Corporate Credit Unions, 64786-64862 [2010-24616]

Agencies

• National Credit Union Administration

[Federal Register Volume 75, Number 202 (Wednesday, October 20, 2010)]
[Rules and Regulations]
[Pages 64786-64862]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-24616]



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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; Final Rule

Federal Register / Vol. 75 , No. 202 / Wednesday, October 20, 2010 / 
Rules and Regulations

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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: Final rule.

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SUMMARY: NCUA is issuing final amendments to its rule governing 
corporate credit unions. The major revisions involve corporate credit 
union capital, investments, asset-liability management, governance, and 
credit union service organization (CUSO) activities. The amendments 
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 rulemaking contains conforming amendments to rules 
governing Prompt Corrective Action (for natural person credit unions); 
Investments and Deposit Activities (for federal credit unions); 
Administrative Actions, Adjudicative Hearings, Rules of Practice and 
Procedure, and Investigations; and 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: This rule is effective January 18, 2011, except that the 
amendments to 12 CFR 702.105(a), 703.14(b), 704.2, 704.3, 704.4, and 
subpart M of 12 CFR part 747, are effective October 20, 2011.

FOR FURTHER INFORMATION CONTACT: David Shetler, Deputy Director, Office 
of Corporate Credit Unions, at telephone (703) 518-6640, National 
Credit Union Administration, 1775 Duke Street, Alexandria, Virginia 
22314; Ross Kendall, Staff Attorney, Office of General Counsel, at the 
address above or telephone (703) 518-6540; or Paul Peterson, Associate 
General Counsel, at the address above or telephone (703) 518-6540.

SUPPLEMENTARY INFORMATION:

I. Background

    In January 2009, NCUA solicited public comment on whether 
comprehensive changes to the structure of the corporate credit union 
(corporate) system were warranted. 74 FR 6004 (Feb. 4, 2009). This 
corporate Advanced Notice of Proposed Rulemaking (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 (ALM) and credit risk, and whether to 
make modifications in the area of corporate governance. NCUA received 
some 445 comments in response to the ANPR. NCUA reviewed these public 
comments closely and considered them carefully.
    On November 19, 2009, the NCUA Board issued a Notice of Proposed 
Rulemaking (NPR) containing extensive, specific proposed revisions to 
NCUA's rule governing corporate credit unions (corporates) and related 
rule provisions. 74 FR 65210 (Dec. 9, 2009). The proposed revisions 
covered corporate capital, prompt corrective action (PCA), investments, 
ALM, CUSOs, and governance. Briefly summarized, the major provisions in 
the proposal would have:
     Imposed new minimum capital ratios, new risk based capital 
calculations, and new elements of capital, all in general accordance 
with the Basel I capital requirements imposed by the banking regulators 
on banks.
     Required that retained earnings (RE) constitute a certain 
portion of corporate capital, and that corporates build retained 
earnings over time.
     Eliminated the current prohibition on conditioning 
membership, the receipt of services, or the pricing of services upon 
the purchase of paid-in capital.
     Added new PCA provisions similar to those currently 
applicable to banks.
     Prohibited investments in collateralized debt obligations 
(CDOs) and net interest margin (NIM) securities.
     Toughened the capital requirements for expanded investment 
authority, and restricted the credit ratings for investments purchased 
by such corporates to a minimum of ``A-.''
     Required that a corporate examine every available 
Nationally Recognized Statistical Rating Organization (NRSRO) rating 
for a particular security and only employ the lowest of those ratings, 
and that at least 90 percent of a corporate's investments be rated by 
at least two NRSROs.
     Tightened the existing single obligor concentration limit 
and imposed new sector concentration limits.
     Placed limits on subordinated positions in structured 
securities.
     Imposed new limits on the maximum difference between the 
estimated average life of the asset cash flows and the average life of 
the liability cash.
     Restricted the weighted average life (WAL) of a 
corporate's cash-flowing assets to two years.
     Limited a corporate's aggregate borrowing to the lesser of 
10 times capital or 50 percent of shares and capital; and further 
restrict secured borrowing to maximum maturities of 30 days and only 
for liquidity purposes.
     Prohibited a corporate from accepting investments or loans 
from any one entity that exceed ten percent of the corporate's assets.
     Required that a corporate CUSO only engage in categories 
of services preapproved by NCUA, including, initially, brokerage and 
investment advisory services.
     Required that a corporate CUSO agree with the corporate by 
contract to permit NCUA access to the CUSO's books, records, personnel, 
equipment, and facilities.
     Required that all corporate board members hold either a 
CEO, CFO, or COO position at a member credit union or other member 
entity.
     Generally limited corporate board members to no more than 
six years of service.
     Required that a majority of a corporate's board members be 
representatives of natural person credit unions (NPCUs).
     Required that each corporate annually disclose to its 
members the compensation of each senior executive officer and director.
     Required a merging federally-chartered corporate 
affirmatively disclose to both NCUA and its members any material, 
merger-related increase in compensation for any senior executive or 
director.
     Prohibited parties affiliated with a corporate from 
receiving 1) indemnification in connection with administrative or civil 
proceedings instituted by NCUA or a state regulatory authority where 
the party is ultimately found liable and 2) golden parachute payments.
    The preamble to the NPR included an extensive discussion of the 
crisis in the corporates giving rise to the need for regulatory reform, 
followed by a discussion of the nature of, and justification for, each 
proposed revision. Id. at 65211-65255.

