Alternatives to the Use of Credit Ratings, 74103-74112 [2012-30076]

Download as PDF 74103 Rules and Regulations Federal Register Vol. 77, No. 240 Thursday, December 13, 2012 This section of the FEDERAL REGISTER contains regulatory documents having general applicability and legal effect, most of which are keyed to and codified in the Code of Federal Regulations, which is published under 50 titles pursuant to 44 U.S.C. 1510. The Code of Federal Regulations is sold by the Superintendent of Documents. Prices of new books are listed in the first FEDERAL REGISTER issue of each week. NATIONAL CREDIT UNION ADMINISTRATION 12 CFR Parts 703, 704, 709, and 741 RIN 3133–AD86 Alternatives to the Use of Credit Ratings National Credit Union Administration (NCUA). AGENCY: ACTION: Final rule. NCUA is issuing a final rule to implement certain statutory requirements in Title IX of the DoddFrank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) pertaining to the use of credit ratings to assess creditworthiness. The final rule removes references to credit ratings in NCUA regulations or replaces them with other appropriate standards of creditworthiness as required by the Dodd-Frank Act. SUMMARY: DATES: This rule is effective June 11, 2013. FOR FURTHER INFORMATION CONTACT: Mark Vaughan, Director, Division of Analytics and Surveillance, or Dale Klein, Senior Capital Markets Specialist, Office of Examination and Insurance, at (703) 518–6360; or Frank Kressman, Associate General Counsel, or Lisa Henderson, Staff Attorney, at (703) 518– 6540. All may be reached at the National Credit Union Administration, 1775 Duke Street, Alexandria, VA 22314. wreier-aviles on DSK5TPTVN1PROD with SUPPLEMENTARY INFORMATION: I. Background II. Public Comments III. Actions of Other Regulators IV. Final Rule Standard V. Specific Amendments to NCUA Regulations VI. Regulatory Procedures VerDate Mar<15>2010 14:58 Dec 12, 2012 Jkt 229001 I. Background Why is NCUA adopting this rule? Section 939A of the Dodd-Frank Act requires all federal agencies, including NCUA, to review their regulations for any use of credit ratings to assess the creditworthiness of a security or money market instrument, remove those references, and substitute in those regulations other standards of creditworthiness that they determine to be appropriate.1 On February 17, 2011, the NCUA Board issued a Notice of Proposed Rulemaking (NPRM) to implement section 939A.2 How did the NCUA Board propose to replace the ratings in the NPRM? The NPRM identified references made to nationally recognized statistical rating organization (NRSRO) 3 credit ratings in parts 703, 704, 709, and 742 of NCUA regulations.4 The NPRM generally treated NRSRO credit rating references three different ways, as discussed below, depending on how the rating was used in the regulations. The preamble to the NPRM also acknowledged that there were many possible standards of creditworthiness that could be used and sought suggestions for alternative standards. For regulations pertaining to investment securities, the NPRM replaced minimum rating requirements with a requirement that the federal credit union (FCU) or corporate credit union (corporate) conduct and document a credit analysis demonstrating that the issuer of the security has a certain, specified capacity to meet its financial commitments. These replacement standards were based on narrative descriptions provided by the NRSROs for certain letter ratings. For example, where NCUA regulations currently require an investment to have a AA rating, the proposal required the credit union to determine that the issuer of the security had a very strong capacity to meet its financial commitments. The NPRM preamble noted that a credit union 1 Public Law 111–203, 124 Stat. 1376 (2010) sec. 939A. 2 76 FR 11164 (Mar. 1, 2011). 3 An NRSRO is an entity registered with the U.S. Securities and Exchange Commission (SEC) under section 15E of the Securities Exchange Act of 1934. See 15 U.S.C. 78o–7, as implemented by 17 CFR 240.17g–1. 4 12 CFR parts 703, 704, 709, and 742. PO 00000 Frm 00001 Fmt 4700 Sfmt 4700 could use internal and external assessments when evaluating the financial strength of an issuer. The preamble also noted that NCUA would provide additional supervisory guidance on assessing creditworthiness. For regulations pertaining to counterparty transactions, the NPRM replaced minimum rating requirements with a requirement that the credit union conduct a credit analysis of the counterparty based on a standard approved by the credit union’s board. For provisions not related to investment and counterparty suitability, the NPRM generally deleted references to ratings without requiring a substitute analysis. II. Public Comments The public comment period for the NPRM ended on May 2, 2011, and NCUA received 11 comments. In general, most of the commenters did not support the proposal. While many acknowledged that the Dodd-Frank Act requires NCUA to remove ratings references, they opposed replacing the ratings with a credit analysis tied to a narrative description, arguing that it was too subjective and would cause confusion. These commenters generally did not propose alternative standards of creditworthiness. A number of commenters stated that the proposal went beyond the requirements of the Dodd-Frank Act, arguing that the legislation does not prohibit financial institutions from using credit ratings. The NCUA Board notes that nothing in the NPRM prohibited credit unions from using credit ratings as an element of the required credit analysis. A few commenters responded to NCUA’s request for comments on alternative standards of creditworthiness. One suggested that NCUA publish a list of acceptable ‘‘safe harbor’’ investments. The NCUA Board believes that establishing such a list would effectively transfer credit union risk management to NCUA. Credit union boards and management teams are in a better position to assess the appropriateness of investment instruments and transactions based on their credit unions’ unique risk preferences, portfolio objectives, and balance sheet composition. A safe harbor provision exempts an investor from due diligence responsibility and could be viewed as NCUA’s tacit E:\FR\FM\13DER1.SGM 13DER1 wreier-aviles on DSK5TPTVN1PROD with 74104 Federal Register / Vol. 77, No. 240 / Thursday, December 13, 2012 / Rules and Regulations endorsement of the suitability of certain investments. Without providing specific numbers, another commenter suggested generally that an alternative standard could be based on credit spreads. The NCUA Board does not support this approach because credit spreads are a function of open markets and they reflect investor interest for reasons that include, but are not limited to, credit risk. Market credit spreads for various asset classes experience variability depending on current supply and demand for the product, actual market interest rates, and a variety of other factors. While the NCUA Board declines to establish specific allowable credit spreads, it notes that FCUs and corporates may use credit spread information as a factor in assessing changes in creditworthiness. Several commenters suggested that NCUA wait to finalize alternative standards of creditworthiness until other financial institution regulators have proposed or finalized standards. Since the NCUA Board issued the NPRM, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) have issued final rules replacing credit ratings with alternative creditworthiness standards similar to those the NCUA Board proposed in the NPRM. Further, the SEC has issued comparable proposed rules. We discuss these final and proposed rules below. We also discuss how the NCUA Board has adjusted the replacement credit standards in this final rule from those in the NPRM. Several commenters requested more guidance on how a credit union’s board of directors should establish credit quality standards for counterparties. In general, a credit union board should clearly articulate the institution’s risk tolerance for counterparty credit risk by approving relevant policies, including a framework for establishing limits on individual counterparty exposures and concentrations of exposures. In turn, senior management should establish and implement a comprehensive risk measurement and management framework consistent with this risk tolerance that provides for the ongoing monitoring, reporting, and control of counterparty credit risk exposures. The policies and framework should be appropriate to the size, nature, and complexity of the credit union’s counterparty credit risk profile. III. Actions of Other Regulators The OCC and FDIC have issued final rules replacing NRSRO-based security VerDate Mar<15>2010 14:58 Dec 12, 2012 Jkt 229001 creditworthiness standards.5 The new rules redefine an ‘‘investment grade’’ security as one where the issuer has an adequate capacity to meet all financial commitments under the security for the projected life of the security. To meet this new standard, national banks and federal and state savings associations must determine that the risk of default by the obligor is low and that the full and timely repayment of principal and interest is expected. The SEC has proposed to remove references to credit ratings in its regulations governing investments made by mutual funds.6 The proposal includes replacing creditworthiness standards that reference credit ratings with standards that would reflect evaluating other criteria. It would replace a requirement that a security purchased by a money market mutual fund be rated in ‘‘one of the two highest short-term rating categories’’ with a standard that the security have minimal credit risk. The determination of minimal credit risk would be based on factors pertaining to credit quality and the issuer’s ability to meet its short-term financial obligations. Under the SEC’s proposed rule 2a-7, while the mutual fund’s board of directors must independently determine that an investment has minimal credit risk, it would be permitted to continue using credit ratings as one factor to make that determination.7 The SEC also has proposed to amend the Broker-Dealer Net Capital Rule to remove references to credit ratings.8 That rule currently applies lower capital requirements to certain types of securities held by broker-dealers if the securities are rated in high rating categories by at least two NRSROs. Under the SEC’s proposal, for commercial paper, nonconvertible debt, and preferred stock to qualify for the lower capital requirements, a brokerdealer would be required to establish, 5 77 FR 35253 (June 13, 2012); 77 FR 43151 (July 24, 2012). 6 76 FR 12896 (Mar. 9, 2011). 7 Specifically, the SEC proposal states: ‘‘Nothing in the proposed rule would prohibit a money market fund from relying on policies and procedures it has adopted to comply with the current rule as long as the board concluded that the [credit] ratings specified in the policies and procedures establish similar standards to those proposed and are credible and reliable for that use.’’ 76 FR 12899 (Mar. 9, 2011) n.32. The SEC’s March 9, 2011, proposal also notes that in addition to referencing credit ratings, the SEC rules already require a mutual fund board of directors to determine that a security meets the requisite investment standards based on factors ‘‘in addition to any ratings assigned.’’ Thus, under the SEC’s current rule, a mutual fund may not purchase an investment based on the credit rating alone. 8 76 FR 26550 (May 6, 2011). PO 00000 Frm 00002 Fmt 4700 Sfmt 4700 maintain, and enforce written policies and procedures designed to assess a security’s credit and liquidity risks. Based on this process, the broker-dealer would have to determine that the investment poses only a ‘‘minimal amount of credit risk.’’ Under the SEC’s proposed amendments, a broker-dealer could consider various factors in assessing a security’s credit risk. These factors could include credit spreads, securitiesrelated research, internal or external credit risk assessments (including credit ratings), and default statistics. The preamble to the SEC’s proposal states that the criteria are meant to capture securities that should generally qualify as investment grade under the current ratings-based standard ‘‘without placing undue reliance on third-party credit ratings.’’ IV. Final Rule Standard In response to comments that the NPRM’s proposed creditworthiness standards are confusing, and taking into account the other federal financial regulatory agencies’ final and proposed rules, the NCUA Board is replacing the various NRSRO-based security creditworthiness standards in NCUA regulations with only two standards: ‘‘Investment grade’’ and ‘‘minimal amount of credit risk.’’ An investment grade security is one where the credit union determines that the issuer has an adequate capacity to meet all financial commitments under the security for the projected life of the asset or exposure, even under adverse economic conditions. An issuer has an adequate capacity to meet financial commitments if the risk of default by the obligor is low, and the full and timely repayment of principal and interest on the security is expected. A security with a minimal amount of credit risk is one where the credit union determines that the issuer has a very strong capacity to meet all financial commitments under the security for the projected life of the asset or exposure, even under adverse economic conditions. An issuer has a very strong capacity to meet all financial commitments if the risk of default by the obligor is very low, and the full and timely repayment of principal and interest on the security is expected. As discussed below, ‘‘investment grade’’ is used in part 703 and, with one exception, ‘‘minimal amount of credit risk’’ is used in part 704. In evaluating the creditworthiness of a security, a credit union may consider any of the following factors, to the extent appropriate: • Credit spreads (i.e., whether it is possible to demonstrate that a security E:\FR\FM\13DER1.SGM 13DER1 wreier-aviles on DSK5TPTVN1PROD with Federal Register / Vol. 77, No. 240 / Thursday, December 13, 2012 / Rules and Regulations is subject to a particular amount of credit risk based on the spread between the security’s yield and the yield of Treasury or other securities); • Securities-related research (i.e., whether providers of securities-related research believe the issuer of the security will be able to meet its financial commitments, generally or specifically, with respect to the securities held by the credit union); • Internal or external credit risk assessments (i.e., whether credit assessments developed internally by the credit union or externally by a credit rating agency, irrespective of its status as an NRSRO, express a view as to a particular security’s credit risk); • Default statistics (i.e., whether providers of credit information relating to securities express a view that specific securities have a probability of default consistent with other securities with a particular amount of credit risk); • Inclusion on an index (i.e., whether a security, or issuer of the security, is included as a component of a recognized index of instruments that are subject to a specific amount of credit risk); • Priorities and enhancements (i.e., the extent to which a security is covered by credit enhancements, such as overcollateralization and reserve accounts); • Price, yield, and/or volume (i.e., whether the price and yield of a security are consistent with other securities that the credit union has determined are subject to a particular amount of credit risk and whether the price resulted from active trading); and • Asset class-specific factors (e.g., in the case of structured finance products, the quality of the underlying assets). NCUA will discuss these and other factors in supervisory guidance to be provided to FCUs and corporates before the effective date of this final rule. Several commenters argued that the rule itself, not just the preamble, should explicitly state that a credit union may consider third-party assessments in evaluating the financial strength of issuers and counterparties. The NCUA Board agrees and has included the above list of resources, including external risk assessments, in the new regulatory definitions of ‘‘investment grade’’ and ‘‘minimal amount of credit risk’’ discussed below. VerDate Mar<15>2010 14:58 Dec 12, 2012 Jkt 229001 V. Specific Amendments to NCUA Regulations a. Part 703—Investment and Deposit Activities Definitions Section 703.2 contains definitions of terms related to the investment activities of natural person FCUs.9 Three of the definitions refer to credit ratings. Deposit Note Section 703.2 defines ‘‘deposit note’’ as an obligation of a bank that is similar to a certificate of deposit ‘‘but is rated.’’ The NPRM deleted the definition of ‘‘deposit note’’ entirely, as the term is standard in the securities industry. NCUA received no comments on this deletion, and the NCUA Board is adopting it as proposed. Mortgage Related and Small Business Related Securities Section 107(15)(B) and (C) of the FCU Act 10 provides authority for an FCU to purchase a mortgage related security, as that term is defined in section 3(a)(41) of the Securities Exchange Act of 1934 (Exchange Act),11 and a small business related security as that term is defined in section 3(a)(53) of the Exchange Act.12 Section 703.2 defines ‘‘mortgage related security’’ and ‘‘small business related security’’ by referencing and quoting the Exchange Act definitions. Prior to July 20, 2012, the Exchange Act definitions contained references to NRSRO ratings. The Dodd-Frank Act removed the NRSRO references from the Exchange Act definitions, effective July 20, 2012, providing instead that each type of security must meet standards of creditworthiness as established by the SEC.13 The NPRM amended § 703.2 by retaining the cross-references to the Exchange Act but removing the quotations from the Exchange Act in the definitions of mortgage related security and small business related security. Under the proposal, an FCU could not purchase a mortgage related security or small business related security unless it determined that the security meets the SEC’s definition of the term. Several commenters stated that NCUA should delay modifying the definitions of mortgage related security and small business related security until the SEC has established the requisite standards of creditworthiness. While the SEC has CFR 703.2. U.S.C. 1757(15)(B) and (C). 