[Federal Register Volume 76, Number 40 (Tuesday, March 1, 2011)]
[Proposed Rules]
[Pages 11164-11172]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-4070]
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NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Parts 703, 704, 709, and 742
RIN 3133-AD86
Removing References to Credit Ratings in Regulations; Proposing
Alternatives to the Use of Credit Ratings
AGENCY: National Credit Union Administration (NCUA).
ACTION: Notice of proposed rulemaking.
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SUMMARY: NCUA is proposing rules to implement certain statutory
provisions in Title IX of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (the Dodd-Frank Act). The proposed rules
replace or remove references to credit ratings in NCUA regulations.
DATES: Comments must be received on or before May 2, 2011.
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/Resources/RegulationsOpinionsLaws/ProposedRegulations.aspx. Follow the
instructions for submitting comments.
E-mail: Address to [email protected]. Include ``[Your name]
Comments on ``Notice of Proposed Rulemaking--Removing References to
Credit Ratings'' 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 Web site at http://www.ncua.gov/Resources/RegulationsOpinionsLaws/ProposedRegulations.aspx as submitted, except
as may not be possible for
[[Page 11165]]
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: Mark Vaughan, Director, Division of
Capital Markets, or Dale Klein, Senior Capital Markets Specialist, at
the address above or telephone (703) 518-6620; or Lisa Henderson, Staff
Attorney, or Frank Kressman, Staff Attorney, at the address above or
telephone (703) 518-6540.
SUPPLEMENTARY INFORMATION:
I. Background
Section 939A of the Dodd-Frank Act requires each Federal agency to
review (1) any regulation issued by such agency that requires the use
of an assessment of the creditworthiness of a security or money market
instrument; and (2) any references to or requirements in such
regulations regarding credit ratings.\1\ Section 939A further requires
each agency to modify any such regulations identified by the review to
remove any reference to or requirement of reliance on credit ratings
and to substitute in such regulations such standards of
creditworthiness as each respective agency shall determine as
appropriate for such regulations. In developing substitute standards of
creditworthiness, an agency shall seek to establish, to the extent
feasible, uniform standards of creditworthiness for use by the agency,
taking into account the entities it regulates that would be subject to
such standards.\2\
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\1\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, Sec. 939A (2010).
\2\ Id.
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NCUA has identified 24 general areas of its regulations that
contain references to nationally recognized statistical rating
organization (NRSRO) \3\ credit ratings. Eight are found in part 703 of
the regulations governing the investment activities of natural person
Federal credit unions (FCUs). 12 CFR part 703. Fourteen are found in
part 704 of the regulations governing the operations, investment
activities, and capital risk-weighting of corporate credit unions. 12
CFR part 704. There is also one reference to credit ratings in part 709
of the regulations governing the involuntary liquidation of Federal
credit unions and one reference in part 742 of the regulations
governing NCUA's regulatory flexibility program. 12 CFR parts 709 and
742.
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\3\ An NRSRO is an entity registered with the U.S. Securities
and Exchange Commission (SEC) under section 15E of the Securities
Exchange Act of 1934. See 15 U.S.C. 78o-7, as implemented by 17 CFR
240.17g-1.
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II. General Approach
The proposed rule generally handles NRSRO ratings three different
ways, depending on the manner in which the rating is used in the
regulations. For investments, the proposal generally replaces the
minimum credit rating requirement with a requirement that the credit
union do an internal credit analysis of the investment pursuant to a
particular narrative standard. For counterparty transactions, the
proposal generally replaces the minimum credit rating requirement with
a requirement that the credit union do an internal credit analysis of
the counterparty pursuant to an internal standard set by the credit
union's board. For ratings usage outside of investment and counterparty
suitability, the proposal generally removes the ratings reference
without requiring some substitute analysis. These three approaches are
discussed in more detail below and in Section III.
a. Investment Authority
Where the regulations require that a security have particular
rating in order for it to be a permissible investment for a credit
union, the proposed rule replaces the minimum rating with a narrative
standard that is focused primarily on credit quality. The proposal
generally requires a credit union to conduct and document an internal
analysis demonstrating that the issue or issuer of a security has a
certain, specified capacity to meet its financial commitments.
For each section of the rule, the necessary capacity to meet
financial commitments is correlated to narrative descriptions provided
by the NRSRO rating agencies. For example, two of the larger NRSROs,
Standard and Poor's and Fitch, state that a AA issuer rating (e.g.,
``in one of the two highest ratings categories'') means the obligor has
a very strong capacity to meet its financial commitments. Accordingly,
where the NCUA regulations currently require an investment to have a AA
rating or equivalent, the proposal generally requires the credit union
to determine that the issuer of the security has a very strong capacity
to meet its financial commitments. The proposal contains similar
translations for other ratings (e.g., a rating of BBB is equivalent to
adequate capacity, and a rating of A is equivalent to strong capacity).
The Board believes that this approach to replacing credit ratings
is consistent with both the letter and spirit of the Dodd-Frank Act.
The legislative history of Dodd-Frank indicates that Congress was
concerned not with any particular rating level, or associated narrative
standard, but rather, with the NRSROs' failure to apply the narrative
standard accurately and consistently to certain securities.\4\ The
Dodd-Frank Act was intended to reduce over-reliance on ratings and
encourage investors to conduct their own analyses.\5\ This proposal
furthers those aims by requiring that credit unions conduct their own
analyses using long-standing, and accepted, narrative standards.