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    The public comment period for the NPR closed on March 9, 2010. NCUA 
received 815 public, written comments letters totaling more than 2,600 
pages of comments. In addition, NCUA held several town halls and 
webinars during the comment period during which NCUA both answered 
questions about the proposed rulemaking and listened to oral comments 
about the proposal.
    Most commenters liked some portions of the proposed rule and 
disliked other portions. The most common comment on the overall 
rulemaking was support for the proposed stronger capital requirements; 
increased limits on single obligors; concentration limits on certain 
investment sectors; and prohibitions on certain high risk securities--
but also serious reservations about other portions of the proposal, 
including certain ALM, investment, CUSO, and corporate governance 
provisions.
    Of those commenters who expressed a general opinion on the overall 
rulemaking, many, including some trade groups and various larger NPCUs 
(i.e., over $1.2 billion in assets), generally support the rule. Many 
more commenters, however, generally oppose the proposed rule, among 
them many small and medium-sized NPCUs ranging up to over $1 billion in 
assets. Many of the commenters in opposition believed that the various 
investment and ALM restrictions in the proposed rule would cause major 
changes in corporate operations; that these changes would threaten the 
ability of corporates to provide liquidity and other valuable services 
to NPCUs; and that these changes might force NPCUs to turn to banks 
(their competitors) for services--considered by the commenters as a 
more expensive and less reliable alternative to today's corporate 
system. The comments that pertain to specific, proposed revisions are 
discussed in more detail in the section-by-section analysis below.
    The NCUA Board has now determined to issue final revisions based on 
the proposal and the comments received. Generally, these revisions will 
become effective 90 days following the publication in the Federal 
Register, but the effective date for many of the revisions will be 
delayed beyond 90 days.
    The remainder of this preamble contains four sections: A summary of 
the significant revisions in the final rule, a section-by-section 
analysis of all the revisions, an analysis of how the final investment, 
credit risk, and asset liability provisions might affect a corporate's 
ability to achieve its capital requirements, and a discussion of the 
regulatory procedures affecting this rulemaking.

II. Summary of Significant, Final Revisions

A. Overview

    Ultimately, the primary purposes of this extensive rulemaking were 
twofold. First, NCUA wanted to design a corporate rule that would 
prevent the catastrophic losses that occurred in the corporate system 
beginning in 2007 from ever recurring. Second, NCUA wanted to allow for 
the survival of some form of a well-run corporate system that could 
provide necessary services, including payments systems services, to its 
members, and build and attract sufficient capital.
    The Board believes this final rule accomplishes these two purposes.
    First, and as discussed in more detail below, the 2007 losses 
resulted almost entirely from private label residential mortgage backed 
securities (RMBS), with many of the worst performing of these 
securities being subordinated RMBS. The final rule prohibits corporates 
from purchasing either private label RMBS, or subordinated-type 
securities, going forward. In the most specific sense, then, the rule 
will make it impossible for corporates to repeat what happened in 2007. 
Of course, the next financial crisis may not be a credit or mortgage 
crisis, so the final rule includes a series of other investment, credit 
risk, ALM, liquidity, and capital measures that together should greatly 
reduce the systemic risk posed by the corporates regardless of the 
source of the next crisis.
    Second, the Board believes that a well-run corporate should be able 
to operate within the confines of the new rule and construct a business 
model, and an investment portfolio, that permits it to attract capital 
and grow retained earnings going forward. Again, this is discussed and 
demonstrated in some detail in Section IV. of the preamble below.
Affected Sections of NCUA's Rules and Regulations
    The final revisions affect part 704, Corporate Credit Unions, and 
several other sections of NCUA's regulations. The following chart lists 
the affected sections. It also summarizes the applicability dates for 
each section and, in some cases, the applicability dates for particular 
paragraphs or individual definitions.

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                                                   Delayed applicability
                                                     date? (e.g., ``+12
                                                       months'' means
                                                     delayed 12 months
    Current rule provision           Amended?        following date of
                                                    publication of final
                                                      rule in Federal
                                                         Register)
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704.1 Scope...................  No...............  Not applicable (N/A).
704.2 Definitions.............  Yes. Removed and   First replacement of
                                 replaced twice.    704.2. +90 days.
                                 Second            Second replacement of
                                 replacement        704.2. +12 months.
                                 introduces        Adjusted core
                                 capital and PCA    capital.
                                 definitions.
                                                      --deduct PCC or
                                                       NCA at another
                                                       corporate. +12
                                                       months
                                                      --deduct certain
                                                       excess PCC. +72
                                                       months to +120
                                                       months
                                                      --deduct PCC in
                                                       excess of
                                                       retained
                                                       earnings. +120
                                                       months
                                                      Permanent leverage
                                                       ratio. +36 months
704.3 Corporate credit union    Yes..............  Current 704.3
 capital.                                           replaced. +12
                                                    months.
                                                   704.3(a)(3): If RE
                                                    ratio less than
                                                    0.45, must submit
                                                    REAP. +36 months.
                                                   704.3(f)(4):
                                                    Corporate with
                                                    unconverted MCAs
                                                    must notify MCA
                                                    holders of account
                                                    status. +14 months.
704.4 Board responsibilities..  Yes. The current   Current 704.4
                                 Board              replaced with PCA
                                 responsibilities   section. +12 months.
                                 is redesignated
                                 as 704.13. New
                                 704.4 Prompt
                                 corrective
                                 action (PCA)
                                 added.
704.5 Investments.............  Yes..............  +90 days.
704.6 Credit risk management..  Yes..............  +90 days.
704.7 Lending.................  No...............  N/A.