11 15 U.S.C. 78c(a)(41). 12 15 U.S.C. 78c(a)(53). 13 Dodd-Frank Act, sec. 939(e). not established a final standard of creditworthiness, it has established a transitional standard so that markets can continue to function.14 Accordingly, the NCUA Board is adopting the definitions as proposed. Investment Grade For clarity, the NCUA Board is adding a definition of ‘‘investment grade’’ to part 703. Under the definition, a security is considered to be investment grade if the issuer of that security has an adequate capacity to meet financial commitments under the security for the projected life of the asset or exposure, even under adverse economic conditions. An issuer has an adequate capacity to meet financial commitments if the risk of default by the obligor is low, and the full and timely repayment of principal and interest on the security is expected. An FCU may consider any or all of the following factors, to the extent appropriate, with respect to a security’s credit risk: credit spreads; securities-related research; internal or external credit risk assessments; default statistics; inclusion on an index; priorities and enhancements; price, yield, and/or volume; and asset classspecific factors. Broker-Dealers and Safekeepers Sections 703.8(b)(3) and 703.9(d) list a number of factors that FCUs should consider when evaluating the reliability of broker-dealers and investment safekeepers, respectively.15 One factor is NRSRO reports. The NPRM replaced the NRSRO reference in those sections with the phrase ‘‘external assessments of creditworthiness.’’ NCUA received no comments on §§ 703.8(b)(3) and 703.9(d), and the NCUA Board is adopting the revision as proposed. Permissible Investments Section 703.14 establishes standards for permissible investments for FCUs.16 Section 703.14(e) provides that an FCU may purchase a municipal security that an NRSRO has rated in one of the four highest rating categories.17 The NPRM removed the minimum rating requirements, substituting a requirement that the FCU demonstrate that the issuer of a security has at least an adequate capacity to meet its financial obligations, even under adverse economic conditions, for the projected life of the security. As discussed above, the final rule labels such a standard ‘‘investment grade.’’ 9 12 10 12 PO 00000 Frm 00003 Fmt 4700 Sfmt 4700 74105 14 77 FR 42980 (July 23, 2012). CFR 703.8(b)(3), 703.9(d). 16 12 CFR 703.14. 17 12 CFR 703.14(e). 15 12 E:\FR\FM\13DER1.SGM 13DER1 wreier-aviles on DSK5TPTVN1PROD with 74106 Federal Register / Vol. 77, No. 240 / Thursday, December 13, 2012 / Rules and Regulations Under the final rule, an FCU may purchase a municipal security if it conducts and documents a credit analysis that reasonably concludes the security is at least investment grade, as defined in § 703.2. To further limit the risk associated with the purchase of municipal securities, the NPRM added new concentration limits on such holdings. Specifically, it required an FCU to limit its aggregate holdings of municipal securities to no more than 75 percent of the FCU’s net worth and its holdings of municipal securities issued by any single issuer to no more than 25 percent of the FCU’s net worth. One commenter suggested that municipal security concentration limits should distinguish between general obligation and revenue bonds. The commenter suggested that an appropriate aggregate limit would be 100 percent of net worth for general obligation bonds and 25 percent of net worth for revenue bonds. The NCUA Board disagrees with this suggestion. The NCUA Board acknowledges that general obligation bonds and revenue bonds are considered separate asset classes by many investors. These municipal securities, like all capital market instruments, undergo structural changes over time resulting in changing risk profiles. The risk of loss to a FCU may be similar with both types of municipal securities if there were an adverse event at the issuer level. Therefore, limiting exposure to any single obligor to 25 percent of net worth is prudent to mitigate risks of loss to the NCUSIF. Section 703.14(g) permits an FCU to purchase a European financial options contract for the purpose of hedging the risk associated with issuing share certificates with dividends tied to an equity index.18 There are a number of conditions for any such purchase, including that the counterparty meet certain NRSRO ratings requirements and that the aggregate amount of such indexlinked certificates not exceed the FCU’s net worth. The NPRM removed the reference to the NRSRO ratings and instead required that the counterparty meet credit standards approved by the FCU’s board. To mitigate any risk associated with the removal of credit ratings in this context, the proposal tightened the concentration limit from 100 percent of the FCU’s net worth to 50 percent of the FCU’s net worth. NCUA received no comments specifically on this section, and the NCUA Board is adopting it as proposed. 18 12 CFR 703.14(g). VerDate Mar<15>2010 14:58 Dec 12, 2012 Jkt 229001 Section 703.14(h) permits an FCU to invest in mortgage note repurchase transactions under certain conditions, including that the counterparty meet certain NRSRO ratings requirements and that the aggregate amount of the investments with all counterparties be limited to 100 percent of the FCU’s net worth.19 The NPRM removed the reference to the NRSRO ratings, requiring instead that the counterparty meet credit standards approved by the FCU’s board. The proposal also lowered the aggregate concentration limit to 50 percent of the FCU’s net worth. NCUA received no comments specifically on this section, and the NCUA Board is adopting it as proposed. In the time between the issuance of the NPRM and this final rule, the NCUA Board added a new § 703.14(j) to permit FCUs to purchase certain commercial mortgage related securities (CMRS) and deleted part 742 of the regulations governing NCUA’s Regulatory Flexibility (RegFlex) Program.20 Before these 2012 rule changes, § 703.16(d) generally prohibited FCUs from purchasing private label CMRS, but § 742.4(a)(6) permitted RegFlex credit unions to purchase such a security provided, among other things, the security was rated in one of the two highest rating categories by at least one NRSRO.21 The NPRM removed the NRSRO requirement from former § 742.4(a)(6), replacing it with the requirement that the issuer have a very strong capacity to meet its financial obligations, even under adverse economic conditions, for the projected life of the security. New § 703.14(j) was made final with the ratings-based requirement because it preceded this final rule. Consistent with the discussion above, however, the NCUA Board is replacing this ratings-based requirement with a requirement that the FCU conduct and document a credit analysis that reasonably concludes the security is at least investment grade. Grandfathered Investments Part 703 grandfathers certain specific securities and transactions purchased or entered into before or within certain dates.22 Several commenters argued that this final rule should explicitly provide that investments purchased under existing credit rating requirements are also grandfathered. The NCUA Board disagrees. As a matter of sound practice, FCUs must manage the credit risk 19 12 CFR 703.14(h). FR 31981 (May 31, 2012). 21 See 12 CFR 703.16(d), 742.4(a)(6). 22 12 CFR 703.18, as amended by 77 FR 31981 (May 31, 2012). 20 77 PO 00000 Frm 00004 Fmt 4700 Sfmt 4700 inherent in their investment securities and transactions by taking into account the risk of deterioration. FCUs have an ongoing obligation to reevaluate creditworthiness and address deterioration as appropriate. An FCU’s initial evaluation of credit quality is not a permanent justification for asset retention. b. Part 704—Corporate Credit Unions Definitions Section 704.2 contains definitions of terms related to the investment activities of corporates.23 The NPRM eliminated the definition of ‘‘NRSRO’’ and deleted references to NRSROs in the definitions of ‘‘asset-backed commercial paper (ABCP) program’’ and ‘‘small business related security.’’ NCUA received no comments on these proposed changes, and the NCUA Board adopts them in the final rule.24 In § 704.2, the definition of ‘‘eligible ABCP liquidity facility’’ provides that if the assets that the facility is required to fund against have received NRSRO ratings at the time of the facility’s inception, the facility can be used to fund only those assets that are rated investment grade by an NRSRO at the time of funding.25 The NPRM removed the NRSRO references, providing instead that a facility can be used to fund only those assets or exposures that demonstrate adequate capacity to meet their financial obligations, even under adverse economic conditions, for the projected life of the asset or exposure. As discussed above, this ‘‘investment grade’’ standard no longer contains an explicit rating requirement. Under the final rule, an eligible ABCP liquidity facility can be used to fund only those assets or exposures the corporate credit union reasonably concludes are at least investment grade. The NCUA Board is adding definitions of ‘‘investment grade’’ and ‘‘minimal amount of credit risk’’ to § 704.2. ‘‘Investment grade’’ has the same meaning as in part 703, and ‘‘minimal amount of credit risk’’ means the issuer of a security has a very strong capacity to meet all financial 23 12 CFR 704.2. NCUA’s authority to regulate the investment activities of natural person FCUs is limited by the FCU Act, see discussion above under ‘‘Part 703—Investment and Deposit Activities,’’ its authority to regulate the investment activities of corporate credit unions is less limited. See 12 U.S.C. 1766(a) (providing that corporate credit unions are subject to such rules, regulations, and orders as the NCUA Board deems appropriate). Accordingly, NCUA may revise the definition of ‘‘small business related security’’ in part 704 without regard to section 107(15)(C) of the FCU Act, 12 U.S.C. 1757(15)(C). 25 12 CFR 704.2. 24 While E:\FR\FM\13DER1.SGM 13DER1 Federal Register / Vol. 77, No. 240 / Thursday, December 13, 2012 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with commitments under the security for its projected life, even under adverse economic conditions. In both cases, a corporate may consider the following factors with respect to a security’s credit risk: Credit spreads; securities-related research; internal or external credit risk assessments; default statistics; inclusion on an index; priorities and enhancements; price, yield, and/or volume; and asset class-specific factors. Credit Risk Management Section 704.6(f) establishes minimum credit quality standards for corporate credit union investments.26 The standards include that each investment must have an NRSRO rating and that at least 90 percent of a corporate’s investment portfolio must have at least two such ratings. The standards further require long-term investment ratings of at least AA¥, short-term ratings of at least A¥, and monitoring of the ratings as long as a corporate holds the investment. The NPRM removed the minimum rating requirements, providing instead that for an investment to be permissible, it must be originated by an issuer that has at least a very strong capacity to meet its financial obligations, even under adverse economic conditions, for the projected life of the security. This standard applied to both long-term and short-term investments. The NPRM also required a corporate to monitor any changes in credit quality of the investment as long as it held the investment. The NCUA Board has decided to label this standard ‘‘minimal amount of credit risk.’’ This standard requires a higher level of credit quality than the ‘‘investment grade’’ standard discussed above, as it requires an issuer to have a ‘‘very strong’’ rather than just ‘‘adequate’’ capacity to meet financial commitments. The higher standard is appropriate for corporates given their mission of providing liquidity to natural person credit unions in a wide range of economic circumstances. The 2010 comprehensive overhaul of NCUA’s corporate credit union regulations was designed to enable corporates to serve primarily as liquidity facilities and payment system providers.27 As liquidity facilities, corporates must maintain high quality, marketable investments that can be sold quickly, without incurring undue loss, to fund loan and share demands. Securities with higher credit quality naturally are more marketable than those with lower quality. Thus, the NCUA Board does not 26 12 CFR 704.6(f). 75 FR 64786 (Oct. 20, 2010). 27 See VerDate Mar<15>2010 14:58 Dec 12, 2012 intend for the elimination of references to credit ratings to fundamentally change the standards that corporates should use when deciding whether a security is eligible for purchase. To enhance the ability of NCUA and corporate capital holders to monitor this process, the NCUA Board is considering modifying the corporate Call Report to require additional investment disclosures. Accordingly, under § 704.6(f)(1) of this final rule, a corporate may purchase an investment only if it conducts and documents a credit analysis that reasonably concludes the security has no more than a minimal amount of credit risk. In addition, under § 704.6(f)(2) of this final rule, a corporate must monitor any changes in the credit quality of the investment and retain appropriate supporting documentation as long as the corporate owns the investment. At the time the NPRM was issued, § 704.6(f)(4) required a corporate to develop an investment action plan if an NRSRO that initially rated a security later downgraded the rating below the minimum requirements. The NPRM modified this to require an investment action plan if the issuer no longer had a very strong capacity to meet its financial obligations for the security. Between the issuance of the NPRM and this final rule, the NCUA Board revised § 704.6 by moving paragraph (f)(4) to a new paragraph (h).28 Like former paragraph (f)(4), new paragraph (h)(1) requires a corporate to develop an investment action plan if an NRSRO that initially rates an investment later downgrades the rating below the minimum requirements. In light of the changes to the creditworthiness standard in § 704.6(f)(1) discussed above, the NCUA Board is revising § 704.6(h)(1) to trigger the requirement to prepare an investment action plan if appropriate monitoring of the investment would lead to the reasonable conclusion that the investment’s credit quality has more than a minimal amount of credit risk. Section 704.6(g) requires a corporate to maintain documentation for each credit limit with each obligor or transaction counterparty, including rating agency information. The NPRM deleted the reference to rating agency information. NCUA received no comments on this section, and the NCUA Board adopts it as proposed. Expanded Authorities Under Part I of Appendix B to part 704, corporates that meet certain 28 76 Jkt 229001 PO 00000 FR 79531 (Dec. 22, 2011). Frm 00005 Fmt 4700 Sfmt 4700 74107 conditions may purchase investments with lower credit ratings than the general AA requirement of § 704.6(f). Part I allows corporates to purchase investments with long-term ratings of at least A¥ and short-term ratings of at least A¥2. In addition, in the latter case, the issuer must have at least a long-term rating no lower than A¥ or the investment must be a domesticallyissued asset-backed security. The NPRM replaced these ratings requirements with a requirement that an issuer have at least a strong capacity to meet its financial obligations. In this final rule, the NCUA Board has determined to permit corporates that qualify for Part I authorities to purchase securities that are at least investment grade. As discussed above, with respect to part 703, a security is considered to be investment grade if the issuer of that security has adequate capacity to meet financial commitments under the security for the projected life of the asset or exposure, even under adverse economic conditions. This standard permits more credit risk than the ‘‘minimal amount of credit risk’’ standard. A corporate that has been approved for Part I authorities has additional systems that will enable it to appropriately monitor this additional credit risk to ensure that the investments held remain marketable. Part II of Appendix B to part 704 authorizes qualifying corporates to purchase certain foreign investments provided, among other things, the sovereign issuer and/or the country in which the obligor is organized has a long-term foreign currency debt rating no lower than AA¥. The NPRM deleted the NRSRO reference, providing instead that a corporate may purchase a foreign investment only pursuant to an explicit policy established by the corporate’s board of directors. The NPRM also required a corporate to determine that a foreign issuer or issuer had at least a very strong capacity to meet its financial obligations. The NCUA Board has decided to replace this standard with a requirement that the issue or issuer have no more than a minimal amount of credit risk. In accordance with the NPRM discussion, the NCUA Board is replacing the ratings requirement in Part III of Appendix B to part 704 with a requirement that a counterparty meet minimum credit quality standards as established by the corporate’s board of directors. Risk-Based Capital Appendix C to Part 704 explains how a corporate must compute its riskweighted assets for purposes of E:\FR\FM\13DER1.SGM 13DER1 74108 Federal Register / Vol. 77, No. 240 / Thursday, December 13, 2012 / Rules and Regulations determining its capital ratios. In the definitions section, ‘‘traded position’’ is defined with reference to an NRSRO rating and is used only in paragraphs II(c)(3) and (4).29 Paragraphs II(c)(3) and (4) provide alternative methods for calculating the risk weights of certain assets. Since these alternative methods involve reliance on NRSRO ratings, the NPRM deleted these paragraphs, as well as the definition of ‘‘traded position.’’ The NPRM added a new paragraph II(c)(3) which allowed a corporate with advanced risk management and reporting systems to seek NCUA approval to use an internal ratings-based approach to calculate risk-weights for those positions.30 The NCUA Board received no comments on these aspects of the NPRM and is adopting them as proposed. The NPRM also removed other ratings-based requirements in Appendix C, replacing several with board of director standards and one, in paragraph II(a)(2)(viii)(A), with a requirement that a qualifying securities firm demonstrate at least a strong capacity to meet its financial obligations, even under adverse economic conditions, for the projected life of an exposure. The NCUA Board is replacing this with the ‘‘minimal amount of credit risk’’ standard. c. Part 709—Involuntary Liquidation of Federal Credit Unions and Adjudication of Creditor Claims Involving Federally Insured Credit Unions in Liquidation Part 709 of the NCUA regulations governs the involuntary liquidation of FCUs and the adjudication of creditor claims involving federally insured credit unions (FICUs).31 Section 709.10(b) provides that NCUA will not 29 12 CFR Part 704, Appendix C, Part I(b). internal credit risk rating systems typically: (1) Are an integral part of the corporate’s risk management system that explicitly incorporates the full range of risks arising from the corporate’s participation in securitization activities; (2) link internal credit ratings to measurable outcomes; (3) separately consider the risk associated with the underlying loans or borrowers and the risk associated with the structure of the particular securitization transaction; (4) identify gradations of risk; (5) use clear, explicit criteria to classify assets into each internal rating grade; 6) employ independent credit risk management or loan review personnel to assign or review the credit risk ratings; (7) include an internal audit procedure to periodically verify that internal risk ratings are assigned in accordance with the corporate’s established criteria; (8) monitor the performance of the assigned internal credit risk ratings over time to determine the appropriateness of the initial credit risk rating assignment, and adjust individual credit risk ratings or the overall internal credit risk rating system, as needed; and (9) make credit risk rating assumptions that are consistent with, or more conservative than, the credit risk rating assumptions and methodologies of NRSROs. 31 12 CFR part 709. wreier-aviles on DSK5TPTVN1PROD with 30 Acceptable VerDate Mar<15>2010 14:58 Dec 12, 2012 Jkt 229001 use its authority to repudiate contracts under Section 207(c) of the FCU Act 32 to reclaim, recover, or recharacterize financial assets transferred by a FICU in connection with a securitization or in the form of a participation. Section 709.10(f) provides that NCUA will not attempt to avoid an otherwise legally enforceable securitization or participation agreement solely because the agreement does not meet the requirements of sections 207(b)(9) and 208(a)(3) of the FCU Act. These sections provide that, to be enforceable against NCUA, any agreement that tends to diminish or defeat NCUA’s interest in an asset must be executed contemporaneously with the acquisition of the asset by the credit union.33 Section 709.10(a)(5) sets forth a definition of ‘‘securitization’’ that includes a reference to NRSRO ratings. The NPRM deleted paragraph (a)(5) and references to securitization in paragraphs (b), (f), and (g), with the rationale that credit unions do not securitize assets within the meaning of part 709. In addition, the proposal deleted paragraph (a)(6), defining ‘‘special purpose entity,’’ as this phrase is only used in the definition of ‘‘securitization.’’ Although NCUA received no comments on the proposed changes to part 709, this final rule retains the language relating to securitizations. In conformance with the requirements of the Dodd-Frank Act, however, the NCUA Board is replacing the definition of ‘‘securitization’’ in part 709, which contains an NRSRO reference, with the definition in part 704, which does not. Section 709.10(a)(5) now defines a ‘‘securitization’’ as the pooling and repackaging by a special purpose entity of assets or other credit exposures that can be sold to investors. d. Part 741—Requirements for Insurance Part 741 prescribes various requirements for obtaining and maintaining federal insurance. It does not contain a reference to NRSRO ratings but does require federally insured, state-chartered credit unions (FISCUs) to establish an additional special reserve for investments if those credit unions are permitted by their respective state laws to make investments beyond those authorized in the FCU Act or NCUA regulations.34 As a consequence of this requirement, and to reduce the possibility that a FISCU will have to establish a special reserve, 32 12 U.S.C. 1787(c). U.S.C. 1787(b)(9) and 1788(a)(3). 34 12 CFR 741.3(a)(2). many states have instituted credit union investment laws that parallel part 703. For example, a state may authorize its state-chartered credit unions to purchase municipal securities rated in one of the four highest rating categories, as § 703.14(e) has provided for FCUs. Although no changes were proposed to Part 741, one commenter stated that if a FISCU holds a ratings-based investment permissible under state law, that investment should not be considered ‘‘nonconforming’’ under § 741.3(a)(2). The NCUA Board agrees that a safe harbor should be preserved, and has added a sentence to § 741.3(a)(2) stating that if a FISCU conducts and documents a credit analysis that reasonably concludes an investment is at least investment grade, as defined in § 703.2, and the investment is otherwise permissible for FCUs, the investment is not considered to be beyond those authorized by NCUA regulations. e. Part 742—Regulatory Flexibility Program The NPRM removed an NRSRO requirement from a paragraph in part 742, but as discussed above, the NCUA Board subsequently moved that paragraph to § 703.14(j) and deleted part 742.35 The NCUA Board’s treatment of the relocated paragraph in this final rule is also discussed above. VI. Regulatory Procedures a. Regulatory Flexibility Act The Regulatory Flexibility Act requires NCUA to prepare an analysis to describe any significant economic impact a rule may have on a substantial number of small entities (primarily those credit unions under $10 million in assets). This final rule removes NRSRO ratings from NCUA’s regulations. NCUA data show that credit unions with under $10 million in assets generally do not engage in investment activities that are affected by those portions of the NCUA rules that refer to NRSRO ratings. Accordingly, NCUA has determined and certifies that this final rule will not have a significant economic impact on a substantial number of small credit unions. b. Paperwork Reduction Act The Paperwork Reduction Act of 1995 (PRA) applies to rulemakings in which an agency by rule creates a new paperwork burden on regulated entities or modifies an existing burden. 44 U.S.C. 3507(d); 5 CFR part 1320. For purposes of the PRA, a paperwork burden may take the form of a reporting, 33 12 PO 00000 Frm 00006 Fmt 4700 Sfmt 4700 35 77 E:\FR\FM\13DER1.SGM FR 31981 (May 31, 2012). 13DER1 Federal Register / Vol. 77, No. 240 / Thursday, December 13, 2012 / Rules and Regulations wreier-aviles on DSK5TPTVN1PROD with recordkeeping, or disclosure requirement, both referred to as information collections. The Office of Management and Budget (OMB) approved the current information collection requirements in part 703 in 2007 and assigned them control number 3133–0133. OMB approved the current information collection requirements in part 704 and assigned them control number 3133–0129. We believe that all of the corporate credit unions already have policies and procedures in place for evaluating the credit risk of securities activities, but this final rule may require additional analysis of credit risk for natural person FCUs and thus result in additional burden hours. We estimate that approximately 750 natural person FCUs may need to develop or augment a system for evaluating creditworthiness. We estimate that, on average, the FCUs will spend 20 hours on such a system, resulting in an initial aggregate burden of 15,000 hours. This estimate is based on the fact that many of these FCUs already have some criteria in place for evaluating creditworthiness. We further estimate that, on average, each of those FCUs will spend an additional 10 hours each year reviewing, adjusting, and applying its system for evaluating creditworthiness, for a total of 7,500 hours across the industry. Once again, this estimate reflects that many of these FCUs already are applying a system of evaluating creditworthiness. As required by the PRA, NCUA has submitted a copy of this proposal to OMB for its review and approval. c. Executive Order 13132 Executive Order 13132 encourages independent regulatory agencies to consider the impact of their actions on state and local interests. In adherence to fundamental federalism principles, NCUA, an independent regulatory agency as defined in 44 U.S.C. 3502(5), voluntarily complies with the executive order. This final rule will not have substantial direct effects on the states, on the connection between the national government and the states, or on the distribution of power and responsibilities among the various levels of government. NCUA has determined that this final rule does not constitute a policy that has federalism implications for purposes of the executive order. d. Assessment of Federal Regulations and Policies on Families NCUA has determined that this final rule will not affect family well-being VerDate Mar<15>2010 14:58 Dec 12, 2012 Jkt 229001 within the meaning of section 654 of the Treasury and General Government Appropriations Act, 1999, Public Law 105–277, 112 Stat. 2681 (1998). e. Small Business Regulatory Enforcement Fairness Act The Small Business Regulatory Enforcement Fairness Act of 1996 (Pub. L. 104–121) provides generally for congressional review of agency rules. A reporting requirement is triggered in instances where NCUA issues a final rule as defined by section 551 of the Administrative Procedure Act. 5 U.S.C. 551. OMB has determined that this rule is not a major rule for purposes of the Small Business Regulatory Enforcement Fairness Act of 1996. List of Subjects 12 CFR Part 703 Credit unions, Investments, Reporting and recordkeeping requirements. 12 CFR Part 704 Credit unions, Investments, Reporting and recordkeeping requirements. 12 CFR Part 709 Credit unions, Liquidations. 12 CFR Part 741 74109 commitments if the risk of default by the obligor is low and the full and timely repayment of principal and interest on the security is expected. A Federal credit union may consider any or all of the following factors, to the extent appropriate, with respect to the credit risk of a security: Credit spreads; securities-related research; internal or external credit risk assessments; default statistics; inclusion on an index; priorities and enhancements; price, yield, and/or volume; and asset classspecific factors. This list of factors is not meant to be exhaustive or mutually exclusive. * * * * * Mortgage related security means a security as defined in section 3(a)(41) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(41)). * * * * * Small business related security means a security as defined in section 3(a)(53) of the securities Exchange Act of 1934 (15 U.S.C. 78c(a)(53)). This definition does not include Small Business Administration securities permissible under section 107(7) of the Federal Credit Union Act. * * * * * 3. In § 703.8, revise paragraph (b)(3) to read as follows: Credit unions, Reporting and recordkeeping requirements, Requirements for insurance. ■ By the National Credit Union Administration Board on December 6, 2012. Mary F. Rupp, Secretary of the Board. * For the reasons stated above, the National Credit Union Administration amends 12 CFR parts 703, 704, 709, and 741 as set forth below: PART 703—INVESTMENTS AND DEPOSIT ACTIVITIES 1. The authority citation for part 703 continues to read as follows: ■ Authority: 12 U.S.C. 1757(7), 1757(8), 1757(15). 2. In § 703.2 remove the definition of Deposit note, add a definition of Investment grade, and revise the definitions of Mortgage related security and Small business related security to read as follows: ■ § 703.2 Definitions. * * * * * Investment grade means the issuer of a security has an adequate capacity to meet the financial commitments under the security for the projected life of the asset or exposure, even under adverse economic conditions. An issuer has an adequate capacity to meet financial PO 00000 Frm 00007 Fmt 4700 Sfmt 4700 § 703.8 Broker-dealers. * * * * (b) * * * (3) If the broker-dealer is acting as the Federal credit union’s counterparty, the ability of the broker-dealer and its subsidiaries or affiliates to fulfill commitments, as evidenced by capital strength, liquidity, and operating results. The Federal credit union should consider current financial data, annual reports, external assessments of creditworthiness, relevant disclosure documents, and other sources of financial information. * * * * * 4. In § 703.9, revise paragraph (d) to read as follows: ■ § 703.9 Safekeeping of investments. * * * * * (d) Annually, the Federal credit union must analyze the ability of the safekeeper to fulfill its custodial responsibilities, as evidenced by capital strength, liquidity, and operating results. The Federal credit union should consider current financial data, annual reports, external assessments of creditworthiness, relevant disclosure documents, and other sources of financial information. E:\FR\FM\13DER1.SGM 13DER1 74110 Federal Register / Vol. 77, No. 240 / Thursday, December 13, 2012 / Rules and Regulations 5. In § 703.14, revise paragraphs (e), (g)(9), (g)(11), (h)(1), (h)(2), and (j)(1) to read as follows: ■ § 703.14 Permissible investments. * * * * * (e) Municipal security. A Federal credit union may purchase and hold a municipal security, as defined in section 107(7)(K) of the Act, only if it conducts and documents an analysis that reasonably concludes the security is at least investment grade. The Federal credit union must also limit its aggregate municipal securities holdings to no more than 75 percent of the Federal credit union’s net worth and limit its holdings of municipal securities issued by any single issuer to no more than 25 percent of the Federal credit union’s net worth. * * * * * (g) * * * (9) The counterparty to the transaction meets the minimum credit quality standards as approved by the Federal credit union’s board of directors. * * * * * (11) The aggregate amount of equitylinked member share certificates does not exceed 50 percent of the Federal credit union’s net worth; * * * * * (h) * * * (1) The aggregate of the investments with any one counterparty is limited to 25 percent of the Federal credit union’s net worth and 50 percent of its net worth with all counterparties; (2) At the time the Federal credit union purchases the securities, the counterparty, or a party fully guaranteeing the counterparty, must meet the minimum credit quality standards as approved by the Federal credit union’s board of directors. * * * * * (j) * * * (1) The Federal credit union conducts and documents a credit analysis that reasonably concludes the CMRS is at least investment grade. * * * * * PART 704—CORPORATE CREDIT UNIONS 6. The authority citation for part 704 continues to read as follows: wreier-aviles on DSK5TPTVN1PROD with ■ Authority: 12 U.S.C. 1762, 1766(a), 1772a, 1781, 1789, and 1795e. 7. In § 704.2: a. Revise the definitions of Assetbacked commercial paper program and Eligible ABCP liquidity facility; ■ ■ VerDate Mar<15>2010 14:58 Dec 12, 2012 Jkt 229001 b. Add a definition of Investment grade and Minimal amount of credit risk; ■ c. Remove the definition of Nationally Recognized Statistical Rating Organization; and ■ d. Revise the definition of Small business related security. The revisions and addition read as follows: ■ § 704.2 Definitions. * * * * * Asset-backed commercial paper program (ABCP program) means a program that primarily issues commercial paper and that is backed by assets or other exposures held in a bankruptcy-remote special purpose entity. The term sponsor of an ABCP program means a corporate credit union that: (1) Establishes an ABCP program; (2) Approves the sellers permitted to