[Federal Register Volume 75, Number 57 (Thursday, March 25, 2010)]
[Proposed Rules]
[Pages 14372-14375]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-6391]
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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: Proposed rule with request for comments.
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SUMMARY: NCUA proposes to revise 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: Comments must be received on or before May 24, 2010.
ADDRESSES: You may submit comments by any of the following methods
(Please send comments by one method only):
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
NCUA Web Site: http://www.ncua.gov/RegulationsOpinionsLaws/proposed_regs/proposed_regs.html. Follow the
instructions for submitting comments.
E-mail: Address to [email protected]. Include ``[Your
name] Comments on Proposed Rule 742, Regulatory Flexibility Program''
in the e-mail subject line.
Fax: (703) 518-6319. Use the subject line described above
for e-mail.
Mail: Address to Mary Rupp, Secretary of the Board,
National Credit Union Administration, 1775 Duke Street, Alexandria,
Virginia 22314-3428.
Hand Delivery/Courier: Same as mail address.
Public Inspection: All public comments are available on the
agency's website at http://www.ncua.gov/RegulationsOpinionsLaws/comments as submitted, except as may not be possible for technical
reasons. Public comments will not be edited to remove any identifying
or contact information. Paper copies of comments may be inspected in
NCUA's law library at 1775 Duke Street, Alexandria, Virginia 22314, by
appointment weekdays between 9 a.m. and 3 p.m. To make an appointment,
call (703) 518-6546 or send an e-mail to [email protected].
FOR FURTHER INFORMATION CONTACT: Frank Kressman, Staff Attorney, Office
of General Counsel, at the above address 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).
[[Page 14373]]
B. Discussion
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. NCUA
proposes amendments to the fixed assets, MBL, stress testing of
investments, and discretionary control of investments provisions of the
RegFlex rule. NCUA requests comment on those amendments.
2. Fixed Assets
The Federal Credit Union Act authorizes FCUs to purchase, hold, and
dispose of property necessary or incidental to its 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). NCUA believes that investing
in higher levels of non-earning assets can materially affect a credit
union's earnings ability and, therefore, its viability. Call report
data collected by NCUA shows a higher percentage of earnings problems
among credit unions with more than five percent of shares and retained
earnings invested in fixed assets; the percentage of earnings problems
increases as the level of fixed assets increases.
The following examples illustrate the kinds of fixed asset related
financial problems some credit unions are experiencing and are a source
of concern for NCUA. They demonstrate how credit unions are
experiencing earnings and net worth problems as a result of excessive
investment in fixed assets.
Example 1. Between 2005 and 2006, an FCU substantially increased
its investment in fixed assets to 14.77% of total assets by relocating
their main office, opening a new branch, and converting the old main
office into a branch. This caused its operating expenses to increase to
99.85% of gross income, which left insufficient earnings to cover loan
losses, pay dividends, and maintain net worth. The FCU expanded its
operations without conducting a sufficient analysis of the impact of
the expansion and developing a sound financial plan. The FCU has
performed poorly since 2006 and its net worth ratio has dropped from
approximately 10.76% in 2005 to 6.10% in 2010. The credit union is
currently supervised by NCUA's Division of Special Actions.
Example 2. In December 2006, a credit union was interested in
expanding and, at the time, its fixed assets were 1.46% of total
assets. It built a new main office in 2007 in an effort to promote
growth. The credit union projected it could grow into its new main
office but due to the economic down-turn, cost overruns in the building
construction, and other poor management decisions, it did not realize
its projections. Since 2007, net income has been negative. By late
2008, fixed assets had risen to 17.50% of total assets, largely due to
the cost of the building. The credit union is seeking a merger partner
but has been unsuccessful to date, mainly due to the cost and
devaluation of the new building.
Example 3. In 2004, a credit union decided to build a branch office
to help promote growth. At the time, its net worth was 15.19% and fixed
assets were 2.36% of total assets. When construction was completed in
2006, fixed assets had risen to 13.76% of total assets. Since then,
income has been negative and net worth has declined to 9.15%. The
credit union has closed the branch and put it up for sale but has not
received any offers.
Example 4. An FCU began an aggressive fixed asset expansion
project. The project caused its fixed assets to mushroom to
approximately 16% of total assets. The FCU is unable to support this
level of capital expenditures and has created a safety and soundness
problem. NCUA issued a temporary cease and desist order to require the
FCU to discontinue the project. The FCU is now cooperating with NCUA to
address this problem. The above examples are a sampling of a larger and
common problem.
