Corporate Credit Unions, 65210-65293 [E9-28219]

Agencies

• National Credit Union Administration

[Federal Register Volume 74, Number 235 (Wednesday, December 9, 2009)]
[Proposed Rules]
[Pages 65210-65293]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E9-28219]



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Part II





National Credit Union Administration





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



Corporate Credit Unions; Proposed Rule

Federal Register / Vol. 74 , No. 235 / Wednesday, December 9, 2009 / 
Proposed Rules

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NATIONAL CREDIT UNION ADMINISTRATION

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

RIN 3133-AD58


Corporate Credit Unions

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed rule.

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SUMMARY: NCUA is issuing proposed amendments to its rule governing 
corporate credit unions contained in part 704. The major revisions 
involve corporate credit union capital, investments, asset-liability 
management, governance, and credit union service organization (CUSO) 
activities. The amendments would establish a new capital scheme, 
including risk-based capital requirements; impose new prompt corrective 
action requirements; place various new limits on corporate investments; 
impose new asset-liability management controls; amend some corporate 
governance provisions; and limit a corporate CUSO to categories of 
services preapproved by NCUA. In addition, this proposal contains 
conforming amendments to part 702, Prompt Corrective Action (for 
natural person credit unions); part 703, Investments and Deposit 
Activities (for federal credit unions); part 747, Administrative 
Actions, Adjudicative Hearings, Rules of Practice and Procedure, and 
Investigations; and part 709, Involuntary Liquidation of Federal Credit 
Unions and Adjudication of Creditor Claims Involving Federally Insured 
Credit Unions. These amendments will strengthen individual corporates 
and the corporate credit union system as a whole.

DATES: Comments must be received on or before March 9, 2010.

ADDRESSES: You may submit comments by any of the following methods 
(Please send comments by one method only):
     Federal eRulemaking Portal: https://www.regulations.gov. 
Follow the instructions for submitting comments.
     NCUA Web site: https://www.ncua.gov/RegulationsOpinionsLaws/proposed_regs/proposed_regs.html. Follow the 
instructions for submitting comments.
     E-mail: Address to regcomments@ncua.gov. Include ``[Your 
name] Comments on Part 704 Corporate Credit Unions'' 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 https://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) 518-6540 or send an e-mail to OGCMail@ncua.gov.

FOR FURTHER INFORMATION CONTACT: Richard Mayfield, Capital Markets 
Specialist, Office of Corporate Credit Unions, at the address above or 
telephone: (703) 518-6642; Ross Kendall, Staff Attorney, Office of 
General Counsel (OGC), at the address above or telephone (703) 518-
6540; Paul Peterson, Director, Applications Section, OGC, at the 
address above or telephone (703) 518-6540; or Todd Miller, Regional 
Capital Market Specialist, Region V, at telephone (703) 409-4317.

SUPPLEMENTARY INFORMATION: 
    The NCUA's primary mission is to ensure the safety and soundness of 
federally-insured credit unions. NCUA performs this important public 
function by examining all federal credit unions, participating in the 
examination and supervision of federally-insured state chartered credit 
unions in coordination with state regulators, and insuring federally-
insured credit union members' accounts. In its statutory role as the 
administrator of the National Credit Union Share Insurance Fund 
(NCUSIF), the NCUA insures and supervises approximately 7,740 
federally-insured credit unions, representing 98 percent of all credit 
unions and approximately 89 million members.\1\
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    \1\ Within the fifty states, approximately 155 state-chartered 
credit unions are privately insured and are not subject to NCUA 
regulation or oversight.
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    Over 95 percent of natural person credit unions (NPCUs) belong to, 
and receive services from, corporate credit unions (corporates). There 
are 27 retail corporates that provide services directly to NPCUs, and 
there is one wholesale corporate, U.S. Central Federal Credit Union 
(U.S. Central), that provides services to many of the 27 retail 
corporates.
    The corporate system offers a broad range of support to NPCUs. The 
products and services provided by U.S. Central to retail corporates, 
and by retail corporates to NPCUs, include: Investment/deposit 
services, wire transfers, share draft processing and imaging, automated 
clearinghouse transactions (ACH) processing, automatic teller machine 
(ATM) processing, bill payment services and security safekeeping. The 
volume of payment systems-related transactions throughout the system 
annually runs into the millions and the dollar amounts associated with 
those transactions are in the billions each month. Corporates also 
serve as liquidity providers for NPCUs. Natural person credit unions 
invest excess liquidity in a corporate when the NPCU has lower loan 
demand and draw down the invested liquidity when loan demand increases. 
In sum, corporates provide NPCUs with convenient and quality services 
and expertise, all at a fair price. For many NPCUs, this is a 
combination that makes the corporate system a valuable resource and, 
for some smaller NPCUs, an essential resource.
    Federally-chartered corporates are governed by federal law and 
state chartered corporates by state law. In addition, all corporates 
that are federally-insured, or that accept share deposits from NPCU 
members that are federally insured, must comply with NCUA's part 704 
corporate credit union rule. 12 CFR part 704; Sec.  704.1, and 12 
U.S.C. 1766(a). This proposal contains significant changes to part 704 
and conforming changes to other parts of NCUA's rules. The changes 
include new investment limitations, asset-liability management 
requirements, capital standards, prompt corrective action requirements, 
corporate governance requirements, and CUSO requirements.
    Prior to drafting this proposal, the Board considered all of the 
existing part 704, but ultimately concluded that the rule provisions 
addressed in this proposal, and discussed below, were the provisions 
that needed modification. These modifications are intended not only to 
avert a repeat of the recent problems encountered in the corporate 
system but also to anticipate new problems that might occur. For 
example, while the recent corporate problems were caused in part by 
spread widening associated with perceptions of credit risk, the 
proposal requires a corporate conduct a new spread widening test that 
should demonstrate sensitivity to both credit risk and other potential 
market risks. Likewise, increased capital requirements and well-defined 
concentration limits protect not only