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704.8 Asset and liability       Yes..............  Generally, +90 days.
 management.                                       704.8(k): Prohibition
                                                    on a corporate
                                                    receiving more than
                                                    15 percent of
                                                    business from one
                                                    member or credit
                                                    union. +30 months.
704.9 Liquidity management....  Yes..............  +90 days.
704.10 Investment action plan.  No...............  N/A.
704.11 Corporate CUSOs........  Yes..............  Generally, +90 days.
                                                   704.11(e)(1):
                                                    Requirement for NCUA
                                                    approval of
                                                    corporate CUSO
                                                    activities. +180
                                                    days.
                                                   704.11(e)(2):
                                                    Requirement that
                                                    corporate divest
                                                    from CUSO engaged in
                                                    unapproved
                                                    activities. +12
                                                    months.
704.12 Permissible services...  No...............  N/A.
704.13 [Reserved].............  Yes..............  The current 704.4
                                                    Board
                                                    responsibilities
                                                    redesignated as
                                                    704.13. +90 days.
704.14 Representation.........  Yes..............  Generally, +90 days.
                                                   704.14(a)(2):
                                                    Requirement that
                                                    only CEO, CFO, or
                                                    COO may seek
                                                    election to
                                                    corporate board.
                                                    +120 days.
                                                   704.14(a)(9):
                                                    Requirement that at
                                                    least a majority of
                                                    each corporate's
                                                    directors be
                                                    representatives of
                                                    NPCUs. +36 months.
704.15 Audit requirements.....  No...............  N/A.
704.16 Contract/written         No...............  N/A.
 agreements.
704.17 State-chartered          No...............  N/A.
 corporate credit unions.
704.18 Fidelity bond coverage.  No...............  N/A.
704.19 Wholesale corporate      Yes..............  Current 704.19
 credit unions.                                     removed, and new
                                                    704.19, Disclosure
                                                    of executive and
                                                    director
                                                    compensation, added.
                                                    +90 days.
704.20 None...................  Yes..............  New 704.20, Golden
                                                    parachute and
                                                    indemnification
                                                    payments, added. +90
                                                    days.
Appendix A Model forms........  Yes..............  Amended and renamed
                                                    Capital
                                                    Prioritization and
                                                    Model Forms. +90
                                                    days.
                                                   Appdx A, Part I:
                                                    Corporates may
                                                    determine that newly
                                                    contributed capital
                                                    has priority over
                                                    existing capital.
                                                    +90 days.
Appendix B Expanded             Yes..............  Generally, +90 days.
 Authorities and Requirements.                     Part I(e): Substitute
                                                    ``leverage ratio''
                                                    for ``capital
                                                    ratio.'' +12 months.
Appendix C None...............  Yes..............  New Appendix C, Risk-
                                                    Based Capital Cred-
                                                    it Risk-Weight
                                                    Categories, added.
                                                    +12 months.
702.105.......................  Yes..............  Conforming amendment
                                                    (to substitute new
                                                    capital terms). +12
                                                    months.
703.14(b).....................  Yes..............  Conforming amendment
                                                    (to substitute new
                                                    capital terms). +12
                                                    months.
709.5(b)......................  Yes..............  Conforming amendment
                                                    (to substitute new
                                                    capital terms). +90
                                                    days.
Part 747, subpart M...........  Yes..............  Add new subpart M on
                                                    due process for PCA
                                                    actions. +12 months.
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Third Party Evaluation of Proposed Rulemaking
    NCUA commissioned an outside consultant, Kamakura, Inc., to provide 
NCUA with an assessment of the proposed corporate rule. Kamakura issued 
its final report, entitled Impact Analysis--Proposed Modification of 12 
Code of Federal Regulations Part 704--National Credit Union 
Administration (the ``Kamakura Report''), on July 12, 2010. Interested 
parties can download a copy of the Kamakura Report from NCUA's Web site 
at https://www.ncua.gov. As discussed throughout the following preamble, 
NCUA carefully considered the Kamakura Report when finalizing the 
investment and ALM provisions of this rulemaking.
Legacy Assets
    The ability of some corporates to comply with the provisions of 
this final rule depends on managing certain ``legacy assets'' on their 
balance sheet. These legacy assets are securities, generally private 
label RMBS, that continue to carry significant credit risk and market 
values far below their intrinsic values.
     NCUA has been working for some time on a plan to isolate such 
legacy assets in those corporates where the exposure represents the 
greatest risk to the insurance fund. In general, these cases represent 
corporate credit unions where expected future credit losses exceed the 
corporate's total capital, and recapitalization would not occur without 
agency assistance. NCUA has, as promised, released its plans for 
dealing with those corporates' legacy assets. Information about the 
plans can be obtained from NCUA's Web site at https://www.ncua.gov.
    Some corporates have lesser positions in RMBS assets where NCUA 
does not expect the associated credit losses to exceed the corporate's 
total capital. They may also have other assets with long WALs, 
positions that are concentrated beyond the prescribed diversification 
limits, or other portfolios that otherwise inhibit compliance with new 
rule. NCUA expects these institutions to develop business plans and 
take action to become compliant with the rule. Generally, NCUA will 
want these corporates to sell these legacy assets as soon as possible 
so as to come into compliance with the corporate rule. If the corporate 
decides an alternative approach to selling the legacy assets is sound 
and supportable, the corporate will have to submit a draft investment 
action plan to NCUA for its approval under Sec.  704.10 and other 
provisions of the corporate rule, such as Sec.  704.8(j)(2)(i). For 
example, NCUA will consider approval of an action plan that includes 
retention of these legacy assets while they amortize if the corporate 
can

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document that the expected future credit losses on these assets are 
significantly less than the losses the corporate would take if the 
investments were sold at current market prices. Depending on the 
circumstances of the corporate, an NCUA-approved action plan might 
permit the corporate to operate temporarily outside the WAL limitations 
and other applicable investment, credit risk, or ALM limitations in the 
corporate rule. In addition, NCUA might grant these corporates a waiver 
of time to build the retained earnings required by this regulation--but 
only to the extent of documented losses flowing from legacy assets 
identified in an approved action plan. 12 CFR 704.1(b).
Effect of the Dodd-Frank Act on the Use of Credit Ratings
    Just recently, on July 21, 2010, Congress enacted the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (DFA). The DFA, which 
contains 848 pages divided into 16 separate Titles, has multiple 
impacts on NCUA, its regulations, and its enforcement authority. The 
Board is carefully considering the implications of the DFA and the 
actions NCUA is required to take under the DFA.
     Section 939A of the DFA is likely to affect NCUA's regulations, 
including the corporate credit union regulation. Both NCUA's current 
and revised corporate rules include references to NRSRO credit ratings. 
As stated in section 939A, NCUA has one year to review all its 
regulations and modify them to remove such references and ``substitute 
in such regulations such standard of credit-worthiness as [the Board] 
shall determine to be appropriate.'' Until the Board completes that 
review and modification, however, corporates will be expected to comply 
with all the provisions of the corporate rule that make reference to 
NRSRO ratings.
    Section 704.2 contains a definition of small business related 
securities, and that definition refers to the definition of the same 
term in Section 3(a)(53) of the Securities Exchange Act of 1934 (SEA). 
The Dodd Frank Act, however, changed the SEA definition, and the Board 
determined that it wanted to continue to use the older definition. 
Accordingly, this final rule revises the Sec.  704.2 definition of 
small business related securities to remove the reference to the SEA 
definition.
    Section 939(e)(2) the DFA, however, eliminates the reference to 
NRSRO ratings in Section 3(a)(53), and substitutes a reference to 
``meets standards of credit-worthiness established by the [Securities 
and Exchange] Commission (SEC).'' Again, until such time as either the 
SEC or NCUA can provide some content to the latter phrase, NCUA 
believes that the definition of small business related security in 
Sec.  704.2 should remain unchanged.