participate in an ABCP program; (3) Approves the asset pools to be purchased by an ABCP program; or (4) Administers the ABCP program by monitoring the assets, arranging for debt placement, compiling monthly reports, or ensuring compliance with the program documents and with the program’s credit and investment policy. * * * * * Eligible ABCP liquidity facility means a legally binding commitment to provide liquidity support to assetbacked commercial paper by lending to, or purchasing assets from any structure, program or conduit in the event that funds are required to repay maturing asset-backed commercial paper and that meets the following criteria: (1)(i) At the time of the draw, the liquidity facility must be subject to an asset quality test that precludes funding against assets that are 90 days or more past due or in default; and (ii) The facility can be used to fund only those assets or exposures that the corporate credit union has reasonably concluded, based on a documented analysis, are at least investment grade; or (2) If the assets that are funded under the liquidity facility do not meet the criteria described in paragraph (1) of this definition, the assets must be guaranteed, conditionally or unconditionally, by the United States Government, its agencies, or the central government of an Organization for Economic Cooperation and Development (OECD) country. * * * * * Investment grade means the issuer of the security has an adequate capacity to meet the financial commitments under PO 00000 Frm 00008 Fmt 4700 Sfmt 4700 the security for the projected life of the asset or exposure, even under adverse economic conditions. An issuer has an adequate capacity to meet financial commitments if the risk of default by the obligor is low and the full and timely repayment of principal and interest on the security is expected. A corporate credit union may consider any or all of the following factors, to the extent appropriate, with respect to the credit risk of a security: Credit spreads; securities-related research; internal or external credit risk assessments; default statistics; inclusion on an index; priorities and enhancements; price, yield, and/or volume; and asset classspecific factors. This list of factors is not meant to be exhaustive or mutually exclusive. * * * * * Minimal amount of credit risk means the amount of credit risk when the issuer of a security has a very strong capacity to meet all financial commitments under the security for the projected life of the asset or exposure, even under adverse economic conditions. An issuer has a very strong capacity to meet all financial commitments if the risk of default by the obligor is very low, and the full and timely repayment of principal and interest on the security is expected. A corporate credit union may consider any or all of the following factors, to the extent appropriate, with respect to the credit risk of a security: Credit spreads; securities-related research; internal or external credit risk assessments; default statistics; inclusion on an index; priorities and enhancements; price, yield, and/or volume; asset classspecific factors. This list of factors is not meant to be exhaustive or mutually exclusive. * * * * * Small business related security means a security that represents an interest in one or more promissory notes or leases of personal property evidencing the obligation of a small business concern and originated by an insured depository institution, insured credit union, insurance company, or similar institution which is supervised and examined by a Federal or State authority, or a finance company or leasing company. This definition does not include Small Business Administration securities permissible under section 107(7) of the Act. * * * * * ■ 8. In § 704.6, revise paragraphs (f), (g)(2)(iii), and (h)(1) to read as follows: § 704.6 * E:\FR\FM\13DER1.SGM Credit risk management. * * 13DER1 * * Federal Register / Vol. 77, No. 240 / Thursday, December 13, 2012 / Rules and Regulations (f) Credit ratings—(1) Before purchasing an investment, a corporate credit union must conduct and document an analysis that reasonably concludes the investment has no more than a minimal amount of credit risk. (2) A corporate credit union must identify and monitor any changes in credit quality of the investment and retain appropriate supporting documentation as long as the corporate owns the investment. (g) * * * (2) * * * (iii) The latest available financial reports, industry analyses, and internal and external analyst evaluations sufficient to support each approved credit limit. (h) * * * (1) Appropriate monitoring of the investment would reasonably lead to the conclusion that the investment presents more than a minimal amount of credit risk; or * * * * * ■ 9. In Appendix B: ■ a. Remove Part I (a)(2); ■ b. Redesignate Part I (a)(3), (4), and (5) as Part I (a)(2), (3), and (4), respectively; ■ c. Remove Part II (b)(2); ■ d. Redesignate Part II (b)(3), (4), and (5) as Part II (b)(2), (3), and (4), respectively; and ■ e. Revise Part I (a)(1), Part II (b)(1), and Part III (b) to read as follows: established by the corporate’s board of directors; (2) If the intended counterparty is foreign, the corporate must have Part II expanded authority and the counterparty must meet minimum credit quality standards as established by the corporate’s board of directors; (3) The corporate must identify the criteria relied upon to determine that the counterparty meets the credit quality requirements of this part at the time the transaction is entered into and monitor those criteria for as long as the contract remains open; and (4) The corporate must comply with § 704.10 of this part if the credit quality of the counterparty deteriorates below the minimum credit quality standards established by the corporate’s board of directors. Appendix B to Part 704—Expanded Authorities and Requirements * * * * * * * * * * Part I * (a) * * * (1) Purchase an investment after conducting and documenting an analysis that reasonably concludes the investment is at least investment grade; * * * * * * * * Part II * * (b) * * * (1) Investments must be made pursuant to an explicit policy established by the corporate credit union’s board of directors. Before purchasing an investment, the corporate credit union must conduct and document an analysis that reasonably concludes the foreign issue or issuer has no more than a minimal amount of credit risk; * * * * * * * * wreier-aviles on DSK5TPTVN1PROD with Part III * * (b) Credit Quality: All derivative transactions are subject to the following requirements: (1) If the intended counterparty is domestic, the counterparty must meet minimum credit quality standards as VerDate Mar<15>2010 14:58 Dec 12, 2012 Jkt 229001 * * * * * 10. In Appendix C: a. Remove the definition of Traded position from paragraph I(b); ■ b. Revise paragraphs II (a)(2)(viii)(A), II (a)(2)(viii)(B) introductory text, II (b)(1)(iv), II (b)(2)(ii), and II (b)(4): ■ c. Remove paragraphs II (c)(3) and (4); ■ d. Add new paragraph II (c)(3); and ■ e. Redesignate paragraph II (c)(5) and (6) as paragraphs II (c)(4) and (5), respectively. The revisions and addition read as follows: ■ ■ Appendix C to Part 704—Risk-Based Capital Credit Risk-Weight Categories * * * * Part II: Risk-Weightings (a) * * * (2) * * * (viii) * * * (A) A qualifying securities firm must meet the minimum credit quality standards as established by the corporate credit union’s board of directors or have at least one issue of long-term unsecured debt that is reasonably determined to present no more than a minimal amount of credit risk, whichever requirement is more stringent. Alternatively, a qualifying securities firm may rely on the creditworthiness of its parent consolidated company, if the parent consolidated company guarantees the claim. (B) A collateralized claim on a qualifying securities firm does not have to comply with the requirements of paragraph (a) of this section of Appendix C if the claim arises under a contract that: * * * * * (b) * * * (1) * * * (iv) Unused portions of ABCP liquidity facilities that do not meet the definition of an eligible ABCP liquidity facility. The resulting credit equivalent amount is assigned to the risk category appropriate to the assets to be funded by the liquidity facility based on the assets or the obligor, after considering any collateral or guarantees. (2) * * * PO 00000 Frm 00009 Fmt 4700 Sfmt 4700 74111 (ii) Unused portions of commitments (including home equity lines of credit and eligible ABCP liquidity facilities) with an original maturity exceeding one year except those listed in paragraph II (b)(5) of this Appendix. For eligible ABCP liquidity facilities, the resulting credit equivalent amount is assigned to the risk category appropriate to the assets to be funded by the liquidity facility based on the assets or the obligor, after considering any collateral or guarantees. * * * * * (4) 10 percent credit conversion factor (Group D). Unused portions of eligible ABCP liquidity facilities with an original maturity of one year or less. The resulting credit equivalent amount is assigned to the risk category appropriate to the assets to be funded by the liquidity facility based on the assets or the obligor, after considering any collateral or guarantees. * * * * * (c) * * * (3) Internal ratings-based approach— (i) Calculation. Corporate credit unions with advanced risk management and reporting systems may seek NCUA approval to use credit risk models to calculate riskweighted asset amounts for positions described in paragraphs II (c)(1) and (2) of this section of the Appendix C. In determining whether to grant approval, NCUA will consider the financial condition and risk management sophistication of the corporate credit union and the adequacy of the corporate’s risk models and supporting management information systems. (ii) Consistent use of internal ratings-based approach. A corporate credit union that has been granted NCUA approval to use an internal ratings-based approach and that has determined to use such an approach must do so in a consistent manner for all securities so rated. * * * * * PART 709—INVOLUNTARY LIQUIDATION OF FEDERAL CREDIT UNIONS AND ADJUDICATION OF CREDITOR CLAIMS INVOLVING FEDERALLY INSURED CREDIT UNIONS IN LIQUIDATIONS 11. The authority citation for part 709 continues to read as follows: ■ Authority: 12 U.S.C. 1757, 1766, 1767, 1786(h), 1787, 1788, 1789, 1789a. 12. In § 709.10, revise paragraph (a)(5) to read as follows: ■ § 709.10 Treatment by conservator or liquidating agent of financial assets transferred in connection with a securitization or participation. * * * * * (a) * * * (5) Securitization means the pooling and repackaging by a special purpose entity of assets or other credit exposures that can be sold to investors. Securitization includes transactions that E:\FR\FM\13DER1.SGM 13DER1 74112 Federal Register / Vol. 77, No. 240 / Thursday, December 13, 2012 / Rules and Regulations create stratified credit risk positions whose performance is dependent upon an underlying pool of credit exposures, including loans and commitments. * * * * * PART 741—REQUIREMENTS FOR INSURANCE 13. The authority citation for part 741 continues to read as follows: ■ Authority: 12 U.S.C. 1757, 1766(a), 1781– 1790, and 1790d; 31 U.S.C. 3717. 14. In § 741.3, revise paragraph (a)(2) by adding a sentence between the first and second sentences to read as follows: ■ § 741.3 Criteria. * * * * * (a) * * * (2) * * * For purposes of this paragraph, if a state-chartered credit union conducts and documents an analysis that reasonably concludes an investment is at least investment grade, as defined in § 703.2 of this chapter, and the investment is otherwise permissible for Federal credit unions, that investment is not considered to be beyond those authorized by the Act or the NCUA Rules and Regulations. * * * * * * * * [FR Doc. 2012–30076 Filed 12–12–12; 8:45 am] BILLING CODE 7535–01–P NATIONAL CREDIT UNION ADMINISTRATION 12 CFR Part 713 RIN 3133–AD98 Fidelity Bond and Insurance Coverage National Credit Union Administration (NCUA). ACTION: Final rule. AGENCY: The NCUA Board (Board) is adopting as a final rule, without change, the interim final rule that the Board issued in May 2012 that amended NCUA’s fidelity bond rule. The interim final rule removed references in the fidelity bond rule to NCUA’s former Regulatory Flexibility Program (RegFlex), which granted a RegFlex credit union broader authority to choose the deductible amount of its fidelity bond policy. DATES: Effective December 13, 2012, the interim final rule published May 31, 2012, at 77 FR 31981, is adopted as final without change. FOR FURTHER INFORMATION CONTACT: Frank Kressman, Associate General Counsel, Office of General Counsel, at the above address or telephone: (703) 518–6540. wreier-aviles on DSK5TPTVN1PROD with SUMMARY: VerDate Mar<15>2010 14:58 Dec 12, 2012 Jkt 229001 The NCUA Board (Board) is adopting as a final rule, without change, the interim final rule that the Board issued in May 2012 that amended NCUA’s fidelity bond rule.1 The interim final rule removed references in the fidelity bond rule to NCUA’s former Regulatory Flexibility Program (RegFlex), which granted a RegFlex credit union broader authority to choose the deductible amount of its fidelity bond policy.2 Specifically, the interim final rule amended the standard used for granting authority to a federal credit union (FCU) to choose an increased deductible amount. Before the Board issued the interim final rule, the standard was based on an FCU’s assets and status as a RegFlex FCU. The standard used after the interim final rule is based on an FCU’s assets, CAMEL ratings, and capital level. The new standard is also used by NCUA in other rules affected by the elimination of RegFlex. SUPPLEMENTARY INFORMATION: I. Background II. Comments III. Regulatory Procedures I. Background What did the interim final rule change and why is NCUA adopting this final rule? In issuing a proposed rule in 2011 to remove part 742 from NCUA’s regulations and eliminate the RegFlex Program,3 NCUA inadvertently overlooked references to RegFlex in its fidelity bond rule.4 At that time, the fidelity bond rule established a formula for calculating the maximum deductible an FCU could carry on its fidelity bond based partly on the FCU’s asset size. The rule set a cap of $200,000, but permitted RegFlex FCUs with assets in excess of $1 million a higher maximum deductible of up to $1 million.5 With the issuance of the final rule to eliminate RegFlex, the NCUA Board also issued an interim final rule to amend the fidelity bond rule.6 The interim final rule changed the regulatory standard for permitting an FCU to have an increased deductible on its fidelity bond. As noted, the standard used before the interim final rule was that a RegFlex FCU with assets in excess of $1 million had such authority. The 1 77 FR 31981 (May 31, 2012). Board established RegFlex in 2002. 66 FR 58656 (Nov. 23, 2001). RegFlex relieved FCUs from certain regulatory restrictions and granted them additional powers if they demonstrated sustained superior performance as measured by CAMEL rating and net worth classification. 3 76 FR 81421 (Dec. 28, 2011). 4 12 CFR 713.6. 5 12 CFR 713.6(a)(1), (c). 6 77 FR 31981 (May 31, 2012). 2 The PO 00000 Frm 00010 Fmt 4700 Sfmt 4700 standard used after the interim final rule is that such authority is granted to an FCU with assets in excess of $1 million that is, among other things, well capitalized.7 Specifically, the interim final rule permits an FCU to choose a maximum deductible amount for its fidelity bond coverage of $1 million if the FCU has: (1) Received a composite CAMEL rating of ‘‘1’’ or ‘‘2’’ during its last two full examinations and (2) maintained a ‘‘well capitalized’’ net worth classification for the immediately preceding six quarters or has remained ‘‘well capitalized’’ for the immediately preceding six quarters after applying the applicable risk-based net worth requirement. Once a year, an FCU meeting the interim final rule’s well capitalized standard must review its continued eligibility for a higher deductible under the rule, which is the same approach applied by the Board when it adopted the fidelity bond provisions in 2005.8 An FCU’s continued eligibility will be based on its asset size as reflected in its most recent year-end 5300 call report and its net worth as reflected in that same report. If an FCU that previously qualified for the higher deductible limit has a decrease in assets based on its most recent year-end 5300 call report or its net worth has decreased so that it would no longer qualify under the well capitalized standard in the fidelity bond rule, then it must obtain the coverage otherwise required by Part 713 with an appropriate deductible. A similar result occurs if an FCU meets the assets threshold and its net worth continues to qualify it under the well capitalized standard, but it has failed to receive a CAMEL rating of ‘‘1’’ or ‘‘2’’ during its most recent examination report. II. Comments NCUA received no written responses to its request for comment on the interim final rule.9 Accordingly, the NCUA Board adopts as final, without change, the interim final rule published in May 2012.10 III. Regulatory Procedures Regulatory Flexibility Act NCUA must prepare an analysis to describe any significant economic impact a rule may have on a substantial number of small entities (primarily those under ten million dollars in assets). The final rule reframes a 7 See 70 FR 61713 (Oct. 26, 2005) for a broader perspective of the regulatory history of part 713. 8 Id. at 61714. 9 77 FR 31981 (May 31, 2012). 10 Id. E:\FR\FM\13DER1.SGM 13DER1

