of credit not yet drawn upon) are assigned a conversion factor and
then risk weighted as if the underlying assets were, in fact, on the
corporate's balance sheet. Recourse obligations (e.g., a recourse
obligation on a transferred loan) and direct credit substitutes (e.g.,
a mortgage backed security that is subordinated to other securities in
the same issuance) are generally treated as if the entire amount of the
supported asset is on the credit union's balance sheet. Residual
interests (e.g., retained, subordinated interests in a loan or loan
participation transfer, or a retained credit enhancing interest-only
strip) have different, more severe risk weighting calculations.

[[Page 64801]]

A corporate may employ a ratings-based risk weighting
option for certain investments, (i.e., a recourse obligation, a direct
credit substitute, a residual interest, or an asset- or mortgage-backed
security extended in connection with a securitization) that have NRSRO
ratings. When there is more than one available NRSRO rating, the
corporate must use the lowest rating.

Appendix C, Paragraph I(a) Scope

The final rule amends paragraph I(a)(4) to emphasize that this
Appendix does not provide authority for corporates to invest in or
purchase any particular type of asset or to engage in any particular
type of activity. In other words, a corporate credit must have other
identifiable authority for any investment it makes or activity it
engages in. So, for example, this Appendix describes risk weightings
for subordinated securities, even though the final Sec. 704.5
prohibits corporates from investing in subordinated securities and so a
corporate credit union cannot invest in subordinated securities. This
risk-weighting provision is retained because it is possible that a
corporate could come into possession of a security that is
impermissible for direct investment (e.g., through enforcement of a
lien on a defaulted loan), or that such securities that are
impermissible now might become permissible in the future, and Appendix
C will not have to be amended to deal with those situations.

Appendix C, Paragraph II(a) Risk Weighting of On-Balance Sheet Assets

A few commenters sought clarity on the risk weighting for ABS and
MBS. Asset backed securities are risk weighted in the ``all others''
risk weighting category (i.e., 100 percent risk weighting) unless rated
using the ratings based approach. For private label MBS that are backed
by non-qualifying mortgage loans, or a combination of non-qualifying
and qualifying mortgage loans, these MBS are also risk-weighted at 100
percent, again unless rated using the ratings based approach. Only MBS
backed entirely by qualifying mortgages may use the 50 percent risk
weighting permitted by paragraph II(a)(3)(iii).

Appendix C, Paragraph II(b) Risk-Weighting of Off-Balance Sheet Items

Paragraph II(b)(6) Off-Balance Sheet Derivative Contracts; Interest
Rate and Foreign Exchange Rate Contracts (Group F).--
One commenter stated that NCUA should consider excluding off-
balance sheet items from the risk-based assets calculation. This
commenter stated that an alternative may be to allow a corporate to
establish a distinct capital pool for off-balance sheet items to
prevent any confusion about the items having the same risk as on-
balance sheet assets of the corporate. The Board believes the rule as
proposed is clear enough on the treatment of on-balance sheet and off-
balance sheet items.
One commenter noted that the proposal assigns derivative risk
weights for interest rate swaps and foreign currency swaps, but not for
other types of derivatives, and corporates may, if authorized by NCUA
under the Expanded Authorities, engage in other forms of derivative
transactions. The commenter sought clarification of this issue. The
Board agrees that clarification is necessary, and so the final rule
includes an ``all others'' catch-all category of derivative risk
weighting. As with interest rate swaps and foreign currency swaps, the
credit equivalent amount for these other derivatives is generally
determined by summing the current credit exposure and the potential
future credit exposure. Appendix C, Paragraph II(b)(6)(ii). The current
credit exposure is calculated the same way for all derivatives,
including other derivatives. Appendix C, Paragraph II(b)(6)(ii)(A). The
potential future credit exposure is determined by multiplying the
notional principal times a credit conversion factor. Appendix C,
Paragraph II(b)(6)(ii)(B). The size of this credit conversion factor
depends on the remaining maturity of the derivative. For the catch-all
derivatives category, the conversion factors in the final rule are ten
percent (remaining maturity of one year or less), 12 percent (remaining
maturity of over one year but less than five years), and 15 percent
(remaining maturity over five years). This treatment of these other
derivatives is similar to that used by the Federal Reserve and the
other banking regulators. See 12 CFR part 208, Appendix A, Paragraph
III.E.2.e. (Capital Regulation of the Board of Governors of the Federal
Reserve).
After the credit equivalent amount is determined for any
derivative, including the catch-all category, a risk weighting is
applied to the credit equivalent amount depending on the nature of the
counterparty. Appendix C, Paragraph II(b)(6)(iv)(A). The maximum risk
weight, however, for the credit equivalent amount of any derivative
contract is 50 percent.
One commenter sought clarification on the effects of collateral
posted by derivative counterparties on the risk weighting of those
derivatives. Appendix C only recognizes certain forms of collateral for
the purposes of risk-weighting: cash, treasuries, U.S. Government
agency securities, securities issued by the central governments of OECD
countries, and securities issued by multilateral lending institutions
or regional development banks in which the United States is a
member.\17\ The portion of the derivative's credit equivalent amount
equal to the fair market value of this collateral is generally risk-
weighted at 20 percent. See Appendix C, Paragraphs II(a)(2)(ii), (vii),
(xiii), and (xv).
---------------------------------------------------------------------------

\17\ Other forms of collateral, or risk-weighting percentages,
may be used for risk-weighting if the derivatives counterparty is a
qualified securities firm. See Appendix C, Sections II(a)(1)(viii)
and II(a)(2)(viii).
---------------------------------------------------------------------------

Another commenter asked whether derivatives used for hedging the
credit risk of other assets in the corporate's portfolio would have a
reduced, or zero, risk weighting. The answer is no. Whether or not a
derivative is used for hedging is not relevant to its risk weighting
for purposes of these Basel I capital ratio calculations.

Appendix C, Paragraph II(c) Risk Weighting of Recourse Obligations,
Direct Credit Substitutes, and Certain Other Positions

Paragraph II(c)(3) Ratings Based Approach (RBA)
One commenter asked for clarification on the discretion of
corporates to choose between a ratings-based, and non-ratings based,
approach to risk weighting for those investments that carry an NRSRO
rating and could be risk-weighted using the RBA. The proposed rule
language could be interpreted as permitting corporates the freedom to
choose their ratings approach if both the general risk weighting and
RBA risk weighting might apply, and, perhaps, to apply differing
approaches to differing securities on the same call report. To ensure
consistency, the Board has added a new paragraph II(c)(3)(iii) to the
final rule to require a corporate that uses RBA risk weighting for one
or more securities on a particular call report use the RBA approach for
all eligible securities on that call report. This requirement is
consistent with how the other banking regulators have addressed this
issue, at least informally. See, e.g., 73 FR 43993 (July 29, 2008)
(``Regardless of the method a banking organization chooses [on a call
report], it would have to use that approach consistently for all
corporate exposures.''). The Board also notes that, currently, RBA is
not permissible under Basel I for corporate debt obligations, even
short-term debt

[[Page 64802]]

obligations.\18\ Without the RBA option, corporate debt will generally
be risk weighted at 100 percent. The Board has determined a lower risk
weight may be appropriate for highly-rated, short term corporate debt
(i.e., an original or remaining final maturity of 120 days or less), as
proposed by the other banking agencies in their Basel II
regulations.\19\
---------------------------------------------------------------------------

\18\ In the proposal, the RBA is only permitted for a position
that is a ``recourse obligation, direct credit substitute, residual
interest, or asset- or mortgage-backed security * * * .''
\19\ [Reserved]

------------------------------------------------------------------------
Risk-weight
Short term rating category percentage
------------------------------------------------------------------------
Highest Investment Grade................................... 20
Second-Highest Investment Grade............................ 50
Third-Highest Investment Grade............................. 100
Below investment grade..................................... 150
No applicable external ratings............................. 100
------------------------------------------------------------------------

Accordingly, paragraph II(c)(3)(ii)(A)(1) is amended in the final
rule to permit corporates the optional use of the RBA for short term
corporate debt.

Section 704.4 Prompt Corrective Action (PCA)

The proposed PCA provisions are similar to those currently
applicable to banks. Under the proposal, each corporate would be
assigned to one of five capital categories: well-capitalized,
adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized. The potential
consequences of failing to meet capital standards include restrictions
on activities, restrictions on investments and asset growth,
restrictions on the payment of dividends, restrictions on executive
compensation, requirements to elect new directors or dismiss
management, and possible conservatorship. The proposed due process for
credit unions and their employees associated with the new PCA
provisions was set out in a new subpart to part 747 of NCUA's rules.
Many commenters thought generally that the imposition of PCA
standards for corporates was a good idea and long overdue. A few
commenters stated that the PCA powers given to NCUA under the proposal
were appropriate, because as long as the possibility exists for
reckless behavior at corporate credit unions, the agency needs the
power to intervene. One NPCU commenter said that it at first thought
the proposal gave NCUA too much power and was overreaching, but then
upon further reflection changed its mind given what has happened and
NCUA's central role to oversee the corporate system. One corporate
commenter specifically stated that the minimum four percent (leverage
and Tier 1 risk based capital ratios) and eight percent (total risk
based capital ratio) were appropriate for adequate PCA capitalization.
Many commenters, however, thought that the proposed PCA provisions
gave NCUA too much discretionary power and room for arbitrary
decisions. Some commenters saw a general need for more clarity and
certainty in the due process and appellate rights associated with PCA
actions. The Board has addressed these concerns with some changes to
the final rule as discussed below.

704.4(a) Purpose

This proposed paragraph set forth the purpose of prompt corrective
action. One sentence, related to the coordination with the state
authorities for state-chartered corporates on discretionary supervisory
activities, was amended and moved in the final rule to paragraph
704.4(f). The amendment is discussed below.

704.4(b) Scope

This proposed paragraph sets forth the scope of the PCA section.

704.4(b)(2) Prohibition on Advertising of PCA Category Without Prior
NCUA Approval

The proposal required that no corporate may state in any
advertisement or promotional material its PCA category unless NCUA
specifically permits such statement or the law requires it. Many NPCU
commenters stated that corporates should be required to disclose their
capital category as the proposed prohibition denies transparency to the
corporate's member/owners and makes it difficult for them to do their
due diligence.
The Board is sympathetic to the concerns of the commenters. The
members of a corporate need some transparency on the corporate's
activities. The members are ultimately responsible for what the
corporate does or does not do, and the members usually have both
capital and uninsured shares at risk in the corporate. NCUA understands
this, and will be taking additional actions in the future, such as
improved call reporting requirements, to increase such transparency, at
least with regard to the balance sheet. In fact, likely 99 percent of
the time, a member will be able to determine a corporate's PCA status
from the call report since NCUA will be requiring that a corporate
report its capital levels, including its Leverage, T1RBC, and Total RBC
ratios, on the call report. If members need additional financial
information beyond the call report, they can request the corporate
provide them the information voluntarily, or even involuntarily in
response to a member petition filed under the member inspection
process. 12 CFR 701.3. And, of course, the members have the ultimate
power over their corporate board, since the members elect--and can
refuse to reelect--board directors who are not responsive to the
members.
NCUA wants to clarify one aspect of the members' rights to
financial information from their corporates. Exam reports, and other
documents prepared by NCUA, or prepared specifically by the corporate
at NCUA's request or in response to an NCUA request, belong to NCUA and
not to the corporate.\20\ The corporate will not be able to release
this information to anyone, including the corporate's members, without
obtaining NCUA's prior approval.
---------------------------------------------------------------------------

\20\ State regulators will likely have similar controls over
their interactions with their state chartered corporates.
---------------------------------------------------------------------------

One commenter agreed with the proposed prohibition on publicizing
PCA category, but thought it needed to be clarified since certain PCA
terms, such as ``adequately capitalized'' and ``well capitalized,'' are
common expressions and could be used unintentionally. The Board
understands that such phrases might be used unintentionally, but
believes it important that corporates strive as much as possible not to
discuss their capital adequacy in the public media.

704.4(c) Notice of Capital Category

The proposal set forth the effective date of a PCA capital
category, and when the corporate must give notice to NCUA of a change
in capital category, and vice versa.

704.4(c)(2)(ii) Notice of Capital Category

This paragraph provides for NCUA notice to the corporate of a
change in capital category. One NPCU commenter complained that this
provision appears to give NCUA the authority to subjectively reclassify
a corporate capital classification based on administrative review, and
the commenter objected to this. The Board notes that this provision
does not give NCUA substantive authority to change a PCA category. Such
authority arises from other provisions, such as 704.3(d)(2) and
704.4(d)(3). These

[[Page 64803]]

provisions each have their own associated due process.

704.4(d) Capital Measures and Capital Category Definitions

The proposal set forth the various PCA capital categories and the
minimum capital ratios for each category.

704.4(d)(3) Authority of NCUA, After Due Process, To Downgrade a
Corporate One PCA Capital Category for an Unsafe or Unsound Condition
or Practice

Some commenters opposed the proposed downgrade authority in
704.4(d)(3) as giving too much power to NCUA examiners and the OCCU
Director. In fact, under the proposal this authority would reside in
the NCUA Board (subject to delegation), not the OCCU Director or
examiners.
One commenter who opposed this provision stated that probably
within the past five years every corporate would have been downgraded
because it had at least one Corporate Risk Information System (CRIS)
rating of three or lower.\21\ Another NPCU commenter expressed concern
that NCUA might use this power to downgrade a corporate to force an
involuntary merger, resulting in a transfer of the NPCU member, and his
capital accounts, to another corporate which the NPCU may not want to
support. Two commenters stated that the rule needed to provide a
corporate with the opportunity, and time, to correct the deficiencies
leading to the adverse CRIS rating before a PCA downgrade. Two of these
commenters noted that during the exam process corporates are given a
time frame to correct deficiencies.
---------------------------------------------------------------------------

\21\ The proposal, however, does not require NCUA enforce a PCA
downgrade because of a low CRIS rating--it only empowers the NCUA
Board to take such action.
---------------------------------------------------------------------------

The Board believes the discretionary authority vested in it by
proposed 704.4(d)(3) to downgrade a corporate is appropriate. The Board
notes that it would not normally authorize a downgrade of a corporate
based solely on a negative CRIS rating until the corporate had had a
reasonable opportunity to correct the deficiencies underlying the CRIS
rating.
The Board also notes that it is highly likely that there will be
some corporate combinations in the coming years. While most of these
mergers would be voluntary, some might be involuntary. NPCUs should
take this fact into account when deciding which corporate they will use
for services and how much capital they are willing to contribute to
that corporate.

704.4(d)(4) Modification of Minimum PCA Percentages

Proposed 704.4(d)(4) permits the NCUA, for good cause, to modify
any of the minimum PCA percentages for a particular corporate as
provided for in 704.3(d). A few commenters objected to this provision
because they thought this proposal transfers power from the NCUA Board
to the OCCU Director. Again, this authority is simply a cross reference
to the authority in 704.3(d). There is no delegation to the OCCU
Director, and 704.3(d) provides the affected corporate with due
process.

704.4(e) Capital Restoration Plans

The proposal described when a corporate must file a plan with the
NCUA, the contents of the plan, the consequences for failure to file a
plan, and NCUA's processing and approval of the plan.

704.4(e)(5) Disapproval of Capital Plan

Proposed 704.4(e)(5) provides that if an undercapitalized corporate
does not submit a capital restoration plan acceptable to NCUA the
corporate will be downgraded to significantly undercapitalized.
Two commenters protested that this allows the Director of the OCCU
to treat a corporate that is undercapitalized the same as if it was
significantly undercapitalized, and allows the Director to do so for an
undue length of time. The Board disagrees. The PCA provisions encourage
a corporate to file a timely and realistic capital restoration plan. If
a corporate fails to do that, the Board must have the authority to take
appropriate action to protect the corporate, its members, and the
NCUSIF. In addition, the proposal makes no delegation to the OCCU
Director.

704.4(f) Mandatory and Discretionary Supervisory Actions

This proposed paragraph sets forth various mandatory and
discretionary PCA actions depending on a corporate's PCA category. One
commenter thought that the PCA supervisory actions that come into play
depending on the corporate's PCA capital categories, and which are
variously labeled within the proposal as mandatory or discretionary at
the given capital category, should never be mandatory. Instead, they
should all be discretionary with NCUA. The Board disagrees. The Board
wants corporates to know, with certainty, that certain PCA effects will
happen if a corporate falls into a particular PCA category.
A few commenters asked that, for discretionary PCA actions against
state chartered corporates, if NCUA determines such an action is
appropriate, NCUA give the appropriate state supervisory authority
(SSA) an opportunity to take the action separately from, or jointly
with, NCUA. As pointed out by the commenters, this approach is
consistent with NCUA's PCA rules for NPCUs located in paragraph
702.205(c) of part 702. Accordingly, the final rule amends paragraph
704.4(f)(2) to permit the appropriate SSA an opportunity to take
discretionary PCA actions independently from, or jointly with, NCUA.

704.4(g) Directives to Take Prompt Corrective Action

The proposed paragraph requires advance notice of pending
directives to significantly and critically undercapitalized corporates.
There were no significant comments on this paragraph.

704.4(h) Procedures for Reclassifying a Corporate Credit Union Based on
Criteria Other Than Capital

The proposed paragraph requires advance notice of intent to
reclassify and makes reference to the associated due process provision.
There were no significant comments on this paragraph.

704.4(i) Order to Dismiss a Director or Senior Executive Officer

The proposed paragraph provides that affected individuals are
entitled to a copy of the order or directive provided to the corporate,
along with notice of the right to seek reinstatement. The paragraph
also makes reference to the associated due process. There were no
significant comments on this paragraph.

704.4(j) Enforcement of Directives

The proposal cross references Sec. 747.3005 as the source of the
process for enforcing PCA directives. There were no comments on this
paragraph.

704.4(k) Remedial Actions Towards Undercapitalized, Significantly
Undercapitalized, and Critically Undercapitalized Corporate Credit
Unions

The proposal prescribes certain remedial actions for corporates in
these PCA categories.

704.4(k)(1) Prohibition on Undercapitalized Credit Union Paying
Dividends on Capital Accounts

Proposed 704.4(k)(1) prohibited a corporate credit union from
making any capital distribution, including payment of dividends on
perpetual and nonperpetual capital accounts, if, after

[[Page 64804]]

making the distribution, the credit union would be undercapitalized.
A few commenters supported this prohibition. Many commenters,
however, were opposed to this prohibition, generally saying that this
undermined the attractiveness of capital accounts and would discourage
recapitalization of the corporate credit union system, and that the
decision on payment of dividends should be left to the corporate's
board of directors. One commenter stated that this prohibition could
perpetuate the undercapitalized condition. Several of these commenters
stated that this prohibition should be limited to significantly or
critically undercapitalized corporates. Several others said that this
prohibition should be tied to some sort of minimum RE ratio, not the
fact that the corporate may be undercapitalized.
The Board disagrees with the commenters that oppose the
prohibition. When a corporate is undercapitalized, the payment of
dividends on existing capital depletes the corporate's RE and worsens
the corporate's capital position, increasing the odds of the
corporate's failure. The Board disagrees with those commenters that
believe that a corporate must be significantly undercapitalized before
it is in true capital trouble. The undercapitalized PCA category
indicates serious capital problems that the corporate must address, and
anything that undermines capital retention and growth in the
undercapitalized PCA category must be controlled. The Board notes that
this prohibition on the payment of dividends at undercapitalized
corporates is also consistent with the Basel capital regulations of the
other banking regulators.
The Board does believe that the NCUA's authority to waive the
prohibition as stated in the proposal is unnecessary (due to 704.1(b)),
and perhaps even harmful, as this internal waiver language suggests
that the NCUA might grant such dividend waivers as a matter of routine.
Accordingly, the final rule eliminates the NCUA waiver authority from
the text of 704.4(k)(1).

704.4(k)(2)(v) Discretionary Safeguards

This proposed paragraph stated that NCUA may, with respect to any
undercapitalized corporate credit union, take one or more of the
actions described in paragraph (k)(3)(ii) (e.g., for significantly
undercapitalized corporates) if the NCUA determined those actions are
necessary to carry out the purpose of the PCA section.
Many commenters thought this proposed paragraph went too far.
Several of these commenters mischaracterized this authority as residing
with the OCCU Director when, in fact, under the proposal this authority
would reside in the NCUA Board (subject to delegation). Some commenters
stated that under this provision, the NCUA could fire any employee and
or remove any board at any existing corporate today, and will be able
to do so for years to come as long as the corporates remain
undercapitalized. One commenter called this provision outrageous, and
two others questioned its constitutionality. Another commenter said
these powers should be reserved only for corporates categorized as
either significantly or critically undercapitalized.
The Board agrees with this last commenter, and has eliminated this
proposed paragraph from the final rule.

704.4(k)(6)(ii)(C) Restricting the Activities of Critically
Undercapitalized Corporates

Proposed paragraph 704.4(k)(6)(ii)(C) prohibits a critically
undercapitalized corporate from amending its charter or bylaws without
the prior approval of the NCUA, except as necessary to carry out any
other requirement of law, regulation, or order.
A few commenters stated that this usurped the authority of state
regulators over state charters. The Board disagrees. A corporate that
is critically undercapitalized represents a significant risk to the
NCUSIF. Accordingly, the NCUA must have control over any significant
activities that corporate might undertake, including, but not limited
to, charter changes that affect the control or governance of the
corporate.
Proposed paragraph 704.4(k)(6)(ii)(F) prohibited a corporate from
paying interest on new or renewed liabilities at a rate that would
increase the corporate credit union's weighted average cost of funds to
a level significantly exceeding the prevailing rates of interest on
insured deposits in the corporate credit union's normal market areas.
One commenter stated that corporates under PCA should not be restricted
to dividend rates in the region the institution is located since some
corporates have national fields of membership.
The Board notes that most corporates, even with national FOMs, have
a concentration of members within a particular area of the country. In
the case of a corporate which has no such identifiable concentration,
the market area of the corporate would be the entire nation.
Accordingly, the Board sees no need to amend the paragraph as proposed.

704.8(j)(2)(ii) Proposed PCA Downgrade for Failure To Correct NEV Test
Failures

The proposed paragraph 704.8(j)(2) in the asset liability section,
would require PCA category downgrades for failure to correct NEV test
failures. One commenter recommended that PCA compliance and regulatory
remedies be eliminated for the NEV type testing, stating that there was
no precedent for the application of PCA beyond the three ``routine
capital measures.'' The Board strongly disagrees. Corporates must
comply with the corporate rule's NEV requirements. And, if a corporate
fails to comply, NCUA must have the supervisory tools to deal with such
noncompliance. The PCA downgrade provisions in 704.8(j)(2)(ii) provide
the NCUA with the necessary tools.
One commenter suggested that there should be a phase-in period for
the new PCA requirements, but this commenter did not indicate whether
the desired phase-in was over and above the 12 months currently
envisioned under the proposal. The final rule retains the one-year
phase-in of the PCA provisions as proposed.
Except as discussed above, the Board adopts the final Sec. 704.4
as proposed.
The proposal also included a new subpart M to Part 747, setting
forth the procedures and due process available in connection with the
PCA provisions of Sec. 704.4. The proposal adopts subpart M as
proposed.

704.5 Investments

704.5(a) Through 704.5(g)

The proposal did not contain any amendments to these seven
paragraphs, and they remain as in the current rule.

704.5(h) Prohibitions

The proposed paragraph 704.5(h) added prohibitions on corporate
credit unions investing in collateralized debt obligations (CDOs) and
net interest margin securities (NIMs).
Many commenters supported the prohibition on CDOs and NIMs, and the
final rule retains these prohibitions. Many commenters also stated a
desire for additional restrictions on corporate investments. These
additional restrictions ranged from limiting corporate credit unions to
investing only in government securities to additional prohibitions on
securities, including residential mortgage-backed securities (RMBS) and
subordinated securities that caused the credit union industry so much
of a loss. NCUA hired

[[Page 64805]]

Kamakura Corporation (Kamakura) to assist in analyzing the proposed
rule, and Kamakura also recommended prohibiting investments in
subordinated securities and placing further limits on private label
RMBS.\22\
---------------------------------------------------------------------------

\22\ Kamakura Report, p. 10.
---------------------------------------------------------------------------

The Board agrees with these commenters and, accordingly, has added
a new paragraph (h)(7) to the final rule to prohibit corporates from
investing in private label RMBS. Private label RMBS are not guaranteed
by the United States Government, its agencies, or its sponsored
enterprises. The RMBS' underlying assets, residential mortgage loans,
are also more sensitive to macro-economic factors than other
investments available to corporate credit unions. In fact, of the
current combined losses at Western Corporate Federal Credit Union
(WesCorp) and U.S. Central Federal Credit Union (U.S. Central), over 95
percent were related to private label RMBS. NPCUs also invest directly
in residential mortgages, and by prohibiting corporates from purchasing
private label RMBS, the pro-cyclical nature of corporate and NPCU
balance sheets is also diminished. Given the lack of a guarantee, the
sensitivity of mortgages to macro-economic factors, the concentration
of mortgages on the balance sheets of natural person credit unions, and
the recent history of corporate investments, the NCUA Board believes a
prohibition on private label RMBS is warranted.

704.2 Definition of Private Label Security

The final rule defines private label security as ``a security that
is not issued or guaranteed by the U.S. government, its agencies, or
its government-sponsored enterprises (GSEs).''

704.2 Definition of Residential Mortgage-Backed Security

One commenter noted that while the proposed rule defined the terms
``residential property'' and ``residential mortgage backed security,''
the proposed definition of RMBS did not include the use of the phrase
``residential property.'' The Board agrees that, for precision, the
RMBS definition should refer to ``residential property,'' and the final
rule now defines RMBS as ``a mortgage-backed security collateralized
primarily by mortgage loans on residential properties.'' Also, as a
point of clarification, this 704.2 definition of RMBS includes not only
securities primarily backed by first lien residential mortgages, but
also securities primarily backed by other-than-first-lien residential
mortgages, such as home equity loans.

704.5(h)(8) Prohibiting Subordinated Securities

The Board has also added a new paragraph 704.5(h)(8) to the final
rule prohibiting investment in subordinated securities. Subordinated
securities present greater credit risk, liquidity risk, and price
volatility than more senior securities. Losses on subordinated
securities may at times reach 100 percent of principal, even when a
more senior security in the same issuance may only lose pennies on the
dollar. In fact, over 48 percent of the current combined losses
incurred by WesCorp and U.S. Central are attributable to subordinated
securities, mostly subordinated RMBS.

704.2 Definition of Subordinated Security

The proposal defined subordinated security in Sec. 704.2 as ``[a]
security that has a junior claim on the underlying collateral or assets
to other securities in the same issuance. If a security is junior only
to money market fund eligible securities in the same issuance, the
former security is not subordinated for purposes of this definition.''
The final rule retains this definition, but adds the words ``at the
time of purchase'' because a subordinated security can lose its
subordination as the more senior tranches are paid down. The final rule
also moves the existing prohibition on purchasing stripped MBS from
paragraph (h)(7) to (h)(9).
The relationship between the other investment, credit risk, and ALM
prohibitions, and these two 704.5(h) prohibitions on private label RMBS
and subordinated securities, is discussed in more detail below.
Accordingly, and except as described above, the Board adopts the
final Sec. 704.5, and associated definitions, as proposed.

704.6 Credit Risk Management

The proposed Sec. 704.6 included tighter single obligor limits and
new sector concentration limits. The proposal also required that all
corporate investments, other than in another corporate or CUSO, have a
minimum credit rating from all publicly available NRSROs of no lower
than AA- for long-term ratings and A-1 for short-term ratings.
Additionally, 90 percent of corporate investments must have at least
two NRSRO ratings.
Several commenters thought the proposed tightening of the existing
single obligor limits, and establishing of new sector limits, was a
positive change, and some asked for even tighter restrictions. On the
other hand, several commenters thought the proposed limits were too
tight and may increase risk and limit the corporates' ability to manage
their businesses and balance sheets efficiently. The Board agrees that
some of the proposed limits should be tightened and others relaxed, as
discussed below.

704.6(a) Policies

The proposal did not contain any amendments to this paragraph.

704.6(b) Exemptions

The proposed paragraph 704.6(b) exempted certain assets from both
the sector concentration limits and the single obligor concentration
limit, including fixed assets, loans, investments in CUSOs, investments
issued by the United States or its agencies or its government sponsored
enterprises, and investments fully guaranteed or insured as to
principal and interest by the United States or its agencies.
Several commenters believed settlement funds should also be exempt.
These commenters were concerned that the tight single obligor limit
would force corporates to find many additional settlement
counterparties given the proposed tighter limit of 25 percent of
capital per obligor. The commenters were particularly concerned about
seasonal patterns that cause settlement activity to fluctuate
throughout the year and could potentially cause violations of the
single obligor limits.
The Board agrees with these concerns, and has added settlement
funds in federally insured depository institutions to the list of
exempt investments in the final 704.6(b). The Board has also added a
definition of settlement funds to the final Sec. 704.2 to read as set
forth in the regulatory text of this rule.
Corporates must take care to properly classify settlement funds and
not include non-settlement short-term investments in this category.
Generally, the characteristics of settlement funds are: (1) Funds are
used for immediate-value transactions (transactions that must be paid
for immediately to be processed or have a particular value at the time
of processing); (2) Funds are used to settle transactions from
institutions such as clearing houses, banks, payment processors, and
other credit unions; and (3) Funds are used for same-day settlement
accounts, or in the case of automated clearing house transactions
within a few days. The amount of money a corporate classifies as
``settlement funds'' at a third party for purposes of exclusion from
the 704.6

[[Page 64806]]

single obligor limit should also be no more than the third party
requires under the terms of its settlement policies.
The proposed 704.6(b) had a complete exemption for agency MBS, but
the Board has instead determined not to exempt such MBS. Rather, the
Board intends to permit investment in MBS, including agency MBS,
subject to concentration limits described below. Accordingly, the final
rule amends the 704.6(b) exemption for ``investments that are issued or
fully guaranteed as to principal and interest by the U.S. government or
its agencies or its sponsored enterprises'' by adding the words ``other
than mortgage backed-securities'' at the end. Also, the reference to
subordinated securities is eliminated from the final rule since such
securities will be prohibited.

704.6(c) Issuer Concentration Limits

The proposed 704.6(c) tightens the single obligor limits to 25
percent of capital, subject to certain enumerated exceptions.
In addition to the enumerated exceptions, many commenters felt
short-term investments, such as federal funds, should have either a
relaxed single obligor limit, or be exempt from the single obligor
limit, due to the lower risk associated with these transactions. The
Board agrees. Investments of shorter maturity present less credit risk,
all else being equal. Still, it is not appropriate to exempt these
short term investments from some limit, as these obligations (including
federal funds) do have some credit risk. Accordingly, the Board adds a
new paragraph (c)(2)(i) to the final rule limiting investments in one
obligor to 50 percent of capital where the remaining maturity of all
obligations with that obligor are less than 30 days.
In general, the obligor in a securitization situation will be the
Qualified Special Purpose Entity (QSPE) trust that issues the
securities. Some commenters were concerned that there were very few
potential obligors in the credit card ABS sector, particularly given
the prevalence of ``master'' QSPE trusts, and so the single obligor
limitation could keep corporates from making any significant
investments in the credit card ABS sector. Accordingly, the final rule
adds a new paragraph 704.6(c)(2)(ii) to the final rule relaxing the
single obligor limitation for credit card master trusts to 50 percent
of capital. The Board observes that credit card ABS, both as a sector
and as individual securities, have withstood both systemic and issuer
shocks since these ABS were first issued. Given the sector's relative
safety and the limited number of potential counterparties, NCUA
believes a 50 percent obligor limitation for these master trusts is
appropriate.

704.2 Definition of Obligor

The final rule amends this definition to clarify that, for purposes
of securities issued out of a trust, such as a Qualified Special
Purpose Entity (QSPE) trust, the trust itself is the obligor.

704.6(d) Sector Concentration Limits

NCUA proposed, as part of its sector concentration limits, that
private label RMBS be limited to the lower of 500 percent of capital or
50 percent of assets. Some commenters, and Kamakura, were concerned
that these limits were not tight enough. Kamakura recommended tighter
limits for both commercial mortgage-backed securities (CMBS) and
private label RMBS and a combined limit for the MBS sectors due to the
higher correlation of mortgages to macro-economic factors.\23\ Kamakura
recommended a sector limit of 15 percent of the portfolio each for both
CMBS and private label RMBS, and a combined sector limit of 25 percent
of the portfolio. As discussed earlier, the final rule prohibits
private label residential MBS. The Board also agrees a tighter limit
for the CMBS sector is appropriate. Additionally, the Board believes an
overall restriction on the amount of MBS, including agency MBS, is
appropriate due to the additive nature of the corporates' concentration
exposure when considered along with NPCU mortgage exposure.
---------------------------------------------------------------------------

\23\ Kamakura Report, p. 10.
---------------------------------------------------------------------------

Accordingly, the Board amended the final paragraph (d)(1)(i) to
limit all MBS, inclusive of commercial mortgage-backed securities, to
the lower of 1000 percent of capital or 50 percent of assets.
Additionally, the final rule revises paragraph (d)(1)(ii) to tighten
the limit on CMBS to the lower of 300 percent of capital or 15 percent
of assets.
Paragraphs (d)(1) and (d)(2) establish sector concentration limits
for specified investment types, and paragraph (d)(3) establishes a
general, aggregate limit of 100 percent of capital or 5 percent of
assets for any other investment type not described in (d)(1) or (d)(2).
Some commenters were concerned that investments in federal funds might
be included in the (d)(3) limit since fed funds were not specifically
enumerated in the other sectors and were not generally exempt under
704.6(b). The Board recognizes that corporate credit unions need
flexibility to engage in short-term investments and agrees that federal
funds transactions with federally insured depository institutions
should be explicitly excluded from the sector concentration limits in a
manner similar to deposits in those institutions. Accordingly, the
final rule amends paragraph (d)(4) to explicitly exclude federal funds
investments in other federally insured depository institutions from
sector concentration limits.

704.6(e) Corporate Debt Obligation Subsector Limits

The proposed paragraph 704.6(e) set out concentration limits for
subordinated securities. Since the final 704.5(h) outright prohibits
subordinated securities, the proposed text is no longer necessary and
has been deleted from the final rule and replaced with a different
provision, as discussed below.
The proposed 704.6(d)(1)(viii) limited corporate debt obligations
to the lower of 1000 percent of capital or 50 percent of assets. Some
commenters, including some trade associations, thought these limits
were not restrictive enough. Some of these commenters recommended that
NCUA further restrict concentrations in corporate debt by industry. The
NCUA Board agrees. The final rule replaces the proposed 704.6(e) with a
new 704.6(e) establishing subsector limits for corporate debt
obligations. The final rule limits corporate debt to the lower of 200
percent of capital or 10 percent of assets for each of the 20 North
American Industry Classification System (NAICS) industry sectors. The
20 NAICS sectors are listed in the following table:

------------------------------------------------------------------------
Industry Industry
Code classification Code classification
------------------------------------------------------------------------
11................ Agriculture, 53 Real Estate and
Forestry, Rental and
Fishing and Leasing.
Hunting.
21................ Mining, 54 Professional,
Quarrying, and Scientific, and
Oil and Gas Technical
Extraction. Services.
22................ Utilities........ 55 Management of
Companies and
Enterprises.
23................ Construction..... 56 Administrative
and Support and
Waste Management
and Remediation
Services.

[[Page 64807]]

31-33............. Manufacturing.... 61 Educational
Services.
42................ Wholesale Trade.. 62 Health Care and
Social
Assistance.
44-45............. Retail Trade..... 71 Arts,
Entertainment,
and Recreation.
48-49............. Transportation 72 Accommodation and
and Warehousing. Food Services.
51................ Information...... 81 Other Services
(except Public
Administration).
52................ Finance and 92 Public
Insurance. Administration.
------------------------------------------------------------------------

These subsector limits will ensure more diversification in
corporate debt obligations and reduce correlation risk due to excessive
concentrations in any single subsector, particularly the finance
subsector.

704.6(f) Credit Ratings

As discussed above, the proposed paragraph 704.6(f) required that
corporates consult all publicly available NRSRO ratings and use those
ratings to screen potential investments.
Several commenters and Kamakura expressed concerns regarding
reliance on credit ratings provided by NRSROs. Kamakura recommended
corporates not look to NRSRO ratings and instead implement a macro
economic analysis approach to evaluating credit risk and conduct their
own internal analysis on the probability of default of any given
securities.\24\ The current 704.6(a), which NCUA did not amend in this
rulemaking, requires that a corporate adopt a credit risk policy and
evaluate the credit risk of individual securities. Still, the Board
disagrees with the idea that NRSRO ratings have no value and that they
should be entirely ignored when conducting credit analysis on a
particular security. NRSRO ratings are useful tools when used, as in
the proposed 704.6(f), only to exclude, not include, securities as
potential corporate investments. Corporates must do additional credit
analysis on each security that passes the initial NRSRO ratings screen,
and each security that passes the NRSRO screen must comply with each
and every one of the other investment, credit risk, and ALM provisions
of this final rule.
---------------------------------------------------------------------------

\24\ Kamakura report, pp. 8-10.
---------------------------------------------------------------------------

704.6(g) Reporting and Documentation

The proposal did not contain any amendments to this paragraph.
Accordingly, and except as described above, the Board adopts the final
Sec. 704.6 as proposed.

704.8 Asset and Liability Management (ALM)

The proposed Sec. 704.8 contained several new ALM provisions,
including a modification to the provision on early withdrawal
penalties, two cash flow mismatches limits, a new 2-year limit on the
WAL of a corporate's assets, and a requirement to measure net interest
income. Some commenters were in favor of the revisions in the proposed
rule. Many commenters, however, objected to different provisions within
the proposed rule, generally complaining about the complexity and
efficacy of the multi-level testing in proposed paragraphs 704.8(e),
(f), and (g). As discussed below, the Board has made several changes
from the proposed Sec. 704.8 to the final.

704.8(a) Policies

Proposed paragraph 704.8(a)(6) contained a conforming change to
reference the two proposed cash flow mismatch sensitivity tests.
Because, as discussed below, these tests are not adopted in the final
rule, the conforming amendment has been removed from paragraph (a)(6).

704.8(b) Asset and Liability Management Committee (ALCO)

The proposal did not contain any amendments to this paragraph.

704.8(c) Penalty for Early Withdrawals

The proposal limited a corporate's ability to pay a market-based
redemption price to no more than its book value, thus eliminating the
corporate's ability to pay a premium on early withdrawals. Hundreds of
commenters objected to this prohibition, arguing that the proposed
prohibition on premiums would make corporates less competitive with
their certificates, and thus reduce corporate liquidity on the front-
end. The NCUA Board agrees now that prohibiting a premium is not likely
to protect the corporate's liquidity, and could interfere with the
corporate's competiveness, and so the Board determined not to adopt the
final 704.8(c) as proposed. Instead, paragraph 704.8(c) will remain as
in the current rule. Some comments also indicated that all corporates
are not applying the current rule correctly. For example, the Board
noted a corporate may base its market-based penalty on the asset values
the certificate is matched against, and so the redemption value would
decline as the value of the underlying assets decline. This methodology
violates the current regulation's requirement that penalties be based
on the cost of replacing the lost funds.
The following example illustrates the application of the rule in a
premium situation.
Assume a corporate is offering 2-year certificates at a 2-percent
coupon, and 1-year certificates at a 1.5-percent coupon, and that the
corporate then issues a 2-year certificate to ``NPCU A.'' One year
later, assume NPCU A wishes to redeem the certificate and that interest
rates have dropped, so that the corporate is now issuing 1-year
certificates at 1 percent. That would make the replacement cost of the
original certificate approximately 100 basis points (BP) (assuming the
corporate can immediately issue a new certificate), but the dividend
rate on the original certificate is more than that, at 200 BP. So the
net savings for the corporate because of the early redemption is 100
BP. NCUA would then expect the corporate, at a minimum, to redeem this
certificate at a premium of nearly 100 BP, but subtract some penalty
spread to account for the uncertainty, and expense, in actually issuing
a replacement certificate. Using this methodology and a penalty spread
of, say, 25 BP, the 2-year certificate will be redeemed at an
approximate price of 100.75. The market-based penalty, then, would
technically be 25 BP, which reduced the 100 BP premium to 75 BP.

704.8(d) Interest Rate Sensitivity Analysis

The proposal did not contain any specific amendments to this
paragraph. However, the final rule clarifies that for interest rate
risk (IRR) tests conducted ``at least quarterly,'' at least one of the
tests must be conducted on the last day of the calendar quarter.
Traditionally, the last day of the quarter has been used by the
corporates, and this clarification ensures consistency in measurement
periods. Additionally, if ``at least monthly'' testing is required
because NEV ratio falls below three percent, the last day of the month
must also be one of the testing dates.

[[Page 64808]]

(Proposed) 704.8(e) Cash Flow Mismatch Sensitivity Analysis

See discussion in next paragraph.

(Proposed) 704.8(f) Cash Flow Mismatch Sensitivity Analysis With 50
Percent Slowdown in Prepayment Speeds

The proposal established new limits on cash flow mismatch
sensitivity tests. Although the proposed tests were structured in terms
of the effect on NEV of an immediate 300 basis point increase in the
yield demanded by investors, the effect of the proposal was to ensure
that the gap between the average life of a corporate's assets and its
liabilities would remain within a few months and so not present
extensive liquidity and market risk to the corporate.
Many commenters thought the two proposed cash flow mismatch
sensitivity tests were too restrictive. Other commenters thought these
tests were too complicated. Some commenters did not understand the
tests were measuring the risk associated with cash flow mismatches, and
these commenters discussed spread widening based on historical averages
for such widening. Kamakura recommended eliminating the paragraph (e)
and (f) stress tests, stating that these tests pose a potential burden
on corporate credit unions, greatly reduce the number of securities
available for investment, and do not appear to identify securities with
differences in credit performance meaningfully related to the
performance of securities throughout the credit crisis.
The Board generally concurs with these commenters and Kamakura, and
the two proposed cash flow mismatch tests have been removed from the
final rule. The elimination of the these two tests will allow
corporates to have a larger mismatch between asset and liability cash
flows, which increases earnings potential but also increases credit and
liquidity risk. To mitigate this increased risk, the NCUA Board has
retained the proposed 2-year WAL on assets and added an asset WAL
extension test as discussed below.

(Proposed) 704.8(g), (Final) 704.8(e) Net interest income modeling

In addition to this NEV testing, the proposal required every
corporate conduct net interest income (NII) modeling. The Board did not
receive any significant comments on this provision, other than ones
stating that corporates already did this modeling as a matter of
policy. The final rule amends the timing of the modeling to read ``be
performed at least quarterly, including once on the last day of the
calendar quarter.'' As discussed above, this change ensures consistency
in the modeling results. This paragraph is also renumbered as paragraph
704.8(e) in the final.