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against the types of risk that materialized in the past but also 
different risks that might materialize suddenly in the future.
    This preamble is organized in four sections as follows. Section I 
discusses the historical background leading up to the need for this 
rulemaking. Section II summarizes affected portions of the current 
corporate rule and the proposed changes to those portions. Section III 
contains a more complete analysis of the proposed changes with 
references to particular sections and paragraph numbers within part 
704. Section IV discusses various statutory requirements applicable to 
the rulemaking process.
    Section III, with its analysis of each proposed change to part 704, 
is particularly important. Included in subsection III.E are 
illustrations of how the various provisions of this proposal, if they 
had been applied to the corporate system in the past, would have 
drastically reduced the recent corporate losses. Section III looks not 
only to the past, but also the future. Specifically, subsection III.D. 
includes a discussion of how a hypothetical corporate might structure 
its balance sheet so as to achieve the proposed new capital 
requirements while at the same time complying with the various proposed 
investment and asset-liability limitations. The Board encourages 
commenters to take a very close look at the discussion in III.D. This 
discussion will help commenters to understand how the Board envisions 
the various elements of the proposal, working together, can permit the 
corporate system to return to a position of providing necessary 
services to natural person credit unions while ensuring the system 
operates within appropriate safety and soundness constraints. The Board 
invites comment on all aspects of Section III, including the viability 
of the assumptions employed by NCUA.

I. History of Current Issues in the Corporate System

I.A. Corporate System: Prior to 2000

    Up until the late 1990s, federally chartered corporates had a 
defined field of membership (FOM) serving a specific state or 
geographic region. Most state chartered corporates had national FOMs 
but primarily serviced the state in which they were incorporated. In 
1998, the NCUA Board began to approve national FOMs for federal 
corporates, in part to provide requested parity with state charters. 
Within a few years most corporates had a national FOM.
    NCUA's intention in allowing national FOMs was to provide NPCUs 
with the ability to select membership in a corporate that best met the 
needs of each NPCU in serving its members. The anticipated level of 
competition was expected to spur consolidation within the industry to 
build scale and improve efficiencies. In turn, this would build capital 
through increased earnings. While a few mergers occurred, one of the 
primary consequences of competition was to reduce margins on services 
and put pressure on the corporates to seek greater yields on their 
investments.

I.B. Corporate System: 2000 Through Mid-2007

    The investment provisions of NCUA's corporate regulation, located 
at 12 CFR part 704, have for many years permitted corporates to 
purchase private label mortgage-backed and mortgage-related securities 
(collectively referred to as MBS). Part 704, however, restricts most 
corporates (those without expanded investment authority) to investing 
in only the highest credit quality rated securities by at least one 
Nationally Recognized Statistical Rating Organization (NRSRO).\2\ 
Historically, highly rated securities have experienced minimal defaults 
and have been very liquid. Under NCUA rules, some corporates were 
permitted to exercise expanded investment authority and to purchase 
investment grade securities rated down to BBB because they had higher 
capital ratios, more highly trained personnel, and more capacity in 
their systems to monitor and model their portfolios. Even those 
corporates that had expanded credit risk authority, however, used it 
sparingly. In addition to being limited to securities with very high 
NRSRO ratings, corporates were required to perform a comprehensive 
credit analysis of the underlying collateral supporting the marketable 
security.
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    \2\ The term nationally recognized statistical rating 
organization (NRSRO) is used in federal and state statutes and 
regulations to confer regulatory benefits or prescribe requirements 
based on credit ratings issued by credit rating agencies identified 
by the Securities and Exchange Commission (SEC) as NRSROs. The 
Credit Rating Agency Reform Act of 2006 requires a credit rating 
agency seeking to be treated as an NRSRO to apply for, and be 
granted, registration with the SEC. See final SEC Rule, Oversight of 
Credit Rating Agencies Registered as Nationally Recognized 
Statistical Rating Organizations, at 72 FR 33564 (June 18, 2007).
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    Either through direct purchase, or indirectly through investments 
at U.S. Central, the corporate system became heavily invested in 
privately issued MBS. Between 2003 and mid-2007, the percentage of 
investments in MBS grew from 24 percent to 37 percent. At purchase, 
these securities provided the corporates with a modest increase in 
yield over traditional investments in other asset-backed securities 
(e.g., securitized credit card and auto receivables). The vast majority 
of MBS had high credit ratings (AA equivalent or above) and interest 
rates that reset on a monthly or quarterly basis, which closely matched 
the corporates' need to fund dividends on member shares.\3\ These 
features made MBS highly marketable and thus provided adequate 
liquidity to the corporates so they, in turn, could provide liquidity 
to their NPCU members.
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    \3\ Overnight share dividends repriced daily. Fixed rate share 
certificates were funded by investing in interest rate swaps. The 
swaps converted the variable rates paid by the MBS to fixed rates 
that could be used to pay the certificate dividends.
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    U.S. Central and Western Corporate Federal Credit Union (WesCorp) 
had the highest concentrations of MBS in the entire corporate 
system.\4\ The advent of national FOMs produced the competition that 
may, in turn, have helped generate these MBS concentrations. WesCorp 
was able to attract new NPCU members in part by offering dividend rates 
higher than other corporates. Consequently, it maintained an aggressive 
earnings strategy achieved by acquiring higher yielding (i.e., riskier, 
though still highly rated) MBS with greater amounts of credit risk. In 
direct response to WesCorp's market share success, other corporates 
likely pressured U.S. Central, their wholesale corporate, to pay 
higher, more competitive dividends which those corporates could pass 
along to their NPCU members. As a result, U.S. Central changed its 
portfolio strategy and also invested heavily in higher yielding MBS.
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    \4\ NCUA placed both USC and WesCorp into conservatorship in 
March 2009, as discussed further below.
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    NCUA communicated to corporates the need to establish reasonable 
concentration limits in their board policies. In January 2003, NCUA 
issued Corporate Credit Union Guidance Letter 2003-01, which expressly 
highlighted the risks associated with credit concentrations and 
specifically addressed the need for corporates to establish appropriate 
limitations within their credit risk management policies.
    During this timeframe, NCUA was also beginning to focus efforts on 
identifying and educating NPCUs on emerging risks associated with 
proper credit risk management of lending, including real estate 
lending, because of a nation-wide increase in alternative lending 
arrangements. Over the next few years, NCUA and the federal banking 
agencies worked cooperatively to provide numerous pieces of industry

