Risk-Based Capital, 66625-66723 [2015-26790]
Download as PDF
<![CDATA[
Vol. 80
Thursday,
No. 209
October 29, 2015
Part II
National Credit Union Administration
mstockstill on DSK4VPTVN1PROD with RULES2
12 CFR Parts 700, 701, 702, 703, et al.
Risk-Based Capital; Final Rule
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
PO 00000
Frm 00001
Fmt 4717
Sfmt 4717
E:\FR\FM\29OCR2.SGM
29OCR2
66626
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
NATIONAL CREDIT UNION
ADMINISTRATION
12 CFR Parts 700, 701, 702, 703, 713,
723, and 747
RIN 3133–AD77
Risk-Based Capital
National Credit Union
Administration (NCUA).
ACTION: Final rule.
AGENCY:
The NCUA Board (Board) is
amending NCUA’s current regulations
regarding prompt corrective action
(PCA) to require that credit unions
taking certain risks hold capital
commensurate with those risks. The
risk-based capital provisions of this
final rule apply only to federally
insured, natural-person credit unions
with assets over $100 million.
The overarching intent is to reduce
the likelihood of a relatively small
number of high-risk outliers exhausting
their capital and causing systemic
losses—which, by law, all federally
insured credit unions would have to pay
through the National Credit Union
Share Insurance Fund (NCUSIF).
This final rule restructures NCUA’s
PCA regulations and makes various
revisions, including amending the
agency’s current risk-based net worth
requirement by replacing it with a new
risk-based capital ratio for federally
insured, natural-person credit unions
(credit unions).
The risk-based capital requirement set
forth in this final rule is more consistent
with NCUA’s risk-based capital measure
for corporate credit unions and, as the
law requires, more comparable to the
regulatory risk-based capital measures
used by the Federal Deposit Insurance
Corporation (FDIC), Board of Governors
of the Federal Reserve System, and
Office of the Comptroller of Currency
(Other Banking Agencies). The effective
date is intended to coincide with the
full phase-in of FDIC’s risk-based capital
measures in 2019.
The final rule also eliminates several
provisions in NCUA’s current PCA
regulations, including provisions
relating to the regular reserve account,
risk-mitigation credits, and alternative
risk weights.
DATES: This final rule is effective on
January 1, 2019.
FOR FURTHER INFORMATION CONTACT:
Policy and Accounting: Larry Fazio,
Director, Office of Examination and
Insurance, at (703) 518–6360; JeanMarie
Komyathy, Director, Division of Risk
Management, Office of Examination and
Insurance, at (703) 518–6360; John
mstockstill on DSK4VPTVN1PROD with RULES2
SUMMARY:
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Shook, Loss/Risk Analyst, Division of
Risk Management, Office of
Examination and Insurance, at (703)
518–3799; Steven Farrar, Supervisory
Financial Analyst, Division of Capital
and Credit Markets, Office of
Examination and Insurance, at (703)
518–6393; Tom Fay, Senior Capital
Markets Specialist, Division of Capital
and Credit Markets, Office of
Examination and Insurance, at (703)
518–1179; Rick Mayfield, Senior Capital
Markets Specialist, Division of Capital
and Credit Markets, Office of
Examination and Insurance, at (703)
518–6501; Aaron Langley, Risk
Management Officer, Division of
Analytics and Surveillance; Office of
Examination and Insurance, at (703)
518–6360; or Legal: John H. Brolin or
Justin Anderson, Senior Staff Attorneys,
Office of General Counsel, at (703) 518–
6540; or by mail at National Credit
Union Administration, 1775 Duke
Street, Alexandria, VA 22314.
SUPPLEMENTARY INFORMATION:
I. Background
II. Summary of the Final Rule
III. Legal Authority
IV. Section-by-Section Analysis
V. Effective Date
VI. Impact of This Final Rule
VII. Regulatory Procedures
I. Background
NCUA’s primary mission is to ensure
the safety and soundness of federally
insured credit unions. NCUA performs
this function by examining and
supervising federally chartered credit
unions, participating in the examination
and supervision of federally insured,
state-chartered credit unions in
coordination with state regulators, and
insuring members’ accounts at all
federally insured credit unions.1 In its
role as the administrator of the NCUSIF,
NCUA insures and regulates
approximately 6,270 federally insured
credit unions, holding total assets
exceeding $1.1 trillion and representing
approximately 99 million members.
At its January 2014 meeting, the
Board issued a proposed rule (the
Original Proposal) 2 to amend NCUA’s
PCA regulations, part 702. The proposed
amendments were intended to
implement the statutory requirements of
the Federal Credit Union Act (FCUA)
and follow recommendations made by
the Government Accountability Office
(GAO) and NCUA’s Inspector General.
The proposal was also intended to
amend NCUA’s risk-based capital
1 Within
the nine states that allow privately
insured credit unions, approximately 129 statechartered credit unions are privately insured and
are not subject to NCUA regulation or oversight.
2 79 FR 11183 (Feb. 27, 2014).
PO 00000
Frm 00002
Fmt 4701
Sfmt 4700
regulations to be more consistent with
NCUA’s risk-based capital measure for
corporate credit unions and comparable
to the new regulatory risk-based capital
regulations finalized by the Other
Banking Agencies in 2013.3 In response
to the Original Proposal, the Board
received over 2,000 comments with
many suggestions on how to improve
the proposed regulation. The comments
received addressed a wide range of
issues. In general, however, the
commenters nearly all agreed that,
because the proposal assigned higher
risk weights to some credit union asset
classes, it would have placed credit
unions at a competitive disadvantage to
banks. The change most frequently
recommended by commenters to
address this concern was to adopt the
same risk weights as the Other Banking
Agencies. The Board generally agreed
and, after reviewing all of the comments
received, determined that it was
appropriate to issue a second proposed
rule.
So, at its January 2015 meeting, the
Board issued a second proposed rule
(the Second Proposal) 4 to amend
NCUA’s PCA regulations, part 702. The
Second Proposal, which was based
largely on the comments NCUA
received on the Original Proposal,
addressed the competitive disadvantage
concerns raised by commenters and
made the proposal more comparable to
the Other Banking Agencies’ risk-based
capital requirements. Particular changes
from the Original Proposal included: (1)
Amending the definition of ‘‘complex’’
credit union, resulting in an increase in
the asset threshold from $50 million to
$100 million; (2) reducing the number
of asset concentration thresholds for
residential real estate loans and
commercial loans (formerly classified as
member business loans); (3) assigning
the same risk weights to one-to-four
family non-owner-occupied residential
real estate loans and other types of
residential real estate loans; (4)
eliminating provisions intended to
address interest rate risk (IRR); (5)
eliminating the proposed individual
minimum capital requirement; and (6)
extending the effective date to January
1, 2019. These changes would have,
among other things, substantially
reduced the number of credit unions
subject to the rule, and would have
provided credit unions significantly
3 The Office of the Comptroller of Currency, and
the Board of Governors of the Federal Reserve
System: 78 FR 62017 (Oct. 11, 2013); and the
Federal Deposit Insurance Corporation: 78 FR
55339 (Sept. 10, 2013).
4 80 FR 4339 (Jan. 27, 2015).
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
more time to prepare to implement the
rule’s requirements.
Summary of Public Comments on the
Second Proposal
In response to the Second Proposal,
the Board received over 2,100
comments. While the total number of
comment letters received was higher
than the number received in response to
the Original Proposal, the comment
letters responding to the Second
Proposal were significantly shorter and
raised fewer distinct concerns regarding
the rule’s provisions. In addition,
significantly fewer credit unions sent in
comment letters in response to the
Second Proposal. In response to the
Original Proposal, NCUA received
comment letters from more than 1,100
different credit unions, while only 514
different credit unions sent in comment
letters in response to the Second
Proposal. In addition, more than 900 of
the comment letters received in
response to the Second Proposal
provided no substantive input on the
rule. Nearly all of these non-substantive
letters simply stated that the commenter
believed Congress should ‘‘approve’’ the
rule, or that the commenter wanted to
‘‘vote no’’ on the rule.
A majority of significant comment
letters received stated that the
commenter opposed the proposal in its
entirety and suggested that the Second
Proposal be withdrawn. Most of these
commenters stated they opposed the
rule for one or more of the following
reasons: A substantial number of
commenters suggested that the strong
performance of credit unions and the
NCUSIF during and after the 2007–2009
financial crisis demonstrated there was
no need for the proposal, and that the
Board provided no evidence that the
proposal would have reduced material
losses to the NCUSIF if it had been in
place before the financial crisis. Other
commenters maintained that the
proposal was unnecessary given how
extremely well capitalized the industry
is today. Commenters contended further
that, given NCUA’s own estimates that
fewer than 30 credit unions would be
less than well capitalized under the
proposed risk-based capital ratio if it
went into effect immediately, NCUA’s
current risk-based capital regulations
and other supervisory tools seem to be
doing an adequate job. Several
commenters claimed that most credit
union failures, including the corporate
credit unions (Corporates), and
significant losses to the NCUSIF were
the result of high concentration levels in
risky loans and investments, or were
otherwise related to a lack of internal
controls that should have been
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
identified through the examination
process. Commenters suggested that,
instead of updating NCUA’s risk-based
capital regulations, the Board should
focus on enhanced training to improve
examiner skills. A substantial number of
commenters also claimed that the
proposal would regulate credit unions
in the same general manner as banks.
They argued credit unions should be
regulated differently than banks because
they are structured and operate
differently. Other commenters argued
the proposed rule would place credit
unions at a competitive disadvantage to
banks, because in these commenters’
opinion, the proposed rule would
require credit unions to hold
incrementally more capital than banks
given similar levels of asset
concentration. At least one commenter
suggested that the proposal would drive
the largest credit unions to convert to
bank charters. Other commenters argued
that risk-based capital requirements, to
which banks have been subject for
approximately 25 years, have not
worked well. In addition, they argued
that bank regulators are now moving
away from risk-based capital structures
after they failed to help banks during
the 2007–2009 recession. In support of
this argument, many commenters cited
a statement in which one FDIC Board
Member, the FDIC’s Vice Chairman,
stated publicly that he believed the riskbased capital approach to regulation
was a bad idea. A substantial number of
commenters expressed concern that the
proposal would stifle growth,
innovation, diversification, and member
services within credit unions by
restricting credit unions’ use of capital,
and would impose excessive costs on
credit unions and their members. At
least one commenter suggested that the
proposal would likely cause more risk,
not less risk, to the system as a whole
because the lower risk weightings
assigned in some asset classes compared
to others would force credit unions to
take on excessive concentrations of
lower risk-weighted assets. This, the
commenter argued, would increase
concentration risk compared to a
diverse balance sheet.
Other commenters expressed concern
that the proposal would be detrimental
to the interests of many credit union
members because credit unions would
have to charge their members higher
interest rates and fees and pay lower
interest on deposits to raise the
additional capital required under the
proposal. A significant number of
commenters maintained that the
benefits of the proposal did not
PO 00000
Frm 00003
Fmt 4701
Sfmt 4700
66627
outweigh its costs to the credit union
industry.
A significant number of commenters
opposing the rule also argued that the
Board failed to adequately justify the
proposed changes to NCUA’s current
risk-based net worth requirement. At
least one commenter suggested that the
Board should not base its justification
for the risk-based capital regulation on
global financial trends. Other
commenters claimed that the historical
loss data and other information
provided by NCUA in the proposed rule
did not support establishing a higher
capital standard for credit unions than
banks. Some commenters disagreed
with the Board’s statutory justification
for NCUA to maintain comparability
with the capital rules of FDIC, and
argued that the Board overemphasized
the need for the regulation to be
comparable to the other banking agency
regulations. Commenters acknowledged
that comparability is commendable
where there are truly comparable
institutions. Commenters suggested,
however, that the fundamental structure
of credit unions as not-for profit
financial cooperatives is not comparable
with the for-profit banking system.
Commenters suggested further that
member-owned credit unions generally
have a different risk model than the
profit-oriented banks, so if anything
credit unions should have lower riskbased capital requirements than banks.
Those commenters argued that the
narrative accompanying the Second
Proposal did not indicate sufficient
research and analysis into the
differences between banks and credit
unions had been done or, if it had, that
it was not presented in a transparent
manner that adequately justified the
structure of the proposal.
A substantial number of commenters
pointed out that, of the 1,400 credit
unions with more than $100 million in
assets, only 27 would have a risk-based
capital ratio below the 10 percent level
proposed for a credit union to be well
capitalized. Commenters contended
that, based on these numbers, the
current rule and other supervisory tools
already at NCUA’s disposal were
already doing an adequate job. Other
commenters argued that only 112 credit
unions failed during the 2007–2009
recession, costing the insurance fund
less than $1 billion, which they
suggested was remarkable considering
the dollars and number of commercial
banks that failed. Of the natural-person
credit unions that did fail during the
crisis, the commenters acknowledged
that most were under the $100 million
asset size threshold proposed.
Commenters contended that, from 1998
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
66628
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
to 2012, the NCUSIF fund losses were
only $989 million; $513 million came
from 7 credit unions in the $200 million
to $500 million asset range, and $343
million came from credit unions under
$100 million that would not have been
covered under the Second Proposal. At
least one commenter claimed that its
analysis of the 26 credit unions with
more than $80 million in assets just
before the crisis (as of December 2007)
that subsequently failed revealed that
only seven would have had a lower
capital classification under Second
Proposal. The commenter suggested that
six of the 21 well-capitalized credit
unions under current rules would have
been downgraded—four to adequately
capitalized and two to
undercapitalized—and that one
adequately capitalized credit union
under the current rules would have
been classified as undercapitalized
under the proposal. In other words, the
commenter maintained, of the 26
failures, a total of three credit unions
would have been demoted to
undercapitalized if the Second Proposal
had been in effect before the crisis. And
the amount of capital they would have
been required to obtain to become
adequately capitalized was only $7
million, as compared to the insurance
loss of over $700 million. The
commenter claimed that the amount of
capital that would have been necessary
for all seven downgraded credit unions
to regain their previous capital
classifications (six to well-capitalized,
one to adequately-capitalized) would
have totaled $43 million.
While most commenters did oppose
finalizing the proposal, a substantial
number of the commenters who
opposed the rule acknowledged that the
Board, in response to comments
received on the Original Proposal, had
made significant improvements to
Second Proposal. Specific
improvements mentioned included: The
removal of the IRR provisions; the new
zero percent risk weight assigned to
cash held at the Federal Reserve; the
reduction of the concentration
thresholds from three to two tiers for
residential mortgages, junior liens, and
commercial loans; the removal of the
1.25 percent cap on allowance for loan
and lease losses (ALLL); the lower 10
percent risk-based capital ratio
threshold level required for credit
unions to be classified as well
capitalized; the removal of the
enumerated processes to require that
individual credit unions hold higher
levels of capital under certain
circumstances; the increase in the asset
size threshold for defining credit unions
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
as ‘‘complex’’; the extended
implementation period; the lower riskweights assigned to many categories of
assets; and the designation of one-tofour family non-owner occupied
mortgage loans as residential loans.
A small number of commenters stated
that they supported the Second
Proposal. These commenters generally
agreed that the credit union system
should have risk-based capital
requirements that protect the Share
Insurance Fund and other well run
credit unions by requiring that credit
unions with more complex balance
sheets hold modestly more capital.
Several commenters supported the
proposal because they felt that the
Board had listened to commenters
following the Original Proposal and had
made substantial improvements to the
Second Proposal. Several commenters
supported the proposal for various other
reasons: One financial services
consulting firm suggested that, overall,
the proposal presented a fair alternative
to the risk-based capital requirements
applicable to banks. At least one state
supervisory authority suggested that, on
the whole, the proposal was sound and
substantially better than NCUA’s
current risk-based capital rule. One
credit union commenter stated that it
supported the proposal because insured
credit unions, which together hold
assets of $1.1 trillion, are backed by the
full faith and credit of the United States.
And if insured credit unions engaging in
high-risk lending fail in significant
enough numbers, then the taxpayer is
left holding the bill. One individual
stated that he supported the proposal
because, in his opinion, it would lower
the number of loans credit unions could
make by imposing higher risk weights
on loans made to higher-risk persons.
Another individual supported the
proposal because he believed it would
lower rates for consumers who utilize
credit unions. Yet another individual
suggested that he supported the
proposal because credit unions should
be given the same scrutiny as other
major lenders and not be given a free
pass because they have good intentions
as non-profits. The commenter
suggested further that credit unions
should be subject to tough and robust
regulations such as the proposed riskbased capital rule.
In addition to the comments on the
Second Proposal discussed above,
NCUA received the following general
comments: At least one commenter
agreed that NCUA’s current risk-based
net worth regulation is outdated and
does not accurately reflect the level of
risk in individual credit unions, but
criticized that the statutory net worth
PO 00000
Frm 00004
Fmt 4701
Sfmt 4700
ratio level is fixed at 7 percent. The
commenter suggested that if the 7
percent net worth ratio level is
inadequate, the Board should convince
Congress to arrive at an appropriate net
worth level rather than address risks
through revisions to NCUA’s risk-based
capital regulations. Another commenter
recommended that a risk-based capital
requirement be developed to replace the
statutory net worth ratio, instead of
imposing a risk-based capital
requirement in addition to the statutory
net worth ratio requirement. The
commenter argued that managing two
different capital limits would place an
unnecessary burden on credit unions
and serve as an additional competitive
disadvantage to the credit union charter.
A significant number of commenters
suggested that the proposed rule went
too far in treating credit unions like
banks, and that if credit unions are
regulated and supervised as banks they
will be forced to act more like banks,
which would be to the detriment of
their members. At least one state
supervisory authority agreed with using
a Basel III style capital model, but
remained concerned that notable
differences continued to exist between
NCUA’s proposed model and the one
employed by FDIC and other federal
bank regulators. In particular, the
commenter suggested that the
differences between the risk weightings
for a number of the proposed asset
categories represented a missed
opportunity to reduce public confusion,
and might actually increase confusion.
The commenter explained that public
users of government-provided Call
Report data could assume that NCUA’s
risk-based capital ratio is the same as
other institutions’ measurements of
capital using the same terminology, but,
under the Second Proposal, the ratios
could be materially different for banks
and credit unions. A bank trade
association recommended the Board
adopt the same Basel III model adopted
by the Other Banking Agencies because
without comparable capital
requirements, credit unions will be
undercapitalized relative to community
banks, and such undercapitalization,
along with credit unions’ limited access
to alternative forms of capital when
needed, could increase the bailout risk
faced by the American taxpayer. The
commenter suggested that because
credit unions are not required to pay
federal income taxes on earnings and
can retain a larger percentage of their
earnings than community banks, they
should have little or no difficulty in
maintaining very high levels of Tier 1
capital. The commenter also suggested
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
that the Board impose a capital
surcharge of 5 percent on credit unions
when they exceed total consolidated
assets of $10 billion because large credit
unions, with their limited ability to
react to depleted capital levels in times
of economic uncertainty, should be
subjected to increased scrutiny and
additional capital reserves. Other
commenters suggested that, before
issuing a proposed rule, NCUA test
regulatory approaches of the type
included in the Second Proposal
through the examination process and
share the results with the industry.
Some commenters suggested that the
rule does not take into account that the
vast majority of credit unions already
have written policies to deal with
balance sheet risk. At least one
commenter suggested that the rule
would not protect credit unions or
NCUA in the event of another crisis that
requires natural-person credit unions to
pay out huge assessments. A few
commenters recommended that the
proposed risk-based capital ratio
measure should be used as a modeling
tool rather than a rigid rule, similar to
interest rate risk monitoring tools. The
commenters suggested that this would
allow credit union risk to be calculated
as a model by examiners using risk
weights appropriate for each credit
union’s environment, and discuss with
boards and management their views of
risk for various asset classes. A model,
the commenters suggested, would be far
more flexible than a rule, and would
allow for the pragmatic management of
risk rather than through rule-based
estimates of risk, which may or may not
be accurate. Finally, one credit union
supported making the risk-based capital
framework as complicated as it needs to
be to more accurately reflect the unique
needs and structure of the credit union
industry. The commenter suggested that
the Board, for example, took a step in
that direction in the Second Proposal
when it created a risk-weight category
for ‘‘commercial loans’’ as distinct from
traditional member business loans for
purposes of the risk-based capital ratio
measure.
mstockstill on DSK4VPTVN1PROD with RULES2
Discussion
Commenters calling for a withdrawal
of the proposed rule altogether are
ignoring NCUA’s general statutory
requirement to maintain a risk-based
system comparable to the Other Banking
Agencies’ requirements.5 In 2013, the
Other Banking Agencies issued final
5 See 12 U.S.C. 1790d(b)(1)(A)(ii), which requires
that the NCUA’s system of PCA be ‘‘comparable’’
to the PCA requirements in section 1831o of the
Federal Deposit Insurance Act.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
rules updating the risk-based capital
regulations for insured banks.6 The
changes to the Other Banking Agencies’
risk-based capital regulations, the
lessons learned from the 2007–2009
recession, and the fact that NCUA’s
current risk-based net worth
requirement is ineffective and has not
been materially updated since 2002,
prompted the Board to propose
revisions to NCUA’s current risk-based
net worth ratio requirement and other
aspects of NCUA’s current PCA
regulations. The proposed changes were
also prompted by specific
recommendations to NCUA made by
GAO in its January 2012 review of
NCUA’s system of PCA. In particular,
GAO recommended that NCUA design a
more forward-looking system to detect
problems earlier.7
The Second Proposal addressed the
important role and benefits of capital.
The proposal discussed the impact of a
financial crisis and the benefit a higher
level of capital provided to insulate
certain financial institutions from the
effects of unexpected adverse
developments in assets and liabilities.
Higher levels of capital can reduce the
probability of a systemic crisis, allow
credit unions to continue to serve as
credit providers during times of stress
without government intervention, and
produce benefits that outweigh the
associated costs. The proposal also
emphasized that credit unions’ senior
management and boards are accountable
for ensuring that appropriate capital
levels are in place based on the credit
union’s risk exposure.
Capital is the buffer that depository
institutions, including credit unions,
use to prevent institutional failure or
dramatic deleveraging during times of
strees. As evidenced by the 2007–2009
recession, during a financial crisis a
buffer can mean the difference between
the survival or failure of a financial
insitution. Financial crises are very
costly, both to the economy in general
and to individual depository
institutions.8 While the onset of a
6 78 FR 55339 (Sept. 10, 2013) (FDIC published
an interim final rule regarding regulatory capital for
their regulated institutions separately from the
Other Banking Agencies.) and 78 FR 62017 (Oct. 11,
2013) (The Office of the Comptroller of the
Currency and the Board of Governors of the Federal
Reserve System later published a regulatory capital
final rule for their regulated institutions, which is
consistent with the requirements in FDIC’s IFR.).
7 See U.S. Govt. Accountability Office, GAO–12–
247, Earlier Actions Are Needed to Better Address
Troubled Credit Unions (Jan. 2012), available at
https://www.gao.gov/products/GAO-12-247.
8 Credit unions play a sizable role in the U.S.
depository system. Assets in the credit union
system amount to more than $1.1 trillion, roughly
8 percent of U.S. chartered depository institution
assets (source: NCUA Calculation using the
PO 00000
Frm 00005
Fmt 4701
Sfmt 4700
66629
financial crisis is inherently
unpredictable, a review of the historical
record over a range of countries and
recent time periods has suggested that a
significant crisis involving depository
institutions occurs about once every 20
to 25 years, and has a typical
cumulative discounted cost in terms of
lost aggregate output relative to the
precrisis trend of about 60 percent of
precrisis annual output.9 In other
words, the typical crisis results in losses
over time, relative to the precrisis trend
economic growth, that amount to more
than half of the economy’s output before
the onset of the crisis.
The 2007–2009 financial crisis and
the associated economic dislocations
during the Great Recession were
particularly costly to the United States
in terms of lost output and jobs. Real
GDP declined more than four percent,
almost nine million jobs were lost, and
the unemployment rate rose to 10
percent.10 The cited figures are just the
financial accounts of the United States, Federal
Reserve Statistical Release Z.1, Table L.110,
September 18, 2014). Data from the Federal Reserve
indicate that credit unions account for about 12
percent of private consumer installment lending.
(Source: NCUA calculations using data from the
Federal Reserve Statistical Release G.19, Consumer
Credit, September 2014. Total consumer credit
outstanding (not mortgages) was $3,246.8 billion of
which $826.2 billion was held by the federal
government and $293.1 billion was held by credit
unions. The 12 percent figure is the $293.1 billion
divided by the total outstanding less the federal
government total). Just over a third of households
have some financial affiliation with a credit union.
(Source: NCUA calculations using data from the
Federal Reserve 2013 survey of Consumer Finance.)
All Federal Reserve Statistical Releases are
available at http:\\www.federalreserve.gov\
econresdata\statisticsdata.htm.
9 Basel Committee on Banking Supervision, An
assessment of the long-term economic impact of
stronger capital and liquidity requirements 3–4
(August 2010), available at https://www.bis.org/publ/
bcbs173.pdf. These losses do not explicitly account
for government interventions that ameliorated the
observed economic impact. This is the median loss
estimate.
10 The National Bureau of Economic Research
Business Cycle Dating Committee defines the
beginning date of the recession as December 2007
(2007Q4) and the ending date of the recession as
June 2009 (2009Q2). See the National Bureau of
Economic Research Web site: https://www.nber.org/
cycles/cyclesmain.html. The real GDP decline was
calculated by NCUA using data for 2007Q4 and
2009Q2 from the National Income and Product
Accounts, Bureau of Economic Analysis, U.S.
Department of Commerce; see Table 1.1.3. Data are
available at https://www.bea.gov/iTable/
iTable.cfm?ReqID=9&step=1#reqid=9&step=1&
isuri=1. Data accessed November 11, 2014. The jobs
lost figure was calculated by NCUA using data from
the Bureau of Labor Statistics (BLS), U.S.
Department of Labor, Current Employment
Statistics, CES Peak-Trough Tables. The statistic
cited is the decline in total nonfarm employees
from December 2007 through February 2010, which
BLS defines as the trough of the employment series.
Data available at: https://www.bls.gov/ces/
cespeaktrough.htm and accessed on November 11,
2014. The unemployment rate was taken from the
E:\FR\FM\29OCR2.SGM
Continued
29OCR2
66630
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
direct losses. Compared to where the
economy would have been had it
followed the precrisis trend, the losses
in terms of GDP and jobs would be
higher. For example, using the results
described in the previous paragraph as
a guide, the cumulative loss of output
from the 2007–2009 financial crisis is
roughly $10 trillion (2014 dollars).11
Other estimates of the total loss, derived
using approaches different than
described in the previous paragraph, are
similar. For example, researchers at the
Federal Reserve Bank of Dallas, using a
different approach that achieved results
within the same range, estimated a
range of loss of $6 trillion to $14 trillion
due to the crisis.12
Research using bank data across
several countries and time periods
indicates that higher levels of capital
insulate financial institutions from the
effects of unexpected adverse
developments in their asset portfolio or
their deposit liabilities.13 For the
financial system as a whole, research on
the banking sector has shown that
higher levels of capital can reduce the
probability of a systemic crisis.14 By
reducing the probability of a systemic
financial crisis and insulating
individual institutions from failure,
higher capital requirements confer very
large benefits to the overall economy.15
With the median long-term output loss
associated with a crisis in the range of
60 percent of precrisis GDP, a one
percentage point reduction in the
probability of a crisis would add
Bureau of Labor Statistics, U.S. Department of
Labor, Current Population Survey, series
LNS14000000. Accessed November 11, 2014 at
https://data.bls.gov/pdq/SurveyOutputServlet. The
unemployment rate peaked at 10 percent in October
2009.
11 NCUA calculations based on from the National
Income and Product Accounts, Bureau of Economic
Analysis, U.S. Department of Commerce. Data from
Table 1.1.6 show real GDP at $14.992 trillion in
2007Q4 in chained 2009 dollars. Adjusting to 2014
dollars using the GDP price index and using the 60
percent loss figure cited yields an estimated loss of
approximately $10 trillion in 2014 dollars. Data are
available at https://www.bea.gov/iTable/
iTable.cfm?ReqID=9&step=1#reqid=9&step
=1&isuri=1.
12 Tyler Atkinson, David Luttrell & Harvey
Rosenblum, Fed. Reserve Bank of Dall, How Bad
Was It? The Costs and Consequences of the 2007–
2009 Financial Crisis (July 2013), available at
https://dallasfed.org/assets/documents/research/
staff/staff1301.pdf.
13 See An Assessment of the Long-Term Economic
Impact of Stronger Capital and Liquidity
Requirements, Basel Committee on Banking
Supervision, August 2010. Pages 14–17. The study
indicates that the seven percent TCE/RWA ratio is
equivalent to a five percent ratio of equity to total
assets. The average ratio of equity to total assets for
the 14 largest OECD countries from 1980 to 2007
was 5.3 percent.
14 Id.
15 Id.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
roughly 0.6 percent to GDP each year
(permanently).16
While higher levels of capital can
insulate depository institutions from
adverse shocks, holding higher levels of
capital does have costs, both to
individual institutions and to the
economy as a whole. For the most part,
the largest cost associated with holding
higher levels of capital, in the long term,
is foregone opportunities; that is, from
the loss of potential earnings from
making loans, from the cost to bank
customers and credit union members of
higher loan rates and lower deposit
rates, and the downstream costs from
the customers’ and members’ reduced
spending.17 Estimating the size of these
effects is difficult. However, despite
limitations on the ability to quantify
these effects, the annual costs appear to
be significantly smaller than the losses
avoided by reducing the probability of
a systemic crisis. For example, research
using data on banking systems across
developed countries indicates that a one
percentage point increase in the capital
ratio increases lending spreads (the
spread between lending rates and
deposit rates) by 13 basis points.18 The
research also shows that the long-run
reduction in output (real GDP)
consistent with a one percentage point
increase in the Tier 1 common equity 19
to risks assets ratio would be on the
order of 0.1 percent.20 Thus, it is clear
that the relatively large potential longterm benefits of holding higher levels of
capital outweigh the relatively small
long-term costs.
The 2007–2009 financial crisis
revealed a number of inadequacies in
the current approach to capital
requirements. Banks, in particular,
experienced an elevated number of
failures and the need for federal
16 Id.
17 See An Assessment of the Long-Term Economic
Impact of Stronger Capital and Liquidity
Requirements, Basel Committee on Banking
Supervision, August 2010. Pages 21–27.
18 There are a number of simplifying assumptions
involved in the calculation, including the
assumption that banks fully pass through the
increase in the cost of capital to their borrowers.
See Basel Committee on Banking Supervision, An
Assessment of the Long-Term Economic Impact of
Stronger Capital and Liquidity Requirements 21–27
(Aug. 2010).
19 Tier 1 common equity is made up of common
stock, retained earnings, accumulated other
comprehensive income, and some miscellaneous
minority interests and common stock as part of an
employee stock ownership plan.
20 To be clear, the 0.1 percent figure represents
the one-time, long-term loss, which should be
compared with the 60 percent loss potentially
avoided by reducing the probability of a financial
crisis by a little more than one percentage point.
See An Assessment of the Long-Term Economic
Impact of Stronger Capital and Liquidity
Requirements, Basel Committee on Banking
Supervision, August 2010. Pages 21–27.
PO 00000
Frm 00006
Fmt 4701
Sfmt 4700
intervention in the form of capital
infusions.21
Credit unions also experienced
elevated losses and the need for
government intervention. From 2008
through 2012, five corporate credit
unions failed. Had NCUA not
intervened in 2009 and 2010 by
providing over $20 billion in liquidity
assistance, over $100 billion in
guarantees, and borrowing over $5
billion from the U.S. Treasury, the
resulting losses to consumer credit
unions on their uninsured funds
invested at these institutions would
have exceeded $30 billion. NCUA
estimates as many as 2,500 consumer
credit unions would have failed at
additional cost to the Share Insurance
Fund.
In addition, during that same period,
27 consumer credit unions with assets
greater than $50 million failed at a cost
of $728 million to the NCUSIF.22 NCUA
performed back-testing of the 9 complex
credit unions (those with over $100
million in assets) that failed during this
period to determine whether this final
rule would have resulted in earlier
identification of emerging risks and
reduced losses to the NCUSIF. The
back-testing revealed that maintaining a
risk-based capital ratio in excess of 10
percent would have required 8 of the 9
complex credit unions that failed to
hold additional capital.
The failure of the 27 consumer credit
unions was due in large part to holding
inadequate levels of capital relative to
the levels of risk associated with their
assets and operations. In many cases,
the capital deficiencies relative to
elevated risk levels were identified by
examiners and communicated through
the examination process to officials at
these credit unions.23 Although the
credit union officials were provided
with notice of the capital deficiencies,
they ignored the supervisory concerns
21 For a readable overview of the 2007–2009
financial crisis and the government response see,
The Final Report of the Congressional Oversight
Panel, Congressional Oversight Panel, March 16,
2011. See also Ben S. Bernanke, ‘‘Some Reflections
on the Crisis and the Policy Response,’’ Speech at
the Russell Sage Foundation and The Century
Foundation Conference on ‘‘Rethinking Finance,’’
New York, New York, April 13, 2012. Available at:
https://www.federalreserve.gov/newsevents/speech/
2012speech.htm.
22 These figures are based on data collected by
NCUA throughout the crisis, and do not include the
costs associated with failures of corporate credit
unions.
23 See, e.g., OIG–13–10, Material Loss Review of
Chetco Federal Credit Union (October 1, 2013),
OIG–13–05, Material Loss Review of Telesis
Community Credit Union (March 15, 2013), OIG–
10–15, Material Loss Review of Ensign Federal
Credit Union, (Sept. 23, 2010), OIG–10–03, Material
Loss Reviews of Cal State 9 Credit union (April 14,
2010).
E:\FR\FM\29OCR2.SGM
29OCR2
66631
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
or did not act in a timely manner to
address the concerns raised.
Furthermore, NCUA’s ability to take
enforcement actions to address
supervisory concerns in a timely
manner was cited by GAO as limited
under NCUA’s current regulations.
From 2008 to 2012, over a dozen very
large consumer credit unions, and
numerous smaller ones, also were in
danger of failing and required extensive
NCUA intervention, financial
assistance, or both, along with increased
reserve levels for the NCUSIF.24 NCUA
estimates these actions saved the
NCUSIF over $1 billion in losses.
The clear implication from the impact
of the 2007–2009 recession on the credit
unions noted above is that capital levels
in these cases were inadequate,
especially relative to the riskiness of the
assets that some institutions were
holding on their books.
Unlike banks that can issue other
forms of capital like common stock,
credit unions that need to raise
additional capital when faced with a
capital shortfall generally have no
choice except to reduce member
dividends or other interest payments,
raise lending rates, or cut non-interest
expenses in an attempt to direct more
income to retained earnings.25 Thus, the
first round impact of falling or low
capital levels at credit unions is likely
a direct reduction in credit union
members’ access to credit or interest
bearing accounts. Hence, an important
policy objective of capital standards is
to ensure that financial institutions
build sufficient capital to continue
functioning as financial intermediaries
during times of stress without
government intervention or assistance.
NCUA’s analysis of credit union Call
Report data from 2006 forward, as
detailed below, also makes it clear that
higher capital levels keep credit unions
from becoming undercapitalized during
periods of economic stress. The table
below summarizes the changes in the
net worth ratio that occurred during the
recent economic crisis. Of credit unions
with a net worth ratio of less than eight
percent in the fourth quarter of 2006, 80
percent fell below seven percent at some
time during the 2007–2009 financial
crisis and its immediate aftermath. Of
credit unions with 8 percent to 10
percent net worth ratios in the fourth
quarter of 2006, just under 33 percent
fell below seven percent during the
crisis period. However, of credit unions
that entered the crisis with at least 10
percent net worth ratios, less than five
percent fell below the seven percent
well capitalized standard during the
crisis or its immediate aftermath.