(Proposed) 704.8(h) (Final) 704.8(f) Weighted Average Asset Life

The proposal prohibited the weighted average life (WAL) of a
corporate's loans and investment portfolio, excluding derivatives and
equity investments (e.g., investments with indefinite maturities such
as PIC and CUSO investments), from exceeding two years.
The primary purpose of this restriction in the proposal was to
ensure that a corporate did not artificially inflate the WAL of its
liabilities so as to get around the asset--liability cash flow mismatch
limits. Many commenters objected to the 2-year asset WAL restriction.
Some of these commenters were concerned that the 2-year WAL
restriction would prevent corporates from providing long term liquidity
loans to NPCUs. Loans over two years in maturity are not generally
liquidity loans--they are loans used for term balance sheet funding to
match off against longer-term loans or to fund portfolio growth. Since
a corporate's primary role in lending is as a liquidity provider of
short-term loans, NPCUs cannot rely on corporates to provide term
lending in significant amounts. NPCUs have other viable options for
longer-term funding such as the Federal Home Loan Bank system, which
provides both fixed rate and variable rate lending.
With the elimination of the cash flow mismatch tests in proposed
paragraphs 704.8(e) and 704.8(f), the NCUA Board believes it is very
important to retain the proposed 2-year WAL restriction on the
investment portfolio. This 2-year limit forces corporates to
accommodate to the fact that corporates are, first and foremost,
providers of payment systems, which, in turn, requires some matching of
the investment portfolio to the short term payment liabilities to
ensure liquidity for the payments system. Providing liquidity to NPCUs,
particularly long-term liquidity, is of secondary importance to this
payment systems function.\25\ Still, the 2-year WAL restriction is a
portfolio-wide restriction, and the WAL restriction will allow
corporates to make limited amounts of term loans exceeding two years in
maturity if those loans are matched by other corporate assets of less
than two year maturities.
---------------------------------------------------------------------------

\25\ Providing investments on a principal basis will be even
less of a priority in the corporate business model going forward.
---------------------------------------------------------------------------

Some of the commenters thought the 2-year asset WAL would prevent a
corporate from being able to earn sufficient spread to build retained
earnings in a timely manner. As discussed in more detail below in
connection with some hypothetical corporate portfolios, the Board does
not believe this is true. In fact, as suggested in the Kamakura report,
the proposed cash flow mismatch tests were in most cases the
determining factor in limiting a corporate's ability to populate its
investment portfolio with ABS and MBS that generated higher yields for
the corporate. Under the proposed 704.8(e) cash flow mismatch test, and
assuming a 4 percent NEV, a corporate's asset WAL could not exceed its
liability WAL by more than about 3 months without violating proposed
704.8(e). That meant that if the WAL of the corporate's liabilities was
about 8 months--which is about the current average for corporates--then
the corporate's asset WAL could only be about 11 months. Since the
final rule will not contain the proposed cash flow mismatch tests, this
corporate can take its asset WAL all the way out from 11 months to 2
years, generating more earning power (assuming an upward sloping yield
curve). NCUA expects the WAL of a corporates' liabilities to remain
relatively short going forward as they focus on the payment systems
function. Accordingly, the elimination of the cash flow mismatch tests
will have an even greater positive impact on corporates' ability to
maintain longer assets and generate earnings from such assets.\26\
---------------------------------------------------------------------------

\26\ Though a corporate is still bound by the IRR NEV
constraints in paragraph 704.8(d).
---------------------------------------------------------------------------

The proposal required that a corporate assume, when calculating the
WAL, that no issuer options will be exercised. For example, the
corporate cannot assume that an issuer will execute a clean-up call.
The final rule also requires that the corporate not assume that any
market options will be exercised. This requirement addresses the
failure of auction rate securities. During the credit crisis, auction
rate securities, initially considered by some to have a maturity of
approximately one month, extended out in some cases to 15 or 20 years
when the auction failed.
The final rule also provides that if the WAL of a corporate credit
union's investment portfolio exceeds two years on the testing date,
this WAL must be measured more frequently. In that case the measurement
must be taken at least monthly, including once on the last day

[[Page 64809]]

of the month, until the WAL is once again below two years.
With the elimination of the cash flow mismatch tests in paragraphs
704.8(e) and 704.8(f), the proposed WAL limit has been renumbered in
the final rule from 704.8(h) to 704.8(f).

704.2 Definition of Weighted Average Life

The current Sec. 704.2 definition of weighted average life uses a
calculation based on the average time for a return of a dollar of
principal. Although stripped MBS are generally impermissible for
corporates, it is possible that a corporate might hold some sort of
stripped interest only (IO) security that has no principal return.
Accordingly, the Board amends the final definition of weighted average
life to include for IO securities a calculation based on the average
time to the expected receipt of a dollar of interest.

(Final) 704.8(g) Weighted Average Life With 50 Percent Slowdown in
Prepayment Speeds

As discussed above, the Board's decision to forgo the proposed cash
flow sensitivity tests increases the importance of the proposed 2-year
asset WAL in protecting the payment systems from excessive risk. In
addition to the 2-year WAL restriction, and to protect against
extension risk, the Board has added a new paragraph 704.8(g) to the
final rule limiting asset WAL extension to 2.25 years assuming a 50
percent slowdown in prepayment speeds, regardless of asset type.
In the past, many market participants believed that lower interest
rates would create faster prepayment speeds in residential MBS. During
the recent credit crisis, however, prepayment speeds slowed
substantially in many RMBS, even with lower interest rates. In some
cases, a prepayment slowdown can produce radical increases in the WAL
of a security (e.g., in excess of one thousand percent), particularly
in support tranches. Accordingly, this new 50 percent slowdown test
limits the extension risk, and the related credit and liquidity risk,
that a corporate can accept into its portfolio. This new 704.8(g) WAL
test with prepayment slowdown is similar to the proposed 704.8(f) cash
flow mismatch sensitivity test with prepayment slowdown that the Board
is not adopting, except that this new 704.8(g) is simpler to calculate
and not as restrictive as the proposed 704.8(f).

704.8(h) Government Issued and Guaranteed Securities

Many commenters thought securities that are issued or fully
guaranteed as to principal and interest by the U.S. government or its
agencies or its sponsored enterprises should be exempt from the cash
flow mismatch and 2-year WAL restrictions. The most common argument was
the absence of credit risk in these securities.
The Board is sympathetic to this concern, and so the final rule
allows the WAL of securities that are issued by, or fully guaranteed as
to principal and interest by, the U.S. government or its agencies or
its sponsored enterprises to be multiplied by a factor of 0.50 when
determining the WAL of a corporate's entire portfolio. So, for example,
a 4-year WAL agency security will be treated as if it has a 2-year WAL
for purposes of the WAL calculations in paragraph 704.8(f) and (g). The
Board also considered exempting government securities from both the
asset WAL tests, but concluded that such an exemption was not
appropriate because these securities do have some market volatility.
The Board determined to use the 0.50 factor because it provides
corporate credit unions with a material measure of relief from the WAL
calculation without creating undue market risk. Small factors, such as
0.25, would not provide a significant benefit to the corporates, while
larger factors, such as 0.75, raised concerns over market risk and the
potential negative effects on NEV. During the global credit crisis,
even agency RMBS spreads widened significantly between October 2008 and
November 2008. During this period, spreads between the Bloomberg
generic 5-year Fannie Mae Benchmark and the swap curve widened by 111
BP, introducing significant market risk on these securities. Other
Bloomberg generic indices also widened significantly, with the longer
term benchmarks widening even more. The Board believes the 0.50 factor
provides the best balance between WAL relief and ensuring that
corporate NEV positions are protected.

704.8(i) Effective and Spread Durations

The proposed paragraph 704.8(i) required a corporate measure at
least once a quarter, the effective duration and spread durations of
each of its assets and liabilities, where the values of these are
affected by changes in interest rates or credit spreads. There was no
significant comment on this provision. The Board determined to clarify
the timing of the tests by inserting the phrase ``including once on the
last day of the calendar quarter.'' Otherwise, this paragraph was
finalized as proposed.

704.8(j) Regulatory Violations

The proposed paragraph 704.8(j) required that a corporate take
action to report, and cure, violations of Sec. 704.8. The proposal
also stated that if the corporate could not timely cure the violation,
the corporate would suffer a PCA downgrade.
One commenter thought it inappropriate to tie the failure of ALM
tests to PCA downgrades. The Board disagrees. A corporate must maintain
its NEV levels, and protect those NEV levels from credit, extension,
and liquidity risk. A PCA downgrade, and the associated PCA provisions
in Sec. 704.4, give the Board the necessary tools to deal with a
corporate's failure to meet important regulatory requirements.

704.8(k) Overall Limit on Business Generated From Individual Credit
Unions

The proposed paragraph 704.8(k) prohibited a corporate from
accepting from a member or nonmember credit union or other entity any
investment, including shares, loans, PCC, or NCAs if, following that
investment, the aggregate of all investments from that member or entity
in the corporate would exceed 10 percent of the corporate credit
union's moving daily average net assets.
Hundreds of commenters opposed this limit on business from
individual entities. Some commenters believed, for example, that this
restriction would prevent a corporate from certain borrowings, such as
liquidity borrowings from sources like the Federal Home Loan Banks.
This was not the Board's intent. Accordingly, the final 704.8(k)
applies the limit only to member and nonmember credit unions. The Board
has also increased the limit in the final rule from 10 percent of a
corporate credit union's moving daily average net assets to 15 percent.
This increase in the limit is appropriate because of seasonal factors
that affect the amounts of settlement funds a NPCU may have with a
corporate. The Board believes, however, that increasing the limit
beyond 15 percent is not appropriate and could lead to excessive
concentrations of risk with one or two members. The final 704.8(k) will
not become effective for 30 months following the date the final rule is
published in the Federal Register.

[[Page 64810]]

Accordingly, and except as described above, the Board adopts the
final Sec. 704.8, and associated definitions, as proposed.

704.9 Liquidity Management

704.9(a) General

The proposed paragraph (a)(3) required a corporate maintain
sufficient sources of cash and cash equivalents to support its payment
system obligations. There was no significant comment on this proposal,
and it is adopted into the final rule.

704.9(b) Borrowing Limits

The proposed paragraph 704.9(b) replaced the current borrowing
limits of up to the greater of 10 times capital or 50 percent of shares
(excluding shares created by the use of member reverse repurchase
agreements) and capital, with a limit of the lower of 10 times capital
or 50 percent of capital and shares on aggregate borrowing. The
proposal also added a new sublimit on secured borrowing, as discussed
below.

704.9(b)(1) Secured Borrowings

The proposal permitted a corporate to borrow on a secured basis,
but, generally, only for liquidity purposes and only with a maximum
maturity of 30 days. A corporate may also borrow on a secured basis for
non-liquidity purposes, but only if the corporate is well-capitalized
and only in an amount equal to the corporate's excess capital.
Several commenters felt current borrowing limits were sufficient
while others felt their corporates should have no borrowing limits.
These latter commenters argued the risks associated with borrowing
would be captured by asset liability management modeling. Dozens of
commenters also felt the 30 day limit on secured borrowings established
by Sec. 704.9(b)(1) was too restrictive and would reduce a corporate's
ability to offer lending products and interest rate swaps to natural
person credit unions. Many commenters stated any negative ramifications
of borrowing in excess of 30 days would be constrained by other aspects
of the proposed rule. Many commenters felt Sec. 704.9(b)(1) should be
eliminated all together.
The Board believes the proposed borrowing limits are prudent and
sufficient to allow corporate credit unions to manage liquidity needs
and to safeguard their payment systems. The Board also still believes
that corporates should be limited in their ability to borrow on a
secured basis for other than liquidity purposes. As demonstrated by
recent events, secured borrowing can create additional risks for the
corporate and the NCUSIF. Secured lenders require collateral to be
valued at market and they impose an additional haircut (margin) to
ensure the borrowing is fully and continuously collateralized. Market
shocks can create short-term market values that are significantly below
long-term intrinsic values and which can magnify potential losses if
the creditor seized the collateral and sold it as permitted by the
lending agreements.
Accordingly, the final rule retains restrictions on secured
borrowing for non-liquidity purposes and retains the 30 day maximum
term for secured borrowings made for liquidity purposes. These
restrictions will not preclude a corporate from renewing liquidity-
related borrowings on a rolling basis. These limits on aggregate
borrowing and secured borrowing should help mitigate the consequences
of future adverse market events for the corporates and the NCUSIF.
As with most of these final revisions, the effective date of the
paragraph 704.9(b) revisions will be January 18, 2011. NCUA expects
that corporates will not enter into any new borrowings before that date
that will put them out of compliance with 704.9(b) on that date. Also,
to the extent that a corporate has one or more borrowings on that date
that are not in compliance with the requirements of 704.9(b), NCUA will
expect the corporate to move aggressively to pay off those borrowings
or to replace them with borrowings that comply with 704.9(b).
Accordingly, and except as described above, the Board adopts the
final Sec. 704.9 as proposed.

Appendix B to Part 704--Expanded Authorities and Requirements

The proposed rule revised the qualification criteria, and elements
of, the Base-plus and Part I authority, and eliminated the current Part
II authority, in Appendix B.

General

The final Appendix B includes language requiring state chartered
corporates seeking expanded authority first obtain the approval of
their SSAs before submitting an application to NCUA. This requirement
is consistent with 12 CFR 704.1(b).

Base Plus

The final Base-Plus section removes the references to the proposed
cash flow sensitivity tests in Sec. 704.8(e)(1) and Sec. 704.8(f)(1)
since these two proposed tests do not appear in the final rule.
Language has also been added to clarify that for monthly NEV testing,
the last day of the month must also be one of the testing dates.

Part I

To qualify for Part I authority, the proposal added a requirement
that a corporate achieve and maintain a leverage ratio of at least 6
percent, meaning that its Tier 1 capital, divided by its moving DANA,
must equal or exceed 6 percent. The proposal also limited the aggregate
amount of investments purchased under Part I authorities to the lower
of 500 percent of capital or 25 percent of a corporate credit union's
assets. NCUA did not receive any significant comment on these
proposals, and they are retained in the final Part I. The final Part I
removes the references to the proposed cash flow sensitivity tests in
Sec. 704.8(e)(1) and Sec. 704.8(f)(1) since these two proposed tests
do not appear in the final rule.

Part II

The proposal removed the current Part II, which generally permitted
investments down to BBB, and renumbered the existing Part III, on
foreign investments, as Part II.
NCUA did not receive any significant comment on the removal of the
current Part II, and it is removed and replaced in the final rule with
the Part on foreign investments.
The proposed Part II on foreign investments established credit
exposure limits for any single foreign obligor not to exceed 50 percent
of capital. The NCUA Board intended this limit to be consistent with
the single obligor limits established by the proposed and final Sec.
704.6(c). Accordingly, the final paragraph (a)(4) of Part II is amended
to limit exposure to a single foreign obligor to the greater of 25
percent of capital or $5 million.

Part III

The proposal renumbered the current Part IV, which permits limited
investments in derivative transactions, to Part III.
Paragraph (a) Permissible Purposes for Derivatives
The proposal modified the current authority in paragraph (a) to
ensure that corporates do not use derivatives to take on additional
risk. Proposed paragraph (a) permits the use of derivatives only to
create structured products, mitigate interest rate and credit risk on
its own balance sheet, or to hedge the balance sheet of its members.
NCUA received no significant comment on this proposal, and the final
paragraph (a) is adopted as proposed.

[[Page 64811]]

Paragraph (b) Credit Ratings of Derivatives Counterparties
The proposed paragraph (b)(1)(i) limited corporates to derivative
counterparties rated no lower than the minimum permissible rating for
comparable permissible term investments. Some commenters were concerned
with the lack of AA- rated counterparties for corporates without Part I
Expanded Authority. These commenters argued this AA- rating restriction
would keep corporates from finding an adequate number of qualifying
derivative counterparties. Some commenters also cited the netting and
collateral posting required in derivative transactions, noting these
requirements mitigate the credit risk of a derivative transaction in
comparison to a similarly rated investment transaction.
The Board concurs there are few potential derivatives
counterparties rated AA- or higher. In fact, there are many more
potential derivatives counterparties rated A or A-, and a corporate
that wants to engage in derivatives activity needs access to
counterparties rated A or A-. The Board believes the credit quality of
derivative counterparties is not as important as the credit quality of
investment issuers. The nature of derivative transactions the
corporates generally make (e.g., interest rate swaps) make them less
risky than traditional investments, given the relatively low exposure
levels and the mitigation of credit risk associated with bilateral
netting agreements and collateral requirements.
Accordingly, the final paragraphs (b)(1)(i) and (ii) permit
corporates that qualify for Part III derivatives authority to engage in
derivatives transactions with domestic counterparties rated no lower
than A-, and, if the corporate has Part II Expanded Authorities, with
foreign counterparties rated no lower than permissible under that Part
II. The final paragraph (b)(1)(iv) also requires the corporate comply
with the Investment Action Plan provisions of Sec. 704.10 if any
rating relied upon to meet the requirements of paragraphs (b)(1)(i) or
(ii) is downgraded below the minimum rating requirements.
In addition, the Board notes that OCCU publishes separately from
Part 704 the specific criteria to qualify for any particular expanded
authority. NCUA will publish the parameters for Part III qualification,
which parameters will include compliance with industry best practices
on bilateral netting of derivatives and the posting of collateral.

Part IV

The proposal renumbered the current Part V authority on
participation lending as Part IV. The final rule reflects this
renumbering.
Accordingly, and except as described above, the Board adopts the
final Appendix B as proposed.

Section 704.11 Corporate Credit Union Service Organizations (CUSOs)

704.11(e) Permissible Activities

The current 704.11(e), entitled prohibited activities, prohibits a
CUSO from acquiring control, directly or indirectly, of another
depository financial institution or to invest in shares, stocks, or
obligations of an insurance company, trade association, liquidity
facility, or similar organization.
The proposal would move the current prohibition language in
704.11(e) to proposed paragraph 704.11(g)(4) and replace the current
704.11(e) with a new paragraph entitled permissible activities. The new
proposed 704.11(e) would require that a corporate CUSO agree to limit
its activities to brokerage activities, investment advisory services,
or other categories of activities (including but not limited to service
activities) as approved in writing by the NCUA and published on the
NCUA Web site.
Several commenters generally agreed with the proposed regulation of
CUSO activities and enhancement of CUSO transparency. Some of these
commenters are concerned about the migration of activities from
corporates to CUSOs and increased corporate exposure to CUSO risks.
Many commenters, however, objected to the proposal that NCUA
preapprove and publish a listing of approved corporate CUSO activities.
Some objected to such NCUA preapproval generally, while others felt
that publishing the list separate and apart from the rule created too
much ambiguity in the rule and would inhibit proper corporate planning.
Those commenters that objected categorically to NCUA preapproval felt
such a preapproval requirement would discourage corporate ownership of
CUSOs, and that such ownership was important because corporates bring a
level of expertise to CUSO management that NPCUs may not bring. One of
these commenters stated that NCUA should continue the approach of
delineating those activities that are prohibited, not those that are
approved. Another commenter believes that NCUA should not place limits
on corporate CUSOs at this time because the most recent corporate
crisis was an investment issue not related to CUSOs.
The Board believes that NCUA must have some oversight over
corporate CUSOs. These CUSOs affect not only the health of the
corporates, but also the health of the credit union system as a whole,
because many corporate CUSOs serve NPCUs directly. The Board is
concerned that some activities might migrate from corporates to CUSOs
as a result of this rulemaking, and NCUA needs to understand and
preapprove the activities of these CUSOs and have access to these
CUSOs. In addition, the Board reiterates that it is not regulating just
in reaction to the immediate past crisis, but also attempting to
anticipate future problems and construct a regulatory scheme that will
help NCUA deal with those problems when they arise.
One commenter wanted to know why NCUA had only identified two
activities (brokerage and investment advisory services) as preapproved
in the rule text, and stated that only one of its four existing CUSOs
would prequalify under these approved activities. This commenter stated
that another activity, ``item processing,'' which was very important to
its members, had been moved from the corporate to a CUSO to separate
the ``operational risk'' from the corporate, and this commenter wanted
a lengthier list of preapproved activities in the rule, including item
processing. Two commenters suggested NCUA should expand the list of
preapproved activities in the regulation to include item processing,
shared data processing, and ``shared services.'' This commenter and
others also stated that the rule should outline the process and
criteria for approving each new category and explain the criteria.
Other commenters asked that the approved list include business lending
services, ALM services, card services, and the programs for the
purchase of CDs from other depository institutions. One commenter
stated that data processing should be preapproved. A few commenters
stated that the corporate rule should include the same list of
preapproved CUSO activities as currently exists for federal credit
union CUSOs in part 712 of NCUA's rules. One said that, at a minimum,
NCUA should incorporate into part 704 all the activities described in
712.5(a), (b), (e), (g), and (k).
The Board preapproved brokerage and investment advisor services
because the Board believes providing those services are very
appropriate corporate CUSO activities. The Board does not believe that
all the preapproved categories of activities in Sec. 712.5 for natural
person

[[Page 64812]]

federal credit union CUSOs are necessarily appropriate for corporate
CUSOs, and so declines to incorporate Sec. 712.5 language into
704.11(e). In fact, at this time, the Board will not be adding
additional preapproved activities into the rule text of 704.11(e).
Corporate CUSOs may submit descriptions of the activities they
currently perform, or desire to perform, to NCUA beginning immediately
on publication of this rule, and NCUA will begin the review and
approval process for those activities. The Board wants to examine each
activity, whether new to corporate CUSOs or a preexisting activity.
One commenter suggested that a corporate submit a business case
when seeking approval for a service rather than limit, upfront, the
kinds of activities permissible. This commenter noted that the credit
union system needs to have the flexibility to grasp opportunities as
they arise. Some commenters objected to the informal nature of the NCUA
approval process and wanted additional definitions and information in
the rule text.
In fact, the Board's intent with the proposed, informal approval
process is to streamline that process and to ensure that appropriate
activities are approved as quickly as possible. Once NCUA has approved
and published an activity category, any corporate CUSO may engage in
that activity without further approval. The Board intends this process
to be flexible enough to accommodate opportunities as they arise,
without creating too much risk to the credit union system. On the other
hand, the Board understands that corporates and their CUSOs need
certainty, and some sort of permanence to the category or approved
activities. The Board does not want corporates or their CUSOs to be
concerned that NCUA might use the informal process to remove or
radically alter a category of approved activities after NCUA's
publication of that approval. Accordingly, the final rule adds a new
paragraph (e)(3) that provides NCUA will not remove a particular
activity from the approved list, or make substantial changes to the
content or description of that approved activity, except through the
formal rulemaking process.
One commenter was concerned about potential service disruptions as
existing CUSOs go about obtaining NCUA approval. Some commenters stated
that corporates would need a transition period following publication of
the final rule to determine if their current corporates were engaged in
activities acceptable to NCUA, with one suggesting 180 days. Another
commenter thought NCUA should publish a list of approved activities in
advance of the final rule, and another stated that there should be a
``fast track'' approval process for existing CUSOs. One commenter
suggested that there should also be a 12-month period for a corporate
to divest from impermissible CUSOs.
The Board is sympathetic to these concerns about the transition to
the preapproval system. Accordingly, the requirement in the final rule
that NCUA preapprove CUSO activities will not become applicable until
April 18, 2011, so as to provide time for application to NCUA and NCUA
review. Further, the final rule will permit a corporate an additional
12 months to extricate itself from an impermissible CUSO, if the
corporate can demonstrate that, on the date of publication of the final
rule, (1) the CUSO was actively engaged in the activity, and (2) the
activity met all the requirements of Sec. 704.11 as that rule existed
prior to effective date of final rule.
A few commenters stated that, for state chartered corporates, the
states should determine what CUSO activities were appropriate. One
commenter stated that NCUA should retain only the authority to
``restrict an activity that is determined to present an undue material
risk to the insurance fund.''
It is the intent of the Board that NCUA will review corporate CUSO
activities for their potential impact on the insurance fund.
Unfortunately, the Board cannot know in advance every sort of activity
that a CUSO might wish to engage in that might have a negative impact
on the NCUSIF. Accordingly, the proposed preapproval process is
necessary. This is particularly true given that corporate CUSO
activities present greater systemic risk to the credit union system,
and the NCUSIF, than natural person credit union CUSO activities.
Many commenters wanted to know if existing CUSOs, and existing
activities, would be exempt from the approval process (i.e.,
grandfathered). Several commenters stated that previously approved
corporate CUSOs and CUSO activities should be added to NCUA's approved
list of CUSO activities in the proposed rule text; two commenters
stated that NCUA is ``aware'' of current CUSO activities, and so should
preapprove those current CUSO activities in the regulation. Another
NPCU stated that a corporate should simply notify NCUA of what CUSOs it
had and what they were doing and should not have to seek any NCUA
approval, and that NCUA could obtain all the information it needs about
the CUSO from ``public'' sources.
The Board will not be grandfathering preexisting CUSO activities.
NCUA has not previously approved any existing CUSO activities, and is
not necessarily fully aware of all activities that corporate CUSOS
currently undertake or intend to undertake. Many CUSOs are privately
held, and public sources provide insufficient information about what
these CUSOs are doing.

704.11(g) Written Agreement With CUSO

704.11(g)(5) Agreement to Provide NCUA Expanded Access

The proposal also amends NCUA's CUSO access authority, currently
limited to the CUSO's ``books, records, and any other pertinent
documentation,'' to include access as well to a CUSO's ``personnel,
facilities, and equipment.''
Several commenters objected to the proposed expansion of NCUA
access to a corporate CUSO, most believing it was overly intrusive and
disruptive. Some of these commenters who disliked the proposed NCUA
access did acknowledge that corporates might shunt nonperforming assets
or problematic activities off to CUSOs, or that some particular
corporate CUSO activities might pose particular risk to corporates or
NPCUs, and these commenters generally thought that perhaps NCUA should
be able to obtain access to corporate CUSOs, but only for ``material''
risks. One of these commenters stated that ``for example, CMBS and
SimpliCD may pose the threat of material losses in contrast to a
corporate's minority interest in MDC or CUDL.'' None of these
commenters, however, specified how, or by whom, such materiality would
be determined.
As these commenters acknowledge, the NCUA is concerned about the
potential migration of activities and risk from the corporates to their
CUSOs. If the NCUA believes it needs access to a particular CUSO, it
cannot be placed in the position of arguing with the corporate, or the
CUSO, about whether the perceived risk is ``material.'' Accordingly,
the Board declines to adopt that standard for CUSO access.
Some commenters expressed concern that the expanded NCUA access
envisioned for corporate CUSOs might cause third party service
providers to decline credit union investment for fear of being
categorized as a CUSO. In response, the Board notes that service
providers cannot generally accept direct credit union investment
without becoming CUSOs, but that the CUSOs of

[[Page 64813]]

natural person federal credit unions are permitted to invest in non-
CUSO service providers under certain circumstances. See 12 CFR
712.5(r). If a corporate wants to invest a minimal amount in a third
party service provider, but insulate the service provider from NCUA
access and oversight, the corporate can request approval from NCUA to
add such an investment activity above as an approved corporate CUSO
activity. Before approving such a CUSO investment activity, however,
the corporate or its CUSO would have to explain the arrangement,
including the extent of the proposed investment by the CUSO in the
service provider and why NCUA access to the particular service provider
is not necessary to ensure protection of the NCUSIF.
Some commenters thought NCUA did not have the expertise to examine
CUSO activities, or that regulation by state regulators, or that NCUA
access to CUSOs through NPCU FCU owners, would be sufficient. In fact,
NCUA doubts that it would ever become the primary regulator of a CUSO,
or would conduct routine exams of any particular CUSO. The intent of
the provision is to ensure that NCUA can get quick and complete access
to a CUSO should the need arise.
Some commenters believe that access by NCUA would only be
appropriate where the corporate has a ``controlling interest,'' as
opposed to a minority interest. The Board disagrees. Three or four
corporates, or corporates and other credit unions, could form a CUSO
where no one credit union had a controlling interest, and this CUSO
could present the same risk to the credit union system as a CUSO that
is controlled by one corporate.
One corporate commenter stated that the proposal ``appears to give
the NCUA expanded authority over a CUSO simply by virtue of a corporate
credit union holding stock in a CUSO.'' This commenter did not see why
a corporate CUSO should receive different NCUA supervision than a
natural person credit union CUSO. This commenter does not understand
that NCUA has long required, for both natural person FCU CUSOs and
corporate CUSOs, that the CUSOs permit NCUA access to their books,
records, and documentation. See, e.g., 12 CFR 712.3(a)(3). Given the
expanded rule that corporate CUSOs are likely to play in the future of
the credit union system, the proposal ensures that NCUA has access
commensurate with the systemic risk that corporate CUSOs may present.
Accordingly, and except as described above, the Board adopts the
final Sec. 704.11 as proposed.

Section 704.14 Representation

Proposed Revisions

The proposal required that all corporate board members hold either
a CEO, CFO, or COO position at their member credit union or other
member entity. The proposal also required that a majority of a
corporate's board members be representatives of natural person credit
union members and that individual board members, and the organizations
they represent, be limited to no more than six consecutive years of
board service. In addition, the proposal prohibited any person from
sitting on the boards of two or more corporates at the same time, and
would preclude a single organizational member from having more than one
individual representative on the board of any given corporate. Some
aspects of the proposal, such as the requirement that a majority of the
corporate board be representatives of natural person credit unions,
would be phased in over time. The provisions governing term limits
would have taken effect at the time of the next election to the board,
so that no currently sitting director would have to resign before his
current term expired, regardless of the length of time he had been on
the board.

General Comments on the Proposal

Some commenters asserted that NCUA's efforts to impose limits or
standards in the area of board membership were excessive and beyond the
scope of what was appropriate for the regulator. Many stated that
attempts to regulate in this area usurped the rights of the membership
to make their own decisions concerning their representatives and were
inconsistent with the democratic principles that are fundamental to
credit unions.
The NCUA has long been in the business of setting standards for
credit union governance. The Federal Credit Union Act, for example,
provides the Board with specific authority to promulgate standard FCU
bylaws, as well as general authority to regulate both federal credit
unions and federally insured credit unions, and to protect the NCUSIF.
See, e.g., 12 U.S.C. 1758. Corporate credit unions play a fundamental
role in the credit union system, creating both significant systemic
benefits and significant systemic risks, and the make-up of the board
of directors has a significant impact on the risk to the NCUSIF.
Accordingly, NCUA has, for many years, established governance
parameters for corporates. While members retain the right to elect
directors, for example, the NCUA has previously imposed governance
requirements, such as standard federal corporate bylaws and rules
pertaining to conflicts of interest and overlapping relationships
between directors and trade associations that apply to all corporates.
The proposed and final governance provisions are consistent, in form
and content, with these principles.
Some commenters questioned whether the proposed limits and
restrictions would have made any difference in avoiding the losses that
corporates sustained during the recent market dislocation. Whether or
not these new provisions might have affected the size or scope of the
losses is not determinable. Still, the Board reiterates its belief that
improving and strengthening corporate governance will help corporate
credit unions to survive whatever market conditions they must face in
the years ahead.
Another commenter, representing the views of state regulators,
asserted that issues such as director qualifications and term limits
for state chartered entities rightfully come under the province of
state law, as administered by state regulators, and that NCUA has no
business regulating for all corporates in these areas. In response, the
Board reiterates that part 704 has historically been applicable to all
corporates, including state chartered corporates, because of their
systemic risk to the credit union system and the NCUSIF. The final rule
contains several requirements and references to collaboration between
NCUA and the relevant state regulator when working with state chartered
corporates, and the Board intends the tradition of collaboration will
continue.
Some commenters expressed concern that NCUA may elect to impose
some or all of the proposed governance requirements on directors of
natural person credit unions. The Board did issue a proposed rule in
July, 2010, that would extend the golden parachute and indemnification
provisions originally proposed for corporates to all insured credit
unions. 75 FR 47236 (Aug. 5, 2010). The Board does not, however,
presently anticipate that any of the other governance provisions in
this rule, as proposed or finalized, will also be extended to natural
person credit unions.
A discussion of the specific governance revisions adopted in the
final rule follows.

704.14(a) Board Representation

704.14(a)(2) Boards Limited to CEOs, CFOs, or COOs

The proposed 704.14(a)(2) prospectively limited those who could

[[Page 64814]]

seek reelection to sitting CEOs, CFOs, or COOs.
A large number of commenters opposed the requirement that service
on the board of a corporate be limited to individuals currently holding
the position of CEO, CFO, or COO of a member institution. Several
commenters noted that many credit unions are run by individuals holding
the title of manager or treasurer, and that the rule should be changed
to accommodate such circumstances. Many commenters criticized this
provision as being, simultaneously, overly restrictive and ineffective.
These commenters stated that there may be many individuals with the
willingness, capacity, and expertise sufficient to enable them to be
very effective members of the board, but who may not hold one of these
three titles. These commenters believe that accountants, attorneys, and
capital market specialists, for example, may all have the type of
background that could be of value to a corporate credit union. Some
commenters also supported extending the qualifications to retirees.
Commenters also noted that just having one of the three enumerated
titles is no assurance that an individual will exhibit the requisite
competence or commitment required to be a successful member of the
board. Many commenters questioned whether any evidence exists to
support the view that any of the problems currently afflicting the
corporate sector can be attributed to boards being comprised of
individuals lacking these titles; many also suggested that the
imposition of this requirement would have done nothing to avert the
problems that were encountered. Several noted, for example, that there
was no shortage of persons holding these titles on the boards of the
two corporates currently in the conservatorship of the NCUA.
Many commenters complained that, by imposing this restriction, the
agency would be overstepping the boundary of appropriate regulatory
oversight and treading on territory that is more properly left to the
membership. These commenters believe that the democratic principles
that have always characterized the member-owned, member-controlled
credit union movement require that members be allowed to make their own
decisions about whom to elect to the board. Many of these commenters
suggested that a more appropriate approach for NCUA to take in this
respect would be to impose a requirement that nominating committees
establish guidelines concerning education and experience criteria that
must be met by candidates for board positions. Alternatively, many
commenters proposed that NCUA approach this issue by requiring
corporates to implement mandatory training and continuing education
programs for all directors, possibly through a new bylaw provision
establishing such a requirement. Some suggested that NCUA simply impose
an experience requirement, such as five years working in the credit
union sector, as a prerequisite to eligibility to serve on a corporate
board; one suggested imposing a minimum age for service on the board.
Another commenter suggested imposing a requirement that directors may
only come from member credit unions with a specified minimum level of
investment in the corporate. Several commenters also urged NCUA to
require corporates to adopt best practices for boards to follow in this
context, including provisions dealing with attendance, training, self
assessment and review.
A few commenters, typically representing smaller credit unions,
believed that one probable outcome of this rule would be that smaller
credit unions, which typically have relatively few employees, could be
effectively excluded from representation on boards. In some cases, for
example, the CEO (or Treasurer/Manager) may be one of only two or three
full time employees. The credit union may be unable to spare the
individual or allow him or her to devote the type of time commitments
required of board membership. Consequently, according to these
commenters, many such credit unions may go without representation at
their corporate.
Other comments on director qualifications included the suggestion
that NCUA allow directors of corporates to be paid for their service on
the board. Several commenters also suggested that NCUA should allow up
to 20 percent of the board to consist of outside directors,
specifically to include individuals with capital market knowledge and
experience, provided that NCUA also establish and impose appropriate
safeguards to protect against conflicts of interest involving such
individuals. One commenter suggested extending the qualification
concept to include executive officers, by imposing a knowledge or
experience requirement before individuals may take a position with
responsibility for finance, investment, credit risk and enterprise risk
areas of the corporate's business.
The Board acknowledges that, in the case of some natural person
credit unions, the person fulfilling the role of chief executive
actually holds the title of Treasurer/Manager. This title, which is
perhaps more common among smaller credit unions, has traditionally been
used as a more descriptive term for what the chief executive actually
does on a day to day basis. In any event, the Board recognizes that the
same rationale that deems a CEO as qualified to serve on the board of a
corporate should apply equally to the case of persons holding the
Treasurer/Manager title. Accordingly, the final rule has been expanded
to include this position in the category of persons qualified to
fulfill the role of corporate credit union director.
The Board has elected not to make additional changes to the
proposed rule. Although the Board recognizes that some individuals who
are not employed in one of the identified, qualifying positions may
actually have the ability to serve on a corporate board, the Board
nevertheless believes the listed positions (as noted above, expanded to
include Treasurer/Managers) provide a good proxy for the most
qualified, experienced and capable individuals in the credit union
industry. These are, in other words, the very persons whose knowledge,
skills and abilities are necessary to guide and direct corporates
through to the next stage of their business.
The Board notes, in this respect, that corporate boards are free to
retain the services of subject matter experts as consultants or
advisors to the board, to the extent that such expertise in a
particular field, such as capital markets or real estate, should be
viewed as necessary. Corporates are also free to propose non-standard
bylaw provisions that would require, for example, that incumbent
directors must receive periodic training from qualified sources on
issues of importance to the corporate's operations and business model,
including such aspects as capital markets and investments, asset-
liability management, accounting and regulatory compliance. As the
Board noted in the preamble to the proposed rule, citing Corporate
Credit Union Guidance Letter 2005-02, directors must have considerable
knowledge and devote sufficient time to have an adequate understanding
of a corporate's operations. If anything, these principles have greater
urgency in 2010 than they had in 2005 when that Guidance Letter was
first issued. The Board also rejects the notion of allocating some
portion of director slots to outside directors, as this would be
inconsistent with the democratic principles that have always been
fundamental to the credit union industry.

704.14(a)(3) Term Limits

The proposed paragraph 704.14(a)(3) provided generally that no
corporate

[[Page 64815]]

board members could seek election if, at the end of the term to which
elected that board member would have served more than six consecutive
years.
The issue of a mandatory 6-year term limit for board members
attracted, by far, the most comment within the sphere of comments
directed toward the governance aspects of the proposal, with hundreds
of commenters opposed to the proposed term limit. Many commenters
opposed the notion of term limits altogether, arguing that members
should not be constrained in their ability to select individuals of
their own choosing to serve on the board. These commenters argued that
NCUA would be exceeding its proper role by establishing an arbitrary
barrier that would undermine freedom of choice of the membership.
Virtually all of the persons who commented on the term limit proposal
asserted that a 6-year period is too short. These commenters argued
that a 6-year period would create significant disruption in the
management and operation of corporates, at a time when significant
challenges to their survival are foreseeable and when the full
attention and concentration of the board will most be required. Many
commenters expressed concern that the effect of the term limit
provisions would be to severely disrupt the institutional knowledge
available to the board. Several pointed out that six years is less than
the duration of the typical business cycle. One commenter predicted
that the turnover caused by the proposed term limit would create
``havoc;'' and many others cautioned against the likelihood of
unintended consequences should the provision become final.
Some of these commenters may have misread the proposal, as it would
not require any currently sitting director to resign his or her seat.
Instead, it would apply to those seeking re-election. Most corporate
boards should have staggered terms, such that only a percentage of the
entire board is up for re-election each year. Nevertheless, the Board
acknowledges the concern identified by some commenters who indicated
that, at least initially, the average remaining tenure for current
board members would probably be about three years under the proposal.
Some commenters argued that corporate boards are substantially
different from NPCU boards and that a dramatically greater learning
curve exists before a director can typically acquire the level of
knowledge and expertise he or she needs to make a meaningful
contribution to the work of the board. These commenters believe that a
6-year term limit would require experienced directors to exit the board
just at the time they had become productive, leaving the corporate
dangerously exposed to the oversight and management of an inexperienced
board.
Other points argued by commenters in opposition to the 6-year term
limit included that management officials of the corporate would become
more vulnerable to pressure to implement short-sighted policies or
programs to meet the direction of board members who will not be with
the corporate long-term. Another point raised by several commenters
representing or served by corporates in small or rural states is that
the universe of candidates available for service on the board is
relatively small, and that the turnover required by a 6-year term limit
would create a hardship for those corporates to recruit and retain
capable directors. Some commenters called for the grandfathering of
service by existing board members completed before the final effective
date of the rule; a few asserted that the rule should not be applied to
cover the term of service of an individual appointed to fill an
unexpired term, lest such individual be precluded from seeking two
elected terms, which the rule would ostensibly permit.
Commenters opposed to the 6-year limit suggested a wide range of
alternatives. Most commenters suggested that, if required at all, the
term limit should be extended to 9 or 12 years, to allow for the
development of appropriate experience on the board and to dampen the
impact of sudden, massive turnover; some commenters proposed a 10-year
or 15-year term limit, and one even advocated for 20 years. Another
suggested allowing the lesser of four consecutive terms or nine years,
while another suggested abandonment of term limits for directors but
imposing a specific limit on the time a board member may hold a
particular board office, such as chairman, etc.
The Board is persuaded by the arguments made by commenters to the
effect that the imposition by rule of mandatory term limits for
directors is inconsistent with the democratic principles on which
credit unions are founded. Accordingly, the final rule deletes the
proposed paragraph 704.14(a), with its associated mandatory term limit,
and renumbers the remaining subparagraphs of 704.14(a). The Board notes
that individual corporates may as a matter of policy determine that
some sort of limitation on consecutive service by directors is
appropriate. In such cases, the corporate is free to propose a non-
standard bylaw imposing reasonable term limits. The corporate could
also, for example, impose an internal requirement that board offices,
such as board chairman, be rotated among directors in accordance with a
prescribed schedule.

704.14(a)(4) Individual Service on More Than One Corporate Board

The proposed paragraph 704.14(a)(4) prohibited any individual from
being elected or appointed to serve on the board if, after such
election or appointment, the individual would be a director at more
than one corporate credit union. The NCUA did not receive any
significant comment on this proposal, and there is no change to it in
the final (other than renumbering to (a)(3)).

704.14(a)(5) Multiple Member Representatives on Corporate Board

The proposed paragraph 704.14(a)(5) prohibited any individual from
being elected or appointed to serve on a corporate board if, after such
election or appointment, any member of the corporate credit union would
have more than one representative on the board of the corporate. The
NCUA did not receive any significant comment on this proposal, and
there is no change to it in the final rule (other than renumbering to
(a)(4)).

704.14(a)(10) Majority of Directors Must Be NPCU Representatives

The proposed paragraph 704.14(a)(10) required that at least a
majority of directors of every corporate credit union, including the
chair of the board, must serve on the board as representatives of
natural person credit union members. This requirement would be
effective 36 months after publication of the final rule in the Federal
Register. The commenters addressing this proposal were generally
supportive, and there is no change to it in the final (other than
renumbering to (a)(9)).
Accordingly, and except as discussed above, the Board adopts the
final Sec. 704.14 as proposed.

(Current) Section 704.19 Wholesale Corporate Credit Unions

The proposal would eliminate the current Sec. 704.19, which grants
wholesale corporate credit unions a lesser RE reserve requirement than
the requirement generally applicable to retail corporates.
No commenters objected to the elimination of this provision, and
the final rule eliminates it.

[[Page 64816]]

(Proposed and Final) Section 704.19 Disclosure of Executive and
Director Compensation

The proposal would have required that each corporate prepare, on an
annual basis, a document that discloses the compensation, in dollars,
of each senior executive officer and director. Compensation is broadly
defined, and includes benefits, deferred payments, informal
arrangements, and payments made to acquaintances and relatives. Any
member of the corporate could obtain a copy of the disclosure upon
request, and the corporate would also be required to distribute the
information to its members at least once a year, in the annual report
or by some other means of its choosing. The proposal would have
permitted the corporate to include with the disclosure additional
information if necessary to put the disclosure in context. With respect
to any corporate merger, a merging federally-chartered corporate would
be required to affirmatively disclose to both NCUA and its members any
material, merger-related increase in compensation (i.e., an increase of
more than 15 percent of annualized compensation or $10,000, whichever
is greater) for any senior executive or director. The proposal would
have also required a state-chartered corporate to make the merger-
related disclosure, but only to NCUA unless state law requires
otherwise.

General Comments

Many commenters expressed concern with this aspect of the proposal.
Several expressed opposition based on privacy, arguing that an
executive's compensation is no one's business except his or her own.
Others took the view that the proposed disclosure requirements were
punitive in nature and would not, had they been in place, have had any
significant impact on helping corporates weather the recent market
dislocation and economic crisis.
The Board disagrees that the disclosure requirements are in any way
punitive or violative of legitimate privacy expectations. The rule is
designed to assure that corporate credit union members are aware of the
level of compensation paid to senior management officials. As the Board
noted in the preamble to the proposed rule:

The member-owners of a corporate credit union have a strong
financial interest in the corporate. The typical corporate member
has large investments in the corporate and much of this investment
is at risk, either in the form of paid-in capital, membership
capital, or uninsured shares. The corporate member has a powerful
interest in ensuring this at-risk investment is properly managed and
protected. That interest extends both to ensuring the corporate
provides proper financial incentives to its managers to do a good
job and also that the corporate is properly expending its funds--
information categories that both include senior management
compensation.

74 FR 65210, 65252 (December 9, 2009). The Board believes the members'
interest in this information outweighs any privacy interests the senior
managers may have in the information. The Board also believes these
interests exist whether or not such information would have mitigated
the corporate losses sustained during the last two years.
Many commenters predict that the disclosures will make recruitment
and retention of qualified senior executives much more difficult, as
potential candidates will opt for other positions not subject to
potential disclosure. The Board disagrees, as discussed further below.
Other commenters argued that adequate methods currently exist for
members to gain access to compensation information, while several
asserted that compensation information should only be accessible to the
NCUA, which ought to use its own regulatory powers and oversight to
assure that arrangements are not unreasonable. Some commenters asserted
that information should be made available only on an aggregate basis,
or should only be made available to members on request, rather than
disseminated.
The Board is of the view that disclosure on an aggregate basis
would not provide the level of warranted transparency. Further, the
Board does not believe NCUA's role should be the arbiter of appropriate
compensation in lieu of the members.
A few commenters evidently misread the disclosure requirement and
complained that the disclosure should not be made to members of the
public or to the media, which in fact the proposal does not require.
Other commenters called for the rule to allow corporates to present the
compensation information in their own preferred format, with contextual
information, which is also permissible under the current proposal. One
commenter asked for a definition of the term ``compensation'' for
purposes of the required disclosure. The proposed rule, however, does
contain a detailed definition of ``compensation'' in Sec. 704.2.