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\4\ With respect to the financial crisis, the Senate Report
stated that ``erroneous credit ratings'' caused serious and far
reaching problems. See S. Rep. No. 111-176, p. 36 (2010). Report of
the Committee on Banking, Housing, and Urban Affairs. The Senate
Report attributed the errors to the overreliance by the NRSROs on
mathematical risk models and to conflicts of interest in the ratings
process, not to incorrect standards. See Dodd-Frank Wall Street
Reform: Conference Report Summary. Similarly, the House Report on
H.R. 3890, the rating agency reform legislation later incorporated
into H.R. 4173 as passed by the House, notes that NRSROs issued
ratings based upon unsatisfactory credit analyses. See H. Rep. No.
111-685, Part I, p. 19 (2010). Report of the Committee on Financial
Services.
\5\ http://banking.senate.gov/public/_files/070110_Dodd_Frank_Wall_Street_Reform_comprehensive_summary_Final.pdf.
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The Board believes that this approach does not present a
significant change for most credit unions. NCUA already requires
natural person FCUs and corporates to have credit risk management
policies that go beyond simple reliance on credit ratings. Section
703.6 requires an FCU to conduct and document a credit analysis on any
non-guaranteed or insured investment. 12 CFR 703.6. Section 704.6
requires a corporate to operate according to a credit risk management
policy that is commensurate with the investment risks and activities it
undertakes, and the corporate's policy must address credit limit
approval processes, due diligence analysis requirements, maximum credit
limits with each obligor and transaction counterparty, and
concentrations of credit risk. 12 CFR 704.6. Accordingly, credit unions
that purchase investments with some credit risk should already have in
place robust processes--including internal testing and assessment and/
or reviewing reports, analyses, opinions, and other assessments issued
by third parties--analyzing the risk that an issue or issuer will fail
to perform on its obligation. NCUA will provide additional supervisory
guidance on the indicators that support a determination that an
[[Page 11166]]
issue or issuer has the necessary capacity (e.g., adequate, strong,
very strong, etc.) to meet its financial commitments.
b. Counterparties
Where the regulations require that a transaction counterparty have
a particular rating, the proposed rule substitutes a requirement that
the counterparty meet minimum credit quality standards as established
by the credit union's board of directors. In developing and applying
credit quality standards, the board of directors may incorporate
external ratings, reports, analyses, opinions, and other assessments
issued by third-parties. Since counterparty risk is more akin to loan
than investment risk, a credit union would be expected to document its
credit assessment and analysis using a system similar to its internal
loan grading system. These internal processes would be subject to
examiner review and classification, similar to the process used for
credit union loan classification.
Sections 703.6 and 704.6, noted above, also require credit unions
to establish appropriate processes to evaluate the creditworthiness of
securities counterparties. Any credit union doing business with a
counterparty should already consider a counterparty's financial
statements, its general reputation, and whether there have been any
formal enforcement actions against the counterparty or its affiliates
by State or Federal securities regulators. A credit union should know
the counterparty's character, integrity of management, activities, and
financial markets in which it deals.
c. Removal Without Replacement
Where NCUA has determined that a provision that references NRSRO
ratings is no longer necessary, the proposed rule deletes or
substantially modifies the provision.
d. Other Approaches
As discussed below, in Section IV, the Board is not wedded to these
proposed alternatives to credit ratings in the investment and
counterparty contexts. Commenters who believe a different approach (or
approaches) is warranted should describe their alternatives and give a
supporting justification.
III. Specific Proposed Amendments
a. Part 703--Investment and Deposit Activities
Definitions
Section 703.2 contains definitions of terms related to the
investment activities of natural person FCUs. Three of the definitions
make reference to credit ratings.
Section 703.2 defines ``deposit note'' as an obligation of a bank
that is similar to a certificate of deposit ``but is rated.'' The NCUA
Board is proposing to delete the definition of ``deposit note''
entirely, as the term is standard in the securities industry.
Part 703 permits FCUs to invest in Collateralized Mortgage
Obligations (CMOs), and CMOs are defined in Sec. 703.2 as multiclass
mortgage related securities. An FCU's authority to purchase mortgage
related securities comes from Sec. 107(15)(b) of the Act, 12 U.S.C.
1757(15)(b), which defines mortgage related security by cross reference
to the same phrase in Sec. 3(a)(41) of the Securities Exchange Act of
1934, 15 U.S.C. 78c(a)(41) (Exchange Act). The pre-Dodd-Frank Exchange
Act definition included a reference to NRSRO ratings, but Dodd-Frank
Act eliminated the NRSRO reference in Sec. 3(a)(41) of the Exchange
Act, substituting the language: ``meets standards of creditworthiness
as established by the [Securities and Exchange] Commission (SEC).'' \6\
The Dodd-Frank Act requires the SEC to establish those standards by
July 21, 2012.\7\
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\6\ Dodd-Frank Act, Sec. 939.
\7\ Id.
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Section 703.2 defines mortgage related security by using the
language found in the pre-Dodd Frank Act definition in Sec. 3(a)(41)
of the Exchange Act, including the reference to NRSRO ratings. This
proposal removes the reference to NRSRO ratings from Sec. 703.2, and
replaces it with a short cross reference to Sec. 3(a)(41). Under the
proposal, FCUs that wish to purchase mortgage related securities,
including CMOs, must determine and document that the security is, in
fact, a mortgage related security as defined by the SEC. In the time
period before the SEC moves to specify ``standards of
creditworthiness'' for mortgage related securities, an FCU is
prohibited from purchasing a CMO or other mortgage related security
unless the FCU has specific evidence that the SEC considers that
security to meet the requirements of Sec. 3(a)(41).