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guidance on non-traditional mortgage products. NCUA warned of the 
potential adverse impact these types of loans could have on consumers 
and credit union balance sheets. Natural person credit unions have 
responded favorably to the supervision oversight of NCUA; to date, 
these types of mortgage loans represent less than 4 percent of all 
first mortgage loans outstanding in the credit union industry.
    In April 2007, several months before the distress in the mortgage 
market surfaced, NCUA issued Corporate Credit Union Guidance Letter No. 
2007-02, focusing on the various risks associated with MBS. This letter 
addressed MBS credit risk, liquidity risk, market value risk, and 
concentration risk, and by mid-2007 corporates had, by-and-large, 
ceased the purchase of private label MBS. Still, by the summer of 2007 
the MBS at the heart of the corporate problem were already on the books 
of U.S. Central and WesCorp. At that time, all their investments, 
including MBS, were still rated investment grade, and 98 percent were 
rated AA or higher. It was not until a year later (June 2008) that 
these corporates' MBS credit ratings began migrating downward, and even 
then 96 percent were still investment grade and 92 percent were still 
rated AA or better.

I.C. Corporate System: Mid-2007 Through Mid-2008

    Beginning mid-year 2007, real estate values declined across many 
markets in the U.S. and greater numbers of mortgages became delinquent 
leading to a greater number of foreclosures. The higher number of 
foreclosures further eroded housing prices, resulting in lower recovery 
of principal and even higher losses when the foreclosed properties were 
liquidated. This resulted in sharp price declines for MBS and a 
corresponding shallowing of the market as a flight to quality arose.
    Initially, market participants believed the market disturbance was 
limited to the subprime market and would be short-lived, and the 
performance of the senior credit positions in MBS, such as those 
primarily held by corporates, would not be at risk; however, that has 
proven not to be the case. By the end of 2007 and early into 2008, what 
started out as problems with sub-prime mortgages spread to Alt-A loans, 
option ARM loans, and finally to prime mortgage loans.\5\
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    \5\ Alt-A loans are between subprime and prime. Generally, the 
borrowers have good credit histories, but pay higher interest 
because of some other risk factor, such as low documentation or high 
loan-to-value ratio. Option ARM loans (option adjustable rate 
mortgages) allow the borrower to choose between different payment 
options period to period. Prime mortgage loans are considered high 
quality, with highly rated borrowers and other criteria indicating 
relatively low risk.
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    Some MBS were backed by underlying loans that had imprudent 
underwriting. These alternative mortgage loans were aggressively made 
to buyers in high-price home markets as a means to address home 
affordability.\6\ The weak credit fundamentals of the underlying 
mortgages, the inherent risk of the MBS structures, and the declining 
home market combined to severely affect the performance of MBS holdings 
of some corporates.
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    \6\ Very few, if any, of these problem loans that found their 
way into MBS pools were originated by credit unions.
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    MBS prices and marketability declined significantly. Even bonds 
that held AA ratings or higher were unable to be sold at prices close 
to par, discouraging investors, including corporates, from selling 
them. Corporates increasingly looked to borrowings to meet liquidity 
demands. By pledging their MBS assets as security, corporates were able 
to obtain financing from external lenders.
    In hindsight, it would have been preferable for the corporates to 
have sold their problem MBS in 2007. However, any sale following the 
MBS market dislocation in the summer of 2007 would have forced 
unrealized losses to become realized losses at a time when actual 
credit impairment of the underlying assets was viewed by many as 
unlikely. Absent a market of willing buyers, private label MBS 
increasingly could only be sold at a very severe discount (distressed 
prices)--causing losses even more significant than the accumulated 
unrealized losses on available-for-sale securities reflected on the 
financial statements. The conventional market wisdom at the time was 
that the problems in the MBS markets were temporary and it did not make 
economic sense to sell securities until market liquidity and 
counterparty trust improved.
    Conditions did not improve and as the MBS markets became more 
distressed and illiquid, the margin requirements set by lenders for MBS 
collateral pledged by their corporate credit union borrowers increased. 
The cost of primary borrowing sources available to corporates became 
prohibitively expensive as a result. Due to the continued price 
devaluation of MBS, the ability to borrow by pledging corporate 
investment portfolios diminished significantly, thereby increasing 
liquidity pressures. In turn, this reduced leverage diminished the 
yields paid by the corporates and made them less attractive. NPCUs 
began to invest part of their excess liquidity elsewhere, further 
increasing corporate liquidity concerns.
    In response to these concerns, NCUA directed corporates to consider 
a number of steps to ensure adequate sources of liquidity, including: 
encouraging the establishment of commercial paper and medium-term note 
programs; encouraging additional liquidity sources (both advised and 
committed); encouraging an increase in the number of repo transaction 
counterparties; encouraging membership in a Federal Home Loan Bank 
(FHLB); requiring independent third party stress test modeling of 
mortgage-related securities to determine if the securities would 
continue to cash flow; assisting U.S. Central to gain access to the 
Federal Reserve Board's discount window; and encouraging education and 
communication with their members about what was occurring in the 
financial market and how it was affecting their balance sheets. 
Corporates have done a good job of communicating these issues with 
their members and this did assist in preventing significant outflows of 
funds from the corporate system.
    On August 11, 2008, the Wall Street Journal published an article on 
the unrealized losses on available-for-sale securities in the corporate 
system. The article generated additional questions and concerns 
throughout the credit union industry and increased the possibility of a 
run on corporate shares. A run would have forced some corporates to 
sell their MBS at severely depressed prices, leading to loss of not 
only all the member capital in the affected corporates but also most 
member shares.\7\ The loss of these shares would have likely caused the 
failure of many member NPCUs and required numerous recapitalizations of 
the NCUSIF, with catastrophic effects on the credit union system as a 
whole.
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    \7\ The vast majority of shares in corporates are uninsured 
because the account balances are well above the $250,000 federal 
insurance limit.
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    Also in that August 2008 timeframe the media publicized problems 
with Fannie Mae, Freddie Mac, Bear Stearns, Countrywide, and numerous 
other financial entities. Liquidity in the global markets froze: 
liquidity had become not only expensive, but almost impossible to 
obtain. Unfortunately, these events coincided with seasonal liquidity 
demands placed by NPCUs on their corporates. Traditionally, NPCUs 
withdraw funds during August and September, and funds begin to flow 
back into the corporates in October. The