DISTRIBUTION OF NET WORTH RATIOS OF CREDIT UNIONS WITH AT LEAST $100 MILLION IN ASSETS BY LOWEST NET
WORTH RATIO DURING THE FINANCIAL CRISIS
Lowest net worth ratio between 2007Q1 and 2010Q4
Net worth ratio in 2006Q4
<6%
<8 percent ............................................................................
8–10 percent ........................................................................
≥10 percent ..........................................................................
Similarly, the table below shows how
credit unions with at least $100 million
in assets in the fourth quarter of 2006
fared during the five years after the
fourth quarter of 2007, which was the
period that encompassed the 2007–2009
6–7%
44.0
13.0
1.9
7–8%
36.0
19.6
2.8
20.0
38.0
9.4
recession. The table shows that the
credit unions that survived the crisis
and recession had higher net worth
ratios going into the Great Recession. In
particular, credit unions with more than
$100 million in assets before the crisis
8–10%
≥10%
0.0
29.4
38.8
Number
of credit
unions
Total
0.0
0.0
47.1
100.0
100.0
100.0
50
316
830
began, but failed during the crisis, had
a median precrisis net worth ratio of
less than nine percent, while similarly
sized institutions that survived the
crisis had, on average, precrisis net
worth ratios in excess of 11 percent.
CHARACTERISTICS OF FICUS WITH ASSETS >$100 MILLION AT THE END OF 2006 BY FIVE YEAR SURVIVAL BEGINNING
2007Q4
Median
Number of
institutions
Failures ....................................................
Survivors ..................................................
27
1138
Net worth
ratio
(percent)
Assets
($M)
162.7
237.9
Loan to
asset ratio
(percent)
8.97
11.20
84.0
71.0
Real estate
loan share
(percent)
58.0
49.0
Member
business loan
share
(percent)
8.3
0.7
mstockstill on DSK4VPTVN1PROD with RULES2
Survivorship is determined based on whether a FICU stopped filing a Call Report over the five years starting in the fourth quarter of 2007. Failures exclude credit unions that merged or voluntarily liquidated. Note: All failures had precrisis net worth ratios in excess of seven percent.
Aside from demonstrating the
differences in the capital positions of
credit unions that failed from those that
did not fail, the table above highlights
two additional considerations. First, the
table shows that other performance
indicators were different between the
two groups of credit unions. In
particular, the survivors had a lower
median loan-to-asset ratio, a lower
median share of total loans in real estate
loans, and a lower share of member
business loans in their overall loan
portfolio.
24 As most of these credit unions are still active
institutions, or have merged into other active
institutions, NCUA cannot provide additional
details publicly.
25 Low-income designated credit unions can issue
secondary capital accounts that count as net worth
for PCA purposes. As of June 30, 2014, there are
2,107 low-income designated credit unions. Given
the nature (e.g., size) of these credit unions and the
types of instruments they can offer, however, there
is often a very limited market for these accounts.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
PO 00000
Frm 00007
Fmt 4701
Sfmt 4700
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
A key limitation of the leverage ratio
is that it is a lagging indicator because
it is based largely on accounting
standards. Accounting figures are pointin-time values largely based on
historical performance to date. Further,
the leverage ratio does not discriminate
between low-risk and high-risk assets or
changes in the composition of the
balance sheet. A risk-based capital ratio
measure is more prospective in that, as
a credit union makes asset allocation
choices, it drives capital requirements
before losses occur and capital levels
decline. The differences in indicators
between the failure group and the
survivors in the table above demonstrate
that factors in addition to capital levels
play an important role in preventing
failure. For example, all of the failures
listed in the table above had net worth
ratios in excess of the well capitalized
level at the end of 2006. The severe
weakness of NCUA’s current risk-based
net worth requirement is further
demonstrated by the fact that, of the 27
credit unions that failed during the
Great Recession, only two of those
credit unions were considered less than
well capitalized due to the existing
RBNW requirement.26 A well designed
risk-based capital ratio standard would
have been more successful in helping
credit unions avoid failure precisely
because such standards are targeted at
activities that result in elevated risk.
The need for a risk-based capital
standard beyond a leverage ratio is
further supported when considering a
more comprehensive review of credit
union failures. The figures below
present data from NCUA’s review of the
192 credit union failures that occurred
over the past 10 years and indicates that
160 failed credit unions had net worth
ratios greater than seven percent two
years prior to their failure. Further, the
failed credit unions exhibited a 12
percent average net worth ratio two
years prior to their failure.
BILLING CODE 7535–01–P
26 See table above (referencing the 27 failures of
credit unions over $100 million in assets).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
PO 00000
Frm 00008
Fmt 4701
Sfmt 4725
E:\FR\FM\29OCR2.SGM
29OCR2
ER29OC15.000</GPH>
66632
mstockstill on DSK4VPTVN1PROD with RULES2
BILLING CODE 7535–01–C
The table above shows that credit
unions with high net worth ratios can
and have failed, demonstrating that a
leverage ratio alone has not always
proven to be an adequate predictor of a
credit union’s future viability. However,
a more robust risk-based capital
standard would reflect the presence of
elevated balance sheet risk sooner, and
in relevant cases would improve a credit
union’s odds of survival.
A recession or other source of
financial stress poses more difficulties
for credit unions with limited capital
options and with capital levels lower
than what their risks warrant. A capital
shortfall reduces a credit union’s ability
to effectively serve its members. At the
same time, the shortfall can cascade to
the rest of the credit union system
through the NCUSIF, potentially
affecting an even broader number of
credit union members. Credit unions are
an important source of consumer credit
and a capital shortfall that affects the
credit union system could reduce
general consumer access to credit for
millions of credit union members.27
27 Credit unions play a sizable role in the U.S.
depository system. Assets in the credit union
system amount to more than $1.1 trillion, roughly
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Accordingly, a risk-based capital rule
that is effective in requiring credit
unions with low capital ratios and a
large share of high-risk assets to hold
more capital relative to their risk profile,
while limiting the burden on already
well capitalized credit unions, should
provide positive net benefits to the
credit union system and the United
States economy. Improved resilience
enhances credit unions’ ability to
function during periods of financial
stress and reduce risks to the NCUSIF.
eight percent of U.S. chartered depository
institution assets (source: NCUA calculation using
the financial accounts of the United States, Federal
Reserve Statistical Release Z.1, Table L.110,
September 18, 2014). Data from the Federal Reserve
indicate that credit unions account for about 12
percent of private consumer installment lending.
(Source: NCUA calculations using data from the
Federal Reserve Statistical Release G.19, Consumer
Credit, September 2014. Total consumer credit
outstanding (not mortgages) was $3,246.8 billion of
which $826.2 billion was held by the federal
government and $293.1 billion was held by credit
unions. The 12 percent figure is the $293.1 billion
divided by the total outstanding less the federal
government total). Just over a third of households
have some financial affiliation with a credit union.
(Source: NCUA calculations using data from the
Federal Reserve 2013 survey of Consumer Finance.)
All Federal Reserve Statistical Releases are
available at https://www.federalreserve.gov/
econresdata/statisticsdata.htm.
PO 00000
Frm 00009
Fmt 4701
Sfmt 4700
66633
In a risk-based capital system,
institutions that are holding assets that
have historically shown higher levels of
risk are generally required to hold more
capital against those assets. At the same
time, an institution’s leverage ratio,
which does not account for the riskiness
of assets, can provide a baseline level of
capital adequacy in the event that the
approach to assigning risk weights does
not capture all risks. A system including
well-designed and well-calibrated riskbased capital standards is generally
more efficient from the point of view of
the overall economy, as well as for
individual institutions. In general, riskbased capital standards increase capital
requirements at those institutions whose
asset portfolios have, on average, higher
risk.
Conversely, risk-based capital
standards generally decrease the cost of
holding capital for institutions whose
strategies focus on lower risk activities.
In that way, risk-based capital standards
generate the benefits of helping to
insulate the economy from financial
crises, while also preventing some of the
potential costs that would occur from
holding unnecessarily high levels of
capital at low-risk institutions.
E:\FR\FM\29OCR2.SGM
29OCR2
ER29OC15.001</GPH>
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
66634
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
This final rule replaces the current
method for calculating a credit union’s
risk-based net worth ratio with a new
method for calculating a credit union’s
risk-based capital ratio. Under the
current risk-based net worth ratio
measure, a lower ratio is reflective of
financial strength. So the current
measure is not intuitive, and, more
importantly, can’t be compared against
the risk-based capital measures of other
financial institutions. The new riskbased capital ratio, however, is more
commonly applied to depository
institutions worldwide. Generally, the
new risk-based capital ratio is the
percentage of equity and accounts
available to cover losses divided by riskweighted assets. Under this approach, a
higher risk-based capital ratio is an
indicator of financial strength.
The new risk-based capital ratio
adopted in this final rule is designed to
complement the statutory net worth
ratio, which is often referred to as the
leverage ratio. The net worth ratio is a
measure of statutorily defined capital
divided by total assets. The net worth
ratio does not assign relative risk
weights among asset classes, making it
more difficult to manipulate and
provides a simple picture of a financial
institution’s ability to absorb losses,
regardless of the source of the loss. The
new risk-based capital ratio, on the
other hand, is a measure of loss
absorption ability to assets weighted
based on the associated risk, and is
intended to be more forward looking
and reactive to changes in the risk
profile of a credit union. In general, a
risk-based capital requirement increases
capital requirements at those
institutions with asset portfolios that
are, on average, higher risk. Conversely,
risk-based capital standards generally
decrease capital requirements at
institutions with lower risk profiles. In
that way, risk-based capital standards
generate the benefits of helping to
insulate the economy from financial
crises, while also preventing some of the
potential costs that would occur from
holding unnecessarily high levels of
capital at low-risk institutions.
Many commenters suggested that the
Board withdraw the Second Proposal
and retain the existing risk-based capital
requirement and the related riskweights, which are based largely on
interest rate risk and liquidity risk.
Ironically, most of the commenters
objected to the Original Proposal
because it included IRR and liquidity
risk in the proposed risk weights. As
discussed in the Original Proposal,
since its implementation, the current
risk-based net worth requirement has
required less than a handful of credit
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
unions to hold higher levels of capital
than required by the net worth ratio.
Under the current risk-based net worth
requirement, those credit unions that
invest in longer-term, low-credit risk
investments experience a higher riskbased net worth requirement and thus
have a lower buffer above the net worth
ratio than they will have under the final
rule.
The current risk-based net worth
requirement also fails to allow for
comparison of capital adequacy on a
risk-weighted level across financial
institutions. A creditor or uninsured
depositor is able to obtain and
understand the capital measures
available for all banks. Creditors
generally know that, for banks, a higher
capital ratio is an indication of better
financial strength and a reduction in
their risk of loss. Creditors and
uninsured shareholders in credit
unions, however, generally do not
understand the application of the riskbased net worth requirement where a
lower ratio is an indicator of financial
strength; nor are they generally aware
that the risk-based net worth
requirement is only available by
reviewing a specific page of the Call
Report. The current lack of a
comparable risk-based capital measure
for credit unions deprives creditors and
uninsured shareholders of a useful
measure in determining the financial
strength of credit unions.
The Board also disagrees with
commenters who called for a
withdrawal of the Second Proposal
because a limited number of credit
unions may experience a decline in
their capital classification, or because
commenters claimed that back-testing
the proposal would have resulted in
only minor savings to the NCUSIF had
the proposal’s capital requirement been
in place during the 2007–2009
recession. The Original Proposal would
have imposed higher risk-weights for
concentrations of MBLs, junior-lien real
estate loans, and equity investments,
which would have resulted in
approximately 199 credit unions
experiencing a decline in their capital
classification and could have reduced
losses to the NCUSIF to a greater degree
had those requirements been in place
prior to the 2007–2009 recession. Due to
legitimate concerns raised by
commenters regarding the impacts of
the Original Proposal, however, the
Board reduced the risk-weights for
concentrations of MBLs and real estate
loan concentrations in the Second
Proposal. Thus, the potential impacts of
the Second Proposal were lower, but
still require that credit unions taking
higher levels of risk hold higher levels
PO 00000
Frm 00010
Fmt 4701
Sfmt 4700
of capital. Based on the comments
received on the Original Proposal and
the Second Proposal, the risk weights in
the Second Proposal are calibrated to
appropriately balance the impact of the
proposed changes on credit unions
while also providing meaningful
improvement to the risk-based capital
standards to which credit unions will be
held in the future.
The Board disagrees with commenters
who suggested that the Board not
finalize the proposal and instead focus
on enhancing training to improve
examiner skills to reduce the number of
failures and losses to the NCUSIF.
NCUA already continually seeks to
enhance the training and skills of
examiner staff within budget
limitations. NCUA already performs
analyses of all material losses to the
NCUSIF, including material loss
reviews prepared by NCUA’s Inspector
General on losses that exceed $25
million. The loss reviews include
analyses of NCUA’s and the State
Supervisory Authorities’ supervision of
credit unions and include
recommendations to addresses any
weaknesses in related supervision
policies and approaches. Additionally,
not issuing a final rule would result in
retention of the current risk-based net
worth measure, which is not a
comparable measure across financial
institutions and contains risk-weights
that are less closely associated with
credit risk.
Moreover, the Board disagrees with
commenters who suggested that credit
unions should have less stringent
regulatory capital standards than banks.
The combined statutory requirement for
a minimum net worth ratio and the riskbased capital requirement, supported by
the supervision process, is the backbone
of protection for both the credit union
and bank insurance funds. In addition,
prudent capital standards serve to
protect taxpayers who ultimately must
fund any reliance by the insurance
funds on the full faith and credit of the
United States.
Commenters claimed that the Second
Proposal would place credit unions at a
competitive disadvantage to banks by
requiring credit unions to hold
incrementally more capital than banks
given similar asset-concentration levels.
The net worth ratio, which is defined by
statute, requires credit unions to hold
more capital than banks are required to
hold using the comparable Tier 1
leverage ratio for banks.28 Congress
28 The net worth ratio and a bank’s Tier 1 leverage
ratio are both based on the total assets of the
institution. Congress set the net worth ratio 200
basis points higher than the Tier 1 leverage ratio
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
required NCUA to develop PCA
regulations that are comparable to those
of banks, including the risk-based net
worth requirement for complex credit
unions. The Board ensured compliance
with the law while issuing the Second
Proposal, which would not place credit
unions at a competitive disadvantage to
banks. The vast majority of risk weights
for credit unions would be comparable
to the risk weights for banks, and some
risk weights for credit unions would
actually be lower than the risk weights
for banks. Because the Second Proposal
generally used the same overall riskbased capital levels as banks, the
differences in the individual elements of
the calculation can be easily identified
and understood. For example, the
proposed risk weight for secured
consumer loans, which represent about
20 percent of total assets for complex
credit unions, is 25 basis points less
than the corresponding risk weight for
banks. The Second Proposal also would
not cap credit unions’ allowance for
loan and lease losses at 1.25 percent of
risk assets, while the Other Banking
66635
Agencies impose such a cap in the riskbased capital ratio calculation for banks.
In the few instances where the risk
weights are higher for credit unions,
they apply to a very low percentage of
total assets and are directly tied to
sources of higher losses to the NCUSIF,
primarily concentrations of real estate
and business assets.
The table below contains an estimate
of how risk-weights generally compare
between the risk-weights in this final
rule to the risk-weights applied to FDIC
insured institutions.
Sub-category
as % of total
assets
Category as %
of total assets
Lower Risk Weight Than FDIC
Secured Consumer Loans .......................................................................................................................................
........................
21.09%
1.19%
0.11%
0.13%
0.02%
1.46%
........................
........................
........................
........................
2.91%
........................
0.34%
........................
75.66%
More Conservative Risk Weight Than FDIC
First-Lien Real Estate Loans >35 percent of assets ...............................................................................................
Junior-Lien Real Estate Loans >20 percent of assets ............................................................................................
Commercial Loans >50 percent of assets ...............................................................................................................
Non-Current Junior-Lien Real Estate Loans ...........................................................................................................
Unfunded Non-Commercial Loans ..........................................................................................................................
Not Directly Comparable to FDIC
CUSO Investments and Corporate Capital .............................................................................................................
Comparable Risk Weight to FDIC
mstockstill on DSK4VPTVN1PROD with RULES2
All Other Assets .......................................................................................................................................................
Commenters asserted that bank
regulators are moving away from riskbased capital structures and referenced
the FDIC Vice Chairman’s related
statements. The FDIC Vice Chairman,
however, has favored higher generally
accepted accounting principles (GAAP)
equity ratios at banks of at least 10
percent of assets as an alternative to
risk-based capital structures.29 The
NCUA Board lacks authority to impose
higher GAAP equity-to-asset ratios
because the FCUA specifically defines
the net worth ratio for credit unions and
sets forth the minimum ratio levels
required. Moreover, the current
statutory net worth ratio requirement,
combined with a reasonable risk-based
capital ratio requirement to address
institutions taking higher levels of risk,
provides a well targeted level of
protection to the NCUSIF.
The Board disagrees with commenters
who suggested that the proposal would
stifle growth, innovation,
diversification, and member services.
The commenters’ suggested revisions to
the proposal revealed there is clear
disagreement among credit unions and
other interested parties regarding how
the proposal would have impacted
factors such as growth, innovation,
diversification, and member services at
credit unions. This final rule better
reflects each individual credit union’s
risk profile, provides for more active
management of risk in relation to
capital, further ensures individual credit
unions can continue to serve as credit
providers even during times of stress,
and promotes the safety and soundness
of the credit union system.
Commenters asserted that credit
unions would need to charge higher
interest rates, higher fees, and pay lower
rates on deposits to raise capital because
of the new risk-based capital measure.
Credit unions, however, would have
more than three years before the new
risk-based capital requirement goes into
effect. A credit union that determines it
is in danger of having a risk-based
capital ratio level below the required
minimum level has the option of:
Reducing the amount of risk-weighted
assets it holds; raising additional
capital, primarily through earnings; or
both.
NCUA’s analysis of credit union Call
Report data indicates that the
overwhelming majority of complex
credit unions already have sufficient
capital to comply with the proposed
risk-based capital regulation. In
particular, NCUA estimates that over 98
percent of complex credit unions would
be in compliance with the regulatory
capital minimums under the final rule
if it were in effect today. The final rule
is designed to ensure that these credit
unions maintain their capacity to absorb
losses in the future. A few credit unions,
however, will likely want to take
advantage of the three-year
implementation period provided in this
final rule to accumulate retained
earnings, reduce their level of riskassets, or both. As noted above, the
overwhelming majority of credit unions
have sufficient capital to comply with
the revised capital rules, and the
resulting improvements to the stability
and resilience of the credit union
level for banks due to the nature of the 1 percent
NCUSIF deposit, the level of investment within the
corporate credit union system, and credit unions’
limited access to capital other than retained
earnings. U.S. Department of Treasury, Credit
Unions (1997).
29 Thomas M. Hoening, American Banker, The
Safe Way to Give Traditional Banks Regulatory
Relief, (June 22, 2015), available at https://
www.fdic.gov/news/letters/reg-relief.html.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
PO 00000
Frm 00011
Fmt 4701
Sfmt 4700
E:\FR\FM\29OCR2.SGM
29OCR2
66636
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
system outweigh any costs associated
with its implementation.
In this final rule, the Board complied
with the statutory requirement to take
into account the cooperative character
of credit unions in that they are not-forprofit, do not issue capital stock, must
rely on retained earnings to build net
worth, and have boards of directors that
consist primarily of volunteers. To do
this, the Board avoided undue
complexity within the rule by, among
other things, not implementing a
complex conservation buffer
requirement; establishing a simple and
straightforward proxy for the definition
of a complex credit union; reducing the
number of asset concentration
thresholds; and requiring only complex
credit unions to have a written strategy
for maintaining an appropriate level of
capital.
Accordingly, and for the reasons
discussed in more detail below, the
Board is now adopting this final rule to
revise NCUA’s current regulations
regarding PCA to require that complex
credit unions taking certain risks hold
capital commensurate with those risks.
mstockstill on DSK4VPTVN1PROD with RULES2
II. Summary of the Final Rule
This final rule replaces the method
currently used by complex credit unions
to apply risk weights to their assets with
a new risk-based capital ratio measure
that is generally comparable to that
applied to depository institutions
worldwide. As discussed in more detail
in the Legal Authority part of this
preamble, the FCUA gives NCUA broad
discretion in designing the risk-based
net worth requirement applicable to
complex credit unions. Accordingly,
this final rule revises part 702 of
NCUA’s current regulations to establish
a risk-based capital ratio measure that is
the percentage of a credit union’s capital
available to cover losses, divided by the
credit union’s defined risk-weighted
asset base.
This final rule adopts a broadened
definition of capital to be used as the
numerator in the new risk-based capital
ratio measure. The Board is adopting
this change to provide a more
comparable measure of capital across all
financial institutions and to better
account for related elements of the
financial statement that are specifically
available to cover losses and protect the
NCUSIF. This broader definition of
capital more accurately reflects the
amount of capital that is actually
available at a credit union to absorb
losses.
In terms of the denominator for the
risk-based capital ratio measure, section
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
216(d)(2) of the FCUA requires that the
Board, in designing a risk-based net
worth requirement, ‘‘take account of any
material risks against which the net
worth ratio required for [a federally]
insured credit union to be adequately
capitalized may not provide adequate
protection.’’ 30 Section 216(d)(2) of the
FCUA differs from the corresponding
provision in section 38 of the FDI Act,31
which requires the Other Banking
Agencies to implement risk-based
capital requirements, because section
216(d)(2) specifically requires that
NCUA’s risk-based requirement address
‘‘any material risks.’’ Accordingly, the
Board is required to account for any
material risks in the risk-based
requirement unless the risk is deemed
immaterial because of the existence of
another mechanism that the Board
believes adequately accounts for the
risk.
NCUA’s risk-based net worth
requirement has included some aspect
of IRR since its inception in 2000.
Further, IRR, if not adequately
addressed through some regulatory,
statutory or supervisory mechanism, can
represent a material risk for purposes of
NCUA’s risk-based requirement. Based
on long-term balance sheet trends at
credit unions, the comments received
on the Second Proposal, and NCUA’s
experiences dealing with problem
institutions, however, the Board
concluded that NCUA can adequately
address IRR through its other
regulations and supervisory processes.
Accordingly, the final rule generally
excludes IRR from NCUA’s risk-based
capital ratio calculation. But the Board
may consider adopting additional
regulatory or supervisory approaches for
addressing IRR at credit unions if the
need arises in the future.
With the removal of the IRR
component from the current rule, this
final rule narrows the list of risks
accounted for in the denominator of the
new risk-based capital ratio measure.
The methodology for assigning risk
weights in this final rule primarily
accounts for credit risk and
concentration risk.
This final rule incudes a tiered risk
weight framework 32 for high
30 12
U.S.C. 1790d(d)(2) (emphasis added).
U.S.C. 1831o.
32 The tiered framework would provide for an
incrementally higher capital requirement resulting
in a blended rate for the corresponding portfolio.
That is, the portion of the portfolio below the
threshold would receive a lower risk weight, and
the portion above the threshold would receive a
higher risk weight. The higher risk weight would
be consistent across asset categories as a 50 percent
increase from the base rate. Some comments on the
31 12
PO 00000
Frm 00012
Fmt 4701
Sfmt 4700
concentrations of residential real estate
loans and commercial loans 33 in
NCUA’s risk-based capital ratio
measure. As a credit union’s
concentration in these asset classes
increases, incrementally higher levels of
capital are required. This approach
addresses concentration risk as it relates
to minimum required capital levels
through a transparent, standardized,
regulatory requirement. The
concentration thresholds do not limit a
credit union’s lending activity; rather,
the thresholds merely require the credit
union to hold additional capital to
account for the elevated concentration
risk. The inclusion of concentration risk
in the final rule does not put credit
unions at a competitive disadvantage to
banks because most real estate and
member business loans (except for loans
held in high concentrations) would still
be assigned risk weights similar to those
applicable to banks.
Consistent with many commenters
and with section 216(b)(1)(A)(ii) of the
FCUA, which requires NCUA’s PCA
requirement be comparable to the Other
Banking Agencies’ PCA requirements,
the Board relied primarily on the risk
weights assigned to various asset classes
under the Basel Accords and the Other
Banking Agencies’ risk-based capital
regulations for this final rule.34 So this
final rule provides for greater
comparability to the Other Banking
Agencies’ risk weights than NCUA’s
current risk-based net worth regulation.
The Board, however, has tailored the
risk weights in this final rule for certain
assets that are unique to credit unions
or where a demonstrable and
compelling case exists, based on
contemporary and sustained
performance differences, to differentiate
for certain asset classes (such as
consumer loans) between banks and
credit unions, or where a provision of
the FCUA requires doing so.
Original Proposal suggested NCUA should have
combined similar exposures across asset classes,
such as investments and loans. For example,
residential mortgage-backed security concentrations
could have been included with the real estate loan
thresholds due to the similarity of the underlying
assets. However, given the more liquid nature and
price transparency of a security, the Board believes
including this with the risk thresholds for real
estate lending is not necessary.
33 The definition of commercial loans and the
differences between commercial loans and MBLs
are discussed in more detail in the section-bysection analysis.
34 The Board has simplified certain aspects of this
final rule to take into account the cooperative
character of credit unions while still imposing riskbased capital standards that are substantially
similar and equivalent in rigor to the standards
imposed on banks. See 12 U.S.C. 1790d(b)(1)(B).
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
The following is a table showing a
summary of the risk weights included in
this final rule. See the section-bysection analysis part of the preamble
66637
below for more details on the changes
to the asset classes and risk weights.
SUMMARY OF THE RISK WEIGHTS
0%
Cash/Currency/Coin ............................................................
Investments:
Unconditional Claims—U.S. Government ...................
Balances Due from Federal Reserve Banks ...............
Federally Insured Deposits in Financial Institutions ....
Debt Instruments issued by NCUA and FDIC .............
Central Liquidity Facility Stock ....................................
Uninsured deposits at U.S. Federally Insured Institutions ..........................................................................
Agency Obligations ......................................................
FNMA and FHLMC pass through Mortgage Backed
Securities (MBS) ......................................................
General Obligation Bonds Issued by State or Political
Subdivisions .............................................................
Federal Home Loan Bank Stock and Balances ..........
Senior Agency Residential MBS or Asset-Backed Securities (ABS) Structured .........................................
Revenue Bonds Issued by State or Political Subdivisions .........................................................................
Senior Non-Agency Residential MBS Structured ........
Corporate Membership Capital ....................................
Industrial Development Bonds .....................................
Agency Stripped MBS (Interest Only) .........................
Part 703 Compliant Investment Funds a ......................
Value of General Account Insurance (bank owned life
insurance, and credit union owned life insurance) a
Corporate Perpetual Capital ........................................
Mortgage Servicing Assets ..........................................
Separate Account Life Insurance a ..............................
Publicly Traded Equity Investment (non-CUSO) .........
Mutual Funds Part 703 Non-Compliant a .....................
Non-Publicly Traded Equity Investments (non-CUSO)
Subordinated Tranche of Any Investment b .................
Consumer Loans:
Share-Secured (shares held at the credit union) ........
Share-Secured (shares held at another depository institution) ....................................................................
Current Secured ..........................................................
Current Unsecured ......................................................
Non-Current .................................................................
Real Estate Loans:
Share-Secured (shares held at the credit union) ........
Share-Secured (shares held at another depository institution) ....................................................................
Current First Lien <35% of Assets ..............................
Current First Lien >35% of Assets ..............................
Not Current First Lien ..................................................
Current Junior Lien <20% of Assets ...........................
Current Junior Lien >20% of Assets ...........................
Noncurrent Junior Lien ................................................
Commercial Loans:
Share-Secured (shares held at the credit union) ........
Share-Secured (shares held at another depository institution) ....................................................................
Portion of Commercial Loans with Compensating Balance ..........................................................................
Commercial Loans <50% of Assets ............................
Commercial Loans >50% of Assets ............................
Non-current ..................................................................
Miscellaneous:
Loans to CUSOs ..........................................................
Equity Investment in CUSO .........................................
Other Balance Sheet Items not Assigned ...................
20%
50%
75%
100%
150%
250%
300%
400%
1250%
X
..........
..........
..........
..........
..........
..........
..........
..........
...........
X
X
X
X
X
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
...........
...........
...........
...........
...........
..........
..........
X
X
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
...........
...........
..........
X
..........
..........
..........
..........
..........
..........
..........
...........
..........
..........
X
X
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
...........
...........
..........
X
..........
..........
..........
..........
..........
..........
..........
...........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
X
X
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
Xc
X
X
X
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
...........
...........
...........
...........
...........
...........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
X
Xc
..........
..........
Xc
..........
Xc
..........
..........
Xc
..........
..........
..........
..........
..........
..........
..........
..........
X
..........
..........
..........
..........
..........
..........
..........
..........
X
Xc
X
..........
..........
..........
..........
..........
..........
..........
..........
Xc
..........
...........
...........
...........
...........
...........
...........
...........
X
X
..........
..........
..........
..........
..........
..........
..........
..........
...........
..........
..........
..........
..........
X
..........
..........
..........
..........
..........
..........
..........
..........
X
..........
..........
..........
..........
X
..........
..........
..........
..........
X
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
...........
...........
...........
...........
X
..........
..........
..........
..........
..........
..........
..........
..........
...........
..........
..........
..........
..........
..........
..........
..........
X
..........
..........
..........
..........
..........
..........
..........
X
..........
..........
..........
..........
..........
..........
..........
X
..........
..........
..........
..........
..........
..........
..........
X
X
..........
..........
..........
..........
..........
..........
..........
X
X
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
...........
...........
...........
...........
...........
...........
...........
X
..........
..........
..........
..........
..........
..........
..........
..........
...........
..........
X
..........
..........
..........
..........
..........
..........
..........
...........
..........
..........
..........
..........
X
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
X
..........
..........
..........
..........
X
X
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
...........
...........
...........
...........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
X
Xc
X
..........
Xc
..........
..........
..........
..........
..........
..........
..........
..........
..........
..........
...........
...........
...........
a With
the option to use the look-through options.35
the option to use the gross-up approach.36
c If a credit union’s total equity exposures are ‘‘non-significant’’ 37 under § 702.104(c)(3)(i), then the risk weight is 100 percent. This lowers the
risk weight to 100 percent for CUSO equity exposures, corporate perpetual capital, and all other equity investments when they are part of a credit union’s non-significant equity exposures.
mstockstill on DSK4VPTVN1PROD with RULES2
b With
35 The ‘‘look-through’’ approaches are discussed
in more detail in the part of this preamble
discussing § 702.104(c)(3)(iii)(B).
36 The ‘‘gross-up’’ approach is discussed in more
detail in the part of this preamble discussing
§ 702.104(c)(3)(iii)(A).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
37 Under § 702.104(c)(3)(i) of this final rule, a
credit union has non-significant equity exposures if
the aggregate amount of its equity exposures does
not exceed 10 percent of the sum of the credit
union’s capital elements of the risk-based capital
ratio numerator (as defined under paragraph
§ 702.104(b)(1)). To determine its aggregate amount
of its equity exposures, the credit union must
PO 00000
Frm 00013
Fmt 4701
Sfmt 4700
include the total amounts (as recorded on the
statement of financial condition in accordance with
GAAP) of the following (1) equity investments in
CUSOs, (2) perpetual contributed capital at
corporate credit unions, (3) nonperpetual capital at
corporate credit unions, and (3) equity investments
subject to a risk weight in excess of 100 percent.
E:\FR\FM\29OCR2.SGM
29OCR2
66638
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
The following table provides an
estimate of the risk weighting for
aggregate assets held by complex credit
union assets as of December 31, 2014.
Complex credit
union assets
(in millions) 38
Risk weight
0% ................................................................................................................................................
20% ..............................................................................................................................................
50% ..............................................................................................................................................
75% ..............................................................................................................................................
100% ............................................................................................................................................
150% ............................................................................................................................................
250% or greater ...........................................................................................................................
The following table compares onbalance sheet risk weights in this final
rule to the applicable risk weights
Percent of
complex credit
union assets
Cumulative
percent of
complex credit
union assets
$18,713
289,932
224,618
270,440
217,159
8,017
1,195
1.82
28.15
21.81
26.24
21.08
0.78
0.12
1.82
29.97
51.78
78.02
99.01
99.88
100.00
assigned by other federal banking
agencies:
NCUA
Risk-weight
FDIC
Risk-weight
0%
0%
0%
0%
0%
0%
0%
20%
20%
20%
20%
20%
20%
50%
50%
Corporate Membership Capital ........................................................................................................................
Industrial Development Bonds .........................................................................................................................
Agency Stripped MBS (Interest Only) ..............................................................................................................
Part 703 Compliant Investment Funds .............................................................................................................
Value of General Account Insurance (bank owned life insurance, and credit union owned life insurance) a
Corporate Perpetual Capital .............................................................................................................................
Mortgage Servicing Assets ...............................................................................................................................
Separate Account Life Insurance .....................................................................................................................
Publicly Traded Equity Investment (non-CUSO) ..............................................................................................
Mutual Funds Part 703 Non-Compliant ............................................................................................................
Non-Publicly Traded Equity Investments (non-CUSO) ....................................................................................
Subordinated Tranche of Any Investment ........................................................................................................
mstockstill on DSK4VPTVN1PROD with RULES2
Cash/Currency/Coin .................................................................................................................................................
Investments:
Unconditional Claims—U.S. Government ........................................................................................................
Balances Due from Federal Reserve Banks ....................................................................................................
Federally Insured Deposits in Financial Institutions .........................................................................................
Debt Instruments issued by NCUA and FDIC .................................................................................................
Central Liquidity Facility Stock .........................................................................................................................
Uninsured deposits at U.S. Federally Insured Institutions ...............................................................................
Agency Obligations ...........................................................................................................................................
FNMA and FHLMC pass through Mortgage Backed Securities (MBS) ...........................................................
General Obligation Bonds Issued by State or Political Subdivisions ..............................................................
Federal Home Loan Bank Stock and Balances ...............................................................................................
Senior Agency Residential MBS or Asset-Backed Securities (ABS) Structured .............................................
Revenue Bonds Issued by State or Political Subdivisions ..............................................................................
Senior Non-Agency Residential MBS Structured .............................................................................................
100%
100%
100%
100% a
100%
100%/150% c
250%
300% a
100%/300% c
300% a
100%/400% c
1,250% b
0%
0%
0%
0%
n/a
20%
20%
20%
20%
20%
20%
50%
Gross-up or
Simplified
Supervisory
Formula
n/a
100%
100%
n/a
100%
n/a
250%
Look-through
300%
n/a
400%
Gross-up or
Simplified
Supervisory
Formula
Consumer Loans:
Share-Secured (shares held at the credit union) .............................................................................................
Share-Secured (shares held at another depository institution) .......................................................................
Current Secured ...............................................................................................................................................
Current Unsecured ...........................................................................................................................................
Non-Current Consumer ....................................................................................................................................
Real Estate Loans:
Share-Secured (shares held at the credit union) .............................................................................................
Share-Secured (shares held at another depository institution) .......................................................................