Agencies

[Federal Register Volume 77, Number 240 (Thursday, December 13, 2012)]
[Rules and Regulations]
[Pages 74103-74112]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-30076]



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Rules and Regulations
                                                Federal Register
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This section of the FEDERAL REGISTER contains regulatory documents 
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Federal Register / Vol. 77, No. 240 / Thursday, December 13, 2012 / 
Rules and Regulations

[[Page 74103]]



NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 703, 704, 709, and 741

RIN 3133-AD86


Alternatives to the Use of Credit Ratings

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule.

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SUMMARY: NCUA is issuing a final rule to implement certain statutory 
requirements in Title IX of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (the Dodd-Frank Act) pertaining to the use of 
credit ratings to assess creditworthiness. The final rule removes 
references to credit ratings in NCUA regulations or replaces them with 
other appropriate standards of creditworthiness as required by the 
Dodd-Frank Act.

DATES: This rule is effective June 11, 2013.

FOR FURTHER INFORMATION CONTACT: Mark Vaughan, Director, Division of 
Analytics and Surveillance, or Dale Klein, Senior Capital Markets 
Specialist, Office of Examination and Insurance, at (703) 518-6360; or 
Frank Kressman, Associate General Counsel, or Lisa Henderson, Staff 
Attorney, at (703) 518-6540. All may be reached at the National Credit 
Union Administration, 1775 Duke Street, Alexandria, VA 22314.

SUPPLEMENTARY INFORMATION: 
I. Background
II. Public Comments
III. Actions of Other Regulators
IV. Final Rule Standard
V. Specific Amendments to NCUA Regulations
VI. Regulatory Procedures

I. Background

Why is NCUA adopting this rule?

    Section 939A of the Dodd-Frank Act requires all federal agencies, 
including NCUA, to review their regulations for any use of credit 
ratings to assess the creditworthiness of a security or money market 
instrument, remove those references, and substitute in those 
regulations other standards of creditworthiness that they determine to 
be appropriate.\1\ On February 17, 2011, the NCUA Board issued a Notice 
of Proposed Rulemaking (NPRM) to implement section 939A.\2\
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    \1\ Public Law 111-203, 124 Stat. 1376 (2010) sec. 939A.
    \2\ 76 FR 11164 (Mar. 1, 2011).
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How did the NCUA Board propose to replace the ratings in the NPRM?

    The NPRM identified references made to nationally recognized 
statistical rating organization (NRSRO) \3\ credit ratings in parts 
703, 704, 709, and 742 of NCUA regulations.\4\ The NPRM generally 
treated NRSRO credit rating references three different ways, as 
discussed below, depending on how the rating was used in the 
regulations. The preamble to the NPRM also acknowledged that there were 
many possible standards of creditworthiness that could be used and 
sought suggestions for alternative standards.
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    \3\ An NRSRO is an entity registered with the U.S. Securities 
and Exchange Commission (SEC) under section 15E of the Securities 
Exchange Act of 1934. See 15 U.S.C. 78o-7, as implemented by 17 CFR 
240.17g-1.
    \4\ 12 CFR parts 703, 704, 709, and 742.
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    For regulations pertaining to investment securities, the NPRM 
replaced minimum rating requirements with a requirement that the 
federal credit union (FCU) or corporate credit union (corporate) 
conduct and document a credit analysis demonstrating that the issuer of 
the security has a certain, specified capacity to meet its financial 
commitments. These replacement standards were based on narrative 
descriptions provided by the NRSROs for certain letter ratings. For 
example, where NCUA regulations currently require an investment to have 
a AA rating, the proposal required the credit union to determine that 
the issuer of the security had a very strong capacity to meet its 
financial commitments. The NPRM preamble noted that a credit union 
could use internal and external assessments when evaluating the 
financial strength of an issuer. The preamble also noted that NCUA 
would provide additional supervisory guidance on assessing 
creditworthiness. For regulations pertaining to counterparty 
transactions, the NPRM replaced minimum rating requirements with a 
requirement that the credit union conduct a credit analysis of the 
counterparty based on a standard approved by the credit union's board. 
For provisions not related to investment and counterparty suitability, 
the NPRM generally deleted references to ratings without requiring a 
substitute analysis.

II. Public Comments

    The public comment period for the NPRM ended on May 2, 2011, and 
NCUA received 11 comments. In general, most of the commenters did not 
support the proposal. While many acknowledged that the Dodd-Frank Act 
requires NCUA to remove ratings references, they opposed replacing the 
ratings with a credit analysis tied to a narrative description, arguing 
that it was too subjective and would cause confusion. These commenters 
generally did not propose alternative standards of creditworthiness. A 
number of commenters stated that the proposal went beyond the 
requirements of the Dodd-Frank Act, arguing that the legislation does 
not prohibit financial institutions from using credit ratings. The NCUA 
Board notes that nothing in the NPRM prohibited credit unions from 
using credit ratings as an element of the required credit analysis.
    A few commenters responded to NCUA's request for comments on 
alternative standards of creditworthiness. One suggested that NCUA 
publish a list of acceptable ``safe harbor'' investments. The NCUA 
Board believes that establishing such a list would effectively transfer 
credit union risk management to NCUA. Credit union boards and 
management teams are in a better position to assess the appropriateness 
of investment instruments and transactions based on their credit 
unions' unique risk preferences, portfolio objectives, and balance 
sheet composition. A safe harbor provision exempts an investor from due 
diligence responsibility and could be viewed as NCUA's tacit

[[Page 74104]]

endorsement of the suitability of certain investments.
    Without providing specific numbers, another commenter suggested 
generally that an alternative standard could be based on credit 
spreads. The NCUA Board does not support this approach because credit 
spreads are a function of open markets and they reflect investor 
interest for reasons that include, but are not limited to, credit risk. 
Market credit spreads for various asset classes experience variability 
depending on current supply and demand for the product, actual market 
interest rates, and a variety of other factors. While the NCUA Board 
declines to establish specific allowable credit spreads, it notes that 
FCUs and corporates may use credit spread information as a factor in 
assessing changes in creditworthiness.
    Several commenters suggested that NCUA wait to finalize alternative 
standards of creditworthiness until other financial institution 
regulators have proposed or finalized standards. Since the NCUA Board 
issued the NPRM, the Office of the Comptroller of the Currency (OCC) 
and the Federal Deposit Insurance Corporation (FDIC) have issued final 
rules replacing credit ratings with alternative creditworthiness 
standards similar to those the NCUA Board proposed in the NPRM. 
Further, the SEC has issued comparable proposed rules. We discuss these 
final and proposed rules below. We also discuss how the NCUA Board has 
adjusted the replacement credit standards in this final rule from those 
in the NPRM.
    Several commenters requested more guidance on how a credit union's 
board of directors should establish credit quality standards for 
counterparties. In general, a credit union board should clearly 
articulate the institution's risk tolerance for counterparty credit 
risk by approving relevant policies, including a framework for 
establishing limits on individual counterparty exposures and 
concentrations of exposures. In turn, senior management should 
establish and implement a comprehensive risk measurement and management 
framework consistent with this risk tolerance that provides for the 
ongoing monitoring, reporting, and control of counterparty credit risk 
exposures. The policies and framework should be appropriate to the 
size, nature, and complexity of the credit union's counterparty credit 
risk profile.

III. Actions of Other Regulators

    The OCC and FDIC have issued final rules replacing NRSRO-based 
security creditworthiness standards.\5\ The new rules redefine an 
``investment grade'' security as one where the issuer has an adequate 
capacity to meet all financial commitments under the security for the 
projected life of the security. To meet this new standard, national 
banks and federal and state savings associations must determine that 
the risk of default by the obligor is low and that the full and timely 
repayment of principal and interest is expected.
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    \5\ 77 FR 35253 (June 13, 2012); 77 FR 43151 (July 24, 2012).
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    The SEC has proposed to remove references to credit ratings in its 
regulations governing investments made by mutual funds.\6\ The proposal 
includes replacing creditworthiness standards that reference credit 
ratings with standards that would reflect evaluating other criteria. It 
would replace a requirement that a security purchased by a money market 
mutual fund be rated in ``one of the two highest short-term rating 
categories'' with a standard that the security have minimal credit 
risk. The determination of minimal credit risk would be based on 
factors pertaining to credit quality and the issuer's ability to meet 
its short-term financial obligations. Under the SEC's proposed rule 2a-
7, while the mutual fund's board of directors must independently 
determine that an investment has minimal credit risk, it would be 
permitted to continue using credit ratings as one factor to make that 
determination.\7\
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    \6\ 76 FR 12896 (Mar. 9, 2011).
    \7\ Specifically, the SEC proposal states: ``Nothing in the 
proposed rule would prohibit a money market fund from relying on 
policies and procedures it has adopted to comply with the current 
rule as long as the board concluded that the [credit] ratings 
specified in the policies and procedures establish similar standards 
to those proposed and are credible and reliable for that use.'' 76 
FR 12899 (Mar. 9, 2011) n.32.
    The SEC's March 9, 2011, proposal also notes that in addition to 
referencing credit ratings, the SEC rules already require a mutual 
fund board of directors to determine that a security meets the 
requisite investment standards based on factors ``in addition to any 
ratings assigned.'' Thus, under the SEC's current rule, a mutual 
fund may not purchase an investment based on the credit rating 
alone.
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    The SEC also has proposed to amend the Broker-Dealer Net Capital 
Rule to remove references to credit ratings.\8\ That rule currently 
applies lower capital requirements to certain types of securities held 
by broker-dealers if the securities are rated in high rating categories 
by at least two NRSROs. Under the SEC's proposal, for commercial paper, 
nonconvertible debt, and preferred stock to qualify for the lower 
capital requirements, a broker-dealer would be required to establish, 
maintain, and enforce written policies and procedures designed to 
assess a security's credit and liquidity risks. Based on this process, 
the broker-dealer would have to determine that the investment poses 
only a ``minimal amount of credit risk.''
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    \8\ 76 FR 26550 (May 6, 2011).
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    Under the SEC's proposed amendments, a broker-dealer could consider 
various factors in assessing a security's credit risk. These factors 
could include credit spreads, securities-related research, internal or 
external credit risk assessments (including credit ratings), and 
default statistics. The preamble to the SEC's proposal states that the 
criteria are meant to capture securities that should generally qualify 
as investment grade under the current ratings-based standard ``without 
placing undue reliance on third-party credit ratings.''

IV. Final Rule Standard

    In response to comments that the NPRM's proposed creditworthiness 
standards are confusing, and taking into account the other federal 
financial regulatory agencies' final and proposed rules, the NCUA Board 
is replacing the various NRSRO-based security creditworthiness 
standards in NCUA regulations with only two standards: ``Investment 
grade'' and ``minimal amount of credit risk.'' An investment grade 
security is one where the credit union determines that the issuer has 
an adequate capacity to meet all financial commitments under the 
security for the projected life of the asset or exposure, even under 
adverse economic conditions. An issuer has an adequate capacity to meet 
financial commitments if the risk of default by the obligor is low, and 
the full and timely repayment of principal and interest on the security 
is expected. A security with a minimal amount of credit risk is one 
where the credit union determines that the issuer has a very strong 
capacity to meet all financial commitments under the security for the 
projected life of the asset or exposure, even under adverse economic 
conditions. An issuer has a very strong capacity to meet all financial 
commitments if the risk of default by the obligor is very low, and the 
full and timely repayment of principal and interest on the security is 
expected. As discussed below, ``investment grade'' is used in part 703 
and, with one exception, ``minimal amount of credit risk'' is used in 
part 704.
    In evaluating the creditworthiness of a security, a credit union 
may consider any of the following factors, to the extent appropriate:
     Credit spreads (i.e., whether it is possible to 
demonstrate that a security

[[Page 74105]]

is subject to a particular amount of credit risk based on the spread 
between the security's yield and the yield of Treasury or other 
securities);
     Securities-related research (i.e., whether providers of 
securities-related research believe the issuer of the security will be 
able to meet its financial commitments, generally or specifically, with 
respect to the securities held by the credit union);
     Internal or external credit risk assessments (i.e., 
whether credit assessments developed internally by the credit union or 
externally by a credit rating agency, irrespective of its status as an 
NRSRO, express a view as to a particular security's credit risk);
     Default statistics (i.e., whether providers of credit 
information relating to securities express a view that specific 
securities have a probability of default consistent with other 
securities with a particular amount of credit risk);
     Inclusion on an index (i.e., whether a security, or issuer 
of the security, is included as a component of a recognized index of 
instruments that are subject to a specific amount of credit risk);
     Priorities and enhancements (i.e., the extent to which a 
security is covered by credit enhancements, such as 
overcollateralization and reserve accounts);
     Price, yield, and/or volume (i.e., whether the price and 
yield of a security are consistent with other securities that the 
credit union has determined are subject to a particular amount of 
credit risk and whether the price resulted from active trading); and
     Asset class-specific factors (e.g., in the case of 
structured finance products, the quality of the underlying assets).
    NCUA will discuss these and other factors in supervisory guidance 
to be provided to FCUs and corporates before the effective date of this 
final rule.
    Several commenters argued that the rule itself, not just the 
preamble, should explicitly state that a credit union may consider 
third-party assessments in evaluating the financial strength of issuers 
and counterparties. The NCUA Board agrees and has included the above 
list of resources, including external risk assessments, in the new 
regulatory definitions of ``investment grade'' and ``minimal amount of 
credit risk'' discussed below.