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tightening liquidity environment was of significant concern to NCUA and 
the corporate system, because corporates must maintain adequate 
liquidity to ensure the uninterrupted functioning of the payment 
systems.
    The potential loss of member confidence in their corporates, ever-
increasing concerns about the credit quality of MBS, and the seasonal 
liquidity outflows all created the ``perfect storm'' for the corporate 
system. NCUA was concerned that some corporates would be unable to meet 
the liquidity demands of their members in the short-term or be unable 
to fund payment systems activity. In addition, NCUA had indications of 
an exodus of NPCU funds from the corporate system due to a lack of 
confidence. Accordingly, in the fall of 2008 it became critical for 
NCUA to initiate dramatic action to bolster confidence in the 
corporates and ensure the continuing flow of liquidity in the credit 
union system. The NCUA's initial public actions involved liquidity 
support, while the Board intensified its contingency planning on 
related issues, including corporate capital and corporate 
restructuring.
    During the last half of calendar year 2008 NCUA took several 
actions, in tandem with the Central Liquidity Facility (CLF), to 
increase liquidity throughout the entire credit union system, 
especially within the corporates. These pro-liquidity actions included:
     Encouraging corporates with large unrealized losses on 
holdings of MBS to make application to the Federal Reserve Discount 
Window.
     Converting loans made by corporates to NPCUs to CLF-funded 
loans using funds borrowed by the CLF from the U.S. Treasury.
     Announcing and implementing the Temporary Corporate Credit 
Union Liquidity Guarantee Program (TCCULGP) on October 16, 2008. The 
TCCULGP is similar to the FDIC's Temporary Liquidity Guarantee Program 
announced by the FDIC on October 14, 2008. The TCCULGP provides a 100 
percent guarantee on certain new unsecured debt obligations issued by 
eligible corporates.
     Announcing and implementing the Credit Union System 
Investment Program (CU SIP) and the Credit Union Homeowners 
Affordability Relief Program (CU HARP). Both programs allow 
participating NPCUs to borrow funds from the CLF and invest those funds 
in CU SIP notes issued by corporates, injecting additional liquidity 
into the corporates and the entire credit union system. With the launch 
of CU HARP and CU SIP, NCUA provided about $8 billion of additional 
funding to corporates to pay down external borrowings.\8\
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    \8\ The SIP and HARP programs were key in providing liquidity to 
the corporates and the credit union system at this critical 
juncture. These two programs, and other CLF lending, would not have 
been possible without NCUA's advocacy the previous September for 
lifting the CLF cap.
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    The unrealized losses in the corporate system grew to nearly $18 
billion by year-end 2008. The severity of the MBS price declines and 
credit downgrades, along with the erosion of subordinated classes 
within the MBS structures held by corporates, required reconsideration 
by some corporate credit unions that all such fair value declines were 
temporary.\9\ In January, 2009, several corporates reported major 
realized losses and significant capital depletion, and it became 
apparent that the NCUA's liquidity assistance efforts by themselves 
would not be sufficient to stabilize the corporates. The NCUA Board 
continued its consideration of issues including corporate capital and 
corporate restructuring and, at its January 28, 2009, meeting, the NCUA 
Board took the following actions in furtherance of corporate 
stabilization:
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    \9\ The term ``subordinated'' means that the security will 
absorb credit losses in the underlying pool of loans before other, 
more senior, securities absorb credit losses. In general, the 
principal of the subordinated security will be exhausted before the 
more senior securities absorb any loss.
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     Approved issuance of a $1 billion NCUSIF capital note to 
U.S. Central as a result of pending realized losses on MBS and other 
asset-backed securities. This action was necessary to preserve 
confidence in U.S. Central, given its pivotal role in the corporate 
system, and maintain external sources of funding.
     Approved the Temporary Corporate Credit Union Share 
Guarantee Program (TCCUSGP), which guarantees uninsured shares at 
participating corporates through September 30, 2011. This program was 
vital in maintaining NPCU confidence in the corporate system.
     Authorized the engagement of Pacific Investment Management 
Company, L.L.C. (PIMCO), an independent third party, to conduct a 
comprehensive analysis of expected non-recoverable credit losses for 
distressed securities held by corporates. This information served to 
augment NCUA's previous analysis of potential losses to the NCUSIF and 
provided an independent assessment of the reliability of information 
provided by the corporates. The focus on non-recoverable credit losses 
rather than the higher and more volatile losses due to other market 
factors was consistent with the need to determine the actual loss 
exposure of the NCUSIF.
     Announced that losses to the NCUSIF associated with 
corporates would be several billion dollars, exceeding the NCUSIF's 
entire retained earnings and impairing each credit union's one percent 
capitalization deposit.
     Issued an Advance Notice of Public Rulemaking (ANPR) on 
restructuring the corporate rule. The sixty-day comment period expired 
in April 2009. NCUA received almost five hundred comment letters, 
providing suggestions on possible regulatory reforms for corporates and 
the corporate system.
    In March 2009, due to huge operating losses at U.S. Central and 
WesCorp, lack of sufficient capital, and for other reasons, the NCUA 
Board was forced to place these two corporates into conservatorship. 
The action protected retail credit union share deposits and the 
interests of the NCUSIF and helped clear the way for NCUA to take 
additional mitigating actions as they might become necessary.
    As of May 2009, NCUA estimated that losses to the NCUSIF associated 
with the troubles in the corporate system exceeded the entire equity in 
the Fund and impaired approximately 69 percent of the capitalization 
deposit that all federally insured credit unions maintain with the 
NCUSIF. These losses necessitated premium and deposit replenishment 
assessments that would, in total, cost insured credit unions an amount 
equal to almost one percent of their insured shares. Though the credit 
union system as a whole had the net worth to absorb these costs and 
remain well capitalized, the legal structure of the NCUSIF would have 
required that credit unions take all these insurance expense charges at 
once, which would result in a contraction of credit union lending and 
other services. This would come at a particularly difficult time, when 
it was vital that credit unions be a source of consumer confidence and 
continue to make credit available to support an economic recovery. In 
fact, the NCUA Board realized that such a large, sudden impact on 
credit unions' financial statements could further destabilize consumer 
confidence.
    The Board was committed to seeking the lowest cost option for 
stabilizing the corporate system, while also minimizing the adverse 
impact on natural person credit unions and their members so that credit 
unions could remain a vibrant and healthy sector of the U.S. financial 
system. In pursuit of these ends, the Board drafted legislation to 
create a Temporary Corporate Credit Union Stabilization Fund (CCUSF). 
The