704.19(a) Annual Disclosure

The proposal required that corporates must annually prepare and
maintain a disclosure of the compensation, in dollar terms, of each
senior executive officer and director.
Several commenters made the point that, as currently defined, the
term ``senior executive officer'' would extend to individuals who may
hold a title, such as vice president, but who are not truly senior
level executives with program level or operational authority or
responsibility. Commenters suggested that these are not the types of
employees who ought to be subject to the disclosure requirements. Many
commenters suggested that NCUA adjust the rule to limit it to the truly
senior level executives, for example by limiting the disclosure
obligation to the CEO and the executives who report directly to the
CEO, or by limiting the disclosure to include only the top five
officials in terms of compensation. Another suggestion was to simply
establish a compensation threshold and extend the disclosure obligation
to all earners receiving income above the threshold. Several suggested
that NCUA follow the SEC rules on identifying which are the truly
senior level officials for purposes of this disclosure obligation.
Others suggested that NCUA should simply adopt and follow the approach
applicable to those state chartered corporates that must file the IRS
Form 990 compensation disclosures.
The Board agrees that the proposal was very broad. In many
corporates, individuals may hold the title of vice president but not
necessarily have program level or operational authority. Mandatory
disclosure of compensation paid to such individuals would extend the
concept of transparency beyond what the Board considers to be a
reasonable level. Accordingly, the Board has modified the final
paragraph 704.19(a) so that disclosure is required only of compensation
paid to approximately the top ten percent of employees with, generally,
a minimum of three employees who must disclose and a maximum of five.
Specifically:
Final paragraph (a)(1) requires corporates with 41 or more
employees must disclose compensation paid to the top 5 most highly paid
individuals.
Final paragraph (a)(2) requires corporates with between 30
and 41 full time employees must disclose the compensation paid to the 4
most highly compensated employees.
Final paragraph (a)(3) requires corporates with 30 or
fewer full time employees must disclose compensation paid to the 3 most
highly paid individuals.
In addition, final paragraph (a)(4) requires that compensation paid
to the corporate's chief executive officer must

[[Page 64817]]

also be disclosed, if the chief executive officer is not already
included among the most highly compensated employees described in
subparagraphs (a)(1) through (a)(3).
The Board also determined to remove the reference to directors from
paragraph 704.19(a), as it is highly unlikely that a director, in his
or her capacity as director, would be among the most highly compensated
individuals at the corporate.
The Board believes this revised compensation disclosure provision
strikes a reasonable compromise between the right of the corporate's
members to know the level of compensation paid to its senior staff and
the expectation of privacy that mid and junior level executives have
concerning their personal affairs. Also, as discussed in the preamble
to the proposed rule, the Board has concluded that the disclosures in
the IRS Form 990 are an insufficient substitute for those required in
this final rule.
The Board did not receive any other significant comment on the
proposed provisions of Sec. 704.19. Accordingly, and except as
described above, the Board adopts the final Sec. 704.19 as proposed.

Section 704.20 Limitations on Golden Parachute and Indemnification
Payments

The proposal would have prohibited golden parachutes, that is,
payments made to an institution affiliated party (IAP) that are
contingent on the termination of that person's employment and received
when the corporate making the payment is either troubled,
undercapitalized, or insolvent. The proposal would have also generally
prohibited a corporate, regardless of its financial condition, from
paying or reimbursing an IAP's legal and other professional expenses
incurred in administrative or civil proceedings instituted by NCUA or a
state regulatory authority where the IAP is ultimately found liable.
For federal corporates, the proposed indemnification limits would be in
addition to the requirements of Sec. 701.33.

General Comments

Most commenters that expressed concern about the proposal believed
it might inhibit the ability of a corporate to recruit and retain
qualified individuals willing to serve as board directors. Several
commenters stated that, unlike their counterparts in the banking
sector, these individuals serve without pay, on a voluntary basis. Some
commenters expressed concern that many such individuals will be
unwilling to serve as board members if they believe their own personal
net worth is at risk and their corporate is unable to offer them
protection against potentially unlimited personal claims.
The Board does not agree with these commenters. First, although
most individuals who serve on the boards of corporates are technically
uncompensated volunteers, they are, in fact, for the most part
employees of NPCU members who are tagged to serve at the corporate by
their NPCU and who do so as part of their responsibilities to the NPCU.
So if the NPCU asks them to serve, they will. Second, the
indemnification limitations in the proposal apply only to
administrative enforcement actions brought by the NCUA or another
appropriate regulator. Such actions, which often take the form of
either a removal action or an attempt to prohibit an individual from
serving on behalf of an insured depository institution in the future,
do not typically threaten the targeted individual with ``unlimited''
personal liability. In addition, the Board notes that paragraph
704.20(a)(9) does allow for the purchase of director and officer
liability insurance to protect the director. Finally, paragraph
704.20(e) of the proposal permits a corporate, if it makes a good faith
determination that the affected director was acting in a manner he or
she believed to be in the best interests of the institution, to make
reasonable indemnification payments subject to the director's written
agreement to reimburse the corporate should the director ultimately be
found liable. As a technical clarification, the final rule replaces the
word ``institution'' with the word ``membership'' in paragraph
704.20(e)(1)(i). See 75 FR 15574, 15575 (March 29, 2010) and 71 FR
77150, 77155 (Dec. 22, 2006). Accordingly, and except as described
above, the Board adopts the final Sec. 704.20 as proposed.

D. Part 709--Involuntary Liquidation of Federal Credit Unions and
Adjudication of Creditor Claims Involving Federally Insured Credit
Unions In Liquidation

The proposed rule revised the payout priority of 709.5(b)(7) to
reference the capital priority option set forth in Appendix A. The
final rule further amends the payout priority to clarify that no claim
is available for capital accounts or instruments depleted in a year
prior to the date of liquidation. This is consistent with the final
amendments to Model Form A in Appendix A, which include disclosure
language that depleted capital has no claim against the liquidation
estate for claims filed beyond the fiscal year of depletion. For
clarity, and to reduce the potential ambiguity associated with ``fiscal
year,'' the final rule also substitutes ``calendar year'' for ``fiscal
year.'' The final rule contains a similar amendment to Sec.
709.5(b)(9).

Part 747--Administrative Actions, Adjudicative Hearings, Rules of
Practice and Procedure, and Investigations

Subpart M--Issuance, Review and Enforcement of Orders Imposing Prompt
Corrective Action on Corporate Credit Unions
The proposal would add a new subpart M to part 747, setting forth
the procedures and due process available in connection with the PCA
provisions of proposed Sec. 704.4.
The Board received very little comment on proposed subpart M, and
the final rule adopts subpart M as proposed.

IV. Analysis of the Final Investment, Credit Risk, and ALM Provisions

The final rule requires that corporates strive to achieve 100 BP of
retained earnings (RE) in the first six years. Of course, some
corporates already have some amount of RE, and so achieving this 100 BP
after six years may not be a challenge for them. For those that
currently have little or no RE, they must earn about 17 BP a year on
average to meet the 6-year mark. This section illustrates how a
corporate might structure its investment portfolio to satisfy the RE
growth requirements while complying with the new investment, credit
risk, and ALM provisions in the final rule.\27\ The intent of this
section is to demonstrate that there are multiple possible approaches
to portfolio construction available to corporates under the rule. NCUA
does not promulgate or endorse a preferred asset allocation or
structure.
---------------------------------------------------------------------------

\27\ The final rule also requires a corporate get to 200 BP in
10 years. We expect that a corporate that can get to 100 BP in 6
years has a reasonable chance to get to 200 BP in 10, particularly
since the RE itself will start generating earnings. Also, the
following modeling assumes a clean sheet balance sheet, that is,
that the corporate is able to sell those assets on its existing
balance sheet that cause it to violate the final corporate rule or
that carry the possibility of significant future credit losses. The
Board realizes that some corporates may be unable to entirely clean
their balance sheet of such legacy assets. As discussed above in the
Legacy assets section, NCUA might grant these corporates waivers of
some corporate rule requirements, including a waiver of the maximum
allowable time to build the retained earnings required by this
regulation. Any waiver involving the required retained earnings
growth rate, however, will tied to the documented amount of losses
flowing from legacy assets identified in an approved action plan. 12
CFR 704.1(b).
---------------------------------------------------------------------------

Several public commenters wrote about the ability of a corporate to
achieve the necessary RE growth under the restrictions of the rule, and
some of

[[Page 64818]]

these commenters provided sample corporate investment portfolios. NCUA
identified 12 different public comment letters with ``model''
investment portfolios, that is, investment portfolios recommended by
the commenters as appropriate for corporates going forward. Among these
12 comment letters there were 3 unique, model portfolios. One unique
portfolio was submitted by Southwest Corporate FCU and another by
Magnus Enterprises.\28\ A third portfolio was submitted by 10 different
commenters. This latter portfolio was originally provided to NCUA by
the Association of Corporate Credit Unions (ACCU).\29\
---------------------------------------------------------------------------

\28\ Both the Southwest and Magnus comment letters were dated
February 17, 2010. These public comment letters, as with all public
comment letters on proposed NCUA regulations, are available on
NCUA's Web site at http://www.ncua.gov. Additionally, the Magnus
comment letter first appeared on the blog http://www.unrealizedlosses.blogspot.com and was likely drafted by the
author of that blog.
\29\ The ACCU analysis was provided to NCUA in an email from
then ACCU Executive Director Brad Miller to Director, OCCU, Scott
Hunt, Subject: ACCU Part 704 Analysis, dated February 22, 2010. For
an example of a public comment letter that employs this particular
ACCU portfolio, see the public comment letter from the California
and Nevada Credit Union Leagues, dated February 17, 2010.
---------------------------------------------------------------------------

To analyze the efficacy of this final rule, this section first
constructs a hypothetical corporate balance sheet that satisfies the
restrictions of the final rule, and then demonstrates that this
portfolio generates the necessary 17 BP of earnings growth per year.
This section then includes a second hypothetical balance sheet, with a
different asset allocation, that also generates sufficient RE. The
section then examines the complete model balance sheets submitted by
Southwest FCU, Magnus, and the ACCU. Each of these balance sheets uses
a different asset allocation from both the NCUA hypothetical balance
sheets and the other two model balance sheets. The analysis shows that
each of these three unique balance sheets either does--or can easily be
modified to--comply with the requirements of the final rule, and that
each of these portfolios can generate more than enough RE inside the
given balance sheet to meet the 17 BP annual RE growth requirement.

A. Hypothetical Balance Sheet 1

NCUA constructed a balance sheet with the following asset
allocation, liability allocation, WAL, capital, and spread
characteristics: \30\
---------------------------------------------------------------------------

\30\ This balance sheet differs from the one described by NCUA
in the proposed rule. Changes in the final rule, such as the
prohibition on private label RMBS, would affect that earlier
hypothetical balance sheet.

Hypothetical Balance Sheet 1
----------------------------------------------------------------------------------------------------------------
Percent of WAL in 50%
Sector balance sheet Spread to LIBOR WAL (years) prepayment
(percent) (basis points) slowdown (years)
----------------------------------------------------------------------------------------------------------------
Assets
----------------------------------------------------------------------------------------------------------------
FFELP Student Loans............. 10 33 3 3.8
ABS--Autos...................... 5 15 2 2.5
ABS--Credit Cards............... 10 25 3 3
Bonds--Corporate................ 20 82 3.5 3.5
Agency RMBS..................... 15 45 \31\ 4 7
Overnight Investments........... 40 0 0 0
-------------------------------------------------------------------------------
Total....................... 100 29.7 1.7 2.03
----------------------------------------------------------------------------------------------------------------
Equity and Liabilities
----------------------------------------------------------------------------------------------------------------
Overnight Shares................ 36 -10 .................. ..................
Term Certificates............... 60 0 .................. ..................
Member Capital.................. 4 0 .................. ..................
-------------------------------------------------------------------------------
Total....................... 100 -3.6 .................. ..................
----------------------------------------------------------------------------------------------------------------
Net Interest Income (basis .................. 33.3 ..................
points)....................
----------------------------------------------------------------------------------------------------------------

Model Balance Sheet Compliance With the Final Corporate Rule
NCUA constructed the asset allocation so that it would comply with
the restrictions of the final rule. Specifically:
---------------------------------------------------------------------------

\31\ The final rule permits the actual WAL of Treasuries, Agency
RMBS, and Agency GSEs to be reduced by a factor of 0.5 for purposes
of the two WAL calculations. Accordingly, this 4-year WAL will be
reduced to 2.0 years, and on the extension test, the 7-year WAL will
be reduced to 3.5 years.
---------------------------------------------------------------------------

All NRSRO ratings are AA or better.
There are no private label RMBS.
Sector limits are observed.
The structured securities are primarily floating rate, so
the IRR NEV test of 704.8(d) is satisfied.\32\
---------------------------------------------------------------------------

\32\ Given today's low rate environment, NEV volatility should
not be significant even with the existence of interest rate caps.
---------------------------------------------------------------------------

The portfolio has a WAL of 1.7 years, which is under the
2.0 year limit in 704.8(f). The final rule permits the actual WAL of
Treasuries, Agency RMBS, and Agency GSEs to be reduced by a factor of
0.5 for purposes of the two WAL calculations. Accordingly, this agency
RMBS WAL will be reduced to 2.0 years.
Under the prepayment slowdown scenario, the WAL extends
only to 2.03 years, well within the 2.25 year limit required by
704.8(g). Corporate bonds do not prepay, so the extension test does not
affect them; and the agency RMBS WAL of 7.0 years will be reduced, when
multiplied by the 0.5 factor, to 3.5 years.
More information about the assets, liabilities, and capital used in
the balance sheet follows.
Assets Used in the Balance Sheet
NCUA has allocated investments across five distinct asset classes
that are permissible corporate investments. For diversification
purposes, no asset sector, other than overnight investments, exceeds 20
percent of the portfolio (although the final rule permits greater
concentration in several of these sectors). NCUA determined that 40
percent of the current average corporate

[[Page 64819]]

credit union portfolio has maturities of less than 180 days, and NCUA
used this for the overnight allocation percentage. Forty percent is
also the median percentage allocation in the public commenter models.
The model uses current spreads over LIBOR, determined as of early
August, 2010, for each asset class. NCUA used two primary sources of
data for its spread numbers. The first source was Bank of America//
Merrill Lynch's, US Securitization Research, Securitization Weekly,
dated August 6, 2010. The second source was Wells Fargo Securities'
Libor/Swap spreads for July 30, 2010. These sources were supplemented
with actual market observations for a number of agency RMBS.\33\ NCUA
believes that these spread numbers represent typical spreads, although
NCUA did find some particular CUSIPs of the same asset type, credit
quality, and WAL that had better spreads.\34\
---------------------------------------------------------------------------

\33\ For example, a Fannie Mae sequential pay floating rate CMO,
CUSIP 31398RV51, with a 6.5 percent cap.
\34\ Examples of particular securities follow.
ABS--Auto.
Example 1. CUSIP 34529LAD6, Issuer Ford Credit Auto Owner Trust,
WAL 2Yr, 1st Settle Date 4/28/10, Coupon 1.32%, Maturity 8/14/10. On
its settlement date 4/28/10, the price was 99.50 and the yield
1.5720. LIBOR 1Yr 1.2% (estimated). Spread over LIBOR: 37 BP Example
2. CUSIP 06052MAB1, Issuer Bank of America Auto Trust, WAL 1Yr, 1st
Settle Date 6/24/10, Coupon 0.91%, Maturity 8/15/10. On its
settlement date 6/24/10, the price was 98.50 and the yield was
2.4574, LIBOR 1Yr 1.2 (estimated). Spread over LIBOR: 125 BP
ABS--Credit Card.
Example 1. CUSIP 02582JFT2, Issuer American Express, WAL 2.9Yr,
1st Settle Date 6/9/09, Coupon 1.69094%, Maturity 5/15/14. On its
settlement date 6/9/09, the price was 100 and the yield was 1.6415.
USD SWAP 3Year 1.30 (estimated). Spread over LIBOR: 34 BP
Example 2. CUSIP 36159JCC3, Issuer GE Capital, WAL 3Yr, 1st
Settle Date 6/24/10, Coupon 2.21%, Maturity 6/15/13. On its
settlement date 6/24/10, price 99.22, yield 2.4950, USD SWAP 3Yr
1.30 (estimated). Spread Over LIBOR: 120 BP
ABS--Student Loan
Example 1. ISIN USU82908AA93, Issuer SLM Student Loan Trust, WAL
0.9yr, 1st Settle Date 7/22/10, Coupon 2.25%, Maturity 7/22/11. On
its settlement date 7/22/10, price 100.10, yield 2.1540, LIBOR 1Y
1.20 (estimated). Spread over LIBOR: 95 BP
Example 2. CUSIP 78445MAA8, Issuer SLM Student Loan Trust, WAL
3.4Yr, 1st Settle Date 3/11/10, Coupon 3.2%, Maturity 3/11/2014. On
its settlement date 3/11/10, price 99.85, yield 3.2692, USD SWAP 3Yr
1.30 (estimated). Spread over LIBOR: 196 BP.
All these securities are rated AA- or higher.
---------------------------------------------------------------------------

The FFELP student loan ABS spread data assumes a generic AAA-rated
bond with a 3-year WAL. The auto ABS spread data assumes a generic AAA-
rated bond backed by prime automobile loans with a 2-year WAL. Auto ABS
backed by subprime automobile loans are also available in the market at
wider spreads but these were not included in the portfolio. The credit
card ABS spread data is for a generic AAA-rated bond with a 3-year WAL.
The corporate bond portion of the portfolio assumes an equal allocation
of generic AA-rated 2-year bonds paying 67 BP over LIBOR and generic
AA-rated 5-year bonds paying 97 BP over LIBOR.
The WAL and WAL extension calculations above reflect the 0.5
reduction factor for the agency RMBS. The WAL life of the portfolio
without the application of this factor would be 1.95 years and the WAL
assuming a 50 percent slowdown in prepayments would be 2.40. This
illustrates the benefit to the corporates of permitting longer WALs for
U.S. Government and Agency securities.
Liabilities Used in the Balance Sheet
The overnight share allocation of 36 percent is based on the lowest
observed month-end level of corporate overnight shares during the past
10 years. The average percentage of overnight shares for the five years
leading up to the implementation of the corporate share guarantee was
higher, ranging from 42 to 49 percent. The 36 percent figure is also
comparable to the median of 42.5 percent in the models submitted by
commenters. Many corporate credit unions use the federal funds
effective rate for setting dividend rates on their overnight accounts;
and NCUA used this benchmark to set the overnight rate at LIBOR--10.
The certificate allocation of 60 percent constitutes the remaining
liabilities after setting overnight shares at 36 percent and
contributed capital at 4 percent. The hypothetical balance sheet
assumes certificates pay LIBOR flat, which is a reasonable spread over
agency securities with similar maturities and is consistent with the
assumptions in the models submitted by Southwest and the ACCU.
Contributed Capital Used in the Balance Sheet
The balance sheet model assumes contributed capital is priced at
LIBOR flat. Some, but not all, commenter models priced contributed
capital at spreads as high as 150 BP or 200 BP over LIBOR. Most capital
instruments pay dividends based on the financial condition and
performance of the underlying organization rather than a strict
formula, and the same should be true for corporate credit unions.
Accordingly, NCUA believes that members should accept a lower dividend
payment on their PCC and NCAs until such time as their corporate is
able to accumulate sufficient earnings to satisfy the RE requirements
of the final rule.
There are various ways that a corporate could structure its PCC and
NCA dividend provisions to facilitate a corporate's RE goals. One way
would be for a corporate to offer capital instruments with a spread of
100 to 200 BP above LIBOR, but which also clearly notes that in any
given year, should the corporate fall short of a particular earnings
growth goal, the actual dividend paid may be reduced as low as zero (on
a noncumulative basis) to make up for the earnings shortfall. To the
extent that a member receives a reduced dividend in a given year, the
member should consider this reduction as a form of fee for services
received.
Model Balance Sheet's Ability To Generate Earnings
There are three major components to the determination of whether a
corporate can generate earnings and the amount of such earnings. One
component is net interest income (NII), which is generally calculated
by taking the difference between the interest generated by the
corporate's loans and investments and subtracting off the cost of the
corporate's liabilities. The other two components are the total non-
interest income (TNII)(which is primarily fee income) and the operating
expenses (OE). A corporate's earnings, or net operating income, is then
calculated using the following equation:

Net Operating Income (Earnings) = NII + TNII--OE

Although the income on a corporate's investment feeds into the NII
and not into either the TNII or the OE, assumptions about the latter
two terms are important in estimating the corporate's ultimate ability
to generate earnings. Accordingly, before looking at a corporate's
asset allocation and the NII it can produce, a discussion of TNII and
OE is in order. For purposes of this document we define the difference
between TNII and OE as net operating expenses (NOE), because it will
generally be a negative number. Then:

Earnings = NII + NOE.

For the most recent 12 months ending in June, 2010, the average
corporate TNII was 25 BP, and the average OE was 40 BP. NOE, then, was
a negative 15 BP and, for the corporate to generate the necessary 17 BP
in earnings, it must strive to generate 32 BP in NII.
NCUA believes that approximating NOE at negative 15 BP is a good
starting point for any analysis. The expected earnings of this
hypothetical balance sheet are demonstrated here:

[[Page 64820]]

------------------------------------------------------------------------
(Basis
Hypothetical Balance Sheet 1 points)
------------------------------------------------------------------------
Net Interest Income (NII) (from model)....................... 33.3
TNII......................................................... 25
OE........................................................... 40
NOE.......................................................... (15)
------------------------------------------------------------------------
Net Income From Operations (Earnings)...................... 18.3
------------------------------------------------------------------------

Accordingly, the asset allocation in hypothetical balance sheet
1 should produce about 18.3 BP of earnings growth a year, more
than the necessary 17 BP of annual earnings necessary to meet the 6-
year RE target.
Methods To Improve Earnings
The Board believes that there are ways that any corporate,
including the model corporate earning 18.3 BP a year above, can improve
its RE growth. For example:
A corporate might improve its NII by improved share
pricing. Corporates have some measure of control of their dividend
pricing structure, and they need to account for asset yields when
making decisions on funding strategies.
The current positively shaped yield curve should improve
earnings as securities roll down the yield curve.
After a corporate has built some retained earnings it can,
if necessary, improve its RE ratio by shrinking its assets.
NCUA also believes that corporates have some pricing power over the
fees they charge their members, and higher fees result in higher TNII.
In addition, corporates can become more efficient, reducing their OE.
Higher TNII and lower OE result in an improved NOE. Currently, the
average corporate NOE is about negative 15 BP, but NCUA believes that
well-run corporates can reduce this NOE number over time--making it
easier to generate the necessary NII to support earnings growth at 17
BP annually.
Historical corporate trends indicate that corporate NOE is, in
fact, declining:

----------------------------------------------------------------------------------------------------------------
2005 2006 2007 2008 2009 2010*
----------------------------------------------------------------------------------------------------------------
TNII.............................. 0.26 0.25 0.21 0.22 0.26 0.24
OE................................ 0.48 0.46 0.41 0.45 0.43 0.38
NOE............................... -0.22 -0.21 -0.19 -0.23 -0.17 -0.14
----------------------------------------------------------------------------------------------------------------
* Annualized.

As the above chart illustrates, corporates have seen continued
improvement in NOE (from -0.22 to -0.14) over the past five years. The
only exception to this trend was in 2008. In that year, the improvement
in NOE reversed temporarily, most likely due to a one-time spike of 5
BP in employee compensation and benefits. Absent that one time expense,
NOE would have been negative 18 BP, right in line with the historical
trend.
NCUA recognizes that the TNII, OE, and NOE information quoted above
is average information and not necessarily reflective of any particular
corporate and its business model. The Board notes, for example, that
for purposes of analyzing its forward-looking model portfolio,
Southwest Corporate FCU used TNII of 37.3 BP and OE of 45.3 BP, both
significantly higher than the current corporate averages.\35\ Yet
Southwest's NOE--the difference between its TNII and OE--was only
negative 12 BP. This is right in line with the improving corporate
trends demonstrated above.
---------------------------------------------------------------------------

\35\ Southwest FCU comment letter, p. 24.
---------------------------------------------------------------------------

B. Hypothetical Balance Sheet 2

There are other balance sheets that differ from Balance Sheet
1 that should generate sufficient earnings going forward. For
example, by reducing the allocation to corporate bonds, and increasing
the allocation to Agency RMBS and adding some commercial mortgage
backed securities (CMBS), a corporate might hold a balance sheet like
this:
---------------------------------------------------------------------------

\36\ After applying the 0.5 reduction factor to the Agency RMBS
permitted by paragraph 704.8(h). The factor is also applied to the
prepayment slowdown WAL.

Hypothetical Balance Sheet 2
----------------------------------------------------------------------------------------------------------------
WAL in 50%
Sector Percent of Spread to LIBOR WAL (years) prepayment
balance sheet (basis points) slowdown (years)
----------------------------------------------------------------------------------------------------------------
Assets
----------------------------------------------------------------------------------------------------------------
FFELP Student Loans.............. 5 33 3 3.8
ABS--Autos....................... 7 15 2 2.5
ABS--Credit Cards................ 8 25 3 3
Bonds--Corporate................. 12 82 3.5 3.5
Agency RMBS...................... 18 45 4 7
CMBS............................. 10 130 5 5
Overnight Invest................. 40 0 0 0
------------------------------------------------------------------------------
Total........................ 100 35.64 \36\ 1.81 2.155
----------------------------------------------------------------------------------------------------------------
Liabilities
----------------------------------------------------------------------------------------------------------------
Overnight Shares................. 36 -10 .................. ..................
Term Certificates................ 60 0 .................. ..................
Member Capital................... 4 0 .................. ..................
------------------------------------------------------------------------------
Total........................ 100 -3.6 .................. ..................
----------------------------------------------------------------------------------------------------------------
Net Interest Income (NII)....................... 39.24 .................. ..................

[[Page 64821]]

TNII............................................ 25 .................. ..................
OE.............................................. 40 .................. ..................
NOE............................................. (15) .................. ..................
----------------------------------------------------------------------------------------------------------------
Net Income From Operations (Earnings)........... 24.24 .................. ..................
----------------------------------------------------------------------------------------------------------------

Again, NCUA constructed this portfolio to be in compliance with the
final rule, including the rule's requirements for asset credit quality,
sector limits, the 2-year asset WAL limit, and the 2.25-year asset
extension limit. Again, the spread sources used include Bank of
America//Merrill Lynch's, US Securitization Research, Securitization
Weekly, dated August 6, 2010; and Wells Fargo Securities' Libor/Swap
spreads for July 30, 2010.
The other general assumptions about assets, liabilities, cost of
capital, and TNII, OE, and NOE are also the same as in hypothetical
1. Since this Balance Sheet 2 earns more than Balance
Sheet 1, the corporate could possibly pay its capital
contributors more on their contributed capital. In fact, the corporate
could pay up to LIBOR +150 on its contributed capital and still
generate more than 17 BP of earnings each year.

C. Hypothetical Balance Sheet 3 (Southwest Corporate Federal
Credit Union)

Southwest Corporate Federal Credit Union (Southwest) submitted the
following model balance sheet as part of its comment letter:

Hypothetical Balance Sheet 3--Southwest Model (From Annex C)
[All data in this table supplied by Southwest]
----------------------------------------------------------------------------------------------------------------
Percent of Maturity \37\
Investments and loans balance sheet Spread to LIBOR (Years)
----------------------------------------------------------------------------------------------------------------
Investments
----------------------------------------------------------------------------------------------------------------
Loans................................................ 7 40 2.0
ABS--Autos........................................... 20 35 2.0
ABS--Credit Cards.................................... 20 38 2.0
FFELP Student Loans.................................. 18 32 2.0
Agency............................................... 10 10 1.0
Overnight............................................ 25 -12 0.0
----------------------------------------------------------
Total............................................ 100 21.2 1.40
----------------------------------------------------------------------------------------------------------------
Liabilities
----------------------------------------------------------------------------------------------------------------
Overnight Shares..................................... 65 -18 0
Certificates......................................... 31 0 0.7
Member Capital....................................... 4 150 0.0
RUDE................................................. 0 .................. 0.0
----------------------------------------------------------
Total............................................ 100 -5.7 0.22
----------------------------------------------------------------------------------------------------------------
Asset/Liability WAL mismatch (years)................................ 1.18 ..................
Net Interest Margin (bps)........................................... 26.9 ..................
Net Fee Income (bps)................................................ 37.3 ..................
Operating Expenses (bps)............................................ 45.3 ..................
----------------------------------------------------------------------------------------------------------------
Net Income From Operations (bps).................................... 18.9 ..................
----------------------------------------------------------------------------------------------------------------

---------------------------------------------------------------------------

\37\ NCUA believes that Southwest meant this to be WAL, not
maturity. In any event, the WAL would be less than or equal to the
maturity.
---------------------------------------------------------------------------

Southwest stated that its model balance sheet has about $7 billion
in assets and is based on Southwest's recommendations and current
business model.
---------------------------------------------------------------------------

Model Balance Sheet Compliance With the Final Corporate Rule
This model appears to comply with the investment, credit risk, and
ALM provisions of the final rule.\38\ Specifically:
---------------------------------------------------------------------------

\38\ NCUA assumes that the commenter constructed this portfolio
in compliance with the NRSRO limits (AA-) and IRR NEV limits. These
limits exist in the current corporate rule, and the final rule does
not change the existing base limits.
---------------------------------------------------------------------------

The asset allocation complies with the sector limits of
704.6(d).
The WAL of the assets, at 1.40 years, is less than the 2.0
year limit in 704.8(f).\39\
---------------------------------------------------------------------------

\39\ Southwest was concerned about the proposed cash flow
mismatch sensitivity tests in the proposed rule, and its mismatch of
1.18 years would have violated one of those tests--but both of those
tests have been removed from the final rule.
---------------------------------------------------------------------------

The portfolio contains no private-label RMBS, which are
prohibited under the final rule 704.5(h).
The portfolio complies with the new asset extension test,
that is, the new

[[Page 64822]]

2.25 year limit in 704.8(g) on WAL of assets assuming a 50% prepayment
slowdown. While Southwest did not discuss this new extension test--
because it was not in the proposed rule--Southwest's balance sheet mix
indicates the portfolio would meet this requirement. For example, the
most likely securities to have any extension risk are those with
student loans and mortgages. If upon prepayment slowdown the student
loan ABS extends to 3 years (market indications are an extension to 2.6
years) and the agency securities (assuming agency MBS) extend to 4
years (a 1.5 year WAL security was observed to extend only to 2.7
years), the WAL of the portfolio is still only 1.96 years. Even then,
the WAL for agency mortgages can be reduced by a factor of 0.5 under
the final rule, 704.5(h). Applying the 0.5 factor to these securities,
the WAL of the extended portfolio would drop to only 1.76 years, again
well below the 2.25 year limit.
Model Balance Sheet's Ability To Generate Earnings
As recognized by Southwest in its comment letter, this balance
sheet generates sufficient income to pass the retained earnings goals
established by the new corporate regulation. Projected retained
earnings are well above 17 BP a year. For example, after 3 years,
Southwest projected the RE growth at 57 basis points, and after 6 years
Southwest projected an RE of 113 basis points.
NCUA notes that this model generates sufficient earnings even when
capital holders are paid at LIBOR +150. Earnings would be enhanced if
the rate of return on capital was reduced, even temporarily.
Effect of Changes in the Spreads Over Time
Southwest expressed some concern that spreads, as they existed when
it wrote to NCUA in February 2010, might tighten over time, thus
reducing a corporate's ability to generate earnings. In Annex D of its
letter, Southwest analyzed its model balance sheet under ``historic''
spread levels and concluded that its model asset allocation would not
produce sufficient earnings at those historic levels.
NCUA agrees that spreads going forward will have an impact on a
corporate's ability to generate earnings. It is impossible, however, to
predict the future--spreads could tighten, widen, or even stay the same
for a protracted period. And even if spreads change, it is uncertain as
to the speed of change. In fact, no one can say if spreads will ever
return to ``historical'' levels, or even what exactly those historical
levels are. For example, Southwest's letter indicates it based its
Annex D analysis on the past 9 years of historical data, and concluded
that the spread over LIBOR for an Agency MBS was only 6 BP during this
time period. Using a longer historical view of the past 20 years,
however, Bloomberg data suggests the average 1-year Agency MBS spreads
were much higher than 6 BP, with an average Agency MBS spread over this
20-year period of about 22 BP and a median of about 16 BP.
Corporates will have to adapt to changing spreads, including
variances within asset classes. As suggested by Southwest FCU, its
model asset allocation would have worked in February 2010, and NCUA
believes the asset allocations in hypotheticals 1 and
2 above will work given today's spreads. The Board believes
that corporates can adapt to changes in spreads, and the WAL limits in
the final rule will provide corporates additional flexibility to shift
allocations.

D. Hypothetical Balance Sheet 4--Magnus Enterprises Model

Magnus proposed a different investment model that grows RE at a
successful rate:

Hypothetical Balance Sheet 4--Magnus Model
[All data in this table supplied by Magnus]
----------------------------------------------------------------------------------------------------------------
Portfolio
Investments and loans percentage LIBOR/EDSF spread Total WAL (years)
----------------------------------------------------------------------------------------------------------------
Assets
----------------------------------------------------------------------------------------------------------------
Agency Mortgages..................................... 35 60 4
ABS--Autos........................................... 10 25 0.6
ABS--Credit Cards.................................... 10 30 1
FFELP Student Loans.................................. 15 25 0.5
Overnight Investments................................ 30 -5 0.003
----------------------------------------------------------
Total............................................ 100 28.75 1.6359
----------------------------------------------------------------------------------------------------------------
Liabilities
----------------------------------------------------------------------------------------------------------------
Overnight Shares..................................... 30 -5 0.003
Certificates......................................... 70 -5 0.5
----------------------------------------------------------
Total............................................ 100 -5 0.3509
----------------------------------------------------------------------------------------------------------------
Net Interest Income................................................. 33.75 ..................
----------------------------------------------------------------------------------------------------------------

Model Balance Sheet Compliance With the Final Corporate Rule
Again, this Magnus Balance Sheet 4 appears to comply with
the investment, credit risk, and ALM provisions of the final rule. The
portfolio contains no private label RMBS and complies with the final
sector limits. The WAL of the assets, at 1.63 years, is under the 2-
year WAL limit. In fact, since the final rule permits agency securities
to multiply their actual WAL by a factor of 0.5 before applying the 2-
year WAL, the effective WAL of this portfolio is well under 1.63 years.
The asset liability mismatch of 1.285 years is not relevant, as the
proposed cash flow mismatch tests have been removed from the final
rule. And NCUA also believes that these assets, if prepayments slowed
by 50 percent, would not cause the portfolio WAL to exceed 2.25 years,
thus satisfying the asset extension test of 704.8(g).

[[Page 64823]]

Model Balance Sheet's Ability To Generate Earnings
The Magnus balance sheet generates a net interest income of 33.75
BP.
Magnus' letter discusses corporate operating expenses. The author
believes, as NCUA does, that corporates can and will become more
efficient. He asserts an operating expense level of 30 BP is achievable
after cost reductions and potential mergers in the coming years. For
purposes of analyzing the Magnus model, however, NCUA used the current
average, annual ratio of corporate operating expenses to daily average
net assets of 40 BP.
Magnus believes that corporates have control over their cost of
capital. Specifically, he says that:

I am not troubled by the lack of cost of capital in [NCUA's
proposed rule] margin analysis. Any new capital that comes into the
corporates is going to come from NPCUs and they all understand that
their capital investment isn't really a traditional investment that
pays a high annual yield. Instead, it's an investment that may not
pay dividends for 10 years or more * * *. Members who value the
cooperative nature of their relationship with their corporate should
be willing to forsake the dividend on PCC and NCA in the short run
in order for the corporate to rebuild retained earnings.

Magnus letter, p. 4. NCUA agrees with this quoted language,
particularly the last sentence. Accordingly, for purposes of analyzing
the Magnus model, the analysis assumes that capital pays only LIBOR
flat.
Magnus' model does not address net fee income. For purposes of
analysis, NCUA made the same TNII assumptions (25 BP) as discussed
previously. Accordingly, the Magnus investment portfolio, with its
primary emphasis on Agency MBS, would produce an annual RE growth of
about 19 BP, as follows:

------------------------------------------------------------------------
(Basis
Analysis of Magnus model points)
------------------------------------------------------------------------
Net Interest Income.......................................... 33.75
TNII......................................................... 25
OE........................................................... 40
NOE.......................................................... (15)
------------------------------------------------------------------------
Net Income From Operations (Earnings)...................... 18.75
------------------------------------------------------------------------

This earnings growth exceeds the necessary 17 BP a year. Again, as
discussed in connection with NCUA's hypothetical 1 above,
there are multiple potential ways to further improve this RE growth.
For example, the corporate could become more efficient, moving toward
the 30 BP expense level discussed by Magnus; or the corporate could use
its pricing power to increase its fee income or reduce its dividends.

E. Hypothetical Balance Sheet 5--ACCU Model

As mentioned above, a number of commenters adopted or referenced a
model developed by the Association of Corporate Credit Unions (ACCU),
given in the table below:

Hypothetical Balance Sheet 5--ACCU Model
[All data in this table supplied by ACCU]
------------------------------------------------------------------------
Percent of
Assets balance sheet Spread to LIBOR
------------------------------------------------------------------------
Loans............................. 10 50
ABS--Autos........................ 20 37
ABS--Credit Cards................. 15 42
FFELP Student Loans............... 5 45
Structured Agency................. 15 34
Bank Floaters..................... 5 29
Other Short-term.................. 8 12
CMBS.............................. 7 100
Overnight......................... 15 4
-------------------------------------
Total......................... 100 36
------------------------------------------------------------------------
Shares and Equity
------------------------------------------------------------------------
Overnight Shares.................. 50 0
Certificates...................... 46 0
Member Capital.................... 4 200
Rude.............................. 0 0
-------------------------------------
Total....................... 100 8
-------------------------------------
Net Interest Margin (basis 28 .................
points)......................
Other Income.................. 18 .................
Operating Expenses............ 32 .................
Net Income.................... 14 .................
------------------------------------------------------------------------

The ACCU asset allocation varies from both the Southwest and Magnus
allocations. For example, the ACCU model includes wider variation in
investment classes and, as with hypothetical 2 above,
introduces some CMBS.
Model Balance Sheet Compliance With the Final Corporate Rule
Again, this balance sheet appears to comply with the investment,
credit risk, and ALM provisions of the final rule. For example, the
portfolio contains no private label RMBS, and it complies with the
final sector limits.
ACCU did not provide direct information about the WAL of its
assets. However, it did provide data from which the asset WAL can be
reverse engineered. Specifically, ACCU also provided this chart:

------------------------------------------------------------------------
NEV Shocks Maximum
------------------------------------------------------------------------
Rates +300 bp................................................ -14.0%

[[Page 64824]]

Credit +100 bp............................................... -30.3%
+Paydowns -50%............................................... -32.7%
------------------------------------------------------------------------

If a credit shock of 100 BP produces an NEV decline of 30 percent
from a starting NEV of 4 percent, that equates to a difference in the
WALs of the assets and liabilities of about 1.2 years. Given that
ACCU's liabilities are half overnight and half certificates, and the
certificates likely have an aggregate WAL of a year or less (as do the
certificates in both the Southwest and Magnus models), the aggregate
liability WAL of the ACCU model is likely less than 0.8 years, which
would make ACCU's asset WAL less than 2.0 years, satisfying the WAL
restriction in the final rule.
As for the asset extension test, ACCU indicates that a 100 BP shock
to its portfolio, assuming a 50 percent prepayment slowdown, produces
an NEV decline of 32.7 percent. This equates to an asset extension of
less than two months, and so the asset WAL, with the slowdown, would be
less than 2.25 years. Accordingly, the ACCU model satisfies the
extension test of 704.8(g).
Model Balance Sheet's Ability To Generate Earnings
ACCU's bottom line of 14 BP annually is 3 BP short of the annual RE
growth needed under the final rule. Although the ACCU model assumes
lower net fee income than the Southwest model, in the ACCU model this
lower fee income is offset by a lower operating expense estimate.
There are multiple ways a corporate starting with the ACCU model
can adjust its earnings capacity to achieve the 17 BP target. For
example,
The corporate can improve its efficiencies and product
pricing, as discussed earlier.
The corporate could change its sector weighting slightly.
For example, if the corporate shifted 5 percent of its portfolio from
Auto ABS to CMBS, the portfolio return would improve by over 3 BP
annually using ACCU's spreads.
ACCU assumed its cost of capital would be 200 BP over
LIBOR. Again, NCUA believes that NPCUs that desire corporate services
should be willing to provide capital at little or no cost, at least
temporarily. If the cost of capital in ACCU's model was reduced to
LIBOR flat, for example, that would increase its operating income by 8
BP annually and put the corporate well over its 17 BP annual earnings
target.
Conclusion
There are multiple, different asset allocations available to
corporates under the restrictions of the new rule that should provide
corporates the necessary earnings flexibility to meet the new RE growth
requirements.

V. Further Revisions to the Corporate Rule

As discussed above, NCUA issued its proposed revisions to the
corporate rule back in November 2009, more than ten months ago. Since
that time NCUA has received significant feedback. NCUA received formal
feedback in the form of 815 public comment letters with over 2,600
pages of comments. NCUA also received much informal feedback, for
example, from the credit union industry (through numerous town hall
meetings and webinars), from other federal regulators, and from the
Kamakura Corporation.
Much of that feedback has resulted in changes from the proposed
rule to this final rule. Some of the feedback, though, went beyond the
scope of the proposed rulemaking. Ideas--even very good ideas--that are
beyond the scope of the proposed rule are not addressed in this final
rulemaking. Instead, the NCUA has considered some of these ideas and
plans in the near future to issue another proposal with further
revisions to the corporate rule. The Board believes it important,
though, as corporates and credit unions move now to adapt to this final
rule, that they also have some information about what these pending
proposals are.
Specifically, the Board will be proposing that:
1. Corporates be subject to internal control reporting requirements
similar to those required under Section 36 of the FDI Act (for banks
and thrifts) and the Sarbanes-Oxley Act of 2002 (for public companies).
See 12 U.S.C. 1831m; Public Law 107-204; and 12 CFR part 363, Annual
Independent Audits and Reporting Requirements (FDIC rulemaking
integrating FDI Act Section 36 and certain Sarbanes-Oxley
requirements).
2. At any given time, an NPCU would be limited to membership in one
corporate of the NPCU's choice. An NPCU could belong to two corporates
for a short period of time, but only when transitioning between those
corporates.
3. The board of directors of a corporate must establish a risk
management committee. The committee will include at least one
independent risk management expert with sufficient experience in
identifying, assessing, and managing risk exposures.
4. When the TCCUSF makes an assessment on FICUs, NCUA would ask all
corporate members that are not FICUs (``non-FICUs'') to make a
voluntary contribution to the TCCUSF. Corporates will hold a membership
vote to determine whether any non-FICU that fails to make the requested
contribution should be expelled from the corporate.
5. Each vote by a corporate's boards of directors must be recorded
in the minutes so that the vote of each individual director is apparent
from the minutes.
6. Corporates would be permitted to charge their members reasonable
one-time or periodic membership fees. The fees must generally be
proportional to the member's asset size, and a member must be given at
least six months notice of any new fee, or any material change to an
existing fee.
In a sense, this final rulemaking is the first step in the
remolding of the corporate rule, and the six proposals above are the
second step. As much as practicable, NCUA intends to mesh the effective
dates of these two rulemakings. As discussed above, the effective date
for most of this final rule is January 18, 2011. Accordingly, the Board
plans to move this second-step rulemaking along by issuing these six
proposals at either the October 2010 or November 2010 Board meeting for
a 30-day public comment period.
Also, although not involving any additional rulemaking, the Board
plans to:
1. Consult with other federal financial regulators to create a data
tracking system to enhance NCUA's ability to systemically conduct trend
analyses to identify recurrent or network-wide issues, and
2. Upgrade NCUA's current guidance on corporate mergers into a
formal corporate credit union merger manual.
NCUA intends to implement the data tracking system within nine
months and publish the merger manual within six months.

VI. Regulatory Procedures

A. Regulatory Flexibility Act

The Regulatory Flexibility Act requires NCUA to prepare an analysis
to describe any significant economic impact a proposed rule may have on
a substantial number of small credit unions (those under ten million
dollars in assets). This final rule only applies to corporates, all but
one of which has assets well in excess of $10 million. Accordingly, the
NCUA Board certifies that this final rule will not have a significant
economic impact on a substantial number of small credit

[[Page 64825]]

unions, and, therefore, a regulatory flexibility analysis is not
required.

B. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 (PRA) applies to rulemakings in
which an agency by rule creates a new paperwork burden on regulated
entities or modifies an existing burden. 44 U.S.C. 3507(d). For
purposes of the PRA, a paperwork burden may take the form of a either a
reporting or a recordkeeping requirement, both referred to as
information collections. NCUA identified and described several
information collection requirements in the proposed rule, including new
requirements in the following broad areas: capital and PCA,
investments, ALM, CUSO procedures, and corporate governance
requirements. As required by the PRA, NCUA submitted a copy of the
proposed regulation to the Office of Management and Budget (OMB) for
its review and approval. Persons interested in submitting comments with
respect to the information collection aspects of the proposed rule were
invited to submit them to the OMB at the address noted in the preamble
to the proposed rule.
While NCUA received a substantial number of comments on the
proposed rule, commenters did not specifically address the agency's
estimates of burden hours or costs, which estimates were set out
specifically in the preamble as required by PRA. However, as discussed
more fully in the preamble to this final rule, the Board has determined
to make several changes in the final rule, and some of those changes
affect the burden estimates for some aspects of the collection
requirements. These changes, all of which have the effect of reducing
the estimated burden, are discussed below.
ALM Requirements
The Board has determined to eliminate entirely the two cash flow
mismatch tests that had been proposed (Sec. Sec. 704.6(e) and (f) in
the proposed rule). The final rule will retain as proposed the two-year
weighted average limit and will now require a new, additional test with
a 2.25 year weighted average life limit that assumes a 50 percent
slowdown in prepayment speeds to limit extension risk. The new test
must be done quarterly and will be required of and affect all
corporates. As with the original proposal, corporates will be required
to calculate and record the effective and spread durations for
individual assets and liabilities to support the test results.
From an information collection standpoint, NCUA estimates that the
net impact of this change will be a reduction by approximately 50
percent in the estimated burden hours associated with ALM requirements.
Accordingly, the revised burden estimate for compliance with this
revised requirement would be as follows:

27 corporates x 84 hours per year = 2268 hours.
Corporate Governance Requirements
The final rule changes the provisions relating to disclosure of
compensation by reducing the number of senior executives whose
compensation must be disclosed. Many commenters noted that the original
proposal could have had the effect of requiring disclosure of
compensation for many individuals, such as some persons holding the
title of vice president, who are not, in fact, in positions with
program or operational level responsibilities. The Board has changed
the language from the proposal to now limit the total number of
required executives subject to disclosure to the top ten percent of
most highly paid individuals, to a maximum of five. For corporates with
thirty or fewer employees, the top three highly paid executives must be
disclosed. In all cases, the compensation paid to the CEO must be
included in the disclosure if the CEO is not in the most highly paid
ten percent. While the initial estimate of the burden for complying
with this aspect of the governance provisions was not substantial, the
Board believes the change will reduce the final burden by approximately
50 percent.
Accordingly, the revised burden estimate for compliance with this
revised requirement would be as follows:

27 corporates x 5 hours = 135 hours.
Summary of Collection Burden (Revised)
With the revisions described above, NCUA estimates the total
information collection burden represented by the final rule, calculated
on an annual basis, as follows:

Capital restoration plans........................ 20 corporates x 50 hours = 1,000 hours.
Retained earnings accumulation plans............. 3 corporates x 50 hours = 150 hours
Notice of intent to redeem contributed capital... 10 corporates x 1 hour = 10 hours.
Notice of PCA category change.................... 10 corporates x 1 hour = 10 hours.
Ratings procurement.............................. 27 corporates x 2 hours = 54 hours.
Investment action plans.......................... 10 corporates x 20 hours = 200 hours.
ALM testing...................................... 27 corporates x 84 hours = 2,268 hours.
CUSO approval requests........................... 12 corporates x 2 hours = 24 hours.
Compensation disclosures......................... 27 corporates x 5 hours = 135 hours.
Merger related disclosures....................... 4 corporates x 5 hours = 20 hours.
Requests to make golden parachute and severance 4 corporates x 4 hours = 16 hours.
payments.
--------------------------------------------------------------
Total Additional Burden Hours................ 3,887 hours.

NCUA does not anticipate that the revisions discussed above will
have any significant impact on the cost estimates set out in the
proposed rule.
NCUA has submitted these burden revisions to the OMB. NCUA expects
that OMB will review and approve the revisions, and publish its
approval, in the near future.

C. Executive Order 13132

Executive Order 13132 encourages independent regulatory agencies to
consider the impact of their actions on state and local interests. In
adherence to fundamental federalism principles, NCUA, an independent
regulatory agency as defined in 44 U.S.C. 3502(5), voluntarily complies
with the executive order.
This final rule applies to all federally-insured corporates,
including state charters. Nonfederally insured corporates must also
agree by contract, as a condition of receiving shares or deposits from
federally-insured credit unions, to adhere to the requirements of this
part and submit to NCUA examinations. The executive order states that:
``National action limiting the policymaking discretion of the states
shall be taken only where there is constitutional and statutory
authority for the action and the national activity is appropriate in
light of the presence of a problem of national significance.'' NCUA has
plenary statutory authority to regulate corporate credit unions and
federally insured credit unions. See 12

[[Page 64826]]

U.S.C. 1766(a) and 12 U.S.C. 1781 et. seq. Further, the risk of loss to
federally-insured credit unions and the NCUSIF due to corporate
activities are concerns of national scope.
The final rule does not impose additional costs or burdens on the
states or have a significant effect on the states' ability to discharge
traditional state government functions. NCUA has determined that the
corporate rule as a whole, and this rulemaking, may have an occasional
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. However, the
potential risk to the NCUSIF and the entire credit union system that
would result without extending the entire corporate rule, including the
revisions in this rulemaking, to all corporates is more significant
than any such effects.
Accordingly, NCUA believes that the protection of corporates, the
NCUSIF, and the entire system of federally-insured credit unions
requires application of this final rule to all such corporates, and
that this application is consistent with Executive Order 13132.

D. The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families

The NCUA has determined that this rule will not affect family well-
being within the meaning of section 654 of the Treasury and General
Government Appropriations Act, 1999, Public Law 105-277, 112 Stat. 2681
(1998).

E. Small Business Regulatory Enforcement Fairness Act

The Small Business Regulatory Enforcement Act of 1996 (Pub. L. 104-
121) provides generally for congressional review of agency rules. A
reporting requirement is triggered in instances where NCUA issues a
final rule as defined by section 551 of the Administrative Procedure
Act. 5 U.S.C. 551. The Office of Management and Budget has determined
that this rule is not a major rule for purposes of the Small Business
Regulatory Enforcement Fairness Act of 1996.

List of Subjects

12 CFR Part 702

Credit unions, Reporting and recordkeeping requirements.

12 CFR Part 703

Credit unions, Investments.

12 CFR Part 704

Credit unions, Corporate credit unions, Reporting and recordkeeping
requirements.

12 CFR Part 709

Credit unions, Liquidations.

12 CFR Part 747

Credit unions, Administrative practices and procedures.

By the National Credit Union Administration Board on September
24, 2010.
Mary F. Rupp,
Secretary of the Board.

0
Accordingly, NCUA amends 12 CFR parts 702, 703, 704, 709, and 747 as
follows:

PART 702--PROMPT CORRECTIVE ACTION

0
1. The authority citation for part 702 continues to read as follows:

Authority: 12 U.S.C. 1766(a), 1790d.

0
2. Effective October 20, 2011, revise paragraph (d) of Sec. 702.105 to
read as follows:

Sec. 702.105 Weighted--average life of investments.

* * * * *
(d) Capital in mixed-ownership Government corporations and
corporate credit unions. For capital stock in mixed-ownership
Government corporations, as defined in 31 U.S.C. 9101(2), and perpetual
and nonperpetual capital in corporate credit unions, as defined in 12
CFR 704.2, the weighted-average life is defined as greater than one (1)
year, but less than or equal to three years;
* * * * *

PART 703--INVESTMENTS AND DEPOSIT ACTIVITIES

0
3. The authority citation for part 703 continues to read as follows:

Authority: 12 U.S.C. 1757(7), 1757(8), 1757(15).

0
4. Effective October 20, 2011, revise paragraph (b) of Sec. 703.14 to
read as follows:

Sec. 703.14 Permissible investments.

* * * * *
(b) Corporate credit union shares or deposits. A Federal credit
union may purchase shares or deposits in a corporate credit union,
except where the NCUA Board has notified it that the corporate credit
union is not operating in compliance with part 704 of this chapter. A
Federal credit union's aggregate amount of perpetual and nonperpetual
capital, as defined in part 704 of this chapter, in one corporate
credit union is limited to two percent of the federal credit union's
assets measured at the time of investment or adjustment. A Federal
credit union's aggregate amount of contributed capital in all corporate
credit unions is limited to four percent of assets measured at the time
of investment or adjustment.
* * * * *

PART 704--CORPORATE CREDIT UNIONS

0
5. Revise the authority citation for part 704 to read as follows:

Authority: 12 U.S.C. 1762, 1766(a), 1772a, 1781, 1789, and
1795e.

0
6. Effective January 18, 2011, revise Sec. 704.2 to read as follows:

Sec. 704.2 Definitions.

As used in this part:
Adjusted trading means any method or transaction whereby a
corporate credit union sells a security to a vendor at a price above
its current market price and simultaneously purchases or commits to
purchase from the vendor another security at a price above its current
market price.
Asset-backed security (ABS) means a security that is primarily
serviced by the cashflows of a discrete pool of receivables or other
financial assets, either fixed or revolving, that by their terms
convert into cash within a finite time period plus any rights or other
assets designed to assure the servicing or timely distribution of
proceeds to the security holders. Mortgage-backed securities are a type
of asset-backed security.
Available to cover losses that exceed retained earnings means that
the funds are available to cover operating losses realized, in
accordance with generally accepted accounting principles (GAAP), by the
corporate credit union that exceed retained earnings net of equity
acquired in a combination. Likewise, available to cover losses that
exceed retained earnings and perpetual contributed capital (PCC) means
that the funds are available to cover operating losses realized, in
accordance with GAAP, by the corporate credit union that exceed
retained earnings net of equity acquired in a combination and PCC. Any
such losses must be distributed pro rata at the time the loss is
realized first among the holders of paid-in capital (PIC), and when all
PIC is exhausted, then pro rata among all MCAs, all subject to the
optional prioritization described in Appendix A

[[Page 64827]]

of this Part. To the extent that any contributed capital funds are used
to cover losses, the corporate credit union must not restore or
replenish the affected capital accounts under any circumstances. In
addition, contributed capital that is used to cover losses in a
calendar year previous to the year of liquidation has no claim against
the liquidation estate.
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.
Capital ratio means the corporate credit union's capital divided by
its moving daily average net assets.
Collateralized debt obligation (CDO) means a debt security
collateralized by mortgage-backed securities, asset-backed securities,
or corporate obligations in the form of loans or debt. Senior tranches
of Re-REMIC's consisting of senior mortgage- and asset-backed
securities are excluded from this definition.
Collateralized mortgage obligation (CMO) means a multi-class
mortgage-backed security.
Commercial mortgage-backed security (CMBS) means a mortgage-backed
security collateralized primarily by multi-family and commercial
property loans.
Compensation means all salaries, fees, wages, bonuses, severance
payments, current year contributions to employee benefit plans (for
example, medical, dental, life insurance, and disability), current year
contributions to deferred compensation plans and future severance
payments, including payments in connection with a merger or similar
combination (whether or not funded; whether or not vested; and whether
or not the deferred compensation plan is a qualified plan under Section
401(a) of the IRS Code). Compensation also includes expense accounts
and other allowances (for example, the value of the personal use of
housing, automobiles or other assets owned by the corporate credit
union; expense allowances or reimbursements that recipients must report
as income on their separate income tax return; payments made under
indemnification arrangements; and payments made for the benefit of
friends or relatives). In calculating required compensation
disclosures, reasonable estimates may be used if precise cost figures
are not readily available.
Contributed capital means either paid-in capital or membership
capital accounts.
Core capital means the sum of:
(1) Retained earnings;
(2) Paid-in capital; and
(3) The retained earnings of any acquired credit union, or of an
integrated set of activities and assets, calculated at the point of
acquisition, if the acquisition was a mutual combination.
Core capital ratio means the corporate credit union's core capital
divided by its moving daily average net assets.
Corporate credit union means an organization that:
(1) Is chartered under Federal or state law as a credit union;
(2) Receives shares from and provides loan services to credit
unions;
(3) Is operated primarily for the purpose of serving other credit
unions;
(4) Is designated by NCUA as a corporate credit union;
(5) Limits natural person members to the minimum required by state
or federal law to charter and operate the credit union; and
(6) Does not condition the eligibility of any credit union to
become a member on that credit union's membership in any other
organization.
Daily average net assets means the average of net assets calculated
for each day during the period.
Derivatives means a financial contract whose value is derived from
the values of one or more underlying assets, reference rates, or
indices of asset values or reference rates. Derivative contracts
include interest rate derivative contracts, exchange rate derivative
contracts, equity derivative contracts, commodity derivative contracts,
credit derivative contracts, and any other instrument that poses
similar counterparty credit risks.
Dollar roll means the purchase or sale of a mortgage-backed
security to a counterparty with an agreement to resell or repurchase a
substantially identical security at a future date and at a specified
price.
Embedded option means a characteristic of certain assets and
liabilities which gives the issuer of the instrument the ability to
change the features such as final maturity, rate, principal amount and
average life. Options include, but are not limited to, calls, caps, and
prepayment options.
Equity investments means investments in real property, equity
securities, and any other ownership interests, including, for example,
investments in partnerships and limited liability companies.
Equity security means any security representing an ownership
interest in an enterprise (for example, common, preferred, or other
capital stock) or the right to acquire (for example, warrants and call
options) or dispose of (for example, put options) an ownership interest
in an enterprise at fixed or determinable prices. However, the term
does not include convertible debt or preferred stock that by its terms
either must be redeemed by the issuing enterprise or is redeemable at
the option of the investor.
Exchangeable collateralized mortgage obligation means a class of a
collateralized mortgage obligation (CMO) that, at the time of purchase,
represents beneficial ownership interests in a combination of two or
more underlying classes of the same CMO structure. The holder of an
exchangeable CMO may pay a fee and take delivery of the underlying
classes of the CMO.
Fair value means the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. If there is a principal
market for the asset or liability, the fair value measurement is the
price in that market (whether that price is directly observable or
otherwise determined using a valuation technique), even if the price in
a different market is potentially more advantageous at the measurement
date. In the absence of a principal market, the fair value measurement
occurs in the most advantageous market for the asset or liability. The
fair value of the asset or liability shall be determined based on the
assumptions that market participants would use in pricing the asset or
liability. In developing those assumptions, the corporate need not
identify specific market participants. Rather, the corporate should
identify characteristics that distinguish market participants
generally, considering factors specific to all of the following: the
asset or liability; the principal (or most advantageous) market for the
asset or liability; and market participants with whom the corporate
would transact in that market. To increase consistency and
comparability in fair value measurements and related disclosures, the
fair value hierarchy prioritizes the inputs to valuation techniques
used to measure fair value into three broad levels. The fair value
hierarchy gives the highest priority to quoted prices (unadjusted) in
active markets for identical assets or liabilities (Level 1) and the
lowest priority to unobservable inputs (Level 3). Examples of valuation
techniques include the present value of estimated future cash

[[Page 64828]]

flows, option-pricing models, and option-adjusted spread models.
Federal funds transaction means a short-term or open-ended
unsecured transfer of immediately available funds by one depository
institution to another depository institution or entity.
Foreign bank means an institution which is organized under the laws
of a country other than the United States, is engaged in the business
of banking, and is recognized as a bank by the banking supervisory
authority of the country in which it is organized.
Immediate family member means a spouse or other family member
living in the same household.
Limited liquidity investment means a private placement or funding
agreement.
Member reverse repurchase transaction means an integrated
transaction in which a corporate credit union purchases a security from
one of its member credit unions under agreement by that member credit
union to repurchase the same security at a specified time in the
future. The corporate credit union then sells that same security, on
the same day, to a third party, under agreement to repurchase it on the
same date on which the corporate credit union is obligated to return
the security to its member credit union.
Membership capital means funds contributed by members that: are
adjustable balance with a minimum withdrawal notice of 3 years or are
term certificates with a minimum term of 3 years; are available to
cover losses that exceed retained earnings and paid-in capital; are not
insured by the NCUSIF or other share or deposit insurers; and cannot be
pledged against borrowings.
Mortgage-backed security (MBS) means a security backed by first or
second mortgages secured by real estate upon which is located a
dwelling, mixed residential and commercial structure, residential
manufactured home, or commercial structure.
Moving daily average net assets means the average of daily average
net assets 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.
Nationally Recognized Statistical Rating Organization (NRSRO) means
any entity that has applied for, and been granted permission to be
considered an NRSRO by the United States Securities and Exchange
Commission.
NCUA means NCUA Board (Board), unless the particular action has
been delegated by the Board.
Net assets means total assets less loans guaranteed by the NCUSIF
and member reverse repurchase transactions. For its own account, a
corporate credit union's payables under reverse repurchase agreements
and receivables under repurchase agreements may be netted out if the
GAAP conditions for offsetting are met.
Net economic value (NEV) means the fair value of assets minus the
fair value of liabilities. All fair value calculations must include the
value of forward settlements and embedded options. Paid-in capital, and
the unamortized portion of membership capital, that is, the portion
that qualifies as capital for purposes of any of the total capital
ratio, is excluded from liabilities for purposes of this calculation.
The NEV ratio is calculated by dividing NEV by the fair value of
assets.
Net interest margin security means a security collateralized by
residual interests in collateralized mortgage obligations, residual
interests in real estate mortgage investment conduits, or residual
interests in other asset-backed securities.
Obligor means the primary party obligated to repay an investment,
e.g., the issuer of a security, such as a Qualified Special Purpose
Entity (QSPE) trust; the taker of a deposit; or the borrower of funds
in a federal funds transaction. Obligor does not include an originator
of receivables underlying an asset-backed security, the servicer of
such receivables, or an insurer of an investment.
Official means any director or committee member.
Paid-in capital means accounts or other interests of a corporate
credit union that: are perpetual, non-cumulative dividend accounts; are
available to cover losses that exceed retained earnings; are not
insured by the NCUSIF or other share or deposit insurers; and cannot be
pledged against borrowings.
Pair-off transaction means a security purchase transaction that is
closed out or sold at, or prior to, the settlement or expiration date.
Private label security means a security that is not issued or
guaranteed by the U.S. government, its agencies, or its government-
sponsored enterprises (GSEs).
Quoted market price means a recent sales price or a price based on
current bid and asked quotations.
Repurchase transaction means a transaction in which a corporate
credit union agrees to purchase a security from a counterparty and to
resell the same or any identical security to that counterparty at a
specified future date and at a specified price.
Residential mortgage-backed security (RMBS) means a mortgage-backed
security collateralized primarily by mortgage loans on residential
properties.
Residential properties means houses, condominiums, cooperative
units, and manufactured homes. This definition does not include boats
or motor homes, even if used as a primary residence, or timeshare
properties.
Residual interest means the ownership interest in remainder cash
flows from a CMO or ABS transaction after payments due bondholders and
trust administrative expenses have been satisfied.
Retained earnings means retained earnings as defined under
Generally Accepted Accounting Principles (GAAP).
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.
Section 107(8) institution means an institution described in
Section 107(8) of the Federal Credit Union Act (12 U.S.C. 1757(8)).
Securities lending means lending a security to a counterparty,
either directly or through an agent, and accepting collateral in
return.
Senior executive officer mean a chief executive officer, any
assistant chief executive officer (e.g., any assistant president, any
vice president or any assistant treasurer/manager), and the chief
financial officer (controller). This term also includes employees of
any entity hired to perform the functions described above.
Settlement date means the date originally agreed to by a corporate
credit union and a counterparty for settlement of the purchase or sale
of a security.
Short sale means the sale of a security not owned by the seller.
Small business related security means a security that is rated in 1
of the 4 highest rating categories by at least one Nationally
Recognized Statistical Rating Organization (NRSRO), and represents an
interest in one or more promissory notes or leases of personal property
evidencing the obligation of a small business concern and originated by
an insured depository institution, insured

[[Page 64829]]

credit union, insurance company, or similar institution which is
supervised and examined by a Federal or State authority, or a finance
company or leasing company. This definition does not include Small
Business Administration securities permissible under Sec. 107(7) of
the Act.
State means any one of the several states of the United States of
America, the District of Columbia, Puerto Rico, and the territories and
possessions of the United States.
Stripped mortgage-backed security means a security that represents
either the principal-only or interest-only portion of the cash flows of
an underlying pool of mortgages.
Subordinated security means a security that, at the time of
purchase, has a junior claim on the underlying collateral or assets to
other securities in the same issuance. If a security is junior only to
money market fund eligible securities in the same issuance, the former
security is not subordinated for purposes of this definition.
Total assets means the sum of all a corporate credit union's assets
as calculated under GAAP.
Total capital means the sum of a corporate credit union's core
capital and its membership capital accounts.
Trade date means the date a corporate credit union originally
agrees, whether orally or in writing, to enter into the purchase or
sale of a security.
Trigger means an event in a securitization that will redirect cash-
flows if predefined thresholds are breached. Examples of triggers are
delinquency and cumulative loss triggers.
Weighted average life means the weighted-average time to the return
of a dollar of principal, calculated by multiplying each portion of
principal received by the time at which it is expected to be received
(based on a reasonable and supportable estimate of that time) and then
summing and dividing by the total amount of principal. The calculation
of weighted average life for interest only securities means the
weighted-average time to the return of a dollar of interest, calculated
by multiplying each portion of interest received by the time at which
it is expected to be received (based on a reasonable and supportable
estimate of that time) and then summing and dividing by the total
amount of interest to be received.
When-issued trading means the buying and selling of securities in
the period between the announcement of an offering and the issuance and
payment date of the securities.

0
7. Effective October 20, 2011, revise Sec. 704.2 to read as follows:

Sec. 704.2 Definitions.

As used in this part:
Adjusted core capital means core capital modified as follows:
(1) Deduct an amount equal to the amount of the corporate credit
union's intangible assets that exceed one half percent of the corporate
credit union's moving daily average net assets, but the NCUA, on its
own initiative, upon petition by the applicable state regulator, or
upon application from a corporate credit union, may direct that a
particular corporate credit union add some or all of these excess
intangibles back to the credit union's adjusted core capital;
(2) Deduct investments, both equity and debt, in unconsolidated
credit union service organizations (CUSOs);
(3) If the corporate credit union, on or after October 20, 2011,
contributes any perpetual contributed capital (PCC), or maintains any
NCAs, at another corporate credit union, deduct an amount equal to this
PCC or NCA;
(4) Beginning on October 20, 2016, and ending on October 20, 2020,
deduct any amount of perpetual contributed capital (PCC) that causes
PCC minus retained earnings, all divided by moving daily net average
assets, to exceed two percent; and
(5) Beginning after October 20, 2020, deduct any amount of PCC that
causes PCC to exceed retained earnings.
Adjusted trading means any method or transaction whereby a
corporate credit union sells a security to a vendor at a price above
its current market price and simultaneously purchases or commits to
purchase from the vendor another security at a price above its current
market price.
Applicable state regulator means the prudential state regulator of
a state chartered corporate credit union.
Asset-backed commercial paper program (ABCP program) means a
program that primarily issues commercial paper that has received a
credit rating from an NRSRO and that is backed by assets or other
exposures held in a bankruptcy-remote special purpose entity. The term
sponsor of an ABCP program means a corporate credit union that:
(1) Establishes an ABCP program;
(2) Approves the sellers permitted to participate in an ABCP
program;
(3) Approves the asset pools to be purchased by an ABCP program; or
(4) Administers the ABCP program by monitoring the assets,
arranging for debt placement, compiling monthly reports, or ensuring
compliance with the program documents and with the program's credit and
investment policy.
Asset-backed security (ABS) means a security that is primarily
serviced by the cashflows of a discrete pool of receivables or other
financial assets, either fixed or revolving, that by their terms
convert into cash within a finite time period plus any rights or other
assets designed to assure the servicing or timely distribution of
proceeds to the security holders. Mortgage-backed securities are a type
of asset-backed security.
Available to cover losses that exceed retained earnings means that
the funds are available to cover operating losses realized, in
accordance with generally accepted accounting principles (GAAP), by the
corporate credit union that exceed retained earnings net of equity
acquired in a combination. Likewise, available to cover losses that
exceed retained earnings and perpetual contributed capital (PCC) means
that the funds are available to cover operating losses realized, in
accordance with GAAP, by the corporate credit union that exceed
retained earnings net of equity acquired in a combination and PCC. Any
such losses must be distributed pro rata at the time the loss is
realized first among the holders of PCC, and when all PCC is exhausted,
then pro rata among all nonperpetual capital accounts (NCAs) and
unconverted membership capital accounts, all subject to the optional
prioritization described in Appendix A of this Part. To the extent that
any contributed capital funds are used to cover losses, the corporate
credit union must not restore or replenish the affected capital
accounts under any circumstances. In addition, contributed capital that
is used to cover losses in a calendar year previous to the year of
liquidation has no claim against the liquidation estate.
Capital means the same as total capital, defined below.
Capital ratio means the corporate credit union's capital divided by
its moving daily average net assets.
Collateralized debt obligation (CDO) means a debt security
collateralized by mortgage-backed securities, asset-backed securities,
or corporate obligations in the form of loans or debt. Senior tranches
of Re-REMIC's consisting of senior mortgage- and asset-backed
securities are excluded from this definition.
Collateralized mortgage obligation (CMO) means a multi-class
mortgage-backed security.
Commercial mortgage-backed security (CMBS) means a mortgage-backed
security collateralized primarily by

[[Page 64830]]

multi-family and commercial property loans.
Compensation means all salaries, fees, wages, bonuses, severance
payments, current year contributions to employee benefit plans (for
example, medical, dental, life insurance, and disability), current year
contributions to deferred compensation plans and future severance
payments, including payments in connection with a merger or similar
combination (whether or not funded; whether or not vested; and whether
or not the deferred compensation plan is a qualified plan under Section
401(a) of the IRS Code). Compensation also includes expense accounts
and other allowances (for example, the value of the personal use of
housing, automobiles or other assets owned by the corporate credit
union; expense allowances or reimbursements that recipients must report
as income on their separate income tax return; payments made under
indemnification arrangements; and payments made for the benefit of
friends or relatives). In calculating required compensation
disclosures, reasonable estimates may be used if precise cost figures
are not readily available.
Consolidated Credit Union Service Organization (Consolidated CUSO)
means any corporation, partnership, business trust, joint venture,
association or similar organization in which a corporate credit union
directly or indirectly holds an ownership interest (as permitted by
Sec. 704.11 of this Part) and the assets of which are consolidated
with those of the corporate credit union for purposes of reporting
under Generally Accepted Accounting Principles (GAAP). Generally,
consolidated CUSOs are majority-owned CUSOs.
Contributed capital means either perpetual or nonperpetual capital.
Core capital means the sum of:
(1) Retained earnings;
(2) Perpetual contributed capital;
(3) The retained earnings of any acquired credit union, or of an
integrated set of activities and assets, calculated at the point of
acquisition, if the acquisition was a mutual combination; and
(4) Minority interests in the equity accounts of CUSOs that are
fully consolidated. However, minority interests in consolidated ABCP
programs sponsored by a corporate credit union are excluded from the
credit unions' core capital or total capital base if the corporate
credit union excludes the consolidated assets of such programs from
risk-weighted assets pursuant to Appendix C of this Part.
Core capital ratio means the corporate credit union's core capital
divided by its moving daily average net assets.
Corporate credit union means an organization that:
(1) Is chartered under Federal or state law as a credit union;
(2) Receives shares from and provides loan services to credit
unions;
(3) Is operated primarily for the purpose of serving other credit
unions;
(4) Is designated by NCUA as a corporate credit union;
(5) Limits natural person members to the minimum required by state
or federal law to charter and operate the credit union; and
(6) Does not condition the eligibility of any credit union to
become a member on that credit union's membership in any other
organization.
Credit-enhancing interest-only strip. (1) Credit-enhancing
interest-only strip means an on-balance sheet asset that, in form or in
substance:
(i) Represents the contractual right to receive some or all of the
interest due on transferred assets; and
(ii) Exposes the corporate credit union to credit risk directly or
indirectly associated with the transferred assets that exceeds its pro
rata share of the corporate credit union's claim on the assets whether
through subordination provisions or other credit enhancement
techniques.
(2) NCUA reserves the right to identify other cash flows or related
interests as a credit-enhancing interest-only strip. In determining
whether a particular interest cash flow functions as a credit-enhancing
interest-only strip, NCUA will consider the economic substance of the
transaction.
Daily average net assets means the average of net assets calculated
for each day during the period.
Daily average net risk-weighted assets means the average of net
risk-weighted assets calculated for each day during the period.
Derivatives means a financial contract whose value is derived from
the values of one or more underlying assets, reference rates, or
indices of asset values or reference rates. Derivative contracts
include interest rate derivative contracts, exchange rate derivative
contracts, equity derivative contracts, commodity derivative contracts,
credit derivative contracts, and any other instrument that poses
similar counterparty credit risks.
Dollar roll means the purchase or sale of a mortgage-backed
security to a counterparty with an agreement to resell or repurchase a
substantially identical security at a future date and at a specified
price.
Eligible ABCP liquidity facility means a legally binding commitment
to provide liquidity support to asset-backed commercial paper by
lending to, or purchasing assets from any structure, program or conduit
in the event that funds are required to repay maturing asset-backed
commercial paper and that meets the following criteria:
(1)(i) At the time of the draw, the liquidity facility must be
subject to an asset quality test that precludes funding against assets
that are 90 days or more past due or in default; and
(ii) If the assets that the liquidity facility is required to fund
against are assets or exposures that have received a credit rating by
an NRSRO at the time the inception of the facility, the facility can be
used to fund only those assets or exposures that are rated investment
grade by an NRSRO at the time of funding; or
(2) If the assets that are funded under the liquidity facility do
not meet the criteria described in paragraph (1) of this definition,
the assets must be guaranteed, conditionally or unconditionally, by the
United States Government, its agencies, or the central government of an
Organization for Economic Cooperation and Development (OECD) country.
Embedded option means a characteristic of certain assets and
liabilities which gives the issuer of the instrument the ability to
change the features such as final maturity, rate, principal amount and
average life. Options include, but are not limited to, calls, caps, and
prepayment options.
Equity investment means investments in real property, equity
securities, and any other ownership interests, including, for example,
investments in partnerships and limited liability companies.
Equity security means any security representing an ownership
interest in an enterprise (for example, common, preferred, or other
capital stock) or the right to acquire (for example, warrants and call
options) or dispose of (for example, put options) an ownership interest
in an enterprise at fixed or determinable prices. However, the term
does not include convertible debt or preferred stock that by its terms
either must be redeemed by the issuing enterprise or is redeemable at
the option of the investor.
Exchangeable collateralized mortgage obligation means a class of a
collateralized mortgage obligation (CMO) that, at the time of purchase,
represents beneficial ownership interests in a combination of two or
more underlying classes of the same CMO structure. The holder of an

[[Page 64831]]

exchangeable CMO may pay a fee and take delivery of the underlying
classes of the CMO.
Fair value means the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. If there is a principal
market for the asset or liability, the fair value measurement is the
price in that market (whether that price is directly observable or
otherwise determined using a valuation technique), even if the price in
a different market is potentially more advantageous at the measurement
date. In the absence of a principal market, the fair value measurement
occurs in the most advantageous market for the asset or liability. The
fair value of the asset or liability shall be determined based on the
assumptions that market participants would use in pricing the asset or
liability. In developing those assumptions, the corporate need not
identify specific market participants. Rather, the corporate should
identify characteristics that distinguish market participants
generally, considering factors specific to all of the following: the
asset or liability; the principal (or most advantageous) market for the
asset or liability; and market participants with whom the corporate
would transact in that market. To increase consistency and
comparability in fair value measurements and related disclosures, the
fair value hierarchy prioritizes the inputs to valuation techniques
used to measure fair value into three broad levels. The fair value
hierarchy gives the highest priority to quoted prices (unadjusted) in
active markets for identical assets or liabilities (Level 1) and the
lowest priority to unobservable inputs (Level 3). Examples of valuation
techniques include the present value of estimated future cash flows,
option-pricing models, and option-adjusted spread models.
Federal funds transaction means a short-term or open-ended
unsecured transfer of immediately available funds by one depository
institution to another depository institution or entity.
Foreign bank means an institution which is organized under the laws
of a country other than the United States, is engaged in the business
of banking, and is recognized as a bank by the banking supervisory
authority of the country in which it is organized.
Immediate family member means a spouse or other family member
living in the same household.
Intangible assets means assets considered to be intangible assets
under GAAP. These assets include, but are not limited to, core deposit
premiums, purchased credit card relationships, favorable leaseholds,
and servicing assets (mortgage and non-mortgage). Interest-only strips
receivable are not intangible assets under this definition.
Leverage ratio means, before October 21, 2013, the ratio of total
capital to moving daily average net assets. This is the interim
leverage ratio.
Leverage ratio means, on or after October 21, 2013, the ratio of
adjusted core capital to moving daily average net assets. This is the
permanent leverage ratio.
Limited liquidity investment means a private placement or funding
agreement.
Member reverse repurchase transaction means an integrated
transaction in which a corporate credit union purchases a security from
one of its member credit unions under agreement by that member credit
union to repurchase the same security at a specified time in the
future. The corporate credit union then sells that same security, on
the same day, to a third party, under agreement to repurchase it on the
same date on which the corporate credit union is obligated to return
the security to its member credit union.
Mortgage-backed security (MBS) means a security backed by first or
second mortgages secured by real estate upon which is located a
dwelling, mixed residential and commercial structure, residential
manufactured home, or commercial structure.
Moving daily average net assets means the average of daily average
net assets for the month being measured and the previous eleven (11)
months.
Moving monthly average net risk-weighted assets means the average
of the net risk-weighted assets for the month being measured and the
previous eleven (11) months. Measurements must be taken on the last day
of each month.
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.
Nationally Recognized Statistical Rating Organization (NRSRO) means
any entity that has applied for, and been granted permission, to be
considered an NRSRO by the United States Securities and Exchange
Commission.
NCUA means NCUA Board (Board), unless the particular action has
been delegated by the Board.
Net assets means total assets less loans guaranteed by the NCUSIF
and member reverse repurchase transactions. For its own account, a
corporate credit union's payables under reverse repurchase agreements
and receivables under repurchase agreements may be netted out if the
GAAP conditions for offsetting are met. Also, any amounts deducted from
core capital in calculating adjusted core capital are also deducted
from net assets.
Net economic value (NEV) means the fair value of assets minus the
fair value of liabilities. All fair value calculations must include the
value of forward settlements and embedded options. Perpetual
contributed capital, and the unamortized portion of nonperpetual
capital that is, the portion that qualifies as capital for purposes of
any of the minimum capital ratios, is excluded from liabilities for
purposes of this calculation. The NEV ratio is calculated by dividing
NEV by the fair value of assets.
Net interest margin security means a security collateralized by
residual interests in collateralized mortgage obligations, residual
interests in real estate mortgage investment conduits, or residual
interests in other asset-backed securities.
Net risk-weighted assets means risk-weighted assets less Central
Liquidity Facility (CLF) stock subscriptions, CLF loans guaranteed by
the NCUSIF, and member reverse repurchase transactions. For its own
account, a corporate credit union's payables under reverse repurchase
agreements and receivables under repurchase agreements may be netted
out if the GAAP conditions for offsetting are met. Also, any amounts
deducted from core capital in calculating adjusted core capital are
also deducted from net risk-weighted assets.
Nonperpetual capital means funds contributed by members or
nonmembers that: are term certificates with an original minimum term of
five years or that have an indefinite term (i.e., no maturity) with a
minimum withdrawal notice of five years; are available to cover losses
that exceed retained earnings and perpetual contributed capital; are
not insured by the NCUSIF or other share or deposit insurers; and
cannot be pledged against borrowings. In the event the corporate is
liquidated, the holders of nonperpetual capital accounts (NCAs) will
claim equally. These claims will be subordinate to all other claims
(including NCUSIF claims), except that any claims by the holders of
perpetual contributed capital (PCC) will be subordinate to the claims
of holders of NCAs.
Obligor means the primary party obligated to repay an investment,
e.g., the issuer of a security, such as a Qualified Special Purpose
Entity (QSPE)

[[Page 64832]]

trust; the taker of a deposit; or the borrower of funds in a federal
funds transaction. Obligor does not include an originator of
receivables underlying an asset-backed security, the servicer of such
receivables, or an insurer of an investment.
Official means any director or committee member.
Pair-off transaction means a security purchase transaction that is
closed out or sold at, or prior to, the settlement or expiration date.
Perpetual contributed capital (PCC) means accounts or other
interests of a corporate credit union that: are perpetual, non-
cumulative dividend accounts; are available to cover losses that exceed
retained earnings; are not insured by the NCUSIF or other share or
deposit insurers; and cannot be pledged against borrowings. In the
event the corporate is liquidated, any claims made by the holders of
perpetual contributed capital will be subordinate to all other claims
(including NCUSIF claims).
Private label security means a security that is not issued or
guaranteed by the U.S. government, its agencies, or its government-
sponsored enterprises (GSEs).
Quoted market price means a recent sales price or a price based on
current bid and asked quotations.
Repurchase transaction means a transaction in which a corporate
credit union agrees to purchase a security from a counterparty and to
resell the same or any identical security to that counterparty at a
specified future date and at a specified price.
Residential mortgage-backed security (RMBS) means a mortgage-backed
security collateralized primarily by mortgage loans on residential
properties.
Residential properties means houses, condominiums, cooperative
units, and manufactured homes. This definition does not include boats
or motor homes, even if used as a primary residence, or timeshare
properties.
Residual interest means the ownership interest in remainder cash
flows from a CMO or ABS transaction after payments due bondholders and
trust administrative expenses have been satisfied.
Retained earnings means retained earnings as defined under
Generally Accepted Accounting Principles (GAAP).
Risk-weighted assets means a corporate credit union's risk-weighted
assets as calculated in accordance with Appendix C of this part.
Section 107(8) institution means an institution described in
Section 107(8) of the Federal Credit Union Act (12 U.S.C. 1757(8)).
Securities lending means lending a security to a counterparty,
either directly or through an agent, and accepting collateral in
return.
Securitization means the pooling and repackaging by a special
purpose entity of assets or other credit exposures that can be sold to
investors. Securitization includes transactions that create stratified
credit risk positions whose performance is dependent upon an underlying
pool of credit exposures, including loans and commitments.
Senior executive officer means a chief executive officer, any
assistant chief executive officer (e.g., any assistant president, any
vice president or any assistant treasurer/manager), and the chief
financial officer (controller). This term also includes employees of
any entity hired to perform the functions described above.
Settlement date means the date originally agreed to by a corporate
credit union and a counterparty for settlement of the purchase or sale
of a security.
Short sale means the sale of a security not owned by the seller.
Small business related security means a security that is rated in 1
of the 4 highest rating categories by at least one nationally
recognized statistical rating organization, and represents an interest
in one or more promissory notes or leases of personal property
evidencing the obligation of a small business concern and originated by
an insured depository institution, insured credit union, insurance
company, or similar institution which is supervised and examined by a
Federal or State authority, or a finance company or leasing company.
This definition does not include Small Business Administration
securities permissible under Sec. 107(7) of the Act.
State means any one of the several states of the United States of
America, the District of Columbia, Puerto Rico, and the territories and
possessions of the United States.
Stripped mortgage-backed security means a security that represents
either the principal-only or interest-only portion of the cash flows of
an underlying pool of mortgages.
Subordinated security means a security that, at the time of
purchase, has a junior claim on the underlying collateral or assets to
other securities in the same issuance. If a security is junior only to
money market fund eligible securities in the same issuance, the former
security is not subordinated for purposes of this definition.
Supplementary Capital means the sum of the following items:
(1) Nonperpetual capital accounts, as amortized under Sec.
704.3(b)(3);
(2) Allowance for loan and lease losses calculated under GAAP to a
maximum of 1.25 percent of risk-weighted assets; and
(3) Forty-five percent of unrealized gains on available-for-sale
equity securities with readily determinable fair values. Unrealized
gains are unrealized holding gains, net of unrealized holding losses,
calculated as the amount, if any, by which fair value exceeds
historical cost. The NCUA may disallow such inclusion in the
calculation of supplementary capital if the NCUA determines that the
securities are not prudently valued.
Tier 1 capital means adjusted core capital. Tier 1 risk-based
capital ratio means the ratio of Tier 1 capital to the moving monthly
average net risk-weighted assets.
Tier 2 capital means supplementary capital plus any perpetual
contributed capital deducted from adjusted core capital.
Total assets means the sum of all a corporate credit union's assets
as calculated under GAAP.
Total capital means the sum of a corporate credit union's adjusted
core capital and its supplementary capital, less the corporate credit
union's equity investments not otherwise deducted when calculating
adjusted core capital.
Total risk-based capital ratio means the ratio of total capital to
moving monthly average net risk-weighted assets.
Trade date means the date a corporate credit union originally
agrees, whether orally or in writing, to enter into the purchase or
sale of a security.
Trigger means an event in a securitization that will redirect cash-
flows if predefined thresholds are breached. Examples of triggers are
delinquency and cumulative loss triggers.
Weighted average life means the weighted-average time to the return
of a dollar of principal, calculated by multiplying each portion of
principal received by the time at which it is expected to be received
(based on a reasonable and supportable estimate of that time) and then
summing and dividing by the total amount of principal. The calculation
of weighted average life for interest only securities means the
weighted-average time to the return of a dollar of interest, calculated
by multiplying each portion of interest received by the time at which
it is expected to be received (based on a reasonable and supportable
estimate of that time) and then summing and

[[Page 64833]]

dividing by the total amount of interest to be received.
When-issued trading means the buying and selling of securities in
the period between the announcement of an offering and the issuance and
payment date of the securities.

0
8. Effective October 20, 2011, revise Sec. 704.3 to read as follows:

Sec. 704.3 Corporate credit union capital.