B. Capital

Summary of Current Capital Provisions
    Currently, corporates have only one mandatory minimum capital 
requirement: they must maintain total capital (i.e., retained earnings 
(RE), paid-in capital, and membership capital accounts) in an amount 
equal to or greater than 4 percent of their moving daily average net 
assets.\1\ 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.
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    \1\ 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 or other particular supervisory actions.
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    The current rule allows a corporate to issue Paid in Capital (PIC) 
to both members and nonmembers, while Membership Capital Accounts 
(MCAs) may only be issued to members. The current rule also prohibits a 
corporate from conditioning membership, the receipt of services, or the 
pricing of services upon the purchase of PIC.
Summary of Proposed Capital Revisions (November 2009)
    The proposal contains a capital scheme based on the Basel I capital 
regimes of the other banking regulators. The proposal renames PIC as 
Perpetual Contributed Capital (PCC), and makes certain changes to the 
MCA requirements and labels those MCAs as Nonperpetual Capital Accounts 
(NCAs). The proposal then seeks to replace the one existing total 
capital ratio with three minimum capital ratios, including two Risk 
Based Capital (RBC) ratios. These RBC ratio calculations involve credit 
risk-weighting the corporate's assets and off balance sheets activities 
to produce a moving daily average net risk-weighted assets (MDANRA).
    The three new proposed ratios are described in the following chart:

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                                                                                Minimum level     Minimum level
              Ratio                    Numerator \2\         Denominator       (adequate cap.)     (well cap.)
                                                                                  (percent)         (percent)
----------------------------------------------------------------------------------------------------------------
Leverage Ratio...................  RE + PCC............  MDANA..............                 4                 5
Tier-One RBC Ratio...............  RE + PCC............  MDANRA.............                 4                 6
Total RBC Ratio..................  RE + PCC + NCAs.....  MDANRA.............                 8                10
----------------------------------------------------------------------------------------------------------------

    The proposal also requires that, in the leverage ratio and Tier 1 
RBC ratio, the corporate may only count PCC to the extent that it does 
not exceed the corporate's RE. That results in the corporate needing 
200 basis points (BP) of RE to reach a 4 percent leverage ratio and so 
be adequately capitalized, and 250 BP to be well-capitalized. This RE 
requirement, and the various other proposed capital measures, are 
phased-in over a ten-year time period, as discussed below.
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    \2\ These numerator formulas are simplifications. The proposal 
actually contains certain adjustments to each capital calculation, 
and those proposed adjustments that received comments are discussed 
below.
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Summary of Proposed Phase-In of Capital Provisions
    The proposal contains a multi-step, multi-year phase-in of the new 
capital requirements:
     Year one. None of the new capital requirements would apply 
during the first year following publication of the final rule. During 
this period the current total capital ratio would remain in effect, as 
well as the revised capital order, and associated waivers, issued by 
the NCUA Board on April 29, 2010.\3\
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    \3\ The Net Economic Value (NEV) limitations that exist in the 
current rule have not changed under this final rule. 12 CFR 
704.8(d). Thus, these NEV limits continue to be in effect and no 
implementation delay for these NEV limits is warranted.
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     Years two and three. The two new risk based capital ratios 
would come into effect on the first anniversary of the publication of 
the final rule. Corporates

[[Page 64790]]