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proposed CCUSF would borrow money from the Treasury for up to seven 
years and use the money to pay expenses associated with the ongoing 
problems in the corporate credit union system, such as the capital 
injection into U.S. Central. The primary purpose of this new CCUSF 
would be to spread over multiple years the costs to insured credit 
unions associated with the corporate credit union stabilization effort, 
and to ensure that the payment by insured credit unions of those costs 
was anti-cyclical, and not pro-cyclical.
    The Board sought Congressional support and passage of the CCUSF. On 
May 20, 2009, Congress enacted and the President signed into law the 
Helping Families Save Their Homes Act of 2009 (Helping Families Act), 
Public Law 111-22. Section 204 of the Helping Families Act created the 
sought-after CCUSF and provided NCUA with other helpful tools, such as 
increasing the authority of the NCUSIF and CCUSF to borrow from the 
Treasury and permitting the NCUSIF to assess premiums over as much as 8 
years to rebuild the equity ratio should the ratio fall below 1.20 
percent.
    Immediately following passage of this legislation, the NCUA Board 
took a series of actions establishing and implementing the CCUSF. On 
June 18, 2009, the Board obligated the CCUSF to accept assignment from 
the NCUSIF of the $1 billion capital note extended to U.S. Central 
executed on January 28, 2009. The Board also determined to legally 
obligate the CCUSF for any liability arising from the TCCUSGP (share 
guarantee) and TCCULGP (liquidity guarantee) programs. These steps 
effectively spread the cost of the corporate stabilization program for 
insured credit unions over multiple years.
    For more than a year, then, going back to the summer of 2008, the 
NCUA Board has worked a number of avenues to stabilize the corporate 
system, involving liquidity improvement and protection, capital 
injections, and spreading the costs to NPCUs of the stabilization 
program out over multiple years. These actions were critical to the 
near- and mid-term survival of the corporate system and to minimizing 
the potential costs to the NCUSIF and to the insured NPCUs obligated to 
the fund the NCUSIF. For the longer term, however, the Board believes 
it needs to address the structure of corporates and the corporate 
system and the investment, capital, and governance standards by which 
corporates operate. Accordingly, the Board has turned its attention to 
part 704, NCUA's corporate rule, and to the public comments that the 
Board solicited in response to its ANPR.

I.D. The Advance Notice of Proposed Rulemaking (ANPR)

    In January 2009, NCUA solicited public comment on whether 
comprehensive changes to the structure of the corporate system were 
warranted. 74 FR 6004 (Feb. 4, 2009). This corporate credit union ANPR 
sought comment on how best to define and structure the role of 
corporates in the credit union system, whether to modify the level of 
required capital for corporates, whether to modify or limit the range 
of permissible investments for corporates, whether to impose new 
standards and limits on asset-liability management and credit risk, and 
whether to make modifications in the area of corporate governance.
    NCUA received some 445 comments in response to the ANPR. More than 
370 of these comments came from natural person credit unions (NPCUs). 
Eighteen corporates, 27 state credit union leagues, four national trade 
associations, and the National Association of State Credit Union 
Supervisors also commented.
    NCUA reviewed these public comments closely and considered them 
carefully in drafting this proposed rule. Certain specific comments 
received in response to the ANPR are discussed in Section C below as 
they relate to particular proposed amendments.

II. Summary of Current Rule and Proposed Changes

    This proposal contains numerous changes to the current corporate 
rule. Some of these changes are short and straightforward, while others 
are more lengthy and complex. This Section II briefly summarizes the 
current part 704 provisions, and the proposed changes. Section III 
describes each proposed change in more detail.

II.A. Current Part 704 Capital Rules

    Currently, corporates have only one mandatory minimum capital 
requirement: They must maintain total capital--retained earnings, paid-
in capital (PIC), and membership capital accounts (MCAs)--in an amount 
equal to or greater than 4 percent of their moving daily average net 
assets.\10\ Failure by a corporate to meet this minimum capital ratio 
triggers the requirement to file a capital restoration plan with NCUA 
and may cause NCUA to issue a capital restoration directive and take 
other administrative action. Although Prompt Corrective Action (PCA) 
applies to NPCUs and to banking entities, PCA does not currently apply 
to corporates.\11\ The current rule also provides that retail 
corporates with a retained earnings ratio of less than two percent must 
increase their retained earnings by a certain amount each quarter, but 
this reserving requirement only applies to a wholesale corporate credit 
union if its retained earnings ratio falls below one percent.
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    \10\ 12 CFR 704.3(d). Corporates have other capital-related 
requirements, such as a core capital ratio and a retained earnings 
ratio, but failure to meet these requirements only triggers future 
earnings retention requirements and does not trigger a capital 
restoration plan requirement.
    \11\ Section 216 of the Federal Credit Union Act establishes a 
PCA scheme for natural person credit unions. 12 U.S.C. 1790d. 
Paragraph (m) of Sec.  216 states specifically that the provisions 
of Sec.  216 are not applicable to corporate credit unions. Since 
corporate credit unions are different in form, function, and mission 
than natural person credit unions, the PCA scheme set forth in this 
proposal differs from that contained in Sec.  216 and its 
implementing regulation, 12 CFR Part 702. The legal authority for 
this proposed corporate PCA scheme is found in two different places. 
Section 120(a) of the Act, states, in pertinent part, that ``[A]ny 
central credit union chartered by the Board shall be subject to such 
rules, regulations, and orders as the Board deems appropriate * * * 
.'' 12 U.S.C. 1766(a). Section 201(b)(9) of the Act also requires 
that federally insured credit unions ``comply with the requirements 
of this [share insurance] title and of regulations prescribed by the 
Board thereto.'' 12 U.S.C. 1781(b)(9).
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II.B. Proposed Amendments to Part 704 Capital Rules