Current First Lien <35% of Assets ...................................................................................................................
Current First Lien >35% of Assets ...................................................................................................................
Not Current First Lien .......................................................................................................................................
Current Junior Lien <20% of Assets ................................................................................................................
Current Junior Lien >20% of Assets ................................................................................................................
Noncurrent Junior Lien .....................................................................................................................................
Commercial Loans:
38 Includes off-balance sheet items after
application of the credit conversion factor.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
PO 00000
Frm 00014
Fmt 4701
Sfmt 4700
E:\FR\FM\29OCR2.SGM
29OCR2
0%
20%
75%
100%
150%
0%
20%
100%
100%
150%
0%
20%
50%
75%
100%
100%
150%
150%
0%
20%
50%
50%
100%
100%
100%
100%
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
NCUA
Risk-weight
Share-Secured (shares held at the credit union) .............................................................................................
Share-Secured (shares held at another depository institution) .......................................................................
Portion of Commercial Loans with Compensating Balance .............................................................................
Commercial Loans <50% of Assets .................................................................................................................
Commercial Loans >50% of Assets .................................................................................................................
Non-current Commercial ..................................................................................................................................
Miscellaneous:
Loans to CUSOs ..............................................................................................................................................
Equity Investment in CUSO .............................................................................................................................
Other Balance Sheet Items not Assigned ........................................................................................................
66639
FDIC
Risk-weight
0%
20%
20%
100%
150%
150%
0%
20%
n/a
100%/150% d
100/150% d
150%
100%
100%/150% c
100%
100%
100%–600%
100%
a With
the option to use the look-through options.
the option to use the gross-up approach.
a credit union’s total equity exposures are ‘‘non-significant’’ under § 702.104(c)(3)(i), then the risk weight is 100 percent. This lowers the risk
weight to 100 percent for CUSO equity exposures, corporate perpetual capital, and all other equity investments when they are part of a credit
union’s non-significant equity exposures.
d FDIC identifies certain commercial loans as High Volatility Commercial Real Estate (HVCRE) and assigns a 150% risk weight.
b With
mstockstill on DSK4VPTVN1PROD with RULES2
c If
The Board notes that FDIC’s capital
standards are the ‘‘minimum capital
requirements and overall capital
adequacy standards for FDIC-supervised
institutions . . . include[ing]
methodologies for calculating minimum
capital requirements . . . .’’ 39 In other
words, FDIC may require an FDICsupervised institution to hold an
amount of regulatory capital greater
than otherwise required under its
capital rules if FDIC determines that the
institution’s capital requirements under
its capital rules are not commensurate
with the institution’s credit, market,
operational, or other risks.40
As indicated above, FDIC’s approach
to risk weights is calibrated to be the
minimum regulatory capital standard.
Similarly, this final rule is calibrated to
be the minimum regulatory capital
standard. Accordingly, the final rule
incorporates a broader regulatory
provision reminding complex credit
unions that, as a matter of safety and
soundness, they are required to
maintain capital commensurate with the
level and nature of all risks to which
they are exposed.41 In addition, the final
rule adds a new provision requiring
complex credit unions to maintain a
written strategy for assessing capital
adequacy and maintaining an
appropriate level of capital.
Capital ratio thresholds are largely a
function of risk weights; and this final
rule more closely aligns NCUA’s risk
weights with those assigned by the
Other Banking Agencies.42 Accordingly,
the final rule adopts a 10 percent riskbased capital ratio level for well
capitalized credit unions, and an 8
percent risk-based capital ratio level for
adequately capitalized credit unions. To
take into account the cooperative
39 See,
e.g., 12 CFR 324.1(a).
e.g., 12 CFR 324.1(d).
41 See, e.g., 12 U.S.C. 1786.
42 See, e.g., 12 CFR 324.32; and 12 CFR 324.403.
40 See,
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
character of credit unions, the Board set
the risk-based capital ratio level for well
capitalized credit unions at 10 percent,
and omitted the capital conservation
buffer imposed on banks.43 The
omission of the capital conservation
buffer simplifies NCUA’s risk-based
capital requirement relative to the Other
Banking Agencies’ rules without
appreciably lowering the protections
provided by NCUA’s risk-based capital
regulations.44
The final rule defines a credit union
as ‘‘complex’’ if it has assets of more
than $100 million.45 Credit unions
meeting this threshold have a portfolio
of assets and liabilities that is complex,
based upon the products and services in
which they are engaged. As discussed
later in this document, the $100 million
asset threshold is a proxy measure based
on detailed analysis, and a clear
demarcation line above which all credit
unions engage in complex activities and
where almost all such credit unions (99
percent) are involved in multiple
complex activities.
An asset size threshold is clear,
logical, and easy to administer when
compared with the more complicated
formula used to determine whether a
credit union is complex under the
current rule.46 Using a more
straightforward proxy for determining
complexity also helps account for the
cooperative character of credit unions,
particularly, the fact that credit unions
have boards of directors that consist
primarily of volunteers. The $100
million asset size threshold exempts
43 The ‘‘capital conservation buffer’’ is explained
in more detail in the discussion on § 702.102(a) in
the section-by-section analysis part of this
preamble.
44 See, e.g., 12 CFR 324.403.
45 There is no exemption for banks from the riskbased capital requirements of the other banking
agencies. There are 1,872 FDIC-insured banks with
assets less than $100 million as of December 2014.
46 12 CFR 702.106.
PO 00000
Frm 00015
Fmt 4701
Sfmt 4700
approximately 76 percent of credit
unions 47 from many of the regulatory
burdens associated with complying with
this rule; yet it will cover almost 90
percent of the assets in the credit union
system. The threshold is consistent with
the fact that the majority of losses (as
measured as a proportion of the total
dollar cost) to the NCUSIF result from
credit unions with assets greater than
$100 million. For a more detailed
discussion of the rationale the Board
considered in defining complex, see the
detailed discussion associated with
section 702.103 in the Section-BySection Analysis part of the preamble
below.
In response to public comments
received, the final rule also makes a
number of changes to the Second
Proposal. These changes include:
Assigning a lower risk weight to nonsignificant equity exposures and certain
share-secured loans; giving credit
unions the option to assign a 100
percent risk weight to certain charitable
donation accounts; permitting credit
unions to use the gross-up approach for
non-subordinated investment tranches;
assigning principal-only mortgagebacked-security STRIPS a risk-weight
based on the underlying collateral;
extending the period during which
credit unions can count supervisory
goodwill and supervisory other
intangible assets in the risk-based
capital ratio numerator; and
incorporating the text of the gross-up
and look-through approaches into a new
appendix A to the PCA regulation. As
discussed in more detail below, for
certain assets, these changes will lower
the risk weights that would have been
assigned under the Second Proposal,
extend the period during which certain
assets can be included in a credit
union’s risk-based capital ratio
47 Based upon December 31, 2014 Call Report
data.
E:\FR\FM\29OCR2.SGM
29OCR2
66640
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
numerator—effectively lowering certain
credit unions’ overall capital
requirement for 10 years—and lower the
impact of the rule for certain complex
credit unions. The final rule also makes
conforming and other minor changes to
NCUA’s regulations, which are also
discussed in more detail below.
To provide credit unions and NCUA
sufficient time to make the necessary
adjustments, such as systems, processes,
and procedures, and to reduce the
burden on affected credit unions, the
revisions adopted in this final rule will
not become effective until January 1,
2019. This effective date is intended to
coincide with the full phase-in of FDIC’s
risk-based capital measures in 2019.
III. Legal Authority
In 1998, Congress enacted the Credit
Union Membership Access Act
(CUMAA).48 Section 301 of CUMAA
added new section 216 to the FCUA,49
which requires the Board to maintain,
by regulation, a system of PCA to restore
the net worth of credit unions that
become inadequately capitalized.
Section 216(b)(1)(A) requires that
NCUA’s system of PCA for federally
insured credit unions be ‘‘consistent
with’’ section 216 of the FCUA, and
‘‘comparable to’’ section 38 of the
Federal Deposit Insurance Act (FDI
Act).50 Section 216(b)(1)(B) requires that
the Board, in designing the PCA system,
take into account credit unions’
cooperative character: That credit
unions are not-for-profit cooperatives
that do not issue capital stock, must rely
on retained earnings to build net worth,
and have boards of directors that consist
primarily of volunteers.51 In 2000, the
Board first implemented the required
system of PCA 52 and, prior to this
rulemaking, had made only minor
adjustments to the rule’s original
requirements.53
48 Public
Law 105–219, 112 Stat. 913 (1998).
U.S.C. 1790d.
50 12 U.S.C. 1790d(b)(1)(A); see also 12 U.S.C.
1831o (Section 38 of the FDI Act setting forth the
PCA requirements for banks).
51 12 U.S.C. 1790d(b)(1)(B).
52 See 65 FR 8584 (Feb. 18, 2000); and 65 FR
44950 (July 20, 2000) (The risk-based net worth
requirement for credit unions meeting the
definition of ‘‘complex’’ was first applied on the
basis of data in the Call Report reflecting activity
in the first quarter of 2001.)
53 NCUA’s risk-based net worth requirement has
been largely unchanged since its implementation,
with the following limited exceptions: Revisions
were made to the rule in 2003 to amend the riskbased net worth requirement for MBLs. 68 FR 56537
(Oct. 1, 2003). Revisions were made to the rule in
2008 to incorporate a change in the statutory
definition of ‘‘net worth.’’ 73 FR 72688 (Dec. 1,
2008). Revisions were made to the rule in 2011 to
expand the definition of ‘‘low-risk assets’’ to
include debt instruments on which the payment of
principal and interest is unconditionally guaranteed
mstockstill on DSK4VPTVN1PROD with RULES2
49 12
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
The stated purpose of section 216 of
the FCUA is to ‘‘resolve the problems of
[federally] insured credit unions at the
least possible long-term loss to the
[NCUSIF].’’ 54 To carry out that purpose,
Congress set forth a basic structure for
PCA in section 216 that consists of three
principal components: (1) A statutory
framework that requires certain
mandatory classifications of credit
unions and that NCUA take certain
mandatory and discretionary actions
against credit unions based on their
classification; (2) an alternative system
of PCA to be developed by NCUA for
credit unions defined as ‘‘new’’; and (3)
a ‘‘risk-based net worth requirement’’
that applies to credit unions that NCUA
defines as ‘‘complex.’’ This final rule
focuses primarily on principal
components (1) and (3), although
amendments to part 702 of NCUA’s
regulations relating to principal
component (2) are also included as part
of this final rule.
Among other things, section 216(c) of
the FCUA requires that NCUA use a
credit union’s net worth ratio to
determine its classification among the
five ‘‘net worth categories’’ set forth in
the FCUA.55 Section 216(o) generally
defines a credit union’s ‘‘net worth’’ as
its retained earnings balance,56 and a
credit union’s ‘‘net worth ratio’’ 57 as the
ratio of its net worth to its total assets.58
As a credit union’s net worth ratio
declines, so does its classification
among the five net worth categories,
thus subjecting it to an expanding range
of mandatory and discretionary
supervisory actions.59
Section 216(d)(1) of the FCUA
requires that NCUA’s system of PCA
include, in addition to the statutorily
defined net worth ratio requirement, ‘‘a
risk-based net worth requirement 60 for
by NCUA. 76 FR 16234 (Mar. 23, 2011). Revisions
were made in 2013 to exclude credit unions with
total assets of $50 million or less from the definition
of ‘‘complex’’ credit union. 78 FR 4033 (Jan. 18,
2013).
54 12 U.S.C. 1790d(a)(1).
55 12 U.S.C. 1790d(c).
56 12 U.S.C. 1790d(o)(2).
57 Throughout this document the terms ‘‘net
worth ratio’’ and ‘‘leverage ratio’’ are used
interchangeably.
58 12 U.S.C. 1790d(o)(3).
59 12 U.S.C. 1790d(c)–(g); and 12 CFR 702.204(a)
& (b).
60 For purposes of this rulemaking, the term ‘‘riskbased net worth requirement’’ is used in reference
to the statutory requirement for the Board to design
a capital standard that accounts for variations in the
risk profile of complex credit unions. The term
‘‘risk-based capital ratio’’ is used to refer to the
specific standards this rulemaking proposes to
function as criteria for the statutory risk-based net
worth requirement. For example, this rulemaking’s
proposed risk-based capital ratio would replace the
risk-based net worth ratio in the current rule. The
term ‘‘risk-based capital ratio’’ is also used by the
PO 00000
Frm 00016
Fmt 4701
Sfmt 4700
insured credit unions that are complex,
as defined by the Board . . . .’’ 61
Unlike the terms ‘‘net worth’’ and ‘‘net
worth ratio,’’ which are specifically
defined in section 216(o), the term
‘‘risk-based net worth’’ is not defined in
the FCUA.62 While Congress prescribed
the net worth ratio requirement in detail
in section 216, it elected not to define
the term ‘‘risk-based net worth,’’ leaving
the details of the risk-based net worth
requirement to be filled in by the Board
through the notice and comment
rulemaking process. Section 216, when
read as a whole, grants the Board broad
authority to design reasonable PCA
regulations, including a risk-based net
worth requirement, so long as the
regulations are comparable to the Other
Banking Agencies’ PCA requirements,
are consistent with the requirements of
section 216 of the FCUA, and take into
account the cooperative character of
credit unions.
Section 216(d)(1) of the FCUA directs
NCUA, in determining which credit
unions will be subject to the risk-based
net worth requirement, to base its
definition of complex ‘‘on the portfolios
of assets and liabilities of credit
unions.’’ 63 The statute does not require,
as some commenters have argued, that
the Board adopt a definition of
‘‘complex’’ that takes into account the
portfolio of assets and liabilities of each
credit union on an individualized basis.
Rather, section 216(d)(1) authorizes the
Board to develop a single definition of
complex that takes into account the
portfolios of assets and liabilities of all
credit unions.
In addition, section 216(d)(2) specifies
that the risk-based net worth
requirement must ‘‘take account of any
material risks against which the net
worth ratio required for [a federally]
insured credit union to be adequately
capitalized [(six percent)] may not
provide adequate protection.’’ 64 In the
Senate Report on CUMAA, Congress
expressed its intent with regard to the
design of the risk-based net worth
requirement and the meaning of section
216(d)(2) by providing:
The NCUA must design the risk-based net
worth requirement to take into account any
Other Banking Agencies and the international
banking community when referring to the types of
risk-based requirements that are addressed in this
proposal. This change in terminology throughout
the proposal would have no substantive effect on
the requirements of the FCUA, and is intended only
to reduce confusion for the reader.
61 12 U.S.C. 1790d(d)(1).
62 See 12 U.S.C. 1790d(o) (Congress specifically
defined the terms ‘‘net worth’’ and ‘‘net worth
ratio’’ in the FCUA, but did not define the statutory
term ‘‘risk-based net worth.’’).
63 12 U.S.C. 1790d(d).
64 12 U.S.C. 1790d(d)(2) (emphasis added).
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
material risks against which the 6 percent net
worth ratio required for a credit union to be
adequately capitalized may not provide
adequate protection. Thus the NCUA should,
for example, consider whether the 6 percent
requirement provides adequate protection
against interest-rate risk and other market
risks, credit risk, and the risks posed by
contingent liabilities, as well as other
relevant risks. The design of the risk-based
net worth requirement should reflect a
reasoned judgment about the actual risks
involved.65
mstockstill on DSK4VPTVN1PROD with RULES2
As indicated by the language above,
Congress intended the Board, in
designing the risk-based net worth
requirement, to address any risks that
may not be adequately accounted for by
the statutory 6 percent net worth ratio
requirement. The legislative history is
silent on why Congress chose to tie the
provision in section 216(d)(2) to the
statutory 6 percent net worth ratio
requirement for adequately capitalized
credit unions and not the 7 percent net
worth ratio requirement for well
capitalized credit unions.
Section 216(c) of the FCUA provides
that, if a credit union meets the
definition of ‘‘complex’’ and it meets or
exceeds the net worth ratio requirement
to be classified as either adequately
capitalized or well capitalized, the
credit union must also satisfy the
corresponding risk-based net worth
requirement to be classified as either
adequately capitalized or well
capitalized.66 Accordingly, under the
separate risk-based net worth
requirement, a complex credit union
must, in addition to meeting the
statutory net worth ratio requirement,
also meet or exceed the corresponding
minimum risk-based net worth
requirement in order to receive a capital
classification of adequately capitalized
or well capitalized, as the case may be.67
For example, a complex credit union
must meet or exceed both the applicable
net worth ratio requirement and the
applicable risk-based net worth
65 S. Rep. No. 193, 105th Cong., 2d Sess. 13
(1998).
66 See 12 U.S.C. 1790d(c)(1)(A) & (c)(1)(B).
67 The risk-based net worth requirement also
indirectly impacts credit unions in the
‘‘undercapitalized’’ and lower net worth categories,
which are required to operate under an approved
net worth restoration plan. The plan must provide
the means and a timetable to reach the ‘‘adequately
capitalized’’ category. See 12 U.S.C. 1790d(f)(5) and
12 CFR 702.206(c). However, for ‘‘complex’’ credit
unions in the ‘‘undercapitalized’’ or lower net
worth categories, the minimum net worth ratio
‘‘gate’’ to that category will be six percent or the
credit union’s risk-based net worth requirement, if
higher than 6 percent. In that event, a complex
credit union’s net worth restoration plan will have
to prescribe the steps a credit union will take to
reach a higher net worth ratio ‘‘gate’’ to that
category. See 12 CFR 702.206(c)(1)(i)(A) and 12
U.S.C. 1790d(c)(1)(A)(ii) & (c)(1)(B)(ii).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
requirement to be classified as well
capitalized. If the credit union fails to
meet either requirement, it is classified
in the lowest category for which it meets
both the net worth ratio requirement
and the risk-based net worth
requirement.
If a complex credit union meets or
exceeds the net worth ratio requirement
to be classified as well capitalized or
adequately capitalized, but fails to meet
the corresponding minimum risk-based
net worth requirement to be adequately
capitalized, then the credit union’s
capital classification is
‘‘undercapitalized’’ based on the riskbased net worth requirement. Similarly,
if a complex credit union’s net worth
ratio meets or exceeds the requirement
that corresponds to the well capitalized
category, but its risk-based net worth
ratio meets only the requirement that
corresponds with the adequately
capitalized capital category, then that
credit union’s capital classification is
adequately capitalized. In either case,
the credit union is subject to the
mandatory supervisory and
discretionary supervisory actions
applicable to its capital classification
category.68
In response to the Second Proposal, a
significant number of commenters
questioned the Board’s legal authority to
impose a risk-based net worth
requirement on both well capitalized
and adequately capitalized credit
unions. As also discussed in the
Section-by-Section part of the preamble
below, the commenters’ selective
reading of section 216 of the FCUA is
a misinterpretation. NCUA is legally
authorized to impose a risk-based net
worth requirement on both well
capitalized and adequately capitalized
credit unions under the FCUA. Section
216(c)(1)(A) specifically provides that,
to be classified as well capitalized, a
complex credit union must meet the
statutory net worth ratio requirement
and any applicable risk-based net worth
requirement. Section 216(c)(1)(A)(ii)
provides that a credit union must meet
any applicable risk-based net worth
requirement under section 216(d) of this
section to be classified as well
capitalized. The plain language of
sections 216(c)(1)(A)(ii) and
(c)(1)(B)(ii),, read in conjunction with
the language in section 216(d), indicates
Congress’ intent to authorize the Board
to impose risk-based net worth
requirements on both well capitalized
and adequately capitalized credit
unions.
Section 216(d)(2) of the FCUA sets
forth specific requirements for the
68 12
PO 00000
U.S.C. 1790d(c)(1)(c)(ii).
Frm 00017
Fmt 4701
Sfmt 4700
66641
design of the risk-based net worth
requirement mandated under section
216(d)(1).69 Specifically, section
216(d)(2) requires that the Board
‘‘design the risk-based net worth
requirement to take account of any
material risks against which the net
worth ratio required for an insured
credit union to be adequately
capitalized may not provide adequate
protection.’’70 Under section
216(c)(1)(B) of the FCUA, the net worth
ratio required for an insured credit
union to be adequately capitalized is six
percent.71 The plain language of section
216(d)(2) supports NCUA’s
interpretation that Congress intended
for the Board to design a risk-based net
worth requirement to take into account
any material risks that may not be
addressed adequately through the
statutory 6 percent net worth ratio
required for a credit union to be
adequately capitalized.72
In other words, the language in
section 216(d)(2) of the FCUA simply
identifies the types of risks that NCUA’s
risk-based net worth requirement
should address (i.e., those risks not
already addressed by the statutory six
percent net worth ratio requirement). It
is a misinterpretation of section
216(d)(2) to argue, as some commenters
have, that Congress’s use of the term
‘‘adequately capitalized’’ in section
216(d)(2) somehow limits the Board’s
authority to require that complex credit
unions maintain a higher risk-based
capital ratio level to be classified as well
capitalized. Rather than prohibiting the
Board from imposing a higher risk-based
capital ratio level for credit unions to be
classified as well capitalized, section
216(d)(2) simply requires that the Board
design the risk-based net worth
requirement to take into account those
risks that may not adequately be
addressed by the statute’s six percent
net worth ratio requirement. Thus, the
plain language of section 216(d) does
not support those commenters’
interpretation.
The Board’s legal authority to impose
a risk-based net worth requirement on
both well capitalized and adequately
capitalized credit unions is further
supported by the Other Banking
69 12
U.S.C. 1790d(d).
U.S.C. 1790d(d)(2) (emphasis added).
71 12 U.S.C. 1790d(c)(1)(B).
72 See S. Rep. No. 193, 105th Cong., 2d Sess.
(1998) (providing in relevant part: ‘‘The NCUA
must design the risk-based net worth requirement
to take into account any material risks against
which the 6 percent net worth ratio required for an
insured credit union to be adequately capitalized
may not provide adequate protection.’’).
70 12
E:\FR\FM\29OCR2.SGM
29OCR2
66642
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
Agencies’ PCA statute and regulations.73
Some commenters have argued that
Congress’s use of the singular noun
‘‘requirement’’ in Section 216(d) of the
FCUA indicates its intent that there be
only one risk-based net worth ration
level tied to the adequately capitalized
level. Section 38(c)(1)(A) of the FDI Act,
upon which section 216 of the FCUA
was modeled,74 however, requires that
the Other Banking Agencies’ ‘‘relevant
capital measures’’ include ‘‘(i) a leverage
limit; and (ii) a risk-based capital
requirement.’’ 75 Despite Congress’ use
of the singular noun ‘‘requirement’’ in
section 38 of the FDI Act, the Other
Banking Agencies’ PCA regulations,
which went into effect before Congress
passed CUMAA, have long required that
their regulated institutions meet
different risk-based capital ratio levels
to be classified as well capitalized,
adequately capitalized,
undercapitalized, or significantly
undercapitalized. Moreover, the United
States Code addresses the singular—
plural question in its rules of statutory
construction: ‘‘In determining the
meaning of any Act of Congress, unless
the context indicates otherwise . . .
words importing the singular include
and apply to several persons, parties, or
things; words importing the plural
include the singular . . .’’ 76 Therefore,
setting different risk-based capital ratio
levels for credit unions to be adequately
and well capitalized, is consistent with
the requirements of section 216 of the
FCUA and is ‘‘comparable’’ to the Other
Banking Agencies’ PCA regulations.
As explained in the Second Proposal,
the FCUA requires NCUA to establish a
risk-based capital system that is
comparable to that in place for FDIC
insured banks, and to take into account
the cooperative character of credit
unions. Some commenters criticized,
however, that the Second Proposal took
into account only the comparability
requirement, and ignored the
requirement to take into consideration
the cooperative nature of credit unions.
In support of their assertion, the
commenters suggested that, because of
their unique cooperative structure,
strong member focus, and the absence of
stock options for executives or pressure
from stockholders, credit unions eschew
excessive risk taking. The commenters
73 See 12 U.S.C. 1831o, and, e.g., 12 CFR
324.403(b).
74 See S. Rep. No. 193, 105th Cong., 2d Sess., 12
(1998) (Providing in relevant part: ‘‘New section
216 [of the FCUA] is modeled on section 38 of the
Federal Deposit Insurance Act, which has applied
to FDIC-insured depository institutions since
1992.’’).
75 12 U.S.C. 1831o(c)(1)(A) (emphasis added).
76 1 U.S.C. 1.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
suggested further, that in the face of the
2007–2009 financial crisis, credit
unions—unlike their counterparts in the
for-profit banking sector—served as both
a counter-cyclical force and a safe
haven, with much stronger loan and
deposit growth than banking
institutions. Accordingly, many
commenters suggested that the Board, to
take into account the cooperative
character of credit unions, must impose
risk-based capital requirements that are
equal to or lower than the standards
applicable to banks.
The Board disagrees with the claim
that NCUA failed to take into account
the cooperative character of credit
unions in designing the risk-based
capital requirement. In the Original
Proposal, which varied to a greater
degree from the Other Banking
Agencies’ capital regulations than the
Second Proposal, the Board proposed a
significant number of alternative
provisions, many of which were
specifically intended to take into
account the cooperative character of
credit unions. The overwhelming
response from credit unions in relation
to that proposed approach, however,
was to recommend that the Board revise
the proposal to be more like the capital
requirements adopted by the Other
Banking Agencies to avoid putting
credit unions at a competitive
disadvantage to banks. As discussed in
more detail below, the Board generally
agreed with commenters’
recommendations in that regard, and
designed the Second Proposal to be
more like the Other Banking Agencies’
capital regulations. In the preamble to
the Second Proposal, however, the
Board specifically discussed ways in
which the proposal continued to deviate
from the Other Banking Agencies’
capital requirements to take into
account the cooperative character of
credit unions. Furthermore, while it
may generally be true that ‘‘credit
unions eschew excessive risk taking,’’ as
suggested by some commenters, that fact
alone does not support assigning lower
risk weights to credit union assets, or
requiring that credit unions meet lower
risk-based capital ratio levels to be
adequately or well capitalized. To the
contrary, for reasons explained in more
detail below, a credit union that
eschews excessive risk taking should
have no trouble maintaining a high riskbased capital ratio level under this final
rule.
At least one commenter also
suggested that credit unions’ reliance
primarily on retained earnings to build
capital and operate make their
operational structures both unique and
challenging. Thus, the commenter
PO 00000
Frm 00018
Fmt 4701
Sfmt 4700
concluded that, by requiring a higher
risk-based capital ratio level for well
capitalized credit unions, the Second
Proposal failed to take these factors into
consideration, as required by section
216(b)(1)(B) of the FCUA. The Board
disagrees. Credit unions’ limited access
to supplemental forms of capital and
reliance primarily on retained earnings
for building capital suggests, if
anything, that requiring credit unions to
maintain higher levels of capital is
appropriate. In a financial downturn,
the retained earnings of a financial
institution are likely to decrease. Under
such circumstances, an institution with
limited access to other alternative forms
of capital needs a higher level of capital
on hand to ensure its survival. In the
case of NCUA’s capital requirements,
that higher level of capital is already
required under the statutory net worth
ratio requirement, which requires credit
unions maintain higher leverage (net
worth) ratios than banks. Accordingly,
consistent with the Second Proposal,
the risk-based capital ratio levels
adopted in this final rule for adequately
and well capitalized credit unions are
designed to be generally equivalent to
the corresponding risk-based capital
ratio levels required for banks.
IV. Section-by-Section Analysis
Part 702—Capital Adequacy
Revised Structure of Part 702
Consistent with the Second Proposal,
this final rule reorganizes part 702 by
consolidating NCUA’s PCA
requirements, which are currently
included under subsections A, B, C, and
D, under new subparts A and B. New
subpart A is titled ‘‘Prompt Corrective
Action’’ and new subpart B is titled
‘‘Alternative Prompt Corrective Action
for New Credit Unions.’’ The
reorganization is designed so that a
credit union need only reference the
subpart that applies to its institution,
rather than having to flip back-and-forth
between multiple subparts in part 702 to
identify the applicable minimum capital
standards and PCA regulations.
Consolidating these sections reduces
confusion and will save credit union
staff from having to frequently flip back
and forth through the four subparts of
the current PCA rule.
In general, this final rule restructures
part 702 by consolidating most of the
sections relating to capital and PCA that
are applicable to only credit unions that
are not ‘‘new’’ under new subpart A.
The specific sections that would be
included in new subpart A and the
changes to those sections are discussed
in more detail below.
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
Similarly, this final rule consolidates
most of NCUA’s rules relating to
alternative capital and PCA
requirements for ‘‘new’’ credit unions
under new subpart B. The sections
under new subpart B remain largely
unchanged from the requirements of
current part 702 relating to alternative
capital and PCA, except for revisions to
the sections relating to reserves and the
payment of dividends. The specific
sections included in new subpart B and
the specific changes to the sections are
discussed in more detail below.
Finally, this final rule retains subpart
E of part 702, Stress Testing, but redesignates and re-numbers the current
subpart as subpart C. Other than redesignating and re-numbering the
subpart, the language and requirements
of current subpart E are unchanged by
this final rule.
Section 702.1 Authority, Purpose,
Scope, and Other Supervisory Authority
Consistent with the Proposal, § 702.1
of the final rule remains substantially
similar to current § 702.1, but is
amended to update terminology and
internal cross references within the
section, consistent with the changes that
are being made in other sections of part
702. No substantive changes to the
section are intended.
Section 216(b)(1) of the FCUA
requires the Board to adopt by
regulation a system of PCA for insured
credit unions that is ‘‘comparable to’’
the system of PCA prescribed in the FDI
Act, that is also ‘‘consistent’’ with the
requirements of section 216 of the
FCUA, and that takes into account the
cooperative character of credit unions.77
Paragraph (d)(1) of the same section
requires that NCUA’s system of PCA
include ‘‘a risk-based net worth
requirement for insured credit unions
that are complex . . .’’ When read
together, these sections grant the Board
broad authority to design reasonable
risk-based capital regulations to carry
out the stated purpose of section 216,
which is to ‘‘resolve the problems of
[federally] insured credit unions at the
least possible long-term loss to the
[National Credit Union Share Insurance]
Fund.’’ 78 As explained in more detail
below, this final rule is comparable,
although not identical in detail, to the
PCA and risk-based capital
requirements for banks. In addition, as
explained throughout the preamble to
this final rule, this rule deviates from
the PCA and risk-based capital
requirements applicable to banks as
required by section 216 of the FCUA,
77 12
78 12
U.S.C. 1790d(b)(1).
U.S.C. 1790d(a)(1).
VerDate Sep<11>2014
22:13 Oct 28, 2015
and to take into account the cooperative
character of credit unions. Accordingly,
the revised risk-based net worth
requirement and this final rule are
consistent with section 216 of the
FCUA.
Section 702.2—Definitions
The Second Proposal would have
removed the paragraph numbers
assigned to each of the definitions under
current § 702.2 and would have
reorganized the section so the new and
existing definitions were listed in
alphabetic order. Many of the
definitions in current § 702.2 were
retained, however, with no substantive
changes. The reorganization of the
section and the removal of the
paragraph numbering made proposed
§ 702.2 more consistent with current
§§ 700.2, 703.2 and 704.2 of NCUA’s
regulations.79 In addition, proposed
§ 702.2 included a number of new
definitions, and would have amended
some of the definitions in current
§ 702.2.
Consistent with section 202 of the
FCUA,80 the Second Proposal also
incorporated the phrase ‘in accordance
with GAAP’ into many of the definitions
to clarify that generally accepted
accounting principles must be used
determine how an item is recorded on
the statement of financial condition
from which it would be incorporated
into the risk-based capital calculation.
This proposed change was intended to
help clarify the meaning of terms used
in the Second Proposal.
The Board received no comments on
the proposed technical changes to
§ 702.2. The Board did, however,
receive one general comment on the
definitions section: At least one
commenter stated that the revisions to
the definitions, particularly those that
now rely on GAAP definitions, seemed
fair and reasonable. At least one
commenter also suggested that the
proposed changes to the definitions
were all for the better and made the rule
much clearer. The Board agrees with the
commenters and has decided to retain
the changes described above in this final
rule.
The following definitions, consistent
with the Second Proposal, are also
added to, amended in, or removed from
§ 702.2 by this final rule:
Allowances for loan and lease losses
(ALLL). The Second Proposal defined
the term ‘‘allowances for loan and lease
losses’’ as valuation allowances that
have been established through a charge
against earnings to cover estimated
79 12
80 12
Jkt 238001
PO 00000
CFR 700.2; 12 CFR 703.2; and 12 CFR 704.2.
U.S.C. 1782(a)(6)(C)(i).
Frm 00019
Fmt 4701
Sfmt 4700
66643
credit losses on loans, lease financing
receivables or other extensions of credit
as determined in accordance with
GAAP.
The Board received no comments on
the proposed definition and has decided
to retain the definition in this final rule
without change.
Amortized cost. The Second Proposal
defined the term ‘‘amortized cost’’ as the
purchase price of a security adjusted for
amortizations of premium or accretion
of discount if the security was
purchased at other than par or face
value.
The Board received no comments on
the proposed definition and has decided
to retain the definition in this final rule
without change.
Appropriate regional director. The
Second Proposal would have amended
current § 702.2 to remove the definition
of the term ‘‘appropriate regional
director’’ from the current rule.
The Board received no comments on
this proposed revision and has decided
to retain the revision in this final rule
without change.
Appropriate state official. Under the
Second Proposal, the Board proposed
revising the definition of the term
‘‘appropriate state official’’ by adding
the italicized words (‘‘state’’ and ‘‘the’’)
to the current definition, and by
removing the words ‘‘chartered by the
state which chartered the affected credit
union.’’ The revised definition would
have provided that the term
‘‘appropriate state official’’ means the
state commission, board or other
supervisory authority having
jurisdiction over the credit union.
Public Comments on the Second
Proposal
One commenter suggested that,
although the proposed revision to the
definition was meant to provide clarity,
it might obfuscate the role of state
supervisors in the PCA process because
several states could have ‘‘jurisdiction’’
over a given credit union on a particular
issue. In contemplating the possible
effects of the proposed revision, the
commenter asked a number of
questions: Will NCUA consult with all
state regulators where an affected credit
union has a branch or member when
taking discretionary supervisory
action? 81 Will a credit union have to
obtain approval from all states that it
operates in before issuing dividends
when less than adequately
capitalized? 82 The commenter
suggested further that while timely
sharing of information across all
81 12
82 12
E:\FR\FM\29OCR2.SGM
CFR 702.110(c).
CFR 702.114(b).
29OCR2
66644
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
affected regulators was a laudable goal,
crucial and time sensitive decisions
regarding the reclassification or
conservatorship of a credit union should
be made by only the primary chartering
authority of the institution in
consultation with the deposit insurer.
Accordingly, the commenter
recommended that the Board should
amend this definition to read ‘‘the state
commission, board or other supervisory
authority which chartered the affected
credit union.’’
mstockstill on DSK4VPTVN1PROD with RULES2
Discussion
The Board generally agrees with the
commenter and is adopting the
proposed revisions to the definition of
‘‘appropriate state official’’ by making
the following changes: At the end of the
proposed the definition, the final rule
deletes the words ‘‘having jurisdiction
over the’’ from the proposed definition,
and adds in their place the words ‘‘that
chartered the affected.’’ This change
clarifies that NCUA must consult with
only the state authority that chartered
the credit union; not every state agency
having some form of jurisdiction over
the credit union.
Accordingly, the final rule defines
‘‘appropriate state official’’ as the state
commission, board or other supervisory
authority that chartered the affected
credit union.