would be required to meet a minimum 4 percent Tier 1 RBC ratio and a 
minimum 8 percent Total RBC ratio. In addition, corporates would be 
required to satisfy an interim leverage ratio, defined almost 
identically to the existing total capital ratio. Because NCUA should 
have resolved the legacy assets at this point, and most corporates will 
have very low-risk weighted assets, neither of the two RBC ratios will 
likely dictate the amount of capital corporates need at this point. 
Instead, actual minimum capital requirement will likely be dictated by 
the interim leverage ratio, meaning a corporate will need 200 BP in 
PCC/RE and another 200 BP in NCAs.
     Years four through six. At the third anniversary of the 
publication of the final rule, the 4 percent minimum leverage ratio 
goes into effect. In addition, any corporate that does not have at 
least 45 BP of RE on the third anniversary must file a retained 
earnings action plan (REAP) with the NCUA illustrating how it is going 
to achieve the upcoming RE requirements at the sixth and tenth 
anniversaries of the final rule.
     Years seven through ten. At the sixth anniversary of the 
publication of the final rule, a corporate must have at least 100 BP of 
RE to be considered adequately capitalized.
     Year eleven and after. At the tenth anniversary of the 
publication of the final rule, a corporate must have at least 200 BP of 
RE to be considered adequately capitalized.
Overview of Significant Capital Revisions in This Final Rule
    Most of the public comments on the capital provisions, including 
comments received from corporate credit unions, were supportive of the 
new proposed Basel I capital requirements, including the use of risk-
based capital measures. Some of these commenters specifically supported 
the use of Basel I standards over Basel II, stating that Basel I was 
adequate and less complex.
    The Board agrees with these commenters, and has generally adopted, 
with some modifications, the minimum capital ratios, risk based capital 
calculations, and new elements of capital, as set forth in the proposed 
rule. As in the proposed, the final revisions will require that RE 
constitute a certain portion of capital. For example, to be adequately 
capitalized, a corporate must have at least 100 BP of RE after six 
years, and 200 BP of RE after ten years. Other elements of the new 
capital provisions will also be phased in over time, beginning one year 
after publication of this final rulemaking. The final revisions 
eliminate the current prohibition on conditioning membership, services, 
or the pricing of services upon the purchase of paid-in capital. 
Details about each final revision are contained in the section-by-
section analysis below.
    Some commenters, including NPCUs, questioned whether corporates 
need any capital. Other commenters stated that NCUA should not require 
any contributed capital, and that corporates should be given sufficient 
time to ``earn'' their way to adequate capitalization.
    The Board is concerned that NCUA's extraordinary actions to 
stabilize and protect the corporate system over the past few years have 
been misunderstood by some of these commenters. Because of NCUA's 
actions, including the Temporary Corporate Credit Union Share Guarantee 
Program (TCCUSGP) and the Temporary Corporate Credit Union Liquidity 
Guarantee Program (TCCULGP), many corporates have been able to operate 
as going concerns with artificially low levels of capital. Measures 
like the TCCUSGP and TCCULGP are, however, temporary measures. In the 
future, NCUA will wind down and terminate these measures, and 
corporates will have to function on their own. Further, corporates and 
their members cannot expect to ever again receive such extraordinary 
government support, either explicitly or implicitly, from NCUA or any 
other government entity.\4\ In fact, it is NCUA's intention with the 
various revisions in this final rule to ensure that the corporates, 
going forward, never again present the sort of systemic risk to the 
entire credit union system that requires such extraordinary 
intervention. And this means that, without building adequate capital 
going forward, corporates will not be able to function.
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    \4\ Except, of course, for the standard federal share insurance 
of up to $250,000, as mandated by the Federal Credit Union Act.
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    Inadequate levels of capital introduce unacceptable moral hazards. 
When the owners of an entity have significant amounts of their own 
capital at stake, they have incentive to ensure that the entity is 
prudently operated and does not engage in overly risky activity, 
because the risk of loss is born by the capital owners. However, when 
the owners have little or no capital at stake, they have the incentive 
to overlook, or even encourage, risky behavior by the entities' 
management. We observed some of this risky behavior at certain 
corporates in the recent past--and this behavior was likely fueled by 
contributed capital levels that were too low for the risks undertaken, 
as well as the fact that some member owners of these corporates did not 
fully understand the nature and extent of their potential capital 
losses and so were not actively engaged in the oversight of their 
corporates. NCUA will not permit corporates to operate with low capital 
levels that encourage risky behavior. Accordingly, NCUA intends with 
this rulemaking to ensure corporates have adequate capital levels going 
forward to mitigate such moral hazard.\5\
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    \5\ The Board also believes that all NPCUs now understand the 
nature of any capital commitment to a corporate and the need to be 
involved in the direction and management of their corporates.
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    In addition to introducing unacceptable moral hazards, low capital 
levels have negative, direct effects on an entity's ability to 
function. For example, potential creditors would not likely lend to any 
corporate that does not have capital sufficient to absorb losses, 
because the creditors will have legitimate fears that any operating 
losses in the corporate will keep the creditors from getting repaid. 
Likewise, potential third-party vendors would not do business with 
corporates that do not have capital available to absorb operating 
losses, because these vendors would be afraid that any losses would 
have negative effects on the corporate's ability to pay the vendors' 
invoices.\6\
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    \6\ As indicated above, after the TCCUSGP and the TCCULGP have 
served their purposes and been terminated NCUA will no longer 
provide corporates with extraordinary support. NCUA will disabuse 
the public, the members, any potential creditors of a corporate, and 
any potential vendors of a corporate, of the idea that NCUA will 
again intervene to protect insolvent corporates.
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    In sum, going forward corporates must survive on their own and 
without continued government assistance--and that means corporates must 
have their own adequate capital.
    In response to the other comments, NCUA is not requiring that any 
of a corporate's capital be contributed capital. NCUA will not, 
however, continue its extraordinary support of the corporate system 
over the time it would take to build sufficient capital just through RE 
growth alone. For example, to achieve a 4 percent capital ratio just 
through RE growth could take 20 years or longer. It is inappropriate 
for the NCUA, which is a government entity, to provide the necessary 
guarantees and other assistance that would enable a corporate to 
survive that long with such low levels of capital. And that means that, 
to survive as a going concern without continued government assistance, 
a corporate must solicit and achieve sufficient capital in the form of 
contributed capital. Any corporate that

[[Page 64791]]