    NCUA intends to change the corporate capital requirements to make 
them stronger and more consistent with the requirements of the banking 
regulators. For example, the other regulators employ three different 
minimum capital ratios, not one ratio like NCUA. The current corporate 
minimum capital ratio is also calculated differently from any of the 
three ratios employed by the other regulators.
    The proposal replaces the current four percent total capital ratio 
with a four percent leverage ratio, and limits the capital that can be 
used to calculate the leverage ratio to core, or Tier 1, capital, which 
would include only the more permanent forms of corporate capital. The 
proposal also includes new minimum risk-based capital ratios that are 
calculated based on risk-weighted assets. Failure to meet these minimum 
ratios will trigger a capital restoration plan requirement, potential 
capital restoration directives, and other, new prompt corrective action 
(PCA) provisions. The new PCA provisions are similar to those currently 
applicable to banks. The due process associated with the new PCA 
provisions is set out in a new subpart to part 747 of NCUA's rules.
    The proposal also refines the acceptable elements of corporate 
capital. For example, after an appropriate phase-in period a certain 
percentage of core

[[Page 65215]]

capital must be in the form of retained earnings. The timing and amount 
of this retained earnings requirement is discussed in detail in Section 
III below.
    The proposal will also toughen the requirements for Tier 2 capital 
accounts (i.e., MCAs) that can be used in part to satisfy the new total 
risk based capital ratio. Specifically, the current minimum three year 
requirement for MCAs will be lengthened to five years, and the 
adjustable balance type of MCA accounts will be eliminated.
    The proposal also renames the two types of contributed capital 
accounts (PIC and MCA) to render the names more descriptive of what 
they actually are. PIC is renamed as perpetual contributed capital 
(PCC), and MCAs are renamed as nonperpetual capital accounts (NCAs). 
The proposal further permits corporates to issue PCC and NCAs to both 
members and nonmembers.
    The proposal will eliminate the current prohibition on corporates 
requiring credit unions to contribute capital to obtain membership or 
receive services. It will also permit members to transfer corporate 
capital instruments they hold to third parties and will require 
corporates to facilitate such transfers.
    The proposal also eliminates the special treatment that wholesale 
corporates receive with regard to retained earnings reserving 
requirements. All corporates will be subject to the same requirements 
with regard to retained earnings.
    Finally, the proposal permits a corporate, at its option, to give 
new contributed capital priority over existing contributed capital.

II.C. Current Part 704 Investment Limitations

    Among other investment provisions, the current part 704:
     Requires that a corporate maintain an internal investment 
policy that includes reasonable and supportable concentration limits, 
including limits by investor type and sector, but does not prescribe 
standards for determining the reasonableness of those limits.
     Requires that the aggregate of all investments in any 
single obligor is limited to the greater of 50 percent of capital or $5 
million.
     Specifies, for permissible investment types, that the 
investment must be rated no lower than AA--by at least one Nationally 
Recognized Statistical Rating Organization (NRSRO) at time of purchase. 
The required rating may be lower for certain investment types if the 
corporate has expanded authorities. Additional requirements apply if 
the rating is subsequently lowered. Certain investment types, such as 
U.S. government securities and CUSO investments, are exempt from the 
NRSRO requirement.
     Specifically prohibits certain types of investments, 
including most derivatives, most stripped MBS (e.g., interest only 
strips and principal only strips), mortgage servicing rights, and 
residual interests in asset-backed securities (ABS).
     Does not address investments that are structured to be 
subordinate, in terms of potential credit losses, to other securities.

II.D. Proposed Amendments to Part 704 Investment Limitations

    The proposal will impose specific concentration limits by 
investment sector. Sectors include residential mortgage-backed 
securities, commercial mortgage-backed securities, student loan asset-
backed securities, automobile loan/lease asset-backed securities, 
credit card asset-backed securities, other asset-backed securities, 
corporate debt obligations, municipal securities, registered investment 
companies, and an all others category to account for the development of 
new investments types. The proposal further restricts the purchase of 
high-risk structured instruments that concentrate, and thus multiply, 
market risk exposures, such as investments that return a multiple of a 
particular market interest rate. These limits would be in addition to 
current limits on derivatives. The proposal would also limit 
subordinated positions in all sectors. This limit will reduce a 
corporate's credit risk by restricting its ability to purchase 
mezzanine residential mortgage-backed securities, as some corporates 
did, or other subordinated structured securities that are not the most 
senior security in terms of credit risk.
    The proposed changes would prohibit additional investment types 
that have proven problematic, such as collateralized debt obligations 
(CDOs) and Net Interest Margin (NIM) securities.
    The proposed changes would require that a corporate get multiple 
ratings from different NRSROs, and only use the lowest of the ratings, 
and require that ratings be used only to exclude an investment, not as 
authorization to include one. Credit ratings will not be a substitute 
for pre-purchase due diligence and ongoing risk monitoring. Downgrades 
below the minimum rating threshold will continue to trigger investment 
action plans. These provisions, along with the asset-liability 
management (ALM) provisions described below, will reduce reliance on 
NRSRO ratings.
    The proposal will eliminate the current Part II expanded investment 
authority, modify the current Part IV expanded authority on 
derivatives, and impose increased capital requirements to qualify for 
Part I and II expanded investment authorities.

II.E. Current Part 704 ALM Provisions

    The current part 704 requires that corporates maintain an internal 
ALM policy. The rule requires that as part of that policy the corporate 
do Net Economic Value (NEV) modeling to measure interest rate risk, but 
the rule does not have any other specific requirements relating to the 
risks of mismatches between asset and liability cash flows. The current 
part 704 requires that any corporate permitting early withdrawals on 
share certificates ``assess a market-based penalty sufficient to cover 
the estimated replacement cost of the certificate redeemed.'' The 
current rule does not establish any minimum amount of cash, or cash 
equivalents, that a corporate must, for liquidity purposes, maintain on 
hand at all times. The current rule limits a corporate's borrowing to 
the greater of 10 times capital or 50 percent of shares and capital, 
but does not place any additional limits on secured borrowings.