Similarly, Sec. 703.2 cross-references the definition of ``small
business related security'' with its definition in Sec. 3(a)(53) of
the Exchange Act, 15 U.S.C. 78c(a)(53), and then repeats that
definition verbatim. Again, this flows from the authority in the FCU
Act, 12 U.S.C. 1757(15)(C), and its cross reference to the definition
of small business security in the Exchange Act. As with the definition
of ``mortgage related security,'' discussed above, the definition of
``small business related security'' prior to the Dodd-Frank Act
included a reference to NRSRO ratings. The Dodd-Frank Act eliminated
that reference, substituting instead creditworthiness standards to be
established by the SEC, and providing the SEC with two years to
establish such standards.\8\ This proposed rule removes the language of
the former Exchange Act definition and redefines ``small business
related security'' by a short cross-reference to the Exchange Act
provision. An FCU wishing to purchase a small business related security
must demonstrate that it meets the Sec. 3(a)(53) requirements, as
determined by the SEC. The proposed rule retains the exemption for
Small Business Administration securities permissible under Sec. 107(7)
of the Federal Credit Union Act, 12 U.S.C. 1757(7).
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\8\ Id.
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Broker-Dealers and Safekeepers
Sections 703.8(b)(3) and 703.9(d) list a number of factors that
FCUs should consider when evaluating the reliability of broker-dealers
and investment safekeepers, respectively. One factor is NRSRO reports.
The proposed rule replaces the NRSRO reference with ``external
assessments of creditworthiness.'' FCUs may obtain these assessments
from various sources.
Permissible Investments
Section 703.14 establishes standards for permissible investments
for FCUs.
Section 703.14(e) provides that an FCU may purchase a municipal
security (muni) that an NRSRO has rated in one of the four highest
rating categories. The proposed rule removes the minimum rating
requirements, providing instead that for an investment to be
permissible, it must be originated by an issuer that has at least an
adequate capacity to meet its financial obligations, even under adverse
conditions, for the projected life of the security. As noted above, an
FCU may evaluate the financial strength of an issuer by conducting
internal assessments and/or reviewing assessments issued by third-
parties.
To further limit the risk associated with the purchase of munis,
the proposal adds new concentration limits on such holdings.
Specifically, an FCU must limit its aggregate muni holdings to no more
than 75 percent of the credit union's net worth and limit its holdings
of munis issued by any single issuer to no more than 25 percent of net
worth. Since most munis are exempt from
[[Page 11167]]
income taxation, and FCUs are tax exempt entities that cannot take full
advantage of the tax exempt status of munis, it is unlikely that any
particular FCU would desire to purchase or hold municipal securities in
amounts that would exceed these proposed limits.
Section 703.14(g) permits an FCU to purchase a European financial
options contract for the purpose of hedging the risk associated with
issuing share certificates with dividends tied to an equity index. Two
of the requirements of the current 703.14(g) are that the counterparty
meets certain NRSRO ratings requirements and that the aggregate amount
of such index-linked certificates not exceed the credit union's net
worth. The proposal removes the reference to the NRSRO ratings and
instead requires that the counterparty meet credit standards set by the
board. To mitigate any risk associated with the removal of credit
ratings in this context, the proposal tightens the concentration limit
in equity indexed certificates from 100 percent of the credit union's
net worth to 50 percent of the credit union's net worth.
Section 703.14(h) permits an FCU to invest in Mortgage note
repurchase transactions. Three of the requirements of the current Sec.
703.14(h) are that (1) the counterparty meets certain NRSRO ratings
requirements, (2) the aggregate amount of the investments with any one
counterparty be limited to 25 percent of the credit union's net worth,
and (3) the aggregate amount of the investments with all counterparties
be limited to 100 percent of net worth. The proposal removes the
reference to the NRSRO ratings and instead requires that the
counterparty meet credit standards set by the board. To mitigate any
risk associated with the removal of credit ratings in this context, the
proposal tightens the aggregate concentration limit from 100 percent of
net worth to 50 percent of net worth.
b. Part 704--Corporate Credit Unions
Definitions
Section 704.2 contains definitions of terms related to the
investment activities of corporate credit unions. Four of the
definitions refer to credit ratings.
The proposed rule eliminates the definition of ``NRSRO'' as
irrelevant, given that the proposed rule eliminates references to
NRSROs.
The definition of ``asset-backed commercial paper (ABCP) program''
states that it is a program that has received a credit rating from an
NRSRO. The proposed rule deletes that element of the definition as
unnecessary. A corporate that is authorized to invest in ABCPs is
expected to conduct due diligence on an ABCP investment just as any
other investment.
The definition of ``eligible ABCP liquidity facility'' provides
that if the assets that the facility is required to fund against have
received an NRSRO rating at the time of the inception of the facility,
the facility can be used to fund only those assets that are rated
investment grade by an NRSRO at the time of funding. The proposed rule
removes the NRSRO references, providing instead that a facility can be
used to fund only those assets or exposures that demonstrate adequate
capacity to meet their financial obligations, even under adverse
economic conditions, for the projected life of the asset or exposure. A
corporate may base its evaluation of the financial strength of an asset
or exposure on internal and external assessments.
The definition of ``small business related security'' in Sec.
