Fixed Assets, Member Business Loans, and Regulatory Flexibility Program, 14372-14375 [2010-6391]

Agencies

• National Credit Union Administration

[Federal Register Volume 75, Number 57 (Thursday, March 25, 2010)]
[Proposed Rules]
[Pages 14372-14375]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-6391]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 701, 723 and 742

RIN 3133-AD68


Fixed Assets, Member Business Loans, and Regulatory Flexibility 
Program

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed rule with request for comments.

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SUMMARY: NCUA proposes to revise certain provisions of its Regulatory 
Flexibility Program (RegFlex) to enhance safety and soundness for 
credit unions. Those provisions pertain to fixed assets, member 
business loans (MBL), stress testing of investments, and discretionary 
control of investments. Some of these revisions will require conforming 
amendments to NCUA's fixed assets and MBL rules.

DATES: Comments must be received on or before May 24, 2010.

ADDRESSES: You may submit comments by any of the following methods 
(Please send comments by one method only):
     Federal eRulemaking Portal: 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 Proposed Rule 742, Regulatory Flexibility Program'' 
in the e-mail subject line.
     Fax: (703) 518-6319. Use the subject line described above 
for e-mail.
     Mail: Address to Mary Rupp, Secretary of the Board, 
National Credit Union Administration, 1775 Duke Street, Alexandria, 
Virginia 22314-3428.
     Hand Delivery/Courier: Same as mail address.
    Public Inspection: All public comments are available on the 
agency's website at 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) 518-6546 or send an e-mail to OGCMail@ncua.gov.

FOR FURTHER INFORMATION CONTACT: Frank Kressman, Staff Attorney, Office 
of General Counsel, at the above address or telephone (703) 518-6540.

SUPPLEMENTARY INFORMATION:

A. Background--Regulatory Flexibility Program

    The RegFlex Program exempts from certain regulatory restrictions 
and grants additional powers to those federal credit unions (FCUs) that 
have demonstrated sustained superior performance as measured by CAMEL 
ratings and net worth classifications. 12 CFR 742.1. An FCU may qualify 
for RegFlex treatment automatically or by application to the 
appropriate regional director. 12 CFR 742.2. Specifically, an FCU 
automatically qualifies when it has received a composite CAMEL rating 
of ``1'' or ``2'' for the two preceding examinations and has maintained 
a net worth classification of ``well capitalized'' under Part 702 of 
NCUA's rules for six consecutive preceding quarters or, if subject to a 
risk-based net worth (RBNW) requirement under Part 702, has remained 
``well capitalized'' for six consecutive preceding quarters after 
applying the applicable RBNW requirement. An FCU that does not 
automatically qualify may apply for a RegFlex designation with the 
appropriate regional director. 12 CFR 742.2(a) and (b). An FCU's 
RegFlex authority can be lost or revoked. 12 CFR 742.3.
    The NCUA Board established RegFlex in 2002. 66 FR 58656 (November 
23, 2001). Since then, NCUA has amended RegFlex a number of times to 
increase available relief for FCUs from a variety of regulatory 
restrictions or lessen the criteria required for obtaining RegFlex 
status. 71 FR 4039 (January 25, 2006); 72 FR 30247 (May 31, 2007); 74 
FR 13083 (March 26, 2009).

[[Page 14373]]

B. Discussion

1. Overview

    The current RegFlex rule provides RegFlex credit unions with 
regulatory relief in the following ten areas: (1) Charitable 
contributions; (2) nonmember deposits; (3) fixed assets; (4) MBLs; (5) 
discretionary control of investments; (6) stress testing of 
investments; (7) Zero-coupon securities; (8) borrowing repurchase 
transactions; (9) commercial mortgage related securities; and (10) 
purchase of obligations from a federally insured credit union. NCUA 
proposes amendments to the fixed assets, MBL, stress testing of 
investments, and discretionary control of investments provisions of the 
RegFlex rule. NCUA requests comment on those amendments.