II.F. Proposed Amendments to Part 704 ALM Provisions

    The proposal would:
     Establish a maximum limit on the weighted average life of 
a corporate's aggregate assets.
     Establish limits on cash flow mismatches so as not to 
exceed an acceptable gap between the average life of assets and 
liabilities.
     Require additional testing for spread widening and net 
interest income (NII) modeling; including testing standards.
     Further limit a corporate's ability to pay a market-based 
redemption price to no more than par, thus eliminating the ability to 
pay a premium on early withdrawals.
     Require a corporate maintain a minimum amount of cash or 
cash equivalents to ensure sufficient liquidity protection for payment 
system operations.
     Restrict the use of secured borrowings for purposes other 
than liquidity needs.
    The effects of these new, proposed ALM provisions, as well as the 
investment provisions discussed in paragraph E. above, are illustrated 
in more detail in subsection III.D. below.

[[Page 65216]]

II.G. Current Part 704 Corporate Governance Provisions

    The current part 704 places limitations on board representation, 
including limits on the number of trade organization representatives. 
The current rule does not, however, place any experience or knowledge 
requirements on individual corporate directors. The current rule does 
not require any disclosure of executive compensation to the members of 
a corporate, nor does it place any limits on golden parachute severance 
packages for senior executives.\12\ The current part 704 does not limit 
the representation of corporate executives and officials on the boards 
of other corporates.
---------------------------------------------------------------------------

    \12\ The Internal Revenue Code, and state law, may require some 
disclosure for state chartered corporates, but not for federal 
charters.
---------------------------------------------------------------------------

II.H. Proposed Amendments to Part 704 Corporate Governance Provisions

    The proposed changes, after appropriate phase-in periods, would: 
\13\
---------------------------------------------------------------------------

    \13\ Some of these proposals are phased-in over time.
---------------------------------------------------------------------------

     Require that corporate directors currently hold a Chief 
Executive Officer (CEO), Chief Financial Officer (CFO), or Chief 
Operating Officer (COO) position, at their credit union or member 
entity.
     Require that all compensation agreements between a 
corporate and its senior executives and directors be disclosed to the 
members of the corporate upon request and at least once annually to the 
entire membership.
     Provide for disclosure of material increases in 
compensation related to corporate mergers.
     Prohibit certain golden parachute payments and related 
indemnification provisions.
     Require that a majority of all corporate boards (including 
USC) consist of representatives from natural person credit unions.
     Establish term limits on both corporate members and 
individuals serving as representatives of corporate members.
     Prohibit an individual from serving on the boards of more 
than one corporate at a time and prohibit an organizational entity from 
having two or more individual representatives on the board of a single 
corporate.

II.I. Miscellaneous Proposed Amendments to Part 704

    The proposal:
     Removes Sec.  704.19, which provided wholesale corporates 
with a lower retained earnings requirement than retail corporates.
     Restricts the total amount of investments and loans a 
corporate may accept from any single member.
     Requires that corporate CUSOs restrict their services to 
brokerage services, investment advisory services, and other categories 
of services as preapproved by NCUA.
     Expands the current requirement that corporate CUSOs agree 
to give NCUA access to books and records to include access to the 
CUSO's personnel and facilities.

III. Discussion and Analysis of Particular Proposed Amendments

    This proposed rule contains amendments to different sections and 
appendices in part 704. The following table summarizes the current 
organization of part 704, and where, when, and how the Board intends to 
amend that organization and substance.

------------------------------------------------------------------------
          Current part 704 Rule Provision                 Amended?
------------------------------------------------------------------------
704.1 Scope.......................................  No.
704.2 Definitions.................................  Yes. First amendment
                                                     effective upon
                                                     publication of
                                                     final rule. Second
                                                     amendment effective
                                                     one year after
                                                     publication of
                                                     final rule.
704.3 Corporate credit union capital..............  Yes. Removed and
                                                     replaced effective
                                                     one year after
                                                     publication of
                                                     final rule.
704.4 Board responsibilities......................  Yes. Effective one
                                                     year after
                                                     publication of
                                                     final rule, current
                                                     Board
                                                     responsibilities
                                                     moved to 704.13.
                                                     Effective one year
                                                     after publication
                                                     of final rule, new
                                                     704.4 (Prompt
                                                     corrective action)
                                                     added.
704.5 Investments.................................  Yes.
704.6 Credit risk management......................  Yes.
704.7 Lending.....................................  No.
704.8 Asset and liability management..............  Yes.
704.9 Liquidity management........................  Yes.
704.10 Investment action plan.....................  No.
704.11 Corporate CUSOs............................  Yes.
704.12 Permissible services.......................  No.
704.13 [Reserved].................................  Effective one year
                                                     after publication
                                                     of final rule,
                                                     current 704.4,
                                                     Board
                                                     responsibilities,
                                                     moved to 704.13. No
                                                     change to
                                                     substance.
704.14 Representation.............................  Yes.
704.15 Audit requirements.........................  No.
704.16 Contract/written agreements................  No.
704.17 State-chartered corporate credit unions....  No.
704.18 Fidelity bond coverage.....................  No.
704.19 Wholesale corporate credit unions..........  Yes. Current 704.19
                                                     removed. New
                                                     704.19, Disclosure
                                                     of executive and
                                                     director
                                                     compensation,
                                                     added.
704.20 None.......................................  Yes. New 704.20,
                                                     Golden parachute
                                                     and indemnification
                                                     payments, added.
Appendix A--Model Forms...........................  Yes. Renamed Capital
                                                     Prioritization and
                                                     Model Forms.
Appendix B--Expanded Authorities and Requirements.  Yes.
Appendix C--None..................................  Yes. Effective one
                                                     year after
                                                     publication of
                                                     final rule, new
                                                     Appendix C, Risk-
                                                     Based Capital
                                                     Credit Risk-Weight
                                                     Categories, added.
------------------------------------------------------------------------

    This section of the preamble discusses each of these proposed 
amendments in detail. This section generally follows the organization 
of part 704, that is, starting with the proposed capital (Sec.  704.3) 
and PCA (Sec.  704.4) amendments, then investments (Sec.  704.5) and 
credit risk (Sec.  704.6), then asset and liability management (Sec.  
704.8), then corporate

[[Page 65217]]

board representation Sec.  (704.14), and then the new sections relating 
to disclosure of executive and director compensation (Sec.  704.19) and 
golden parachutes and indemnification (Sec.  704.20).
    Many of the proposed amendments require new definitions that appear 
in Sec.  704.2, and the discussion of these definitions appears with 
the discussion of the associated substantive change to the corporate 
rule. The proposal includes amendments to the Appendices A and B, and 
adds a new Appendix C. Since Appendix B relates to investment 
authority, the proposed amendments to that appendix are discussed as 
part of the discussion of Sec.  704.5. Since Appendices A and C (on 
model forms and the risk-weighting of assets, respectively) relate to 
corporate capital, the changes to these appendices are discussed as 
part of the discussion of the proposed Sec.  704.3. The proposed 
addition of subpart L to part 747 provides the due process associated 
with the new PCA provision, and so is discussed as part of the Sec.  
704.4 discussion.
    The proposed changes to capital terminology in part 704 also 
necessitate conforming amendments to parts 702, 703, and 709, as 
discussed below.