704.2 is different from that in Sec. 703.2, discussed above. When NCUA
comprehensively revised part 704 in September 2010, the Board noted
that Congress had already passed the Dodd-Frank Act, amending the
Exchange Act's definition of small business related security.\9\ The
Board stated that it wanted to continue to use the old Exchange Act
definition and therefore retained the description of the security\10\
while removing the reference to the Exchange Act. The definition
retained an NRSRO reference, however, and the proposed rule removes
that reference. As is the case with Sec. 703.2, the proposed rule
retains the exemption for Small Business Administration securities
permissible under Sec. 107(7) of the Federal Credit Union Act, 12
U.S.C. 1757(7).
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\9\ 75 FR 64786, 64789 (Oct. 20, 2010).
\10\ Prior to the Dodd-Frank Act, Section 3(a)(53) of the
Exchange Act defined a ``small business related security'' as ``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.''
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Credit Risk Management
Section 704.6(f) establishes minimum credit quality standards for
corporate credit union investments. 12 CFR 704.6(f). The standards
include that each investment must have an NRSRO rating and that at
least 90 percent of a corporate's investment portfolio must have at
least two such ratings. The standards further require that long-term
investments be rated at least AA- (or equivalent) and short-term
investments be rated at least A- (or equivalent). Finally, Sec.
704.6(f) requires a corporate to monitor NRSRO ratings as long as it
holds a rated investment and to develop an action plan, pursuant to
Sec. 704.10, for any investment subject to a ratings downgrade below
AA- for a long-term investment or A- for a short-term investment.
The proposed rule removes the minimum rating requirements,
providing instead that for an investment to be permissible, it must be
originated by an issuer that has at least a very strong capacity to
meet its financial obligations, even under adverse conditions, for the
projected life of the security. This standard would apply to both long-
term and short-term investments. As discussed above, a corporate may
base its evaluation of the financial strength of an issuer on internal
and external assessments. Under the proposed rule, a corporate must
monitor any changes in credit quality of the investment as long as it
owns the investment and develop an action plan, under Sec. 704.10, if
there is reason to believe that the obligor no longer has a very strong
capacity to meet its financial obligations for the remaining projected
life of the security.
Section 704.6(g) requires a corporate credit union to maintain
documentation for each credit limit with each obligor or transaction
counterparty, including rating agency information. The proposed rule
deletes the reference to rating agency information.
Expanded Authorities
Appendix B to Part 704 sets out expanded authorities for corporates
that have met certain requirements.
Part I of Appendix B authorizes corporates to purchase investments
with long-term ratings no lower than A- (or equivalent) and short-term
ratings no lower than A-2 (or equivalent). The proposed rule removes
the rating requirements, providing instead that for an investment to be
permissible, it must be originated by an issuer that has at least a
strong capacity to meet its financial obligations, even under adverse
economic conditions, for the projected life of the security. Again,
this standard would apply to both long-term and short-term investments.
As in other parts of the proposed rule that substitute ratings with
multi-faceted issuer evaluations, a corporate may consider a variety of
sources in making that evaluation.
Part II of Appendix B authorizes a corporate to purchase a foreign
[[Page 11168]]
investment provided, among other things, that the sovereign issuer,
and/or the country in which the obligor is organized, has a long-term
foreign currency debt rating no lower than AA- (or equivalent). The
proposed rule deletes the NRSRO reference, providing instead that a
corporate may purchase a foreign investment only pursuant to an
explicit policy established by the board of directors. Further, any
foreign issue or issuer must have a very strong capacity to meet its
financial obligations, even under adverse economic conditions, for the
projected life of the security.
Part III of Appendix B provides that, for derivative transactions,
domestic counterparties must be rated at least A- (or equivalent). Part
III also requires a corporate to monitor the ratings as long as a
contract remains open and to develop an action plan, pursuant to Sec.
704.10, for any counterparty downgraded below the minimum rating
requirements. The proposed rule removes the rating requirements,
mandating instead that the counterparty meet minimum credit quality
standards as established by the corporate's board of directors. A
corporate must identify the criteria relied upon to determine that the
standards are met at the time the transaction is entered into and
monitor those criteria for as long as the contract remains open.
Finally, a corporate must develop a Sec. 704.10 action plan if the
credit quality of the counterparty deteriorates below the standards
established by the corporate's board.
Risk-Based Capital
Appendix C to Part 704 explains how a corporate must compute its
risk-weighted assets for purposes of determining its capital ratios.
Appendix C contains several references to NRSRO ratings.
In the definitions section of Appendix C, ``traded position'' is
defined with reference to an NRSRO rating. The proposed rule removes
the definition of ``traded position,'' as the term is used only in
paragraphs II(c)(3) and (4), which are proposed to be deleted, as
discussed below.
Paragraph II(a)(2)(viii) provides that claims on qualifying
securities firms, if rated in one of the three highest investment grade
categories by an NRSRO, may be risk-weighted at 20 percent. The
proposed rule removes the ratings references, requiring instead that,
for a 20 percent risk weighting, a qualifying securities firm must
either meet minimum credit quality standards as established by the
corporate credit union's board of directors or demonstrate at least a
strong capacity to meet its financial obligations, even under adverse
economic conditions, for the projected life of the exposure. The
corporate will use whichever requirement is more stringent. The board
of directors must explicitly accept the regulatory minimum credit
quality standard or establish a higher standard to be applied by
management.
Paragraph II(a)(2)(viii) also provides that a qualifying securities
firm may rely on the rating of its parent consolidated company if the
parent consolidated company guarantees the claim. The proposed rule
removes the rating reference, providing instead that a qualifying
securities firm may rely on the creditworthiness of its parent
consolidated company if the parent consolidated company guarantees the
claim. The parent company's creditworthiness is measured by the same
standards as that of the qualifying securities firm.