2. Fixed Assets

    The Federal Credit Union Act authorizes FCUs to purchase, hold, and 
dispose of property necessary or incidental to its operations. 12 
U.S.C. 1757(4). Generally, the fixed asset rule provides limits on 
fixed asset investments, establishes occupancy and other requirements 
for acquired and abandoned premises, and prohibits certain 
transactions. 12 CFR 701.36. Fixed assets are defined in 701.36(e) as 
premises, furniture, fixtures, and equipment and includes any office, 
branch office, suboffice, service center, parking lot, facility, real 
estate where a credit union transacts or will transact business, office 
furnishings, office machines, computer hardware and software, automated 
terminals, and heating and cooling equipment. Section 701.36 prohibits 
an FCU with $1 million or more in assets from investing in fixed 
assets, the aggregate of which exceeds five percent of the FCU's shares 
and retained earnings, although upon an FCU's application, a regional 
director may set a higher limit. 12 CFR 701.36(a)(1) and (2).
    The RegFlex rule exempts RegFlex credit unions from the referenced 
five percent limit. 12 CFR 701.36(a)(1). NCUA believes that investing 
in higher levels of non-earning assets can materially affect a credit 
union's earnings ability and, therefore, its viability. Call report 
data collected by NCUA shows a higher percentage of earnings problems 
among credit unions with more than five percent of shares and retained 
earnings invested in fixed assets; the percentage of earnings problems 
increases as the level of fixed assets increases.
    The following examples illustrate the kinds of fixed asset related 
financial problems some credit unions are experiencing and are a source 
of concern for NCUA. They demonstrate how credit unions are 
experiencing earnings and net worth problems as a result of excessive 
investment in fixed assets.
    Example 1. Between 2005 and 2006, an FCU substantially increased 
its investment in fixed assets to 14.77% of total assets by relocating 
their main office, opening a new branch, and converting the old main 
office into a branch. This caused its operating expenses to increase to 
99.85% of gross income, which left insufficient earnings to cover loan 
losses, pay dividends, and maintain net worth. The FCU expanded its 
operations without conducting a sufficient analysis of the impact of 
the expansion and developing a sound financial plan. The FCU has 
performed poorly since 2006 and its net worth ratio has dropped from 
approximately 10.76% in 2005 to 6.10% in 2010. The credit union is 
currently supervised by NCUA's Division of Special Actions.
    Example 2. In December 2006, a credit union was interested in 
expanding and, at the time, its fixed assets were 1.46% of total 
assets. It built a new main office in 2007 in an effort to promote 
growth. The credit union projected it could grow into its new main 
office but due to the economic down-turn, cost overruns in the building 
construction, and other poor management decisions, it did not realize 
its projections. Since 2007, net income has been negative. By late 
2008, fixed assets had risen to 17.50% of total assets, largely due to 
the cost of the building. The credit union is seeking a merger partner 
but has been unsuccessful to date, mainly due to the cost and 
devaluation of the new building.
    Example 3. In 2004, a credit union decided to build a branch office 
to help promote growth. At the time, its net worth was 15.19% and fixed 
assets were 2.36% of total assets. When construction was completed in 
2006, fixed assets had risen to 13.76% of total assets. Since then, 
income has been negative and net worth has declined to 9.15%. The 
credit union has closed the branch and put it up for sale but has not 
received any offers.
    Example 4. An FCU began an aggressive fixed asset expansion 
project. The project caused its fixed assets to mushroom to 
approximately 16% of total assets. The FCU is unable to support this 
level of capital expenditures and has created a safety and soundness 
problem. NCUA issued a temporary cease and desist order to require the 
FCU to discontinue the project. The FCU is now cooperating with NCUA to 
address this problem. The above examples are a sampling of a larger and 
common problem.
    Accordingly, for the reasons discussed above, NCUA does not believe 
it is prudent to continue to exempt RegFlex credit unions from the five 
percent limit on fixed assets and proposes to rescind that exemption.

3. MBLs

    The MBL rule requires a credit union making a business loan to 
obtain the personal liability and guarantee of the borrower's 
principals as part of the rule's collateral and security requirements. 
12 CFR 723.7(b). Under the current rules, RegFlex credit unions are 
exempt from that requirement but may choose to require the principals' 
guarantee as part of their own underwriting standards and best 
practices. Id.
    NCUA proposes to rescind this exemption for RegFlex credit unions. 
NCUA believes obtaining the principals' personal guarantee is a prudent 
underwriting practice that greatly enhances the likelihood of loan 
repayment and should be required of all credit unions. A credit union 
that fails to do so subjects itself to increased risk, particularly in 
these economic times when MBL delinquencies and MBL charge-offs have 
increased. The below table illustrates the magnitude of MBL-related 
losses in credit unions.

                          September 30, 2009 Consolidated Financial Performance Report
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                                      2005 %          2006 %          2007 %          2008 %         9/2009 %
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Delinquent MBLs.................            0.42            0.53            1.87            2.26            3.33
Charged Off MBLs................            0.07            0.11            0.15            0.46            0.47
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[[Page 14374]]

    The below table illustrates an example of one credit union with a 
high concentration of MBLs with increasing net charge-offs.