Call Report. The Second Proposal
defined the term ‘‘Call Report’’ as the
Call Report required to be filed by all
credit unions under § 741.6(a)(2).
The Board received no comments on
the definition and has decided to retain
the proposed definition in this final rule
without change.
Carrying value. The Second Proposal
defined the term ‘‘carrying value,’’ with
respect to an asset, as the value of the
asset on the statement of financial
condition of the credit union,
determined in accordance with GAAP.
The Board received no comments on
the proposed definition, but is clarifying
in this final rule that ‘‘carrying value’’
applies to both assets and liabilities.
Accordingly, this final rule defines
‘‘carrying value’’ as the value of the
asset or liability on the statement of
financial condition of the credit union,
determined in accordance with GAAP.
Central counterparty (CCP). The
Second Proposal defined the term
‘‘central counterparty’’ as a counterparty
(for example, a clearing house) that
facilitates trades between counterparties
in one or more financial markets by
either guaranteeing trades or novating
contracts.
The Board received no comments on
the definition and has decided to retain
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
the proposed definition in this final rule
without change.
Charitable donation account. The
Second Proposal did not use or define
the term ‘‘charitable donation account.’’
Under the proposal, such accounts,
which federal credit unions are
authorized to establish under
§ 721.3(b)(2) of NCUA’s regulations,
would have been assigned a risk weight
based on the risk-weight of each
individual asset type in the account.
Public Comments on the Second
Proposal
NCUA received several comments
regarding the risk weights assigned to
charitable donation accounts under the
Second Proposal. Commenters
suggested that the proposed risk weights
assigned to charitable donation accounts
would contravene the appeal for credit
unions to put money into these
investments to fund charitable
activities. The commenters pointed out
that the risk-based capital regulation
from the Office of the Comptroller of the
Currency (OCC) recognizes the
importance of community development
investments and assigns a risk weight of
100 percent to such assets. Commenters
suggested that the NCUA Board should
adopt a similar approach to encourage
charitable donation accounts to support
charitable goals and purposes.
Discussion
The Board generally agrees with the
commenters and, as also discussed in
the part of the preamble associated with
§ 702.104(c), has decided to assign a 100
percent risk weight to certain charitable
donation accounts under this final rule,
at the credit union’s option. Under the
Second Proposal, the assets held in a
charitable donation account were each
assigned a risk weight based on each
individual asset type in the account.
After reviewing the comments received,
however, the Board generally agrees
with commenters who suggested that
charitable donation account equity
exposures, which are held at credit
unions, have a role analogous to
community development equity
exposures, which are held at banks, and
therefore warrant assigning such
accounts an equivalent risk weight.
Community development equity
exposures are assigned a 100 percent
risk weight under the Other Banking
Agencies’ regulations. Thus, this final
rule gives credit unions the option for
risk weighting charitable donation
accounts in a manner that is generally
equivalent to the Other Banking
Agencies’ 100 percent risk weight for
community development investment
equity exposures. Under this final rule,
PO 00000
Frm 00020
Fmt 4701
Sfmt 4700
a credit union has the option of
applying risk weights to the individual
assets within a charitable donation
account, or just applying a 100 percent
risk weight to the whole charitable
donation account. A credit union
cannot, however, use a combination of
the two methods described to assign a
risk weight to the same charitable
donation account.
In defining ‘‘charitable donation
account,’’ the Board chose to limit the
types of accounts that would qualify for
the 100 percent risk weight. In
particular, the Board chose allow such
treatment for accounts only if they met
certain restrictions in 12 CFR
721.3(b)(2)(i), (b)(2)(ii), and (b)(2)(v).
Thus, to qualify for the optional 100
percent risk weight under
§ 702.104(c)(3)(ii) of this final rule, an
account must meet the following
criteria:
• The book value of the credit union’s
investments in all charitable donation
accounts (CDAs), in the aggregate, as
carried on its statement of financial
condition prepared in accordance with
generally accepted accounting
principles, must be limited to 5 percent
of the credit union’s net worth at all
times for the duration of the accounts,
as measured every quarterly Call Report
cycle. This means that regardless of how
many CDAs the credit union invests in,
the combined book value of all such
investments must not exceed 5 percent
of its net worth. The credit union must
bring its aggregate accounts into
compliance with the maximum
aggregate funding limit within 30 days
of any breach of this limit.
• The assets of a charitable donation
account must be held in a segregated
custodial account or special purpose
entity and must be specifically
identified as a charitable donation
account.
• The credit union is required to
distribute to one or more qualified
charities, no less frequently than every
5 years, and upon termination of a
charitable donation account regardless
of the length of its term, a minimum of
51 percent of the account’s total return
on assets over the period of up to 5
years. Other than upon termination, the
credit union may choose how frequently
charitable donation account
distributions to charity will be made
during each period of up to 5 years. For
example, the credit union may choose to
make periodic distributions over a
period of up to 5 years, or only a single
distribution as required at the end of
that period. The credit union may
choose to donate in excess of the
minimum distribution frequency and
amount;
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
The three criteria above are included
in the definition of charitable donation
account to ensure that such accounts, if
assigned a 100 percent risk weight, will
be used primarily for charitable
purposes and not present a material risk
to a credit union regardless of the types
of assets held in the accounts. The
definition includes a 5 percent of net
worth limit on charitable donation
accounts to reflect an amount that
allows a credit union to generate income
for the charity while ensuring any risks
associated with such accounts do not
pose safety and soundness issues. In
determining the 5 percent of net worth
limit, the Board considered the
investment types a credit union could
purchase in a charitable donation
account, which can include investments
with significant credit risk. The Board
determined that a 5 percent of net worth
limit was reasonable given NCUA’s
charitable donation account regulations
and necessary to ensure that the
accounts were small enough to not pose
a safety and soundness issue to the
NCUSIF if assigned a 100 percent risk
weight.
The definition also specifies that
charitable donation accounts must be
held in segregated custodial accounts or
special purpose entities, and must be
specifically identified as charitable
donation accounts, to ensure holdings
can be measured for exposure and
monitored for performance and
distribution. The Board determined the
segregation of accounts is necessary to
ensure a credit union and NCUA could
measure compliance with the net worth
and distribution criteria, consistent with
safety and soundness and the account’s
purpose.
Finally, the definition specifies that
distributions must be made in a
particular manner to ensure such
accounts are used primarily for
charitable giving. By specifying the
distribution manner, the definition of
charitable donation account ensures that
the account will primarily be used for
charitable giving. This distinction is
generally consistent with the Other
Banking Agencies’ regulations, which
assign a 100 percent risk-weight to
community development investment
equity exposures.
Without each of the three criteria
discussed above, a charitable donation
account would primarily be an
investment vehicle for a credit union
and could present a material risk to the
credit union and the NCUSIF.
Accordingly, this final rule defines
‘‘charitable donation account’’ as an
account that satisfies all of the
conditions in 12 CFR 721.3(b)(2)(i),
(b)(2)(ii), and (b)(2)(v).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Commercial loan. The Second
Proposal defined the new term
‘‘commercial loan’’ as any loan, line of
credit, or letter of credit (including any
unfunded commitments) to individuals,
sole proprietorships, partnerships,
corporations, or other business
enterprises for commercial, industrial,
and professional purposes, but not for
investment or personal expenditure
purposes. The definition would have
also provided that the term commercial
loan excludes loans to CUSOs, first- or
junior-lien residential real estate loans,
and consumer loans.
Public Comments on the Second
Proposal
The Board received many comments
regarding the proposed new term
‘‘commercial loan’’ and its definition.
Several commenters agreed with
creating a category of ‘‘commercial
loans’’ as distinct from traditional
member business loans for purposes of
the risk-based capital ratio requirement.
At least one commenter stated that,
while differentiating between
‘‘commercial loans’’ for risk-based
capital purposes and ‘‘member-business
loans’’ as defined for lending purposes
is appropriate, the subtle differences in
these definitions may cause confusion.
Similarly, another commenter suggested
that even though it would require
changes to the call report and how
credit union classify these loans, the
Board was right to use the broader
definition of commercial loans in the
proposal because there is no difference
in the credit risk of member business
loans and commercial loans.
Conversely, other commenters
suggested that replacing the term
‘‘member business loan,’’ which credit
unions and NCUA’s regulations already
use, with the new term ‘‘commercial
loan’’ for purposes of the risk-based
capital regulation would cause
unnecessary confusion. Other
commenters suggested that the proposed
definition of ‘‘commercial loan’’ should
be revised to be consistent with the
definition of ‘‘member business loan’’ in
part 723 of NCUA’s regulations because
they believed the differences between
the two definitions were immaterial to
a credit union’s capital requirement, but
would add unnecessary administrative
burden to the Call Report.
In addition, a trade association
commenter pointed out that the
proposed definition of a ‘‘commercial
loan’’ specifies that it is a loan ‘‘to
individuals, sole proprietorships,
partnerships, corporations, or other
business enterprises,’’ and explicitly
excludes loans to CUSOs, first- or
junior-lien residential real estate loans,
PO 00000
Frm 00021
Fmt 4701
Sfmt 4700
66645
and consumer loans. The commenter
pointed out, however, that the preamble
to the Second Proposal seemed to
indicate that whether or not a loan is
‘‘commercial’’ will be based exclusively
on the purpose of the loan, use of the
proceeds, and type of collateral. The
Commenter suggested that if a loan can
be considered commercial regardless of
the type of borrower, the Board should
consider removing the list of potential
borrowers and simply retaining the
exclusions of specific loan types. The
commenter suggested further that the
proposal specified that a commercial
loan is a loan made for ‘‘commercial,
industrial, and professional purposes,
but not for investment or personal
expenditure purposes.’’ But, under part
723 of NCUA’s regulations, MBLs are
made for commercial, corporate, other
business investment property or
venture, or agricultural purposes.83 The
commenter recommending clarifying
the alignment of these two definitions in
the final rule, and that if the only
intended differences in treatment arise
from the definitions of loans to CUSOs,
first- or junior-lien residential real estate
loans, and consumer loans, then the
Board should consider adopting the
member business loan language and
retaining those explicit exclusions. At
least one commenter also pointed out
that current § 723.1(d) and (e) of
NCUA’s member business lending
regulations reference treatment of
purchased member and non-member
loans and loan participations for riskweight purposes under part 702, and
encouraged the Board to review those
sections for consistency with the
proposed definition of commercial loan.
Another commenter requested that the
Board clarify whether the definition of
‘‘commercial loans’’ includes loans to
non-profits. One state supervisory
authority commenter requested
clarification on whether the definition,
which lists a number of specific asset
types, would include agricultural loans.
Discussion
As stated in the Second Proposal, the
new term ‘‘commercial loan’’ and its
proposed definition more accurately
capture the risks these loans present
than the term MBL, and better identifies
loans that are made for a commercial
purpose and have similar risk
characteristics. While there could be
some initial confusion associated with
the use of this new term, the Board
notes that such confusion can be
addressed during the implementation
period and in guidance before the final
rule becomes effective in 2019.
83 12
E:\FR\FM\29OCR2.SGM
CFR 723.1(a).
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
66646
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
Guidance contained in the Call Report
for the proper reporting of commercial
loans will also provide information to
credit unions to ensure proper reporting
of both ‘‘commercial’’ loans for the
purpose of assigning risk weights and
the reporting of MBLs for the purpose of
monitoring compliance with the
statutory limit.
The Board agrees, however, with
commenters who suggested that the
purpose of a loan determine its
classification as a ‘‘commercial’’ loan.
The risks associated with a commercial
loan are related to its purpose.
Moreover, the proposed list of entities
that could have received the loans
encompassed all possibilities, including
non-profit organizations. Thus the
removal of the list of parties who could
receive the loans would be
inconsequential. Accordingly, the Board
is amending the definition of
‘‘commercial loan’’ to remove the words
‘‘to individuals, sole proprietorships,
partnerships, corporations, or other
business enterprises.’’
The Board maintains, however, that
the listing of commercial purposes in
the proposed definition was adequate
and plainly included agricultural loans
if they are granted for a commercial or
industrial purpose. Similarly, it is clear
that a loan purchased by a credit union,
which was made for a commercial
purpose, was also included within the
proposed definition of a commercial
loan, whether it is a loan to member or
non-member. Thus no additional
changes to the definition are necessary.
Accordingly, this final rule defines
‘‘commercial loan’’ as any loan, line of
credit, or letter of credit (including any
unfunded commitments) for
commercial, industrial, and professional
purposes, but not for investment or
personal expenditure purposes. The
definition provides further that the term
commercial loan excludes loans to
CUSOs, first- or junior-lien residential
real estate loans, and consumer loans.
Commitment. The Second Proposal
defined the term ‘‘commitment’’ as any
legally binding arrangement that
obligates the credit union to extend
credit, to purchase or sell assets, or
enter into a financial transaction.
The Board received no comments on
the proposed definition, but has decided
to clarify in this final rule that a
‘‘commitment’’ can also refer to funding
transactions. Accordingly, this final rule
would define ‘‘commitment’’ as any
legally binding arrangement that
obligates the credit union to extend
credit, purchase or sell assets, enter into
a borrowing agreement, or enter into a
financial transaction.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Consumer loan. The Second Proposal
defined the term ‘‘consumer loan’’ as a
loan to one or more individuals for
household, family, or other personal
expenditures, including any loans
secured by vehicles generally
manufactured for personal, family, or
household use regardless of the purpose
of the loan. The proposed definition
would have provided further that the
term consumer loan excludes
commercial loans, loans to CUSOs, firstand junior-lien residential real estate
loans, and loans for the purchase of fleet
vehicles.
Discussion
The Board agrees with the commenter
who suggested that a consumer loan
should be defined by the purpose of the
loan and not depend on the type of
entity receiving the loan, be it an
individual, corporation, or some other
business. The material risks associated
with holding a prudently underwritten
consumer loan are related to its
purpose, not on the type of borrower.
Accordingly, this final rule amends the
proposed definition of consumer loan to
remove the words ‘‘to one or more
individuals’’ from the definition.
The Board also generally agrees with
the commenter who suggested the final
rule should further clarify the reference
to ‘‘fleet vehicles’’ in the proposed
definition of consumer loans. As
pointed out by the commenter, NCUA’s
General Counsel issued a legal opinion
letter in 2012 that interprets the term
‘‘fleet’’ for purposes of § 723.7(e) of
NCUA’s regulations.85 The letter
provides that a fleet means ‘‘five or
more vehicles that are centrally
controlled and used for a business
purpose, including for the purpose of
transporting persons or property for
commission or hire.’’ The meaning of
the term ‘‘fleet,’’ as used in the proposed
definition of consumer loan, should be
consistent with the use of the term in
§ 723.7(e). While the Second Proposal
did not propose adopting the definition
of ‘‘fleet’’ provided in the 2012 legal
opinion letter, the term should have the
same meaning. The term does not need
to be defined in this final rule. Future
changes in market realities surrounding
the use of the term ‘‘fleet’’ make
adopting a fixed definition of the term
impractical. The Board agrees, however,
that revising the proposed use of the
term ‘‘fleet’’ in the definition of
consumer loan to be more consistent
with the use of the term fleet in
§ 723.7(e) will help avoid confusion
regarding the term’s meaning.
Accordingly, the final rule revises the
last clause in the second sentence of the
definition of the term ‘‘consumer loan’’
to provide, ‘‘and loans for the purchase
of one for more vehicles to be part of a
fleet of vehicles.’’
NCUA will provide separate examiner
guidance on the application of the
definition of consumer loans to ensure
consistent interpretation of the
definition in the future. NCUA’s Call
Report instructions will also contain
appropriate guidance for the proper
reporting of consumer loans. For the
reasons discussed above, this final rule
defines the term ‘‘consumer loan’’ as a
loan for household, family, or other
personal expenditures, including any
loans that, at origination, are wholly or
substantially secured by vehicles
generally manufactured for personal,
family, or household use regardless of
the purpose of the loan. The definition
provides further that the term consumer
loan excludes commercial loans, loans
to CUSOs, first- and junior-lien
residential real estate loans, and loans
for the purchase of one or more vehicles
to be part of a fleet of vehicles.
Contractual compensating balance.
The Second Proposal defined the term
‘‘contractual compensating balance’’ as
the funds a commercial loan borrower
must maintain on deposit at the lender
credit union as security for the loan in
accordance with the loan agreement,
subject to a proper account hold and on
deposit as of the measurement date.
84 NCUA, Definition of Fleet, Legal Opinion Letter
12–0764 (Sept. 13, 2012), available at https://
www.ncua.gov/Legal/Pages/OL2012-12-0764.aspx.
85 NCUA, Definition of Fleet, Legal Opinion Letter
12–0764 (Sept. 13, 2012), available at https://
www.ncua.gov/Legal/Pages/OL2012-12-0764.aspx.
Public Comments on the Second
Proposal
The proposed definition of ‘‘consumer
loan’’ referenced loans ‘‘to one or more
individuals . . . including any loans
secured by vehicles generally
manufactured for personal, family, or
household use regardless of the purpose
of the loan.’’ At least one commenter
requested that the Board clarify whether
the same loan would still be considered
a consumer loan if made to an
incorporated entity. If the definition is
not dependent on the type of borrower,
the commenter suggested that the words
‘‘one or more individuals’’ were not
necessary. The commenter also
requested that the Board clarify the
definition of a loan ‘‘for the purchase of
fleet vehicles,’’ and, to maximize ease of
compliance, recommended the Board
incorporate the definition of ‘‘fleet’’
contained in a 2012 NCUA legal opinion
directly into the definition.84
PO 00000
Frm 00022
Fmt 4701
Sfmt 4700
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
The Board received no comments on
the definition and has decided to retain
the proposed definition in this final rule
without change.
Credit conversion factor (CCF). The
Second Proposal defined the term
‘‘credit conversion factor’’ as the
percentage used to assign a credit
exposure equivalent amount for selected
off-balance sheet accounts.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Credit union. The Second Proposal
defined the term ‘‘credit union’’ as a
federally insured, natural-person credit
union, whether federally or statechartered. The proposal would have
amended the current definition of the
term ‘‘credit union’’ to remove the
words ‘‘as defined by 12 U.S.C. 1752(6)’’
from the end of the definition because
they were unnecessary, and could
mistakenly be read to limit the
definition of ‘‘credit unions’’ to statechartered credit unions.
The Board received no comments on
the proposed revisions to the definition
of ‘‘credit union’’ and has decided to
retain the proposed definition in this
final rule without change.
Current. The Second Proposal defined
the term ‘‘current,’’ with respect to any
loan, as less than 90 days past due, not
placed on non-accrual status, and not
restructured.
Public Comments on the Second
Proposal
The Board received only a small
number of comments on the proposed
definition of the term ‘‘current.’’ Most
commenters who mentioned it
supported the proposed definition of
‘‘current.’’ One credit union commenter,
however, suggested that the Board
should define ‘‘current’’ as loans that
are 60 days past due, which was the
period provided in the Original
Proposal, because expanding the
delinquency loans to 90 days has more
risk and greater exposer to potential
loss. Another commenter recommended
that the definition of ‘‘current’’ be
revised so it does not automatically
exclude all restructured loans. Another
commenter argued that while it is
understandable to require a higher riskweighting for non-current loans,
lumping restructured loans into this
same category and treatment would be
punitive. The commenter suggested that
the definition of ‘‘restructured loans’’ be
amended to specifically address loans
that the commenter referred to as
‘‘troubled debt relief assets,’’ which are
loans that have been modified because
of financial hardship in the face of some
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
type of credit impairment. According to
the commenter, the Financial
Accounting Standards Board already
requires excess reserves be held for
these assets based on the difference
between the net present value of the
loans under the original terms versus
the modified terms. The commenter
contended that credit unions currently
hold reserves of over 10 percent against
loans that are performing and have very
low incidents of future default.
Therefore, the commenter concluded,
treating a ‘‘troubled debt relief asset’’ as
a non-current loan would not reflect the
fact that a modification has been made
to a loan and it is performing. The
commenter suggested that such
restructurings aid the future
performance of such loans.
Discussion
The Board believes that the proposed
definition of ‘‘current’’ is consistent
with § 741.3(b)(2), which specifies that
a credit union’s written lending policies
must include ‘‘loan workout
arrangements and nonaccrual standards
that include the discontinuance of
interest accrual on loans past due by 90
days or more,’’ and aligns well with the
definition of ‘‘current loan’’ under the
Other Banking Agencies’ regulations.86
In general, loans that are more than 90
days past due, or restructured, tend to
have higher incidences of default
resulting in losses. The proposed
definition is consistent with the
definition used under the Other Banking
Agencies’ risk-based capital rules and is
not dependent upon, nor contradictory
to, related accounting pronouncements.
Additional guidance will be provided to
credit unions in the future regarding
reporting troubled debt restructuring
(TDR) loans through supervisory
guidance and in the instructions on the
Call Report. Accordingly, the Board has
decided to retain the proposed
definition in this final rule without
change.
CUSO. The Second Proposal defined
the term ‘‘CUSO’’ as a credit union
service organization as defined in parts
712 and 741.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Custodian. The Second Proposal
defined the term ‘‘custodian’’ as a
financial institution that has legal
custody of collateral as part of a
qualifying master netting agreement,
clearing agreement or other financial
agreement.
86 See,
PO 00000
e.g., 12 CFR 324.32(k).
Frm 00023
Fmt 4701
Sfmt 4700
66647
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Depository institution. The Second
Proposal defined the term ‘‘depository
institution’’ as a financial institution
that engages in the business of
providing financial services; that is
recognized as a bank or a credit union
by the supervisory or monetary
authorities of the country of its
incorporation and the country of its
principal banking operations; that
receives deposits to a substantial extent
in the regular course of business; and
that has the power to accept demand
deposits. The definition provided
further that the term depository
institution includes all federally insured
offices of commercial banks, mutual and
stock savings banks, savings or building
and loan associations (stock and
mutual), cooperative banks, credit
unions and international banking
facilities of domestic depository
institutions, and all privately insured
state-chartered credit unions.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Derivatives Clearing Organization
(DCO). The Second Proposal defined the
term ‘‘Derivatives Clearing Organization
(DCO)’’ as having the same definition as
provided by the Commodity Futures
Trading Commission in 17 CFR 1.3(d).
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Derivative contract. The Second
Proposal defined the term ‘‘derivative
contract’’ as a financial contract whose
value is derived from the values of one
or more underlying assets, reference
rates, or indices of asset values or
reference rates. The definition provided
further that the term derivative contract
includes interest rate derivative
contracts, exchange rate derivative
contracts, equity derivative contracts,
commodity derivative contracts, and
credit derivative contracts. The
definition also provided that the term
derivative contract also includes
unsettled securities, commodities, and
foreign exchange transactions with a
contractual settlement or delivery lag
that is longer than the lesser of the
market standard for the particular
instrument or five business days.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Equity investment. The Second
Proposal defined the term ‘‘equity
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
66648
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
investment’’ as investments in equity
securities, and any other ownership
interests, including, for example,
investments in partnerships and limited
liability companies.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Equity investment in CUSOs. The
Second Proposal defined the term
‘‘equity investment in CUSOs’’ as the
unimpaired value of the credit union’s
equity investments in a CUSO as
recorded on the statement of financial
condition in accordance with GAAP.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Exchange. The Second Proposal
defined the term ‘‘exchange’’ as a
central financial clearing market where
end users can trade derivatives.
The Board received no comments on
this definition, but has decided to
clarify in this final rule that derivatives
are engaged in through agreements and
not traded like securities. Accordingly,
this final rule would define ‘‘exchange’’
as a central financial clearing market
where end users can enter into
derivative transactions.
Excluded goodwill, and excluded
other intangible assets. The Second
Proposal defined the term ‘‘excluded
goodwill’’ as the outstanding balance,
maintained in accordance with GAAP,
of any goodwill originating from a
supervisory merger or combination that
was completed no more than 29 days
after publication of this rule in final
form in the Federal Register. The
definition provided further that the term
excluded goodwill and its
accompanying definition would expire
on January 1, 2025.
The Second Proposal would have also
defined the term ‘‘excluded other
intangible assets’’ as the outstanding
balance, maintained in accordance with
GAAP, of any other intangible assets
such as core deposit intangibles,
member relationship intangibles, or
trade name intangible originating from a
supervisory merger or combination that
was completed no more than 29 days
after publication of this rule in final
form in the Federal Register. The
definition provided further that the term
excluded other intangible assets and its
accompanying definition would expire
on January 1, 2025.
Public Comments on the Second
Proposal
The Board received many comments
regarding the proposed treatment of
goodwill and other intangible assets
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
under NCUA’s risk-based capital
requirement. A significant number of
commenters requested that the terms
‘‘excluded goodwill’’ and ‘‘excluded
intangible assets’’ and their proposed
treatment be retained permanently (or, if
not retained permanently, commenters
requested that the time period during
which they are allowed be extended).
The specific comments received and a
more detailed description of the Board’s
response are provided below in the part
of the preamble associated with
§ 702.104(b)(2).
Discussion
The Board generally agrees with
commenters who suggested the time
periods allowed for these proposed
exclusions be extended. The Board
added these two definitions to take into
account the impact goodwill or other
intangible assets recorded from
transactions defined as supervisory
mergers or combinations have on the
calculation of the risk-based capital
ratio upon implementation. The
proposed exclusions would have
applied to supervisory mergers or
combinations that were completed prior
to the date of publication of this final
rule in the Federal Register. The
proposed exclusion would have ended
on January 1, 2025. For the reasons
discussed below in the part of the
preamble associated with
§ 702.104(b)(2), the Board has decided
to revise the proposed definitions of
‘‘excluded goodwill’’ and ‘‘excluded
other intangible assets’’ to extend the
period during which credit unions can
count these assets in the risk-based
capital ratio numerator to January 1,
2029. In addition, the Board is
extending the period, after the
publication of this final rule in the
Federal Register, during which credit
unions can obtain ‘‘excluded goodwill’’
and ‘‘excluded other intangible assets’’
to 60 days to allow credit unions
additional time to adjust to the changes
made by this final rule.
Accordingly, this final rule defines
‘‘excluded goodwill’’ as the outstanding
balance, maintained in accordance with
GAAP, of any goodwill originating from
a supervisory merger or combination
that was completed on or before a date
to be set upon publication, which will
be 60 days after publication of this final
rule in the Federal Register. The
definition provides further that the term
and definition expire on January 1,
2029.
Similarly, this final rule also defines
‘‘excluded other intangible assets’’ as
the outstanding balance, maintained in
accordance with GAAP, of any other
intangible assets such as core deposit
PO 00000
Frm 00024
Fmt 4701
Sfmt 4700
intangible, member relationship
intangible, or trade name intangible
originating from a supervisory merger or
combination that was completed on or
before a date to be set upon publication,
which will be 60 days after publication
of this final rule in the Federal Register.
The definition provides further that the
term and definition expire on January 1,
2029.
Exposure amount. The Second
Proposal defined the term ‘‘exposure
amount’’ as:
• The amortized cost for investments
classified as held-to-maturity and
available-for-sale, and the fair value for
trading securities.
• The outstanding balance for Federal
Reserve Bank stock, Central Liquidity
Facility stock, Federal Home Loan Bank
stock, nonperpetual capital and
perpetual contributed capital at
corporate credit unions, and equity
investments in CUSOs.
• The carrying value for non-CUSO
equity investments, and investment
funds.
• The carrying value for the credit
union’s holdings of general account
permanent insurance, and separate
account insurance.
• The amount calculated under
§ 702.105 of this part for derivative
contracts.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Fair value. The Second Proposal
defined the term ‘‘fair value’’ as having
the same meaning as provided in GAAP.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Financial collateral. The Second
Proposal defined the term ‘‘financial
collateral’’ as collateral approved by
both the credit union and the
counterparty as part of the collateral
agreement in recognition of credit risk
mitigation for derivative contracts.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
First-lien residential real estate loan.
The Second Proposal defined the term
‘‘first-lien residential real estate loan’’ as
a loan or line of credit primarily secured
by a first-lien on a one-to-four family
residential property where: (1) The
credit union made a reasonable and
good faith determination at or before
consummation of the loan that the
member will have a reasonable ability to
repay the loan according to its terms;
and (2) in transactions where the credit
union holds the first-lien and junior-
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
lien(s), and no other party holds an
intervening lien, for purposes of this
part the combined balance will be
treated as a single first-lien residential
real estate loan.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
GAAP. The Second Proposal defined
the term ‘‘GAAP’’ as generally accepted
accounting principles in the United
States as set forth in the Financial
Accounting Standards Board’s (FASB)
Accounting Standards Codification
(ASC).
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
General account permanent
insurance. The Second Proposal defined
the term ‘‘general account permanent
insurance’’ as an account into which all
premiums, except those designated for
separate accounts are deposited,
including premiums for life insurance
and fixed annuities and the fixed
portfolio of variable annuities, whereby
the general assets of the insurance
company support the policy. Under the
proposed definition, general account
permanent insurance would have
included direct obligations to the
insurance provider. This would have
meant that the credit risk associated
with general account permanent
insurance was to the insurance
company, which generally makes such
insurance accounts have a lower credit
risk than separate account insurance. A
separate account insurance is a
segregated accounting and reporting
account held separately from the
insurer’s general assets.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
General obligation. The Second
Proposal defined the term ‘‘general
obligation’’ as a bond or similar
obligation that is backed by the full faith
and credit of a public sector entity.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Goodwill. The Second Proposal
defined the term ‘‘goodwill’’ as an
intangible asset, maintained in
accordance with GAAP, representing
the future economic benefits arising
from other assets acquired in a business
combination (e.g., merger) that are not
individually identified and separately
recognized. The Proposed definition
provided further that goodwill does not
include excluded goodwill.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Government guarantee. The Second
Proposal defined the term ‘‘government
guarantee’’ as a guarantee provided by
the U.S. Government, FDIC, NCUA or
other U.S. Government agencies, or a
public sector entity.
Public Comments on the Second
Proposal
One state supervisory authority
commenter requested clarification on
the definition of ‘‘government
guarantee,’’ and whether the definition
includes any type of guarantee from a
state government, state government
agency, or municipality.
Discussion
The Board definition of ‘‘government
guarantee’’ does include guarantees
from a state government, state
government agency, or municipality.
The definition expressly includes a
guarantee provided by a ‘‘public sector
entity,’’ which the second proposal
defines separately in § 702.2 as a state,
local authority, or other governmental
subdivision of the United States below
the sovereign level. The proposed
definition of ‘‘public sector entity’’
would include state governments, state
government agencies, and
municipalities. Accordingly, the Board
has decided to retain the proposed
definition of ‘‘government guarantee’’ in
this final rule without change.
Government-sponsored enterprise
(GSE). The Second Proposal defined the
term ‘‘government-sponsored
enterprise’’ as an entity established or
chartered by the U.S. Government to
serve public purposes specified by the
U.S. Congress, but whose debt
obligations are not explicitly guaranteed
by the full faith and credit of the U.S.
Government.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Guarantee. The Second proposal
defined the term ‘‘guarantee’’ as a
financial guarantee, letter of credit,
insurance, or similar financial
instrument that allows one party to
transfer the credit risk of one or more
specific exposures to another party.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Identified losses. The Second
Proposal defined the term ‘‘identified
losses’’ as those items that have been
determined by an evaluation made by
PO 00000
Frm 00025
Fmt 4701
Sfmt 4700
66649
NCUA, or in the case of a state-chartered
credit union, the appropriate state
official, as measured on the date of
examination in accordance with GAAP,
to be chargeable against income, equity
or valuation allowances such as the
allowances for loan and lease losses.
The definition provided further that
examples of identified losses would be
assets classified as losses, off-balance
sheet items classified as losses, any
provision expenses that are necessary to
replenish valuation allowances to an
adequate level, liabilities not shown on
the books, estimated losses in
contingent liabilities, and differences in
accounts that represent shortages.
Public Comments on the Second
Proposal
At least one commenter requested that
the Board specify in the definition of
‘‘identified losses’’ that such losses are
only chargeable against losses.
Discussion
The commenter’s suggested revision
to the proposed definition is not
consistent with generally accepted
accounting principles. The definition of
‘‘identified losses’’ specifies that it be
recorded in accordance with GAAP to
appropriately address this matter and
any further limiting conditions could
run afoul of GAAP reporting.
Accordingly, the Board has decided to
retain the proposed definition in this
final rule without change.
Industrial development bond. The
Second Proposal defined the term
‘‘industrial development bond’’ as a
security issued under the auspices of a
state or other political subdivision for
the benefit of a private party or
enterprise where that party or
enterprise, rather than the government
entity, is obligated to pay the principal
and interest on the obligation.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Intangible assets. The Second
Proposal defined the term ‘‘intangible
assets’’ as assets, maintained in
accordance with GAAP, other than
financial assets, that lack physical
substance.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Investment fund. The Second
Proposal defined the term ‘‘investment
fund’’ as an investment with a pool of
underlying investment assets. The
proposed definition provided further
that the term investment fund includes
an investment company that is
E:\FR\FM\29OCR2.SGM
29OCR2
66650
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
registered under section 8 of the
Investment Company Act of 1940, as
amended, and collective investment
funds or common trust investments that
are unregistered investment products
that pool fiduciary client assets to invest
in a diversified pool of investments.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Junior-lien residential real estate loan.
The Second Proposal defined the term
‘‘junior-lien residential real estate loan’’
as a loan or line of credit secured by a
subordinate lien on a one-to-four family
residential property. The proposed
definition generally included all
residential real estate loans that did not
meet the definition of a first-lien
residential real estate loan because the
credit union is secured by a second or
subsequent lien on the residential
property loan.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Limited Recourse. The Second
Proposal did not define the term
‘‘limited recourse.’’
mstockstill on DSK4VPTVN1PROD with RULES2
Public Comments on the Second
Proposal
At least one commenter suggested that
the Board define ‘‘limited recourse’’ as
provided under GAAP and clarify that
the definition excludes normal reps and
warranties in a loan sale transaction.
Discussion
There is no need to define ‘‘limited
recourse’’ because the Second Proposal
and this final rule define the term
‘‘loans transferred with limited
recourse.’’ That definition provides
sufficient information regarding the
rule’s use of the term ‘‘limited
recourse,’’ and adequately addresses the
normal representations and warranties
associated with limited recourse.
Accordingly, the Board has decided not
to separately define the term ‘‘limited
recourse’’ in this final rule.
Loan to a CUSO. The Second Proposal
defined the term ‘‘loan to a CUSO’’ as
the outstanding balance of any loan
from a credit union to a CUSO as
recorded on the statement of financial
condition in accordance with GAAP.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change. For an unconsolidated
CUSO, a credit union must assign the
risk weight to the outstanding balance of
the loans to the CUSO as presented on
the statement of financial condition. For
a consolidated CUSO, the risk weight of
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
a loan to a CUSO is normally zero since
the consolidation entries eliminate the
intercompany transaction.