Paragraph II(b) addresses the risk-weighting of off-balance sheet
assets. Certain assets relating to asset backed commercial paper (ABCP)
facilities are weighted ``based on the assets of the obligor, after
considering any collateral or guarantees, or external credit ratings
under paragraph II(c)(3).'' See paragraphs II(b)(1)(iv), II(b)(2)(ii),
and II(b)(4). The proposed rule also deletes the phrase ``or external
credit ratings under paragraph II(c)(3)'' for each of these three
paragraphs, as paragraph II(c)(3) itself will be deleted under this
proposal.
Paragraphs II(c)(1) and (c)(2) provide a general approach to risk-
weighting recourse obligations, direct credit substitutes, and residual
interests. Paragraphs II(c)(3) and (c)(4) provide alternative methods
for calculating the risk weights of certain recourse obligations,
direct credit substitutes, and residual interests. Since these
alternative methods involve reliance on NRSRO ratings, the proposed
rule deletes these paragraphs. The proposed rule adds a new paragraph
II(c)(3) which allows a corporate with advanced risk management and
reporting systems to seek NCUA approval to use an internal ratings-
based approach to risk-weight those positions.\11\
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\11\ Acceptable internal credit risk rating systems typically:
(1) Are an integral part of the corporate's risk management system
that explicitly incorporates the full range of risks arising from
the corporate's participation in securitization activities; (2) link
internal credit ratings to measurable outcomes; (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; (5) use
clear, explicit criteria to classify assets into each internal
rating grade; (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'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.
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c. Part 709--Involuntary Liquidation of Federal Credit Unions and
Adjudication of Creditor Claims Involving Federally Insured Credit
Unions in Liquidation
Part 709 governs the involuntary liquidation of FCUs and the
adjudication of creditor claims involving federally insured credit
unions (FICUs). Section 709.10(b) provides that NCUA will not use its
authority to repudiate contracts under 12 U.S.C. 1787(c) to reclaim,
recover, or recharacterize financial assets transferred by a FICU in
connection with a securitization or in the form of a participation.
Section 709.10(f) provides that NCUA will not attempt to avoid an
otherwise legally enforceable securitization or participation agreement
solely because the agreement does not meet the contemporaneous
requirement of sections 207(b)(9) and 208(a)(3) of the FCU Act.
Section 709.10(a)(5) includes a definition of ``securitization''
that includes a reference to NRSRO ratings. The proposed rule deletes
the definition of securitization in paragraph (a)(5) and the references
to securitization in paragraphs (b), (f), and (g), as credit unions do
not securitize assets within the meaning of Part 709. In addition, the
proposal deletes the definition of ``special purpose entity'' in
paragraph (a)(6), as this phrase is only used in the definition of
``securitization.''
d. Part 742--Regulatory Flexibility Program
Part 742 provides an exemption from certain regulatory restrictions
for credit unions that have demonstrated sustained superior
performance. Pursuant to Sec. 742.4(a)(9) a credit union is exempt
from the prohibition in Sec. 703.13(d)(3) against the purchase of a
commercial mortgage related security provided, among other things, that
the security is rated in one of the two highest rating categories by at
least one NRSRO. The proposed rule removes the NRSRO requirement,
replacing it with the requirement that the issuer have very strong
capacity to meet its financial obligations, even under adverse
[[Page 11169]]
economic conditions, for the projected life of the security.
IV. Request for Comment
As discussed above, this proposal removes the references to NRSRO
credit ratings from NCUA regulations. In some places, the proposal
replaces these references with alternative standards of
creditworthiness. In other places, the Board believes that no
alternative is necessary.
The Board realizes there are many possible alternative standards of
creditworthiness, including some alternatives not used by the Board in
this proposal. For example, some other banking regulators, and third-
party commenters on proposals published by those regulators, have
suggested alternatives based on criteria such as macro-economic
factors, minimum probabilities of defaults, permitting the purchase of
only high quality and highly liquid investments, and other
criteria.\12\
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\12\ See Advanced Notice of Proposed Rulemaking on Alternatives
to the Use of External Credit Ratings in the Regulations of the OCC,
issued by the Office of the Comptroller of the Currency, 75 FR 49423
(Aug. 13, 2010); Advanced Notice of Proposed Rulemaking on
Alternatives to the Use of External Credit Ratings in the
Regulations of the OTS, issued by the Office of Thrift Supervision,
75 FR 63107 (Oct. 14, 2010);http://www.regulations.gov/#!searchResults;dct=PS;rpp=10;so=DESC;sb=postedDate;po=0;s=OCC-2010-
0017; http://www.regulations.gov/#!searchResults;dct=PS;rpp=10;so=DESC;sb=postedDate;po=0;s=OTS-2010-
0029
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NCUA is open to the use of alternatives other than those contained
in this proposal. Accordingly, commenters are encouraged to address the
specific questions set forth below in addition to providing general
comments.
Are there some other alternative standards of creditworthiness that
are better, or more appropriate, than those proposed by NCUA? If so,
please specify:
What the alternative standards are;
The sections(s) of NCUA regulations in which the alternative(s)
should be employed; and Why the alternative(s) are better than the
standards used in this proposal.
