[Federal Register Volume 75, Number 208 (Thursday, October 28, 2010)]
[Rules and Regulations]
[Pages 66295-66298]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-27149]
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Rules and Regulations
Federal Register
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Federal Register / Vol. 75, No. 208 / Thursday, October 28, 2010 /
Rules and Regulations
[[Page 66295]]
NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Parts 701, 723, and 742
RIN 3133-AD68
Fixed Assets, Member Business Loans, and Regulatory Flexibility
Program
AGENCY: National Credit Union Administration (NCUA).
ACTION: Final rule.
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SUMMARY: NCUA is revising certain provisions of its Regulatory
Flexibility Program (RegFlex) to enhance safety and soundness for
credit unions. Those provisions pertain to fixed assets, member
business loans (MBL), stress testing of investments, and discretionary
control of investments. Some of these revisions will require conforming
amendments to NCUA's fixed assets and MBL rules.
DATES: The rule is effective November 29, 2010.
FOR FURTHER INFORMATION CONTACT: Frank Kressman, Senior Staff Attorney,
Office of General Counsel, 1775 Duke Street, Alexandria, Virginia 22314
or telephone (703) 518-6540.
SUPPLEMENTARY INFORMATION:
A. Background--Regulatory Flexibility Program
The RegFlex Program exempts from certain regulatory restrictions
and grants additional powers to those federal credit unions (FCUs) that
have demonstrated sustained superior performance as measured by CAMEL
ratings and net worth classifications. 12 CFR 742.1. An FCU may qualify
for RegFlex treatment automatically or by application to the
appropriate regional director. 12 CFR 742.2. Specifically, an FCU
automatically qualifies when it has received a composite CAMEL rating
of ``1'' or ``2'' for the two preceding examinations and has maintained
a net worth classification of ``well capitalized'' under Part 702 of
NCUA's rules for six consecutive preceding quarters or, if subject to a
risk-based net worth (RBNW) requirement under Part 702, has remained
``well capitalized'' for six consecutive preceding quarters after
applying the applicable RBNW requirement. An FCU that does not
automatically qualify may apply for a RegFlex designation with the
appropriate regional director. 12 CFR 742.2(a) and (b). An FCU's
RegFlex authority can be lost or revoked. 12 CFR 742.3.
The NCUA Board established RegFlex in 2002. 66 FR 58656 (November
23, 2001). Since then, NCUA has amended RegFlex a number of times to
increase available relief for FCUs from a variety of regulatory
restrictions or lessen the criteria required for obtaining RegFlex
status. 71 FR 4039 (January 25, 2006); 72 FR 30247 (May 31, 2007); 74
FR 13083 (March 26, 2009).
B. March 2010 Proposal
1. Overview
The current RegFlex rule provides RegFlex credit unions with
regulatory relief in the following ten areas: (1) Charitable
contributions; (2) nonmember deposits; (3) fixed assets; (4) MBLs; (5)
discretionary control of investments; (6) stress testing of
investments; (7) zero-coupon securities; (8) borrowing repurchase
transactions; (9) commercial mortgage related securities; and (10)
purchase of obligations from a federally insured credit union. In March
2010, the NCUA Board proposed amendments to the fixed assets, MBL,
stress testing of investments, and discretionary control of investments
provisions of the RegFlex rule and requested comment on those
amendments. 75 FR 14372 (March 25, 2010). The following sections
discuss those proposed amendments in greater detail.
2. Fixed Assets
The Federal Credit Union Act authorizes FCUs to purchase, hold, and
dispose of property necessary or incidental to their operations. 12
U.S.C. 1757(4). Generally, the fixed asset rule provides limits on
fixed asset investments, establishes occupancy and other requirements
for acquired and abandoned premises, and prohibits certain
transactions. 12 CFR 701.36. Fixed assets are defined in 701.36(e) as
premises, furniture, fixtures, and equipment and includes any office,
branch office, suboffice, service center, parking lot, facility, real
estate where a credit union transacts or will transact business, office
furnishings, office machines, computer hardware and software, automated
terminals, and heating and cooling equipment. Section 701.36 prohibits
an FCU with $1 million or more in assets from investing in fixed
assets, the aggregate of which exceeds five percent of the FCU's shares
and retained earnings, although upon an FCU's application, a regional
director may set a higher limit. 12 CFR 701.36(a)(1) and (2).