is unable to obtain the requisite levels of capital in a timely manner 
may have to be liquidated or merged.
    Some commenters questioned the need for any minimum RE requirement. 
One corporate stated that, from a NCUSIF standpoint, contributed 
capital acts in the same capacity as RE. This commenter believes that 
the building of RE is typically a decision made by the organization's 
Board and so does not believe that the portion of capital that is RE 
should be designated within the regulation. Another corporate 
commenter, however, recognized the need for a minimum RE requirement.
    As discussed at length in the preamble to the proposed rule, NCUA 
believes that, eventually, some part of a corporate's capital must 
consist of RE. This is the only form of corporate capital that, when 
depleted, does not result in losses that flow downstream to NPCUs. 
Without some RE, the corporates would be a continued source of 
instability to the credit union system as a whole.
    A few commenters stated that NCUA needed to look at other sources 
besides credit unions to recapitalize the corporate system, without 
specifying which sources. The Board is unaware of any other logical 
sources of capital. Corporates are member-owned cooperatives 
established to serve their member NPCUs, so logically the primary 
source of a corporate's contributed capital should be its member-owner 
NPCUs. Still, corporates have always been free to sell paid-in capital 
to nonmembers, including non-credit union nonmembers, but to date have 
been either unwilling or unable to do so. The proposal, and these final 
revisions, permit corporates to sell all forms of contributed capital, 
including nonperpetual capital, to nonmembers at the corporate's 
discretion. To the extent, however, that some commenters might believe 
that NCUA or the federal government can donate capital to corporates, 
that is neither legally possible nor a good idea as a policy matter. As 
stated above, credit unions in general, and corporates in particular, 
cannot depend on continued government assistance to survive.
    Some commenters thought the proposed capital requirements were 
overly complex. The NCUA Board disagrees. Corporates are complex 
financial entities and so require some detail and nuance in their 
regulation. The Board notes that the Basel I standards, and associated 
regulations, are no more complex than those capital standards imposed 
on banking entities with similarly complex operations and activities.
    A few commenters that generally opposed the new capital standards 
stated that the NCUA's basic rationale for the proposed changes is that 
the permanence of capital and a risk-based capital standard would have 
mitigated the losses at Corporates in the past two years. This is not a 
correct statement. NCUA has long been considering amendments to improve 
corporate capital standards, even before the credit crisis of 2007. The 
new capital standards, as proposed and finalized here, are intended to 
help protect the corporates, their members, and the NCUSIF from future 
losses, whether or not those future losses are related to credit risk 
in the mortgage markets (as in 2007) or are caused by other factors.
    A few commenters questioned why NCUA was imposing capital 
requirements on corporates that were similar to banking capital 
requirements while at the same time imposing ALM and investment 
requirements that were different from those imposed on banks. The Board 
believes that while many corporates engage in activities and take on 
risks similar to banks, and thus should have a capital regime similar 
to banks, the risks that corporates pose to NPCUs are systemic risks, 
and thus different than the risks posed by one bank to another bank. It 
is true that a few very large banks may present systemic risks to the 
banking system, but the Basel I standards contained in this rulemaking 
are different than the Basel II advanced standards that very large 
banks are subject to.
    Several NPCU commenters were concerned that the likelihood of 
ongoing corporate consolidation, combined with factors in the proposal 
such as the lengthening of the MCA three year requirement to five years 
and the requisite NCUA approval for any return of PCC, all increased 
the possibility that an NPCU might find itself stuck with significant 
capital in a corporate to which that NPCU did not want to belong. 
Natural person credit unions will have to decide, going forward, what 
services they want from corporates. As part of that decision, they will 
have to decide if they are willing to contribute capital to one or more 
corporates. If they decide to contribute capital, they will have to 
take into account the possibility that the corporate may then 
consolidate or merge with another corporate. If that should happen, and 
the NPCU no longer desires services from the continuing corporate, the 
NPCU does have several options. First, it may ask the corporate to 
redeem the capital. If such redemption complies with NCUA's 
regulations, and NCUA approves the redemption, the corporate may redeem 
the capital. Second, the member NPCU can attempt to transfer (sell) the 
capital to another member. And, third, the member NPCU can attempt to 
transfer the capital to a nonmember.
    A few commenters believe the proposed capital phase-in period is 
appropriate, and one NPCU labeled it as generous. Many commenters, 
however, believe that the proposal provides too short a time period for 
the phase-in of the proposed new capital requirements.
    The Board believes that the final capital phase-in, which mirrors 
the proposed phase-in, is both appropriate and feasible. As discussed 
in the preamble to the proposed rule, the phase-in period balances the 
need for corporates to (1) quickly achieve sufficient capital, and wean 
themselves from government assistance, through solicitations of 
contributed capital and growth of RE, while (2) providing for an 
adequate opportunity to make that solicitation and achieve that growth.
    The proposed rule was issued ten months ago, and corporates have 
had some time since then to consider the ramifications of the proposal. 
Further, none of the new capital provisions will be effective until the 
first anniversary of the publication of this final rulemaking in the 
Federal Register. This one year period gives corporates ample 
opportunity to analyze the elements of this final rule, perfect their 
business plans, convince their members of the validity of their 
business plans, and solicit contributed capital.\7\ Corporates that are 
well-run should be able to make an effective solicitation so as to 
garner sufficient contributed capital by the first anniversary.
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    \7\ Some corporates may not even need additional capital on the 
first anniversary.
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    Under the final rule, the first specific RE target (e.g. 45 BP of 
accumulated RE) does not go into effect until the third anniversary of 
publication, and the first specific RE requirement (100 BP) does not go 
into effect until the sixth anniversary of publication. As discussed in 
the sections below on the asset liability management provisions of the 
final rule, the final investment and ALM provisions permit corporate 
credit unions a bit more leeway in the mismatch of their assets and 
liability cash flows than in the proposed rule, and the Board believes 
this should help corporate credit unions generate additional earnings 
on their assets. As also discussed below, NCUA has modeled various 
investment portfolios that corporates could purchase under provisions 
of the final corporate rule, and the Board has concluded that a well-
run corporate can, in fact, generate

[[Page 64792]]

45 BP of earnings in the first three years and 100 BP of earnings in 
the first six years as required by the capital phase-in.
    Other, more specific comments on capital are discussed in the 
section-by-section analysis below.

C. Prompt Corrective Action (PCA)

    Although prompt corrective action (PCA) applies to natural person 
credit unions (NPCUs) and to banking entities, PCA does not currently 
apply to corporates. The proposed rule contained a PCA regime similar 
to what the other banking regulators, and the Federal Deposit Insurance 
Act, impose on banks.
    The final rule adopts the proposed PCA provisions substantially as 
proposed. Each corporate will be assigned to one of five capital 
categories: Well-capitalized, adequately capitalized, undercapitalized, 
significantly undercapitalized, and critically undercapitalized. The 
potential consequences of failing to meet capital standards include 
restrictions on activities, restrictions on investments and asset 
growth, restrictions on the payment of dividends, restrictions on 
executive compensation, requirements to elect new directors or dismiss 
management, and possible conservatorship. The final rule does include 
some due process enhancements beyond those contained in the proposed 
rule.