In proposing alternative standards of creditworthiness, please
specifically address whether and how the standards:
Provide for a reasonable and objective assessment of the likelihood
of full repayment of principal and interest over the life of the
security and in stressed market and economic scenarios;
Foster prudent risk management;
Are transparent, replicable, and well defined;
Allow for supervisory review;
Differentiate among investments in the same asset class with
different credit risk;
Provide for the timely and accurate measurement of negative and
positive changes in investment quality over time, to the extent
practicable;
Strike the appropriate balance between the cost of the credit risk
assessment, the risk of an incorrect assessment, and the burden of the
assessment; and
Provide for a lesser burden (if appropriate), on smaller credit
unions.
V. Regulatory Procedures
a. Regulatory Flexibility Act
The Regulatory Flexibility Act requires NCUA to prepare an analysis
to describe any significant economic impact any proposed regulation may
have on a substantial number of small entities (those under $10 million
in assets). The proposed rule would remove NRSRO ratings from NCUA's
regulations. Generally, credit unions with under $10 million in assets
do not engage in investment activities that are affected by those
portions of the NCUA rules that refer to NRSRO ratings. Accordingly,
the proposed amendments will not have a significant economic impact on
a substantial number of small credit 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); 5 CFR part
1320. For purposes of the PRA, a paperwork burden may take the form of
a reporting, recordkeeping, or disclosure requirement, each referred to
as an information collection. The Office of Management and Budget (OMB)
has approved the current information collection requirements in part
703 and assigned them control number 3133-0133. OMB has approved the
current information collection requirements in part 704 and assigned
them control number 3133-0129.
The proposed rule would potentially modify credit unions' existing
practices to impose record-keeping burdens. The proposed amendments
would replace NRSRO ratings-based criteria for evaluating
creditworthiness with new subjective standards based on the credit
union's own evaluation of creditworthiness. The credit union would have
to be able to explain how the securities it purchased or counterparties
with which it did business meet the standards set forth in the proposed
amendments. As such, we believe that some credit unions may be required
to develop additional criteria for assessing the creditworthiness of
securities and counterparties and apply those criteria.
We believe that all of the corporate credit unions already have
policies and procedures in place for evaluating the credit risk of
securities activities, but the proposed amendments may require
additional analysis of credit risk and thus result in additional
burdens on some natural person FCUs. We estimate that approximately 750
natural person FCUs may need to develop or augment a system for
evaluating creditworthiness. We estimate that, on average, the FCUs
will spend 20 hours on such a system, resulting in an initial aggregate
burden of 15,000 hours. This estimate is based on our belief that many
of these FCUs already have some criteria in place for evaluating
creditworthiness.
We further estimate that, on average, each of those FCUs will spend
an additional 10 hours each year reviewing, adjusting, and applying its
system for evaluating creditworthiness, for a total of 7,500 hours
across the industry. Once again, this estimate reflects our belief that
many of these FCUs already are applying a system of evaluating
creditworthiness.
As required by the PRA, NCUA is submitting a copy of this proposal
to OMB for its review and approval. Persons interested in submitting
comments with respect to the information collection aspects of the
proposed rule should submit them to OMB at the address noted below.
The NCUA considers comments by the public on this proposed
collection of information in:
Evaluating whether the proposed collection of information is
necessary for the proper performance of the functions of the NCUA,
including whether the information will have a practical use;
Evaluating the accuracy of the NCUA's estimate of the burden of the
proposed collection of information, including the validity of the
methodology and assumptions used;
Enhancing the quality, usefulness, and clarity of the information
to be collected; and
Minimizing the burden of collection of information on those who are
to respond, including through the use of appropriate automated,
electronic, mechanical, or other technological collection techniques or
other forms of
[[Page 11170]]
information technology; e.g., permitting electronic submission of
responses.
The Paperwork Reduction Act requires OMB to make a decision
concerning the collection of information contained in the proposed
regulation between 30 and 60 days after publication of this document in
the Federal Register. Therefore, a comment to OMB is best assured of
having its full effect if OMB receives it within 30 days of
publication. This does not affect the deadline for the public to
comment to the NCUA on the proposed regulation.
Comments on the proposed information collection requirements should
be sent to: Office of Information and Regulatory Affairs, OMB, New
Executive Office Building, Washington, DC 20503; Attention: NCUA Desk
Officer, with a copy to Mary Rupp, Secretary of the Board, National
Credit Union Administration, 1775 Duke Street, Alexandria, Virginia
22314-3428.
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.
The proposed rule would not have substantial direct effects on the
States, on the connection 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 proposal
does not constitute a policy that has federalism implications for
purposes of the executive order.
d. The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families
The NCUA has determined that this proposed rule will not affect
family well-being within the meaning of Sec. 654 of the Treasury and
General Government Appropriations Act, 1999, Public Law 105-277, 112
Stat. 2681 (1998).
List of Subjects
12 CFR Part 703
Credit unions, Investments, Reporting and recordkeeping
requirements.
12 CFR Part 704
Credit unions, Investments, Reporting and recordkeeping
requirements.
12 CFR Part 709
Bank deposit insurance, Credit unions.
12 CFR Part 742
Credit unions, Investments, Reporting and recordkeeping
requirements.
By the National Credit Union Administration Board on February
17, 2011.
Mary F. Rupp,
Secretary of the Board.
For the reasons stated in the preamble, the National Credit Union
Administration proposes to amend 12 CFR parts 703, 704, 709, and 742 as
set forth below:
PART 703--INVESTMENTS AND DEPOSIT ACTIVITIES
1. The authority citation for part 703 continues to read as
follows:
Authority: 12 U.S.C. 1757(7), 1757(8), 1757(15).