Loan secured by real estate. The
Second Proposal defined the term ‘‘loan
secured by real estate’’ as a loan that, at
origination, is secured wholly or
substantially by a lien(s) on real
property for which the lien(s) is central
to the extension of the credit. The
definition provided further that a lien is
‘‘central’’ to the extension of credit if the
borrowers would not have been
extended credit in the same amount or
on terms as favorable without the lien(s)
on real property. The definition also
provided that, for a loan to be ‘‘secured
wholly or substantially by a lien(s) on
real property,’’ the estimated value of
the real estate collateral at origination
(after deducting any more senior liens
held by others) must be greater than 50
percent of the principal amount of the
loan at origination.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Loans transferred with limited
recourse. The Second Proposal defined
the term ‘‘Loans transferred with limited
recourse’’ as the total principal balance
outstanding of loans transferred,
including participations, for which the
transfer qualified for true sale
accounting treatment under GAAP, and
for which the transferor credit union
retained some limited recourse (i.e.,
insufficient recourse to preclude true
sale accounting treatment). The
definition provided further that the term
loans transferred with limited recourse
excludes transfers that qualify for true
sale accounting treatment but contain
only routine representation and
warranty clauses that are standard for
sales on the secondary market, provided
the credit union is in compliance with
all other related requirements, such as
capital requirements.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Mortgage-backed security (MBS). The
Second Proposal defined the term
‘‘mortgage-backed security’’ as a
security backed by first- or junior-lien
mortgages secured by real estate upon
which is located a dwelling, mixed
residential and commercial structure,
residential manufactured home, or
commercial structure.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Mortgage partnership finance
program. The Second Proposal defined
PO 00000
Frm 00026
Fmt 4701
Sfmt 4700
the term ‘‘mortgage partnership finance
program’’ as any Federal Home Loan
Bank program through which loans are
originated by a depository institution
that are purchased or funded by the
Federal Home Loan Banks, where the
depository institutions receive fees for
managing the credit risk of the loans
and servicing them. The definition
would provide further that the credit
risk must be shared between the
depository institutions and the Federal
Home Loan Banks.
Public Comments on the Second
Proposal
The Board received several comments
on the proposed definition of ‘‘mortgage
partnership finance program.’’ One
commenter explained that the Federal
Home Loan Banks have programs
through which they acquire
conventional and government-issued
residential mortgage loans from certain
of their members, called Participating
Financial Institutions (PFIs). The
commenter explained that the Mortgage
Partnership Finance (MPF) Program is
offered today by most Federal Home
Loan Banks, but that the Federal Home
Loan Banks of Cincinnati and
Indianapolis each independently
operate a similar member product called
the Mortgage Purchase Program (MPP).
According to the commenter, both the
MPP and MPF Programs operate
pursuant to Federal Housing Finance
Agency regulation and the majority of
PFIs that sell mortgage loans under
these programs are small to mid-sized
community banks, thrifts, and credit
unions. Several commenters suggested
that NCUA’s proposed definition of
‘‘Mortgage Partnership Finance
Program,’’ could be reasonably
construed to only apply to MPF Program
loans that a credit union services. If the
intent of the rule is to treat all MPF
program loans the same, regardless of
whether the credit union retains or sells
the servicing, then the commenters
recommended the Board clarify the
definition by deleting the words ‘‘and
servicing them’’ from the definition of
‘‘Mortgage Partnership Finance
Program.’’
Commenters also suggested that,
although the MPP and the MPF
Programs are similar in many respects,
there is an important difference
regarding recourse risk. According to
the commenters, the MPF Program
achieves credit enhancement by creating
a contingent liability for PFIs while the
MPP achieves credit enhancement by
creating a contingent asset for the PFI.
Because credit unions retain recourse
risk on MPF loans but not on MPP
loans, the commenters recommended
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
that the Board amend the proposed
definition of ‘‘Mortgage Partnership
Finance Program’’ to clarify that the
term expressly excludes MPP loans. In
particular, the commenters
recommended that the Board add the
words ‘‘in a manner other than by
establishing a contingent asset for the
benefit of or payable to the depository
institution’’ at the end of the definition
of Member Partnership Finance
Program.
Discussion
The Board generally agrees with the
commenters who suggested removing
the words ‘‘and servicing them’’ from
the proposed definition of ‘‘mortgage
partnership finance program.’’ The
Board’s intent is to treat all MPF
program loans the same under the final
rule regardless of whether the credit
union retains or sells the servicing.
Accordingly, this final rule revises the
definition of mortgage partnership
finance program to remove the words
‘‘and servicing them.’’
The Board also agrees with
commenters who suggested there is an
important difference between the MPP
and the MPF Programs regarding
recourse risk. MPF loans are not the
same as MPP loans with regard to risk
because credit unions retain recourse
risk through a credit enhancement
obligation to the Federal Home Loan
Bank for credit losses on MPF loans.
Loans sold under the MPP program are
risk-weighted based on the contractual
recourse obligation, if any. Thus the
commenters’ suggested change to the
definition of MPF Programs is
necessary.
Accordingly, this final rule defines
‘‘mortgage partnership finance program’’
as any Federal Home Loan Bank
program through which loans are
originated by a depository institution
that are purchased or funded by the
Federal Home Loan Banks, where the
depository institution receives fees for
managing the credit risk of the loans.
The definition provides further that the
credit risk must be shared between the
depository institution and the Federal
Home Loan Banks.
Mortgage servicing assets. The Second
Proposal defined the term ‘‘mortgage
servicing asset’’ as those assets,
maintained in accordance with GAAP,
resulting from contracts to service loans
secured by real estate (that have been
securitized or owned by others) for
which the benefits of servicing are
expected to more than adequately
compensate the servicer for performing
the servicing.
The Board received no comments on
this definition and has decided to retain
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
the proposed definition in this final rule
without change.
NCUSIF. The Second Proposal
defined the term ‘‘NCUSIF’’ as the
National Credit Union Share Insurance
Fund as defined by 12 U.S.C. 1783.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Net worth. Generally consistent with
the current rule, the Second Proposal
defined the term ‘‘net worth’’ as:
• The retained earnings balance of the
credit union at quarter-end as
determined under GAAP, subject to
bullet 3 of this definition.
• For a low-income-designated credit
union, net worth also includes
secondary capital accounts that are
uninsured and subordinate to all other
claims, including claims of creditors,
shareholders, and the NCUSIF.
• For a credit union that acquires
another credit union in a mutual
combination, net worth also includes
the retained earnings of the acquired
credit union, or of an integrated set of
activities and assets, less any bargain
purchase gain recognized in either case
to the extent the difference between the
two is greater than zero. The acquired
retained earnings must be determined at
the point of acquisition under GAAP. A
mutual combination, including a
supervisory combination, is a
transaction in which a credit union
acquires another credit union or
acquires an integrated set of activities
and assets that is capable of being
conducted and managed as a credit
union.
• The term ‘‘net worth’’ also includes
loans to and accounts in an insured
credit union, established pursuant to
section 208 of the FCUA, provided such
loans and accounts:
Æ Have a remaining maturity of more
than five years;
Æ Are subordinate to all other claims
including those of shareholders,
creditors, and the NCUSIF;
Æ Are not pledged as security on a
loan to, or other obligation of, any party;
Æ Are not insured by the NCUSIF;
Æ Have non-cumulative dividends;
Æ Are transferable; and
Æ Are available to cover operating
losses realized by the insured credit
union that exceed its available retained
earnings.’’
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Net worth ratio. The Second Proposal
defined the term ‘‘net worth ratio’’ as
the ratio of the net worth of the credit
union to the total assets of the credit
union rounded to two decimal places.
PO 00000
Frm 00027
Fmt 4701
Sfmt 4700
66651
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
New credit union. The Second
Proposal would have revised the
definition of ‘‘new credit union’’ by
removing the definition provided in
current § 702.2 and providing that the
term has the same meaning as in
§ 702.201.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Nonperpetual capital. The Second
Proposal defined the term
‘‘nonperpetual capital’’ as having the
same meaning as in 12 CFR 704.2.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Off-balance sheet items. The Second
Proposal defined the term ‘‘off-balance
sheet items’’ as items such as
commitments, contingent items,
guarantees, certain repo-style
transactions, financial standby letters of
credit, and forward agreements that are
not included on the statement of
financial condition, but are normally
reported in the financial statement
footnotes.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Off-balance sheet exposure. The
Second Proposal defined the term ‘‘offbalance sheet exposure’’ as: (1) For
loans sold under the Federal Home Loan
Bank mortgage partnership finance
(MPF) program, the outstanding loan
balance as of the reporting date, net of
any related valuation allowance. (2) For
all other loans transferred with limited
recourse or other seller-provided credit
enhancements and that qualify for true
sales accounting, the maximum
contractual amount the credit union is
exposed to according to the agreement,
net of any related valuation allowance.
(3) For unfunded commitments, the
remaining unfunded portion of the
contractual agreement.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
On-balance sheet. The Second
Proposal defined the term ‘‘on-balance
sheet’’ as a credit union’s assets,
liabilities, and equity, as disclosed on
the statement of financial condition at a
specific point in time.
The Board received no comments on
this definition and has decided to retain
E:\FR\FM\29OCR2.SGM
29OCR2
66652
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
the proposed definition in this final rule
without change.
Other intangible assets. The Second
Proposal defined the term ‘‘other
intangible assets’’ as intangible assets,
other than servicing assets and
goodwill, maintained in accordance
with GAAP. The definition provided
further that other intangible assets does
not include excluded other intangible
assets.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Over-the-counter (OTC) interest rate
derivative contract. The Second
Proposal defined the term ‘‘over-thecounter (OTC) interest rate derivative
contract’’ as a derivative contract that is
not cleared on an exchange.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Part 703 compliant investment fund.
The Second proposal used the term
‘‘part 703 compliant investment fund,’’
but did not specifically define the term
in § 702.2. The discussion in the
preamble to the proposal, however, used
the term to mean an investment fund
that is restricted to holding only
investments that are permissible under
12 CFR 703.14(c).
mstockstill on DSK4VPTVN1PROD with RULES2
Public Comments on the Second
Proposal
The Board received many comments
on the risk weights assigned to ‘‘part
703 compliant investment funds.’’ Some
of the comments received seemed to
indicate that credit unions and other
interested parties were unclear
regarding the rule’s use of the term. The
specific comments received regarding
investment funds and part 703
compliance are discussed in more detail
below in the part of preamble associated
with § 702.104(c).
Discussion
The Board has decided to define the
term ‘‘part 703 compliant investment
funds’’ in § 702.2 to clarify the meaning
of the term and avoid possible
confusion in the future. Accordingly,
this final rule defines ‘‘part 703
compliant investment fund’’ as an
investment fund that is restricted to
holding only investments that are
permissible under 12 CFR 703.14(c).
Perpetual contributed capital. The
Second Proposal defined the term
‘‘perpetual contributed capital’’ as
having the same meaning as in 12 CFR
704.2.
The Board received no comments on
this definition and has decided to retain
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
the proposed definition in this final rule
without change.
Public sector entity (PSE). The Second
Proposal defined the term ‘‘public sector
entity’’ as a state, local authority, or
other governmental subdivision of the
United States below the sovereign level.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Qualifying master netting agreement.
The Second Proposal defined the term
‘‘qualifying master netting agreement’’
as a written, legally enforceable
agreement, provided that:
• The agreement creates a single legal
obligation for all individual transactions
covered by the agreement upon an event
of default, including upon an event of
conservatorship, receivership,
insolvency, liquidation, or similar
proceeding, of the counterparty;
• The agreement provides the credit
union the right to accelerate, terminate,
and close out on a net basis all
transactions under the agreement and to
liquidate or set off collateral promptly
upon an event of default, including
upon an event of conservatorship,
receivership, insolvency, liquidation, or
similar proceeding, of the counterparty,
provided that, in any such case, any
exercise of rights under the agreement
will not be stayed or avoided under
applicable law in the relevant
jurisdictions, other than in receivership,
conservatorship, resolution under the
Federal Deposit Insurance Act, Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, or under
any similar insolvency law applicable to
GSEs;
• The agreement does not contain a
walkaway clause (that is, a provision
that permits a non-defaulting
counterparty to make a lower payment
than it otherwise would make under the
agreement, or no payment at all, to a
defaulter or the estate of a defaulter,
even if the defaulter or the estate is a net
creditor under the agreement); and
• In order to recognize an agreement
as a qualifying master netting agreement
for purposes of this part, a credit union
must conduct sufficient legal review, at
origination and in response to any
changes in applicable law, to conclude
with a well-founded basis (and maintain
sufficient written documentation of that
legal review) that:
Æ The agreement meets the
requirements of paragraph (2) of this
definition; and
Æ In the event of a legal challenge
(including one resulting from default or
from conservatorship, receivership,
insolvency, liquidation, or similar
proceeding), the relevant court and
PO 00000
Frm 00028
Fmt 4701
Sfmt 4700
administrative authorities would find
the agreement to be legal, valid, binding,
and enforceable under the law of
relevant jurisdictions.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Recourse. The second Proposal
defined the term ‘‘recourse’’ as a credit
union’s retention, in form or in
substance, of any credit risk directly or
indirectly associated with an asset it has
transferred that exceeds a pro-rata share
of that credit union’s claim on the asset
and disclosed in accordance with
GAAP. The definition provided further
that if a credit union has no claim on
an asset it has transferred, then the
retention of any credit risk is recourse.
The definition also provided that a
recourse obligation typically arises
when a credit union transfers assets in
a sale and retains an explicit obligation
to repurchase assets or to absorb losses
due to a default on the payment of
principal or interest or any other
deficiency in the performance of the
underlying obligor or some other party.
Finally, the definition provided that
recourse may also exist implicitly if the
credit union provides credit
enhancement beyond any contractual
obligation to support assets it has
transferred.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Residential mortgage-backed security.
The Second Proposal defined the term
‘‘residential mortgage-backed security’’
as a mortgage-backed security backed by
loans secured by a first-lien on
residential property.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Residential property. The Second
Proposal defined the term ‘‘residential
property’’ as a house, condominium
unit, cooperative unit, manufactured
home, or the construction thereof, and
unimproved land zoned for one-to-four
family residential use. The definition
provided further that the term
residential property excludes boats and
motor homes, even if used as a primary
residence, and timeshare property.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Restructured. The Second Proposal
defined the term ‘‘restructured,’’ with
respect to any loan, as a restructuring of
the loan in which a credit union, for
economic or legal reasons related to a
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
borrower’s financial difficulties, grants a
concession to the borrower that it would
not otherwise consider. The definition
provided further that the term
restructured excludes loans modified or
restructured solely pursuant to the U.S.
Treasury’s Home Affordable Mortgage
Program.
mstockstill on DSK4VPTVN1PROD with RULES2
Public Comments on the Second
Proposal
At least one commenter argued that
the definition of the term
‘‘restructured,’’ as it applied to loans,
and the accompanying footnote in the
preamble to the Second Proposal were
troublesome.87 The commenter believed
that the footnote accompanying the
preamble discussion on the definition of
‘‘restructured’’ suggested that a loan that
was restructured was what FASB calls
a TDR. The commenter was confused
further by the following statement in the
preamble: ‘‘A loan extended or renewed
at a stated interest rate equal to the
current market interest rate for new debt
with similar risk is not a restructured
loan.’’ 88 According to the commenter,
however, such a loan would be treated
as a restructured loan for accounting
purposes by FASB and under the TDR
guidance. To avoid confusion, the
commenter recommended that the
Board amend the definition of
‘‘restructured’’ to be consistent with the
standards and guidance set by FASB.
Discussion
The proposed definition of
‘‘restructured’’ was based on the
classification of restructured loans for
the purpose of assigning appropriate
risk weights. The proposed definition is
consistent with the definition used
under the Other Banking Agencies’ riskbased capital rules and is not dependent
upon nor contradictory to related
accounting pronouncements. Additional
guidance will be provided to credit
unions in the future regarding riskweighting restructured loans through
supervisory guidance and in the
instructions on the Call Report.
Accordingly, the Board has decided to
retain the proposed definition of
‘‘restructured’’ in this final rule without
change.
Revenue obligation. The Second
Proposal defined the term ‘‘revenue
obligation’’ as a bond or similar
obligation that is an obligation of a
public sector entity, but which the
public sector entity is committed to
repay with revenues from the specific
87 See 80 FR 4339, 4369 (Jan. 27, 2015) (Footnote
119, referred to by the commenter, relates to
Financial Accounting Standards Board ASC 310–
40, ‘‘Troubled Debt Restructuring by Creditors.’’).
88 Id. at 4369.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
project financed rather than general tax
funds. Generally, such bonds or debts
are paid with revenues from the specific
project financed rather than the general
credit and taxing power of the issuing
jurisdiction.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Risk-based capital ratio. The Second
Proposal defined the term ‘‘risk-based
capital ratio’’ as the percentage, rounded
to two decimal places, of the risk-based
capital ratio numerator to risk weighted
assets, as calculated in accordance with
§ 702.104(a).
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Risk-weighted assets. The Second
Proposal defined the term ‘‘riskweighted assets’’ as the total riskweighted assets as calculated in
accordance with § 702.104(c).
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Secured consumer loan. The Second
Proposal defined the term ‘‘secured
consumer loan’’ as a consumer loan
associated with collateral or other item
of value to protect against loss where
the creditor has a perfected security
interest in the collateral or other item of
value.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Senior executive officer. The Second
Proposal defined the term ‘‘senior
executive officer’’ as a senior executive
officer as defined by 12 CFR
701.14(b)(2).
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Separate account insurance. The
Second Proposal defined the term
‘‘separate account insurance’’ as an
account into which a policyholder’s
cash surrender value is supported by
assets segregated from the general assets
of the carrier.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Shares. The Second Proposal defined
the term ‘‘shares’’ as deposits, shares,
share certificates, share drafts, or any
other depository account authorized by
federal or state law.
The Board received no comments on
this definition and has decided to retain
PO 00000
Frm 00029
Fmt 4701
Sfmt 4700
66653
the proposed definition in this final rule
without change.
Share-secured loan. The Second
Proposal defined the term ‘‘sharesecured loan’’ as a loan fully secured by
shares on deposit at the credit union
making the loan, and does not include
the imposition of a statutory lien under
12 CFR 701.39.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
with the following conforming changes.
This final rule amends the definition of
share-secured loans to be consistent
with the new zero percent risk weight
assigned to share-secured loans, where
the shares securing the loan are on hold
with the credit union, which is
discussed in more detail below.
Accordingly, this final rule defines the
term ‘‘share-secured loan’’ as a loan
fully secured by shares, and does not
include the imposition of a statutory
lien under § 701.39 of this chapter.
STRIPS. The Second Proposal defined
the term ‘‘STRIPS’’ as separate traded
registered interest and principal
security.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Structured product. The Second
Proposal defined the term ‘‘structured
product’’ as an investment that is
linked, via return or loss allocation, to
another investment or reference pool.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Subordinated. The Second Proposal
defined the term ‘‘subordinated’’ to
mean, with respect to an investment,
that the investment has a junior claim
on the underlying collateral or assets to
other investments in the same issuance.
The definition provided further that the
term subordinated does not apply to
securities that are junior only to money
market fund eligible securities in the
same issuance.
Public Comments on the Second
Proposal
At least one commenter
recommended the Board more clearly
define the term ‘‘subordinated’’ with
respect to a ‘‘tranche.’’ As discussed in
the part of the preamble associated with
§ 702.104(c)(2), commenters also
expressed some confusion regarding
NCUA’s use of the term ‘‘nonsubordinated’’ in the Second Proposal.
Additionally, commenters expressed
their desire to have the risk-weight
assigned to a non-subordinated tranche
E:\FR\FM\29OCR2.SGM
29OCR2
66654
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
be based on the underlying collateral in
the tranche.
Discussion
The Second Proposal defined the
terms ‘‘subordinated’’ and ‘‘tranche.’’
These definitions, when read together,
make it clear that a subordinated
tranche is an investment that has a
junior claim to other securities within
the same transaction.
The Board agrees, however, that
clarifying the definition of
‘‘subordinated’’ to clarify the meaning of
the term non-subordinated in § 702.2
will help clarify the meaning of the term
for credit unions and other interested
parties, and clarify that under this final
rule all tranches of investments,
regardless of standing, can be riskweighted using the gross-up approach.
As discussed in more detail below,
commenters suggested that credit
unions be given the option of using the
gross-up approach to risk-weight nonsubordinated tranches of investments. A
non-subordinated instrument is the
most senior tranche in a security with
a senior/subordinated structure. The
Board has decided to further clarify the
definition of ‘‘subordinated’’ for credit
unions using the gross-up approach for
both subordinated and nonsubordinated investment tranches. This
change will benefit credit unions
purchasing non-subordinated tranches
of securities collateralized with lower
credit risk assets.
Accordingly, this final rule defines
the term ‘‘subordinated’’ as meaning,
with respect to an investment, that the
investment has a junior claim on the
underlying collateral or assets to other
investments in the same issuance. The
definition also provides that an
investment that does not have a junior
claim to other investments in the same
issuance on the underlying collateral or
assets is non-subordinated. Finally, the
definition provides that a security that
is junior only to money-market-eligible
securities in the same issuance is also
non-subordinated.
Supervisory merger or combination.
The Second Proposal defined the term
‘‘supervisory merger or combination’’ as
a transaction that involved the
following:
• An assisted merger or purchase and
assumption where funds from the
NCUSIF are provided to the continuing
credit union;
• A merger or purchase and
assumption classified by NCUA as an
‘‘emergency merger’’ where the acquired
credit union is either insolvent or ‘‘in
danger of insolvency’’ as defined under
appendix B to part 701 of this chapter;
or
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
• A merger or purchase and
assumption that included NCUA’s or
the appropriate state official’s
identification and selection of the
continuing credit union.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Swap dealer. The Second Proposal
defined the term ‘‘swap dealer’’ as
having the same meaning as defined by
the Commodity Futures Trading
Commission in 17 CFR 1.3(ggg).
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Total assets. The Second Proposal
retained the definition of ‘‘total assets’’
in current § 702.2, but would have
restructured the definition and provided
additional clarifying language. The
proposal amended the definition to
provide that ‘‘total assets’’ means a
credit union’s total assets as measured 89
by either:
• Average quarterly balance. The
credit union’s total assets measured by
the average of quarter-end balances of
the current and three preceding
calendar quarters;
• Average monthly balance. The
credit union’s total assets measured by
the average of month-end balances over
the three calendar months of the
applicable calendar quarter;
• Average daily balance. The credit
union’s total assets measured by the
average daily balance over the
applicable calendar quarter; or
• Quarter-end balance. The credit
union’s total assets measured by the
quarter-end balance of the applicable
calendar quarter as reported on the
credit union’s Call Report.
Public Comments on the Second
Proposal
One commenter suggested that the
proposed definition of ‘‘total assets’’
would create inconsistency as to how
risk-based capital results are reported
and would hinder comparability among
credit unions. The commenter
recommended that the Board amend the
definition to require that total assets be
measured by the average of quarter-end
balances of the current and three
preceding calendar quarters.
Discussion
With the exception of a few nonsubstantive amendments, the proposed
89 For each quarter, a credit union must elect one
of the measures of total assets listed in paragraph
(2) of this definition to apply for all purposes under
this part except §§ 702.103 through 702.106 (riskbased capital requirement).
PO 00000
Frm 00030
Fmt 4701
Sfmt 4700
definition of ‘‘total assets’’ is the same
as the definition in current § 702.2. In
fact, the revision suggested by the
commenter above would reduce the
number of options available to a credit
union in determining which total assets
to apply in calculating its net worth
ratio. Such a narrowing of the definition
is not appropriate. Accordingly, the
Board has decided to retain the
proposed revisions to the definition in
this final rule without change.
Tranche. The Second Proposal
defined the term ‘‘tranche’’ as one of a
number of related securities offered as
part of the same transaction. The
definition provided further that the term
tranche includes a structured product if
it has a loss allocation based off of an
investment or reference pool.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
Unfunded commitment. Neither the
current rule nor the Second Proposal
define the term ‘‘unfunded
commitment.’’
Public Comments on the Second
Proposal
At least one commenter
recommended that the Board define the
term ‘‘unfunded commitment’’ in the
final rule because the commenter
believed the proposed definition was
unclear as to whether a credit union real
estate loan pipeline or outstanding auto
loan convenience check would be
classified as an unfunded commitment.
Discussion
The proposal provides in § 702.2 that
‘‘off-balance sheet exposure’’ means, for
unfunded commitments, the remaining
unfunded portion of the contractual
agreement. The definition of offbalance-sheet exposure defines
unfunded commitment, so adding an
additional separate definition for
unfunded commitment would be
redundant. Additional guidance,
however, will be included in future
supervisory guidance and in the
instructions on the Call Report.
Accordingly, the Board has decided not
to define the term ‘‘unfunded
commitment’’ in this final rule.
Unsecured consumer loan. The
Second Proposal defined the term
‘‘unsecured consumer loan’’ as a
consumer loan not secured by collateral.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
without change.
U.S. Government agency. The Second
Proposal defined the term ‘‘U.S.
Government agency’’ as an
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
instrumentality of the U.S. Government
whose obligations are fully and
explicitly guaranteed as to the timely
payment of principal and interest by the
full faith and credit of the U.S.
Government.
The Board received no comments on
this definition and has decided to retain
the proposed definition in this final rule
with only minor clarifying amendments.
In particular, the Board clarified in the
definition that NCUA is a U.S.
Government agency, to confirm that
NCUA’s obligations receive a zero
percent risk weight. Accordingly, the
final rule defines ‘‘U.S. Government
agency’’ as an instrumentality of the
U.S. Government whose obligations are
fully and explicitly guaranteed as to the
timely payment of principal and interest
by the full faith and credit of the U.S.
Government. The definition provides
further that the term ‘‘U.S. Government
agency’’ includes NCUA.
Weighted-average life of investments.
Under the Second Proposal, the
definition of ‘‘weighted-average life of
investments’’ and the provisions in
current § 702.105 of NCUA’s regulation
would have been removed completely.
Other than the comments supporting
the removal of IRR from NCUA’s riskbased capital requirement, the Board
received no comments regarding the
removal of this definition and has
decided to retain the proposed
amendment in this final rule without
change.
mstockstill on DSK4VPTVN1PROD with RULES2
A. Subpart A—Prompt Corrective
Action
The Second Proposal would have
established a new subpart A titled
‘‘Prompt Corrective Action.’’ New
subpart A would have contained the
sections of part 702 relating to capital
measures, supervisory PCA actions,
requirements for net worth restoration
plans, and reserve requirements for all
credit unions not defined as ‘‘new’’
pursuant to section 216(b)(2) of the
FCUA.90 The Board received no
comments on these revisions and has
decided to retain the proposed
amendments in this final rule.
Section 702.101 Capital Measures,
Capital Adequacy, Effective Date of
Classification, and Notice to NCUA
The Second Proposal retained the
requirements of § 702.101 leaving it
largely unchanged from current
§ 702.101, with a few notable exceptions
that are discussed in more detail below.
The title of proposed § 702.101 would
have been changed to ‘‘Capital
Measures, capital adequacy, effective
90 12
U.S.C. 1790d(b)(2).
VerDate Sep<11>2014
22:13 Oct 28, 2015
date of classification, and notice to
NCUA’’ to better reflect the three major
topics that would have been covered in
the section. In addition, proposed
§ 702.101 would have amended current
§ 702.101 to include a new capital
adequacy provision that was based on a
similar provision in FDIC’s capital
regulations.91 The new capital adequacy
provision was added as proposed
§ 702.101(b). Paragraphs (b) and (c) of
current § 702.101 would have been
renumbered as paragraphs (d) and (e).
The new capital adequacy provision
would not have affected credit unions’
PCA capital category, but could have
supported the assessment of capital
adequacy in the supervisory process
(assigning CAMEL and risk ratings).
Public Comments on the Second
Proposal
A substantial number of commenters
objected to the proposed addition of
capital adequacy provisions to
§ 702.101. Many commenters stated that
they were concerned about the
subjective nature of the capital
adequacy provision. Commenters
contended that if a credit union meets
the net worth and risk-based capital
requirements, NCUA should not have
the ability to require the credit union to
hold additional capital. Other
commenters argued that the proposed
capital adequacy provisions could be
problematic because they would grant
examiners considerable latitude to
determine whether a credit union needs
more capital even if it is well
capitalized according to standard net
worth and risk-based capital ratio
requirements. Commenters argued that
credit unions and the NCUSIF have
functioned well without these
provisions and NCUA has not provided
sufficient justification to support their
imposition now. Still other commenters
noted that credit unions already provide
for capital adequacy through budgeting,
ALM planning, liquidity, interest rate
risk, and risk management, and
speculated that the proposed capital
adequacy provision would subject credit
unions’ capital plans to be judged in an
arbitrary and subjective manner by
hundreds of different NCUA examiners.
The commenters argued that such an
approach would provide examiners
with too much authority to change the
‘‘playing field,’’ especially when there is
no independent entity to which a credit
union can appeal. At least one
commenter suggested that the Board
already has this authority so adding to
the existing authority would be
unnecessary and redundant.
91 12
Jkt 238001
PO 00000
CFR 324.10.
Frm 00031
Fmt 4701
Sfmt 4700
66655
One commenter, however,
acknowledged that codifying the
additional capital adequacy
requirements in § 702.101(b) was
reasonable. But the commenter
suggested that the standards
surrounding the provision’s use should
be made clear because NCUA already
examines credit unions to determine
whether they have sufficient net worth
relative to risk, and whether credit
unions have adequate policies,
practices, and procedures regarding net
worth and capital accounts.92 The
commenter noted further, the proposed
rule indicates that it ‘‘may provide
specific metrics for necessary reductions
in risk levels, increases in capital levels
beyond those otherwise required under
part 702, and some combination of risk
reduction and increased capital.’’ 93 The
commenter recommended that the
Board clarify how it envisions
§ 702.101(b) augmenting NCUA’s
current supervisory process and any
enforcement authority the agency holds
in conjunction with that process.
Another commenter suggested that
credit unions with lower risk profiles
and/or higher capital levels should be
subjected to less rigorous examinations
of risk management. The commenter
also suggested that credit unions with
higher risk levels against a given set of
reasonable thresholds, or those with
lower capital levels, should have their
examination of risk elevated to the risk
management specialists within NCUA.
The commenter suggested that removing
field examiners with little specific
knowledge from the examination
findings and recommendation process
would provide a more consistent exam,
and recommended that NCUA produce
a set of known, published and
reasonable filters to define outlier credit
unions, including a cross-risk look at
risks due to concentration, low capital
or earnings levels, interest rate
exposure, credit quality, etc.
At least one commenter questioned
the Board’s legal authority to adopt a
provision that would require individual
credit unions to hold capital above that
required under the other provisions of
the regulation. The commenter
acknowledged that the FCUA
establishes a risk-based net worth
requirement for complex credit unions,
but suggested it does not grant NCUA
the authority to impose individualized
capital requirements on a credit unionby-credit union basis. Another
92 See LTCU 00–CU–08 (Nov. 2000); see also
NCUA Examiner’s Guide, Ch. 16. available at
https://www.ncua.gov/Legal/GuidesEtc/
ExaminerGuide/chapter16.pdf.
93 80 FR 4340, 4359 (Jan. 27, 2015).
E:\FR\FM\29OCR2.SGM
29OCR2
66656
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
commenter suggested if Congress had
intended the capital thresholds required
under PCA to be minimum
requirements, it would have described
the classification as minimally
capitalized. The commenter maintained
that each credit union’s long-term
desired capital ratio will depend on the
credit union’s own assessment of the
risks it faces, and its tolerance for risk.
The commenter recommended the
Board delete the capital adequacy
provisions, because credit unions’
capital plans should not be the subject
of examination and supervision, and the
goals a credit union establishes for its
own capital sufficiency should not
become targets or standards for review
in an examination.
One commenter requested
clarification on how NCUA would
coordinate the requirements of this new
provision with state regulators for
capital planning purposes.
Discussion
The Board has carefully considered
the comments above, and disagrees with
commenters who suggested that the
capital adequacy provisions are
unnecessary. As stated in the preamble
to the Second Proposal, capital helps to
ensure that individual credit unions can
continue to serve as credit
intermediaries even during times of
stress, thereby promoting the safety and
soundness of the overall U.S. financial
system. As a prudential matter, NCUA
has a long-established policy that
federally insured credit unions should
hold capital commensurate with the
level and nature of the risks to which
they are exposed. In some cases, this
may entail holding capital above the
minimum requirements, depending on
the nature of the credit union’s activities
and risk profile.
Proposed § 702.101(b) was based on a
similar provision in the Other Banking
Agencies’ rules 94 and is within the
Board’s legal authority under the FCUA.
The FCUA grants NCUA broad authority
to take action to ensure the safety and
soundness of credit unions and the
NCUSIF and to carry out the powers
granted to the Board.95 Requiring credit
unions to maintain capital adequacy is
part of ensuring safety and soundness,
and is not a new concept.96 NCUA’s
long-standing practice has been to
monitor and enforce capital adequacy
through the supervisory process.
Proposed § 702.101(b) would, with the
exception of the written capital
adequacy plan discussed in more detail
94 See,
e.g., 12 CFR 324.10(d)(1) & (2).
U.S.C. 1786; and 1789.
96 See, e.g. 78 FR 55340, 55362 (Sept. 10, 2013).
below, merely codify the existing
statutory requirement. The proposed
new capital adequacy provision would
not affect credit unions’ PCA capital
category, but would support the
assessment of capital adequacy in the
supervisory process (assigning CAMEL
and risk ratings).
Section 206 of the FCUA provides the
Board with broad authority to intervene
and require credit unions to take actions
to correct unsafe or unsound practices,
including requiring individual credit
unions to hold capital above that
required under NCUA’s PCA
regulation.97 And section 209 of the
FCUA specifically authorizes the Board
to prescribe such rules and regulations
as it may deem necessary or appropriate
to carry out the provisions of subchapter
II of the FCUA, which includes section
206. Accordingly, NCUA clearly has the
legal authority to include proposed
§ 702.101(b) in this final rule.
Accordingly, the Board has decided to
retain the proposed capital adequacy
provisions in this final rule without
change.
101(b) Capital Adequacy
For the reasons discussed above, the
new capital adequacy provisions are
added as § 702.101(b) of this final rule,
and paragraphs (b) and (c) of current
§ 702.101 are designated as paragraphs
(d) and (e) of § 702.101 of this final rule.
101(b)(1)
The Second Proposal would have
revised § 702.101(b)(1) to provide:
Notwithstanding the minimum
requirements in this part, a credit union
defined as complex must maintain
capital commensurate with the level
and nature of all risks to which the
institution is exposed.
For the reasons discussed above, the
Board has decided to retain the
proposed capital adequacy provision in
proposed § 702.101(b)(1) in this final
rule without change.
101(b)(2)
Proposed § 702.101(b)(2) provided: A
credit union defined as ‘‘complex’’ must
have a process for assessing its overall
capital adequacy in relation to its risk
profile and a comprehensive written
strategy for maintaining an appropriate
level of capital.
Public Comments on the Second
Proposal
A significant number of commenters
specifically objected to the proposed
new provision added as § 702.101(b)(2)
that would require complex credit
95 12
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
97 12
PO 00000
U.S.C. 1786.
Frm 00032
Fmt 4701
Sfmt 4700
unions to have a comprehensive written
strategy for maintaining an appropriate
level of capital. One commenter pointed
out that, while the Board has taken steps
to closely align this proposal with
banking agency requirements in other
areas, it has chosen to deviate from that
standard to add a written reporting
requirement for credit unions under this
provision.98 The commenter suggested
that given that the specific requirements
of the proposed capital adequacy plan
are not delineated in this proposed rule,
but will be subsequently outlined in
supervisory guidance, commenters are
unable to determine the extent of the
burden this requirement might entail.