V. Specific Amendments to NCUA Regulations

a. Part 703--Investment and Deposit Activities

Definitions
    Section 703.2 contains definitions of terms related to the 
investment activities of natural person FCUs.\9\ Three of the 
definitions refer to credit ratings.
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    \9\ 12 CFR 703.2.
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Deposit Note
    Section 703.2 defines ``deposit note'' as an obligation of a bank 
that is similar to a certificate of deposit ``but is rated.'' The NPRM 
deleted the definition of ``deposit note'' entirely, as the term is 
standard in the securities industry. NCUA received no comments on this 
deletion, and the NCUA Board is adopting it as proposed.
Mortgage Related and Small Business Related Securities
    Section 107(15)(B) and (C) of the FCU Act \10\ provides authority 
for an FCU to purchase a mortgage related security, as that term is 
defined in section 3(a)(41) of the Securities Exchange Act of 1934 
(Exchange Act),\11\ and a small business related security as that term 
is defined in section 3(a)(53) of the Exchange Act.\12\ Section 703.2 
defines ``mortgage related security'' and ``small business related 
security'' by referencing and quoting the Exchange Act definitions. 
Prior to July 20, 2012, the Exchange Act definitions contained 
references to NRSRO ratings. The Dodd-Frank Act removed the NRSRO 
references from the Exchange Act definitions, effective July 20, 2012, 
providing instead that each type of security must meet standards of 
creditworthiness as established by the SEC.\13\
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    \10\ 12 U.S.C. 1757(15)(B) and (C).
    \11\ 15 U.S.C. 78c(a)(41).
    \12\ 15 U.S.C. 78c(a)(53).
    \13\ Dodd-Frank Act, sec. 939(e).
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    The NPRM amended Sec.  703.2 by retaining the cross-references to 
the Exchange Act but removing the quotations from the Exchange Act in 
the definitions of mortgage related security and small business related 
security. Under the proposal, an FCU could not purchase a mortgage 
related security or small business related security unless it 
determined that the security meets the SEC's definition of the term. 
Several commenters stated that NCUA should delay modifying the 
definitions of mortgage related security and small business related 
security until the SEC has established the requisite standards of 
creditworthiness. While the SEC has not established a final standard of 
creditworthiness, it has established a transitional standard so that 
markets can continue to function.\14\ Accordingly, the NCUA Board is 
adopting the definitions as proposed.
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    \14\ 77 FR 42980 (July 23, 2012).
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Investment Grade
    For clarity, the NCUA Board is adding a definition of ``investment 
grade'' to part 703. Under the definition, a security is considered to 
be investment grade if the issuer of that security has an adequate 
capacity to meet financial commitments under the security for the 
projected life of the asset or exposure, even under adverse economic 
conditions. An issuer has an adequate capacity to meet financial 
commitments if the risk of default by the obligor is low, and the full 
and timely repayment of principal and interest on the security is 
expected. An FCU may consider any or all of the following factors, to 
the extent appropriate, with respect to a security's credit risk: 
credit spreads; securities-related research; internal or external 
credit risk assessments; default statistics; inclusion on an index; 
priorities and enhancements; price, yield, and/or volume; and asset 
class-specific factors.
Broker-Dealers and Safekeepers
    Sections 703.8(b)(3) and 703.9(d) list a number of factors that 
FCUs should consider when evaluating the reliability of broker-dealers 
and investment safekeepers, respectively.\15\ One factor is NRSRO 
reports. The NPRM replaced the NRSRO reference in those sections with 
the phrase ``external assessments of creditworthiness.'' NCUA received 
no comments on Sec. Sec.  703.8(b)(3) and 703.9(d), and the NCUA Board 
is adopting the revision as proposed.
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    \15\ 12 CFR 703.8(b)(3), 703.9(d).
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Permissible Investments
    Section 703.14 establishes standards for permissible investments 
for FCUs.\16\ Section 703.14(e) provides that an FCU may purchase a 
municipal security that an NRSRO has rated in one of the four highest 
rating categories.\17\ The NPRM removed the minimum rating 
requirements, substituting a requirement that the FCU demonstrate that 
the issuer of a security has at least an adequate capacity to meet its 
financial obligations, even under adverse economic conditions, for the 
projected life of the security. As discussed above, the final rule 
labels such a standard ``investment grade.''

[[Page 74106]]

Under the final rule, an FCU may purchase a municipal security if it 
conducts and documents a credit analysis that reasonably concludes the 
security is at least investment grade, as defined in Sec.  703.2.
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    \16\ 12 CFR 703.14.
    \17\ 12 CFR 703.14(e).
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    To further limit the risk associated with the purchase of municipal 
securities, the NPRM added new concentration limits on such holdings. 
Specifically, it required an FCU to limit its aggregate holdings of 
municipal securities to no more than 75 percent of the FCU's net worth 
and its holdings of municipal securities issued by any single issuer to 
no more than 25 percent of the FCU's net worth.
    One commenter suggested that municipal security concentration 
limits should distinguish between general obligation and revenue bonds. 
The commenter suggested that an appropriate aggregate limit would be 
100 percent of net worth for general obligation bonds and 25 percent of 
net worth for revenue bonds. The NCUA Board disagrees with this 
suggestion. The NCUA Board acknowledges that general obligation bonds 
and revenue bonds are considered separate asset classes by many 
investors. These municipal securities, like all capital market 
instruments, undergo structural changes over time resulting in changing 
risk profiles. The risk of loss to a FCU may be similar with both types 
of municipal securities if there were an adverse event at the issuer 
level. Therefore, limiting exposure to any single obligor to 25 percent 
of net worth is prudent to mitigate risks of loss to the NCUSIF.
    Section 703.14(g) permits an FCU to purchase a European financial 
options contract for the purpose of hedging the risk associated with 
issuing share certificates with dividends tied to an equity index.\18\ 
There are a number of conditions for any such purchase, including that 
the counterparty meet certain NRSRO ratings requirements and that the 
aggregate amount of such index-linked certificates not exceed the FCU's 
net worth. The NPRM removed the reference to the NRSRO ratings and 
instead required that the counterparty meet credit standards approved 
by the FCU's board. To mitigate any risk associated with the removal of 
credit ratings in this context, the proposal tightened the 
concentration limit from 100 percent of the FCU's net worth to 50 
percent of the FCU's net worth. NCUA received no comments specifically 
on this section, and the NCUA Board is adopting it as proposed.
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    \18\ 12 CFR 703.14(g).
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    Section 703.14(h) permits an FCU to invest in mortgage note 
repurchase transactions under certain conditions, including that the 
counterparty meet certain NRSRO ratings requirements and that the 
aggregate amount of the investments with all counterparties be limited 
to 100 percent of the FCU's net worth.\19\ The NPRM removed the 
reference to the NRSRO ratings, requiring instead that the counterparty 
meet credit standards approved by the FCU's board. The proposal also 
lowered the aggregate concentration limit to 50 percent of the FCU's 
net worth. NCUA received no comments specifically on this section, and 
the NCUA Board is adopting it as proposed.
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    \19\ 12 CFR 703.14(h).
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    In the time between the issuance of the NPRM and this final rule, 
the NCUA Board added a new Sec.  703.14(j) to permit FCUs to purchase 
certain commercial mortgage related securities (CMRS) and deleted part 
742 of the regulations governing NCUA's Regulatory Flexibility 
(RegFlex) Program.\20\ Before these 2012 rule changes, Sec.  703.16(d) 
generally prohibited FCUs from purchasing private label CMRS, but Sec.  
742.4(a)(6) permitted RegFlex credit unions to purchase such a security 
provided, among other things, the security was rated in one of the two 
highest rating categories by at least one NRSRO.\21\ The NPRM removed 
the NRSRO requirement from former Sec.  742.4(a)(6), replacing it with 
the requirement that the issuer have a very strong capacity to meet its 
financial obligations, even under adverse economic conditions, for the 
projected life of the security. New Sec.  703.14(j) was made final with 
the ratings-based requirement because it preceded this final rule. 
Consistent with the discussion above, however, the NCUA Board is 
replacing this ratings-based requirement with a requirement that the 
FCU conduct and document a credit analysis that reasonably concludes 
the security is at least investment grade.
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    \20\ 77 FR 31981 (May 31, 2012).
    \21\ See 12 CFR 703.16(d), 742.4(a)(6).
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Grandfathered Investments
    Part 703 grandfathers certain specific securities and transactions 
purchased or entered into before or within certain dates.\22\ Several 
commenters argued that this final rule should explicitly provide that 
investments purchased under existing credit rating requirements are 
also grandfathered. The NCUA Board disagrees. As a matter of sound 
practice, FCUs must manage the credit risk inherent in their investment 
securities and transactions by taking into account the risk of 
deterioration. FCUs have an ongoing obligation to reevaluate 
creditworthiness and address deterioration as appropriate. An FCU's 
initial evaluation of credit quality is not a permanent justification 
for asset retention.
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    \22\ 12 CFR 703.18, as amended by 77 FR 31981 (May 31, 2012).
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b. Part 704--Corporate Credit Unions

Definitions
    Section 704.2 contains definitions of terms related to the 
investment activities of corporates.\23\ The NPRM eliminated the 
definition of ``NRSRO'' and deleted references to NRSROs in the 
definitions of ``asset-backed commercial paper (ABCP) program'' and 
``small business related security.'' NCUA received no comments on these 
proposed changes, and the NCUA Board adopts them in the final rule.\24\
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    \23\ 12 CFR 704.2.
    \24\ While NCUA's authority to regulate the investment 
activities of natural person FCUs is limited by the FCU Act, see 
discussion above under ``Part 703--Investment and Deposit 
Activities,'' its authority to regulate the investment activities of 
corporate credit unions is less limited. See 12 U.S.C. 1766(a) 
(providing that corporate credit unions are subject to such rules, 
regulations, and orders as the NCUA Board deems appropriate). 
Accordingly, NCUA may revise the definition of ``small business 
related security'' in part 704 without regard to section 107(15)(C) 
of the FCU Act, 12 U.S.C. 1757(15)(C).
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    In Sec.  704.2, the definition of ``eligible ABCP liquidity 
facility'' provides that if the assets that the facility is required to 
fund against have received NRSRO ratings at the time of the facility's 
inception, the facility can be used to fund only those assets that are 
rated investment grade by an NRSRO at the time of funding.\25\ The NPRM 
removed the NRSRO references, providing instead that a facility can be 
used to fund only those assets or exposures that demonstrate adequate 
capacity to meet their financial obligations, even under adverse 
economic conditions, for the projected life of the asset or exposure. 
As discussed above, this ``investment grade'' standard no longer 
contains an explicit rating requirement. Under the final rule, an 
eligible ABCP liquidity facility can be used to fund only those assets 
or exposures the corporate credit union reasonably concludes are at 
least investment grade.
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    \25\ 12 CFR 704.2.
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    The NCUA Board is adding definitions of ``investment grade'' and 
``minimal amount of credit risk'' to Sec.  704.2. ``Investment grade'' 
has the same meaning as in part 703, and ``minimal amount of credit 
risk'' means the issuer of a security has a very strong capacity to 
meet all financial

[[Page 74107]]