2. In Sec. 703.2 remove the definition of Deposit note, and revise
the definitions of Mortgage related security and Small business related
security to read as follows:
Sec. 703.2 Definitions.
* * * * *
Mortgage related security means a security as defined in Section
3(a)(41) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(41)).
* * * * *
Small business related security means a security as defined in
Section 3(a)(53) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(53)). This definition does not include Small Business
Administration securities permissible under Sec. 107(7) of the Act.
* * * * *
3. In Sec. 703.8, revise paragraph (b)(3) to read as follows:
Sec. 703.8 Broker-dealers.
* * * * *
(b) * * *
(3) If the broker-dealer is acting as the Federal credit union's
counterparty, the ability of the broker-dealer and its subsidiaries or
affiliates to fulfill commitments, as evidenced by capital strength,
liquidity, and operating results. The Federal credit union should
consider current financial data, annual reports, external assessments
of creditworthiness, relevant disclosure documents, and other sources
of financial information.
* * * * *
4. In Sec. 703.9, revise paragraph (d) to read as follows:
Sec. 703.9 Safekeeping of investments.
* * * * *
(d) Annually, the Federal credit union must analyze the ability of
the safekeeper to fulfill its custodial responsibilities, as evidenced
by capital strength, liquidity, and operating results. The Federal
credit union should consider current financial data, annual reports,
external assessments of creditworthiness, relevant disclosure
documents, and other sources of financial information.
5. In Sec. 703.14, revise paragraphs (e), (g)(9), (g)(11), (h)(1)
and (h)(2) to read as follows:
Sec. 703.14 Permissible investments.
* * * * *
(e) Municipal security. A Federal credit union may purchase and
hold a municipal security, as defined in Section 107(7)(K) of the Act,
only if the issuer has at least adequate capacity to meet its financial
obligations, even under adverse economic conditions, for the projected
life of the security. The credit union must prepare and document an
internal analysis that evaluates the capacity of the issuer to meet its
financial obligations, assuming adverse conditions, for the projected
life of the security. The credit union must also limit its aggregate
municipal securities holdings to no more than 75 percent of the credit
union's net worth and limit its holdings of municipal securities issued
by any single issuer to no more than 25 percent of the credit union's
net worth.
* * * * *
(g) * * *
(9) The counterparty to the transaction meets the minimum credit
quality standards as established by the Federal credit union's board of
directors.
* * * * *
(11) The aggregate amount of equity-linked member share
certificates does not exceed 50 percent of the credit union's net
worth;
* * * * *
(h) * * *
(1) The aggregate of the investments with any one counterparty is
limited to 25 percent of the credit union's net worth and 50 percent of
its net worth with all counterparties;
(2) At the time the Federal credit union purchases the securities,
the counterparty, or a party fully guaranteeing the counterparty, must
meet the minimum credit quality standards as established by the Federal
credit union's board of directors.
* * * * *
[[Page 11171]]
PART 704--CORPORATE CREDIT UNIONS
6. The authority citation for part 704 continues to read as
follows:
Authority: 12 U.S.C. 1762, 1766(a), 1772a, 1781, 1789, and
1795e.
7. In Sec. 704.2:
a. Remove the definition of Nationally Recognized Statistical
Rating Organization;
b. Revise the definition of Asset-backed commercial paper program
as revised on October 20, 2010, at 75 FR 64829, effective October 20,
2011; and
c. Revise the definitions for Eligible ABCP liquidity facility, and
Small business related security as added and revised, respectively, on
October 20, 2010, at 75 FR 64829, effective October 20, 2011.
The additions and revisions read as follows:
Sec. 704.2 Definitions.
* * * * *
Asset-backed commercial paper program (ABCP program) means a
program that primarily issues commercial paper 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.
* * * * *
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) The facility can be used to fund only those assets or
exposures that demonstrate adequate capacity to meet their financial
obligations, even under adverse economic conditions, for the projected
life of the asset or exposure; 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.
* * * * *
Small business related security means a security that 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.
* * * * *
8. In Sec. 704.6, revise paragraphs (f) and (g)(2)(iii), to read
as follows:
Sec. 704.6 Credit risk management.
* * * * *
(f) Credit ratings--(1) At the time of purchase, each investment
must be originated by an issuer that has at least a very strong
capacity to meet its financial obligations, even under adverse economic
conditions, for the projected life of the security.
(2) A corporate credit union must obtain and retain appropriate
documentation supporting the purchase of an investment. This
documentation must include the criteria, information, and analysis
relied upon to determine the credit quality of the investment,
including the capacity of the issuer to meet its obligations under
adverse economic conditions. A corporate credit union must identify and
monitor any changes in credit quality of the investment and retain
appropriate supporting documentation as long as the corporate owns the
investment.
(3) An investment is subject to the requirements of Sec. 704.10
if:
(i) There is reason to believe that the obligor no longer has a
very strong capacity to meet its financial obligations for the
remaining projected life of the security; 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) * * *
(2) * * *
(iii) The latest available financial reports, industry analyses,
and internal and external analyst evaluations sufficient to support
each approved credit limit.