III.A. Amendments to Part 704 Relating to Capital

Current Part 704 Capital Requirements
    Adequate capital is essential to the safe and sound operation of a 
corporate. It ensures that the corporate has a buffer against the 
losses associated with all the various risks associated with the 
investments and activities of a corporate.
    Currently, part 704 contains only one mandatory, minimum capital 
requirement: that corporates achieve and maintain a ratio of capital to 
moving daily average net assets of at least four percent. Part 704 
defines capital, generally, to include retained earnings, paid-in 
capital (PIC), and membership capital accounts (MCAs). The current 
capital requirements in part 704 differ in certain respects from the 
capital requirements that banking regulators impose on banks. For 
example, part 704 does not include any capital calculations based on 
risk-weighted assets. Part 704 also permits certain membership capital 
accounts to qualify as corporate capital where those same accounts 
would not satisfy the bank regulators' definition of capital. Part 704 
permits membership capital accounts with terms as short as three years, 
while banking regulators require such capital to have terms of at least 
five years. In addition, part 704 permits adjustable balance membership 
capital accounts; while banking regulators do not recognize any sort of 
adjustable balance accounts as capital.
Public Comment on the ANPR
    The ANPR discussed various approaches that NCUA is considering with 
respect to capital requirements for corporates and solicited comment on 
several aspects of this issue. For example, the agency asked whether it 
should establish a new leverage ratio consisting only of more permanent 
(core) capital and excluding MCAs; increase the required capital ratio 
to more than four percent; and implement changes that would result in 
redefining MCAs in line with accepted banking notions of capital. The 
agency asked whether it should establish new minimum capital ratios 
based on risk-weighted asset classifications, which could include the 
use of some form of membership capital. Another question presented for 
comment and discussion in the ANPR was whether natural person credit 
unions should maintain contributed capital as a prerequisite to 
obtaining services from a corporate.
    Comments about capital and capital requirements were wide ranging, 
reflecting the importance and difficulty of this issue. Many commenters 
believe there is a need for greater capital within the corporate system 
and for more sensitive measures of the necessary capital.
    Ninety-seven commenters addressed the question of whether the 
agency should establish a new required capital ratio consisting of core 
capital only and excluding membership capital accounts. Sixty-four 
favored such a new capital ratio while 33 opposed it. One hundred 
sixteen commenters discussed whether a corporate should be permitted to 
provide services only to members who contributed tier 1 capital; 82 
favored this restriction while 34 opposed it. Regarding the question of 
whether the required capital ratio should be increased, the vast 
majority of commenters--80 of 93--favored increasing the required 
capital ratio to more than four percent.
    Of the 58 commenters who addressed the topic of whether the agency 
should change the rules regarding the manner in which membership 
capital can be adjusted, 44 favored and 14 opposed rule changes in this 
area. On the question of whether the corporates should be subject to 
risk-based capital standards, the commenters were nearly unanimous, 
with 173 of 185 comments favoring risk-based capital standards for 
corporates.
    Commenters advocating greater capital requirements generally 
supported a phase-in period before any new requirements become 
effective. The corporate trade association and many corporates 
suggested that all corporates should attain a minimum Tier 1 core 
capital ratio of four percent using 12 month daily average net assets 
(DANA) by the end of 2010 and higher minimum core capital levels in the 
future based on Basel.\14\ These commenters also said the use of DANA 
is necessary to account for fluctuations in assets due to the cash flow 
seasonality of credit unions, although there were different views among 
the commenters about the appropriate length of DANA, ranging from three 
months to three years.
---------------------------------------------------------------------------

    \14\ The definitions of DANA, and moving DANA, are laid out and 
discussed further on in this preamble.
---------------------------------------------------------------------------

    Some commenters took the opposing view, suggesting that current 
capital requirements are adequate with proper oversight and risk 
management. One commenter noted that an increased capital contribution 
requirement would limit the flexibility of credit unions in dealing 
with the corporate system. Another commenter indicated that, with an 
appropriate limitation on the investment authority and range of 
permissible services offered by a corporate in a consolidated corporate 
network, current capital rules should be adequate.
    Other commenters advocated that NCUA require mandatory capital 
contributions by natural person credit unions as a condition of 
receiving services from a corporate. One corporate that supported 
mandatory capital for services stated that such a requirement would 
likely drive the regionalization of corporates as natural person credit 
unions would limit their corporate relationships to one nearby 
corporate. Some commenters, however, took the opposite view, believing 
mandatory capital contributions to be too limiting on the ability of 
credit unions to choose the corporate they want to do business with; 
these commenters suggested that the corporate simply charge higher 
service fees for members not contributing capital.
    Many of those commenters who discussed the issue of membership 
capital accounts (MCAs) supported the idea of making MCA conform to the 
accepted banking standard of Tier 2 capital, e.g., to require that it 
be a minimum of five year term or, if of indefinite term, subject to at 
least five years notice of withdrawal. Many commenters suggested that 
MCA contributions be tied to asset size and

[[Page 65218]]

also that NCUA mandate that corporates implement MCA with uniform 
characteristics, so that there would be less competition among the 
corporates for capital from NPCUs. Some commenters also stated that MCA 
withdrawals should only be permitted if the corporate would be in 
compliance with applicable capital standards after withdrawal. Some 
commenters expressed the opposite view, with one suggesting that 
withdrawal within six months of notice should be sufficient.
    Commenters who supported the idea of a risk-based approach to 
capital indicated that they believed that appropriately designed risk-
based ca