The commenter noted that all credit
unions with assets of $50 million or
more are already required to have a
written policy on interest rate risk
management and a program to
implement it effectively,99 as well as a
written liquidity policy and contingency
funding plan.100 In addition, the
commenter noted that the largest credit
unions are already required by
regulation to maintain a written capital
policy and capital plan that is approved
annually by NCUA.101 The commenter
recommended the Board explain why it
felt compelled to add a written
requirement to this provision for credit
unions, and make every effort to
streamline it and other similar
requirements to minimize the associated
regulatory burden.
One commenter recommended that if
the Board adopts a written capital
strategy requirement for all complex
credit unions, it utilize that written
strategy to ensure that credit unions are
addressing any heightened risks from
loan concentrations. The commenter
suggested such an approach should
obviate the need for elevated risk
weights in connection with real estate
and commercial loans by allowing
NCUA to address concentration risk in
a more targeted way. The commenter
suggested further that such an approach
would satisfy recommendations from
NCUA’s Office of Inspector General
(OIG) and GAO that NCUA consider
concentration risk as it pertains to
capital adequacy, without creating a
competitive disadvantage for all
complex credit unions in relation to
their banking counterparts. The
commenter also recommended that the
Board incorporate any written capital
strategy required within the credit
98 There is no mandated written element to the
corresponding FDIC provision. 12 CFR 324.1(d); 12
CFR 324.100(d).
99 12 CFR 741.3.
100 12 CFR 741.12.
101 12 CFR 702.501 through 702.506.
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
union’s strategic plan, or another
existing report in order to minimize
duplication of effort across various
reporting requirements. In addition, the
commenter suggested that an exemption
from the requirement be provided to
institutions that are already subject to
capital planning and stress testing
requirements, as the analysis
contemplated by this part would already
be addressed by those existing
requirements. Other commenters
contended that the written capital plan
requirement is not necessary for the vast
majority of complex credit unions based
on their management, risk profiles, and
current levels of capital. And if NCUA
examiners have concerns regarding the
credit unions they supervise, those
commenters argued, those situations
should be addressed on an individual
basis and not through rulemaking that
would apply universal requirements to
all complex credit unions, regardless of
how well managed they may be.
At least one commenter stated that
while NCUA should be able to access
the adequacy of a credit union’s capital
adequacy plan, safeguards should be put
in place to prevent over-zealous
examiners from implementing
individualized minimum capital
requirements during the exam process.
Another commenter suggested that the
concept of a written strategy was not
bad, but that the final rule should
provide additional clarity about what
exactly would be required under the
provision. Yet another commenter
asked: What are the components of the
‘‘comprehensive written strategy’’
contemplated under this provision?
What are the possible consequences of
an examiner determining that a credit
union’s comprehensive written strategy
does not meet the requirements? The
commenter requested that the Board
provide more description in this area
and elaborate on its expectations of
credit unions.
Discussion
The Board disagrees with commenters
who suggested the requirement that
complex credit unions maintain a
written capital strategy be removed from
the final rule. The supervisory
evaluation of a complex credit union’s
capital adequacy, including the
requirement to maintain a written
capital strategy, is focused on the credit
union’s own process and strategy for
assessing and maintaining its overall
capital adequacy in relation to its risk
profile. The supervisory evaluation may
include various factors—such as
whether the credit union is engaged in
merger activity, entering into new
activities, introducing new products,
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
operating in a challenging economic
environment, engaged in nontraditional
activities, or exposed to other risks like
interest rate risk or operational risks.
The assessment evaluates the
comprehensiveness and effectiveness of
the capital planning in light of its
activities. An effective capital planning
process involves an assessment of the
risk to which a credit union is exposed
and its process for managing and
mitigating those risks, an evaluation of
capital relative to those risks, and
consideration of the potential impact on
earnings and capital from current and
prospective economic conditions. Under
the proposal, the evaluation of an
individual credit union’s risk
management strategy and process will
be commensurate with the credit
union’s size, sophistication, and risk
profile—which is similar to the current
supervisory process for credit unions.
For credit unions subject to Capital
Planning and Stress Testing under
subpart E of part 702 of NCUA’s
regulations, compliance with § 702.504
will result in compliance with
§ 702.101(b). Thus, those credit unions
subject to the stress testing regulation
will not be expected to write redundant
capital plans to fulfill the requirements
of this final rule.
For other complex credit unions that
will be expected to write capital plans,
supervisory guidance will be issued to
help those credit unions evaluate their
compliance with § 702.101(b). The
supervisory guidance will also be
designed to provide consistency in the
examination process.
Accordingly, the Board has decided to
retain the proposed capital adequacy
provision in proposed § 702.101(b)(1) in
this final rule without change.
Section 702.102 Capital Classifications
Under the Second Proposal, the title
of § 702.102 would have been changed
from ‘‘statutory net worth categories’’ to
‘‘capital classifications.’’ The section
would have continued to list the five
statutory capital categories that are
provided in § 216(c) of the FCUA.102
The Board received no comments on
these revisions and has decided to
retain the proposed amendments in this
final rule without change.
102(a) Capital Categories
The Second Proposal would have
revised current § 702.102(a) to include
new minimum risk-based capital ratio
levels for complex credit unions.
Consistent with section 216(c)(1)(A)
through (E) of the FCUA, the minimum
net worth ratio levels listed in proposed
102 12
PO 00000
U.S.C. 1790d(c).
Frm 00033
Fmt 4701
Sfmt 4700
66657
§§ 702.102(a)(1) through (5) would have
continued to match the ratio levels
listed in the statute for each capital
category, and would have included both
the net worth ratio and the proposed
risk-based capital ratio as elements of
the capital categories for ‘‘well
capitalized,’’ ‘‘adequately capitalized,’’
and ‘‘undercapitalized’’ credit unions.
The new minimum risk-based capital
ratio levels included components that
required higher capital ratio levels to
reflect increased risk due to
concentration risk and credit risk.
The Original Proposal also introduced
a new, scaled approach to assigning
minimum risk-based capital ratio levels
to the capital classifications for well
capitalized, adequately capitalized, and
undercapitalized credit unions. This
scaled approach recognized the
relationship between higher risk-based
capital ratios and the creditworthiness
of credit unions.
Public Comments on the Second
Proposal
The Board received numerous general
comments concerning the capital
categories. Most of those commenters
simply stated that they opposed the
proposed two-tiered risk-based capital
requirement, believed that the Board
generally lacked the legal authority to
impose the risk-based capital
requirement as proposed, or both.
Others specifically suggested that the
language in section 216(d) of the FCUA
prohibits NCUA from adopting different
risk-based capital ratio threshold levels
for well capitalized and adequately
capitalized credit unions. At least one
commenter suggested that section
216(d)(2) expressly ties NCUA’s
statutory authority to its assessment of
whether the 6 percent net worth ratio
threshold provides ‘‘adequate
protection’’ because the term
‘‘adequately capitalized’’ used in the
section refers to the ‘‘adequately
capitalized’’ net worth category defined
in section 216(c)(1)(B)(i) of the FCUA.
The commenter suggested further that
the FCUA limits NCUA, in developing
the risk-based net worth requirement, to
considering only ‘‘whether the 6 percent
requirement provides adequate
protection’’ against the risks faced by
credit unions because section 216(d)(2)
speaks only to whether an institution is
‘‘adequately capitalized,’’ not ‘‘well
capitalized.’’ Accordingly, the
commenter concludes that NCUA lacks
the authority to implement a separate
risk-based net worth threshold level for
the ‘‘well capitalized’’ net worth
category. The commenter argued further
that the legislative history of the FCUA
suggests that section 216(d) bars NCUA
E:\FR\FM\29OCR2.SGM
29OCR2
66658
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
from implementing a separate RBC ratio
for ‘‘well capitalized’’ credit unions
because an earlier version of CUMAA
passed by the House of Representatives
provided in relevant part:
[NCUA is authorized to] establish
reasonable net worth requirements, including
risk-based net worth requirements in the case
of complex credit unions, for various
categories of credit unions and prescribe the
manner in which net worth is calculated (for
purposes of such requirements) with regard
to various types of investments, including
investments in corporate credit unions,
taking into account the unique nature and
role of credit unions.103
mstockstill on DSK4VPTVN1PROD with RULES2
The language quoted above was never
included in the Senate version of the
CUMAA legislation, which was
ultimately enacted, nor was it ever
included in the FCUA. The commenter
suggested that this legislative change
demonstrates Congress’ express
consideration and rejection of NCUA’s
proposed approach of adopting separate
RBC thresholds for ‘‘well capitalized’’
and ‘‘adequately capitalized’’ credit
unions.
Another commenter suggested that
any credit union, with a 7 percent or
higher net worth ratio, that fails to
exceed its required risk-based capital
ratio level be given consideration in any
prompt corrective action required under
the risk-based capital regulation. In such
a case, the commenter recommended
the Board limit the remedy to a capital
restoration plan that allows the credit
union a reasonable and appropriate
period of time to improve its risk-based
capital ratio—even as they maintain
their statutory net worth ratio above 7
percent.
Discussion
NCUA has the authority to impose the
proposed risk-based capital requirement
on complex credit unions. For the
reasons discussed in both the Second
Proposal and above in the legal
authority part of this preamble,
requiring credit unions to meet different
minimum risk-based capital ratio levels
to be adequately and well capitalized is
consistent with the plain language of
section 216 of the FCUA, is
‘‘comparable’’ to the Other Banking
Agencies’ PCA regulations, and takes
into account the cooperative character
of credit unions. Moreover, the Agency
is not persuaded by the language quoted
above from a prior House bill,104 which
Congress ultimately choose not to
include in CUMAA. Contrary to the
commenter’s suggestion, Congress’
103 H.R. Rep. 105–472, 1998 WL 141880, at *9
(1998).
104 H.R. Rep. 105–472, 1998 WL 141880, at *9
(1998).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
choice of language in section 216(d)
instead of the language in a prior House
version of CUMAA does not
demonstrate that Congress expressly
considered and rejected NCUA’s
proposed approach of adopting separate
RBC thresholds for well capitalized and
adequately capitalized credit unions.
Furthermore, requiring complex
credit unions to meet a higher riskbased capital ratio threshold to be
classified as well capitalized allows for
a graduated scale, which can measure
either a decline or improvement in a
credit union’s risk-based capital level in
relation to the minimum capital
requirements. Such a system provides
for earlier identification and resolution
of credit unions experiencing gradual
declines in the level of capital held on
a risk-based measure. Under the current
rule, a credit union failing the riskbased net worth requirement is
immediately subject to the mandatory
supervision action for undercapitalized
credit unions and may not have been
fully aware of their declining capital
buffer. The use of a two-tiered riskbased capital measure also allows
stakeholders and creditors, such as
uninured shareholders, to reasonably
compare financial institution capital
measures to the minimum regulatory
requirements on a risk-based level.
The Agency also questions the legality
of the suggestion to amend the final rule
to require only a capital restoration plan
in cases where a credit union fails to
meet or exceed the minimum risk-based
capital requirement, but meets or
exceeds the 7 percent net worth ratio
requirement. Such an approach was not
proposed and appears to conflict with
the mandatory restrictions on
undercapitalized credit unions under
section 216(g) of the FCUA.
Accordingly, the Board has decided to
retain the proposed capital categories in
this final rule without change.
102(a)(1) Well Capitalized
Proposed § 702.102(a)(1) required a
credit union to maintain a net worth
ratio of 7 percent or greater and, if it
were a complex credit union, a riskbased capital ratio of 10 percent or
greater to be classified as well
capitalized. The higher proposed riskbased capital requirement for the well
capitalized classification was designed
to boost the resiliency of complex credit
unions throughout financial cycles and
align them with the standards used by
the Other Banking Agencies.105
105 See,
PO 00000
e.g., 12 CFR 324.10; 324.11; and 324.403.
Frm 00034
Fmt 4701
Sfmt 4700
Public Comments on the Second
Proposal
A substantial number of commenters
speculated that the proposed risk-based
capital ratio level for well capitalized
credit unions would place credit unions
at a competitive disadvantage to banks
unless all credit unions are given the
ability to meet the 10 percent
requirement with supplemental (Tier 2)
capital, as banks are allowed to do
under their rules. The commenters
recommended the Board either delay
the final release of the risk-based capital
rule until it has developed a
supplemental capital rule or eliminate
the 10 percent risk-based capital ratio
requirement and establish a single-tier
requirement of 8 percent that aligns
with the banking industry’s Tier 1
capital requirement.
A few commenters suggested that, in
removing the effect of the capital
conservation buffer from the Original
Proposal, the Board should have
lowered the risk-based capital ratio
requirement to 8 percent, not the 10
percent in the Second Proposal. After
examining the makeup of capital at
credit unions and banks, the commenter
suggested that Tier 1 capital is most
similar because both credit union and
bank Tier 1 capital is comprised of
either equity or retained earnings, and
both bank and credit union Tier 1
capital represent the strongest form of
capital on a financial institution’s
balance sheet. Under NCUA’s Second
Proposal, credit unions could count
their ALLL towards their risk-based
capital requirement, which is similar to
banks; however, banks have the added
benefit of counting supplemental capital
as Tier 2 capital. Since NCUA has not
yet authorized all credit unions to use
secondary capital as part of their capital
base for risk-based capital purposes, the
commenter claimed the most logical
point of comparability between banks
and credit unions is Tier 1 capital. The
commenter recommended that the
Board set the risk-based capital ratio
level at 8 percent, which aligns with the
banking industry’s Tier 1 risk-based
capital ratio level for well capitalized
banks, to ensure that credit unions’ and
banks’ risk-based capital requirements
are comparable. The commenter
recommended further that such an
approach would eliminate the capital
benefit from the ALLL to ensure
comparability to the banks’ Tier 1 riskbased capital ratio requirement.
One bank trade association
commenter, however, suggested that the
Board adopt the same Basel III model
that was adopted by prudential banking
regulators. The commenter argued the
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
NCUA’s proposed model would not be
the same because under the Second
Proposal, credit unions were not
subjected to a capital conservation
buffer, which banks are. The commenter
suggested that, because of this
difference, the proposed risk-based
capital ratio level required for a credit
union to be classified as well capitalized
was 50 basis points lower than the
analogous requirement applicable to
banks under the Other Banking
Agencies’ regulations. The commenter
suggested further that credit unions,
with their ability to avoid the payment
of U.S. income taxes and retain all their
earnings, should not be subject to lower
capital requirements than banks while
managing the same risk profile as
community banks that are subject to
taxation.
Other commenters simply stated they
believed the proposal did not
sufficiently justify assigning a risk-based
capital ratio requirement for well
capitalized credit unions that is 3
percent higher than the statutory 7
percent net worth ratio level required
for a credit union to be classified as well
capitalized.
One commenter speculated that the
proposed risk-based capital ratio of 10
percent would limit the ability of credit
unions to allocate resources as they see
fit, directly impacting what credit
unions can do for their members
because credit unions need flexibility to
be successful. The commenter pointed
out that credit union management is
held accountable by fiduciary
responsibility of the Board of Directors,
while some are overseen by both
Certified Public Accountants’ opinion
audits and ongoing NCUA examination,
and are therefore in the best position to
determine the appropriate balance to
best serve the needs of their members.
the exception of a small earnings
retention requirement, are not subject to
mandatory or discretionary supervisory
actions. In contrast, credit unions that
fall to the undercapitalized category are
financially weak and are subject to
various mandatory and discretionary
supervisory actions intended to resolve
the capital deficiency and limit risk
taking until capital levels are restored to
prudent levels. The lack of graduated
thresholds in the current rule’s
construct for the risk-based net worth
requirement does not effectively provide
for early reflection through a credit
union’s net worth category, as suggested
in the GAO and OIG reports. Under the
current rule, a change in the credit
union’s risk profile, capital levels, or
both, that results in a decline in the
credit union’s risk-based net worth
ratio, does not affect its net worth
category until it results in the credit
union falling to the point where the
situation mandates that harsh
supervisory actions be taken.
The Board reasons that the more
effective approach and better policy
option is to adopt a higher threshold for
the well capitalized category than for
the adequately capitalized category to
provide a more graduated framework
where a credit union does not
necessarily drop directly from well
capitalized to undercapitalized. In fact,
this policy objective is reflected in how
Congress, in section 216(c) of the FCUA,
and the Other Banking Agencies, in
their risk-based capital regulations,
designed the graduated PCA capital
categories.
For a given risk asset, the amount of
capital required to be held for that risk
asset is calculated by multiplying the
dollar amount of the risk asset times the
risk weight times the desired capital
level. To illustrate, where the threshold
for well capitalized is 10 percent, a
Discussion
credit union that has one dollar in a risk
asset assigned a 50 percent risk weight
There are sound policy reasons for
would need to hold capital of five cents
setting a higher risk-based capital ratio
($1 multiplied by 50 percent multiplied
threshold for the well capitalized
category than the one for the adequately by 10 percent). The point of this
illustration is that the risk weights are
capitalized category. Under the current
interdependent with the thresholds set
rule, a credit union’s capital
for the regulatory capital categories. The
classification could rapidly decline
risk weights included in the Second
directly from well capitalized to
Proposal were based predominantly on
undercapitalized if it fails to meet the
those used by the Other Banking
required risk-based net worth ratio
Agencies, as suggested by credit unions
level.106 Moreover, credit unions
and other interested parties who
classified as well capitalized are
submitted comment letters in response
generally considered financially sound,
to the Original Proposal. For the total
afforded greater latitude under some
other regulatory provisions,107 and, with capital-to-risk assets ratio, the Other
Banking Agencies establish a threshold
of 10 percent to be well capitalized.108
106 Per the FCUA, ‘‘undercapitalized’’ is the
lowest PCA category in which a failure to meet the
risk-based net worth requirement can result.
107 See 12 CFR 745.9–2; and 12 CFR 723.7.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
108 The Other Banking Agencies’ Total Risk-Based
Capital ratio is the most analogous standard for
PO 00000
Frm 00035
Fmt 4701
Sfmt 4700
66659
For NCUA’s risk-based capital
requirement to be comparable, it should
also be equivalent in rigor to the Other
Banking Agencies’ risk-based capital
requirement.109 The rigor of a regulatory
capital standard is primarily a function
of how much capital an institution is
required to hold for a given type of
asset. Thus, if NCUA chose any
threshold below 10 percent for the
minimum required level of regulatory
capital, it would either result in
systematically lower incentives for
credit unions to accumulate capital or
the risk weights would need to be
adjusted commensurately to offset the
effect of the lower threshold. For
example, if a uniform threshold for both
well and adequately capitalized were
maintained and set at only 8 percent, as
some commenters suggested, there
would be a decline in the overall rigor
of the risk-based capital ratio. While
NCUA’s proposed risk weights for
various assets could be increased by 20
percent to offset this effect, adjusting the
risk weights in this manner would
create more difficulty in comparing
asset types and risk weights across
financial institutions, and lead to
misunderstanding.
Conversely, the uniform threshold
level for the well capitalized and
adequately capitalized categories could
be maintained, but raised to maintain
the rigor of the risk-based capital
standard and avoid adjusting the risk
weights. This approach would set a
higher point at which credit unions
would fall to undercapitalized (such as
any risk-based capital ratio under 10
percent), and therefore be subject to
mandatory and discretionary
supervisory actions. The Board
concluded this approach would not be
optimal, as the supervisory
consequences for credit unions with
risk-based capital ratios between eight
percent and 10 percent would be worse
than for institutions operating under the
Other Banking Agencies’ rules.
Maintaining the rigor of the risk-based
net worth requirement is also important
for another key policy objective of the
Board: Ensuring the risk-based net
worth requirement is relevant and
meaningful. A relevant and meaningful
risk-based net worth requirement will
result in capital levels better correlated
credit unions given the proposed broadening of the
definition of capital to include accounts that would
not be included in the definition of Tier 1 capital,
such as the allowance for loan and lease losses and
secondary capital for low-income designated credit
unions.
109 See S. Rep. No. 193, 105th Cong., 2d Sess.
§ 301 (1998) (‘‘ ‘Comparable’ here means parallel in
substance though not necessarily identical in detail)
and equivalent in rigor.’’).
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
66660
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
to risk, and better inform credit union
decision making.110 To be relevant and
meaningful, the risk-based net worth
requirement must result in minimum
regulatory capital levels on par with the
net worth ratio for credit unions with
elevated risk, and be the governing ratio
(require more capital than the net worth
ratio) for credit unions with
extraordinarily high risk profiles. If the
highest threshold for the risk-based
capital ratio were set as low as 8 percent
for well capitalized credit unions, as
some commenters suggested, the riskbased net worth requirement would
govern very few, if any, credit unions.
If the highest risk-based capital ratio
threshold were set at 8 percent, NCUA
estimates at most seven credit unions
would have the proposed risk-based
capital ratio be the governing
requirement, with only one credit union
currently holding insufficient capital to
meet the requirement.
Further, capital is a lagging indicator
because it is founded primarily on
accounting standards, which by their
nature are largely based on past
performance. The net worth ratio is
even more so a lagging indicator
because it applies capital—a lagging
measure in itself—to total assets. Thus,
the net worth ratio does not distinguish
among risky assets or changes in a
balance sheet’s composition. A riskbased capital ratio is more prospective
by accounting for asset allocation
choices and driving capital
requirements before losses occur and
capital levels decline. The more relevant
the risk-based net worth requirement is,
the more likely that credit unions will
build capital sufficient to prevent
precipitous declines in their PCA
capital classifications that could result
in greater regulatory oversight and even
failure.
To be relevant and meaningful, the
risk-based net worth requirement also
needs to encourage credit unions to
build and maintain capital as they
increase risk to be able to absorb any
corresponding unexpected losses. A
graduated, or tiered, system of capital
category thresholds that distinguishes
between the well capitalized and
adequately capitalized categories will
incentivize credit unions to hold sound
levels of capital without invoking
supervisory action before necessary.
While there is no requirement for a
credit union to be well capitalized, and
there are no supervisory interventions
required for a credit union with an
adequately capitalized classification,
110 The benefits of a capital system better
correlated to risk are discussed in the Summary of
the Final Rule part of this preamble.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
there are some regulatory privileges and
other benefits for a credit union that is
well capitalized. Chief among those
benefits is the accumulation of
sufficient capital to weather financial
and economic stress. During the 2007–
2009 financial crisis, some credit unions
experienced large losses in a
compressed timeframe, resulting in a
rapid deterioration of net worth. Some
credit unions that historically had been
classified as well capitalized were
quickly downgraded to
undercapitalized. As noted in the
Second Proposal, credit unions that
failed at a loss to the NCUSIF on average
were very well capitalized, based on
their net worth ratios, 24 months prior
to failure (average net worth ratio of
12.1 percent). Over the last 10 years,
more than 80 percent of all credit union
failures involved institutions that were
well capitalized in the 24 months
immediately preceding their failure.
Unlike the net worth ratio, which is
indifferent to the composition of assets,
a well-designed risk-based net worth
requirement should reflect material
shifts in the risk profile of assets.
A risk-based capital framework that
encourages and promotes capital
accumulation benefits not only those
credit unions that achieve the wellcapitalized classification, but the entire
credit union system. Thus, the Board
remains committed to implementing the
risk-based requirement under a
graduated (multi-tiered) capital category
framework.
The Board agrees with the
commenters who suggested that a 10
percent risk-based capital ratio
threshold would simplify the
comparison with the Other Banking
Agencies’ rules by removing the effect of
the capital conservation buffer. The 10
percent threshold for well capitalized
credit unions, along with the 8 percent
threshold for adequately capitalized
credit unions, would also be consistent
with the total risk-based capital ratio
requirements contained in the Other
Banking Agencies’ capital rules.
Capital ratio thresholds are largely a
function of risk weights. As discussed in
other parts of this final rule, the Board
is now more closely aligning NCUA’s
risk weights with those assigned by the
Other Banking Agencies. Therefore, for
consistency, the Board reasons that
NCUA’s risk-based capital ratio
threshold levels should likewise align
with those of the Other Banking
Agencies as closely as possible.
The Board plans to address additional
forms of supplemental capital in a
separate proposed rule, with the intent
to finalize a new supplemental capital
rule before the effective date of this risk-
PO 00000
Frm 00036
Fmt 4701
Sfmt 4700
based capital final rule. Therefore there
is no need to delay release of this final
rule. The Board notes the second riskbased capital proposal invited general
comment on supplemental capital much
in the way an advanced notice of
proposed rulemaking would do. A
notice of proposed rulemaking on
supplemental capital with specific
criteria and requirements is necessary
under the Administrative Procedure Act
before the Board could issue a final rule.
Issuing a new, more specific and
detailed proposed rule on supplemental
capital will give interested parties full
opportunity to comment on it.
Accordingly, the Board has decided to
retain proposed § 702.102(a)(1) in this
final rule without change.
102(a)(2) Adequately Capitalized
Under the Second Proposal,
§ 702.102(a)(2) required a credit union
to maintain a net worth ratio of 6
percent or greater and, if it were a
complex credit union, a risk-based
capital ratio of 8 percent or greater to be
classified as adequately capitalized.
This risk-based capital ratio level is
comparable to the 8 percent total riskbased capital ratio level required by the
Other Banking Agencies for a bank to be
adequately capitalized.
Other than the comments discussed
above and in other parts of this
preamble, the Board received no
comments on the proposed adequately
capitalized risk-based capital ratio level.
Therefore, the Board has decided to
retain proposed § 702.102(a)(2) in this
final rule without change.
102(a)(3) Undercapitalized
Under the Second Proposal,
§ 702.102(a)(3) would have classified a
credit union as undercapitalized if: (1)
The credit union has a net worth ratio
of 4 percent or more but less than 6
percent; or (2) the credit union, if
complex, has a risk-based capital ratio
of less than 8 percent.
Other than the comments discussed
above and other parts of this preamble,
the Board received no comments on the
proposed undercapitalized risk-based
capital ratio requirement. Therefore, the
Board has decided to retain proposed
§ 702.102(a)(3) without change.
102(a)(4) Significantly Undercapitalized
Under the Original Proposal,
proposed § 702.102(a)(4) would have
classified a credit union as significantly
undercapitalized if:
• The credit union has a net worth
ratio of 2 percent or more but less than
4 percent; or
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
• The credit union has a net worth
ratio of 4 percent or more but less than
5 percent, and either—
o Fails to submit an acceptable net
worth restoration plan within the time
prescribed in § 702.111;
o Materially fails to implement a net
worth restoration plan approved by the
Board; or
o Receives notice that a submitted net
worth restoration plan has not been
approved.
The Board received no comments on
the revisions to this paragraph and has
decided to retain the proposed
amendments in this final rule without
change.
102(a)(5) Critically Undercapitalized
Under the Second Proposal,
§ 702.102(a)(5) classified a credit union
as critically undercapitalized if it had a
net worth ratio of less than 2 percent.
The Second Proposal would have also
made some minor technical
amendments to the language in current
§ 702.102(a)(5), but would not have
changed the criteria for being classified
as critically undercapitalized under part
702.
The Board received no comments on
the revisions to this paragraph and has
decided to retain the proposed
amendments in this final rule without
change.
102(b) Reclassification Based on
Supervisory Criteria Other Than Net
Worth
The Second Proposal would have
retained current § 702.102(b), with only
a few amendments to update
terminology and make minor edits for
clarity. No substantive changes were
intended.
The Board received no comments on
the revisions to this paragraph and has
decided to retain the proposed
amendments in this final rule without
change.
102(c) Non-Delegation
Proposed § 702.102(c) would have
been unchanged from current
§ 702.102(c).
The Board received no comments on
this paragraph and has decided to retain
the paragraph in this final rule without
change.
mstockstill on DSK4VPTVN1PROD with RULES2
102(d) Consultation With State Officials
Proposed § 702.102(d) would have
retained current § 702.102(d) with only
non-substantive amendments for
consistency with other sections of
NCUA’s regulations. No substantive
changes were intended.
The Board received no comments on
this paragraph and has decided to retain
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
the proposed amendments in this final
rule without change.
Section 702.103 Applicability of the
Risk-Based Capital Ratio Measure
The Second Proposal would have
changed the title of current § 702.103
from ‘‘Applicability of risk-based net
worth requirement’’ to ‘‘Applicability of
risk-based capital ratio measure.’’
Proposed § 702.103 would have
provided that, for purposes of § 702.102,
a credit union is defined as ‘‘complex’’
and the risk-based capital ratio measure
is applicable only if the credit union’s
quarter-end total assets exceed $100
million, as reflected in its most recent
Call Report.
Public Comments on the Second
Proposal
The Board received a large number of
comments on proposed § 702.103.
Several commenters argued that the
FCUA requires the Board to define
‘‘complex’’ credit unions based on the
‘‘portfolios of assets and liabilities of
credit unions,’’ and that the proposed
use of an asset size threshold to define
‘‘complex’’ credit unions would not
comply with the statutory requirement.
A substantial number of commenters
also stated that they opposed the
proposed definition of ‘‘complex’’ credit
union because they believed asset size
should not be a primary qualifier of a
credit union’s complexity.
At least one trade association
commenter, however, acknowledged
that an asset threshold proxy, while less
precise than individual balance sheet
analysis, would allow for a streamlined
application of the rule and would
minimize opportunities for arbitrage.
The commenter suggested that if the
definition of ‘‘complex’’ were tied to
specific activities, credit unions could
be incentivized, on the margin, to
simply avoid those activities in order to
avoid the risk-based capital
requirements. And such conduct could
have unintended consequences and
create new unanticipated risks to capital
adequacy. Similarly, at least one credit
union commenter stated that using an
asset size threshold to define complex
credit unions would give credit unions
a bright line test and eliminate the
difficulty of having to anticipate what
products and services should be
classified as complex. Another credit
union commenter suggested that a rule
that identified specific types of lending
activity that made an institution
complex might mask undue
concentration risk.
A substantial number of commenters
suggested that asset size, if used in the
final rule, should be raised to some
PO 00000
Frm 00037
Fmt 4701
Sfmt 4700
66661
amount above $100 million. Specific
threshold amounts suggested by
commenters ranged from $250 million
to $10 billion. Several commenters
speculated that refining the complexity
analysis and raising the asset size
threshold would not considerably
increase the risk to the Share Insurance
Fund because by the time the final rule
is implemented in 2019, an even greater
percentage of system assets would be
covered. Other commenters maintained
that the final rule should only apply to
credit unions that meet the same asset
size threshold used by the Other
Banking Agencies to define small banks.
One commenter suggested that the
Board should align the definitions of
‘‘complex’’ credit union across all of
NCUA’s regulations so they are the
same, and, at a minimum, the Board
should increase the threshold to $250
million to be consistent with the
definition in the derivatives regulation.
Some commenters contended that the
proposed list of assets and liabilities
identified as complex were much too
broad. One commenter suggested that
Congress limited the application of riskbased capital to complex credit
unions 111 and directed NCUA to design
the risk-based capital standard to
protect against material risks that may
not be adequately captured by the net
worth ratio requirement 112 because
Congress intended that credit unions be
designated as ‘‘complex’’ based on only
their involvement in high-risk activities
that the net worth ratio requirement
may not account for. The commenter
noted further that the list of complex
assets and liabilities used by the Board
to set the asset size threshold at $100
million included several standard
activities that are already contemplated
by the statutory net worth ratio
requirement. The commenter believed,
for example, that real estate loans,
investments with maturities greater than
five years, and internet banking are
staple activities of financial services
institutions in today’s marketplace and
should not be considered complex; and
that other activities only become
complex when undertaken in significant
volumes—for example, a credit union
that lends a member $60,000 to
purchase new equipment for his bakery
is engaged in member business lending,
but that credit union should not be
designated as complex by virtue of that
single loan. The commenter contended
that the size of the portfolio and its
significance to the credit union’s overall
business strategy drives complexity; so
the commenter concluded that member
111 12
112 12
E:\FR\FM\29OCR2.SGM
U.S.C. 1790d(d)(1).
U.S.C. 1790d(d)(2).
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
66662
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
business, indirect, interest-only, and
participation loans should only indicate
complexity where the activity exceeds a
certain percentage of total assets, and
borrowings should only denote
complexity where they constitute a
significant element of the credit union’s
funding strategy. Other commenters
suggested that a credit union be defined
as ‘‘complex’’ only if it engages in three
or more of the following assets or
liabilities: Member business loans,
participation loans, interest-only loans,
indirect loans, non-federally guaranteed
student loans, borrowings, and
derivatives. Still other commenters
suggested that the definition of
‘‘complex’’ be based on the following
activities: Participation loans, interestonly loans, indirect loans, real estate
loans, non-agency mortgage backed
securities, non-mortgage related
securities with embedded options,
collateralized mortgage obligations/real
estate mortgage investment conduits,
commercial mortgage-related securities,
and derivatives.
In addition, commenters argued that
because they do not adequately
represent complexity, the Board should
not use the following assets or
liabilities: Real estate loans, obligations
fully guaranteed by the U.S.
Government, investments with
maturities of greater than five years,
non-agency mortgage-backed securities,
non-mortgage-related securities with
embedded options, collateralized
mortgage obligations/real estate
mortgage investment conduits,
commercial mortgage-related securities,
and internet banking. In addition, one
commenter argued that internet
banking, a service that credit unions
provide, is neither an asset nor a
liability so the FCUA bars NCUA from
considering internet banking when
considering complexity.
One commenter recommended that
the asset size threshold should be set
where all or most credit unions are
engaged in four or more of the activities
the Board identifies as complex. The
commenter claimed that the FCUA,
which requires NCUA to specify which
credit unions are ‘‘complex’’ based on
the portfolios of assets and liabilities of
credit unions,113 prohibits a credit
union from being classified based on a
single complex activity.
Another commenter suggested that
using an asset size threshold alone to
define complexity was appropriate and
that the presence of more complex
lending products should not necessarily
define a complex credit union because
financial institutions in general become
113 12
U.S.C. 1790(d)(1).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
more complex with size and by moving
into more complex/sophisticated
financial transactions such as mortgagebacked securities, derivatives, loan sales
or purchases, mortgage pipelines and
servicing assets. The commenter
suggested that these types of financial
transactions are not ordinary in smaller
asset size institutions because they
generally require more scale and
overhead of a larger institution to
manage and understand.
Other commenters recommended that
the Board define complexity using a
credit union’s product offerings, in a
manner similar to that used in the
current rule. The commenters suggested
that the most analogous approach would
be a ratio of risk-weighted assets to total
assets greater than 67 percent as
measure by the proposal’s risk weights.
At least one of those commenters,
however, acknowledged that the 67
percent threshold might not be a
meaningful measure of risk, but that
using different thresholds yielded
similar results.
At least one commenter suggested that
all federally insured credit unions with
assets of $500 million or less should be
excluded from the definition of
‘‘complex,’’ and that only those credit
unions with $500 million or more in
assets and that have an NCUA
Complexity Index (discussed in the
Supplementary Information to the
Original Proposal) value of 17 or higher
should be required to meet NCUA’s riskbased capital requirement. Similarly,
another commenter suggested that all
federally insured credit unions with
assets of $500 million or less should be
excluded from the definition of
‘‘complex,’’ and that only those credit
unions with $500 million or more in
assets and that have an NCUA
Complexity Index value of 20 or higher
should be required to meet NCUA’s riskbased capital requirement. Yet another
commenter suggested that all federally
insured credit unions with assets of $1
billion or less should be excluded from
the definition of ‘‘complex,’’ and that
only those credit unions with assets
above $1 billion and that have an NCUA
Complexity Index value of 20 or higher
should be required to meet NCUA’s riskbased capital requirement.
Additional suggestions provided by
commenters for defining credit unions
as ‘‘complex’’ included:
• Defining ‘‘complex’’ with attributes
such as deposit account features,
member services, loan and investment
products, and portfolio makeup.