(a) Capital requirements. (1) A corporate credit union must
maintain at all times:
(i) A leverage ratio of 4.0 percent or greater;
(ii) A Tier 1 risk-based capital ratio of 4.0 percent or greater;
and
(iii) A total risk-based capital ratio of 8.0 percent or greater.
(2) To ensure it meets its capital requirements, a corporate credit
union must develop and ensure implementation of written short- and
long-term capital goals, objectives, and strategies which provide for
the building of capital consistent with regulatory requirements, the
maintenance of sufficient capital to support the risk exposures that
may arise from current and projected activities, and the periodic
review and reassessment of the capital position of the corporate credit
union.
(3) Beginning with the first call report submitted on or after
October 21, 2013, a corporate credit union must calculate and report to
NCUA the ratio of its retained earnings to its moving daily average net
assets. If this ratio is less than 0.45 percent, the corporate credit
union must, within 30 days, submit a retained earnings accumulation
plan to the NCUA for NCUA's approval. The plan must contain a detailed
explanation of how the corporate credit union will accumulate earnings
sufficient to meet all its future minimum leverage ratio requirements,
including specific semiannual milestones for accumulating retained
earnings. In the case of a state-chartered corporate credit union, the
NCUA will consult with the appropriate state supervisory authority
(SSA) before making a determination to approve or disapprove the plan,
and will provide the SSA a copy of the completed plan. If the corporate
credit union fails to submit a plan acceptable to NCUA, or fails to
comply with any element of a plan approved by NCUA, the corporate will
immediately be classified as significantly undercapitalized or, if
already significantly undercapitalized, as critically undercapitalized
for purposes of prompt corrective actions. The corporate credit union
will be subject to all the associated actions under Sec. 704.4.
(b) Requirements for nonperpetual capital accounts (NCAs)--(1)
Form. NCA funds may be in the form of a term certificate or a no-
maturity notice account.
(2) Disclosure. The terms and conditions of a nonperpetual capital
account must be disclosed to the recorded owner of the account at the
time the account is opened and at least annually thereafter.
(i) The initial NCA disclosure must be signed by either all of the
directors of the member credit union or, if authorized by board
resolution, the chair and secretary of the board; and
(ii) The annual disclosure notice must be signed by the chair of
the corporate credit union. The chair must sign a statement that
certifies that the notice has been sent to all entities with NCAs. The
certification must be maintained in the corporate credit union's files
and be available for examiner review.
(3) Five-year remaining maturity. When a no-maturity NCA has been
placed on notice, or a term account has a remaining maturity of less
than five years, the corporate will reduce the amount of the account
that can be considered as nonperpetual capital by a constant monthly
amortization that ensures the capital is fully amortized one year
before the date of maturity or one year before the end of the notice
period. The full balance of an NCA being amortized, not just the
remaining non-amortized portion, is available to absorb losses in
excess of the sum of retained earnings and perpetual contributed
capital until the funds are released by the corporate credit union at
the time of maturity or the conclusion of the notice period.
(4) Release. Nonperpetual capital may not be released due solely to
the merger, charter conversion, or liquidation of the account holder.
In the event of a merger, the capital account transfers to the
continuing entity. In the event of a charter conversion, the capital
account transfers to the new institution. In the event of liquidation,
the corporate may release a member capital account to facilitate the
payout of shares, but only with the prior written approval of the NCUA.
(5) Redemption. A corporate credit union may redeem NCAs prior to
maturity or prior to the end of the notice period only with the prior
approval of the NCUA and, for state chartered corporate credit unions,
the approval of the appropriate state regulator.
(6) Sale. A member may transfer its interest in a nonperpetual
capital account to another member or to a nonmember (other than a
natural person). At least 14 days before consummating such a transfer,
the member must notify the corporate credit union of the pending
transfer. The corporate credit union must, within 10 days of such
notice, provide the member and the potential transferee all financial
information about the corporate credit union that is available to the
public or that the corporate credit union has provided to its members,
including any call report data submitted by the corporate credit union
to NCUA but not yet posted on NCUA's Web site.
(7) Merger. In the event of a merger of a corporate credit union,
nonperpetual capital will transfer to the continuing corporate credit
union. The minimum five-year notice period for withdrawal of no-
maturity capital remains in effect.
(c) Requirements for perpetual contributed capital (PCC)--(1)
Disclosure. The terms and conditions of any perpetual contributed
capital instrument must be disclosed to the recorded owner of the
instrument at the time the instrument is created and must be signed by
either all of the directors of the member credit union or, if
authorized by board resolution, the chair and secretary of the board.
(2) Release. Perpetual contributed capital may not be released due
solely to the merger, charter conversion or liquidation of a member
credit union. In the event of a merger, the perpetual contributed
capital transfers to the continuing credit union. In the event of a
charter conversion, the perpetual contributed capital transfers to the
new institution. In the event of liquidation, the perpetual contributed
capital may be released to facilitate the payout of shares with NCUA's
prior written approval.
(3) Callability. A corporate credit union may call perpetual
contributed capital instruments only with the prior approval of the
NCUA and, for state chartered corporate credit unions, the applicable
state regulator. Perpetual contributed capital accounts are callable on
a pro-rata basis across an issuance class.
(4) Perpetual contributed capital. A corporate credit union may
issue perpetual contributed capital to both members and nonmembers.
(5) The holder of a PCC instrument may transfer its interests in
the instrument to another member or to a nonmember (other than a
natural person). At least 14 days before consummating such a transfer,
the member must notify the corporate credit union of the pending
transfer. The corporate credit union must, within 10 days of such
notice, provide the member

[[Page 64834]]

and the potential transferee all financial information about the
corporate credit union that is available to the public or that the
corporate credit union has provided to its members, including any call
report data submitted by the corporate credit union to NCUA but not yet
posted on NCUA's Web site.
(6) A corporate credit union is permitted to condition membership,
services, or prices for services on a member's ownership of PCC,
provided the corporate credit union gives existing members at least six
months written notice of:
(i) The requirement to purchase PCC, including specific amounts;
and
(ii) The effects of a failure to purchase the requisite PCC on the
pricing of services or on the member's access to membership or
services.
(d) Individual minimum capital requirements.
(1) General. The rules and procedures specified in this paragraph
apply to the establishment of an individual minimum capital requirement
for a corporate credit union that varies from any of the risk-based
capital requirement(s) or leverage ratio requirements that would
otherwise apply to the corporate credit union under this part.
(2) Appropriate considerations for establishing individual minimum
capital requirements. Minimum capital levels higher than the risk-based
capital requirements or the leverage ratio requirement under this part
may be appropriate for individual corporate credit unions. The NCUA may
establish increased individual minimum capital requirements, including
modification of the minimum capital requirements related to being
either significantly and critically undercapitalized for purposes of
Sec. 704.4 of this part, upon a determination that the corporate
credit union's capital is or may become inadequate in view of the
credit union's circumstances. For example, higher capital levels may be
appropriate when NCUA determines that:
(i) A corporate credit union is receiving special supervisory
attention;
(ii) A corporate credit union has or is expected to have losses
resulting in capital inadequacy;
(iii) A corporate credit union has a high degree of exposure to
interest rate risk, prepayment risk, credit risk, concentration risk,
certain risks arising from nontraditional activities or similar risks,
or a high proportion of off-balance sheet risk including standby
letters of credit;
(iv) A corporate credit union has poor liquidity or cash flow;
(v) A corporate credit union is growing, either internally or
through acquisitions, at such a rate that supervisory problems are
presented that are not dealt with adequately by other NCUA regulations
or other guidance;
(vi) A corporate credit union may be adversely affected by the
activities or condition of its CUSOs or other persons or entities with
which it has significant business relationships, including
concentrations of credit;
(vii) A corporate credit union with a portfolio reflecting weak
credit quality or a significant likelihood of financial loss, or has
loans or securities in nonperforming status or on which borrowers fail
to comply with repayment terms;
(viii) A corporate credit union has inadequate underwriting
policies, standards, or procedures for its loans and investments;
(ix) A corporate credit union has failed to properly plan for, or
execute, necessary retained earnings growth, or
(ix) A corporate credit union has a record of operational losses
that exceeds the average of other, similarly situated corporate credit
unions; has management deficiencies, including failure to adequately
monitor and control financial and operating risks, particularly the
risks presented by concentrations of credit and nontraditional
activities; or has a poor record of supervisory compliance.
(3) Standards for determination of appropriate individual minimum
capital requirements. The appropriate minimum capital levels for an
individual corporate credit union cannot be determined solely through
the application of a rigid mathematical formula or wholly objective
criteria. The decision is necessarily based, in part, on subjective
judgment grounded in agency expertise. The factors to be considered in
NCUA's determination will vary in each case and may include, for
example:
(i) The conditions or circumstances leading to the determination
that a higher minimum capital requirement is appropriate or necessary
for the corporate credit union;
(ii) The exigency of those circumstances or potential problems;
(iii) The overall condition, management strength, and future
prospects of the corporate credit union and, if applicable, its
subsidiaries, affiliates, and business partners;
(iv) The corporate credit union's liquidity, capital and other
indicators of financial stability, particularly as compared with those
of similarly situated corporate credit unions; and
(v) The policies and practices of the corporate credit union's
directors, officers, and senior management as well as the internal
control and internal audit systems for implementation of such adopted
policies and practices.
(4) Procedures--(i) In the case of a state chartered corporate
credit union, NCUA will consult with the appropriate state regulator
when considering imposing a new minimum capital requirement.
(ii) When the NCUA determines that a minimum capital requirement is
necessary or appropriate for a particular corporate credit union, it
will notify the corporate credit union in writing of its proposed
individual minimum capital requirement; the schedule for compliance
with the new requirement; and the specific causes for determining that
the higher individual minimum capital requirement is necessary or
appropriate for the corporate credit union. The NCUA shall forward the
notifying letter to the appropriate state supervisory authority (SSA)
if a state-chartered corporate credit union would be subject to an
individual minimum capital requirement.
(iii) The corporate credit union's response must include any
information that the credit union wants the NCUA to consider in
deciding whether to establish or to amend an individual minimum capital
requirement for the corporate credit union, what the individual capital
requirement should be, and, if applicable, what compliance schedule is
appropriate for achieving the required capital level. The responses of
the corporate credit union and SSA must be in writing and must be
delivered to the NCUA within 30 days after the date on which the
notification was received. The NCUA may extend the time period for good
cause, and the time period for response by the insured corporate credit
union may be shortened for good cause:
(A) When, in the opinion of the NCUA, the condition of the
corporate credit union so requires, and the NCUA informs the corporate
credit union of the shortened response period in the notice;
(B) With the consent of the corporate credit union; or
(C) When the corporate credit union already has advised the NCUA
that it cannot or will not achieve its applicable minimum capital
requirement.
(iv) Failure by the corporate credit union to respond within 30
days, or such other time period as may be specified by the NCUA, may
constitute a waiver of any objections to the proposed individual
minimum capital requirement or to the schedule for complying with it,
unless the NCUA has

[[Page 64835]]

provided an extension of the response period for good cause.
(v) After expiration of the response period, the NCUA will decide
whether or not the proposed individual minimum capital requirement
should be established for the corporate credit union, or whether that
proposed requirement should be adopted in modified form, based on a
review of the corporate credit union's response and other relevant
information. The NCUA's decision will address comments received within
the response period from the corporate credit union and the appropriate
state supervisory authority (SSA) (if a state-chartered corporate
credit union is involved) and will state the level of capital required,
the schedule for compliance with this requirement, and any specific
remedial action the corporate credit union could take to eliminate the
need for continued applicability of the individual minimum capital
requirement. The NCUA will provide the corporate credit union and the
appropriate SSA (if a state-chartered corporate credit union is
involved) with a written decision on the individual minimum capital
requirement, addressing the substantive comments made by the corporate
credit union and setting forth the decision and the basis for that
decision. Upon receipt of this decision by the corporate credit union,
the individual minimum capital requirement becomes effective and
binding upon the corporate credit union. This decision represents final
agency action.
(vi) In lieu of the procedures established above, a corporate
credit union may request an informal hearing. The corporate credit
union must make the request for a hearing in writing, and NCUA must
receive the request no later than 10 days following the date of the
notice described in paragraph (d)(4)(ii) of this section. Upon receipt
of the request for hearing, NCUA will conduct an informal hearing and
render a decision using the procedures described in paragraphs (d),
(e), and (f) of Sec. 747.3003 of this chapter.
(5) Failure to comply. Failure to satisfy any individual minimum
capital requirement, or to meet any required incremental additions to
capital under a schedule for compliance with such an individual minimum
capital requirement, will constitute a basis to take action as
described in Sec. 704.4.
(6) Change in circumstances. If, after a decision is made under
paragraph (b)(3)(iv) of this section, there is a change in the
circumstances affecting the corporate credit union's capital adequacy
or its ability to reach its required minimum capital level by the
specified date, the NCUA may amend the individual minimum capital
requirement or the corporate credit union's schedule for such
compliance. The NCUA may decline to consider a corporate credit union's
request for such changes that are not based on a significant change in
circumstances or that are repetitive or frivolous. Pending the NCUA's
reexamination of the original decision, that original decision and any
compliance schedule established in that decision will continue in full
force and effect.
(e) Reservation of authority.
(1) Transactions for purposes of evasion. The NCUA may disregard
any transaction entered into primarily for the purpose of reducing the
minimum required amount of regulatory capital or otherwise evading the
requirements of this section.
(2) Period-end versus average figures. The NCUA reserves the right
to require a corporate credit union to compute its capital ratios on
the basis of period-end assets rather than average assets when the NCUA
determines this requirement is appropriate to carry out the purposes of
this part.
(3) Reservation of authority. (i) Notwithstanding the definitions
of core and supplementary capital in paragraph (d) of this section, the
NCUA may find that a particular asset or core or supplementary capital
component has characteristics or terms that diminish its contribution
to a corporate credit union's ability to absorb losses, and the NCUA
may require the discounting or deduction of such asset or component
from the computation of core, supplementary, or total capital.
(ii) Notwithstanding Appendix C to this Part, the NCUA will look to
the substance of a transaction and may find that the assigned risk-
weight for any asset, or credit equivalent amount or credit conversion
factor for any off-balance sheet item does not appropriately reflect
the risks imposed on the corporate credit union. The NCUA may require
the corporate credit union to apply another risk-weight, credit
equivalent amount, or credit conversion factor that NCUA deems
appropriate.
(iii) If Appendix C to this part does not specifically assign a
risk-weight, credit equivalent amount, or credit conversion factor to a
particular asset or activity of the corporate credit union, the NCUA
may assign any risk-weight, credit equivalent amount, or credit
conversion factor that it deems appropriate. In making this
determination, NCUA will consider the risks associated with the asset
or off-balance sheet item as well as other relevant factors.
(4) Where practicable, the NCUA will consult with the appropriate
state regulator before taking any action under this paragraph (e) that
involves a state chartered corporate credit union.
(5) Before taking any action under this paragraph (e), NCUA will
provide the corporate credit union with written notice of the intended
action and the reasons for such action. The corporate credit union will
have seven days to provide the NCUA with a written response, and the
NCUA will consider the response before taking the action. Upon the
timely request of the corporate credit union, and for good cause, NCUA
may extend the seven day response period.
(f) Former capital accounts. This paragraph addresses membership
capital accounts (MCAs) that qualified as corporate capital prior to
October 20, 2011 but which no longer satisfy the definitions of capital
because the accounts have not been converted by the member to
nonperpetual capital accounts (NCAs) or to perpetual contributed
capital (PCC).
(1) For MCAs structured as adjustable balance accounts, the
corporate will immediately place the account on notice of withdrawal if
the member has not already done so. The corporate will continue to
adjust the balance of the MCA account in accordance with the original
terms of the account until the entire notice period has run and then
return the remaining balance, less any losses, to the member. Until the
expiration of the notice period the entire adjusted balance will be
available to cover losses at the corporate credit union that exceed
retained earnings and PCC (excluding, if a corporate credit union
exercises the capital prioritization option under Part I of Appendix A
to this Part, any PCC with priority under that option).
(2) For term MCAs, the corporate credit union will return the
balance of the MCA account to the member at the expiration of the term.
Until the expiration of term, the entire account balance will be
available to cover losses that exceed retained earnings and PCC
(excluding, if a corporate credit union exercises the capital
prioritization option under part I of Appendix A to this part, any PCC
with priority under that option).
(3) A corporate credit union may count a portion of unconverted
MCAs as Tier 2 capital. Beginning on the date of issuance (for term
MCAs) or the date of notice of withdrawal (for other MCAs), the
corporate may count the entire account balance as Tier 2 capital, but

[[Page 64836]]

will then reduce the amount of the account that can be considered as
Tier 2 capital by a constant monthly amortization that ensures the
capital is fully amortized one year before the date of maturity or one
year before the end of the notice period. For adjustable balance
account MCAs where the adjustment is determined based on some
impermanent measure, such as shares on deposit with the corporate, the
corporate credit union may not treat any part of the account as
capital.
(4) A corporate credit union must, on or before December 20, 2011,
provide any members that hold unconverted MCAs a one-time written
disclosure about the status of their MCA accounts as described in this
paragraph (f).

Sec. 704.4 [Redesignated as Sec. 704.13]

0
9. Effective January 18, 2011, redesignate Sec. 704.4 as Sec. 704.13.

0
10. Effective October 20, 2011, add a new Sec. 704.4 to read as
follows:

Sec. 704.4. Prompt corrective action.

(a) Purpose. The principal purpose of this section is to define,
for corporate credit unions that are not adequately capitalized, the
capital measures and capital levels that are used for determining
appropriate supervisory actions. This section establishes procedures
for submission and review of capital restoration plans and for issuance
and review of capital directives, orders, and other supervisory
directives.
(b) Scope. This section applies to corporate credit unions,
including officers, directors, and employees.
(1) This section does not limit the authority of NCUA in any way to
take supervisory actions to address unsafe or unsound practices,
deficient capital levels, violations of law, unsafe or unsound
conditions, or other practices. The NCUA may take action under this
section independently of, in conjunction with, or in addition to any
other enforcement action available to the NCUA, including issuance of
cease and desist orders, approval or denial of applications or notices,
assessment of civil money penalties, or any other actions authorized by
law.
(2) Unless permitted by the NCUA or otherwise required by law, no
corporate credit union may state in any advertisement or promotional
material its capital category under this part or that the NCUA has
assigned the corporate credit union to a particular category.
(3) Any group of credit unions applying for a new corporate credit
union charter will submit, as part of the charter application, a
detailed draft plan for soliciting contributed capital and building
retained earnings. The draft plan will include specific levels of
contributed capital and retained earnings and the anticipated
timeframes for achieving those levels. The Board will review the draft
plan and modify it as necessary. If the Board approves the plan, the
Board will include any necessary waivers of this section or part.
(c) Notice of capital category. (1) Effective date of determination
of capital category. A corporate credit union will be deemed to be
within a given capital category as of the most recent date:
(i) A 5310 Financial Report is required to be filed with the NCUA;
(ii) A final NCUA report of examination is delivered to the
corporate credit union; or
(iii) Written notice is provided by the NCUA to the corporate
credit union that its capital category has changed as provided in
paragraphs (c)(2) or (d)(3) of this section.
(2) Adjustments to reported capital levels and category--
(i) Notice of adjustment by corporate credit union. A corporate
credit union must provide the NCUA with written notice that an
adjustment to the corporate credit union's capital category may have
occurred no later than 15 calendar days following the date that any
material event has occurred that would cause the corporate credit union
to be placed in a lower capital category from the category assigned to
the corporate credit union for purposes of this section on the basis of
the corporate credit union's most recent call report or report of
examination.
(ii) Determination by the NCUA to change capital category. After
receiving notice pursuant to paragraph (c)(1) of this section, or on
its own initiative, the NCUA will determine whether to change the
capital category of the corporate credit union and will notify the
corporate credit union of the NCUA's determination.
(d) Capital measures and capital category definitions. (1) Capital
measures. For purposes of this section, the relevant capital measures
are:
(i) The total risk-based capital ratio;
(ii) The Tier 1 risk-based capital ratio; and
(iii) The leverage ratio.
(2) Capital categories. For purposes of this section, a corporate
credit union is:
(i) Well capitalized if the corporate credit union:
(A) Has a total risk-based capital ratio of 10.0 percent or
greater; and
(B) Has a Tier 1 risk-based capital ratio of 6.0 percent or
greater; and
(C) Has a leverage ratio of 5.0 percent or greater; and
(D) Is not subject to any written agreement, order, capital
directive, or prompt corrective action directive issued by NCUA to meet
and maintain a specific capital level for any capital measure.
(ii) Adequately capitalized if the corporate credit union:
(A) Has a total risk-based capital ratio of 8.0 percent or greater;
and
(B) Has a Tier 1 risk-based capital ratio of 4.0 percent or
greater; and
(C) Has:
(1) A leverage ratio of 4.0 percent or greater; and
(2) Does not meet the definition of a well capitalized corporate
credit union.
(iii) Undercapitalized if the corporate credit union:
(A) Has a total risk-based capital ratio that is less than 8.0
percent; or
(B) Has a Tier 1 risk-based capital ratio that is less than 4.0
percent; or
(C) Has a leverage ratio that is less than 4.0 percent.
(iv) Significantly undercapitalized if the corporate credit union
has:
(A) A total risk-based capital ratio that is less than 6.0 percent;
or
(B) A Tier 1 risk-based capital ratio that is less than 3.0
percent; or
(C) A leverage ratio that is less than 3.0 percent.
(v) Critically undercapitalized if the corporate credit union has:
(A) A total risk-based capital ratio that is less than 4.0 percent;
or
(B) A Tier 1 risk-based capital ratio that is less than 2.0
percent; or
(C) A leverage ratio that is less than 2.0 percent.
(3) Reclassification based on supervisory criteria other than
capital. Notwithstanding the elements of paragraph (d)(2) of this
section, the NCUA may reclassify a well capitalized corporate credit
union as adequately capitalized, and may require an adequately
capitalized or undercapitalized corporate credit union to comply with
certain mandatory or discretionary supervisory actions as if the
corporate credit union were in the next lower capital category, in the
following circumstances:
(i) Unsafe or unsound condition. The NCUA has determined, after
notice and opportunity for hearing pursuant to paragraph (h)(1) of this
section, that the corporate credit union is in an unsafe or unsound
condition; or
(ii) Unsafe or unsound practice. The NCUA has determined, after
notice and an opportunity for hearing pursuant to paragraph (h)(1) of
this section, that the corporate credit union received a less-than-
satisfactory rating (i.e., three or lower) for any rating category
(other than in a rating category specifically

[[Page 64837]]

addressing capital adequacy) under the Corporate Risk Information
System (CRIS) rating system and has not corrected the conditions that
served as the basis for the less than satisfactory rating. Ratings
under this paragraph (d)(3)(ii) refer to the most recent ratings (as
determined either on-site or off-site by the most recent examination)
of which the corporate credit union has been notified in writing.
(4) The NCUA may, for good cause, modify any of the percentages in
paragraph (d)(2) of this section as described in Sec. 704.3(d).
(e) Capital restoration plans. (1) Schedule for filing plan--
(i) In general. A corporate credit union must file a written
capital restoration plan with the NCUA within 45 days of the date that
the corporate credit union receives notice or is deemed to have notice
that the corporate credit union is undercapitalized, significantly
undercapitalized, or critically undercapitalized, unless the NCUA
notifies the corporate credit union in writing that the plan is to be
filed within a different period. An adequately capitalized corporate
credit union that has been required pursuant to paragraph (d)(3) of
this section to comply with supervisory actions as if the corporate
credit union were undercapitalized is not required to submit a capital
restoration plan solely by virtue of the reclassification.
(ii) Additional capital restoration plans. Notwithstanding
paragraph (e)(1)(i) of this section, a corporate credit union that has
already submitted and is operating under a capital restoration plan
approved under this section is not required to submit an additional
capital restoration plan based on a revised calculation of its capital
measures or a reclassification of the institution under paragraph
(d)(3) of this section unless the NCUA notifies the corporate credit
union that it must submit a new or revised capital plan. A corporate
credit union that is notified that it must submit a new or revised
capital restoration plan must file the plan in writing with the NCUA
within 45 days of receiving such notice, unless the NCUA notifies the
corporate credit union in writing that the plan is to be filed within a
different period.
(2) Contents of plan. All financial data submitted in connection
with a capital restoration plan must be prepared in accordance with the
instructions provided on the call report, unless the NCUA instructs
otherwise. The capital restoration plan must include all of the
information required to be filed under paragraph (k)(2)(ii) of this
section. A corporate credit union required to submit a capital
restoration plan as the result of a reclassification of the corporate
credit union pursuant to paragraph (d)(3) of this section must include
a description of the steps the corporate credit union will take to
correct the unsafe or unsound condition or practice.
(3) Failure to submit a capital restoration plan. A corporate
credit union that is undercapitalized and that fails to submit a
written capital restoration plan within the period provided in this
section will, upon the expiration of that period, be subject to all of
the provisions of this section applicable to significantly
undercapitalized credit unions.
(4) Review of capital restoration plans. Within 60 days after
receiving a capital restoration plan under this section, the NCUA will
provide written notice to the corporate credit union of whether it has
approved the plan. The NCUA may extend this time period.
(5) Disapproval of capital plan. If the NCUA does not approve a
capital restoration plan, the corporate credit union must submit a
revised capital restoration plan, when directed to do so, within the
time specified by the NCUA. An undercapitalized corporate credit union
is subject to the provisions applicable to significantly
undercapitalized credit unions until it has submitted, and NCUA has
approved, a capital restoration plan. If the NCUA directs that the
corporate submit a revised plan, it must do so in time frame specified
by the NCUA.
(6) Failure to implement a capital restoration plan. Any
undercapitalized corporate credit union that fails in any material
respect to implement a capital restoration plan will be subject to all
of the provisions of this section applicable to significantly
undercapitalized institutions.
(7) Amendment of capital plan. A corporate credit union that has
filed an approved capital restoration plan may, after prior written
notice to and approval by the NCUA, amend the plan to reflect a change
in circumstance. Until such time as NCUA has approved a proposed
amendment, the corporate credit union must implement the capital
restoration plan as approved prior to the proposed amendment.
(f) Mandatory and discretionary supervisory actions. (1) Mandatory
supervisory actions.--
(i) Provisions applicable to all corporate credit unions. All
corporate credit unions are subject to the restrictions contained in
paragraph (k)(1) of this section on capital distributions.
(ii) Provisions applicable to undercapitalized, significantly
undercapitalized, and critically undercapitalized corporate credit
unions. Immediately upon receiving notice or being deemed to have
notice, as provided in paragraph (c) or (e) of this section, that the
corporate credit union is undercapitalized, significantly
undercapitalized, or critically undercapitalized, the corporate credit
union will be subject to the following provisions of paragraph (k) of
this section:
(A) Restricting capital distributions (paragraph (k)(1));
(B) NCUA monitoring of the condition of the corporate credit union
(paragraph (k)(2)(i));
(C) Requiring submission of a capital restoration plan (paragraph
(k)(2)(ii));
(D) Restricting the growth of the corporate credit union's assets
(paragraph (k)(2)(iii)); and
(E) Requiring prior approval of certain expansion proposals
(paragraph (k)(2)(iv)).
(iii) Additional provisions applicable to significantly
undercapitalized, and critically undercapitalized corporate credit
unions. In addition to the mandatory requirements described in
paragraph (f)(1) of this section, immediately upon receiving notice or
being deemed to have notice that the corporate credit union is
significantly undercapitalized, or critically undercapitalized, or that
the corporate credit union is subject to the provisions applicable to
corporate credit unions that are significantly undercapitalized because
the credit union failed to submit or implement in any material respect
an acceptable capital restoration plan, the corporate credit union will
become subject to the provisions of paragraph (k)(3)(iii) of this
section that restrict compensation paid to senior executive officers of
the institution.
(iv) Additional provisions applicable to critically
undercapitalized corporate credit unions. In addition to the provisions
described in paragraphs (f)(1)(ii) and (f)(1)(iii) of this section,
immediately upon receiving notice or being deemed to have notice that
the corporate credit union is critically undercapitalized, the
corporate credit union will become subject to these additional
provisions of paragraph (k) of this section:
(A) Restricting the activities of the corporate credit union
((k)(5)(i)); and
(B) Restricting payments on subordinated debt of the corporate
credit union ((k)(5)(ii)).
(2) Discretionary supervisory actions.
(i) All PCA actions listed in paragraph (k) of this section that
are not discussed

[[Page 64838]]

in paragraph (f)(1) of this section are discretionary.
(ii) All discretionary actions available to NCUA in the case of an
undercapitalized corporate credit union are available to NCUA in the
case of a significantly undercapitalized credit union. All
discretionary actions available to NCUA in the case of an
undercapitalized corporate credit union or a significantly
undercapitalized corporate credit union are available to NCUA in the
case of a critically undercapitalized corporate credit union.
(iii) In taking any discretionary PCA actions with a corporate
credit union that is deemed to be undercapitalized, significantly
undercapitalized or critically undercapitalized, or has been
reclassified as undercapitalized, or significantly undercapitalized; or
an action in connection with an officer or director of such corporate
credit union; the NCUA will follow the procedures for issuing
directives under paragraphs (g) and (i) of this section.
(iv) NCUA will consult and seek to work cooperatively with the
appropriate state supervisory authority (SSA) before taking any
discretionary supervisory action with respect to a state-chartered
corporate credit union; will provide notice of its decision to the SSA;
and will allow the appropriate SSA an opportunity to take the proposed
action independently or jointly with NCUA.
(g) Directives to take prompt corrective action. The NCUA will
provide an undercapitalized, significantly undercapitalized, or
critically undercapitalized corporate credit union prior written notice
of the NCUA's intention to issue a directive requiring such corporate
credit union to take actions or to follow proscriptions described in
this part. Section 747.3002 of this chapter prescribes the notice
content and associated process.
(h) Procedures for reclassifying a corporate credit union based on
criteria other than capital. When the NCUA intends to reclassify a
corporate credit union or subject it to the supervisory actions
applicable to the next lower capitalization category based on an unsafe
or unsound condition or practice, the NCUA will provide the credit
union with prior written notice of such intent. Section 747.3003 of
this chapter prescribes the notice content and associated process.
(i) Order to dismiss a Director or senior executive officer. When
the NCUA issues and serves a directive on a corporate credit union
requiring it to dismiss from office any director or senior executive
officer under paragraphs (k)(3) of this section, the NCUA will also
serve upon the person the corporate credit union is directed to dismiss
(Respondent) a copy of the directive (or the relevant portions, where
appropriate) and notice of the Respondent's right to seek
reinstatement. Section 747.3004 of this chapter prescribes the content
of the notice of right to seek reinstatement and the associated
process.
(j) Enforcement of directives. Section 747.3005 of this chapter
prescribes the process for enforcement of directives.
(k) Remedial actions towards undercapitalized, significantly
undercapitalized, and critically undercapitalized corporate credit
unions. (1) Provision applicable to all corporate credit unions. A
corporate credit union is prohibited from making any capital
distribution, including payment of dividends on perpetual and
nonperpetual capital accounts, if, after making the distribution, the
credit union would be undercapitalized.
(2) Provisions applicable to undercapitalized corporate credit
unions.
(i) Monitoring required. The NCUA will--
(A) Closely monitor the condition of any undercapitalized corporate
credit union;
(B) Closely monitor compliance with capital restoration plans,
restrictions, and requirements imposed under this section; and
(C) Periodically review the plan, restrictions, and requirements
applicable to any undercapitalized corporate credit union to determine
whether the plan, restrictions, and requirements are achieving the
purpose of this section.
(ii) Capital restoration plan required.
(A) Any undercapitalized corporate credit union must submit an
acceptable capital restoration plan to the NCUA.
(B) The capital restoration plan will--
(1) Specify--
(i) The steps the corporate credit union will take to become
adequately capitalized;
(ii) The levels of capital to be attained during each year in which
the plan will be in effect;
(iii) How the corporate credit union will comply with the
restrictions or requirements then in effect under this section; and
(iv) The types and levels of activities in which the corporate
credit union will engage; and
(2) Contain such other information as the NCUA may require.
(C) The NCUA will not accept a capital restoration plan unless the
NCUA determines that the plan--
(1) Complies with paragraph (k)(2)(ii)(B) of this section;
(2) Is based on realistic assumptions, and is likely to succeed in
restoring the corporate credit union's capital; and
(3) Would not appreciably increase the risk (including credit risk,
interest-rate risk, and other types of risk) to which the corporate
credit union is exposed.
(iii) Asset growth restricted. An undercapitalized corporate credit
union must not permit its daily average net assets during any calendar
month to exceed its moving daily average net assets unless--
(A) The NCUA has accepted the corporate credit union's capital
restoration plan; and
(B) Any increase in total assets is consistent with the plan.
(iv) Prior approval required for acquisitions, branching, and new
lines of business. An undercapitalized corporate credit union must not,
directly or indirectly, acquire any interest in any entity, establish
or acquire any additional branch office, or engage in any new line of
business unless the NCUA has accepted the corporate credit union's
capital restoration plan, the corporate credit union is implementing
the plan, and the NCUA determines that the proposed action is
consistent with and will further the achievement of the plan.
(3) Provisions applicable to significantly undercapitalized
corporate credit unions and undercapitalized corporate credit unions
that fail to submit and implement capital restoration plans.
(i) In general. This paragraph applies with respect to any
corporate credit union that--
(A) Is significantly undercapitalized; or
(B) Is undercapitalized and--
(1) Fails to submit an acceptable capital restoration plan within
the time allowed by the NCUA under paragraph (e)(1) of this section; or
(2) Fails in any material respect to implement a plan accepted by
the NCUA.
(ii) Specific actions authorized. The NCUA may take one or more of
the following actions:
(A) Requiring recapitalization.
(1) Requiring the corporate credit union to seek and obtain
additional contributed capital.
(2) Requiring the corporate credit union to increase its rate of
earnings retention.
(3) Requiring the corporate credit union to combine, in whole or
part, with another insured depository institution, if one or more
grounds exist under this section or the Federal Credit Union Act for
appointing a conservator or liquidating agent.

[[Page 64839]]

(B) Restricting any ongoing or future transactions with affiliates.
(C) Restricting interest rates paid.
(1) In general. Restricting the rates of dividends and interest
that the corporate credit union pays on shares and deposits to the
prevailing rates on shares and deposits of comparable amounts and
maturities in the region where the institution is located, as
determined by the NCUA.
(2) Retroactive restrictions prohibited. Paragraph (k)(3)(ii)(c) of
this section does not authorize the NCUA to restrict interest rates
paid on time deposits or shares made before (and not renewed or
renegotiated after) the date the NCUA announced this restriction.
(D) Restricting asset growth. Restricting the corporate credit
union's asset growth more stringently than in paragraph (k)(2)(iii) of
this section, or requiring the corporate credit union to reduce its
total assets.
(E) Restricting activities. Requiring the corporate credit union or
any of its CUSOs to alter, reduce, or terminate any activity that the
NCUA determines poses excessive risk to the corporate credit union.
(F) Improving management. Doing one or more of the following:
(1) New election of directors. Ordering a new election for the
corporate credit union's board of directors.
(2) Dismissing directors or senior executive officers. Requiring
the corporate credit union to dismiss from office any director or
senior executive officer who had held office for more than 180 days
immediately before the corporate credit union became undercapitalized.
(3) Employing qualified senior executive officers. Requiring the
corporate credit union to employ qualified senior executive officers
(who, if the NCUA so specifies, will be subject to approval by the
NCUA).
(G) Requiring divestiture. Requiring the corporate credit union to
divest itself of or liquidate any interest in any entity if the NCUA
determines that the entity is in danger of becoming insolvent or
otherwise poses a significant risk to the corporate credit union;
(H) Conserve or liquidate the corporate credit union if NCUA
determines the credit union has no reasonable prospect of becoming
adequately capitalized; and
(I) Requiring other action. Requiring the corporate credit union to
take any other action that the NCUA determines will better carry out
the purpose of this section than any of the actions described in this
paragraph.
(iii) Senior executive officers' compensation restricted.
(A) In general. The corporate credit union is prohibited from doing
any of the following without the prior written approval of the NCUA:
(1) Pay any bonus or profit-sharing to any senior executive
officer.
(2) Provide compensation to any senior executive officer at a rate
exceeding that officer's average rate of compensation (excluding
bonuses and profit-sharing) during the 12 calendar months preceding the
calendar month in which the corporate credit union became
undercapitalized.
(B) Failing to submit plan. The NCUA will not grant approval with
respect to a corporate credit union that has failed to submit an
acceptable capital restoration plan.
(iv) Discretion to impose certain additional restrictions. The NCUA
may impose one or more of the restrictions prescribed by regulation
under paragraph (k)(5) of this section if the NCUA determines that
those restrictions are necessary to carry out the purpose of this
section.
(4) More stringent treatment based on other supervisory criteria.
(i) In general. If the NCUA determines, after notice and an
opportunity for hearing as described in subpart M of part 747 of this
chapter, that a corporate credit union is in an unsafe or unsound
condition or deems the corporate credit union to be engaging in an
unsafe or unsound practice, the NCUA may--
(A) If the corporate credit union is well capitalized, reclassify
the corporate credit union as adequately capitalized;
(B) If the corporate credit union is adequately capitalized (but
not well capitalized), require the corporate credit union to comply
with one or more provisions of paragraphs (k)(1) and (k)(2) of this
section, as if the corporate credit union were undercapitalized; or
(C) If the corporate credit union is undercapitalized, take any one
or more actions authorized under paragraph (k)(3)(ii) of this section
as if the corporate credit union were significantly undercapitalized.
(ii) Contents of plan. Any plan required under paragraph (k)(4)(i)
of this section will specify the steps that the corporate credit union
will take to correct the unsafe or unsound condition or practice.
Capital restoration plans, however, will not be required under
paragraph (k)(4)(i)(B) of this section.
(5) Provisions applicable to critically undercapitalized corporate
credit unions.
(i) Activities restricted. Any critically undercapitalized
corporate credit union must comply with restrictions prescribed by the
NCUA under paragraph (k)(6) of this section.
(ii) Payments on contributed capital and subordinated debt
prohibited. A critically undercapitalized corporate credit union must
not, beginning no later than 60 days after becoming critically
undercapitalized, make any payment of dividends on contributed capital
or any payment of principal or interest on the corporate credit union's
subordinated debt unless the NCUA determines that an exception would
further the purpose of this section. Interest, although not payable,
may continue to accrue under the terms of any subordinated debt to the
extent otherwise permitted by law. Dividends on contributed capital do
not, however, continue to accrue.
(iii) Conservatorship, liquidation, or other action. The NCUA may,
at any time, conserve or liquidate any critically undercapitalized
corporate credit union or require the credit union to combine, in whole
or part, with another institution. NCUA will consider, not later than
90 days after a corporate credit union becomes critically
undercapitalized, whether NCUA should liquidate, conserve, or combine
the institution.
(6) Restricting activities of critically undercapitalized corporate
credit unions. To carry out the purpose of this section, the NCUA will,
by order--
(i) Restrict the activities of any critically undercapitalized
corporate credit union; and
(ii) At a minimum, prohibit any such corporate credit union from
doing any of the following without the NCUA's prior written approval:
(A) Entering into any material transaction other than in the usual
course of business, including any investment, expansion, acquisition,
sale of assets, or other similar action.
(B) Extending credit for any transaction NCUA determines to be
highly leveraged.
(C) Amending the corporate credit union's charter or bylaws, except
to the extent necessary to carry out any other requirement of any law,
regulation, or order.
(D) Making any material change in accounting methods.
(E) Paying compensation or bonuses NCUA determines to be excessive.
(F) Paying interest on new or renewed liabilities at a rate that
would increase the corporate credit union's weighted average cost of
funds to a level significantly exceeding the prevailing rates of
interest on insured deposits in the corporate credit union's normal
market areas.

[[Page 64840]]

0
11. Revise Sec. 704.5 to read as follows:

Sec. 704.5. Investments.

(a) Policies. A corporate credit union must operate according to an
investment policy that is consistent with its other risk management
policies, including, but not limited to, those related to credit risk
management, asset and liability management, and liquidity management.
The policy must address, at a minimum:
(1) Appropriate tests and criteria for evaluating investments and
investment transactions before purchase; and
(2) Reasonable and supportable concentration limits for limited
liquidity investments in relation to capital.
(b) General. All investments must be U.S. dollar-denominated and
subject to the credit policy restrictions set forth in Sec. 704.6.
(c) Authorized activities. A corporate credit union may invest in:
(1) Securities, deposits, and obligations set forth in Sections
107(7), 107(8), and 107(15) of the Federal Credit Union Act, 12 U.S.C.
1757(7), 1757(8), and 1757(15), except as provided in this section;
(2) Deposits in, the sale of federal funds to, and debt obligations
of corporate credit unions, Section 107(8) institutions, and state
banks, trust companies, and mutual savings banks not domiciled in the
state in which the corporate credit union does business;
(3) Corporate CUSOs, as defined in and subject to the limitations
of Sec. 704.11;
(4) Marketable debt obligations of corporations chartered in the
United States. This authority does not apply to debt obligations that
are convertible into the stock of the corporation; and
(5) Domestically-issued asset-backed securities.
(d) Repurchase agreements. A corporate credit union may enter into
a repurchase agreement provided that:
(1) The corporate credit union, directly or through its agent,
receives written confirmation of the transaction, and either takes
physical possession or control of the repurchase securities or is
recorded as owner of the repurchase securities through the Federal
Reserve Book-Entry Securities Transfer System;
(2) The repurchase securities are legal investments for that
corporate credit union;
(3) The corporate credit union, directly or through its agent,
receives daily assessment of the market value of the repurchase
securities and maintains adequate margin that reflects a risk
assessment of the repurchase securities and the term of the
transaction; and
(4) The corporate credit union has entered into signed contracts
with all approved counterparties and agents, and ensures compliance
with the contracts. Such contracts must address any supplemental terms
and conditions necessary to meet the specific requirements of this
part. Third party arrangements must be supported by tri-party contracts
in which the repurchase securities are priced and reported daily and
the tri-party agent ensures compliance; and
(e) Securities Lending. A corporate credit union may enter into a
securities lending transaction provided that:
(1) The corporate credit union, directly or through its agent,
receives written confirmation of the loan, obtains a first priority
security interest in the collateral by taking physical possession or
control of the collateral, or is recorded as owner of the collateral
through the Federal Reserve Book-Entry Securities Transfer System;
(2) The collateral is a legal investment for that corporate credit
union;
(3) The corporate credit union, directly or through its agent,
receives daily assessment of the market value of collateral and
maintains adequate margin that reflects a risk assessment of the
collateral and terms of the loan; and
(4) The corporate credit union has entered into signed contracts
with all agents and, directly or through its agent, has executed a
written loan and security agreement with the borrower. The corporate or
its agent ensures compliance with the agreements.
(f) Investment companies. A corporate credit union may invest in an
investment company registered with the Securities and Exchange
Commission under the Investment Company Act of 1940 (15 U.S.C. 80a), or
a collective investment fund maintained by a national bank under 12 CFR
9.18 or a mutual savings bank under 12 CFR 550.260, provided that the
company or fund prospectus restricts the investment portfolio to
investments and investment transactions that are permissible for that
corporate credit union.
(g) Investment settlement. A corporate credit union may only
contract for the purchase or sale of an investment if the transaction
is settled on a delivery versus payment basis within 60 days for
mortgage-backed securities, within 30 days for new issues (other than
mortgage-backed securities), and within three days for all other
securities.
(h) Prohibitions. A corporate credit union is prohibited from:
(1) Purchasing or selling derivatives, except for embedded options
not required under GAAP to be accounted for separately from the host
contract or forward sales commitments on loans to be purchased by the
corporate credit union;
(2) Engaging in trading securities unless accounted for on a trade
date basis;
(3) Engaging in adjusted trading or short sales;
(4) Purchasing mortgage servicing rights, small business related
securities, residual interests in collateralized mortgage obligations,
residual interests in real estate mortgage investment conduits, or
residual interests in asset-backed securities;
(5) Purchasing net interest margin securities;
(6) Purchasing collateralized debt obligations;
(7) Purchasing private label residential mortgage-backed
securities;
(8) Purchasing subordinated securities; and
(9) Purchasing stripped mortgage-backed securities (SMBS), or
securities that represent interests in SMBS, except as described in
subparagraphs (i) and (iii) below.
(i) A corporate credit union may invest in exchangeable
collateralized mortgage obligations (exchangeable CMOs) representing
beneficial ownership interests in one or more interest-only classes of
a CMO (IO CMOs) or principal-only classes of a CMO (PO CMOs), but only
if:
(A) At the time of purchase, the ratio of the market price to the
remaining principal balance is between .8 and 1.2, meaning that the
discount or premium of the market price to par must be less than 20
points;
(B) The offering circular or other official information available
at the time of purchase indicates that the notional principal on each
underlying IO CMO should decline at the same rate as the principal on
one or more of the underlying non-IO CMOs, and that the principal on
each underlying PO CMO should decline at the same rate as the
principal, or notional principal, on one or more of the underlying non-
PO CMOs; and
(C) The credit union investment staff has the expertise dealing
with exchangeable CMOs to apply the conditions in paragraphs
(h)(5)(i)(A) and (B) of this section.
(ii) A corporate credit union that invests in an exchangeable CMO
may exercise the exchange option only if all of the underlying CMOs are
permissible investments for that credit union.
(iii) A corporate credit union may accept an exchangeable CMO
representing beneficial ownership interests in one or more IO CMOs or
PO CMOs as an asset associated with an

[[Page 64841]]

investment repurchase transaction or as collateral in a securities
lending transaction. When the exchangeable CMO is associated with one
of these two transactions, it need not conform to the conditions in
paragraphs (h)(5)(i)(A) or (B) of this section.
(i) Conflicts of interest. A corporate credit union's officials,
employees, and immediate family members of such individuals, may not
receive pecuniary consideration in connection with the making of an
investment or deposit by the corporate credit union. Employee
compensation is exempt from this prohibition. All transactions not
specifically prohibited by this paragraph must be conducted at arm's
length and in the interest of the corporate credit union.
(j) Grandfathering. A corporate credit union's authority to hold an
investment is governed by the regulation in effect at the time of
purchase. However, all grandfathered investments are subject to the
requirements of Sec. Sec. 704.8 and 704.9.

0
12. Revise Sec. 704.6 to read as follows:

Sec. 704.6. Credit risk management.