Accordingly, for the reasons discussed above, NCUA does not believe
it is prudent to continue to exempt RegFlex credit unions from the five
percent limit on fixed assets and proposes to rescind that exemption.
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 proposes to rescind this exemption for RegFlex credit unions.
NCUA believes 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. A credit union
that fails to do so subjects itself to increased risk, particularly in
these economic times when MBL delinquencies and MBL charge-offs have
increased. The below table illustrates the magnitude of MBL-related
losses in credit unions.
September 30, 2009 Consolidated Financial Performance Report
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2005 % 2006 % 2007 % 2008 % 9/2009 %
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Delinquent MBLs................. 0.42 0.53 1.87 2.26 3.33
Charged Off MBLs................ 0.07 0.11 0.15 0.46 0.47
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[[Page 14374]]
The below table illustrates an example of one credit union with a
high concentration of MBLs with increasing net charge-offs.
December 31, 2009 Financial Performance Report
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2005 % 2006 % 2007 % 2008 % 9/2009 %
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Net Worth Ratio................. 9.81 10.76 9.61 7.71 7.18
Percent of MBLs Compared to 59.51 52.07 55.19 50.77 55.66
Assets.........................
Delinquent MBLs................. 0.15 0.25 1.05 3.62 7.21
Charged Off MBLs................ 0.15 1.18 1.05 0.81 1.70
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This trend in losses and delinquencies is becoming increasingly
common, even among credit unions whose MBLs portfolios represent a
smaller portion of their assets. Accordingly, for the reasons discussed
above, the Board believes it is in the interest of safety and soundness
to rescind the exemption. Credit unions will continue to have the
option of seeking a waiver of the guarantee requirement under 723.10(e)
on a case-by-case basis.
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.
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.
The below chart illustrates 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. Credit unions need to
stress test their investments so they have a clearer understanding of
their risk profile and can better manage risk.
December 31, 2009 Consolidated Financial Performance Report
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12/2008 3/2009 6/2009 9/2009 12/2009
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Total Investment >3 Years Maturities............................... $38.2B $39.7B $43.4B $45.6B $50.7B
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The trends in the net long-term asset ratio reveal that credit
unions are extending maturities in all types of assets, including loans
and investments. NCUA has stressed the need for improved asset-
liability management, and this includes stress testing investments.
For the reasons discussed above, the Board believes all FCUs must
stress test their securities as a matter of safety and soundness and
responsible business practices. Accordingly, the Board proposes 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 light of the current investment
climate and reports of fraudulent practices in the investment banking
industry, the Board is becoming increasingly concerned about the safety
and soundness of credit unions and their investments. Accordingly, the
Board proposes to rescind the RegFlex exemption pertaining to
discretionary control of investments.
C. Regulatory Procedures
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 entities (primarily those under ten
million dollars in assets). This rule enhances safety and soundness
without additional
[[Page 14375]]
regulatory burden. Accordingly, this proposed rule will not have a
significant economic impact on a substantial number of small credit
unions, and therefore, no regulatory flexibility analysis is required.
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 proposed 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 proposed 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 proposed 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).
Agency Regulatory Goal
NCUA's goal is to promulgate clear and understandable regulations
that impose minimal regulatory burden. We request your comments on
whether this proposed rule is understandable and minimally intrusive if
implemented as proposed.
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 March 18,
2010.
Mary Rupp,
Secretary of the Board.
For the reasons discussed above, NCUA proposes to amend 12 CFR
parts 701, 723, and 742 as follows:
PART 701--ORGANIZATION AND OPERATIONS OF FEDERAL CREDIT UNIONS
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.
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 assets for substantive
safety and soundness reasons; and
* * * * *
PART 723--MEMBER BUSINESS LOANS
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]
4. Amend Sec. 723.7 by removing the last sentence of paragraph
(b).
PART 742--REGULATORY FLEXIBILITY PROGRAM
5. The authority citation for part 742 continues to read as
follows:
Authority: 12 U.S.C. 1756, 1766.
Sec. 742.4 [Amended]
6. Amend Sec. 742.4 by removing the first sentence of paragraph
(a)(3) and by removing paragraphs (a)(4), (a)(5), and (a)(6) and
redesignating paragraphs (a)(7), (a)(8), and (a)(9) as paragraph
(a)(4), (a)(5), and (a)(6).
[FR Doc. 2010-6391 Filed 3-24-10; 8:45 am]
BILLING CODE 7535-01-P