• Defining ‘‘complex’’ based on
whether a credit union engages in a
combination of activities including,
participation loans, non-agency
PO 00000
Frm 00038
Fmt 4701
Sfmt 4700
mortgage-backed securities, repurchase
transactions, and derivatives.
• Defining ‘‘complex’’ as credit
unions with over $100 million or more
in assets and that provide member
business loans and invest in derivatives.
• Defining ‘‘complex’’ as credit
unions with $500 million or more in
assets and/or that are engaged in over 50
percent of all of the categories,
especially the investment section, noted
in the preamble to the Second Proposal.
• Defining ‘‘complex’’ as credit
unions with $500 million or more in
assets, and that invest in non-agency
mortgage-backed securities and nonmortgage related securities with
embedded options.
As an alternative, one trade
organization commenter suggested that
with credit unions exiting an extreme
financial crisis where many of these
institutions failed due to lack of highquality capital and elevated risk
profiles, the Board should be focusing
its attention on raising the minimum
regulatory capital levels for all credit
unions.
Other credit union commenters
argued that the risk-based capital
requirements should apply to all credit
unions because recent data on credit
union failures contradict claims that
there is less risk in credit unions with
less than $100 million in assets.
Granted, the commenters suggested, in
rural areas and in a few other special
circumstances, small credit unions play
a crucial role, and in such cases NCUA
should offer waivers. A small credit
union commenter suggested that many
credit unions with $100 million or less
in assets have the same, and often times
more, risk on their balance sheets and
in their operations than credit unions
with over $100 million in assets. The
commenter believed that smaller credit
unions engage in complex activities for
the following reasons: (1) If they do not
offer products and services that the
bigger credit unions do, their members
will leave and the credit unions will
(eventually) be forced to merge (not an
outcome they wanted); (2) they need
products that increase their income and
capital (e.g., business loans,
participation loans, and indirect
lending); (3) they recognize they do not
have the expertise they should have but
it is expensive and hard to attract
expertise based on their compensation
structure. Another credit union
commenter claimed that smaller credit
unions have failed at a higher rate and
have had a higher incidence of
catastrophic failure due to a lack of
comprehensive internal management
and process controls that can lead to
fraud. The commenter maintained that a
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
credit union charter is a privilege and
not a right and that all credit unions
should be subject to the same risk-based
capital requirements and examination
standards.
One commenter suggested that it is
very likely that a small credit union
could pose a much larger risk to the
NCUSIF than a larger credit union, and
that using asset size as a threshold for
complexity suggests that capital is not
as critical for smaller institutions. The
commenter suggested further that
‘‘complexity’’ should be defined based
on the quality of the management of the
risks undertaken by the institution,
which is ideally measured by the ‘‘M’’
in the CAMEL rating. The commenter
recommended that identifying the credit
unions to which the risk-based capital
requirement applies is best done
through the supervision process so that
those credit unions posing a higher risk
to the NCUSIF have higher standards
and expectations by which to abide. The
commenter suggested that this solution
would reduce the ‘‘broad-brush’’ effect
of the current proposal, applying more
stringent standards to those institutions
that may benefit from regulatory risk
management and thus provide greater
protection to the NCUSIF.
A significant number of commenters
requested that the asset size threshold,
if used, be indexed so that it does not
apply to smaller and smaller credit
unions through time due to inflation.
And at least one commenter suggested
that any credit union that is identified
as ‘‘complex’’ by NCUA should be able
to present evidence to the agency as to
why it is not complex and thus, should
not be subject to risk-based capital
requirements. The commenter suggested
further that the process for contesting an
agency designation of ‘‘complex’’
should be detailed in the final rule.
Discussion
The proposed use of an asset size
threshold to define ‘‘complex’’ does
comply with section 216 of the FCUA.
As discussed in the Legal Authority part
of this preamble, section 216(d)(1)
directs NCUA, in determining which
credit unions will be subject to the riskbased net worth requirement, to base its
definition of complex ‘‘on the portfolios
of assets and liabilities of credit
unions.’’ 114 The statute does not
require, as some commenters have
argued, that the Board adopt a definition
of ‘‘complex’’ that takes into account the
portfolio of assets and liabilities of each
credit union on an individualized basis.
Rather, section 216(d)(1) authorizes the
Board to develop a single definition of
114 12
U.S.C. 1790d(d).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
‘‘complex’’ that takes into account the
portfolios of assets and liabilities of all
credit unions. Consistent with section
216(d)(1), the proposed definition of a
‘‘complex’’ credit union included an
asset size threshold that, as explained in
more detail below, was designed by
taking into account the portfolios of
assets and liabilities of all credit unions.
Under the current rule, credit unions
are ‘‘complex’’ and subject to the riskbased net worth requirement only if
they have quarter-end total assets over
$50 million and they have a risk-based
net worth ratio over 6 percent. In effect,
this means that all credit unions with
over $50 million in assets compute the
risk-based net worth requirement to
determine if they meet the complex
definition.
For reasons described more fully
below, the Board maintains that
defining the term ‘‘complex’’ credit
union using a single asset size threshold
of $100 million as a proxy for a credit
union’s complexity is accurate, reduces
the complexity of the rule, provides
regulatory relief for smaller institutions,
and eliminates the potential unintended
consequences of having a checklist of
activities that would determine whether
or not a credit union is subject to the
risk-based capital requirement.
Under the Second Proposal, the term
‘‘complex’’ was defined only for
purposes of the risk-based capital ratio
measure. For the purpose of defining a
complex credit union, assets include
tangible and intangible items that are
economic resources (products and
services) that are expected to produce
economic benefit (income), and
liabilities are obligations (expenses) the
credit union has to outside parties. The
Board recognizes there are products and
services—which under GAAP are
reflected as the credit unions’ portfolio
of assets and liabilities 115—in which
credit unions are engaged that are
inherently complex based on the nature
of their risk and the expertise and
operational demands necessary to
manage and administer such activities
effectively. Thus, credit unions offering
such products and services have
complex portfolios of assets and
liabilities for purposes of NCUA’s riskbased net worth requirement.
Consistent with the Second Proposal,
the following products and services, if
115 Products and services comprise a portfolio of
assets and liabilities through the accounts and fixed
assets that must be maintained to operate, the
resources of staff and funds necessary to operate the
credit union, and the liabilities that may arise from
contractual obligations, among other things.
Altogether, these products and services are
accounted for on the balance sheet through the
assets and liabilities according to GAAP.
PO 00000
Frm 00039
Fmt 4701
Sfmt 4700
66663
engaged in by a credit union, are
accurate indicators of complexity:
• Member Business Loans
• Participation Loans
• Interest-Only Loans
• Indirect Loans
• Real Estate Loans
• Non-Federally Guaranteed Student
Loans
• Investments with Maturities of
Greater than Five Years (where the
investments are greater than one
percent of total assets)
• Non-Agency Mortgage-Backed
Securities
• Non-Mortgage-Related Securities With
Embedded Options
• Collateralized Mortgage Obligations/
Real Estate Mortgage Investment
Conduits
• Commercial Mortgage-Related
Securities
• Borrowings
• Repurchase Transactions
• Derivatives
• Internet Banking
NCUA’s review of Call Report data as
of June 30, 2014 and March 31, 2015,
showed that all credit unions with more
than $100 million in assets were
engaged in offering at least one of the
products and services listed above; 99
percent engaged in two or more
complex activities, and 87 percent
engaged in four or more. On the other
hand, less than two-thirds of credit
unions below $100 million in assets
were involved in even a single complex
activity, and only 15 percent had four or
more. Moreover, credit unions with total
assets of less than $100 million are only
a small share (approximately 10
percent) of the overall assets in the
credit union system—which limits the
exposure of the Share Insurance Fund to
these institutions. Accordingly, a $100
million asset size threshold is a clear
demarcation above which complex
activities are always present, and where
credit unions are almost always engaged
in multiple complex activities.
Additionally, the percentage of credit
unions engaged in multiple activities
using asset size thresholds above $100
million does not produce a significant
demarcation between credit unions
when compared to the differences
observed at the $100 million threshold.
Conversely, using a credit union’s
percentage of risk assets to total assets
as the factor for determining whether
the credit union is complex would
require all credit unions to understand,
monitor, and apply a complex measure
their risk asset to asset ratio each
quarter. This would be an additional
and unnecessary burden for credit
unions below the $100 million asset size
threshold.
E:\FR\FM\29OCR2.SGM
29OCR2
66664
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
As discussed earlier, $100 million in
assets is an accurate proxy for
complexity based on credit unions’
portfolios of assets and liabilities. It is
logical, clear, and easy to administer.
Based on December 31, 2014 Call Report
data, this approach exempts
approximately 76 percent of credit
unions from the regulatory burden
associated with complying with the
risk-based net worth requirement and
capital adequacy plan, while still
covering 90 percent of the assets in the
credit union system. It is also consistent
with the fact that the majority of losses
(68 percent as measured as a proportion
of the total dollar cost) 116 to the
NCUSIF spanning the last 12 years have
come from credit unions with assets
greater than $100 million.117
Accordingly, consistent with
requirements of § 216(d)(1) of the FCUA,
the final rule eliminates current
§ 702.103(b) and defines all credit
unions with over $100 million in assets
as ‘‘complex.’’
Section 702.104
Ratio
Risk-Based Capital
mstockstill on DSK4VPTVN1PROD with RULES2
Under the Second Proposal, the Board
proposed changing the title of current
§ 702.104 from ‘‘Risk portfolio defined’’
to ‘‘Risk-based capital ratio.’’ In
addition, the Board proposed entirely
replacing the requirements for
calculating the risk-based net worth
requirement for ‘‘complex’’ credit
unions under current § 702.104 with a
new risk-based capital ratio measure.118
The proposed section would have
required all ‘‘complex’’ credit unions to
calculate their risk-based capital ratio as
directed under the section. The
proposed risk-based capital ratio was
designed to enhance sound capital
management and help ensure that credit
unions maintain adequate levels of lossabsorbing capital going forward,
strengthening the stability of the credit
union system and ensuring credit
unions serve as a source of credit in
times of stress.
116 Based on an analysis of loss and failure data
collected by NCUA.
117 NCUA performed backtesting analysis of Call
Report and failure data to determine whether this
final regulation would have resulted in earlier
identification of emerging risks and possibly
reduced losses to the NCUSIF. The impact of the
final rule on more recent failures of credit unions
with total assets over $100 million was also
evaluated. The testing revealed that maintaining a
risk-based capital ratio in excess of 10 percent
would have triggered eight out of nine such failing
credit unions to hold additional capital, which
could have prevented failure or reduced losses to
the NCUSIF.
118 12 U.S.C. 1790d(d).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Public Comments on the Second
Proposal
NCUA received many general
comments on the proposed § 702.104.
Many commenters simply stated that
they opposed the new risk-based capital
ratio measure altogether, and preferred
maintaining the current risk-based net
worth measure. Others objected to
specific aspects of the calculation,
which are discussed in more detail
below.
Discussion
As discussed above and in more detail
below, the proposed changes are
necessary to provide a more comparable
measure of capital across all financial
institutions and to better account for
related elements of the financial
statement that are available to cover
losses and protect the NCUSIF. The
proposed risk-based capital ratio
employed the method for computing the
risk-based capital measures used by the
Other Federal Banking Agencies: A
higher ratio reflects the existence of a
higher level of funds available to cover
losses in relation to risk-weighted
assets. Because the risk weights in the
final rule are generally comparable to
those used by banks, the risk-based
capital ratio will allow an interested
party to compare risk-based capital
measures across institutions to obtain a
relative measure of their financial
strength. Additionally, the current riskbased net worth requirement assigns
high risk weights to low-credit-risk
assets to account for interest rate risk—
such as investments in Treasury
securities with maturities in excess of
five years—which results in a higher
risk-based capital requirement for credit
unions holding these types of lowcredit-risk investments. Thus, the Board
concluded it is no longer appropriate to
retain NCUA’s current risk-based net
worth measure.
Consistent with the Second Proposal,
this final rule changes the title of
current § 702.104 from ‘‘Risk portfolio
defined’’ to ‘‘Risk-based capital ratio.’’
In addition, this final rule entirely
replaces the requirements for
calculating the risk-based net worth
ratio for ‘‘complex’’ credit unions under
current § 702.104 with a new risk-based
capital ratio measure.119
104(a) Calculation of Capital for the
Risk-Based Capital Ratio
Under the Second Proposal,
§ 702.104(a) provided that to determine
its risk-based capital ratio, a complex
credit union must calculate the
percentage, rounded to two decimal
119 12
PO 00000
U.S.C. 1790d(d).
Frm 00040
Fmt 4701
Sfmt 4700
places, of its risk-based capital ratio
numerator as described in § 702.104(b)
to its total risk-weighted assets as
described in § 702.104(c). The proposed
method of calculating risk-based capital
was generally consistent with the
methods used in other sectors of the
financial services industry.
Other than the comments discussed
elsewhere in the preamble, the Board
received no comments on the proposed
revisions to this paragraph and has
decided to retain the amendments in
this final rule without change.
104(b) Risk-Based Capital Ratio
Numerator
Under the Second Proposal,
§ 702.104(b) provided that the riskbased capital ratio numerator is the sum
of certain specific capital elements
listed in § 702.104(b)(1), minus
regulatory adjustments listed in
§ 702.104(b)(2).
Other than the comments discussed
elsewhere in the preamble, the Board
received no comments on the proposed
revisions to this paragraph and has
decided to retain the amendments in
this final rule without change.
104(b)(1) Capital Elements of the RiskBased Capital Ratio Numerator
Under the Second Proposal,
§ 702.104(b)(1) listed the capital
elements of the risk-based capital ratio
numerator as follows: Undivided
earnings (including any regular reserve);
appropriation for non-conforming
investments; other reserves; equity
acquired in merger; net income; ALLL;
secondary capital accounts included in
net worth (as defined in § 702.2); and
section 208 assistance included in net
worth (as defined in § 702.2). Consistent
with the Second Proposal,
§ 702.104(b)(1) listed the elements of the
risk-based capital ratio numerator.
Public Comments on the Second
Proposal
The Board received a significant
number of comments suggesting various
amendments or additions to the capital
elements included in the Second
Proposal, which are discussed in more
detail below.
Discussion
The Board generally disagrees with
the comments concerning capital
elements and has, for the reasons
discussed in more detail below, decided
to retain the language in proposed
§ 702.104(b)(1) in this final rule. The
Board proposed § 702.104(b)(1) to
provide for a more comparable measure
of capital across all financial
institutions and better account for
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
related elements of the financial
statement that are available (or not) to
cover losses and protect the NCUSIF. As
explained above, the FCUA gives NCUA
broad discretion in designing the riskbased net worth requirement.
Accordingly, this final rule incorporates
the proposed broadened definition of
capital for purposes of calculating the
new risk-based capital ratio.
Undivided Earnings
The Second Proposal included
undivided earnings in the risk-based
capital ratio numerator. The Board
received no comments on the inclusion
of this capital element in the risk-based
capital ratio numerator. Accordingly,
the Board has decided to retain this
aspect of the Second Proposal in this
final rule without change.
Appropriation for Nonconforming
Investments
The Second Proposal included the
appropriation for nonconforming
investments in the risk-based capital
ratio numerator. The Board received no
comments on the inclusion of this
capital element in the risk-based capital
ratio numerator. Accordingly, the Board
has decided to retain this aspect of the
Second Proposal in this final rule
without change.
mstockstill on DSK4VPTVN1PROD with RULES2
Other Reserves
The Original Proposal included other
reserves in the risk-based capital ratio
numerator. The Board received no
comments on the inclusion of this
capital element in the risk-based capital
ratio numerator. Accordingly, the Board
has decided to retain this aspect of the
Second Proposal in this final rule
without change.
Equity Acquired in Merger
Under the Second Proposal, the riskbased capital ratio numerator included
the equity acquired in merger
component of the balance sheet. This
equity item was used in place of the
total adjusted retained earnings
acquired through business combinations
amount that credit unions currently
report on the PCA net worth calculation
worksheet in the Call Report. Equity
acquired in merger is the GAAP equity
recorded in a business combination and
can vary from the amount of total
adjusted retained earnings acquired
through business combinations, which
is not a GAAP accounting item. The use
of equity acquired in a merger, as
measured using GAAP, more accurately
reflects the overall value of the business
combination transaction.
The Board received no comments on
the inclusion of this capital element in
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
the risk-based capital ratio numerator.
Accordingly, the Board has decided to
retain this aspect of the Second Proposal
in this final rule without change.
Net Income
The Second Proposal included net
income in the risk-based capital ratio
numerator. The Board received no
comments on the inclusion of this
capital element in the risk-based capital
ratio numerator. Accordingly, the Board
has decided to retain this aspect of the
Second Proposal in this final rule
without change.
ALLL
The Second Proposal included the
total amount of the ALLL, maintained in
accordance with GAAP, in the riskbased capital ratio numerator. Credit
unions already expense through the
income statement the expected credit
losses on the loan portfolio. In times of
financial stress, while risk may be
increasing (such as rising non-current
loans), an uncapped inclusion of the
ALLL in the risk-based capital ratio
numerator would allow a properly
funded ALLL to somewhat offset the
impact of the financial stressors on the
risk-based capital ratio.
Public Comments on the Second
Proposal
The vast majority of commenters who
mentioned the treatment of ALLL stated
that they agreed with its proposed
treatment in the Second Proposal. A few
commenters, however, did argue that
the ALLL should be limited to 1.25
percent of risk assets in determining the
risk-based capital ratio numerator.
These commenters suggested that if the
loan loss reserves are established for
identified losses, then they do not
possess the essential characteristic of
capital—the ability to absorb
unidentified losses—and should not be
included in the capital base. The
commenters suggested further that
because it is not always possible to
clearly distinguish between identified
and unidentified losses, the Other
Banking Agencies capped the amount of
ALLL being counted as capital at 1.25
percent of risk assets. These
commenters argued further that limiting
ALLL to 1.25 percent of risk assets
would not create a disincentive for
complex credit unions to fully fund the
ALLL above the 1.25 percent ceiling
because complex credit unions are
bound by generally accepted accounting
principles to fully fund their ALLL, so
not doing so would constitute an unsafe
and unsound practice. Finally, these
commenters argued that removing the
1.25 percent cap on ALLL would
PO 00000
Frm 00041
Fmt 4701
Sfmt 4700
66665
overstate the amount of capital that
complex credit unions have available to
absorb unexpected losses, and would
make the comparison between bank and
credit union risk-based capital ratios
more difficult.
Discussion
The Board disagrees with the
commenters who suggested that the ALL
should be limited to 1.25 percent of risk
assets. All of the ALLL, maintained in
accordance with GAAP, should be
included in the risk-based capital ratio
numerator because credit unions will
have already expensed, through the
income statement, the expected credit
losses on the loan portfolio. In times of
financial stress, while risk may be
increasing (such as rising non-current
loans), an uncapped inclusion of the
ALLL in the risk-based capital ratio
numerator will allow a properly funded
ALLL to somewhat offset the impact of
the financial stressors on the risk-based
capital ratio. Further, NCUA’s
supervision process can address any
concerns with inclusion of the ALLL,
such as ensuring proper funding.
Accordingly, the Board has decided to
retain this aspect of the Second Proposal
in this final rule without change.
Secondary Capital Accounts
The Second Proposal included
secondary capital accounts included in
net worth (as defined in § 702.2) in the
risk-based capital ratio numerator.
While there was overwhelming
support for allowing credit unions to
count secondary capital accounts in the
risk-based capital ratio numerator
(including support for access for
additional forms of supplemental
capital), the Board received no
comments opposing its inclusion.
Accordingly, the Board has decided to
retain this aspect of the Second Proposal
in this final rule without change.
The Board plans to address comments
supporting additional forms of
supplemental capital in a separate
proposed rule, with the intent to finalize
a new supplemental capital rule before
the effective date of this risk-based
capital final rule.
Section 208
Assistance
The Second Proposal included section
208 assistance that is included in net
worth (as defined in § 702.2) in the riskbased capital ratio numerator.
The Board received no comments on
the inclusion of this capital element in
the risk-based capital ratio numerator.
Accordingly, the Board has decided to
retain this aspect of the Second Proposal
in this final rule without change.
E:\FR\FM\29OCR2.SGM
29OCR2
66666
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
Call Report Equity Items Not Included
in the Risk-Based Capital Ratio
Numerator
Under the Second Proposal, the riskbased capital ratio numerator did not
include the following Call Report equity
items: Accumulated unrealized gains
(losses) on available for sale securities;
accumulated unrealized losses for other
than temporary impairment (OTTI) on
debt securities; accumulated unrealized
net gains (losses) on cash flow hedges;
and other comprehensive income. In
designing the proposed rule, the Board
recognized that the items listed above
reflected a credit union’s actual loss
absorption capacity at a specific point in
time, but included gains or losses that
may or may not be realized. The Board
also recognized that including these
items in the risk-based ratio numerator
could lead to volatility in the risk-based
capital ratio measure, difficulty in
capital planning and asset-management,
and other unintended consequences.120
The Board received no comments on
the exclusion of these elements in the
risk-based capital ratio numerator.
Accordingly, the Board has decided to
retain this aspect of the Second Proposal
in this final rule without change.
mstockstill on DSK4VPTVN1PROD with RULES2
Other Supplemental Forms of Capital
Under the Second Proposal,
supplemental forms of capital, other
than those discussed above, were not
included in the risk-based capital ratio
numerator. The Board, however, did
specifically request comment on
specific detailed questions regarding
whether revisions should be made to
NCUA’s regulations through a separate
rulemaking to allow additional
supplemental forms of capital to be
included in the risk-based capital ratio.
Public Comments on the Second
Proposal
A majority of the commenters who
mentioned supplemental capital stated
that it was imperative the Board
consider allowing credit unions ready
access to additional supplemental forms
of capital. Commenters suggested it was
particularly important as risk-based
capital goes into effect, as credit unions
are at a disadvantage in the financial
market because of lack of access to
additional capital outside of retained
earnings. Commenters suggested that if
supplemental capital were to count
toward regulatory capital, it would
benefit the credit union by allowing it
to expand products and services
120 The
Other Banking Agencies’ regulatory
capital rules allow institutions to make an opt-out
election for similar accounts. See, e.g., 12 CFR
324.22; and 78 FR 55339 (Sept. 10, 2013).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
without diluting its regulatory capital,
and it would protect the NCUSIF by
incentivizing credit unions to attract
private capital that could absorb losses
before causing a loss to the Insurance
Fund.
Some commenters suggested further
that the Board include (as a placeholder
in this final rule) supplemental forms of
capital, as defined by the Board and
approved by NCUA or the appropriate
state supervisory authority, in the riskbased capital numerator. Those
commenters suggested the specific
criteria could then be developed
between finalizing the rule and its
effective date in 2019.
Other commenters acknowledged that
because Congress did not speak directly
to the calculation of risk-based capital,
the Board need not be limited by section
216(0)(2) of the FCUA in defining what
elements, including supplemental
capital, constitute the ratio. Several
commenters, however, suggested that
not allowing all credit unions to use
additional supplemental forms of
capital to meet their risk-based capital
requirements would create a more
stringent capital requirement for credit
unions, which would place credit
unions at a competitive disadvantage to
banks. One commenter argued the Board
failed to meet the requirement to
establish a capital framework that is
comparable to the Other Banking
Agencies because credit unions will be
disadvantaged to banks.
Other commenters recommended that
the Board delay the publication of the
final risk-based capital rule so that it
can coincide with the publication of a
final supplemental capital rule.
Discussion
Consistent with the Second Proposal,
this final rule would not include
additional supplemental forms of
capital in the risk-based capital ratio
numerator at this time.
The authorization of additional
supplemental forms of capital for
federal credit unions, and the inclusion
of such forms of capital and the various
forms of capital authorized for federally
insured state-chartered credit unions in
the risk-based capital ratio numerator, is
beyond the scope of this rulemaking.
Delaying the issuance of this final rule
until a separate supplemental capital
proposal could be issued and then
finalized, as several commenters
suggested, would only reduce the
amount of time credit unions have to
prepare to comply with this final rule.
The Board, however, appreciates the
comments requesting access to
additional supplemental forms of
capital for credit unions. Board
PO 00000
Frm 00042
Fmt 4701
Sfmt 4700
Chairman Debbie Matz has formed a
working group at NCUA to consult with
stakeholders and develop a separate
proposed rule regarding supplemental
forms of capital that could be included
in the numerator of the risk-based
capital ratio. The working group has
reviewed the comments received on this
issue, studied the alternative forms of
capital used internationally and within
the cooperative system, and obtained
additional insight from industry
practitioners who were highly interested
or experienced with alternative forms of
capital.
In the near future, the working group
plans to present its recommendations to
the Board for revisions that could be
made to NCUA’s regulations through a
separate rulemaking to allow additional
supplemental forms of capital to be
included in the risk-based capital ratio.
The Board’s intent is to finalize a new
supplemental capital rule before the
effective date of this risk-based capital
final rule.
The Board also continues to support
amending the FCUA to provide all
credit unions access to additional
supplemental forms of capital that,
subject to certain reasonable restrictions
and consumer protections, could be
counted toward a credit union’s net
worth ratio requirement and its riskbased capital requirement.
104(b)(2) Risk-Based Capital Ratio
Numerator Deductions
Under the Second Proposal,
§ 702.104(b)(2) would have provided
that the elements deducted from the
sum of the capital elements of the riskbased capital ratio numerator are: (1)
The NCUSIF Capitalization Deposit; (2)
goodwill; (3) other intangible assets; and
(4) identified losses not reflected in the
risk-based capital ratio numerator.
The Board received a significant
number of comments, which are
outlined in detail below, regarding the
capital elements that would have been
deducted from the risk-based capital
ratio numerator. However, for the
reasons explained in more detail below,
the Board has decided to retain most of
these aspects of the Second Proposal in
this final rule without change.
NCUSIF capitalization deposit. Under
the Second Proposal, the NCUSIF
capitalization deposit was subtracted
from both the numerator and
denominator of the risk-based capital
ratio.121 This treatment of the risk-based
capital ratio would not have altered the
121 See U.S. Govt. Accountability Office,
Available Information Indicates No Compelling
Need for Secondary Capital, GAO–04–849 (2004),
available at https://www.gao.gov/assets/250/
243642.pdf.
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
NCUSIF capitalization deposit’s
accounting treatment for credit unions.
mstockstill on DSK4VPTVN1PROD with RULES2
Public Comments on the Second
Proposal
The Board received many comments
expressing concerns about the Second
Proposal’s treatment of the NCUSIF
capitalization deposit. A minority of
commenters suggested that they agreed
with the proposed treatment of the
NCUSIF deposit. A majority of
commenters who mentioned the
NCUSIF deposit, however, noted that
credit unions treat their NCUSIF
capitalization deposit as an asset on
their books. Those commenters
suggested that while banks expense
their deposit insurance and can never
reclaim it, a credit union’s deposit will
be returned if it decides to liquidate,
convert to another charter, or convert to
private insurance. The commenters
recommended that the Board
acknowledge the difference in treatment
of insurance deposits between the two
systems and assign a capital value to the
NCUSIF capitalization deposit for credit
unions. Another commenter suggested
that, compared to banks, credit unions
on average have 1 percent less capital
than the net worth ratio suggests
because credit unions carry the NCUSIF
capitalization deposit as an asset: Prepaid NCUSIF premiums, which the
commenter argued should be amortized.
The commenter speculated that if credit
unions amortized their NCUSIF
premium at eight basis points per year,
it would have about the same effect as
stabilization premiums and credit
unions would, over 12 years, write off
the deposit. The commenter suggested
further that the deposit adds to the risk
in economic downturns because it poses
the danger of increased pressure on
earnings and capital during a financial
crisis. Another commenter argued that
GAAP recognizes the NCUSIF
capitalization deposit as an asset so it
does not make sense to treat the deposit
as an intangible asset given that it is
easily measured and can be returned or
refunded. Finally, some commenters
recommended that the NCUSIF
capitalization deposit be treated as a
credit union asset with a risk weighting
of 100 percent or lower.
Discussion
As stated in the Second Proposal, the
1997 U.S. Treasury Report on Credit
Unions supports NCUA’s position of
excluding the NCUSIF capitalization
deposit from the risk-based capital ratio
calculation. The Treasury report
concluded that the NCUSIF
capitalization deposit is double counted
because it is an asset on credit union
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
balance sheets and equity in the
NCUSIF.122 The Treasury noted that, in
lieu of expensing the NCUSIF
capitalization deposit, holding
additional capital is necessary to offset
the risk of loss from required credit
union replenishment. According to
comments within the 1997 Treasury
report, Congress established a higher
statutory leverage ratio for credit unions
in part to offset the risk of loss from
required credit union replenishment.123
The NCUSIF capitalization deposit
deduction needs to be addressed in the
risk-based capital ratio, not just the
leverage ratio, to correct for the doublecounting concern in those credit unions
where the risk-based capital ratio is the
governing requirement.
The NCUSIF capitalization deposit is
not available for a credit union to cover
losses from risk exposures on its own
individual balance sheet in the event of
insolvency.124 The purpose of the
NCUSIF capitalization deposit is to
cover losses in the credit union system.
The Board is required to assess
premiums necessary to restore and
maintain the NCUSIF equity ratio at 1.2
percent. Premiums were necessary from
2009 through 2011 as a result of losses.
A series of NCUA Letters to Credit
Unions issued during 2009 discuss the
necessary write-down of the 1 percent
NCUSIF capitalization deposit and
required NCUSIF premium expenses
needed to restore the NCUSIF equity
ratio.125
The NCUSIF capitalization deposit is
refundable in the event of voluntary
credit union charter cancellation or
conversion. However, this aspect does
not change the unavailability of the
NCUSIF capitalization deposit to cover
individual losses while the credit union
is an active going concern, or its at-risk
stature in the event of major losses to
the NCUSIF. NCUA refunds the NCUSIF
capitalization deposit only in the event
a solvent credit union voluntarily
liquidates, or converts to a bank charter
or private insurance.
122 U.S. Dep’t of Treasury, Credit Unions 58
(1997) (‘‘The one percent deposit does present a
double-counting problem. And it would be feasible
for credit unions to expense the deposit now, when
they are healthy and have strong earnings.
However, expensing the deposit would add nothing
to the Share Insurance Fund’s reserves, and [. . .]
better ways of protecting the Fund are available.
Accordingly, we do not recommend changing the
accounting treatment of the 1 percent deposit.’’).
123 Id. at 4–5 & 55–59.
124 12 U.S.C. 1782(c)(1)(B)(iii).
125 NCUA, Premium Assessments, Letter to Credit
Unions 09–CU–20 (Oct. 2009); NCUA, Corporate
Stabilization Fund Implementation, Letter to Credit
Unions 09–CU–14 (June 2009); NCUA, Corporate
Credit Union System Strategy, Letter to Credit
Unions 09–CU–02 (Jan. 2009).
PO 00000
Frm 00043
Fmt 4701
Sfmt 4700
66667
Consistent with its exclusion from the
risk-based capital ratio numerator, the
NCUSIF capitalization deposit was also
deducted from the denominator under
proposed § 702.104(c)(1), which
properly adjusted the risk-based capital
ratio calculation and reduced the impact
of the adjustment.
Neither the Second Proposal nor this
final rule adjusts for the NCUSIF
capitalization deposit twice or puts
credit unions at a disadvantage in
relation to banks because banks have
expensed premiums to build the Deposit
Insurance Fund.
The Board does not agree with
commenters who suggested that the
NCUSIF capitalization deposit should
be treated as an investment similar to
Federal Home Loan Bank (FHLB) stock.
The NCUSIF capitalization deposit and
FHLB stock have several fundamental
differences. The deposit in the NCUSIF
results in double counting of capital
within the credit union system.
Investments in FHLB stock do not. A
financial institution does not need to
change its charter for a FHLB stock
redemption as a credit union must do
for a NCUSIF capitalization deposit
refund. Further, unlike FHLB stock, the
NCUSIF capitalization deposit is not an
income-producing asset. The deposit
has not paid a dividend since 2006. And
it cannot pay another dividend while
the Corporate Stabilization Fund loan
from the Treasury is still outstanding.
The Board is not requiring credit
unions to expense the NCUSIF
capitalization deposit, and does not
believe the risk-based capital treatment
will lead to a change in how this asset
is accounted under GAAP. The Board
agrees with the U.S. Treasury position
as stated in its 1997 Report on Credit
Unions. Treasury stated that expensing
the NCUSIF capitalization deposit
would not strengthen the NCUSIF. The
financial structure of the NCUSIF is
reasonable and works well for credit
unions.
The assignment of an appropriate risk
weight for the NCUSIF capitalization
deposit, based on its credit risk, has the
potential to create additional criticisms,
as a low risk weight may not capture the
true nature of the account and a high
risk weight could produce unnecessary
concern about risk of the deposit. The
NCUSIF capitalization deposit is treated
similarly to other intangible assets, (e.g.
goodwill and core deposits intangible
assets), as they are not available assets
upon liquidation.
Accordingly, for all the reasons
discussed above, the Board has decided
to retain this aspect of the Second
Proposal in this final rule without
change.
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
66668
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
Goodwill and Other Intangible Assets
Under the Second Proposal, goodwill
and other intangible assets were
deducted from both the risk-based
capital ratio numerator and
denominator in order to achieve a riskbased capital ratio numerator reflecting
equity available to cover losses in the
event of liquidation. Goodwill and other
intangible assets contain a high level of
uncertainty regarding a credit union’s
ability to realize value from these assets,
especially under adverse financial
conditions.
The Board, however, recognized that
requiring the exclusion of goodwill and
other intangibles associated with
supervisory mergers and combinations
of credit unions that occurred prior to
this proposal could directly reduce a
credit union’s risk-based capital ratio.
Accordingly, the Board also proposed
allowing credit unions to include
certain goodwill and other intangibles
in the risk-based capital ratio
numerator. In particular, the Second
Proposal would have excluded from the
definition of goodwill, which must be
deducted from the risk-based capital
ratio numerator, any goodwill or other
intangible assets acquired by a credit
union in a supervisory merger or
consolidation that occurred before the
publication of this rule in final form.
The Second Proposal would not have
changed the financial reporting
requirements for credit unions, which
requires they use GAAP to determine
how certain intangibles are valued over
time. Under the proposal, credit unions
would have still been required to
account for goodwill in accordance with
GAAP, and the amount of excluded
goodwill and other intangible assets
would have been based on the
outstanding balance of the goodwill
directly related to supervisory mergers.
The Board proposed allowing the
excluded goodwill and other intangible
assets to be counted until December 31,
2024, to allow affected credit unions to
adjust to this change as they continue to
value goodwill and other intangibles in
accordance with GAAP. The proposed
exclusions would have applied only to
goodwill and other intangible assets
acquired through supervisory mergers or
consolidations and would not have been
available for goodwill and other
intangible assets acquired from mergers
or consolidations that did not meet this
definition. This change would have
provided affected credit unions time to
revise their business practices to ensure
goodwill and other intangible assets
directly related to supervisory mergers
would not adversely impact their riskbased capital ratio.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Public Comments on the Second
Proposal
At least one commenter stated that
they agreed with the proposed treatment
of goodwill and other intangible assets.
A significant number of commenters,
however, suggested that the Board
include all goodwill and other
intangible assets in the risk-based
capital ratio numerator so long as these
intangible assets meet GAAP
requirements (subjected to annual
goodwill impairment testing).