(a) Policies. A corporate credit union must operate according to a
credit risk management policy that is commensurate with the investment
risks and activities it undertakes. The policy must address at a
minimum:
(1) The approval process associated with credit limits;
(2) Due diligence analysis requirements;
(3) Maximum credit limits with each obligor and transaction
counterparty, set as a percentage of capital. In addition to addressing
deposits and securities, limits with transaction counterparties must
address aggregate exposures of all transactions including, but not
limited to, repurchase agreements, securities lending, and forward
settlement of purchases or sales of investments; and
(4) Concentrations of credit risk (e.g., originator of receivables,
servicer of receivables, insurer, industry type, sector type,
geographic, collateral type, and tranche priority).
(b) Exemption. The limitations and requirements of this section do
not apply to certain assets, whether or not considered investments
under this part, including fixed assets, individual loans and loan
participation interests, investments in CUSOs, investments that are
issued or fully guaranteed as to principal and interest by the U.S.
government or its agencies or its sponsored enterprises (other than
mortgage backed-securities), investments that are fully insured or
guaranteed (including accumulated dividends and interest) by the NCUSIF
or the Federal Deposit Insurance Corporation, and settlement funds in
federally insured depository institutions.
(c) Issuer concentration limits--(1) General rule. The aggregate of
all investments in any single obligor is limited to 25 percent of
capital or $5 million, whichever is greater.
(2) Exceptions.
(i) Investments in one obligor where the remaining maturity of all
obligations is less than 30 days are limited to 50 percent of capital;
(ii) Investments in credit card master trust asset-backed
securities are limited to 50 percent of capital in any single obligor;
(iii) Aggregate investments in repurchase and securities lending
agreements with any one counterparty are limited to 200 percent of
capital;
(iv) Investments in non-money market registered investment
companies are limited to of 50 percent of capital in any single
obligor;
(v) Investments in money market registered investment companies are
limited to 100 percent of capital in any single obligor; and
(vi) Investments in corporate CUSOs are subject to the limitations
of Sec. 704.11.
(3) For purposes of measurement, each new credit transaction must
be evaluated in terms of the corporate credit union's capital at the
time of the transaction. An investment that fails a requirement of this
section because of a subsequent reduction in capital will be deemed
non-conforming. A corporate credit union is required to exercise
reasonable efforts to bring nonconforming investments into conformity
within 90 calendar days. Investments that remain nonconforming for 90
calendar days will be deemed to fail a requirement of this section and
the corporate credit union will have to comply with Sec. 704.10.
(d) Sector concentration limits. (1) A corporate credit union must
establish sector limits that do not exceed the following maximums:
(i) Mortgage-backed securities (Inclusive of commercial mortgage-
backed securities)--the lower of 1000 percent of capital or 50 percent
of assets;
(ii) Commercial mortgage-backed securities--the lower of 300
percent of capital or 15 percent of assets;
(iii) FFELP student loan asset-backed securities--the lower of 1000
percent of capital or 50 percent of assets;
(iv) Private student loan asset-backed securities--the lower of 500
percent of capital or 25 percent of assets;
(v) Auto loan/lease asset-backed securities--the lower of 500
percent of capital or 25 percent of assets;
(vi) Credit card asset-backed securities--the lower of 500 percent
of capital or 25 percent of assets;
(vii) Other asset-backed securities not listed in paragraphs (ii)
through (vi)--the lower of 500 percent of capital or 25 percent of
assets;
(viii) Corporate debt obligations--the lower of 1000 percent of
capital or 50 percent of assets; and
(ix) Municipal securities--the lower of 1000 percent of capital or
50 percent of assets.
(2) Registered investment companies--A corporate credit union must
limit its investment in registered investment companies to the lower of
1000 percent of capital or 50 percent of assets. In addition to
applying the limit in this paragraph (d)(2), a corporate credit union
must also include the underlying assets in each registered investment
company in the relevant sectors described in paragraph (d)(1) of this
section when calculating those sector limits.
(3) A corporate credit union will limit its aggregate holdings in
any investments not described in paragraphs (d)(1) or (d)(2) of this
section to the lower of 100 percent of capital or 5 percent of assets.
The NCUA may approve a higher percentage in appropriate cases.
(4) Investments in other federally insured credit unions, deposits
and federal funds investments in other federally insured depository
institutions, and investment repurchase agreements are excluded from
the concentration limits in paragraphs (d)(1), (d)(2), and (d)(3) of
this section.
(e) Corporate debt obligation subsector limits. In addition to the
limitations in paragraph (d)(1)(viii) of this section, a corporate
credit union must not exceed the lower of 200 percent of capital or 10
percent of assets in any single North American Industry Classification
System (NAICS) industry sector. If the corporation does not have a
readily ascertainable NAICS classification, a corporate credit union
will use its reasonable judgment in assigning such a classification.
NCUA may direct, however, that the corporate change the classification.
(f) Credit ratings.--(1) All investments, other than in another
depository institution, must have an applicable credit rating from at
least one NRSRO. At a minimum, 90 percent of all such investments, by
book value, must have a rating by at least two NRSROs. Corporate credit
unions may

[[Page 64842]]

use either public or nonpublic NRSRO ratings to satisfy this
requirement.
(2) At the time of purchase, investments with long-term ratings
must be rated no lower than AA- (or equivalent) by every NRSRO that
provides a publicly available long-term rating on that investment, and
investments with short-term ratings must be rated no lower than A-1 (or
equivalent) by every NRSRO that provides a publicly available short-
term rating on that investment. If the corporate credit union obtains a
nonpublic NRSRO rating, that rating must also be no lower than AA-, or
A-1, for long-term and short-term ratings, respectively.
(3) All rating(s) relied upon to meet the requirements of this part
must be identified at the time of purchase and must be monitored for as
long as the corporate owns the investment. Corporate credit unions must
identify and monitor any new post-purchase NRSRO ratings on investments
they hold.
(4) Investments are subject to the requirements of Sec. 704.10 if:
(i) An NRSRO that rates the investment downgrades that rating,
after purchase, below the minimum rating requirements of this part; or
(ii) The investment is part of an asset class or group of
investments that exceeds the sector or obligor concentration limits of
this section.
(g) Reporting and documentation. (1) At least annually, a written
evaluation of each credit limit with each obligor or transaction
counterparty must be prepared and formally approved by the board or an
appropriate committee. At least monthly, the board or an appropriate
committee must receive an investment watch list of existing and/or
potential credit problems and summary credit exposure reports, which
demonstrate compliance with the corporate credit union's risk
management policies.
(2) At a minimum, the corporate credit union must maintain:
(i) A justification for each approved credit limit;
(ii) Disclosure documents, if any, for all instruments held in
portfolio. Documents for an instrument that has been sold must be
retained until completion of the next NCUA examination; and
(iii) The latest available financial reports, industry analyses,
internal and external analyst evaluations, and rating agency
information sufficient to support each approved credit limit.

0
13. Revise Sec. 704.8 to read as follows:

Sec. 704.8. Asset and liability management.

(a) Policies. A corporate credit union must operate according to a
written asset and liability management policy which addresses, at a
minimum:
(1) The purpose and objectives of the corporate credit union's
asset and liability activities;
(2) The maximum allowable percentage decline in net economic value
(NEV), compared to base case NEV;
(3) The minimum allowable NEV ratio;
(4) Policy limits and specific test parameters for the NEV
sensitivity analysis requirements set forth in paragraphs (d), (e), and
(f) of this section;
(5) The modeling of indexes that serve as references in financial
instrument coupon formulas; and
(6) The tests that will be used, prior to purchase, to estimate the
impact of investments on the percentage decline in NEV compared to base
case NEV. The most recent NEV analysis, as determined under paragraph
(d)(1)(i) of this section may be used as a basis of estimation.
(b) Asset and liability management committee (ALCO). A corporate
credit union's ALCO must have at least one member who is also a member
of the board of directors. The ALCO must review asset and liability
management reports on at least a monthly basis. These reports must
address compliance with Federal Credit Union Act, NCUA Rules and
Regulations (12 CFR chapter VII), and all related risk management
policies.
(c) Penalty for early withdrawals. A corporate credit union that
permits early certificate/share withdrawals must assess market-based
penalties sufficient to cover the estimated replacement cost of the
certificate redeemed. This means the minimum penalty must be reasonably
related to the rate that the corporate credit union would be required
to offer to attract funds for a similar term with similar
characteristics.
(d) Interest rate sensitivity analysis. (1) A corporate credit
union must:
(i) Evaluate the risk in its balance sheet by measuring, at least
quarterly, including once on the last day of the calendar quarter, the
impact of an instantaneous, permanent, and parallel shock in the yield
curve of plus and minus 100, 200, and 300 BP on its NEV and NEV ratio.
If the base case NEV ratio falls below 3 percent at the last testing
date, these tests must be calculated at least monthly, including once
on the last day of the month, until the base case NEV ratio again
exceeds 3 percent;
(ii) Limit its risk exposure to levels that do not result in a base
case NEV ratio or any NEV ratio resulting from the tests set forth in
paragraph (d)(1)(i) of this section below 2 percent; and
(iii) Limit its risk exposures to levels that do not result in a
decline in NEV of more than 15 percent.
(2) A corporate credit union must assess annually if it should
conduct periodic additional tests to address market factors that may
materially impact that corporate credit union's NEV. These factors
should include, but are not limited to, the following:
(i) Changes in the shape of the Treasury yield curve;
(ii) Adjustments to prepayment projections used for amortizing
securities to consider the impact of significantly faster/slower
prepayment speeds; and
(iii) Adjustments to volatility assumptions to consider the impact
that changing volatilities have on embedded option values.
(e) Net interest income modeling. A corporate credit union must
perform net interest income (NII) modeling to project earnings in
multiple interest rate environments for a period of no less than 2
years. NII modeling must, at minimum, be performed at least quarterly,
including once on the last day of the calendar quarter.
(f) Weighted average asset life. The weighted average life (WAL) of
a corporate credit union's loan and investment portfolio, excluding
derivative contracts and equity investments, may not exceed 2 years. A
corporate credit union must test its assets at least quarterly,
including once on the last day of the calendar quarter, for compliance
with this WAL limitation. When calculating its WAL, a corporate credit
union must assume that no issuer or market options will be exercised.
If the WAL of a corporate credit union's assets exceeds 2 years on the
testing date, this test must be calculated at least monthly, including
once on the last day of the month, until the WAL is below 2 years.
(g) Weighted average asset life with 50 percent slowdown in
prepayment speeds. The weighted average life (WAL) of a corporate
credit union's loan and investment portfolio, excluding derivative
contracts and equity investments, may not exceed 2.25 years when
prepayment speeds are reduced by 50 percent. A corporate credit union
must test its investments at least quarterly, including once on the
last day of the calendar quarter, for compliance with this WAL
limitation. When calculating its WAL, a corporate credit union must
assume that no issuer or

[[Page 64843]]

market options will be exercised. If the WAL of a corporate credit
union's assets exceeds 2.25 years, this test must be calculated at
least monthly, including once on the last day of the month, until the
WAL with the 50 slowdown in prepayment speeds is below 2.25 years.
(h) Government issued or guaranteed securities. The WAL of
investments that are issued or fully guaranteed as to principal and
interest by the U.S. government, its agencies or sponsored enterprises,
including investments that are fully insured or guaranteed (including
accumulated dividends and interest) by the NCUSIF or the Federal
Deposit Insurance Corporation, will be multiplied by a factor of 0.50
for purposes of the WAL tests of paragraphs (f) and (g) of this
section.
(i) Effective and spread durations. A corporate credit union must
measure at least once a quarter, including once on the last day of the
calendar quarter, the effective duration and spread durations of each
of its assets and liabilities, where the values of these are affected
by changes in interest rates or credit spreads.
(j) Regulatory violations. (1)(i) If a corporate credit union's
decline in NEV, base case NEV ratio or any NEV ratio resulting from the
test set forth in paragraph (d) of this section violates the limits
established in that paragraph, or the corporate credit union is unable
to satisfy the tests in paragraphs (f) or (g) of this section; and
(ii) The corporate cannot adjust its balance sheet so as to satisfy
the requirements of paragraphs (d), (f), or (g) of this section within
10 calendar days after detecting the violation, then:
(iii) The operating management of the corporate credit union must
immediately report this information to its board of directors,
supervisory committee, and the NCUA.
(2) If any violation described in paragraph (j)(1)(i) persists for
30 or more calendar days, the corporate credit union:
(i) Must immediately submit a detailed, written action plan to the
NCUA that sets forth the time needed and means by which it intends to
correct the violation and, if the NCUA determines that the plan is
unacceptable, the corporate credit union must immediately restructure
its balance sheet to bring the exposure back within compliance or
adhere to an alternative course of action determined by the NCUA; and
(ii) If presently categorized as adequately capitalized or well
capitalized for PCA purposes, immediately be recategorized as
undercapitalized until the violation is corrected, and
(iii) If presently less than adequately capitalized, immediately be
downgraded one additional capital category.
(k) Overall limit on business generated from individual credit
unions. On or after April 22, 2013, a corporate credit union is
prohibited from accepting from any member, or any nonmember credit
union, any investment, including shares, loans, PCC, or NCAs if,
following that investment, the aggregate of all investments from that
entity in the corporate would exceed 15 percent of the corporate credit
union's moving daily average net assets.

0
14. Revise Sec. 704.9 to read as follows:

Sec. 704.9. Liquidity management.

(a) General. In the management of liquidity, a corporate credit
union must:
(1) Evaluate the potential liquidity needs of its membership in a
variety of economic scenarios;
(2) Regularly monitor and demonstrate accessibility to sources of
internal and external liquidity;
(3) Keep a sufficient amount of cash and cash equivalents on hand
to support its payment system obligations;
(4) Demonstrate that the accounting classification of investment
securities is consistent with its ability to meet potential liquidity
demands; and
(5) Develop a contingency funding plan that addresses alternative
funding strategies in successively deteriorating liquidity scenarios.
The plan must:
(i) List all sources of liquidity, by category and amount, that are
available to service an immediate outflow of funds in various liquidity
scenarios;
(ii) Analyze the impact that potential changes in fair value will
have on the disposition of assets in a variety of interest rate
scenarios; and
(iii) Be reviewed by the board or an appropriate committee no less
frequently than annually or as market or business conditions dictate.
(b) Borrowing limits. A corporate credit union may borrow up to the
lower of 10 times capital or 50 percent of capital and shares
(excluding shares created by the use of member reverse repurchase
agreements).
(1) Secured borrowings. A corporate credit union may borrow on a
secured basis for liquidity purposes, but the maturity of the borrowing
may not exceed 30 days. Only a credit union with core capital in excess
of five percent of its moving DANA may borrow on a secured basis for
nonliquidity purposes, and the outstanding amount of secured borrowing
for nonliquidity purposes may not exceed an amount equal to the
difference between core capital and five percent of moving DANA.
(2) Exclusions. CLF borrowings and borrowed funds created by the
use of member reverse repurchase agreements are excluded from this
limit.

0
15. Revise Sec. 704.11 to read as follows:

Sec. 704.11 Corporate Credit Union Service Organizations (Corporate
CUSOs).

(a) A corporate CUSO is an entity that:
(1) Is at least partly owned by a corporate credit union;
(2) Primarily serves credit unions;
(3) Restricts its services to those related to the normal course of
business of credit unions as specified in paragraph (e) of this
section; and
(4) Is structured as a corporation, limited liability company, or
limited partnership under state law.
(b) Investment and loan limitations. (1) The aggregate of all
investments in member and non-member corporate CUSOs must not exceed 15
percent of a corporate credit union's capital.
(2) The aggregate of all investments in and loans to member and
nonmember corporate CUSOs must not exceed 30 percent of a corporate
credit union's capital. A corporate credit union may lend to member and
nonmember corporate CUSOs an additional 15 percent of capital if the
loan is collateralized by assets in which the corporate has a perfected
security interest under state law.
(3) If the limitations in paragraphs (b)(1) and (b)(2) of this
section are reached or exceeded because of the profitability of the
CUSO and the related GAAP valuation of the investment under the equity
method without an additional cash outlay by the corporate, divestiture
is not required. A corporate credit union may continue to invest up to
the regulatory limit without regard to the increase in the GAAP
valuation resulting from the corporate CUSO's profitability.
(c) Due diligence. A corporate credit union must comply with the
due diligence requirements of Sec. Sec. 723.5 and 723.6(f) through (j)
of this chapter for all loans to corporate CUSOs. This requirement does
not apply to loans excluded under Sec. 723.1(b).
(d) Separate entity. (1) A corporate CUSO must be operated as an
entity separate from a corporate credit union.
(2) A corporate credit union investing in or lending to a corporate
CUSO must obtain a written legal opinion that concludes the corporate
CUSO is organized and operated in a manner that the corporate credit
union will not reasonably be held liable for the

[[Page 64844]]

obligations of the corporate CUSO. This opinion must address factors
that have led courts to ``pierce the corporate veil,'' such as
inadequate capitalization, lack of corporate identity, common boards of
directors and employees, control of one entity over another, and lack
of separate books and records.
(e). Permissible activities. (1) Beginning on April 18, 2011, a
corporate CUSO must agree to limit its activities to:
(i) Brokerage services,
(ii) Investment advisory services, and
(iii) Other categories of activities as approved in writing by NCUA
and published on NCUA's Web site.
(2) A corporate credit union must divest from any CUSO that is
engaged in activities not approved by NCUA under paragraph (e)(1) of
this section. A corporate credit union may take until October 20, 2011
to divest itself from a CUSO engaging in one or more unapproved
activities, but only if the CUSO was engaging in those activities
before October 20, 2010 and the corporate credit union can establish
that those activities satisfied the requirements of this section as it
existed before October 20, 2010.
(3) Once NCUA has approved an activity and published that activity
on its Web site as provided for in paragraph (e)(1)(iii) of this
section, NCUA will not remove that particular activity the approved
list, or make substantial changes to the content or description of that
approved activity, except through the formal rulemaking process.
(f) An official of a corporate credit union which has invested in
or loaned to a corporate CUSO may not receive, either directly or
indirectly, any salary, commission, investment income, or other income,
compensation, or consideration from the corporate CUSO. This
prohibition also extends to immediate family members of officials.
(g) Prior to making an investment in or loan to a corporate CUSO, a
corporate credit union must obtain a written agreement that the CUSO:
(1) Will follow GAAP;
(2) Will provide financial statements to the corporate credit union
at least quarterly;
(3) Will obtain an annual CPA opinion audit and provide a copy to
the corporate credit union. A wholly owned or majority owned CUSO is
not required to obtain a separate annual audit if it is included in the
corporate credit union's annual consolidated audit;
(4) Will not acquire control, directly or indirectly, of another
depository financial institution or to invest in shares, stocks, or
obligations of an insurance company, trade association, liquidity
facility, or similar organization;
(5) Will allow the auditor, board of directors, and NCUA complete
access to its personnel, facilities, equipment, books, records, and any
other documentation that the auditor, directors, or NCUA deem
pertinent; and
(6) Will comply with all the requirements of this section.
(h) Corporate credit union authority to invest in or loan to a CUSO
is limited to that provided in this section. A corporate credit union
is not authorized to invest in or loan to a CUSO under part 712 of this
chapter.

0
16. Revise paragraph (a) of Sec. 704.14 to read as follows:
Sec. 704.14. Representation.
(a) Board representation. The board will be determined as
stipulated in its bylaws governing election procedures, provided that:
(1) At least a majority of directors, including the chair of the
board, must serve on the board as representatives of member credit
unions;
(2) On or after February 17, 2011, only individuals who currently
hold the position of chief executive officer, chief financial officer,
chief operating officer, or treasurer/manager at a member may seek
election or re-election to the board;
(3) No individual may be elected or appointed to serve on the board
if, after such election or appointment, the individual would be a
director at more than one corporate credit union;
(4) No individual may be elected or appointed to serve on the board
if, after such election or appointment, any member of the corporate
credit union would have more than one representative on the board of
the corporate;
(5) The chair of the board may not serve simultaneously as an
officer, director, or employee of a credit union trade association;
(6) A majority of directors may not serve simultaneously as
officers, directors, or employees of the same credit union trade
association or its affiliates (not including chapters or other subunits
of a state trade association);
(7) For purposes of meeting the requirements of paragraphs (a)(5)
and (a)(6) of this section, an individual may not serve as a director
or chair of the board if that individual holds a subordinate employment
relationship to another employee who serves as an officer, director, or
employee of a credit union trade association;
(8) In the case of a corporate credit union whose membership is
composed of more than 25 percent non credit unions, the majority of
directors serving as representatives of member credit unions, including
the chair, must be elected only by member credit unions, and
(9) After October 21, 2013, at least a majority of directors of
every corporate credit union, including the chair of the board, must
serve on the board as representatives of natural person credit union
members.
* * * * *

0
17. Revise Sec. 704.19 to read as follows:

Sec. 704.19 Disclosure of executive and director compensation.

(a) Annual disclosure. Corporate credit unions must annually
prepare and maintain a disclosure of the compensation, in dollar terms,
paid to its most highly compensated employees, in accordance with the
following schedule:
(1) For corporate credit unions with forty-one or more full time
employees, disclosure is required of the compensation paid to the five
most highly compensated employees;
(2) For corporate credit unions with between thirty and forty-one
full time employees, disclosure is required of the compensation paid to
the four most highly compensated employees;
(3) For corporate credit unions with thirty or fewer full time
employees, disclosure is required of the compensation paid to the three
most highly compensated employees; and
(4) In all cases, compensation paid to the corporate credit union's
chief executive officer must also be disclosed, if the chief executive
officer is not already included among the most highly compensated
employees described in paragraphs (a)(1) through (a)(3) of this
section.
(b) Availability of disclosure. Any member may obtain a copy of the
most current disclosure, and all disclosures for the previous three
years, on request made in person or in writing. The corporate credit
union must provide the disclosure(s), at no cost to the member, within
five business days of receiving the request. In addition, the corporate
must distribute the most current disclosure to all its members at least
once a year, either in the annual report or in some other manner of the
corporate's choosing.
(c) Supplemental information. In providing the disclosure required
by this section, a corporate credit union may also provide
supplementary information to put the disclosure in context, for
example, salary surveys, a discussion of compensation in relation to
other credit union expenses, or compensation information from

[[Page 64845]]

similarly sized credit unions or financial institutions.
(d) Special rule for mergers. With respect to any merger involving
a corporate credit union that would result in a material increase in
compensation, i.e., an increase of more than 15 percent or $10,000,
whichever is greater, for any senior executive officer or director of
the merging corporate, the corporate must:
(1) Describe the compensation arrangement in the merger plan
documents submitted to NCUA for approval of the merger, pursuant to
Sec. 708b of this part; and
(2) In the case of any federally chartered corporate credit union,
describe the compensation arrangement in the materials provided to the
membership of the merging credit union before the member vote on
approving the merger.
0
18. Add a new Sec. 704.20 to read as follows:

Sec. 704.20. Limitations on golden parachute and indemnification
payments.

(a) Definitions. The following definitions apply for this section:
(1) Board means the National Credit Union Administration Board.
(2) Benefit plan means any plan, contract, agreement or other
arrangement which is an ``employee welfare benefit plan'' as that term
is defined in section 3(1) of the Employee Retirement Income Security
Act of 1974, as amended (29 U.S.C. 1002(1)), or other usual and
customary plans such as dependent care, tuition reimbursement, group
legal services or cafeteria plans; provided however, that such term
does not include any plan intended to be subject to paragraphs
(a)(4)(iv)(C) and (E) of this section.
(3) Bona fide deferred compensation plan or arrangement means any
plan, contract, agreement or other arrangement whereby:
(i) An institution-affiliated party (IAP) voluntarily elects to
defer all or a portion of the reasonable compensation, wages or fees
paid for services rendered which otherwise would have been paid to the
IAP at the time the services were rendered (including a plan that
provides for the crediting of a reasonable investment return on such
elective deferrals) and the corporate credit union either:
(A) Recognizes compensation expense and accrues a liability for the
benefit payments according to Generally Accepted Accounting Principles
(GAAP); or
(B) Segregates or otherwise sets aside assets in a trust which may
only be used to pay plan and other benefits, except that the assets of
such trust may be available to satisfy claims of the institution's or
holding company's creditors in the case of insolvency; or
(ii) A corporate credit union establishes a nonqualified deferred
compensation or supplemental retirement plan, other than an elective
deferral plan described in paragraph (a)(3)(i) of this section:
(A) Primarily for the purpose of providing benefits for certain
IAPs in excess of the limitations on contributions and benefits imposed
by Sections 415, 401(a)(17), 402(g) or any other applicable provision
of the Internal Revenue Code of 1986 (26 USC 415, 401(a)(17), 402(g));
or
(B) Primarily for the purpose of providing supplemental retirement
benefits or other deferred compensation for a select group of
directors, management or highly compensated employees (excluding
severance payments described in paragraph (4)(ii)(E) of this section
and permissible golden parachute payments described in Sec. 704.20(d);
and
(iii) In the case of any nonqualified deferred compensation or
supplemental retirement plans as described in paragraphs (a)(3)(i) and
(ii) of this section, the following requirements will apply:
(A) The plan was in effect at least one year prior to any of the
events described in paragraph (a)(4)(ii) of this section;
(B) Any payment made pursuant to such plan is made in accordance
with the terms of the plan as in effect no later than one year prior to
any of the events described in paragraph (a)(4)(ii) of this section and
in accordance with any amendments to such plan during such one year
period that do not increase the benefits payable thereunder;
(C) The IAP has a vested right, as defined under the applicable
plan document, at the time of termination of employment to payments
under such plan;
(D) Benefits under such plan are accrued each period only for
current or prior service rendered to the employer (except that an
allowance may be made for service with a predecessor employer);
(E) Any payment made pursuant to such plan is not based on any
discretionary acceleration of vesting or accrual of benefits which
occurs at any time later than one year prior to any of the events
described in paragraph (a)(4)(ii) of this section;
(F) The corporate credit union has previously recognized
compensation expense and accrued a liability for the benefit payments
according to GAAP or segregated or otherwise set aside assets in a
trust which may only be used to pay plan benefits, except that the
assets of such trust may be available to satisfy claims of the
corporate credit union's creditors in the case of insolvency; and
(G) Payments pursuant to such plans must not be in excess of the
accrued liability computed in accordance with GAAP.
(4) Golden parachute payment means any payment (or any agreement to
make any payment) in the nature of compensation by any corporate credit
union for the benefit of any current or former IAP pursuant to an
obligation of such corporate credit union that:
(i) Is contingent on, or by its terms is payable on or after, the
termination of such IAP's primary employment or affiliation with the
corporate credit union; and
(ii) Is received on or after, or is made in contemplation of, any
of the following events:
(A) The insolvency (or similar event) of the corporate that is
making the payment; or
(B) The appointment of any conservator or liquidating agent for
such corporate credit union; or
(C) A determination by the Board or the appropriate state
supervisory authority (in the case of a state-chartered corporate
credit union) respectively, that the corporate credit union is in a
troubled condition; or
(D) The corporate credit union is undercapitalized, as defined in
Sec. 704.4; or
(E) The corporate credit union is subject to a proceeding to
terminate or suspend its share account insurance; and
(iii) Is payable to an IAP whose employment by or affiliation with
the corporate is terminated at a time when the corporate credit union
by which the IAP is employed or with which the IAP is affiliated
satisfies any of the conditions enumerated in paragraphs (a)(4)(ii)(A)
through (E) of this section, or in contemplation of any of these
conditions.
(iv) Exceptions. The term golden parachute payment does not
include:
(A) Any payment made pursuant to a pension or retirement plan which
is qualified (or is intended within a reasonable period of time to be
qualified) under Section 401 of the Internal Revenue Code of 1986 (26
U.S.C. 401); or
(B) Any payment made pursuant to a benefit plan as that term is
defined in paragraph (a)(2) of this section; or
(C) Any payment made pursuant to a bona fide deferred compensation
plan or arrangement as defined in paragraph (a)(3) of this section; or

[[Page 64846]]

(D) Any payment made by reason of death or by reason of termination
caused by the disability of an IAP; or
(E) Any payment made pursuant to a nondiscriminatory severance pay
plan or arrangement which provides for payment of severance benefits to
all eligible employees upon involuntary termination other than for
cause, voluntary resignation, or early retirement; provided, however,
that no employee will receive any such payment which exceeds the base
compensation paid to such employee during the twelve months (or such
longer period or greater benefit as the Board will consent to)
immediately preceding termination of employment, resignation or early
retirement, and such severance pay plan or arrangement must not have
been adopted or modified to increase the amount or scope of severance
benefits at a time when the corporate credit union was in a condition
specified in paragraph (a)(4)(ii) of this section or in contemplation
of such a condition without the prior written consent of the Board; or
(F) Any severance or similar payment which is required to be made
pursuant to a state statute which is applicable to all employers within
the appropriate jurisdiction (with the exception of employers that may
be exempt due to their small number of employees or other similar
criteria); or
(G) Any other payment which the Board determines to be permissible
in accordance with Sec. 704.20(d).
(5) Institution-affiliated party (IAP) means any individual meeting
the criteria specified in section 206(r) of the Act (12 U.S.C.
1786(r)).
(6) Liability or legal expense means:
(i) Any legal or other professional fees and expenses incurred in
connection with any claim, proceeding, or action;
(ii) The amount of, and any cost incurred in connection with, any
settlement of any claim, proceeding, or action; and
(iii) The amount of, and any cost incurred in connection with, any
judgment or penalty imposed with respect to any claim, proceeding, or
action.
(7) Nondiscriminatory means that the plan, contract or arrangement
in question applies to all employees of a corporate credit union who
meet reasonable and customary eligibility requirements applicable to
all employees, such as minimum length of service requirements. A
nondiscriminatory plan, contract or arrangement may provide different
benefits based only on objective criteria such as salary, total
compensation, length of service, job grade or classification, which are
applied on a proportionate basis (with a variance in severance benefits
relating to any criterion of plus or minus ten percent) to groups of
employees consisting of not less than the lesser of 33 percent of
employees or 1,000 employees.
(8) Payment means:
(i) Any direct or indirect transfer of any funds or any asset;
(ii) Any forgiveness of any debt or other obligation;
(iii) The conferring of any benefit, including but not limited to
stock options and stock appreciation rights; or
(iv) Any segregation of any funds or assets, the establishment or
funding of any trust or the purchase of or arrangement for any letter
of credit or other instrument, for the purpose of making, or pursuant
to any agreement to make, any payment on or after the date on which
such funds or assets are segregated, or at the time of or after such
trust is established or letter of credit or other instrument is made
available, without regard to whether the obligation to make such
payment is contingent on:
(A) The determination, after such date, of the liability for the
payment of such amount; or
(B) The liquidation, after such date, of the amount of such
payment.
(9) Prohibited indemnification payment means any payment (or any
agreement or arrangement to make any payment) by any corporate credit
union for the benefit of any person who is or was an IAP of such
corporate credit union, to pay or reimburse such person for any civil
money penalty, judgment or other liability or legal expense resulting
from any administrative or civil action instituted by the Board or any
appropriate state regulatory authority that results in a final order or
settlement pursuant to which such person:
(i) Is assessed a civil money penalty;
(ii) Is removed from office or prohibited from participating in the
conduct of the affairs of the corporate credit union; or
(iii) Is required to cease and desist from or take any affirmative
action described in Section 206 of the Act with respect to such
corporate credit union.
(iv) Exceptions. The term prohibited indemnification payment does
not include any reasonable payment by a corporate credit union that:
(A) Is used to purchase any commercial insurance policy or fidelity
bond, provided that such insurance policy or bond must not be used to
pay or reimburse an IAP for the cost of any judgment or civil money
penalty assessed against such person in an administrative proceeding or
civil action commenced by NCUA or the appropriate state supervisory
authority (in the case of a state chartered corporate), but may pay any
legal or professional expenses incurred in connection with such
proceeding or action or the amount of any restitution to the corporate
credit union or its liquidating agent; or
(B) Represents partial indemnification for legal or professional
expenses specifically attributable to particular charges for which
there has been a formal and final adjudication or finding in connection
with a settlement that the IAP has not violated certain laws or
regulations or has not engaged in certain unsafe or unsound practices
or breaches of fiduciary duty, unless the administrative action or
civil proceeding has resulted in a final prohibition order against the
IAP.
(10) Troubled Condition means that the corporate credit union:
(i) Has been assigned:
(A) A 4 or 5 Corporate Risk Information System (CRIS) rating by
NCUA in either the Financial Risk or Risk Management composites, in the
case of a federal corporate credit union, or
(B) An equivalent 4 or 5 CRIS rating in either the Financial Risk
or Risk Management composites by the state supervisory authority (SSA)
in the case of a federally insured, state-chartered corporate credit
union in a state that has adopted the CRIS system, or an equivalent 4
or 5 CAMEL composite rating by the SSA in the case of a federally
insured, state-chartered corporate credit union in a state that uses
the CAMEL system, or
(C) A 4 or 5 CRIS rating in either the Financial Risk or Risk
Management composites by NCUA based on core work papers received from
the SSA in the case of a federally insured, state-chartered credit
union in a state that does not use either the CRIS or CAMEL system. In
this case, the SSA will be notified in writing by the Director of the
Office of Corporate Credit Unions that the corporate credit union has
been designated by NCUA as a troubled institution; or
(ii) Has been granted assistance as outlined under Sections 208 or
216 of the Federal Credit Union Act.
(b) Golden parachute payments prohibited. No corporate credit union
will make or agree to make any golden parachute payment, except as
otherwise provided in this section.
(c) Prohibited indemnification payments. No corporate credit union
will make or agree to make any

[[Page 64847]]

prohibited indemnification payment, except as provided in this section.
(d) Permissible golden parachute payments. (1) A corporate credit
union may agree to make or may make a golden parachute payment if and
to the extent that:
(i) Such an agreement is made in order to hire a person to become
an IAP either at a time when the corporate credit union satisfies or in
an effort to prevent it from imminently satisfying any of the criteria
set forth in paragraph (a)(4)(ii) of this section, and the Board,
consents in writing to the amount and terms of the golden parachute
payment. Such consent by the Board must not improve the IAP's position
in the event of the insolvency of the corporate credit union since such
consent can neither bind a liquidating agent nor affect the provability
of claims in liquidation. In the event that the institution is placed
into conservatorship or liquidation, the conservator or the liquidating
agent, as the case may be, will not be obligated to pay the promised
golden parachute and the IAP will not be accorded preferential
treatment on the basis of such prior approval; or
(ii) Such a payment is made pursuant to an agreement which provides
for a reasonable severance payment, not to exceed twelve months salary,
to an IAP in the event of a merger with another corporate credit union;
provided, however, that a corporate credit union must obtain the
consent of the Board, before making such a payment and this paragraph
(d)(1)(iii) does not apply to any merger between corporates that
results from an assisted transaction as described in Section 208 of the
Act (12 U.S.C. 1788) or the corporate credit union being placed into
conservatorship or liquidation; or
(iii) The Board, with the written concurrence of the appropriate
state supervisory authority (in the case of a state-chartered
corporate), determines that such a payment or agreement is permissible.
(2) A corporate credit union making a request pursuant to
paragraphs (d)(1)(i) through (iii) of this section must demonstrate
that it does not possess and is not aware of any information, evidence,
documents or other materials which would indicate that there is a
reasonable basis to believe, at the time such payment is proposed to be
made, that:
(i) The IAP has committed any fraudulent act or omission, breach of
trust or fiduciary duty, or insider abuse with regard to the corporate
credit union that has had or is likely to have a material adverse
effect on the corporate credit union;
(ii) The IAP is substantially responsible for the insolvency of,
the appointment of a conservator or liquidating agent for, or the
troubled condition, as defined by Sec. 701.14(b)(4), of the corporate
credit union;
(iii) The IAP has materially violated any applicable federal or
state banking law or regulation that has had or is likely to have a
material effect on the corporate credit union; and
(iv) The IAP has violated or conspired to violate Section 215, 656,
657, 1005, 1006, 1007, 1014, 1032, or 1344 of Title 18 of the United
States Code, or Section 1341 or 1343 of such title affecting a
federally insured financial institution as defined in Title 18 of the
United States Code.
(3) In making a determination under paragraphs (d)(1)(i) through
(iii) of this section, the Board may consider:
(i) Whether, and to what degree, the IAP was in a position of
managerial or fiduciary responsibility;
(ii) The length of time the IAP was affiliated with the corporate
credit union, and the degree to which the proposed payment represents a
reasonable payment for services rendered over the period of employment;
and
(iii) Any other factors or circumstances which would indicate that
the proposed payment would be contrary to the intent of Section 206(t)
of the Act or this part.
(e) Permissible indemnification payments. (1) A corporate credit
union may make or agree to make reasonable indemnification payments to
an IAP with respect to an administrative proceeding or civil action
initiated by NCUA or a state regulatory authority if:
(i) The corporate credit union's board of directors, in good faith,
determines in writing after due investigation and consideration that
the institution-affiliated party acted in good faith and in a manner
he/she believed to be in the best interests of the membership;
(ii) The corporate credit union's board of directors, in good
faith, determines in writing after due investigation and consideration
that the payment of such expenses will not materially adversely affect
the institution's or holding company's safety and soundness;
(iii) The indemnification payments do not constitute prohibited
indemnification payments as that term is defined in Sec. 704.20(c);
and
(iv) The IAP agrees in writing to reimburse the corporate credit
union, to the extent not covered by payments from insurance or bonds
purchased pursuant to Sec. 704.20(a)(9)(iv)(A), for that portion of
the advanced indemnification payments which subsequently become
prohibited indemnification payments, as defined in Sec. 704.20(a)(9).
(2) An IAP seeking indemnification payments must not participate in
any way in the board's discussion and approval of such payments;
provided, however, that such IAP may present his/her request to the
board and respond to any inquiries from the board concerning his/her
involvement in the circumstances giving rise to the administrative
proceeding or civil action.
(3) In the event that a majority of the members of the board of
directors are named as respondents in an administrative proceeding or
civil action and request indemnification, the remaining members of the
board may authorize independent legal counsel to review the
indemnification request and provide the remaining members of the board
with a written opinion of counsel as to whether the conditions
delineated in paragraph (e)(1) of this section have been met. If
independent legal counsel opines that said conditions have been met,
the remaining members of the board of directors may rely on such
opinion in authorizing the requested indemnification.
(4) In the event that all of the members of the board of directors
are named as respondents in an administrative proceeding or civil
action and request indemnification, the board will authorize
independent legal counsel to review the indemnification request and
provide the board with a written opinion of counsel as to whether the
conditions delineated in paragraph (e)(1) of this section have been
met. If independent legal counsel opines that said conditions have been
met, the board of directors may rely on such opinion in authorizing the
requested indemnification.
(f) Filing instructions. Requests to make excess nondiscriminatory
severance plan payments pursuant to Sec. 704.20(a)(4)(iv)(E) and
golden parachute payments permitted by Sec. 704.20(d) must be
submitted in writing to the Board. The request must be in letter form
and must contain all relevant factual information as well as the
reasons why such approval should be granted.
(g) Applicability in the event of liquidation or conservatorship.
The provisions of this part, or any consent or approval granted under
the provisions of this part by the Board, will not in any way bind any
liquidating agent or conservator for a failed corporate credit union
and will not in any way obligate the liquidating agent or conservator
to pay any claim or obligation pursuant to any golden

[[Page 64848]]

parachute, severance, indemnification or other agreement. Claims for
employee welfare benefits or other benefits that are contingent, even
if otherwise vested, when a liquidating agent or conservator is
appointed for any corporate credit union, including any contingency for
termination of employment, are not provable claims or actual, direct
compensatory damage claims against such liquidating agent or
conservator. Nothing in this part may be construed to permit the
payment of salary or any liability or legal expense of any IAP contrary
to 12 U.S.C. 1786(t)(3).

0
19. Revise Appendix A to part 704 to read as follows:

Appendix A to Part 704--Capital Prioritization and Model Forms

Part I--Optional Capital Prioritization

Notwithstanding any other provision in this chapter, a corporate
credit union, at its option, may determine that capital contributed
to the corporate on or after January 18, 2011 will have priority,
for purposes of availability to absorb losses and payout in
liquidation, over capital contributed to the corporate before that
date. The board of directors at a corporate credit union that
desires to make this determination must:
(a) On or before January 18, 2011, adopt a resolution
implementing its determination.
(b) Inform the credit union's members and NCUA, in writing and
as soon as practicable after adoption of the resolution, of the
contents of the board resolution.
(c) Ensure the credit union uses the appropriate initial and
periodic Model Form disclosures in Part II below.

Part II--Model Forms

Part II contains model forms intended for use by corporate
credit unions to aid in compliance with the capital disclosure
requirements of Sec. 704.3 and Part I of this Appendix.

Model Form A

Terms and Conditions of Membership Capital Account

Note: This form is for use before October 20, 2011 in the
circumstances where the credit union has determined NOT to give
newly issued capital priority over older capital as described in
Part I of this Appendix.

Model Form B

Terms and Conditions of Membership Capital Account

(1) A membership capital account is not subject to share
insurance coverage by the NCUSIF or other deposit insurer.
(2) A membership capital account is not releasable due solely to
the merger, charter conversion or liquidation of the member credit
union. In the event of a merger, the membership capital account
transfers to the continuing credit union. In the event of a charter
conversion, the membership capital account transfers to the new
institution. In the event of liquidation, the membership capital
account may be released to facilitate the payout of shares with the
prior written approval of NCUA.
(3) A member credit union may withdraw membership capital with
three years' notice.
(4) Membership capital cannot be used to pledge borrowings.
(5)(a) Membership capital that is issued on or after January 18,
2011, is available to cover losses that exceed retained earnings,
contributed capital issued before January 18, 2011, and perpetual
capital issued on or after January 18, 2011. Any such losses will be
distributed pro rata, at the time the loss is realized, among
membership capital account holders with accounts issued on or after
January 18, 2011. To the extent that NCA funds are used to cover
losses, the corporate credit union is prohibited from restoring or
replenishing the affected accounts under any circumstances.
(b) Membership capital that is issued before January 18, 2011 is
available to cover losses that exceed retained earnings and
perpetual capital issued before January 18, 2011. Any such losses
will be distributed pro rata, at the time the loss is realized,
among membership capital account holders with accounts issued before
January 18, 2011. To the extent that NCA funds are used to cover
losses, the corporate credit union is prohibited from restoring or
replenishing the affected accounts under any circumstances.
(c) Attached to this disclosure is a statement that describes
the amount of NCA the credit union has with the corporate credit
union in each of the categories described in paragraphs (5)(a) and
(5)(b) above.
(6) If the corporate credit union is liquidated:
(a) Membership capital accounts issued on or after January 18,
2011 are payable only after satisfaction of all liabilities of the
liquidation estate including uninsured obligations to shareholders
and the NCUSIF, but not including contributed capital accounts
issued before January 18, 2011 and perpetual capital accounts issued
on or after January 18, 2011. However, membership capital that is
used to cover losses in a calendar year previous to the year of
liquidation has no claim against the liquidation estate.
(b) Membership capital accounts issued before January 18, 2011,
are payable only after satisfaction of all liabilities of the
liquidation estate including uninsured obligations to shareholders
and the NCUSIF, but not including perpetual capital accounts issued
before January 18, 2011. However, membership capital that is used to
cover losses in a calendar year previous to the year of liquidation
has no claim against the liquidation estate.
(7) Where the corporate credit union is merged into another
corporate credit union, the membership capital account will transfer
to the continuing corporate credit union. The three-year notice
period for withdrawal of the membership capital account will remain
in effect.
(8) If an adjusted balance account--: The membership capital
balance will be adjusted--(1 or 2)--time(s) annually in relation to
the member credit union's--(assets or other measure)--as of --
(date(s))--. If a term certificate--: The membership capital account
is a term certificate that will mature on--(date)--.
I have read the above terms and conditions and I understand
them.
I further agree to maintain in the credit union's files the
annual notice of terms and

[[Page 64849]]

conditions of the membership capital account.
The notice form must be signed by either all of the directors of
the member credit union or, if authorized by board resolution, the
chair and secretary of the board of the credit union.
The annual disclosure notice form must be signed by the chair of
the corporate credit union. The chair must then sign a statement
that certifies that the notice has been sent to member credit unions
with membership capital accounts. The certification must be
maintained in the corporate credit union's files and be available
for examiner review.

Model Form C

Terms and Conditions of Nonperpetual Capital

Note: This form is for use on and after October 20, 2011 in the
circumstances where the credit union has determined NOT to give
newly issued capital priority over older capital as described in
Part I of this Appendix. Also, corporate credit unions should ensure
that existing membership capital accounts that do not meet the
qualifying conditions for nonperpetual capital are modified so as to
meet those conditions.