D. Corporate Investments, Credit Risk, and Asset-Liability Management 
(ALM)

Summary of Current Investment, Credit Risk, and ALM Provisions
    The current Part 704 generally prohibits certain types of 
investments, including derivatives, stripped mortgage backed securities 
(MBS), mortgage servicing rights, and residual interests in asset 
backed securities (ABS). The rule specifies, for permissible investment 
types, that investments must be rated no lower than AA- by at least one 
NRSRO at time of purchase. Corporates that qualify for Part I expanded 
authority, however, have additional investment authority, including the 
purchase of investments rated down to A-. Corporates that qualify for 
Part II expanded authority may purchase investments rated down to 
BBB(flat). Corporates that qualify for Part III expanded authority may 
invest in certain foreign obligations; corporates that qualify for Part 
IV expanded authority may engage in derivatives transactions for 
certain specified purposes; and corporates with Part V expanded 
authority may engage in certain loan participations.
    The current rule requires that corporates maintain an internal 
investment policy that includes ``reasonable and supportable 
concentration limits'' including limits by ``investor type and 
sector.'' The current rule limits the aggregate of all investments in 
any single obligor to the greater of 50 percent of capital or $5 
million, but includes no regulatory sector limits. The rule does not 
limit investments that are structured to be subordinate, in terms of 
potential credit losses, to other securities.
Summary of Significant Proposed Investment, Credit Risk, and ALM 
Provisions
    NCUA developed the proposed changes to the investment, credit risk, 
and ALM provisions based on lessons learned from both the recent 
experience with corporate investment portfolios and their associated 
losses and comments received from the ANPR.
    NCUA determined that three major risk conditions were the primary 
contributors to the current losses in the corporate system: (1) 
Excessive investment sector concentrations, particularly private label 
RMBS; (2) excessive average-life mismatches between assets and 
liabilities; and (3) excessive concentrations in subordinated 
securities, including mezzanine securities. The proposed revisions to 
the investment and asset-liability provisions of the corporate rule 
control these risk conditions in the aggregate through the use of 
limits, many of which are tied to a corporate credit union's capital. 
The proposal provided a framework that allowed for a level of risk-
taking necessary to support the profitability of a corporate but which 
would also be continuously and adequately protected by the corporate's 
capital.
    The proposed rule established new prohibitions for investments in 
collateralized debt obligations (CDOs) and net interest margin (NIM) 
securities.
    The proposal also required that a corporate examine the NRSRO 
rating from every NRSRO that publicly rates a particular investment and 
only employ the lowest of those ratings and required that at least 90 
percent of a corporate's investments be rated by at least two NRSROs. 
The proposal eliminated Part II expanded authority, thus making ``A-'' 
the lowest possible rating for an NRSRO-rated investment purchased by a 
corporate with expanded investment authority. To qualify for Parts I 
and II (i.e., the current Parts I and III) expanded investment 
authority, the proposal required a corporate achieve and maintain 
higher capital levels, that is, a minimum six percent capital ratio.
    The proposal generally reduced the single obligor limits from 50 
percent of capital to 25 percent of capital, with slightly higher 
limits for investments in mutual funds and repurchase agreements. The 
proposal also imposed specific concentration limits by investment 
sector. Sectors included residential mortgage backed securities (RMBS), 
commercial mortgage backed securities (CMBS), student loan asset backed 
securities (ABS), automobile loan/lease asset backed securities, credit 
card asset backed securities, other asset backed securities, corporate 
debt obligations, municipal securities, and money market mutual funds, 
and an ``all others'' category to account for the development of new 
investment types. The proposed sector limits were, generally, (1) the 
lower of 500 percent of capital/25 percent of assets, or (2) the lower 
of 1000 percent of capital/50 percent of assets (for the less risky 
sectors).
    The proposal excluded certain assets entirely from both the single 
obligor concentration limit in Sec.  704.6(b) and the sector 
concentration limits in Sec.  704.6(c). The excluded assets include 
fixed assets, loans, investments in CUSOs, investments issued by the 
United States or its agencies or its government sponsored enterprises, 
and investments fully guaranteed or insured as to principal and 
interest by the United States or its agencies. Investments in other 
federally-insured credit unions, deposits in other depository 
institutions, and investment repurchase agreements would also be 
excluded from the sector concentration limits but not the single 
obligor concentration limit. Investments in CUSOs, while excluded from 
both the Sec.  704.6 concentration limits, would still be subject to 
the investment limits in the corporate CUSO rule, Sec.  704.11(b).
    The proposal limited subordinated positions in a structured 
security to the lesser of 100 percent of capital/5 percent of assets in 
any given sector class and the lesser of 400 percent of capital/20 
percent of assets in the aggregate.
    The proposal generally limited a corporate's Part III (renumbered 
from Part IV) derivatives activity to derivatives used for the purposes 
of reducing the corporate's overall risk.
Summary of Significant Investment, Credit Risk, and ALM Revisions From 
the Proposed to the Final Rule
    Based on comments received and further review, the NCUA Board 
adopted most of the proposed