commitments under the security for its projected life, even under 
adverse economic conditions. In both cases, a corporate may consider 
the following factors with respect to a security's credit risk: Credit 
spreads; securities-related research; internal or external credit risk 
assessments; default statistics; inclusion on an index; priorities and 
enhancements; price, yield, and/or volume; and asset class-specific 
factors.
Credit Risk Management
    Section 704.6(f) establishes minimum credit quality standards for 
corporate credit union investments.\26\ The standards include that each 
investment must have an NRSRO rating and that at least 90 percent of a 
corporate's investment portfolio must have at least two such ratings. 
The standards further require long-term investment ratings of at least 
AA-, short-term ratings of at least A-, and monitoring of the ratings 
as long as a corporate holds the investment.
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    \26\ 12 CFR 704.6(f).
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    The NPRM removed the minimum rating requirements, providing instead 
that for an investment to be permissible, it must be originated by an 
issuer that has at least a very strong capacity to meet its financial 
obligations, even under adverse economic conditions, for the projected 
life of the security. This standard applied to both long-term and 
short-term investments. The NPRM also required a corporate to monitor 
any changes in credit quality of the investment as long as it held the 
investment.
    The NCUA Board has decided to label this standard ``minimal amount 
of credit risk.'' This standard requires a higher level of credit 
quality than the ``investment grade'' standard discussed above, as it 
requires an issuer to have a ``very strong'' rather than just 
``adequate'' capacity to meet financial commitments. The higher 
standard is appropriate for corporates given their mission of providing 
liquidity to natural person credit unions in a wide range of economic 
circumstances. The 2010 comprehensive overhaul of NCUA's corporate 
credit union regulations was designed to enable corporates to serve 
primarily as liquidity facilities and payment system providers.\27\ As 
liquidity facilities, corporates must maintain high quality, marketable 
investments that can be sold quickly, without incurring undue loss, to 
fund loan and share demands. Securities with higher credit quality 
naturally are more marketable than those with lower quality. Thus, the 
NCUA Board does not intend for the elimination of references to credit 
ratings to fundamentally change the standards that corporates should 
use when deciding whether a security is eligible for purchase. To 
enhance the ability of NCUA and corporate capital holders to monitor 
this process, the NCUA Board is considering modifying the corporate 
Call Report to require additional investment disclosures.
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    \27\ See 75 FR 64786 (Oct. 20, 2010).
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    Accordingly, under Sec.  704.6(f)(1) of this final rule, a 
corporate may purchase an investment only if it conducts and documents 
a credit analysis that reasonably concludes the security has no more 
than a minimal amount of credit risk. In addition, under Sec.  
704.6(f)(2) of this final rule, a corporate must monitor any changes in 
the credit quality of the investment and retain appropriate supporting 
documentation as long as the corporate owns the investment.
    At the time the NPRM was issued, Sec.  704.6(f)(4) required a 
corporate to develop an investment action plan if an NRSRO that 
initially rated a security later downgraded the rating below the 
minimum requirements. The NPRM modified this to require an investment 
action plan if the issuer no longer had a very strong capacity to meet 
its financial obligations for the security. Between the issuance of the 
NPRM and this final rule, the NCUA Board revised Sec.  704.6 by moving 
paragraph (f)(4) to a new paragraph (h).\28\ Like former paragraph 
(f)(4), new paragraph (h)(1) requires a corporate to develop an 
investment action plan if an NRSRO that initially rates an investment 
later downgrades the rating below the minimum requirements. In light of 
the changes to the creditworthiness standard in Sec.  704.6(f)(1) 
discussed above, the NCUA Board is revising Sec.  704.6(h)(1) to 
trigger the requirement to prepare an investment action plan if 
appropriate monitoring of the investment would lead to the reasonable 
conclusion that the investment's credit quality has more than a minimal 
amount of credit risk.
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    \28\ 76 FR 79531 (Dec. 22, 2011).
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    Section 704.6(g) requires a corporate to maintain documentation for 
each credit limit with each obligor or transaction counterparty, 
including rating agency information. The NPRM deleted the reference to 
rating agency information. NCUA received no comments on this section, 
and the NCUA Board adopts it as proposed.
Expanded Authorities
    Under Part I of Appendix B to part 704, corporates that meet 
certain conditions may purchase investments with lower credit ratings 
than the general AA requirement of Sec.  704.6(f). Part I allows 
corporates to purchase investments with long-term ratings of at least 
A- and short-term ratings of at least A-2. In addition, in the latter 
case, the issuer must have at least a long-term rating no lower than A- 
or the investment must be a domestically-issued asset-backed security. 
The NPRM replaced these ratings requirements with a requirement that an 
issuer have at least a strong capacity to meet its financial 
obligations. In this final rule, the NCUA Board has determined to 
permit corporates that qualify for Part I authorities to purchase 
securities that are at least investment grade. As discussed above, with 
respect to part 703, a security is considered to be investment grade if 
the issuer of that security has adequate capacity to meet financial 
commitments under the security for the projected life of the asset or 
exposure, even under adverse economic conditions. This standard permits 
more credit risk than the ``minimal amount of credit risk'' standard. A 
corporate that has been approved for Part I authorities has additional 
systems that will enable it to appropriately monitor this additional 
credit risk to ensure that the investments held remain marketable.
    Part II of Appendix B to part 704 authorizes qualifying corporates 
to purchase certain foreign investments provided, among other things, 
the sovereign issuer and/or the country in which the obligor is 
organized has a long-term foreign currency debt rating no lower than 
AA-. The NPRM deleted the NRSRO reference, providing instead that a 
corporate may purchase a foreign investment only pursuant to an 
explicit policy established by the corporate's board of directors. The 
NPRM also required a corporate to determine that a foreign issuer or 
issuer had at least a very strong capacity to meet its financial 
obligations. The NCUA Board has decided to replace this standard with a 
requirement that the issue or issuer have no more than a minimal amount 
of credit risk.
    In accordance with the NPRM discussion, the NCUA Board is replacing 
the ratings requirement in Part III of Appendix B to part 704 with a 
requirement that a counterparty meet minimum credit quality standards 
as established by the corporate's board of directors.
Risk-Based Capital
    Appendix C to Part 704 explains how a corporate must compute its 
risk-weighted assets for purposes of

[[Page 74108]]

determining its capital ratios. In the definitions section, ``traded 
position'' is defined with reference to an NRSRO rating and is used 
only in paragraphs II(c)(3) and (4).\29\ Paragraphs II(c)(3) and (4) 
provide alternative methods for calculating the risk weights of certain 
assets. Since these alternative methods involve reliance on NRSRO 
ratings, the NPRM deleted these paragraphs, as well as the definition 
of ``traded position.'' The NPRM added a new paragraph II(c)(3) which 
allowed a corporate with advanced risk management and reporting systems 
to seek NCUA approval to use an internal ratings-based approach to 
calculate risk-weights for those positions.\30\ The NCUA Board received 
no comments on these aspects of the NPRM and is adopting them as 
proposed.
---------------------------------------------------------------------------

    \29\ 12 CFR Part 704, Appendix C, Part I(b).
    \30\ Acceptable internal credit risk rating systems typically: 
(1) Are an integral part of the corporate's risk management system 
that explicitly incorporates the full range of risks arising from 
the corporate's participation in securitization activities; (2) link 
internal credit ratings to measurable outcomes; (3) separately 
consider the risk associated with the underlying loans or borrowers 
and the risk associated with the structure of the particular 
securitization transaction; (4) identify gradations of risk; (5) use 
clear, explicit criteria to classify assets into each internal 
rating grade; 6) employ independent credit risk management or loan 
review personnel to assign or review the credit risk ratings; (7) 
include an internal audit procedure to periodically verify that 
internal risk ratings are assigned in accordance with the 
corporate's established criteria; (8) monitor the performance of the 
assigned internal credit risk ratings over time to determine the 
appropriateness of the initial credit risk rating assignment, and 
adjust individual credit risk ratings or the overall internal credit 
risk rating system, as needed; and (9) make credit risk rating 
assumptions that are consistent with, or more conservative than, the 
credit risk rating assumptions and methodologies of NRSROs.
---------------------------------------------------------------------------

    The NPRM also removed other ratings-based requirements in Appendix 
C, replacing several with board of director standards and one, in 
paragraph II(a)(2)(viii)(A), with a requirement that a qualifying 
securities firm demonstrate at least a strong capacity to meet its 
financial obligations, even under adverse economic conditions, for the 
projected life of an exposure. The NCUA Board is replacing this with 
the ``minimal amount of credit risk'' standard.

c. Part 709--Involuntary Liquidation of Federal Credit Unions and 
Adjudication of Creditor Claims Involving Federally Insured Credit 
Unions in Liquidation

    Part 709 of the NCUA regulations governs the involuntary 
liquidation of FCUs and the adjudication of creditor claims involving 
federally insured credit unions (FICUs).\31\ Section 709.10(b) provides 
that NCUA will not use its authority to repudiate contracts under 
Section 207(c) of the FCU Act \32\ to reclaim, recover, or 
recharacterize financial assets transferred by a FICU in connection 
with a securitization or in the form of a participation. Section 
709.10(f) provides that NCUA will not attempt to avoid an otherwise 
legally enforceable securitization or participation agreement solely 
because the agreement does not meet the requirements of sections 
207(b)(9) and 208(a)(3) of the FCU Act. These sections provide that, to 
be enforceable against NCUA, any agreement that tends to diminish or 
defeat NCUA's interest in an asset must be executed contemporaneously 
with the acquisition of the asset by the credit union.\33\
---------------------------------------------------------------------------

    \31\ 12 CFR part 709.
    \32\ 12 U.S.C. 1787(c).
    \33\ 12 U.S.C. 1787(b)(9) and 1788(a)(3).
---------------------------------------------------------------------------

    Section 709.10(a)(5) sets forth a definition of ``securitization'' 
that includes a reference to NRSRO ratings. The NPRM deleted paragraph 
(a)(5) and references to securitization in paragraphs (b), (f), and 
(g), with the rationale that credit unions do not securitize assets 
within the meaning of part 709. In addition, the proposal deleted 
paragraph (a)(6), defining ``special purpose entity,'' as this phrase 
is only used in the definition of ``securitization.''
    Although NCUA received no comments on the proposed changes to part 
709, this final rule retains the language relating to securitizations. 
In conformance with the requirements of the Dodd-Frank Act, however, 
the NCUA Board is replacing the definition of ``securitization'' in 
part 709, which contains an NRSRO reference, with the definition in 
part 704, which does not. Section 709.10(a)(5) now defines a 
``securitization'' as the pooling and repackaging by a special purpose 
entity of assets or other credit exposures that can be sold to 
investors.

d. Part 741--Requirements for Insurance

    Part 741 prescribes various requirements for obtaining and 
maintaining federal insurance. It does not contain a reference to NRSRO 
ratings but does require federally insured, state-chartered credit 
unions (FISCUs) to establish an additional special reserve for 
investments if those credit unions are permitted by their respective 
state laws to make investments beyond those authorized in the FCU Act 
or NCUA regulations.\34\ As a consequence of this requirement, and to 
reduce the possibility that a FISCU will have to establish a special 
reserve, many states have instituted credit union investment laws that 
parallel part 703. For example, a state may authorize its state-
chartered credit unions to purchase municipal securities rated in one 
of the four highest rating categories, as Sec.  703.14(e) has provided 
for FCUs.
---------------------------------------------------------------------------

    \34\ 12 CFR 741.3(a)(2).
---------------------------------------------------------------------------

    Although no changes were proposed to Part 741, one commenter stated 
that if a FISCU holds a ratings-based investment permissible under 
state law, that investment should not be considered ``nonconforming'' 
under Sec.  741.3(a)(2). The NCUA Board agrees that a safe harbor 
should be preserved, and has added a sentence to Sec.  741.3(a)(2) 
stating that if a FISCU conducts and documents a credit analysis that 
reasonably concludes an investment is at least investment grade, as 
defined in Sec.  703.2, and the investment is otherwise permissible for 
FCUs, the investment is not considered to be beyond those authorized by 
NCUA regulations.

e. Part 742--Regulatory Flexibility Program

    The NPRM removed an NRSRO requirement from a paragraph in part 742, 
but as discussed above, the NCUA Board subsequently moved that 
paragraph to Sec.  703.14(j) and deleted part 742.\35\ The NCUA Board's 
treatment of the relocated paragraph in this final rule is also 
discussed above.
---------------------------------------------------------------------------

    \35\ 77 FR 31981 (May 31, 2012).
---------------------------------------------------------------------------

VI. Regulatory Procedures

a. Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
to describe any significant economic impact a rule may have on a 
substantial number of small entities (primarily those credit unions 
under $10 million in assets). This final rule removes NRSRO ratings 
from NCUA's regulations. NCUA data show that credit unions with under 
$10 million in assets generally do not engage in investment activities 
that are affected by those portions of the NCUA rules that refer to 
NRSRO ratings. Accordingly, NCUA has determined and certifies that this 
final rule will not have a significant economic impact on a substantial 
number of small credit unions.

b. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (PRA) applies to rulemakings in 
which an agency by rule creates a new paperwork burden on regulated 
entities or modifies an existing burden. 44 U.S.C. 3507(d); 5 CFR part 
1320. For purposes of the PRA, a paperwork burden may take the form of 
a reporting,

[[Page 74109]]

recordkeeping, or disclosure requirement, both referred to as 
information collections. The Office of Management and Budget (OMB) 
approved the current information collection requirements in part 703 in 
2007 and assigned them control number 3133-0133. OMB approved the 
current information collection requirements in part 704 and assigned 
them control number 3133-0129.
    We believe that all of the corporate credit unions already have 
policies and procedures in place for evaluating the credit risk of 
securities activities, but this final rule may require additional 
analysis of credit risk for natural person FCUs and thus result in 
additional burden hours. We estimate that approximately 750 natural 
person FCUs may need to develop or augment a system for evaluating 
creditworthiness. We estimate that, on average, the FCUs will spend 20 
hours on such a system, resulting in an initial aggregate burden of 
15,000 hours. This estimate is based on the fact that many of these 
FCUs already have some criteria in place for evaluating 
creditworthiness.
    We further estimate that, on average, each of those FCUs will spend 
an additional 10 hours each year reviewing, adjusting, and applying its 
system for evaluating creditworthiness, for a total of 7,500 hours 
across the industry. Once again, this estimate reflects that many of 
these FCUs already are applying a system of evaluating 
creditworthiness.
    As required by the PRA, NCUA has submitted a copy of this proposal 
to OMB for its review and approval.

c. Executive Order 13132

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

d. Assessment of Federal Regulations and Policies on Families

    NCUA has determined that this final 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).

e. Small Business Regulatory Enforcement Fairness Act

    The Small Business Regulatory Enforcement Fairness Act of 1996 
(Pub. L. 104-121) provides generally for congressional review of agency 
rules. A reporting requirement is triggered in instances where NCUA 
issues a final rule as defined by section 551 of the Administrative 
Procedure Act. 5 U.S.C. 551. OMB has determined that this rule is not a 
major rule for purposes of the Small Business Regulatory Enforcement 
Fairness Act of 1996.

List of Subjects

12 CFR Part 703

    Credit unions, Investments, Reporting and recordkeeping 
requirements.

12 CFR Part 704

    Credit unions, Investments, Reporting and recordkeeping 
requirements.

12 CFR Part 709

    Credit unions, Liquidations.

12 CFR Part 741

    Credit unions, Reporting and recordkeeping requirements, 
Requirements for insurance.

    By the National Credit Union Administration Board on December 6, 
2012.
Mary F. Rupp,
Secretary of the Board.

    For the reasons stated above, the National Credit Union 
Administration amends 12 CFR parts 703, 704, 709, and 741 as set forth 
below:

PART 703--INVESTMENTS AND DEPOSIT ACTIVITIES

0
1. The authority citation for part 703 continues to read as follows:

    Authority: 12 U.S.C. 1757(7), 1757(8), 1757(15).

0
2. In Sec.  703.2 remove the definition of Deposit note, add a 
definition of Investment grade, and revise the definitions of Mortgage 
related security and Small business related security to read as 
follows:


Sec.  703.2  Definitions.

* * * * *
    Investment grade means the issuer of a security has an adequate 
capacity to meet the financial commitments under the security for the 
projected life of the asset or exposure, even under adverse economic 
conditions. An issuer has an adequate capacity to meet financial 
commitments if the risk of default by the obligor is low and the full 
and timely repayment of principal and interest on the security is 
expected. A Federal credit union may consider any or all of the 
following factors, to the extent appropriate, with respect to the 
credit risk of a security: Credit spreads; securities-related research; 
internal or external credit risk assessments; default statistics; 
inclusion on an index; priorities and enhancements; price, yield, and/
or volume; and asset class-specific factors. This list of factors is 
not meant to be exhaustive or mutually exclusive.
* * * * *
    Mortgage related security means a security as defined in section 
3(a)(41) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(41)).
* * * * *
    Small business related security means a security as defined in 
section 3(a)(53) of the securities Exchange Act of 1934 (15 U.S.C. 
78c(a)(53)). This definition does not include Small Business 
Administration securities permissible under section 107(7) of the 
Federal Credit Union Act.
* * * * *

0
3. In Sec.  703.8, revise paragraph (b)(3) to read as follows:


Sec.  703.8  Broker-dealers.