The RegFlex rule exempts RegFlex credit unions from the referenced
five percent limit. 12 CFR 701.36(a)(1). In the proposal, NCUA stated
it believed that investing in higher levels of non-earning assets can
materially affect a credit union's earnings ability and, therefore, its
viability. NCUA proposed to rescind this exemption for RegFlex credit
unions. NCUA offered call report data to show that there is a higher
percentage of earnings problems among credit unions with more than five
percent of shares and retained earnings invested in fixed assets and
that the percentage of earnings problems increases as the level of
fixed assets increases. NCUA also included several examples to
illustrate the kinds of fixed asset-related financial problems some
credit unions have experienced.
3. MBLs
The MBL rule requires a credit union making a business loan to
obtain the personal liability and guarantee of the borrower's
principals as part of the rule's collateral and security requirements.
12 CFR 723.7(b). Under the current rules, RegFlex credit unions are
exempt from that requirement but may choose to require the principals'
guarantee as part of their own underwriting standards and best
practices. Id.
NCUA proposed to rescind this exemption for RegFlex credit unions.
NCUA stated that it believed obtaining the principals' personal
guarantee is a prudent underwriting practice that greatly enhances the
likelihood of loan repayment and should be required of all credit
unions. NCUA also stated that a
[[Page 66296]]
credit union that fails to do so subjects itself to increased risk,
particularly in economic times when MBL delinquencies and MBL charge-
offs are increasing. NCUA noted that credit unions would continue to
have the option of seeking a waiver of the guarantee requirement under
723.10(e).
4. Stress Testing of Investments
NCUA's investment rule requires an FCU to monitor the securities it
holds. 12 CFR 703.12. Specifically, at least monthly, an FCU must
prepare a written report setting out the fair value and dollar change
since the prior month-end for each security held with summary
information for its entire portfolio. 12 CFR 703.12(a). Similarly, at
least quarterly, an FCU must prepare a written report setting out the
sum of the fair values of all fixed and variable rate securities whose
features include: (1) Embedded options; (2) remaining maturities
greater than three years; or (3) coupon formulas that are related to
more than one index or are inversely related to, or multiples of, an
index. 12 CFR 703.12(b). If the sum in the quarterly report is greater
than the FCU's net worth, then the report must estimate the potential
impact, in percentage and dollar terms, of an immediate and sustained
parallel shift in market interest rates of plus and minus 300 basis
points on: (1) The fair value of each security in the FCU's portfolio;
(2) the fair value of the FCU's portfolio as a whole; and (3) the FCU's
net worth. 12 CFR 703.12(c). This calculation is known as ``stress
testing'' the securities. Under the current rules, RegFlex credit
unions are exempt from the requirement to stress test their securities.
NCUA noted in the proposal that because of low investment yields
due to the current economic environment, many credit unions are
incurring additional risk by investing in long-term instruments to
increase yield and improve earnings. NCUA believes many credit unions
are purchasing investment products they do not fully understand and are
incurring significant interest rate and liquidity risk.
NCUA offered call report data to illustrate the degree to which
credit unions are investing in products with longer maturities further
out on the yield curve. Although this may help achieve greater yield in
the short term, an increase in market rates could result in a
significant decrease in product value and cause liquidity problems.
NCUA stated that credit unions need to stress test their investments so
they have a clearer understanding of their risk profile, can better
manage risk, and as a matter of safety and soundness and responsible
business practices. Accordingly, the Board proposed to rescind the
RegFlex exemption in this context.
5. Discretionary Control of Investments
NCUA's investment rule requires an FCU to retain discretionary
control over its purchase and sale of investments although, under the
rule, an FCU will not be deemed to have delegated discretionary control
to an investment adviser if the FCU reviews all recommendations from
the investment adviser and authorizes a recommended purchase or sale
transaction before its execution. 12 CFR 703.5(a). An exception to this
general rule is that an FCU may delegate discretionary control over the
purchase and sale of its investments to a person outside the FCU if the
person is an investment advisor registered with the Securities and
Exchange Commission and if the amount delegated is limited to up to 100
percent of the FCU's net worth at the time of delegation. 12 CFR
703.5(b). If an FCU exercises this limited authority, it must adjust
the amount of funds held under discretionary control to comply with the
100 percent of net worth cap at least annually. Id.