Terms and Conditions of Nonperpetual Capital Account

(1) A nonperpetual capital account is not subject to share
insurance coverage by the NCUSIF or other deposit insurer.
(2) A nonperpetual capital account is not releasable due solely
to the merger, charter conversion or liquidation of the member
credit union. In the event of a merger, the nonperpetual capital
account transfers to the continuing credit union. In the event of a
charter conversion, the nonperpetual capital account transfers to
the new institution. In the event of liquidation, the nonperpetual
capital account may be released to facilitate the payout of shares
with the prior written approval of NCUA.
(3) If the nonperpetual capital account is a notice account, a
member credit union may withdraw the nonperpetual capital with a
minimum of five years' notice. If the nonperpetual capital account
is a term instrument it may be redeemed only at maturity. The
corporate credit union may not redeem any account prior to the
expiration of the notice period, or maturity, without the prior
written approval of the NCUA.
(4) Nonperpetual capital cannot be used to pledge borrowings.
(5) Nonperpetual capital is available to cover losses that
exceed retained earnings and perpetual contributed capital. Any such
losses will be distributed pro rata among nonperpetual capital
account holders at the time the loss is realized. To the extent that
NCA funds are used to cover losses, the corporate credit union is
prohibited from restoring or replenishing the affected accounts
under any circumstances.
(6) Where the corporate credit union is liquidated, nonperpetual
capital accounts are payable only after satisfaction of all
liabilities of the liquidation estate including uninsured
obligations to shareholders and the NCUSIF. However, nonperpetual
capital that is used to cover losses in a calendar year previous to
the year of liquidation has no claim against the liquidation estate.
(7) Where the corporate credit union is merged into another
corporate credit union, the nonperpetual capital account will
transfer to the continuing corporate credit union. For notice
accounts, the five-year notice period for withdrawal of the
nonperpetual capital account will remain in effect. For term
accounts, the original term will remain in effect.
(8) If a term certificate--: The nonperpetual capital account is
a term certificate that will mature on--(date)--(insert date with a
minimum five-year original maturity).
I have read the above terms and conditions and I understand
them.
I further agree to maintain in the credit union's files the
annual notice of terms and conditions of the nonperpetual capital
account.
The notice form must be signed by either all of the directors of
the member credit union or, if authorized by board resolution, the
chair and secretary of the board of the credit union.
The annual disclosure notice form must be signed by the chair of
the corporate credit union. The chair must then sign a statement
that certifies that the notice has been sent to member credit unions
with nonperpetual capital accounts. The certification must be
maintained in the corporate credit union's files and be available
for examiner review.

Model Form D

Terms and Conditions of Nonperpetual Capital

Note: This form is for use before October 20, 2011 in the
circumstances where the credit union has determined THAT IT WILL
give newly issued capital priority over older capital as described
in Part I of this Appendix. Also, corporate credit unions should
ensure that existing membership capital accounts that do not meet
the qualifying conditions for nonperpetual capital are modified so
as to meet those conditions.

Terms and Conditions of Nonperpetual Capital Account

(1) A nonperpetual capital account is not subject to share
insurance coverage by the NCUSIF or other deposit insurer.
(2) A nonperpetual capital account is not releasable due solely
to the merger, charter conversion or liquidation of the member
credit union. In the event of a merger, the nonperpetual capital
account transfers to the continuing credit union. In the event of a
charter conversion, the nonperpetual capital account transfers to
the new institution. In the event of liquidation, the nonperpetual
capital account may be released to facilitate the payout of shares
with the prior written approval of NCUA.
(3) If the nonperpetual capital account is a notice account, a
member credit union may withdraw the nonperpetual capital with a
minimum of five years' notice. If the nonperpetual capital account
is a term instrument it may be redeemed only at maturity. The
corporate credit union may not redeem any account prior to the
expiration of the notice period, or maturity, without the prior
written approval of the NCUA.
(4) Nonperpetual capital cannot be used to pledge borrowings.
(5)(a) Nonperpetual capital that is issued on or after January
18, 2011 is available to cover losses that exceed retained earnings,
all contributed capital issued before January 18, 2011, and
perpetual capital issued on or after January 18, 2011. Any such
losses will be distributed pro rata, at the time the loss is
realized, among nonperpetual capital account holders with accounts
issued on or after January 18, 2011. To the extent that NCA funds
are used to cover losses, the corporate credit union is prohibited
from restoring or replenishing the affected accounts under any
circumstances.
(b) Nonperpetual capital that is issued before January 18, 2011,
is available to cover losses that exceed retained earnings and
perpetual capital issued before January 18, 2011. Any such losses
will be distributed pro rata, at the time the loss is realized,
among nonperpetual capital account holders with accounts issued
before January 18, 2011. To the extent that NCA funds are used to
cover losses, the corporate credit union is prohibited from
restoring or replenishing the affected accounts under any
circumstances.
(c) Attached to this disclosure is a statement that describes
the amount of NCA the credit union has with the corporate credit
union in each of the categories described in paragraphs (5)(a) and
(5)(b) above.
(6) If the corporate credit union is liquidated:
(a) Nonperpetual capital accounts issued on or after January 18,
2011 are payable only after satisfaction of all liabilities of the
liquidation estate including uninsured obligations to shareholders
and the NCUSIF, but not including contributed capital accounts
issued before January 18, 2011 or perpetual capital accounts issued
on or after January 18, 2011. However, nonperpetual capital that is
used to cover losses in a calendar year previous to the year of
liquidation has no claim against the liquidation estate.
(b) Nonperpetual capital accounts issued before January 18, 2011
are payable only after satisfaction of all liabilities of the
liquidation estate including uninsured obligations to shareholders
and the NCUSIF, but not including perpetual capital accounts issued
before January 18, 2011. However, nonperpetual capital that is used
to cover losses in a calendar year previous to the year of
liquidation has no claim against the liquidation estate.
(7) Where the corporate credit union is merged into another
corporate credit union, the nonperpetual capital account will
transfer to the continuing corporate credit union. For notice
accounts, the five-year notice period for withdrawal of the
nonperpetual capital account will remain in effect. For term
accounts, the original term will remain in effect.
(8) If a term certificate--: The nonperpetual capital account is
a term certificate that will mature on--(date)--(insert date with a
minimum five-year original maturity).
I have read the above terms and conditions and I understand
them.

[[Page 64850]]

I further agree to maintain in the credit union's files the
annual notice of terms and conditions of the nonperpetual capital
account.
The notice form must be signed by either all of the directors of
the member credit union or, if authorized by board resolution, the
chair and secretary of the board of the credit union.
The annual disclosure notice form must be signed by the chair of
the corporate credit union. The chair must then sign a statement
that certifies that the notice has been sent to member credit unions
with nonperpetual capital accounts. The certification must be
maintained in the corporate credit union's files and be available
for examiner review.

Model Form E

Terms and Conditions of Paid-In Capital

Model Form F

Terms and Conditions of Paid-In Capital

(1) A paid-in capital account is not subject to share insurance
coverage by the NCUSIF or other deposit insurer.
(2) A paid-in capital account is not releasable due solely to
the merger, charter conversion or liquidation of the member credit
union. In the event of a merger, the paid-in capital account
transfers to the continuing credit union. In the event of a charter
conversion, the paid-in capital account transfers to the new
institution. In the event of liquidation, the paid-in capital
account may be released to facilitate the payout of shares with the
prior written approval of NCUA.
(3) The funds are callable only at the option of the corporate
credit union and only if the corporate credit union meets its
minimum required capital and NEV ratios after the funds are called.
The corporate must also obtain NCUA's approval before the corporate
calls any paid-in capital.
(4) Paid-in capital cannot be used to pledge borrowings.
(5) Availability to cover losses.
(a) Paid-in capital issued before January 18, 2011 is available
to cover losses that exceed retained earnings. Any such losses must
be distributed pro rata, at the time the loss is realized, among
holders of paid-in capital issued before January 18, 2011. To the
extent that paid-in capital funds are used to cover losses, the
corporate credit union is prohibited from restoring or replenishing
the affected accounts under any circumstances.
(b) Paid-in capital issued on or after January 18, 2011 is
available to cover losses that exceed retained earnings and any
contributed capital issued before January 18, 2011. Any such losses
must be distributed pro rata, at the time the loss is realized,
among holders of paid-in capital issued on or after January 18,
2011. To the extent that paid-in capital funds are used to cover
losses, the corporate credit union is prohibited from restoring or
replenishing the affected accounts under any circumstances.
(c) Attached to this disclosure is a statement that describes
the amount of perpetual capital the credit union has with the
corporate credit union in each of the categories described in
paragraphs (5)(a) and (5)(b) above.
(6) Where the corporate credit union is liquidated:
(a) Paid-in capital accounts issued on or after January 18, 2011
are payable only after satisfaction of all liabilities of the
liquidation estate including uninsured obligations to shareholders
and the NCUSIF, but not including contributed capital accounts
issued before January 18, 2011. However, paid-in capital that is
used to cover losses in a calendar year previous to the year of
liquidation has no claim against the liquidation estate.
(b) Paid-in capital accounts issued before January 18, 2011 are
payable only after satisfaction of all liabilities of the
liquidation estate including uninsured obligations to shareholders
and the NCUSIF, nonperpetual accounts issued before January 18, 2011
and contributed capital accounts issued on or after January 18,
2011. However, paid-in capital that is used to cover losses in a
calendar year previous to the year of liquidation has no claim
against the liquidation estate.
(7) Where the corporate credit union is merged into another
corporate credit union, the paid-in capital account will transfer to
the continuing corporate credit union.
(8) Paid-in capital is perpetual maturity and noncumulative
dividend.
I have read the above terms and conditions and I understand
them. I further agree to maintain in the credit union's files the
annual notice of terms and conditions of the paid-in capital
instrument.
The notice form must be signed by either all of the directors of
the credit union or, if authorized by board resolution, the chair
and secretary of the board of the credit union.

Model Form G

Terms and Conditions of Perpetual Contributed Capital

Note: This form is for use on and after October 20, 2011 in the
circumstances where the credit union has determined NOT to give
newly issued capital priority over older capital as described in
Part I of this Appendix. Also, capital previously issued under the
nomenclature ``paid-in capital'' is considered perpetual contributed
capital.

[[Page 64851]]

prohibited from restoring or replenishing the affected accounts
under any circumstances.
(7) Where the corporate credit union is liquidated, perpetual
contributed capital accounts are payable only after satisfaction of
all liabilities of the liquidation estate including uninsured
obligations to shareholders and the NCUSIF, and nonperpetual capital
holders. However, perpetual contributed capital that is used to
cover losses in a calendar year previous to the year of liquidation
has no claim against the liquidation estate.
I have read the above terms and conditions and I understand
them. I further agree to maintain in the credit union's files the
annual notice of terms and conditions of the perpetual contributed
capital instrument.
The notice form must be signed by either all of the directors of
the credit union or, if authorized by board resolution, the chair
and secretary of the board of the credit union.

Model Form H

Terms and Conditions of Perpetual Contributed Capital

Note: This form is for use before October 20, 2011 in the
circumstances where the credit union has determined THAT IT WILL
give newly issued capital priority over older capital as described
in Part I of this Appendix. Also, capital previously issued under
the nomenclature ``paid-in capital'' is considered perpetual
contributed capital.

(1) A perpetual contributed capital account is not subject to
share insurance coverage by the NCUSIF or other deposit insurer.
(2) A perpetual contributed capital account is not releasable
due solely to the merger, charter conversion or liquidation of the
member credit union. In the event of a merger, the perpetual
contributed capital account transfers to the continuing credit
union. In the event of a charter conversion, the perpetual
contributed capital account transfers to the new institution. In the
event of liquidation, the perpetual contributed capital account may
be released to facilitate the payout of shares with the prior
written approval of NCUA.
(3) The funds are callable only at the option of the corporate
credit union and only if the corporate credit union meets its
minimum required capital and NEV ratios after the funds are called.
The corporate must also obtain the prior, written approval of the
NCUA before releasing any perpetual contributed capital funds.
(4) Perpetual contributed capital cannot be used to pledge
borrowings.
(5) Perpetual contributed capital is perpetual maturity and
noncumulative dividend.
(6) Availability to cover losses.
(a) Perpetual contributed capital issued before January 18, 2011
is available to cover losses that exceed retained earnings. Any such
losses must be distributed pro rata, at the time the loss is
realized, among holders of perpetual contributed capital issued
before January 18, 2011. To the extent that perpetual contributed
capital funds are used to cover losses, the corporate credit union
is prohibited from restoring or replenishing the affected accounts
under any circumstances.
(b) Perpetual contributed capital issued on or after January 18,
2011 is available to cover losses that exceed retained earnings and
any contributed capital issued before January 18, 2011. Any such
losses must be distributed pro rata, at the time the loss is
realized, among holders of perpetual contributed capital issued on
or after January 18, 2011. To the extent that perpetual contributed
capital funds are used to cover losses, the corporate credit union
is prohibited from restoring or replenishing the affected accounts
under any circumstances.
(c) Attached to this disclosure is a statement that describes
the amount of perpetual capital the credit union has with the
corporate credit union in each of the categories described in
paragraphs (6)(a) and (6)(b) above.
(7) Where the corporate credit union is liquidated:
(a) Perpetual contributed capital accounts issued on or after
January 18, 2011 are payable only after satisfaction of all
liabilities of the liquidation estate including uninsured
obligations to shareholders and the NCUSIF, but not including
contributed capital accounts issued before January 18, 2011.
However, perpetual contributed capital that is used to cover losses
in a calendar year previous to the year of liquidation has no claim
against the liquidation estate.
(b) Perpetual contributed capital accounts issued before January
18, 2011 are payable only after satisfaction of all liabilities of
the liquidation estate including uninsured obligations to
shareholders and the NCUSIF, nonperpetual capital accounts issued
before January 18, 2011, and all contributed capital accounts issued
on or after January 18, 2011. However, perpetual contributed capital
that is used to cover losses in a calendar year previous to the year
of liquidation has no claim against the liquidation estate.
I have read the above terms and conditions and I understand
them. I further agree to maintain in the credit union's files the
annual notice of terms and conditions of the perpetual contributed
capital instrument.
The notice form must be signed by either all of the directors of
the credit union or, if authorized by board resolution, the chair
and secretary of the board of the credit union.

0
21. Revise Appendix B to Part 704 to read as follows:

Appendix B to Part 704--Expanded Authorities and Requirements

A corporate credit union may obtain all or part of the expanded
authorities contained in this Appendix if it meets the applicable
requirements of Part 704 and Appendix B, fulfills additional
management, infrastructure, and asset and liability requirements,
and receives NCUA's written approval. Additional guidance is set
forth in the NCUA publication Guidelines for Submission of Requests
for Expanded Authority.
A corporate credit union seeking expanded authorities must
submit to NCUA a self-assessment plan supporting its request. A
corporate credit union may adopt expanded authorities when NCUA has
provided final approval. If NCUA denies a request for expanded
authorities, it will advise the corporate credit union of the
reason(s) for the denial and what it must do to resubmit its
request. NCUA may revoke these expanded authorities at any time if
an analysis indicates a significant deficiency. NCUA will notify the
corporate credit union in writing of the identified deficiency. A
corporate credit union may request, in writing, reinstatement of the
revoked authorities by providing a self-assessment plan detailing
how it has corrected the deficiency.
A state chartered corporate credit union may not exercise any
expanded authority that exceeds the powers and authorities provided
for under its state laws. Accordingly, requests by state chartered
corporate credit unions for expansions under this part must be
approved by the state regulator before being submitted to NCUA.

Minimum Requirement

In order to participate in any of the authorities set forth in
Base-Plus, Part I, Part II, Part III, or Part IV of this Appendix, a
corporate credit union must evaluate monthly, including once on the
last day of the month, the changes in NEV, NEV ratio, NII, WAL, and
duration as required by paragraphs (d)(1)(i), (e), (f), (g), and (i)
of Sec. 704.8.

Base-Plus

A corporate that has met the requirements for this Base-plus
authority may, in performing the rate stress tests set forth in
704.8(d)(1)(i), allow its NEV to decline as much as 20 percent.

Part I

(a) A corporate credit union that has met all the requirements
established by NCUA for this Part I, including a minimum capital
ratio of at least six percent, may:
(1) Purchase investments with long-term ratings no lower than A-
(or equivalent);
(2) Purchase investments with short-term ratings no lower than
A-2 (or equivalent), provided that the issuer has a long-term rating
no lower than A- (or equivalent) or the investment is a
domestically-issued asset-backed security;
(3) Engage in short sales of permissible investments to reduce
interest rate risk;
(4) Purchase principal only (PO) stripped mortgage-backed
securities to reduce interest rate risk; and
(5) Enter into a dollar roll transaction.
(b) In performing the rate stress tests set forth in Sec.
704.8(d), the NEV of a corporate credit union that has met the
requirements of this Part I may decline as much as:
(1) 20 percent;
(2) 28 percent if the corporate credit union has a seven percent
minimum capital ratio and is specifically approved by NCUA; or
(3) 35 percent if the corporate credit union has an eight
percent minimum capital ratio and is specifically approved by NCUA.
(c) The maximum aggregate amount in unsecured loans and lines of
credit to any one member credit union, excluding pass-through and
guaranteed loans from the CLF and the NCUSIF, must not exceed 100
percent of the corporate credit union's capital. The board of
directors must establish the limit, as a percent of the corporate
credit

[[Page 64852]]

union's capital plus pledged shares, for secured loans and lines of
credit.
(d) The aggregate total of investments purchased under the
authority of Part I (a)(1) and Part I (a)(2) may not exceed the
lower of 500 percent of the corporate credit union's capital or 25
percent of assets.
(e) On or after October 20, 2011, corporate credit unions will
substitute ``leverage ratio'' for ``capital ratio'' wherever it
appears in Part I.

Part II

(a) A corporate credit union that has met the requirements of
Part I of this Appendix and the additional requirements established
by NCUA for Part II may invest in:
(1) Debt obligations of a foreign country;
(2) Deposits and debt obligations of foreign banks or
obligations guaranteed by these banks;
(3) Marketable debt obligations of foreign corporations. This
authority does not apply to debt obligations that are convertible
into the stock of the corporation; and
(4) Foreign issued asset-backed securities.
(b) All foreign investments are subject to the following
requirements:
(1) Investments must be rated no lower than the minimum
permissible domestic rating under the corporate credit union's Part
I authority;
(2) A sovereign issuer, and/or the country in which an obligor
is organized, must have a long-term foreign currency (non-local
currency) debt rating no lower than AA- (or equivalent);
(3) For each approved foreign bank line, the corporate credit
union must identify the specific banking centers and branches to
which it will lend funds;
(4) Obligations of any single foreign obligor may not exceed 25
percent of capital or $5 million, whichever is greater; and
(5) Obligations in any single foreign country may not exceed 250
percent of capital.

Part III

(a) A corporate credit union that has met the requirements
established by NCUA for this Part III may enter into derivative
transactions specifically approved by NCUA to:
(1) Create structured products;
(2) Mitigate interest rate risk and credit risk on its own
balance sheet; and
(3) Hedge the balance sheets of its members.
(b) Credit Ratings:
(1) All derivative transactions are subject to the following
requirements:
(i) If the intended counterparty is domestic, the counterparty
rating must be no lower than A- (or equivalent) by every NRSRO that
provides a publicly available long-term rating on the counterparty;
(ii) If the intended counterparty is foreign, the corporate must
have Part II expanded authority and the counterparty rating must be
no lower than the minimum permissible rating for a comparable term
investment under Part II Authority;
(iii) The corporate must identify the rating(s) relied upon to
meet the requirements of this part at the time the transaction is
entered into and monitor those ratings for as long as the contract
remains open; and
(iv) The corporate credit unions must comply with Sec. 704.10
of this part if any rating relied upon to meet the requirements of
paragraphs (b)(1)(i) or (ii) of this part is downgraded below the
minimum rating requirements.
(2) Exceptions. Credit ratings are not required for derivative
transactions with:
(i) Domestically chartered credit unions;
(ii) U.S. government sponsored enterprises; or
(iii) Counterparties where the transaction is fully guaranteed
by an entity with a minimum permissible rating for comparable term
investments.

Part IV

A corporate credit union that has met all the requirements
established by NCUA for this Part IV may participate in loans with
member natural person credit unions as approved by the NCUA and
subject to the following:
(a) The maximum aggregate amount of participation loans with any
one member credit union must not exceed 25 percent of capital; and
(b) The maximum aggregate amount of participation loans with all
member credit unions will be determined on a case-by-case basis by
the NCUA.

0
22. Add a new Appendix C to Part 704 to read as follows:

Appendix C to Part 704--Risk-Based Capital Credit Risk-Weight
Categories

Table of Contents

I. Introduction
(a) Scope
(b) Definitions
II. Risk-Weightings
(a) On-balance sheet assets
(b) Off-balance sheet activities
(c) Recourse obligations, direct credit substitutes, and certain
other positions
(d) Collateral

Part I: Introduction

(a) Scope

(1) This Appendix explains how a corporate credit union must
compute its risk-weighted assets for purposes of determining its
capital ratios.
(2) Risk-weighted assets equal risk-weighted on-balance sheet
assets (computed under Section II(a) of this Appendix), plus risk-
weighted off-balance sheet activities (computed under Section II(b)
of this Appendix), plus risk-weighted recourse obligations, direct
credit substitutes, and certain other positions (computed under
Section II(c) of this Appendix).
(3) Assets not included (i.e., deducted from capital) for
purposes of calculating capital under part 704 are not included in
calculating risk-weighted assets.
(4) Although this Appendix describes risk-weightings for various
assets and activities, this Appendix does not provide authority for
corporate credit unions to invest in or purchase any particular type
of asset or to engage in any particular type of activity. A
corporate credit union must have other identifiable authority for
any investment it makes or activity it engages in. So, for example,
this Appendix describes risk weightings for subordinated securities.
Section 704.5, however, prohibits corporate credit unions from
investing in subordinated securities, and so a corporate credit
union cannot invest in subordinated securities.

(b) Definitions

The following definitions apply to this Appendix. Additional
definitions, applicable to this entire Part, are located in Sec.
704.2 of this Part.
Cash items in the process of collection means checks or drafts
in the process of collection that are drawn on another depository
institution, including a central bank, and that are payable
immediately upon presentation; U.S. Government checks that are drawn
on the United States Treasury or any other U.S. Government or
Government-sponsored agency and that are payable immediately upon
presentation; broker's security drafts and commodity or bill-of-
lading drafts payable immediately upon presentation; and unposted
debits.
Commitment means any arrangement that obligates a corporate
credit union to:
(1) Purchase loans or securities;
(2) Extend credit in the form of loans or leases, participations
in loans or leases, overdraft facilities, revolving credit
facilities, home equity lines of credit, eligible ABCP liquidity
facilities, or similar transactions.
Depository institution means a financial institution that
engages in the business of providing financial services; that is
recognized as a bank or a credit union by the supervisory or
monetary authorities of the country of its incorporation and the
country of its principal banking operations; that receives deposits
to a substantial extent in the regular course of business; and that
has the power to accept demand deposits. In the United States, this
definition encompasses all federally insured offices of commercial
banks, mutual and stock savings banks, savings or building and loan
associations (stock and mutual), cooperative banks, credit unions,
and international banking facilities of domestic depository
institutions.
Bank holding companies and savings and loan holding companies
are excluded from this definition. For the purposes of assigning
risk-weights, the differentiation between OECD depository
institutions and non-OECD depository institutions is based on the
country of incorporation. Claims on branches and agencies of foreign
banks located in the United States are to be categorized on the
basis of the parent bank's country of incorporation.
Direct credit substitute means an arrangement in which a
corporate credit union assumes, in form or in substance, credit risk
associated with an on-balance sheet or off-balance sheet asset or
exposure that was not previously owned by the corporate credit union
(third-party asset) and the risk assumed by the corporate credit
union exceeds the pro rata share of the corporate credit union's
interest in the third-party asset. If a corporate credit union has
no claim on the third-party asset, then the corporate credit union's
assumption of any

[[Page 64853]]

credit risk is a direct credit substitute. Direct credit substitutes
include:
(1) Financial standby letters of credit that support financial
claims on a third party that exceed a corporate credit union's pro
rata share in the financial claim;
(2) Guarantees, surety arrangements, credit derivatives, and
similar instruments backing financial claims that exceed a corporate
credit union's pro rata share in the financial claim;
(3) Purchased subordinated interests that absorb more than their
pro rata share of losses from the underlying assets, including any
tranche of asset-backed securities that is not the most senior
tranche;
(4) Credit derivative contracts under which the corporate credit
union assumes more than its pro rata share of credit risk on a
third-party asset or exposure;
(5) Loans or lines of credit that provide credit enhancement for
the financial obligations of a third party;
(6) Purchased loan servicing assets if the servicer is
responsible for credit losses or if the servicer makes or assumes
credit-enhancing representations and warranties with respect to the
loans serviced. Servicer cash advances as defined in this section
are not direct credit substitutes;
(7) Clean-up calls on third-party assets. However, clean-up
calls that are 10 percent or less of the original pool balance and
that are exercisable at the option of the corporate credit union are
not direct credit substitutes; and
(8) Liquidity facilities that provide support to asset-backed
commercial paper (other than eligible ABCP liquidity facilities).
Exchange rate contracts means cross-currency interest rate
swaps; forward foreign exchange rate contracts; currency options
purchased; and any similar instrument that, in the opinion of the
NCUA, may give rise to similar risks.
Face amount means the notational principal, or face value,
amount of an off-balance sheet item or the amortized cost of an on-
balance sheet asset.
Financial asset means cash or other monetary instrument,
evidence of debt, evidence of an ownership interest in an entity, or
a contract that conveys a right to receive or exchange cash or
another financial instrument from another party.
Financial standby letter of credit means a letter of credit or
similar arrangement that represents an irrevocable obligation to a
third-party beneficiary:
(1) To repay money borrowed by, or advanced to, or for the
account of, a second party (the account party); or
(2) To make payment on behalf of the account party, in the event
that the account party fails to fulfill its obligation to the
beneficiary.
OECD-based country means a member of that grouping of countries
that are full members of the Organization for Economic Cooperation
and Development (OECD) plus countries that have concluded special
lending arrangements with the International Monetary Fund (IMF)
associated with the IMF's General Arrangements To Borrow. This term
excludes any country that has rescheduled its external sovereign
debt within the previous five years. A rescheduling of external
sovereign debt generally would include any renegotiation of terms
arising from a country's inability or unwillingness to meet its
external debt service obligations, but generally would not include
renegotiations of debt in the normal course of business, such as a
renegotiation to allow the borrower to take advantage of a decline
in interest rates or other change in market conditions.
Original maturity means, with respect to a commitment, the
earliest date after a commitment is made on which the commitment is
scheduled to expire (i.e., it will reach its stated maturity and
cease to be binding on either party), provided that either:
(1) The commitment is not subject to extension or renewal and
will actually expire on its stated expiration date; or
(2) If the commitment is subject to extension or renewal beyond
its stated expiration date, the stated expiration date will be
deemed the original maturity only if the extension or renewal must
be based upon terms and conditions independently negotiated in good
faith with the member at the time of the extension or renewal and
upon a new, bona fide credit analysis utilizing current information
on financial condition and trends.
Performance-based standby letter of credit means any letter of
credit, or similar arrangement, however named or described, which
represents an irrevocable obligation to the beneficiary on the part
of the issuer to make payment on account of any default by a third
party in the performance of a nonfinancial or commercial obligation.
Such letters of credit include arrangements backing subcontractors'
and suppliers' performance, labor and materials contracts, and
construction bids.
Prorated assets means the total assets (as determined in the
most recently available GAAP report but in no event more than one
year old) of a consolidated CUSO multiplied by the corporate credit
union's percentage of ownership of that consolidated CUSO.
Qualifying mortgage loan means a loan that:
(1) Is fully secured by a first lien on a one-to four-family
residential property;
(2) Is underwritten in accordance with prudent underwriting
standards, including standards relating the ratio of the loan amount
to the value of the property (LTV ratio), as presented in the
Interagency Guidelines for Real Estate Lending Policies, 57 FR 62890
(December 31, 1992). A nonqualifying mortgage loan that is paid down
to an appropriate LTV ratio (calculated using value at origination,
appraisal obtained within the prior six months, or updated value
using an automated valuation model) may become a qualifying loan if
it meets all other requirements of this definition;
(3) Maintains an appropriate LTV ratio based on the amortized
principal balance of the loan; and
(4) Is performing and is not more than 90 days past due.
If a corporate credit union holds the first and junior lien(s)
on a residential property and no other party holds an intervening
lien, the transaction is treated as a single loan secured by a first
lien for the purposes of determining the LTV ratio and the
appropriate risk-weight under Appendix C. Also, a loan to an
individual borrower for the construction of the borrower's home may
be included as a qualifying mortgage loan.
Qualifying multifamily mortgage loan. (1) Qualifying multifamily
mortgage loan means a loan secured by a first lien on multifamily
residential properties consisting of 5 or more dwelling units,
provided that:
(i) The amortization of principal and interest occurs over a
period of not more than 30 years;
(ii) The original minimum maturity for repayment of principal on
the loan is not less than seven years;
(iii) When considering the loan for placement in a lower risk-
weight category, all principal and interest payments have been made
on a timely basis in accordance with its terms for the preceding
year;
(iv) The loan is performing and not 90 days or more past due;
(v) The loan is made in accordance with prudent underwriting
standards; and
(vi) If the interest rate on the loan does not change over the
term of the loan, the current loan balance amount does not exceed 80
percent of the value of the property securing the loan, and for the
property's most recent calendar year, the ratio of annual net
operating income generated by the property (before payment of any
debt service on the loan) to annual debt service on the loan is not
less than 120 percent, or in the case of cooperative or other not-
for-profit housing projects, the property generates sufficient cash
flows to provide comparable protection to the institution; or
(vii) If the interest rate on the loan changes over the term of
the loan, the current loan balance amount does not exceed 75 percent
of the value of the property securing the loan, and for the
property's most recent calendar year, the ratio of annual net
operating income generated by the property (before payment of any
debt service on the loan) to annual debt service on the loan is not
less than 115 percent, or in the case of cooperative or other not-
for-profit housing projects, the property generates sufficient cash
flows to provide comparable protection to the institution.
(2) For purposes of paragraphs (1)(vi) and (1)(vii) of this
definition, the term value of the property means, at origination of
a loan to purchase a multifamily property, the lower of the purchase
price or the amount of the initial appraisal, or if appropriate, the
initial evaluation. In cases not involving purchase of a multifamily
loan, the value of the property is determined by the most current
appraisal, or if appropriate, the most current evaluation. In cases
where a borrower refinances a loan on an existing property, as an
alternative to paragraphs (1)(iii), (1)(vi), and (1)(vii) of this
definition:
(i) All principal and interest payments on the loan being
refinanced have been made on a timely basis in accordance with the
terms of that loan for the preceding year; and
(ii) The net income on the property for the preceding year would
support timely principal and interest payments on the new loan in
accordance with the applicable debt service requirement.

[[Page 64854]]

Qualifying residential construction loan, also referred to as a
residential bridge loan, means a loan made in accordance with sound
lending principles satisfying the following criteria:
(1) The builder must have substantial project equity in the home
construction project;
(2) The residence being constructed must be a 1-4 family
residence sold to a home purchaser;
(3) The lending entity must obtain sufficient documentation from
a permanent lender (which may be the construction lender)
demonstrating that the home buyer intends to purchase the residence
and has the ability to obtain a permanent qualifying mortgage loan
sufficient to purchase the residence;
(4) The home purchaser must have made a substantial earnest
money deposit;
(5) The construction loan must not exceed 80 percent of the
sales price of the residence;
(6) The construction loan must be secured by a first lien on the
lot, residence under construction, and other improvements;
(7) The lending credit union must retain sufficient undisbursed
loan funds throughout the construction period to ensure project
completion;
(8) The builder must incur a significant percentage of direct
costs (i.e., the actual costs of land, labor, and material) before
any drawdown on the loan;
(9) If at any time during the life of the construction loan any
of the criteria of this rule are no longer satisfied, the corporate
must immediately recategorize the loan at a 100 percent risk-weight
and must accurately report the loan in the corporate's next
quarterly call report;
(10) The home purchaser must intend that the home will be owner-
occupied;
(11) The home purchaser(s) must be an individual(s), not a
partnership, joint venture, trust corporation, or any other entity
(including an entity acting as a sole proprietorship) that is
purchasing the home(s) for speculative purposes; and
(12) The loan must be performing and not more than 90 days past
due.
The NCUA retains the discretion to determine that any loans not
meeting sound lending principles must be placed in a higher risk-
weight category. The NCUA also reserves the discretion to modify
these criteria on a case-by-case basis provided that any such
modifications are not inconsistent with the safety and soundness
objectives of this definition.
Qualifying securities firm means:
(1) A securities firm incorporated in the United States that is
a broker-dealer that is registered with the Securities and Exchange
Commission (SEC) and that complies with the SEC's net capital
regulations (17 CFR 240.15c3(1)); and
(2) A securities firm incorporated in any other OECD-based
country, if the corporate credit union is able to demonstrate that
the securities firm is subject to consolidated supervision and
regulation (covering its subsidiaries, but not necessarily its
parent organizations) comparable to that imposed on depository
institutions in OECD countries. Such regulation must include risk-
based capital requirements comparable to those imposed on depository
institutions under the Accord on International Convergence of
Capital Measurement and Capital Standards (1988, as amended in
1998).
Recourse means a corporate credit union's retention, in form or
in substance, of any credit risk directly or indirectly associated
with an asset it has sold (in accordance with Generally Accepted
Accounting Principles) that exceeds a pro rata share of that
corporate credit union's claim on the asset. If a corporate credit
union has no claim on an asset it has sold, then the retention of
any credit risk is recourse. A recourse obligation typically arises
when a corporate credit union transfers assets in a sale and retains
an explicit obligation to repurchase assets or to absorb losses due
to a default on the payment of principal or interest or any other
deficiency in the performance of the underlying obligor or some
other party. Recourse may also exist implicitly if a corporate
credit union provides credit enhancement beyond any contractual
obligation to support assets it has sold. Recourse obligations
include:
(1) Credit-enhancing representations and warranties made on
transferred assets;
(2) Loan servicing assets retained pursuant to an agreement
under which the corporate credit union will be responsible for
losses associated with the loans serviced. Servicer cash advances as
defined in this section are not recourse obligations;
(3) Retained subordinated interests that absorb more than their
pro rata share of losses from the underlying assets;
(4) Assets sold under an agreement to repurchase, if the assets
are not already included on the balance sheet;
(5) Loan strips sold without contractual recourse where the
maturity of the transferred portion of the loan is shorter than the
maturity of the commitment under which the loan is drawn;
(6) Credit derivatives that absorb more than the corporate
credit union's pro rata share of losses from the transferred assets;
(7) Clean-up calls on assets the corporate credit union has
sold. However, clean-up calls that are 10 percent or less of the
original pool balance and that are exercisable at the option of the
corporate credit union are not recourse arrangements; and
(8) Liquidity facilities that provide support to asset-backed
commercial paper (other than eligible ABCP liquidity facilities).
Replacement cost means, with respect to interest rate and
exchange-rate contracts, the loss that would be incurred in the
event of a counterparty default, as measured by the net cost of
replacing the contract at the current market value. If default would
result in a theoretical profit, the replacement value is considered
to be zero. This mark-to-market process must incorporate changes in
both interest rates and counterparty credit quality.
Residential properties means houses, condominiums, cooperative
units, and manufactured homes. This definition does not include
boats or motor homes, even if used as a primary residence, or
timeshare properties.
Residual interest. (1) Residual interest means any on-balance
sheet asset that:
(i) Represents an interest (including a beneficial interest)
created by a transfer that qualifies as a sale (in accordance with
Generally Accepted Accounting Principles) of financial assets,
whether through a securitization or otherwise; and
(ii) Exposes a corporate credit union to credit risk directly or
indirectly associated with the transferred asset that exceeds a pro
rata share of that corporate credit union's claim on the asset,
whether through subordination provisions or other credit enhancement
techniques.
(2) Residual interests generally include credit-enhancing
interest-only strips, spread accounts, cash collateral accounts,
retained subordinated interests (and other forms of
overcollateralization), and similar assets that function as a credit
enhancement. Residual interests further include those exposures
that, in substance, cause the corporate credit union to retain the
credit risk of an asset or exposure that had qualified as a residual
interest before it was sold. Residual interests generally do not
include assets purchased from a third party, but a credit-enhancing
interest-only strip that is acquired in any asset transfer is a
residual interest.
(3) Corporate credit unions will use this definition of the term
``residual interests,'' and not the definition in Sec. 704.2, for
purposes of applying this Appendix.
Risk participation means a participation in which the
originating party remains liable to the beneficiary for the full
amount of an obligation (e.g., a direct credit substitute),
notwithstanding that another party has acquired a participation in
that obligation.
Risk-weighted assets means the sum total of risk-weighted on-
balance sheet assets, as calculated under Section II(a) of this
Appendix, and the total of risk-weighted off-balance sheet credit
equivalent amounts. The total of risk-weighted off-balance sheet
credit equivalent amounts equals the risk-weighted off-balance sheet
activities as calculated under Section II(b) of this Appendix plus
the risk-weighted recourse obligations, risk-weighted direct credit
substitutes, and certain other risk-weighted positions as calculated
under Section II(c) of this Appendix.
Servicer cash advance means funds that a residential mortgage
servicer advances to ensure an uninterrupted flow of payments,
including advances made to cover foreclosure costs or other expenses
to facilitate the timely collection of the loan. A servicer cash
advance is not a recourse obligation or a direct credit substitute
if:
(1) The servicer is entitled to full reimbursement and this
right is not subordinated to other claims on the cash flows from the
underlying asset pool; or
(2) For any one loan, the servicer's obligation to make
nonreimbursable advances is contractually limited to an
insignificant amount of the outstanding principal amount on that
loan.
Structured financing program means a program where receivable
interests and asset-or mortgage-backed securities issued by multiple
participants are purchased by a special purpose entity that
repackages those exposures into securities that can be sold to
investors. Structured financing programs

[[Page 64855]]

allocate credit risk, generally, between the participants and credit
enhancement provided to the program.
Traded position means a position retained, assumed, or issued in
connection with a securitization that is rated by a NRSRO, where
there is a reasonable expectation that, in the near future, the
rating will be relied upon by:
(1) Unaffiliated investors to purchase the security; or
(2) An unaffiliated third party to enter into a transaction
involving the position, such as a purchase, loan, or repurchase
agreement.
Unconditionally cancelable means, with respect to a commitment-
type lending arrangement, that the corporate credit union may, at
any time, with or without cause, refuse to advance funds or extend
credit under the facility.
United States Government or its agencies means an
instrumentality of the U.S. Government whose debt obligations are
fully and explicitly guaranteed as to the timely payment of
principal and interest by the full faith and credit of the United
States Government.
United States Government-sponsored agency or corporation means
an agency or corporation originally established or chartered to
serve public purposes specified by the United States Congress but
whose obligations are not explicitly guaranteed by the full faith
and credit of the United States Government.

Part II: Risk-Weightings

(a) On-Balance Sheet Assets

Except as provided in Section II(b) of this Appendix, risk-
weighted on-balance sheet assets are computed by multiplying the on-
balance sheet asset amounts times the appropriate risk-weight
categories. The risk-weight categories are:
(1) Zero percent Risk-Weight (Category 1).
(i) Cash, including domestic and foreign currency owned and held
in all offices of a corporate credit union or in transit. Any
foreign currency held by a corporate credit union must be converted
into U.S. dollar equivalents;
(ii) Securities issued by and other direct claims on the U.S.
Government or its agencies (to the extent such securities or claims
are unconditionally backed by the full faith and credit of the
United States Government) or the central government of an OECD
country;
(iii) Notes and obligations issued or guaranteed by the Federal
Deposit Insurance Corporation or the National Credit Union Share
Insurance Fund and backed by the full faith and credit of the United
States Government;
(iv) Deposit reserves at, claims on, and balances due from
Federal Reserve Banks;
(v) The book value of paid-in Federal Reserve Bank stock;
(vi) That portion of assets directly and unconditionally
guaranteed by the United States Government or its agencies, or the
central government of an OECD country.
(viii) Claims on, and claims guaranteed by, a qualifying
securities firm that are collateralized by cash on deposit in the
corporate credit union or by securities issued or guaranteed by the
United States Government or its agencies, or the central government
of an OECD country. To be eligible for this risk-weight, the
corporate credit union must maintain a positive margin of collateral
on the claim on a daily basis, taking into account any change in a
corporate credit union's exposure to the obligor or counterparty
under the claim in relation to the market value of the collateral
held in support of the claim.
(2) 20 percent Risk-Weight (Category 2).
(i) Cash items in the process of collection;
(ii) That portion of assets conditionally guaranteed by the
United States Government or its agencies, or the central government
of an OECD country;
(iii) That portion of assets collateralized by the current
market value of securities issued or guaranteed by the United States
government or its agencies, or the central government of an OECD
country;
(iv) Securities (not including equity securities) issued by and
other claims on the U.S. Government or its agencies which are not
backed by the full faith and credit of the United States Government;
(v) Securities (not including equity securities) issued by, or
other direct claims on, United States Government-sponsored agencies;
(vi) That portion of assets guaranteed by United States
Government-sponsored agencies;
(vii) That portion of assets collateralized by the current
market value of securities issued or guaranteed by United States
Government-sponsored agencies;
(viii) Claims on, and claims guaranteed by, a qualifying
securities firm, subject to the following conditions:
(A) A qualifying securities firm must have a long-term issuer
credit rating, or a rating on at least one issue of long-term
unsecured debt, from a NRSRO. The rating must be in one of the three
highest investment grade categories used by the NRSRO. If two or
more NRSROs assign ratings to the qualifying securities firm, the
corporate credit union must use the lowest rating to determine
whether the rating requirement of this paragraph is met. A
qualifying securities firm may rely on the rating of its parent
consolidated company, if the parent consolidated company guarantees
the claim.
(B) A collateralized claim on a qualifying securities firm does
not have to comply with the rating requirements under paragraph (a)
if the claim arises under a contract that:
(1) Is a reverse repurchase/repurchase agreement or securities
lending/borrowing transaction executed using standard industry
documentation;
(2) Is collateralized by debt or equity securities that are
liquid and readily marketable;
(3) Is marked-to-market daily;
(4) Is subject to a daily margin maintenance requirement under
the standard industry documentation; and
(5) Can be liquidated, terminated or accelerated immediately in
bankruptcy or similar proceeding, and the security or collateral
agreement will not be stayed or avoided under applicable law of the
relevant jurisdiction. For example, a claim is exempt from the
automatic stay in bankruptcy in the United States if it arises under
a securities contract or a repurchase agreement subject to Section
555 or 559 of the Bankruptcy Code (11 U.S.C. 555 or 559), a
qualified financial contract under Section 207(c)(8) of the Federal
Credit Union Act (12 U.S.C. 1787(c)(8)) or Section 11(e)(8) of the
Federal Deposit Insurance Act (12 U.S.C. 1821(e)(8)), or a netting
contract between or among financial institutions under Sections 401-
407 of the Federal Deposit Insurance Corporation Improvement Act of
1991 (12 U.S.C. 4401-4407), or Regulation EE (12 CFR part 231).
(C) If the securities firm uses the claim to satisfy its
applicable capital requirements, the claim is not eligible for a
risk-weight under this paragraph II(a)(2)(viii);
(ix) Claims representing general obligations of any public-
sector entity in an OECD country, and that portion of any claims
guaranteed by any such public-sector entity;
(x) Balances due from and all claims on domestic depository
institutions. This includes demand deposits and other transaction
accounts, savings deposits and time certificates of deposit, federal
funds sold, loans to other depository institutions, including
overdrafts and term federal funds, holdings of the corporate credit
union's own discounted acceptances for which the account party is a
depository institution, holdings of bankers acceptances of other
institutions and securities issued by depository institutions,
except those that qualify as capital;
(xi) The book value of paid-in Federal Home Loan Bank stock;
(xii) Deposit reserves at, claims on and balances due from the
Federal Home Loan Banks;
(xiii) Assets collateralized by cash held in a segregated
deposit account by the reporting corporate credit union;
(xiv) Claims on, or guaranteed by, official multilateral lending
institutions or regional development institutions in which the
United States Government is a shareholder or contributing member;
\1\
---------------------------------------------------------------------------

\1\ These institutions include, but are not limited to, the
International Bank for Reconstruction and Development (World Bank),
the Inter-American Development Bank, the Asian Development Bank, the
African Development Bank, the European Investments Bank, the
International Monetary Fund and the Bank for International
Settlements.
---------------------------------------------------------------------------

(xv) That portion of assets collateralized by the current market
value of securities issued by official multilateral lending
institutions or regional development institutions in which the
United States Government is a shareholder or contributing member.
(xvi) All claims on depository institutions incorporated in an
OECD country, and all assets backed by the full faith and credit of
depository institutions incorporated in an OECD country. This
includes the credit equivalent amount of participations in
commitments and standby letters of credit sold to other depository
institutions incorporated in an OECD country, but only if the
originating bank remains liable to the member or beneficiary for the
full amount of the commitment or standby letter of credit. Also
included in this category are the credit equivalent amounts of risk
participations in

[[Page 64856]]

bankers' acceptances conveyed to other depository institutions
incorporated in an OECD country. However, bank-issued securities
that qualify as capital of the issuing bank are not included in this
risk category;
(xvii) Claims on, or guaranteed by depository institutions other
than the central bank, incorporated in a non-OECD country, with a
remaining maturity of one year or less;
(xviii) That portion of local currency claims conditionally
guaranteed by central governments of non-OECD countries, to the
extent the corporate credit union has local currency liabilities in
that country.
(3) 50 percent Risk-Weight (Category 3).
(i) Revenue bonds issued by any public-sector entity in an OECD
country for which the underlying obligor is a public-sector entity,
but which are repayable solely from the revenues generated from the
project financed through the issuance of the obligations;
(ii) Qualifying mortgage loans and qualifying multifamily
mortgage loans;
(iii) Privately-issued mortgage-backed securities (i.e., those
that do not carry the guarantee of the U.S. Government, a U.S.
government agency, or a U.S. government sponsored enterprise)
representing an interest in qualifying mortgage loans or qualifying
multifamily mortgage loans. If the security is backed by qualifying
multifamily mortgage loans, the corporate credit union must receive
timely payments of principal and interest in accordance with the
terms of the security. Payments will generally be considered timely
if they are not 30 days past due; and
(iv) Qualifying residential construction loans.
(4) 100 percent Risk-Weight (Category 4).
All assets not specified above or deducted from calculations of
capital pursuant to Sec. 704.2 and Sec. 704.3 of this part,
including, but not limited to:
(i) Consumer loans;
(ii) Commercial loans;
(iii) Home equity loans;
(iv) Non-qualifying mortgage loans;
(v) Non-qualifying multifamily mortgage loans;
(vi) Residential construction loans;
(vii) Land loans;
(viii) Nonresidential construction loans;
(ix) Obligations issued by any state or any political
subdivision thereof for the benefit of a private party or enterprise
where that party or enterprise, rather than the issuing state or
political subdivision, is responsible for the timely payment of
principal and interest on the obligations, e.g., industrial
development bonds;
(x) Debt securities not specifically risk-weighted in another
category;
(xi) Investments in fixed assets and premises;
(xii) Servicing assets;
(xiii) Interest-only strips receivable, other than credit-
enhancing interest-only strips;
(xiv) Equity investments;
(xv) The prorated assets of subsidiaries (except for the assets
of consolidated CUSOs) to the extent such assets are included in
adjusted total assets;
(xvi) All repossessed assets or assets that are more than 90
days past due; and
(xvii) Intangible assets not specifically weighted in some other
category.
(5) Indirect ownership interests in pools of assets. Assets
representing an indirect holding of a pool of assets, e.g., mutual
funds, are assigned to risk-weight categories under this section
based upon the risk-weight that would be assigned to the assets in
the portfolio of the pool. An investment in shares of a mutual fund
whose portfolio consists primarily of various securities or money
market instruments that, if held separately, would be assigned to
different risk-weight categories, generally is assigned to the risk-
weight category appropriate to the highest risk-weighted asset that
the fund is permitted to hold in accordance with the investment
objectives set forth in its prospectus. The corporate credit union
may, at its option, assign the investment on a pro rata basis to
different risk-weight categories according to the investment limits
in its prospectus. In no case will an investment in shares in any
such fund be assigned to a total risk-weight less than 20 percent.
If the corporate credit union chooses to assign investments on a pro
rata basis, and the sum of the investment limits of assets in the
fund's prospectus exceeds 100 percent, the corporate credit union
must assign the highest pro rata amounts of its total investment to
the higher risk categories. If, in order to maintain a necessary
degree of short-term liquidity, a fund is permitted to hold an
insignificant amount of its assets in short-term, highly liquid
securities of superior credit quality that do not qualify for a
preferential risk-weight, such securities will generally be
disregarded in determining the risk-weight category into which the
corporate credit union's holding in the overall fund should be
assigned. The prudent use of hedging instruments by a mutual fund to
reduce the risk of its assets will not increase the risk-weighting
of the mutual fund investment. For example, the use of hedging
instruments by a mutual fund to reduce the interest rate risk of its
government bond portfolio will not increase the risk-weight of that
fund above the 20 percent category. Nonetheless, if the fund engages
in any activities that appear speculative in nature or has any other
characteristics that are inconsistent with the preferential risk-
weighting assigned to the fund's assets, holdings in the fund will
be assigned to the 100 percent risk-weight category.
(6) Derivatives. Certain transactions or activities, such as
derivatives transactions, may appear on a corporate's balance sheet
but are not specifically described in the Section II(a) on-balance
sheet risk-weight categories. These items will be assigned risk-
weights as described in Section II(b) or II(c) below.