                                 December 31, 2009 Financial Performance Report
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                                      2005  %         2006  %         2007  %         2008  %        9/2009  %
----------------------------------------------------------------------------------------------------------------
Net Worth Ratio.................            9.81           10.76            9.61            7.71            7.18
Percent of MBLs Compared to                59.51           52.07           55.19           50.77           55.66
 Assets.........................
Delinquent MBLs.................            0.15            0.25            1.05            3.62            7.21
Charged Off MBLs................            0.15            1.18            1.05            0.81            1.70
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    This trend in losses and delinquencies is becoming increasingly 
common, even among credit unions whose MBLs portfolios represent a 
smaller portion of their assets. Accordingly, for the reasons discussed 
above, the Board believes it is in the interest of safety and soundness 
to rescind the exemption. Credit unions will continue to have the 
option of seeking a waiver of the guarantee requirement under 723.10(e) 
on a case-by-case basis.

4. Stress Testing of Investments

    NCUA's investment rule requires an FCU to monitor the securities it 
holds. 12 CFR 703.12. Specifically, at least monthly, an FCU must 
prepare a written report setting out the fair value and dollar change 
since the prior month-end for each security held with summary 
information for its entire portfolio. 12 CFR 703.12(a). Similarly, at 
least quarterly, an FCU must prepare a written report setting out the 
sum of the fair values of all fixed and variable rate securities whose 
features include: (1) Embedded options; (2) remaining maturities 
greater than three years; or (3) coupon formulas that are related to 
more than one index or are inversely related to, or multiples of, an 
index. 12 CFR 703.12(b). If the sum in the quarterly report is greater 
than the FCU's net worth, then the report must estimate the potential 
impact, in percentage and dollar terms, of an immediate and sustained 
parallel shift in market interest rates of plus and minus 300 basis 
points on: (1) The fair value of each security in the FCU's portfolio; 
(2) the fair value of the FCU's portfolio as a whole; and (3) the FCU's 
net worth. 12 CFR 703.12(c). This calculation is known as ``stress 
testing'' the securities. Under the current rules, RegFlex credit 
unions are exempt from the requirement to stress test their securities.
    Because of low investment yields due to the current economic 
environment, many credit unions are incurring additional risk by 
investing in long-term instruments to increase yield and improve 
earnings. NCUA believes many credit unions are purchasing investment 
products they do not fully understand and are incurring significant 
interest rate and liquidity risk.
    The below chart illustrates the degree to which credit unions are 
investing in products with longer maturities further out on the yield 
curve. Although this may help achieve greater yield in the short term, 
an increase in market rates could result in a significant decrease in 
product value and cause liquidity problems. Credit unions need to 
stress test their investments so they have a clearer understanding of 
their risk profile and can better manage risk.

                                               December 31, 2009 Consolidated Financial Performance Report
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                         12/2008           3/2009           6/2009           9/2009          12/2009
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Total Investment >3 Years Maturities...............................          $38.2B           $39.7B           $43.4B           $45.6B           $50.7B
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The trends in the net long-term asset ratio reveal that credit 
unions are extending maturities in all types of assets, including loans 
and investments. NCUA has stressed the need for improved asset-
liability management, and this includes stress testing investments.
    For the reasons discussed above, the Board believes all FCUs must 
stress test their securities as a matter of safety and soundness and 
responsible business practices. Accordingly, the Board proposes to 
rescind the RegFlex exemption in this context.

5. Discretionary Control of Investments

    NCUA's investment rule requires an FCU to retain discretionary 
control over its purchase and sale of investments although, under the 
rule, an FCU will not be deemed to have delegated discretionary control 
to an investment adviser if the FCU reviews all recommendations from 
the investment adviser and authorizes a recommended purchase or sale 
transaction before its execution. 12 CFR 703.5(a). An exception to this 
general rule is that an FCU may delegate discretionary control over the 
purchase and sale of its investments to a person outside the FCU if the 
person is an investment advisor registered with the Securities and 
Exchange Commission and if the amount delegated is limited to up to 100 
percent of the FCU's net worth at the time of delegation. 12 CFR 
703.5(b). If an FCU exercises this limited authority, it must adjust 
the amount of funds held under discretionary control to comply with the 
100 percent of net worth cap at least annually. Id.
    Under the current rule, a RegFlex credit union is exempt from the 
discretionary control requirements in 703.5 that pertain to the 100 
percent of net worth limitation. In light of the current investment 
climate and reports of fraudulent practices in the investment banking 
industry, the Board is becoming increasingly concerned about the safety 
and soundness of credit unions and their investments. Accordingly, the 
Board proposes to rescind the RegFlex exemption pertaining to 
discretionary control of investments.

C. Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
to describe any significant economic impact a proposed rule may have on 
a substantial number of small entities (primarily those under ten 
million dollars in assets). This rule enhances safety and soundness 
without additional

[[Page 14375]]

regulatory burden. Accordingly, this proposed rule will not have a 
significant economic impact on a substantial number of small credit 
unions, and therefore, no regulatory flexibility analysis is required.

Paperwork Reduction Act

    NCUA has determined that this rule will not increase paperwork 
requirements under the Paperwork Reduction Act of 1995 and regulations 
of the Office of Management and Budget.

Executive Order 13132

    Executive Order 13132 encourages independent regulatory agencies to 
consider the impact of their actions on state and local interests. In 
adherence to fundamental federalism principles, NCUA, an independent 
regulatory agency as defined in 44 U.S.C. 3502(5), voluntarily complies 
with the executive order. This proposed rule would not have a 
substantial direct effect on the states, on the relationship between 
the national government and the states, or on the distribution of power 
and responsibilities among the various levels of government. NCUA has 
determined that this proposed rule does not constitute a policy that 
has federalism implications for purposes of the executive order.

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

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

Agency Regulatory Goal

    NCUA's goal is to promulgate clear and understandable regulations 
that impose minimal regulatory burden. We request your comments on 
whether this proposed rule is understandable and minimally intrusive if 
implemented as proposed.

List of Subjects

12 CFR Part 701

    Credit unions.

12 CFR Part 723

    Credit, Credit unions, Reporting and recordkeeping requirements.

12 CFR Part 742

    Credit unions, Reporting and recordkeeping requirements.

    By the National Credit Union Administration Board on March 18, 
2010.
Mary Rupp,
Secretary of the Board.
    For the reasons discussed above, NCUA proposes to amend 12 CFR 
parts 701, 723, and 742 as follows:

PART 701--ORGANIZATION AND OPERATIONS OF FEDERAL CREDIT UNIONS

    1. The authority citation for part 701 continues to read as 
follows:

    Authority:  12 U.S.C. 1752(5), 1755, 1756, 1757, 1759, 1761a, 
1761b, 1766, 1767, 1782, 1784, 1787, and 1789. Section 701.6 is also 
authorized by 31 U.S.C. 3717. Section 701.31 is also authorized by 
15 U.S.C. 1601 et seq., 42 U.S.C. 1861 and 42 U.S.C. 3601-3610. 
Section 701.35 is also authorized by 42 U.S.C. 4311-4312.

    2. Amend Sec.  701.36 by revising paragraphs (d) introductory text 
and (d)(1) to read as follows:


Sec.  701.36  FCU ownership of fixed assets.

* * * * *
    (d) Regulatory Flexibility Program. Federal credit unions that meet 
Regulatory Flexibility Program standards, as determined pursuant to 
Part 742 of this chapter, are exempt from the three-year partial 
occupancy requirement described in paragraph (b) of this section when 
acquiring unimproved land for future expansion pursuant to the terms of 
section 742.4(a)(3) of this chapter. For a Federal credit union 
eligible for the Regulatory Flexibility Program that subsequently loses 
eligibility:
    (1) Section 742.3 of this chapter provides that NCUA may require 
the credit union to divest any existing fixed assets for substantive 
safety and soundness reasons; and
* * * * *

PART 723--MEMBER BUSINESS LOANS

    3. The authority citation for part 723 continues to read as 
follows:

    Authority:  12 U.S.C. 1756, 1757, 1757A, 1766, 1785, 1789.


Sec.  723.7  [Amended]

    4. Amend Sec.  723.7 by removing the last sentence of paragraph 
(b).

PART 742--REGULATORY FLEXIBILITY PROGRAM

    5. The authority citation for part 742 continues to read as 
follows:


    Authority: 12 U.S.C. 1756, 1766.


Sec.  742.4  [Amended]

    6. Amend Sec.  742.4 by removing the first sentence of paragraph 
(a)(3) and by removing paragraphs (a)(4), (a)(5), and (a)(6) and 
redesignating paragraphs (a)(7), (a)(8), and (a)(9) as paragraph 
(a)(4), (a)(5), and (a)(6).

[FR Doc. 2010-6391 Filed 3-24-10; 8:45 am]
BILLING CODE 7535-01-P