Under the current rule, a RegFlex credit union is exempt from the
discretionary control requirements in 703.5 that pertain to the 100
percent of net worth limitation. In the proposal, NCUA noted that it
was becoming increasingly concerned about the safety and soundness of
credit unions and their investments considering the recent investment
climate and reports of fraudulent practices in the investment banking
industry. Accordingly, the Board proposed to rescind the RegFlex
exemption pertaining to discretionary control of investments.
C. Summary of Comments and Discussion
1. General
NCUA received 50 comments on the proposal: 30 from credit unions,
14 from credit union trade associations, 1 from a bank trade
association, and 5 from other interested parties. Two commenters
supported the proposal in its entirety. The vast majority of commenters
opposed some aspect of the proposal and some supported some aspect of
the proposal.
In broad terms, there was a consensus among commenters' opinion
that the data and examples NCUA cited to support rescinding the four
RegFlex exemptions were insufficient and highlighted a few extreme
cases that do not represent a systemic problem in the credit union
industry. Similarly, commenters generally agreed that the purpose of
RegFlex is still important and should be preserved and noted that NCUA
has the authority to revoke RegFlex status for underperforming credit
unions.
2. MBL
The majority of those commenters who discussed the MBL aspect of
the proposal opposed it. Most said that it would create a significant
competitive disadvantage for credit unions where competing lenders may
not have such a requirement. Most also stated that the personal
guarantee requirement could result in credit unions losing their
highest quality borrowers to competitors that do not require a
guarantee.
Some noted that, even though the personal guarantee exemption is
currently in place, most credit unions still obtain the guarantee on
the bulk of their MBLs. They noted that the exemption should remain in
place for those instances where it makes sense not to require a
guarantee, such as when the borrower poses minimal credit risk, the
underwriting is strong, or where other factors such as high collateral
value is more important than a guarantee. Some commenters also noted
that NCUA should not restrict a credit union's ability to make MBLs at
a time when making small business loans is a national priority.
Finally, many commenters stated that the process for obtaining a waiver
from this requirement is too slow and cumbersome to deal with this
issue.
NCUA has thoroughly considered these comments and appreciates the
concerns the commenters have expressed. For the reasons discussed in
the proposal as summarized above, NCUA still believes it is prudent to
require all credit unions to comply with the personal guarantee
requirement. NCUA recognizes that in the competitive MBL marketplace
credit unions need to be free of unnecessary restrictions that hamper
their ability to serve their members' business loan needs. NCUA does
not believe this is an unnecessary restriction. Additionally, NCUA
acknowledges that the current waiver process, in some circumstances, is
too slow to accommodate the practical timing needs of processing MBLs.
NCUA is committed to making the waiver process more user friendly in
this context and will look into ways of doing so. However, NCUA
believes it is in the interest of safety and soundness to rescind this
exemption and reminds credit unions they will continue to have
[[Page 66297]]
the option of seeking a waiver of the guarantee requirement under
723.10(e).
3. Fixed Assets
The majority of those commenters who discussed the fixed asset
component of the proposal opposed rescinding the exemption from the 5%
fixed asset cap. About a third of them also noted that it could inhibit
branching activities and credit union growth. Many commenters suggested
raising the fixed asset cap to a higher level, such as 8-10% for all
FCUs, or establishing a sliding scale where FCUs with higher net worth
would have a higher fixed asset cap.
Some mentioned that the increasing need to purchase computer
technology necessary to serve their members makes the 5% cap
challenging. A few commenters noted that rescinding the exemption could
be a hardship on those credit unions with long-term growth plans that
are based, in part, on using the exemption. A handful of others
suggested NCUA grandfather those credit unions already exceeding the
cap.
NCUA believes that safety and soundness considerations dictate
rescinding this exemption. Excessive investment in fixed assets often
leads to other financial difficulties for credit unions. Also, the
nature and timing of investing in fixed assets is such that credit
unions have sufficient time to request a waiver from the 5% limitation
if necessary even for credit unions that have begun executing their
growth strategies.
Credit unions that have already exceeded the 5% limit on the
effective date of this rule will be grandfathered at that limit. If
their level of fixed assets subsequently trends downward, then so will
the level at which they are grandfathered. Grandfathered credit unions
are, however, still eligible to apply for a waiver to increase their
fixed asset investments. For example, a credit union grandfathered at
8% whose fixed assets trend downward to 6.5% will have a new
grandfathered limit of 6.5%. Further, if that same credit union then
wishes to increase its fixed assets to 9%, then it may apply for a
waiver to do so. Accordingly, the fixed assets exemption is rescinded
as proposed.