* * * * *
    (b) * * *
    (3) If the broker-dealer is acting as the Federal credit union's 
counterparty, the ability of the broker-dealer and its subsidiaries or 
affiliates to fulfill commitments, as evidenced by capital strength, 
liquidity, and operating results. The Federal credit union should 
consider current financial data, annual reports, external assessments 
of creditworthiness, relevant disclosure documents, and other sources 
of financial information.
* * * * *

0
4. In Sec.  703.9, revise paragraph (d) to read as follows:


Sec.  703.9  Safekeeping of investments.

* * * * *
    (d) Annually, the Federal credit union must analyze the ability of 
the safekeeper to fulfill its custodial responsibilities, as evidenced 
by capital strength, liquidity, and operating results. The Federal 
credit union should consider current financial data, annual reports, 
external assessments of creditworthiness, relevant disclosure 
documents, and other sources of financial information.

[[Page 74110]]


0
5. In Sec.  703.14, revise paragraphs (e), (g)(9), (g)(11), (h)(1), 
(h)(2), and (j)(1) to read as follows:


Sec.  703.14  Permissible investments.

* * * * *
    (e) Municipal security. A Federal credit union may purchase and 
hold a municipal security, as defined in section 107(7)(K) of the Act, 
only if it conducts and documents an analysis that reasonably concludes 
the security is at least investment grade. The Federal credit union 
must also limit its aggregate municipal securities holdings to no more 
than 75 percent of the Federal credit union's net worth and limit its 
holdings of municipal securities issued by any single issuer to no more 
than 25 percent of the Federal credit union's net worth.
* * * * *
    (g) * * *
    (9) The counterparty to the transaction meets the minimum credit 
quality standards as approved by the Federal credit union's board of 
directors.
* * * * *
    (11) The aggregate amount of equity-linked member share 
certificates does not exceed 50 percent of the Federal credit union's 
net worth;
* * * * *
    (h) * * *
    (1) The aggregate of the investments with any one counterparty is 
limited to 25 percent of the Federal credit union's net worth and 50 
percent of its net worth with all counterparties;
    (2) At the time the Federal credit union purchases the securities, 
the counterparty, or a party fully guaranteeing the counterparty, must 
meet the minimum credit quality standards as approved by the Federal 
credit union's board of directors.
* * * * *
    (j) * * *
    (1) The Federal credit union conducts and documents a credit 
analysis that reasonably concludes the CMRS is at least investment 
grade.
* * * * *

PART 704--CORPORATE CREDIT UNIONS

0
6. The authority citation for part 704 continues to read as follows:

    Authority: 12 U.S.C. 1762, 1766(a), 1772a, 1781, 1789, and 
1795e.


0
7. In Sec.  704.2:
0
a. Revise the definitions of Asset-backed commercial paper program and 
Eligible ABCP liquidity facility;
0
b. Add a definition of Investment grade and Minimal amount of credit 
risk;
0
c. Remove the definition of Nationally Recognized Statistical Rating 
Organization; and
0
d. Revise the definition of Small business related security.
    The revisions and addition read as follows:


Sec.  704.2  Definitions.

* * * * *
    Asset-backed commercial paper program (ABCP program) means a 
program that primarily issues commercial paper and that is backed by 
assets or other exposures held in a bankruptcy-remote special purpose 
entity. The term sponsor of an ABCP program means a corporate credit 
union that:
    (1) Establishes an ABCP program;
    (2) Approves the sellers permitted to participate in an ABCP 
program;
    (3) Approves the asset pools to be purchased by an ABCP program; or
    (4) Administers the ABCP program by monitoring the assets, 
arranging for debt placement, compiling monthly reports, or ensuring 
compliance with the program documents and with the program's credit and 
investment policy.
* * * * *
    Eligible ABCP liquidity facility means a legally binding commitment 
to provide liquidity support to asset-backed commercial paper by 
lending to, or purchasing assets from any structure, program or conduit 
in the event that funds are required to repay maturing asset-backed 
commercial paper and that meets the following criteria:
    (1)(i) At the time of the draw, the liquidity facility must be 
subject to an asset quality test that precludes funding against assets 
that are 90 days or more past due or in default; and
    (ii) The facility can be used to fund only those assets or 
exposures that the corporate credit union has reasonably concluded, 
based on a documented analysis, are at least investment grade; or
    (2) If the assets that are funded under the liquidity facility do 
not meet the criteria described in paragraph (1) of this definition, 
the assets must be guaranteed, conditionally or unconditionally, by the 
United States Government, its agencies, or the central government of an 
Organization for Economic Cooperation and Development (OECD) country.
* * * * *
    Investment grade means the issuer of the security has an adequate 
capacity to meet the financial commitments under the security for the 
projected life of the asset or exposure, even under adverse economic 
conditions. An issuer has an adequate capacity to meet financial 
commitments if the risk of default by the obligor is low and the full 
and timely repayment of principal and interest on the security is 
expected. A corporate credit union may consider any or all of the 
following factors, to the extent appropriate, with respect to the 
credit risk of a security: Credit spreads; securities-related research; 
internal or external credit risk assessments; default statistics; 
inclusion on an index; priorities and enhancements; price, yield, and/
or volume; and asset class-specific factors. This list of factors is 
not meant to be exhaustive or mutually exclusive.
* * * * *
    Minimal amount of credit risk means the amount of credit risk when 
the issuer of a security has a very strong capacity to meet all 
financial commitments under the security for the projected life of the 
asset or exposure, even under adverse economic conditions. An issuer 
has a very strong capacity to meet all financial commitments if the 
risk of default by the obligor is very low, and the full and timely 
repayment of principal and interest on the security is expected. A 
corporate credit union may consider any or all of the following 
factors, to the extent appropriate, with respect to the credit risk of 
a security: Credit spreads; securities-related research; internal or 
external credit risk assessments; default statistics; inclusion on an 
index; priorities and enhancements; price, yield, and/or volume; asset 
class-specific factors. This list of factors is not meant to be 
exhaustive or mutually exclusive.
* * * * *
    Small business related security means a security that represents an 
interest in one or more promissory notes or leases of personal property 
evidencing the obligation of a small business concern and originated by 
an insured depository institution, insured credit union, insurance 
company, or similar institution which is supervised and examined by a 
Federal or State authority, or a finance company or leasing company. 
This definition does not include Small Business Administration 
securities permissible under section 107(7) of the Act.
* * * * *

0
8. In Sec.  704.6, revise paragraphs (f), (g)(2)(iii), and (h)(1) to 
read as follows:


Sec.  704.6  Credit risk management.

* * * * *

[[Page 74111]]

    (f) Credit ratings--(1) Before purchasing an investment, a 
corporate credit union must conduct and document an analysis that 
reasonably concludes the investment has no more than a minimal amount 
of credit risk.
    (2) A corporate credit union must identify and monitor any changes 
in credit quality of the investment and retain appropriate supporting 
documentation as long as the corporate owns the investment.
    (g) * * *
    (2) * * *
    (iii) The latest available financial reports, industry analyses, 
and internal and external analyst evaluations sufficient to support 
each approved credit limit.
    (h) * * *
    (1) Appropriate monitoring of the investment would reasonably lead 
to the conclusion that the investment presents more than a minimal 
amount of credit risk; or
* * * * *

0
9. In Appendix B:
0
a. Remove Part I (a)(2);
0
b. Redesignate Part I (a)(3), (4), and (5) as Part I (a)(2), (3), and 
(4), respectively;
0
c. Remove Part II (b)(2);
0
d. Redesignate Part II (b)(3), (4), and (5) as Part II (b)(2), (3), and 
(4), respectively; and
0
e. Revise Part I (a)(1), Part II (b)(1), and Part III (b) to read as 
follows:

Appendix B to Part 704--Expanded Authorities and Requirements

* * * * *

Part I

* * * * *
    (a) * * *
    (1) Purchase an investment after conducting and documenting an 
analysis that reasonably concludes the investment is at least 
investment grade;
* * * * *

Part II

* * * * *
    (b) * * *
    (1) Investments must be made pursuant to an explicit policy 
established by the corporate credit union's board of directors. 
Before purchasing an investment, the corporate credit union must 
conduct and document an analysis that reasonably concludes the 
foreign issue or issuer has no more than a minimal amount of credit 
risk;
* * * * *

Part III

* * * * *
    (b) Credit Quality:
    All derivative transactions are subject to the following 
requirements:
    (1) If the intended counterparty is domestic, the counterparty 
must meet minimum credit quality standards as established by the 
corporate's board of directors;
    (2) If the intended counterparty is foreign, the corporate must 
have Part II expanded authority and the counterparty must meet 
minimum credit quality standards as established by the corporate's 
board of directors;
    (3) The corporate must identify the criteria relied upon to 
determine that the counterparty meets the credit quality 
requirements of this part at the time the transaction is entered 
into and monitor those criteria for as long as the contract remains 
open; and
    (4) The corporate must comply with Sec.  704.10 of this part if 
the credit quality of the counterparty deteriorates below the 
minimum credit quality standards established by the corporate's 
board of directors.
* * * * *

0
10. In Appendix C:
0
a. Remove the definition of Traded position from paragraph I(b);
0
b. Revise paragraphs II (a)(2)(viii)(A), II (a)(2)(viii)(B) 
introductory text, II (b)(1)(iv), II (b)(2)(ii), and II (b)(4):
0
c. Remove paragraphs II (c)(3) and (4);
0
d. Add new paragraph II (c)(3); and
0
e. Redesignate paragraph II (c)(5) and (6) as paragraphs II (c)(4) and 
(5), respectively.
    The revisions and addition read as follows:

Appendix C to Part 704--Risk-Based Capital Credit Risk-Weight 
Categories

* * * * *

Part II: Risk-Weightings

    (a) * * *
    (2) * * *
    (viii) * * *
    (A) A qualifying securities firm must meet the minimum credit 
quality standards as established by the corporate credit union's 
board of directors or have at least one issue of long-term unsecured 
debt that is reasonably determined to present no more than a minimal 
amount of credit risk, whichever requirement is more stringent. 
Alternatively, a qualifying securities firm may rely on the 
creditworthiness of its parent consolidated company, if the parent 
consolidated company guarantees the claim.
    (B) A collateralized claim on a qualifying securities firm does 
not have to comply with the requirements of paragraph (a) of this 
section of Appendix C if the claim arises under a contract that:
* * * * *
    (b) * * *
    (1) * * *
    (iv) Unused portions of ABCP liquidity facilities that do not 
meet the definition of an eligible ABCP liquidity facility. The 
resulting credit equivalent amount is assigned to the risk category 
appropriate to the assets to be funded by the liquidity facility 
based on the assets or the obligor, after considering any collateral 
or guarantees.
    (2) * * *
    (ii) Unused portions of commitments (including home equity lines 
of credit and eligible ABCP liquidity facilities) with an original 
maturity exceeding one year except those listed in paragraph II 
(b)(5) of this Appendix. For eligible ABCP liquidity facilities, the 
resulting credit equivalent amount is assigned to the risk category 
appropriate to the assets to be funded by the liquidity facility 
based on the assets or the obligor, after considering any collateral 
or guarantees.
* * * * *
    (4) 10 percent credit conversion factor (Group D). Unused 
portions of eligible ABCP liquidity facilities with an original 
maturity of one year or less. The resulting credit equivalent amount 
is assigned to the risk category appropriate to the assets to be 
funded by the liquidity facility based on the assets or the obligor, 
after considering any collateral or guarantees.
* * * * *
    (c) * * *
    (3) Internal ratings-based approach--
    (i) Calculation. Corporate credit unions with advanced risk 
management and reporting systems may seek NCUA approval to use 
credit risk models to calculate risk-weighted asset amounts for 
positions described in paragraphs II (c)(1) and (2) of this section 
of the Appendix C. In determining whether to grant approval, NCUA 
will consider the financial condition and risk management 
sophistication of the corporate credit union and the adequacy of the 
corporate's risk models and supporting management information 
systems.
    (ii) Consistent use of internal ratings-based approach. A 
corporate credit union that has been granted NCUA approval to use an 
internal ratings-based approach and that has determined to use such 
an approach must do so in a consistent manner for all securities so 
rated.

* * * * *

PART 709--INVOLUNTARY LIQUIDATION OF FEDERAL CREDIT UNIONS AND 
ADJUDICATION OF CREDITOR CLAIMS INVOLVING FEDERALLY INSURED CREDIT 
UNIONS IN LIQUIDATIONS

0
11. The authority citation for part 709 continues to read as follows:

    Authority:  12 U.S.C. 1757, 1766, 1767, 1786(h), 1787, 1788, 
1789, 1789a.


0
12. In Sec.  709.10, revise paragraph (a)(5) to read as follows:


Sec.  709.10  Treatment by conservator or liquidating agent of 
financial assets transferred in connection with a securitization or 
participation.

* * * * *
    (a) * * *
    (5) Securitization means the pooling and repackaging by a special 
purpose entity of assets or other credit exposures that can be sold to 
investors. Securitization includes transactions that

[[Page 74112]]

create stratified credit risk positions whose performance is dependent 
upon an underlying pool of credit exposures, including loans and 
commitments.
* * * * *

PART 741--REQUIREMENTS FOR INSURANCE

0
13. The authority citation for part 741 continues to read as follows:

    Authority:  12 U.S.C. 1757, 1766(a), 1781-1790, and 1790d; 31 
U.S.C. 3717.


0
14. In Sec.  741.3, revise paragraph (a)(2) by adding a sentence 
between the first and second sentences to read as follows:


Sec.  741.3  Criteria.

* * * * *
    (a) * * *
    (2) * * * For purposes of this paragraph, if a state-chartered 
credit union conducts and documents an analysis that reasonably 
concludes an investment is at least investment grade, as defined in 
Sec.  703.2 of this chapter, and the investment is otherwise 
permissible for Federal credit unions, that investment is not 
considered to be beyond those authorized by the Act or the NCUA Rules 
and Regulations. * * *
* * * * *
[FR Doc. 2012-30076 Filed 12-12-12; 8:45 am]
BILLING CODE 7535-01-P