[[Page 64793]]

provisions but also made some significant changes. The most significant 
changes in the final rule were the removal of the two ALM provisions 
designed to limit cash flow mismatches between assets and liabilities. 
In place of these tests, the final rule substitutes an alternative 
weighted average life extension test on the corporate's investments 
along with specific prohibitions on private label RMBS and subordinated 
securities.
    The effect of these changes is to create the following, final set 
of investment, credit risk, and ALM hurdles through which a corporate 
must run any contemplated investment purchase:
     NRSRO ratings screen. The final rule uses NRSRO ratings as 
a screening tool. The final NRSRO screen is tougher than the current 
rule provides. For example, to get by the ratings screen the corporate 
has to look at all available NRSRO ratings (not just one rating), and 
the corporate has to take the lowest of all the ratings (i.e., it can't 
cherry pick ratings). This ratings screen is exclusionary, not 
inclusionary. Even if a security gets by the ratings screen, there are 
still six additional hurdles (listed below) each security must pass 
before the corporate can buy the security.
     Prohibition of certain highly complex and leveraged 
securities. NCUA is adding to the list of outright prohibited 
securities in part 704 that are overly complex and/or leveraged. So a 
corporate cannot buy the security if it is:
    [cir] A Collateralized debt obligation (CDO), or
    [cir] A Net Interest Margin security (NIM), or
    [cir] A Private label RMBS, or
    [cir] A security subordinated to any other securities in the 
issuance.
     Single obligor limit. The final rule tightens the existing 
limit from 50% of capital to 25% of capital. So if the corporate wanted 
to buy, say, a highly rated student loan asset backed security (ABS) 
issued by ``Mainstreet Bank,'' but the corporate has already reached 
the 25% of capital limit in investments issued by the same Mainstreet 
Bank trust, the corporate can't buy that additional ABS within the same 
trust.
     Sector concentration limits. Assuming the corporate still 
wants to buy that Mainstreet Bank ABS, and it has not reached its 
single obligor limit with Mainstreet Bank, the corporate must then 
apply the sector limits for these ABS. If the purchase of the 
Mainstreet Bank ABS would put the corporate over the private label 
student loan ABS sector limit (generally, the lower of 500% of capital 
or 25% of assets), the corporate can't buy the ABS.
     Portfolio WAL not to exceed two years. If the corporate 
got the Mainstreet Bank ABS past all those hurdles above, there are 
still more hurdles to overcome. The corporate cannot buy the ABS if it 
would put the weighted average life (WAL) of the corporate's loan and 
investment portfolio over two years in length.
     Portfolio WAL (assuming prepayment slowdown of 50%) not to 
exceed 2.25 years. The corporate must then test the Mainstreet Bank ABS 
for extension risk. The corporate cannot buy the ABS if it would put 
the weighted average life of the corporate's loan and investment 
portfolio, assuming the portfolio prepayment speeds slow by 50%, out 
over 2.25 years in length.
     Interest rate risk shock test. This IRR test is in the 
current rule, and the final rule does not change this test. Assuming 
that the Mainstreet Bank ABS is floating rate, and its liabilities 
reset rates in similar fashion, it would likely not be affected at all 
by this particular test. But if its liabilities did not reprice 
similarly to the ABS (e.g., the floating rate ABS was funded by fixed 
rate liabilities), its addition to the portfolio could not cause the 
corporate's NEV to decline by more than 15 percent when the portfolio 
as a whole is shocked by 300 BP.\8\
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    \8\ Assuming the corporate was operating under Base level 
investment authority.
---------------------------------------------------------------------------

    These final revisions provide for a simpler rule that still 
accomplishes NCUA's goal of reducing or eliminating various risks while 
allowing for sufficient potential for growth in a corporate's RE.
Investment Action Plans for Prohibited Investments
    Most of the new investment prohibitions and other credit and ALM 
requirements go into effect 90 days after publication of the final 
rule. Some corporates may hold investments that are in violation of one 
or more of these new prohibitions, and these investments will be 
subject to the investment action plan provisions of Sec.  704.10. For 
example, if a corporate holds a subordinated security prohibited by the 
revised paragraph 704.5(h)(8), and determines not to sell that 
security, it must, within 30 calendar days of the effective date of the 
704.5(h)(8) prohibition prepare and submit to the OCCU Director an 
investment action plan. 12 CFR 704.10(a). If the plan is not approved 
by the OCCU Director, the corporate must comply with the ``Director's 
directed course of action.'' 12 CFR 704.10(c).

E. Liquidity

Summary of Current Rule
    The current rule generally requires a corporate evaluate its 
liquidity needs and plan for appropriate liquidity. It also provides 
that a corporate credit union may borrow up to the greater of 10 times 
capital or 50 percent of capital and shares (excluding shares created 
by the use of member reverse repurchase agreements).
Summary of Significant Revisions
    The proposal restricted a corporate's borrowing to the lower of 10 
times capital or 50 percent of capital and shares (excluding shares 
created by the use of member reverse repurchase agreements). The 
proposal also added a sublimit for secured borrowings. The final rule 
adopts the proposal without changes.

F. Corporate Governance Provisions

Summary of Current Rule
    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; limit the 
representation of corporate managers and officials on the boards of 
other corporates; provide for term limits; require any disclosure of 
senior executive compensation to the members of a corporate; or place 
any limits on ``golden parachute'' severance packages for corporate 
senior executives.
Summary of Significant Governance Revisions
    The final revisions require that all corporate board members hold 
either a CEO, CFO, or COO position at their member credit union or 
other member entity. The final rule will, for clarity, add the 
positions of Manager and Treasurer, as these are often the equivalent 
of CEO or CFO at smaller credit unions. The revisions also require that 
a majority of a corporate's board members be representatives of NPCU 
members. The proposal also included a six year term limit on board 
service, but this mandatory term limit has been removed from the final 
rule.
    The final revisions require that each corporate annually prepare, 
and provide to its members, a document that discloses the compensation 
of certain employees. For corporates with 41 or more employees, the 
disclosure must include the top five compensated employees. For 
corporate with 31 to 40 employees, the disclosure must include

[[Page 64794]]

the top four compensated employees. For corporates with 30 or fewer 
employees, the disclosure must include the top three compensated 
employees.
    With respect to any corporate merger, the final revisions require a 
merging federally-chartered corporate affirmatively disclose to both 
NCUA and its members any material, merger-related increase in 
compensation (i.e., an increase of more than 15 percent of annual 
compensation or $10,000, whichever is greater) for any senior executive 
or director. A state-chartered corporate must also make the merger-
related disclosure, but only to NCUA unless state law requires 
otherwise.
    The final revisions prohibit golden parachutes, that is, payments 
made to an institution affiliated party (IAP) that are contingent on 
the termi