(b) Off-Balance Sheet Items

Except as provided in Section II(c) of this Appendix, risk-
weighted off-balance sheet items are determined by the following
two-step process. First, the face amount of the off-balance sheet
item must be multiplied by the appropriate credit conversion factor
listed in this Section II(b). This calculation translates the face
amount of an off-balance sheet exposure into an on-balance sheet
credit-equivalent amount. Second, the credit-equivalent amount must
be assigned to the appropriate risk-weight category using the
criteria regarding obligors, guarantors, and collateral listed in
Section II(a) of this Appendix.\2\ The following are the credit
conversion factors and the off-balance sheet items to which they
apply.
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\2\ The sufficiency of collateral and guarantees for off-balance
sheet items is determined by the market value of the collateral or
the amount of the guarantee in relation to the face amount of the
item, except for derivative contracts, for which this determination
is generally made in relation to the credit equivalent amount.
Collateral and guarantees are subject to the same provisions noted
under paragraph II(d) of this Appendix C.
---------------------------------------------------------------------------

(1) 100 percent credit conversion factor (Group A).
(i) Risk participations purchased in bankers' acceptances;
(ii) Forward agreements and other contingent obligations with a
certain draw down, e.g., legally binding agreements to purchase
assets at a specified future date. On the date a corporate credit
union enters into a forward agreement or similar obligation, it
should convert the principal amount of the assets to be purchased at
100 percent as of that date and then assign this amount to the risk-
weight category appropriate to the obligor or guarantor of the item,
or the nature of the collateral;
(iii) Indemnification of members whose securities the corporate
credit union has lent as agent. If the member is not indemnified
against loss by the corporate credit union, the transaction is
excluded from the risk-based capital calculation. When a corporate
credit union lends its own securities, the transaction is treated as
a loan. When a corporate credit union lends its own securities or is
acting as agent, agrees to indemnify a member, the transaction is
assigned to the risk-weight appropriate to the obligor or collateral
that is delivered to the lending or indemnifying institution or to
an independent custodian acting on their behalf; and
(iv) Unused portions of ABCP liquidity facilities that do not
meet the definition of an eligible ABCP liquidity facility. The
resulting credit equivalent amount is assigned to the risk category
appropriate to the assets to be funded by the liquidity facility
based on the assets or the obligor, after considering any collateral
or guarantees, or external credit ratings under paragraph II(c)(3)
of this Appendix, if applicable.
(2) 50 percent credit conversion factor (Group B).
(i) Transaction-related contingencies, including, among other
things, performance bonds and performance-based standby letters of
credit related to a particular transaction;
(ii) Unused portions of commitments (including home equity lines
of credit and eligible ABCP liquidity facilities) with an original
maturity exceeding one year except those listed in paragraph
II(b)(5) of this Appendix. For eligible ABCP liquidity facilities,
the resulting credit equivalent amount is assigned to the risk
category appropriate to the assets to be funded by the liquidity
facility based on the assets or the obligor, after considering any
collateral or guarantees, or external credit ratings under

[[Page 64857]]

paragraph II(c)(3) of this Appendix, if applicable; and
(iii) Revolving underwriting facilities, note issuance
facilities, and similar arrangements pursuant to which the corporate
credit union's CUSO or member can issue short-term debt obligations
in its own name, but for which the corporate credit union has a
legally binding commitment to either:
(A) Purchase the obligations the member is unable to sell by a
stated date; or
(B) Advance funds to its member, if the obligations cannot be
sold.
(3) 20 percent credit conversion factor (Group C). Trade-related
contingencies, i.e., short-term, self-liquidating instruments used
to finance the movement of goods and collateralized by the
underlying shipment. A commercial letter of credit is an example of
such an instrument.
(4) 10 percent credit conversion factor (Group D). Unused
portions of eligible ABCP liquidity facilities with an original
maturity of one year or less. The resulting credit equivalent amount
is assigned to the risk category appropriate to the assets to be
funded by the liquidity facility based on the assets or the obligor,
after considering any collateral or guarantees, or external credit
ratings under paragraph II(c)(3) of this Appendix, if applicable;
(5) Zero percent credit conversion factor (Group E). (i) Unused
portions of commitments with an original maturity of one year or
less, except for eligible ABCP liquidity facilities;
(ii) Unused commitments with an original maturity greater than
one year, if they are unconditionally cancelable at any time at the
option of the corporate credit union and the corporate credit union
has the contractual right to make, and in fact does make, either:
(A) A separate credit decision based upon the borrower's current
financial condition before each drawing under the lending facility;
or
(B) An annual (or more frequent) credit review based upon the
borrower's current financial condition to determine whether or not
the lending facility should be continued; and
(iii) The unused portion of retail credit card lines or other
related plans that are unconditionally cancelable by the corporate
credit union in accordance with applicable law.
(6) Off-balance sheet derivative contracts; interest rate and
foreign exchange rate contracts (Group F).
(i) Calculation of credit equivalent amounts. The credit
equivalent amount of an off-balance sheet derivative contract that
is not subject to a qualifying bilateral netting contract in
accordance with paragraph II(b)(6)(ii) of this Appendix is equal to
the sum of the current credit exposure, i.e., the replacement cost
of the contract, and the potential future credit exposure of the
contract. The calculation of credit equivalent amounts is measured
in U.S. dollars, regardless of the currency or currencies specified
in the contract.
(A) Current credit exposure. The current credit exposure of an
off-balance sheet derivative contract is determined by the mark-to-
market value of the contract. If the mark-to-market value is
positive, then the current credit exposure equals that mark-to-
market value. If the mark-to-market value is zero or negative, then
the current exposure is zero. In determining its current credit
exposure for multiple off-balance sheet derivative contracts
executed with a single counterparty, a corporate credit union may
net positive and negative mark-to-market values of off-balance sheet
derivative contracts if subject to a bilateral netting contract as
provided in paragraph II(b)(6)(ii) of this Appendix.
(B) Potential future credit exposure. The potential future
credit exposure of an off-balance sheet derivative contract,
including a contract with a negative mark-to-market value, is
estimated by multiplying the notional principal by a credit
conversion factor.\3\ Corporate credit unions, subject to examiner
review, should use the effective rather than the apparent or stated
notional amount in this calculation. The conversion factors are: \4\
---------------------------------------------------------------------------

\3\ For purposes of calculating potential future credit exposure
for foreign exchange contracts and other similar contracts, in which
notional principal is equivalent to cash flows, total notional
principal is defined as the net receipts to each party falling due
on each value date in each currency.
\4\ No potential future credit exposure is calculated for single
currency interest rate swaps in which payments are made based upon
two floating rate indices, so-called floating/floating or basis
swaps; the credit equivalent amount is measured solely on the basis
of the current credit exposure.

----------------------------------------------------------------------------------------------------------------
Interest rate Foreign exchange Other derivative
Remaining maturity contracts rate contracts contracts
(percent) (percent) (percent)
----------------------------------------------------------------------------------------------------------------
One year or less......................................... 0.0 1.0 10.0
Over one year but less than five years................... 0.50 5.0 12.0
Over five years.......................................... 0.50 5.0 15.0
----------------------------------------------------------------------------------------------------------------

(ii) Off-balance sheet derivative contracts subject to
bilateral netting contracts. In determining its current credit
exposure for multiple off-balance sheet derivative contracts
executed with a single counterparty, a corporate credit union may
net off-balance sheet derivative contracts subject to a bilateral
netting contract by offsetting positive and negative mark-to-market
values, provided that:
(A) The bilateral netting contract is in writing;
(B) The bilateral netting contract creates a single legal
obligation for all individual off-balance sheet derivative contracts
covered by the bilateral netting contract. In effect, the bilateral
netting contract provides that the corporate credit union has a
single claim or obligation either to receive or pay only the net
amount of the sum of the positive and negative mark-to-market values
on the individual off-balance sheet derivative contracts covered by
the bilateral netting contract. The single legal obligation for the
net amount is operative in the event that a counterparty, or a
counterparty to whom the bilateral netting contract has been validly
assigned, fails to perform due to any of the following events:
Default, insolvency, bankruptcy, or other similar circumstances;
(C) The corporate credit union obtains a written and reasoned
legal opinion(s) representing, with a high degree of certainty, that
in the event of a legal challenge, including one resulting from
default, insolvency, bankruptcy or similar circumstances, the
relevant court and administrative authorities would find the
corporate credit union's exposure to be the net amount under:
(1) The law of the jurisdiction in which the counterparty is
chartered or the equivalent location in the case of noncorporate
entities, and if a branch of the counterparty is involved, then also
under the law of the jurisdiction in which the branch is located;
(2) The law that governs the individual off-balance sheet
derivative contracts covered by the bilateral netting contract; and
(3) The law that governs the bilateral netting contract;
(D) The corporate credit union establishes and maintains
procedures to monitor possible changes in relevant law and to ensure
that the bilateral netting contract continues to satisfy the
requirements of this section; and
(E) The corporate credit union maintains in its files
documentation adequate to support the netting of an off-balance
sheet derivative contract.\5\
---------------------------------------------------------------------------

\5\ By netting individual off-balance sheet derivative contracts
for the purpose of calculating its credit equivalent amount, a
corporate credit union represents that documentation adequate to
support the netting of an off-balance sheet derivative contract is
in the corporate credit union's files and available for inspection
by the NCUA. Upon determination by the NCUA that a corporate credit
union's files are inadequate or that a bilateral netting contract
may not be legally enforceable under any one of the bodies of law
described in paragraphs II(b)(5)(ii) of this Appendix, the
underlying individual off-balance sheet derivative contracts may not
be netted for the purposes of this section.
---------------------------------------------------------------------------

(iii) Walkaway clause. A bilateral netting contract that
contains a walkaway clause is not eligible for netting for purposes
of calculating the current credit exposure amount. The term
``walkaway clause'' means

[[Page 64858]]

a provision in a bilateral netting contract that permits a
nondefaulting counterparty to make a lower payment than it would
make otherwise under the bilateral netting contract, or no payment
at all, to a defaulter or the estate of a defaulter, even if the
defaulter or the estate of the defaulter is a net creditor under the
bilateral netting contract.
(iv) Risk-weighting. Once the corporate credit union determines
the credit equivalent amount for an off-balance sheet derivative
contract, that amount is assigned to the risk-weight category
appropriate to the counterparty, or, if relevant, to the nature of
any collateral or guarantee. Collateral held against a netting
contract is not recognized for capital purposes unless it is legally
available for all contracts included in the netting contract.
However, the maximum risk-weight for the credit equivalent amount of
such off-balance sheet derivative contracts is 50 percent.
(v) Exceptions. The following off-balance sheet derivative
contracts are not subject to the above calculation, and therefore,
are not part of the denominator of a corporate credit union's risk-
based capital ratio:
(A) A foreign exchange rate contract with an original maturity
of 14 calendar days or less; and
(B) Any interest rate or foreign exchange rate contract that is
traded on an exchange requiring the daily payment of any variations
in the market value of the contract.
(C) Asset-backed commercial paper programs.
(1) A corporate credit union that qualifies as a primary
beneficiary and must consolidate an ABCP program that is a variable
interest entity under Generally Accepted Accounting Principles may
exclude the consolidated ABCP program assets from risk-weighted
assets if the corporate credit union is the sponsor of the ABCP
program.
(2) If a corporate credit union excludes such consolidated ABCP
program assets from risk-weighted assets, the corporate credit union
must assess the appropriate risk-based capital requirement against
any exposures of the corporate credit union arising in connection
with such ABCP programs, including direct credit substitutes,
recourse obligations, residual interests, liquidity facilities, and
loans, in accordance with Sections II(a), II(b), and II(c) of this
Appendix.
(3) If a corporate credit union has multiple overlapping
exposures (such as a program-wide credit enhancement and a liquidity
facility) to an ABCP program that is not consolidated for risk-based
capital purposes, the corporate credit union is not required to hold
duplicative risk-based capital under this part against the
overlapping position. Instead, the corporate credit union should
apply to the overlapping position the applicable risk-based capital
treatment that results in the highest capital charge.

(1) In general. Except as otherwise permitted in this Section
II(c), to determine the risk-weighted asset amount for a recourse
obligation or a direct credit substitute (but not a residual
interest):
(i) Multiply the full amount of the credit-enhanced assets for
which the corporate credit union directly or indirectly retains or
assumes credit risk by a 100 percent conversion factor (For a direct
credit substitute that is an on-balance sheet asset (e.g., a
purchased subordinated security), a corporate credit union must use
the amount of the direct credit substitute and the full amount of
the asset it supports, i.e., all the more senior positions in the
structure); and
(ii) Assign this credit equivalent amount to the risk-weight
category appropriate to the obligor in the underlying transaction,
after considering any associated guarantees or collateral. Section
II(a) lists the risk-weight categories.
(2) Residual interests. Except as otherwise permitted under this
Section II(c), a corporate credit union must maintain risk-based
capital for residual interests as follows:
(i) Credit-enhancing interest-only strips. A corporate credit
union must maintain risk-based capital for a credit-enhancing
interest-only strip equal to the remaining amount of the strip even
if the amount of risk-based capital that must be maintained exceeds
the full risk-based capital requirement for the assets transferred.
(ii) Other residual interests. A corporate credit union must
maintain risk-based capital for a residual interest (excluding a
credit-enhancing interest-only strip) equal to the face amount of
the residual interest, even if the amount of risk-based capital that
must be maintained exceeds the full risk-based capital requirement
for the assets transferred.
(iii) Residual interests and other recourse obligations. Where a
corporate credit union holds a residual interest (including a
credit-enhancing interest-only strip) and another recourse
obligation in connection with the same transfer of assets, the
corporate credit union must maintain risk-based capital equal to the
greater of:
(A) The risk-based capital requirement for the residual interest
as calculated under Section II(c)(2)(i) through (ii) of this
Appendix; or
(B) The full risk-based capital requirement for the assets
transferred, subject to the low-level recourse rules under Section
II(c)(5) of this Appendix.
(3) Ratings-based approach--(i) Calculation. A corporate credit
union may calculate the risk-weighted asset amount for an eligible
position described in Section II(c)(3)(ii) of this section by
multiplying the face amount of the position by the appropriate risk-
weight determined in accordance with Table A or B of this section.

Table A
------------------------------------------------------------------------
Risk-weight
Long term rating category (in percent)
------------------------------------------------------------------------
Highest or second highest investment grade.............. 20
Third highest investment grade.......................... 50
Lowest investment grade................................. 100
One category below investment grade..................... 200
------------------------------------------------------------------------

Table B
------------------------------------------------------------------------
Risk-weight
Short term rating category (in percent)
------------------------------------------------------------------------
Highest investment grade................................ 20
Second highest investment grade......................... 50
Lowest investment grade................................. 100
------------------------------------------------------------------------

(ii) Eligibility.
(A) Traded positions. A position is eligible for the treatment
described in paragraph II(c)(3)(i) of this Appendix if:
(1) The position is a corporate debt obligation with a remaining
maturity of 120 days or less, a recourse obligation, a direct credit
substitute, a residual interest, or an asset- or mortgage-backed
security and is not a credit-enhancing interest-only strip;
(2) The position is a traded position; and
(3) The NRSRO has rated a long term position as one grade below
investment grade or better or a short term position as investment
grade. If two or more NRSROs assign ratings to a traded position,
the corporate credit union must use the lowest rating to determine
the appropriate risk-weight category under paragraph (3)(i).
(B) Non-traded positions. A position that is not traded is
eligible for the treatment described in paragraph(3)(i) if:
(1) The position is a recourse obligation, a direct credit
substitute, a residual interest, or an asset- or mortgage-backed
security extended in connection with a securitization and is not a
credit-enhancing interest-only strip;
(2) More than one NRSRO rate the position;
(3) All of the NRSROs that rate the position rate it as no lower
than one grade below investment grade (for long term position) or no
lower than investment grade (for short term investments). If the
NRSROs assign different ratings to the position, the corporate
credit union must use the lowest rating to determine the appropriate
risk-weight category under paragraph (3)(i);
(4) The NRSROs base their ratings on the same criteria that they
use to rate securities that are traded positions; and
(5) The ratings are publicly available.
(C) Unrated senior positions. If a recourse obligation, direct
credit substitute, residual interest, or asset- or mortgage-backed
security is not rated by an NRSRO, but is senior or preferred in all
features to a traded position (including collateralization and
maturity), the corporate credit union may risk-weight the face
amount of the senior position under paragraph (3)(i) of this
section, based on the rating of the traded position, subject to
supervisory guidance. The corporate credit union must satisfy NCUA
that this treatment is appropriate. This paragraph (3)(i)(c) applies
only if the traded position provides substantive credit support to
the unrated position until the unrated position matures.
(iii) Consistent use of Ratings Based Approach. A corporate
credit union that determines to use the ratings based approach must
do so in a consistent manner. For example, if the corporate credit
union employs the ratings based approach on at least one security or
position on a given call report, the credit union must use the
ratings

[[Page 64859]]

based approach on that call report for every security and position
that is eligible for the ratings based approach.
(4) Certain positions that are not rated by NRSROs. (i)
Calculation. A corporate credit union may calculate the risk-
weighted asset amount for eligible position described in paragraph
II(c)(4)(ii) of this section based on the corporate credit union's
determination of the credit rating of the position. To risk-weight
the asset, the corporate credit union must multiply the face amount
of the position by the appropriate risk-weight determined in
accordance with Table C of this section.

Table C
------------------------------------------------------------------------
Risk-weight
Rating category (in percent)
------------------------------------------------------------------------
Investment grade........................................ 100
One category below investment grade..................... 200
------------------------------------------------------------------------

(ii) Eligibility. A position extended in connection with a
securitization is eligible for the treatment described in paragraph
II(c)(4)(i) of this section if it is not rated by an NRSRO, is not a
residual interest, and meets the one of the three alternative
standards described in paragraphs (A), (B), or (C) below:
(A) Position rated internally. A direct credit substitute, but
not a purchased credit-enhancing interest-only strip, is eligible
for the treatment described under paragraph II(c)(4)(i) of this
Appendix, if the position is assumed in connection with an asset-
backed commercial paper program sponsored by the corporate credit
union. Before it may rely on an internal credit risk rating system,
the corporate must demonstrate to NCUA's satisfaction that the
system is adequate. Acceptable internal credit risk rating systems
typically:
(1) Are an integral part of the corporate credit union's risk
management system that explicitly incorporates the full range of
risks arising from the corporate credit union's participation in
securitization activities;
(2) Link internal credit ratings to measurable outcomes, such as
the probability that the position will experience any loss, the
expected loss on the position in the event of default, and the
degree of variance in losses in the event of default on that
position;
(3) Separately consider the risk associated with the underlying
loans or borrowers, and the risk associated with the structure of
the particular securitization transaction;
(4) Identify gradations of risk among ``pass'' assets and other
risk positions;
(5) Use clear, explicit criteria to classify assets into each
internal rating grade, including subjective factors;
(6) Employ independent credit risk management or loan review
personnel to assign or review the credit risk ratings;
(7) Include an internal audit procedure to periodically verify
that internal risk ratings are assigned in accordance with the
corporate credit union's established criteria;
(8) Monitor the performance of the assigned internal credit risk
ratings over time to determine the appropriateness of the initial
credit risk rating assignment, and adjust individual credit risk
ratings or the overall internal credit risk rating system, as
needed; and
(9) Make credit risk rating assumptions that are consistent
with, or more conservative than, the credit risk rating assumptions
and methodologies of NRSROs.
(B) Program ratings.
(1) A recourse obligation or direct credit substitute, but not a
residual interest, is eligible for the treatment described in
paragraph II(c)(4)(i) of this Appendix, if the position is retained
or assumed in connection with a structured finance program and an
NRSRO has reviewed the terms of the program and stated a rating for
positions associated with the program. If the program has options
for different combinations of assets, standards, internal or
external credit enhancements and other relevant factors, and the
NRSRO specifies ranges of rating categories to them, the corporate
credit union may apply the rating category applicable to the option
that corresponds to the corporate credit union's position.
(2) To rely on a program rating, the corporate credit union must
demonstrate to NCUA's satisfaction that that the credit risk rating
assigned to the program meets the same standards generally used by
NRSROs for rating traded positions. The corporate credit union must
also demonstrate to NCUA's satisfaction that the criteria underlying
the assignments for the program are satisfied by the particular
position.
(3) If a corporate credit union participates in a securitization
sponsored by another party, NCUA may authorize the corporate credit
union to use this approach based on a program rating obtained by the
sponsor of the program.
(C) Computer program. A recourse obligation or direct credit
substitute, but not a residual interest, is eligible for the
treatment described in paragraph II(c)(4)(i) of this Appendix, if
the position is extended in connection with a structured financing
program and the corporate credit union uses an acceptable credit
assessment computer program to determine the rating of the position.
An NRSRO must have developed the computer program and the corporate
credit union must demonstrate to NCUA's satisfaction that the
ratings under the program correspond credibly and reliably with the
rating of traded positions.
(5) Limitations on risk-based capital requirements--
(i) Low-level exposure rule. If the maximum contractual exposure
to loss retained or assumed by a corporate credit union is less than
the effective risk-based capital requirement, as determined in
accordance with this Section II(c), for the assets supported by the
corporate credit union's position, the risk-based capital
requirement is limited to the corporate credit union's contractual
exposure less any recourse liability account established in
accordance with Generally Accepted Accounting Principles. This
limitation does not apply when a corporate credit union provides
credit enhancement beyond any contractual obligation to support
assets it has sold.
(ii) Mortgage-related securities or participation certificates
retained in a mortgage loan swap. If a corporate credit union holds
a mortgage-related security or a participation certificate as a
result of a mortgage loan swap with recourse, it must hold risk-
based capital to support the recourse obligation and that percentage
of the mortgage-related security or participation certificate that
is not covered by the recourse obligation. The total amount of risk-
based capital required for the security (or certificate) and the
recourse obligation is limited to the risk-based capital requirement
for the underlying loans, calculated as if the corporate credit
union continued to hold these loans as an on-balance sheet asset.
(iii) Related on-balance sheet assets. If an asset is included
in the calculation of the risk-based capital requirement under this
Section II(c) and also appears as an asset on the corporate credit
union's balance sheet, the corporate credit union must risk-weight
the asset only under this Section II(c), except in the case of loan
servicing assets and similar arrangements with embedded recourse
obligations or direct credit substitutes. In that case, the
corporate credit union must separately risk-weight the on-balance
sheet servicing asset and the related recourse obligations and
direct credit substitutes under this section, and incorporate these
amounts into the risk-based capital calculation.
(6) Obligations of CUSOs. All recourse obligations and direct
credit substitutes retained or assumed by a corporate credit union
on the obligations of CUSOs in which the corporate credit union has
an equity investment are risk-weighted in accordance with this
Section II(c), unless the corporate credit union's equity investment
is deducted from the credit union's capital and assets under Sec.
704.2 and Sec. 704.3.
(d) Collateral. The only forms of collateral that are recognized
for risk-weighting purposes are cash on deposit in the corporate
credit union; Treasuries, U.S. Government agency securities, and
U.S. Government-sponsored enterprise securities; and securities
issued by multilateral lending institutions or regional development
banks. Claims secured by cash on deposit are assigned to the zero
percent risk-weight category (to the extent of the cash amount).
Claims secured by securities are assigned to the twenty percent
risk-weight category (to the extent of the fair market value of the
securities).

PART 709--INVOLUNTARY LIQUIDATION OF FEDERAL CREDIT UNIONS AND
ADJUDICATION OF CREDITOR CLAIMS INVOLVING FEDERALLY INSURED CREDIT
UNIONS IN LIQUIDATION.

0
23. The authority citation for part 709 continues to read as follows:

Authority: 12 U.S.C. 1757, 1766, 1767, 1786(h), 1787, 1788,
1789, 1789a.

0
24. Revise paragraphs (b)(7) and (b)(9) of Sec. 709.5 to read as
follows:

[[Page 64860]]

Sec. 709.5 Payout priorities in involuntary liquidation.

* * * * *
(b) * * *
(7) in a case involving liquidation of a corporate credit union,
holders of then-outstanding membership capital accounts and
nonperpetual capital accounts or instruments to the extent not depleted
in a calendar year prior to the date of liquidation and also subject to
the capital priority option described in Appendix A of part 704 of this
chapter;
* * * * *
(9) in a case involving liquidation of a corporate credit union,
holders of then-outstanding paid in capital or perpetual contributed
capital instruments to the extent not depleted in a calendar year prior
to the date of liquidation and also subject to the capital priority
option described in Appendix A of Part 704 of this chapter;
* * * * *

PART 747--ADMINISTRATIVE ACTIONS, ADJUDICATIVE HEARINGS, RULES OF
PRACTICE AND PROCEDURE, AND INVESTIGATIONS.

0
25. The authority citation for part 747 continues to read as follows:

Authority: 12 U.S.C. 1766, 1782, 1784, 1786, 1787; 42 U.S.C.
4012a; Pub. L. 101-410; Pub. L. 104-134.

0
26. Effective October 20, 2011, add a new subpart M to part 747 to read
as follows:
Subpart M--Issuance, Review and Enforcement of Orders Imposing Prompt
Corrective Action on Corporate Credit Unions
Sec.
747.3001. Scope.
747.3002. Review of orders imposing discretionary supervisory
action.
747.3003. Review of order reclassifying a corporate credit union on
safety and soundness criteria.
747.3004. Review of order to dismiss a director or senior executive
officer.
747.3005. Enforcement of directives.
747.3006. Conservatorship or liquidation of critically
undercapitalized corporate credit union.

Subpart M--Issuance, Review and Enforcement of Orders Imposing
Prompt Corrective Action on Corporate Credit Unions

Sec. 747.3001 Scope.

(a) Independent review process. The rules and procedures set forth
in this subpart apply to corporate credit unions which are subject to
discretionary supervisory actions under Sec. 704.4 of this chapter and
to reclassification under Sec. 704.4(d)(3) of this chapter to
facilitate prompt corrective action, and to senior executive officers
and directors of such corporate credit unions who are dismissed
pursuant to a discretionary supervisory action imposed under Sec.
704.4 of this chapter. Section 747.3002 of this subpart provides an
independent appellate process to challenge such decisions.
(b) Notice to State officials. With respect to a State-chartered
corporate credit union under Sec. Sec. 747.3002, 747.3003 and 747.3004
of this subpart, any notices, directives and decisions on appeal served
upon a corporate credit union, or a dismissed director or officer
thereof, by the NCUA will also be served upon the appropriate State
official. Responses, requests for a hearing and to present witnesses,
requests to modify or rescind a discretionary supervisory action and
requests for reinstatement served upon the NCUA by a corporate credit
union, or any dismissed director or officer of a corporate credit
union, will also be served upon the appropriate State official.

Sec. 747.3002 Review of orders imposing discretionary supervisory
action.

(a) Notice of intent to issue directive.--(1) Generally. Whenever
the NCUA intends to issue a directive imposing a discretionary
supervisory action under Sec. Sec. 704.4(k)(2)(v) and 704.4(k)(3) of
this chapter on a corporate credit union classified
``undercapitalized'' or lower, the NCUA will give the corporate credit
union prior notice of the proposed action and an opportunity to
respond.
(2) Immediate issuance of directive without notice. The NCUA may
issue a directive to take effect immediately under paragraph (a)(1) of
this section without notice to the corporate credit union if the NCUA
finds it necessary in order to carry out the purposes of Sec. 704.4 of
this chapter. A corporate credit union that is subject to a directive
which takes effect immediately may appeal the directive in writing to
the NCUA Board (Board). Such an appeal must be received by the Board
within 14 calendar days after the directive was issued, unless the
Board permits a longer period. Unless ordered by the NCUA, the
directive will remain in effect pending a decision on the appeal. The
Board will consider any such appeal, if timely filed, within 60
calendar days of receiving it.
(b) Contents of notice. The NCUA's notice to a corporate credit
union of its intention to issue a directive imposing a discretionary
supervisory action will state:
(1) The corporate credit union's capital measures and capital
category classification;
(2) The specific restrictions or requirements that the Board
intends to impose, and the reasons therefore;
(3) The proposed date when the discretionary supervisory action
would take effect and the proposed date for completing the required
action or terminating the action; and
(4) That a corporate credit union must file a written response to a
notice within 14 calendar days from the date of the notice, or within
such shorter period as the Board determines is appropriate in light of
the financial condition of the corporate credit union or other relevant
circumstances.
(c) Contents of response to notice. A corporate credit union's
response to a notice under paragraph (b) of this section must:
(1) Explain why it contends that the proposed discretionary
supervisory action is not an appropriate exercise of discretion under
this section;
(2) Request the Board to modify or to not issue the proposed
directive; and
(3) Include other relevant information, mitigating circumstances,
documentation, or other evidence in support of the corporate credit
union's position regarding the proposed directive.
(d) NCUA Board consideration of response. The Board, or an
independent person designated by the Board to act on the Board's
behalf, after considering a response under paragraph (c) of this
section, may:
(1) Issue the directive as originally proposed or as modified;
(2) Determine not to issue the directive and to so notify the
corporate credit union; or
(3) Seek additional information or clarification from the corporate
credit union or any other relevant source.
(e) Failure to file response. A corporate credit union which fails
to file a written response to a notice of the Board's intention to
issue a directive imposing a discretionary supervisory action, within
the specified time period, will be deemed to have waived the
opportunity to respond, and to have consented to the issuance of the
directive.
(f) Request to modify or rescind directive. A corporate credit
union that is subject to an existing directive imposing a discretionary
supervisory action may request in writing that the Board reconsider the
terms of the directive, or rescind or modify it, due to changed
circumstances. Unless otherwise ordered by the Board, the directive
will remain in effect while

[[Page 64861]]

such request is pending. A request under this paragraph which remains
pending 60 days following receipt by the Board is deemed granted.

Sec. 747.3003 Review of order reclassifying a corporate credit union
on safety and soundness criteria.

(a) Notice of proposed reclassification based on unsafe or unsound
condition or practice. When the Board proposes to reclassify a
corporate credit union or subject it to the supervisory actions
applicable to the next lower capitalization category pursuant to Sec.
704.4(d)(3) of this chapter (such action hereinafter referred to as
``reclassification''), the Board will issue and serve on the corporate
credit union reasonable prior notice of the proposed reclassification.
(b) Contents of notice. A notice of intention to reclassify a
corporate credit union based on unsafe or unsound condition or practice
will state:
(1) The corporate credit union's current capital ratios and the
capital category to which the corporate credit union would be
reclassified;
(2) The unsafe or unsound practice(s) and/or condition(s)
justifying reasons for reclassification of the corporate credit union;
(3) The date by which the corporate credit union must file a
written response to the notice (including a request for a hearing),
which date will be no less than 14 calendar days from the date of
service of the notice unless the Board determines that a shorter period
is appropriate in light of the financial condition of the corporate
credit union or other relevant circumstances; and
(4) That a corporate credit union which fails to --
(i) File a written response to the notice of reclassification,
within the specified time period, will be deemed to have waived the
opportunity to respond, and to have consented to reclassification;
(ii) Request a hearing will be deemed to have waived any right to a
hearing; and
(iii) Request the opportunity to present witness testimony will be
deemed to have waived any right to present such testimony.
(c) Contents of response to notice. A corporate credit union's
response to a notice under paragraph (b) of this section must:
(1) Explain why it contends that the corporate credit union should
not be reclassified;
(2) Include any relevant information, mitigating circumstances,
documentation, or other evidence in support of the corporate credit
union's position;
(3) If desired, request an informal hearing before the Board under
this section; and
(4) If a hearing is requested, identify any witness whose testimony
the corporate credit union wishes to present and the general nature of
each witness's expected testimony.
(d) Order to hold informal hearing. Upon timely receipt of a
written response that includes a request for a hearing, the Board will
issue an order commencing an informal hearing no later than 30 days
after receipt of the request, unless the corporate credit union
requests a later date. The hearing will be held in Alexandria,
Virginia, or at such other place as may be designated by the Board,
before a presiding officer designated by the Board to conduct the
hearing and to recommend a decision.
(e) Procedures for informal hearing.--(1) The corporate credit
union may appear at the hearing through a representative or through
counsel. The corporate credit union will have the right to introduce
relevant documents and to present oral argument at the hearing. The
corporate credit union may introduce witness testimony only if
expressly authorized by the Board or the presiding officer. Neither the
provisions of the Administrative Procedure Act (5 U.S.C. 554-557)
governing adjudications required by statute to be determined on the
record nor the Uniform Rules of Practice and Procedure (12 CFR part
747) will apply to an informal hearing under this section unless the
Board orders otherwise.
(2) The informal hearing will be recorded, and a transcript will be
furnished to the corporate credit union upon request and payment of the
cost thereof. Witnesses need not be sworn, unless specifically
requested by a party or by the presiding officer. The presiding officer
may ask questions of any witness.
(3) The presiding officer may order that the hearing be continued
for a reasonable period following completion of witness testimony or
oral argument to allow additional written submissions to the hearing
record.
(4) Within 20 calendar days following the closing of the hearing
and the record, the presiding officer will make a recommendation to the
Board on the proposed reclassification.
(f) Time for final decision. Not later than 60 calendar days after
the date the record is closed, or the date of receipt of the corporate
credit union's response in a case where no hearing was requested, the
Board will decide whether to reclassify the corporate credit union, and
will notify the corporate credit union of its decision. The decision of
the Board will be final.
(g) Request to rescind reclassification. Any corporate credit union
that has been reclassified under this section may file a written
request to the Board to reconsider or rescind the reclassification, or
to modify, rescind or remove any directives issued as a result of the
reclassification. Unless otherwise ordered by the Board, the corporate
credit union will remain reclassified, and subject to any directives
issued as a result, while such request is pending.

Sec. 747.3004 Review of order to dismiss a director or senior
executive officer.

(a) Service of directive to dismiss and notice. When the Board
issues and serves a directive on a corporate credit union requiring it
to dismiss from office any director or senior executive officer under
Sec. Sec. 704.4(g) and 704.4(k)(3) of this chapter, the Board will
also serve upon the person the corporate credit union is directed to
dismiss (Respondent) a copy of the directive (or the relevant portions,
where appropriate) and notice of the Respondent's right to seek
reinstatement.
(b) Contents of notice of right to seek reinstatement. A notice of
a Respondent's right to seek reinstatement will state:
(1) That a request for reinstatement (including a request for a
hearing) must be filed with the Board within 14 calendar days after the
Respondent receives the directive and notice under paragraph (a) of
this section, unless the Board grants the Respondent's request for
further time;
(2) The reasons for dismissal of the Respondent; and
(3) That the Respondent's failure to--
(i) Request reinstatement will be deemed a waiver of any right to
seek reinstatement;
(ii) Request a hearing will be deemed a waiver of any right to a
hearing; and
(iii) Request the opportunity to present witness testimony will be
deemed a waiver of the right to present such testimony.
(c) Contents of request for reinstatement. A request for
reinstatement in response to a notice under paragraph (b) of this
section must:
(1) Explain why the Respondent should be reinstated;
(2) Include any relevant information, mitigating circumstances,
documentation, or other evidence in support of the Respondent's
position;
(3) If desired, request an informal hearing before the Board under
this section; and

[[Page 64862]]

(4) If a hearing is requested, identify any witness whose testimony
the Respondent wishes to present and the general nature of each
witness's expected testimony.
(d) Order to hold informal hearing. Upon receipt of a timely
written request from a Respondent for an informal hearing on the
portion of a directive requiring a corporate credit union to dismiss
from office any director or senior executive officer, the Board will
issue an order directing an informal hearing to commence no later than
30 days after receipt of the request, unless the Respondent requests a
later date. The hearing will be held in Alexandria, Virginia, or at
such other place as may be designated by the Board, before a presiding
officer designated by the Board to conduct the hearing and recommend a
decision.
(e) Procedures for informal hearing.--(1) A Respondent may appear
at the hearing personally or through counsel. A Respondent will have
the right to introduce relevant documents and to present oral argument
at the hearing. A Respondent may introduce witness testimony only if
expressly authorized by the Board or by the presiding officer. Neither
the provisions of the Administrative Procedure Act (5 U.S.C. 554-557)
governing adjudications required by statute to be determined on the
record nor the Uniform Rules of Practice and Procedure (12 CFR part
747) apply to an informal hearing under this section unless the Board
orders otherwise.
(2) The informal hearing will be recorded, and a transcript will be
furnished to the Respondent upon request and payment of the cost
thereof. Witnesses need not be sworn, unless specifically requested by
a party or the presiding officer. The presiding officer may ask
questions of any witness.
(3) The presiding officer may order that the hearing be continued
for a reasonable period following completion of witness testimony or
oral argument to allow additional written submissions to the hearing
record.
(4) A Respondent will bear the burden of demonstrating that his or
her continued employment by or service with the corporate credit union
would materially strengthen the corporate credit union's ability to --
(i) Become ``adequately capitalized,'' to the extent that the
directive was issued as a result of the corporate credit union's
capital classification category or its failure to submit or implement a
capital restoration plan; and
(ii) Correct the unsafe or unsound condition or unsafe or unsound
practice, to the extent that the directive was issued as a result of
reclassification of the corporate credit union pursuant to Sec.
704.4(d)(3) of this chapter.
(5) Within 20 calendar days following the date of closing of the
hearing and the record, the presiding officer will make a
recommendation to the Board concerning the Respondent's request for
reinstatement with the corporate credit union.
(f) Time for final decision. Not later than 60 calendar days after
the date the record is closed, or the date of the response in a case
where no hearing was requested, the Board will grant or deny the
request for reinstatement and will notify the Respondent of its
decision. If the Board denies the request for reinstatement, it will
set forth in the notification the reasons for its decision. The
decision of the Board will be final.
(g) Effective date. Unless otherwise ordered by the Board, the
Respondent's dismissal will take and remain in effect pending a final
decision on the request for reinstatement.

Sec. 747.3005 Enforcement of directives.

(a) Judicial remedies. Whenever a corporate credit union fails to
comply with a directive imposing a discretionary supervisory action, or
enforcing a mandatory supervisory action under Sec. 704.4 of this
chapter, the Board may seek enforcement of the directive in the
appropriate United States District Court pursuant to 12 U.S.C.
1786(k)(1).
(b) Administrative remedies--(1) Failure to comply with directive.
Pursuant to 12 U.S.C. 1786(k)(2)(A), the Board may assess a civil money
penalty against any corporate credit union that violates or otherwise
fails to comply with any final directive issued under Sec. 704.4 of
this chapter, or against any institution-affiliated party of a
corporate credit union (per 12 U.S.C. 1786(r)) who participates in such
violation or noncompliance.
(2) Failure to implement plan. Pursuant to 12 U.S.C. 1786(k)(2)(A),
the Board may assess a civil money penalty against a corporate credit
union which fails to implement a capital restoration plan under Sec.
704.4(e) of this chapter, regardless whether the plan was published.
(c) Other enforcement action. In addition to the actions described
in paragraphs (a) and (b) of this section, the Board may seek
enforcement of the directives issued under Section 704.4 of this
chapter through any other judicial or administrative proceeding
authorized by law.

Sec. 747.3006 Conservatorship or liquidation of critically
undercapitalized corporate credit union.

Notwithstanding any other provision of this title, the NCUA may,
without any administrative due process, immediately place into
conservatorship or liquidation any corporate credit union that has been
categorized as critically undercapitalized.

[FR Doc. 2010-24616 Filed 10-19-10; 8:45 am]
BILLING CODE 7535-01-P