9. In Appendix B:
a. Remove Part I(a)(2);
b. Redesignate Part I(a)(3), (4), and (5) as Part I(a)(2), (3), and
(4), respectively;
c. Remove Part II(b)(2);
d. Redesignate Part II(b)(3), (4), and (5) as Part II(b)(2), (3),
and (4), respectively; and
e. Revise Part I(a)(1), Part II(b)(1), and Part III(b) as follows:
Appendix B to Part 704--Expanded Authorities and Requirements
* * * * *
Part I
* * * * *
(a) * * *
(1) Purchase investments originated by an issuer that has at
least a strong capacity to meet its financial obligations, even
under adverse economic conditions, for the projected life of the
security;
* * * * *
Part II
* * * * *
(b) * * *
(1) Investments must be made pursuant to an explicit policy
established by the corporate credit union's board of directors. Any
foreign issue or issuer must have at least a very strong capacity to
meet its financial obligations, even under adverse economic
conditions, for the projected life of the security.
* * * * *
Part III
* * * * *
(b) Credit Quality:
(1) All derivative transactions are subject to the following
requirements:
(i) If the intended counterparty is domestic, the counterparty
must meet minimum credit quality standards as established by the
corporate's board of directors;
(ii) If the intended counterparty is foreign, the corporate must
have Part II expanded authority and the counterparty must meet
minimum credit quality standards as established by the corporate's
board of directors;
(iii) The corporate must identify the criteria relied upon to
determine that the counterparty meets the credit quality
requirements of this part at the time the transaction is entered
into and monitor those criteria for as long as the contract remains
open; and
(iv) The corporate must comply with Sec. 704.10 of this part if
the credit quality of the counterparty deteriorates below the
minimum credit quality standards established by the corporate's
board of directors.
* * * * *
10. In Appendix C:
a. Remove the definition of Traded position from paragraph I(b);
[[Page 11172]]
b. Revise paragraphs II(a)(2)(viii)(A), II(a)(2)(viii)(B)
introductory text, II(b)(1)(iv), II(b)(2)(ii), and II(b)(4);
b. Remove paragraph II(c)(3) and remove and reserve paragraph
II(c)(4); and
c. Add new paragraph II(c)(3).
The revisions and addition read as follows:
Appendix C to Part 704--Risk-Based Capital Credit Risk-Weight
Categories
* * * * *
Part II: Risk-Weightings
(a) * * *
(2) * * *
(viii) * * *
(A) A qualifying securities firm must meet the minimum credit
quality standards as established by the corporate credit union's
board of directors or demonstrate at least a strong capacity to meet
its financial obligations, even under adverse economic conditions,
for the projected life of the exposure, whichever requirement is
more stringent. Alternatively, a qualifying securities firm may rely
on the creditworthiness 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 requirements of paragraph (a) if the
claim arises under a contract that:
* * * * *
(b) * * *
(1) * * *
(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.
* * * * *
(2) * * *
(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.
* * * * *
(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.
* * * * *
(c) * * *
(3) Internal ratings-based approach--
(i) Calculation. Corporate credit unions with advanced risk
management and reporting systems may seek NCUA approval to use
credit risk models to calculate risk-weighted asset amounts for
positions described in paragraphs II(c)(1) and (2) of this section.
In determining whether to grant approval, NCUA will consider the
financial condition and risk management sophistication of the
corporate credit union and the adequacy of the corporate's risk
models and supporting management information systems.
(ii) Consistent use of internal ratings-based approach. A
corporate credit union that has been granted NCUA approval to use an
internal ratings-based approach and that has determined to use such
an approach must do so in a consistent manner for all securities so
rated.
PART 709--INVOLUNTARY LIQUIDATION OF FEDERAL CREDIT UNIONS AND
ADJUDICATION OF CREDITOR CLAIMS INVOLVING FEDERALLY INSURED CREDIT
UNIONS IN LIQUIDATIONS
11. 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.
12. In Sec. 709.10, remove paragraphs (a)(5) and (a)(6), and
revise the section heading and paragraphs (b), (f), and (g) to read as
follows:
Sec. 709.10 Treatment by conservator or liquidating agent of
financial assets transferred in connection with a participation.
* * * * *
(b) The Board, by exercise of its authority to disaffirm or
repudiate contracts under 12 U.S.C. 1787(c), will not reclaim, recover,
or recharacterize as property of the credit union or the liquidation
estate any financial assets transferred to another party by a
federally-insured credit union in connection with a participation,
provided that the transfer meets all the conditions for sale accounting
treatment under generally accepted accounting principles, other than
the ``legal isolation'' condition addressed by this section.
* * * * *
(f) The Board will not seek to avoid an otherwise legally
enforceable participation agreement executed by a federally-insured
credit union solely because such agreement does not meet the
``contemporaneous'' requirement of sections 207(b)(9) and 208(a)(3) of
the Federal Credit Union Act.
(g) This section may be repealed by the NCUA upon 30 days notice
and opportunity for comment provided in the Federal Register, but any
such repeal or amendment will not apply to any transfers of financial
assets made in connection with a participation that was in effect
before such repeal or modification. For purposes of this paragraph, a
participation would be in effect on the date that the parties executed
the participation agreement.
PART 742--REGULATORY FLEXIBILITY PROGRAM
13. The authority citation for part 742 continues to read as
follows:
Authority: 12 U.S.C. 1756, 1766.
14. In Sec. 742.4, revise paragraph (a)(6)(i) to read as follows:
Sec. 742.4 RegFlex relief.
(a) * * *
(6) * * *
(i) The issuer has at least a very strong capacity to meet its
financial obligations, even under adverse economic conditions, for the
projected life of the security;
* * * * *
[FR Doc. 2011-4070 Filed 2-28-11; 8:45 am]
BILLING CODE 7535-01-P