4. Discretionary Control of Investments and Stress Testing of
Investments
A relatively few commenters chose to discuss the discretionary
control of investment authority and stress testing of investments
components of the proposal. Among those that did comment, some opposed
the proposal and others supported it. Accordingly, NCUA adopts the
proposal to rescind these exemptions on safety and soundness grounds.
D. Regulatory Procedures
Regulatory Flexibility Act
The Regulatory Flexibility Act requires NCUA to prepare an analysis
to describe any significant economic impact a rule may have on a
substantial number of small entities (primarily those under ten million
dollars in assets). This rule enhances safety and soundness without
additional regulatory burden. Accordingly, this will not have a
significant economic impact on a substantial number of small credit
unions, and therefore, no regulatory flexibility analysis is required.
Small Business Regulatory Enforcement Fairness Act
The Small Business Regulatory Enforcement Fairness Act (SBREFA) of
1996, Public Law 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 Procedures Act. 5 U.S.C. 551. The Office of Information
and Regulatory Affairs, an office within OMB, has reviewed this rule
and determined that, for purposes of SBREFA, this is not a major rule.
Paperwork Reduction Act
NCUA has determined that this rule will not increase paperwork
requirements under the Paperwork Reduction Act of 1995 and regulations
of the Office of Management and Budget.
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 would not have a substantial
direct effect on the states, on the relationship between the national
government and the states, or on the distribution of power and
responsibilities among the various levels of government. NCUA has
determined that this final rule does not constitute a policy that has
federalism implications for purposes of the executive order.
The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families
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).
List of Subjects
12 CFR Part 701
Credit unions.
12 CFR Part 723
Credit, Credit unions, Reporting and recordkeeping requirements.
12 CFR Part 742
Credit unions, reporting and recordkeeping requirements.
By the National Credit Union Administration Board on October 21,
2010.
Mary Rupp,
Secretary of the Board.
0
For the reasons discussed above, NCUA amends 12 CFR parts 701, 723, and
742 as follows:
PART 701--ORGANIZATION AND OPERATIONS OF FEDERAL CREDIT UNIONS
0
1. The authority citation for part 701 continues to read as follows:
Authority: 12 U.S.C. 1752(5), 1755, 1756, 1757, 1759, 1761a,
1761b, 1766, 1767, 1782, 1784, 1787, and 1789. Section 701.6 is also
authorized by 31 U.S.C. 3717. Section 701.31 is also authorized by
15 U.S.C. 1601 et seq., 42 U.S.C. 1861 and 42 U.S.C. 3601-3610.
Section 701.35 is also authorized by 42 U.S.C. 4311-4312.
0
2. Amend Sec. 701.36 by revising paragraphs (d) introductory text and
(d)(1) to read as follows:
Sec. 701.36 FCU ownership of fixed assets.
* * * * *
(d) Regulatory Flexibility Program. Federal credit unions that meet
Regulatory Flexibility Program standards, as determined pursuant to
Part 742 of this chapter, are exempt from the three-year partial
occupancy requirement described in paragraph (b) of this section when
acquiring unimproved land for future expansion pursuant to the terms of
section 742.4(a)(3) of this chapter. For a Federal credit union
eligible for the Regulatory Flexibility Program that subsequently loses
eligibility:
(1) Section 742.3 of this chapter provides that NCUA may require
the credit union to divest any existing fixed
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assets for substantive safety and soundness reasons; and
* * * * *
PART 723--MEMBER BUSINESS LOANS
0
3. The authority citation for part 723 continues to read as follows:
Authority: 12 U.S.C. 1756, 1757, 1757A, 1766, 1785, 1789.
Sec. 723.7 [Amended]
0
4. Amend Sec. 723.7 by removing the last sentence of paragraph (b).
PART 742--REGULATORY FLEXIBILITY PROGRAM
0
5. The authority citation for part 742 continues to read as follows:
Authority: 12 U.S.C. 1756, 1766.
Sec. 742.4 [Amended]
0
6. Amend Sec. 742.4 by removing the first sentence of paragraph (a)(3)
and removing paragraphs (a)(4), (5), and (6) and redesignating
paragraphs (a)(7), (8), and (9) as (a)(4), (5), and (6), respectively.
[FR Doc. 2010-27149 Filed 10-27-10; 8:45 am]
BILLING CODE 7535-01-P