Commenters reasoned that the exclusion
of non-supervisory goodwill from the
numerator would discourage some well
managed and well capitalized credit
unions from participating in mergers,
and many mergers serve to benefit the
members of both the surviving and nonsurviving credit union. Similarly,
commenters reasoned that mergers can
also have a favorable influence on safety
and soundness—producing institutions
that in combination have stronger
financials and are able to weather more
extreme economic swings.
At least one commenter suggested
that, as an alternative to including all
goodwill and intangible assets in the
risk-based capital ratio numerator, the
Board might limit the retention of nonsupervisory goodwill and other
intangible assets in the numerator of the
risk-based capital ratio for those credit
unions that are well capitalized on the
basis of the net worth ratio. The
commenter suggested further that, at a
minimum, non-supervisory goodwill
that meets annual impairment testing
should be retained in the numerator
over a 10-year phase-out period, and all
previous supervisory goodwill should
be grandfathered without time limit,
subject to regular impairment testing.
The commenter suggested three reasons
for taking such an approach: First, those
credit unions that engaged in such
transactions almost certainly reduced
insurance losses to the Share Insurance
Fund, and should not be penalized after
the fact. Second, they did so with an
understanding of current rules at that
time. Many of these transactions would
likely not have occurred had the
proposed treatment of goodwill been
known; so no longer counting this
goodwill at some point in the future
would be changing the rules midstream.
Third, the amount of previous
supervisory goodwill is a known, fixed,
and relatively small quantity. Only 20
credit unions with more than $100
million in assets have goodwill
amounting to more than 5 percent of net
worth, and the average goodwill to net
worth ratio at these credit unions is 12.8
percent. Supervisory goodwill likely
PO 00000
Frm 00044
Fmt 4701
Sfmt 4700
represents no more than three quarters
of that goodwill (approximately 10
percent of net worth). Considering
future growth, the commenter suggested
that supervisory goodwill will decline
in proportion to net worth and assets
going forward, and grandfathering it
would protect those credit unions that
in the past reduced NCUSIF resolution
costs from a cliff reduction in their RBC
ratios in the future.
Other commenters suggested that
excluding goodwill from the risk-based
capital ratio numerator would harm
credit unions by: (1) Penalizing credit
unions who have recently gone through
a merger, and (2) dis-incentivizing
merger activity, which could prevent
healthy industry consolidation and the
combining of unhealthy credit unions
with stronger ones in the future. Some
commenters suggested that if a wellsituated credit union relies on goodwill
as a component of a merger, and is no
longer able to justify such as a business
decision because of a lack of allowance
for goodwill, NCUA is then forced to
step in, which would negatively impact
the NCUSIF and could require the
payment of additional premiums by all
credit unions. Use of goodwill allows a
well-situated credit union to absorb a
struggling credit union without
negatively impacting the NCUSIF,
which the commenter suggested should
be incentivized. Thus, the commenter
recommended that goodwill arising
from both previous and future mergers
should continue to be counted without
a time limitation, so long as it meets
GAAP requirements.
Several commenters suggested that
the rule grandfather credit unions that
have included goodwill on their books,
and not impose the 10-year limit, since
it has been used by the credit union in
the past and was sanctioned by NCUA.
Another commenter suggested that if
mergers were part of a strategic plan
accomplished before the risk-based
capital rule is finalized, then any
goodwill acquired through those
mergers should be grandfathered.
Some commenters contended that
goodwill acquired through a supervisory
merger should not be treated differently
than goodwill acquired through a
strategic merger. Goodwill acquired
through both types of mergers have
value according to GAAP. One
commenter argued that separating
goodwill and other intangibles derived
through a merger of healthy credit
unions versus those assisted by a
regulator does not make sense for the
following reasons: (1) Some mergers that
involve troubled credit unions may have
had informal assistance from state or
federal regulators, but may not meet the
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
definition outlined in the proposal as
supervisory-assisted. This will create
inconsistency in the application of the
rule. (2) The treatment is inconsistent
and provides potentially more risk to
the NCUSIF as the risk-based capital
ratio may not reflect the actual risk of
future impairment of those assets. (3)
The proposal favors troubled credit
union mergers while discouraging
healthy credit union consolidation due
to the negative impact on the risk-based
capital ratio. (4) Using a 10-year life for
supervisory-assisted transactions
provides only temporary relief for those
credit unions impacted and it overstates
the risk-based capital ratios until the
phase-out period is over.
One commenter argued that the
proposed treatment of goodwill would
place credit unions that acquired failing
or insolvent credit unions (under
supervisory/emergency merger
conditions)—including those where
NCUA, the NCUSIF, and the credit
union industry realized benefits from
the acquisition activities—at a
competitive disadvantage. The
commenter suggested that the proposed
10-year deferral of goodwill is an
equitable solution for those credit
unions that acquired failed credit
unions and received some level of
funded assistance from the NCUSIF, as
the amount of goodwill carried on their
books would typically be less than
goodwill carried by those credit unions
that did not receive assistance. The
commenter explained that this is due to
the fact that the funded amount of
assistance from the NCUSIF upon
receipt by the continuing credit union is
recorded as a reduction to the goodwill
determined at the time the failed credit
union was acquired. The commenter
argued that other credit unions,
however, that acquired failed credit
unions relying on the current risk-based
net worth regulations, but did not
receive funded assistance from the
NCUSIF would be penalized under the
proposed 10-year deferral of goodwill.
The commenter speculated that these
credit unions would be forced to forgo
many opportunities in lieu of having to
meet changed regulator risk-based
capital targets, while their competitors
(for the next 10 years) would have the
opportunity to focus on survival,
service, product innovation, community
reinvestment and growth. Accordingly,
the commenter recommended the Board
grant a one-time permanent exemption
of goodwill to credit unions that made
significant, capital-impacting decisions
under the current risk-based net worth
regulations.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Discussion
There is a high level of uncertainty
regarding the ability of credit unions to
realize the value of goodwill and other
intangibles, particularly in times of
adverse conditions. Thus, the proposed
approach to other intangibles generally
mirrors the treatment by the Other
Banking Agencies.126
However, as discussed in the
definitions part of this rule above, the
longer implementation period included
in this final rule will serve to mitigate
some of the commenters’ concerns
regarding existing goodwill and other
intangibles because it provides affected
credit unions more than 13 years to
write down the goodwill or otherwise
adjust their balance sheet.
While the final rule includes a
provision to address goodwill and other
intangibles acquired through
supervisory mergers and consolidations
that were completed 60 days following
this rule’s publication, the final rule
retains the requirement that all other
goodwill and other intangibles be
excluded from the risk-based capital
ratio numerator as they are not available
to cover losses.
Consistent with the comments, the
Board recognizes that only 15 credit
unions report total goodwill and
intangible assets of more than 1 percent
of assets, and notes that the valuation
under GAAP of these existing assets will
be immaterial by the end of the
extended sunset date.
In future combinations, a credit union
will need to consider the impacts a
combination will have on both its net
worth ratio and its risk-based capital
ratio. For mergers involving financial
assistance from the NCUSIF, this means
a credit union with higher capital may
be able to outbid a competing credit
union. A credit union will need to
consider the impact on its capital when
determining the components of a merger
proposal, which may result in higher
costs to the NCUSIF. However, stronger
capital and a risk-based capital measure
that is less lagging should reduce the
number and cost of failures, resulting in
a net positive benefit to the NCUSIF and
the industry.
Accordingly, for all the reasons
discussed above, the Board has decided
to retain this aspect of the Second
Proposal in this final rule without
change.
Identified Losses Not Reflected in the
Risk-Based Capital Ratio Numerator
The Second Proposal allowed for
identified losses, not reflected as
126 See,
PO 00000
e.g., 12 CFR 324.22.
Frm 00045
Fmt 4701
Sfmt 4700
66669
adjustments in the risk-based capital
ratio numerator, to be deducted. The
inclusion of identified losses allowed
for the calculation of an accurate riskbased capital ratio.
The Board received no comments on
this aspect of the proposal. Accordingly,
the Board has decided to retain this
aspect of the Second Proposal in this
final rule without change.
104(c) Risk-Weighted Assets
In developing the proposed risk
weights included in the Second
Proposal, the Board reviewed the Basel
accords and the U.S. and various
international banking systems’ existing
risk weights.127 The Board considered
the comments contained in Material
Loss Reviews (MLRs) prepared by
NCUA’s OIG and comments by GAO in
their respective reviews of the financial
services industry’s implementation of
PCA.128 The Second Proposal was
designed to address credit risk and
concentration risk in a manner
comparable to the Other Banking
Agencies’ capital regulations.129 As a
result, the Second Proposal would have
substantially changed how the risk
weights for nearly all credit union assets
are assigned. For example, instead of
assigning an investment a risk weight
based on its weighted average life, the
Second Proposal assigned risk weights
to investments based primarily on the
credit quality of the underlying
collateral or repayment ability of the
issuer. These and other adjustments
were intended to address, where
possible depending on the particular
requirements of section 216 of the
FCUA, inconsistencies between the risk
weights assigned to assets under the
Other Banking Agencies’ capital
regulations and NCUA’s current PCA
regulations.
Public Comments on the Second
Proposal
The Board received many general
comments regarding the proposed risk
127 The Basel Committee on Banking Supervision
(BCBS) published Basel III in December 2010 and
revised it in June 2011, available at https://
www.bis.org/publ/bcbs189.htm.
128 Section 988 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act obligates
NCUA’s OIG to conduct MLRs of credit unions that
incurred a loss of $25 million or more to the
NCUSIF. In addition, section 988 requires NCUA’s
OIG to review all losses under the $25 million
threshold to assess whether an in-depth review is
warranted due to unusual circumstances. The MLRs
are available at https://www.ncua.gov/about/
Leadership/CO/OIG/Pages/
MaterialLossReviews.aspx; see also GAO/GGD–98–
153 (July 1998); GAO–07–253 (Feb. 2007), GAO–
11–612 (June 2011), GAO–12–247 (Jan. 2012), and
GAO–13–71 (Jan. 2013).
129 See, e.g., 12 CFR 324.32.
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
66670
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
weights. At least one commenter
suggested the proposal significantly
improved the various risk weightings
and that most of the proposed risk
weightings seemed appropriate. Most
commenters who mentioned the risk
weights also acknowledged that the
Board had made significant
improvements to the risk-weight
categories from the original risk-based
capital proposal, and many of the
adjustments and more detailed asset
categories included in the Second
Proposal were significant
improvements.
A substantial number of the
commenters, however, argued that the
proposed risk weights remained too
high in key areas, given credit unions’
level of risk, and suggested they should
be lower than what the federal bank
regulators require for assets such as
mortgage loans, member business loans,
servicing and certain investments.
These commenters suggested that lower
risk weightings for credit union assets
are appropriate given their different
incentives to manage risk as compared
to banks, and lower loss history based
on their comparison to the banking
industry.
A significant number of commenters
complained that the proposed riskweighting scheme was overly complex.
At least one commenter suggested that
credit unions have assets on their books
at fair value; the change to fair value is
accounted for in either the profit and
loss statement or in other
comprehensive income. The commenter
recommended that the Board clarify the
application of the risk weight for these
assets when a component of their book
value has already impacted capital
through earnings or other
comprehensive income. Other
commenters recommended that the risk
weights and concentration percentages
take into account the standard credit
risk factors such as loan-to-value ratio,
credit score, origination channel, etc.
One commenter suggested that credit
risk is a function of underwriting, the
economy, loan portfolio diversity,
institutional structure, business strategy,
profitability demands, time horizons,
performance-monitoring capacity,
funding stability and other factors. But,
the commenter argued, the proposal
ignores these local, individual factors in
favor of a one-size-fits-all risk
weighting.
Interest rate risk. The Board also
received many comments regarding the
proposed removal of IRR from the riskweight calculation. A majority of the
commenters who mentioned IRR stated
that they agreed with the proposed
removal of interest rate risk from the
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
rule. Moreover, they suggested a
separate IRR standard was not needed to
reasonably account for IRR at credit
unions because NCUA’s current
framework of policies and regulations
sufficiently address the risk. One credit
union commenter did recommend,
however, that NCUA expand the data it
gathers in the 5300 Call Reports and use
that information to facilitate both RBC
compliance and interest rate risk
management. The commenter suggested
Call Reports also be used to monitor
investment losses for credit unions that
invest in complex securities, which
would show the direction a credit union
is trending and provide regulators with
an objective basis for determining which
credit unions need capital buffers that
exceed regulatory minimums.
Concentration risk. The Board
received a substantial number of
comments regarding the Second
Proposal’s retention of concentration
risk measures in the risk weightings of
certain categories of assets. A majority
of the commenters who mentioned it
suggested that concentration risk is best
addressed through the examination
process as it is for banks, and thus,
should be dropped from the risk weights
in the final rule. At least one commenter
argued that the proposed concentration
threshold requirements violate the
FCUA, which requires the Board to
‘‘prescribe a system of prompt corrective
action’’ that is ‘‘comparable to section
1831o’’ of the Federal Deposit Insurance
Act.
One commenter noted that while
NCUA did cite to specific credit union
failures that involved high
concentrations of certain assets, the
Material Loss Reviews associated with
those failures revealed that fraud or
board mismanagement played a pivotal,
if not a determining, role in the failure
of the credit unions. Other commenters
claimed that, based on 2007 and 2014
data, there was no meaningful
difference in the performance of credit
unions with higher or lower levels of
concentration in mortgages or home
equity loans. The proposal would
require credit unions to hold more
capital than banks at certain levels of
asset concentration, which commenters
argued would not create a ‘‘comparable’’
capital framework and would put credit
unions at a competitive disadvantage.
The commenters contended this is
particularly true for mortgages and
home equity loans where the capital
requirements materially increase even at
relatively lower levels of concentration
(35 percent and 20 percent of assets,
respectively).
One commenter claimed the Board
did not provided any evidence the
PO 00000
Frm 00046
Fmt 4701
Sfmt 4700
proposed concentration risk thresholds
aligned with increased capital at risk,
and insisted that the historical loss data
provided by NCUA did not support
establishing a higher capital standard
for credit unions than banks. The
commenter argued that the data in the
Second Proposal showing the
differences in asset concentrations
between those credit unions that failed
and those that survived was insufficient.
And for real estate loans, the commenter
claimed the data was inconclusive
because credit unions that failed had 58
percent of their assets in real estate
whereas those credit unions that
survived had 49 percent. While there
was a higher concentration of real estate
assets for those that failed, the
commenter suggested the difference of 9
percent was not a firm basis on which
to assert higher concentrations of real
estate loans were a significant
contributing factor to the credit union’s
failure such that it warrants higher
capital levels for all complex credit
unions. Similarly, the commenter
argued that the data for commercial
loans would not support a concentration
risk threshold of 50 percent, and alleged
that the Board examined the current
level of real estate exposure across the
industry and set the capital
requirements such that roughly the top
10 percent of the industry would see
their capital requirements increase.
Further, the commenter argued that the
methodology was unsupported by the
evidence, that there was no empirical
evidence to support that either (a) two
standard deviations is the right basis for
determining this threshold, or (b) the
resultant risk thresholds correlated
directly to higher degrees of risk such
that additional capital should be held by
these institutions. The commenter
insisted that, based on the comparability
requirement in the FCUA, the Board
should eliminate the concentration risk
thresholds for these asset classes and set
the risk weights equal to those applied
to the banking industry (50 percent for
mortgages and 100 percent for both
home equity loans and commercial
loans).
Another commenter noted that the
examples given by the Board in support
of adopting concentration risk elements
did not acknowledge the fact that
mortgage and home equity line of credit
(HELOC) underwriting standards have
tightened, and claimed that credit
unions have generally divested away
from residential real estate, and that the
proposal fails to anticipate where the
credit union asset mix will likely
migrate in the future. Based on this
claim, the commenter speculated that
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
the proposed concentration limits may
not prudently attain the desired goal of
portfolio invariance and may, in fact,
threaten the long-term viability of many
credit unions. The commenter
recommended that the Board adopt one
of the following alternative approaches:
(1) Do away with the concentration risk
element altogether; (2) use current
demarcation points as a trigger for
expanded reporting in the Call Report,
thereby allowing NCUA to assess if
there is in fact additional risk; or (3)
increase the current threshold levels
that call for increased weighting—for
example, by moving the mortgage
threshold to 50 percent to match the
commercial loan threshold, and
increasing the residential junior lien
threshold from 20 percent to 25 percent.
One commenter argued that the
proposed approach of including
concentration risk thresholds in the risk
weights was fundamentally flawed
because it considered the relative size of
the portfolio and not the benefit of
diversification. Another commenter
speculated that without more specific
information to capture diversification
within a lending portfolio,130 the
proposal would have limited value in
providing early warning of truly unsafe
concentrations. Instead, the commenter
recommended NCUA address outlier
credit unions through the timely
application of supervisory tools or, if
necessary, by applying the capital
adequacy planning requirements of
section 702.101(b) to credit unions
flagged as outliers. The commenter
suggested that using capital adequacy
plans to address concentration risk
would control for asset concentrations
that pose safety and soundness risk
without placing the wider credit union
system at a competitive disadvantage to
banks. The commenter speculated
further that, given the shifting landscape
of the financial services market and the
credit union industry, building risk
parameters around the current shape of
the market may not align with future
risks.
Yet another commenter suggested that
if concentration risk is maintained in
the final rule, the concentration
threshold level for all secured loan
categories should be 50 percent, and
only unsecured loans should have a
concentration threshold level below 50
percent.
Finally, one commenter argued that
there is no need for the rule to address
concentration risk, claiming that
concentration risk would address itself
since the dollar amount applied against
130 For example, diversification based on
geography, industry, credit profile, or product type.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
the risk weight increases as
concentration increases.
Discussion
After carefully considering the
comments received, the Board generally
agrees with commenters who suggested
that IRR concerns can be addressed
through NCUA guidance, supervision,
and other regulations. NCUA’s
guidance, supervision, and other
regulations are designed to address how
IRR is managed and reported in a
manner that is appropriate to the size,
complexity, risk profile, and scope of
each credit union’s operations. The
Board has determined not to include
IRR in the risk-based net worth
requirement 131 given the other
mechanisms available to NCUA to
address such risk. NCUA will continue
to monitor credit unions’ exposure to
IRR through the supervision process and
plans to provide additional supervisory
guidance in the future.
The Board, however, disagrees with
commenters who suggested further
reductions in the scope of the use of risk
weights to address concentration risk.
Under the Second Proposal, the Board
substantially reduced the risk-based
capital requirements related to
concentration risk by using one
concentration threshold, set at a higher
level, for assets that NCUA determined
are vulnerable to concentration risk. As
stated in the preamble to the Second
Proposal, the concept of addressing
concentration risk with the assignment
of risk weights is consistent with the
risk-based net worth requirement under
current part 702. Higher risk weights are
assigned to real estate loans and MBLs
held in higher concentrations under the
current rule. Elimination or additional
reductions in the concentration risk
dimension of the risk-based net worth
requirement would be inconsistent with
concerns regarding concentration risk
raised by GAO and in MLRs conducted
by NCUA’s OIG.132 The preamble also
131 See 12 U.S.C. 1790d(d)(2) (‘‘The Board shall
design the risk-based net worth requirement to take
account of any material risks against with the net
worth ratio required for an insured credit union to
be adequately capitalized may not provide adequate
protection.’’).
132 See U.S. Govt. Accountability Office, GAO–
12–247, Earlier Actions are Needed to Better
Address Troubled Credit Unions (2012), available
at https://www.gao.gov/products/GAO-12-247; Office
of Inspector General, National Credit Union
Administration, OIG–10–03, Material Loss Review
of Cal State 9 Credit Union (April 14, 2010),
available at https://www.ncua.gov/about/
Leadership/CO/OIG/Documents/
OIG201003MLRCalState9.pdf; Office of Inspector
General, National Credit Union
Administration,OIG–11–07, Material Loss Review
of Beehive Credit Union (July 7, 2011), available at
https://www.ncua.gov/about/Leadership/CO/OIG/
Documents/OIG201107MLRBeehiveCU.pdf; Office
PO 00000
Frm 00047
Fmt 4701
Sfmt 4700
66671
noted that the Basel Committee on
Banking Supervision has stated that
‘‘risk concentrations are arguably the
single most important cause of major
problems in banks.’’ 133
It is not appropriate to rely solely on
the supervisory process to address
concentration risk because the holding
of additional capital for concentration
risk should occur prior to the
development of the concentration risk,
and is difficult to achieve after a
concern with concentration risk is
identified during the supervisory
process.
The concentration risk thresholds
were adjusted in the Second Proposal to
focus on material levels of concentration
risk and for more consistency with the
current effective impact of the
concentration risk on capital
requirements for commercial loans. As a
result of the risk-weight adjustments,
very few credit unions would be subject
to the marginally higher risk weights
due to concentration risk. Credit unions
subject to the concentration risk weights
will not be placed at a competitive
disadvantage, because all banks are
required to maintain capital
commensurate with the level and nature
of all risks, including concentration risk,
to which they are exposed.134
Regarding support for the risk weights
themselves, given the statutory
requirement to maintain comparability
with the Other Banking Agencies’ PCA
requirements,135 NCUA relied primarily
on the risk weights assigned to various
asset classes within the Basel Accords
and established by the Other Banking
Agencies’ risk-based capital regulations
to develop this proposal. The Board,
however, did tailor the proposed risk
weights for assets unique to credit
unions, where contemporary and
sustained performance differences
existed (as shown in Call Report data)
to differentiate for certain asset classes
between banks and credit unions, or
where a provision of the FCUA
necessitated doing so.
The Board generally agrees with
commenters who suggested that credit
risk factors such as loan-to-value ratio
(LTV), credit score, origination and
other individual factors are meaningful
of Inspector General, National Credit Union
Administration, OIG–10–15, Material Loss Review
of Ensign Federal Credit Union, (September 23,
2010), available at https://www.ncua.gov/about/
Leadership/CO/OIG/Documents/
OIG201015MLREnsign.pdf.
133 Basel Committee on Banking Supervision,
International Convergence of Capital Measurement
and Capital Standards: A Revised Framework,
Comprehensive Version 214 (June 2006) available at
https://www.bis.org/publ/bcbs128.pdf.
134 See 12 CFR 324.10(d).
135 See 12 U.S.C. 1790d(b)(1)(A)(ii).
E:\FR\FM\29OCR2.SGM
29OCR2
66672
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
and should be evaluated. However,
reporting loan data on LTVs and credit
scores to NCUA would be
administratively burdensome. For
example, establishing regulations on
how the LTV would be measured would
be complex when considering such
items as how to take into account
private mortgage insurance as the
financial strength of mortgage insurers
varies, or the LTV of a restructured loan.
NCUA also lacks credit union industry
data on loan performance based on LTV
ratios that could be used to establish a
framework for LTV-based risk weights.
And risk weights based on LTVs for real
estate loans would not be comparable to
the risk weight framework used by the
other banking agencies.
Accordingly, the Board has decided to
maintain the proposed approach to riskweighting assets in this final rule.
104(c)(1) General
Under the Second Proposal,
§ 702.104(c)(1) provided that riskweighted assets include risk-weighted
on-balance sheet assets as described in
§§ 702.104(c)(2) and (c)(3), plus the riskweighted off-balance sheet assets in
§ 702.104(c)(4), plus the risk-weighted
derivatives in § 702.104(c)(5), less the
risk-based capital ratio numerator
deductions in § 702.104(b)(2). The
section provided further that, if a
particular asset, derivative contract, or
off balance sheet item has features or
characteristics that suggest it could
potentially fit into more than one risk
weight category, then a credit union
shall assign the asset, derivative
contract, or off-balance sheet item to the
risk weight category that most
accurately and appropriately reflects its
associated credit risk. The Board
proposed adding this language to
account for the evolution of financial
products that could lead to such
products meeting the definition of more
than one risk asset category.
The Board received no comments on
the language in this paragraph of the
proposal. Accordingly, the Board has
decided to retain the language in this
proposed paragraph in this final rule
without change.
104(c)(2) Risk Weights for On-Balance
Sheet Assets
Under the Second Proposal,
§ 702.104(c)(2) defined the risk
categories and risk weights to be
assigned to each defined on-balance
sheet asset. All on-balance sheet assets
were assigned to one of 10 risk-weight
categories.
The Board received a significant
number of comments, which are
discussed in more detail below, on the
proposed risk-weight categories and the
risk weights assigned to particular
assets.
Cash and Investment Risk Weights
Under the Second Proposal, the Board
proposed eliminating the process of
assigning risk weights for investments
based on the weighted average life of
investments in favor of a credit-risk
centered approach for investments. The
credit risk approach to assigning risk
weights under the Second Proposal was
based on applying lower risk weights to
safer investment types and higher risk
weights to riskier investment types.136
The proposed investment risk weights
are similar to the risk weights assigned
to investments under the Other Banking
Agencies’ regulations,137 which are
based on the credit-risk elements of the
issuer, the underlying collateral, and the
payout position of the particular type of
investment. The proposed changes to
the risk weights assigned to investments
are outlined in the following table:
SECOND PROPOSAL: RISK WEIGHTS FOR CASH AND INVESTMENTS
Proposed
(percent)
risk weight
mstockstill on DSK4VPTVN1PROD with RULES2
Item
• The balance of cash, currency and coin, including vault, automatic teller machine, and teller cash .............................................
• The exposure amount of:
Æ An obligation of the U.S. Government, its central bank, or a U.S. Government agency that is directly and unconditionally
guaranteed, excluding detached security coupons, ex-coupon securities, and principal and interest only mortgage-backed
STRIPS.
Æ Federal Reserve Bank stock and Central Liquidity Facility stock.
• Insured balances due from FDIC-insured depositories or federally insured credit unions.
• The uninsured balances due from FDIC-insured depositories, federally insured credit unions, and all balances due from privately-insured credit unions .............................................................................................................................................................
• The exposure amount of:
Æ A non-subordinated obligation of the U.S. Government, its central bank, or a U.S. Government agency that is conditionally guaranteed, excluding principal and interest only mortgage-backed STRIPS.
Æ A non-subordinated obligation of a GSE other than an equity exposure or preferred stock, excluding principal and interest only GSE obligation STRIPS.
Æ Securities issued by PSEs in the United States that represent general obligation securities.
Æ Investment funds whose portfolios are permitted to hold only part 703 permissible investments that qualify for the zero or
20 percent risk categories.
Æ Federal Home Loan stock.
• Balances due from Federal Home Loan Banks.
• The exposure amount of:
Æ Securities issued by PSEs in the U.S. that represent non-subordinated revenue obligation securities.
Æ Other non-subordinated, non-U.S. Government agency or non-GSE guaranteed, residential mortgage-backed securities,
excluding principal and interest only STRIPS.
• The exposure amount of:
Æ Industrial development bonds.
Æ All stripped mortgage-backed securities (interest only and principal only STRIPS).
Æ Part 703 compliant investment funds, with the option to use the look-through approaches.
Æ Corporate debentures and commercial paper.
Æ Nonperpetual capital at corporate credit unions.
Æ General account permanent insurance.
Æ GSE equity exposure and preferred stock.
136 When the Board evaluates the risk of an
investment type, it is based on criteria such as
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
volatility, historical performance of the
investments, and standard market conventions.
PO 00000
Frm 00048
Fmt 4701
Sfmt 4700
137 See,
E:\FR\FM\29OCR2.SGM
e.g., 12 CFR 324.32.
29OCR2
0
20
50
100
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
66673
SECOND PROPOSAL: RISK WEIGHTS FOR CASH AND INVESTMENTS—Continued
Proposed
(percent)
risk weight
Item
•
•
•
•
All other assets listed on the statement of financial condition not specifically assigned a different risk weight.
The exposure amount of perpetual contributed capital at corporate credit unions .........................................................................
The exposure amount of equity investments in CUSOs.
The exposure amount of:
Æ Publicly traded equity investment, other than a CUSO investment.
Æ Investment funds that are not in compliance with part 703 of this Chapter, with the option to use the look-through approaches.
Æ Separate account insurance, with the option to use the look-through approaches.
• The exposure amount of non-publicly traded equity investments, other than equity investments in CUSOs ................................
• The exposure amount of any subordinated tranche of any investment, with the option to use the gross-up approach ...............
mstockstill on DSK4VPTVN1PROD with RULES2
Public Comments on the Second
Proposal
The Board received many general
comments regarding the proposed
investment risk weights. At least one
commenter maintained that the
proposal would unfairly penalize credit
unions by using investment risk weights
to compensate for interest rate risk,
which the commenter argued would
create a bias towards lending and
against investments. Other commenters,
however, suggested that, in general, the
revised risk weights for investments
were reasonable, including the zero risk
weighting for investments issued by the
U.S. Government, including NCUA and
FDIC. Some commenters suggested the
20 percent weight for governmentsponsored enterprises (GSEs) seemed
reasonable given that they are quasigovernment entities.
The Board also received other
comments regarding the risk weights
assigned to the following particular
investments:
Deposits in banks or credit unions.
One commenter contended that the
proposed risk weightings for
investments were mute on weights for
deposits in banks or credit unions. The
commenter believed such deposits
should have some level of risk
weighting, at least for any uninsured
amounts on deposit at banks and credit
unions, because they can be a part of a
smaller credit union’s investment
portfolio.
Part 703 compliant investment funds.
At least one commenter objected to a
default risk weight of 100 percent for
part 703 compliant investment funds,
and 300 percent for non-part 703
compliant funds. The commenter
believed the 200 percent increase in a
default risk weight would be punitive
138 The 1,250 percent risk-weight amount is based
on holding capital dollar-for-dollar at the 8 percent
adequately capitalized level for the risk-based
capital ratio (8 percent adequately capitalized level
*1,250 percent = 100 percent).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
and would create a disadvantage for
state-chartered credit unions. The
commenter suggested there are several
non-conforming, state-authorized
investments that are not based in
equities or other ‘‘volatile and risky
investments’’ and that do not warrant a
300 percent risk weight. The commenter
argued further that, by using part 703 as
a threshold, the Board was assigning a
significantly lower baseline assumption
of risk on the basis of the regulator that
approved the investment, which would
single out state-chartered institutions
and force them to undertake lookthrough calculations on their
investments when federal charters may
be able to rely on the default risk
weight. The commenter recommended
that the default thresholds be tied to the
underlying holdings and investment
strategy of the fund.
At least one commenter
recommended that investment funds
that hold only investments that qualify
for a zero or 20 percent risk weight
should receive a 20 percent risk weight
regardless of whether the underlying
investments are part 703 compliant.
One commenter complained that the
proposed risk-weight categories for nonloan investments were too general,
lumping together assets with widely
varying risks, especially when
considering risks beyond those tied to
interest rate fluctuations. The
commenter suggested that additional
risk-weighting tools within categories
were needed to properly take account of
issuer- and security-specific issues for
both debt and equity securities and nonpart 703 compliant funds. The
commenter speculated further that the
proposed approach would discourage
responsible employee benefit prefunding by penalizing those
investments, and provide incentives for
excessively aggressive equity investing
in pursuit of higher returns to offset the
especially high reserve requirements.
The commenter recommended that the
baseline risk weights should be
PO 00000
Frm 00049
Fmt 4701
Sfmt 4700
150
300
400
138 1,250
presumptive only, so that if a credit
union can present good reasons why a
lower risk weight should be assigned to
its investments within a certain
category, those lower weights should be
applied going forward. Another
commenter suggested that, while the
proposed 100 percent risk weight
assigned to all private issuer corporate
debt is not a punitive level, there ought
to be some ability for a credit union to
demonstrate that the corporate debt it
holds qualifies for a lower weighting,
closer to the 20 percent for state and
local debt, or the 50 percent for revenue
bonds, which are limited for repayment
to the revenue generated by a specific
facility and thus often are in reality
private issuer obligations. The
commenter believed that a flat 100
percent weighting for all corporate debt
takes no account of actual issuerspecific repayment risk, and could serve
to distort reasonable investment
decisions by credit unions looking to
include such issues in their employee
benefit pre-funding portfolios. The
commenter recommended some issue/
issuer-specific risk assessment be
allowed to more rationally, precisely
equal risk and risk weights.
Non-significant equity exposures.
Several commenters suggested that
banks are permitted to apply a 100
percent risk weight to certain equity
exposures deemed non-significant. The
commenters suggested further that nonsignificant exposures mean an equity
exposure that does not exceed 10
percent of the bank’s total capital. The
commenters recommended that NCUA
adopt a similar treatment if the publicly
traded equities and equity allocation
within an investment fund are less than
10 percent of a credit union’s total
capital; then a risk weight of 100
percent shall be applied to the equity
exposure. The commenters suggested
this would reduce the complexity of the
look-through approach and simplify the
overall risk-weighting process for nonsignificant equity exposure.
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
66674
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
Community development investments.
Several commenters suggested that
OCC’s risk-based capital regulation
recognizes the importance of
community development investments
and assigns a risk weight of 100 percent
rather than the standard 300 percent
factor. The commenters suggested
further that the public policy embraced
by OCC with this allowance is to
encourage investments to support
charitable goals and purposes.
Commenters recommended that NCUA
embrace a similar policy and assign a
risk weight of 100 percent for any equity
or corporate bond exposure in a
community development investment.
The commenters suggested that such
treatment would support broader
participation by credit unions with
community development investments
and enhance the goodwill and
reputation of the credit union industry
as it builds an investment resource to
support charitable contributions.
Employee benefit plan investments.
Some commenters argued that the 300
percent risk weighting assigned to
publicly traded equity investments
should be much lower so that credit
unions are not unduly limited in their
investments for employee benefit
funding. One commenter recommended
that the Board continue to apply
standard risk weights to benefit plan
investments. The commenter contended
that a 457(b) executive plan is unfunded and does not vest until the
employee retires or terminates
employment, and the assets underlying
such plans generally must remain the
property of the credit union until vested
and are subject to the claims of general
creditors. The commenter speculated
further that, if the credit union is put
into conservatorship, the investments
never transfer to the employee. So, the
commenter maintained, it is appropriate
for the Board to risk weight such
investments as part of the overall
balance. The commenter expressed
concern that it could be very difficult
for NCUA to determine with certainty
whether, and to what extent, the credit
union held a risk of loss in connection
with the investments because employee
benefit plans can be tailored to fit the
needs of each individual credit union
and executive.
One commenter claimed risk
weighting all publicly traded equities at
300 percent would be punitive and
unjustified by real-world experience
with a long list of blue-chip, dividendpaying, financially secure stocks
regularly included in credit union client
§ 701.19 portfolios. The commenter
suggested that, as with corporate debt,
some tools must be offered to allow a
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
credit union to obtain relief from the
extremely high risk assessment for
specific equity issues which are more
secure than consumer loans in default,
to which the proposal assigns a 150
percent risk weight. The commenter
suggested further that relevant factors
which could support a lowering of the
risk weighting for specific equity
investments include the issuer’s debt
rating, market capitalization and
financial condition, history of dividend
payments, and absence of financial
defaults. The commenter speculated
that imposing a blanket 300 percent risk
weight on all public equity would create
two negative, counterproductive
incentives: First, it would discourage
any public equity investments, driving
down expected overall portfolio return
and requiring investment of a larger
amount of credit union funds to achieve
a needed annual return tied to projected
future benefit costs. Second, for those
credit unions which do nevertheless
include an equity component in their
§ 701.19 portfolios, there would be
pressure to overcome the high reserve
ratio by investing in higher-return,
higher-risk equities, instead of more
stable dividend-paying stocks. The
commenter also maintained that the 300
percent risk weight assigned to prefunded, non-part 703 compliant mutual
funds, while subject to reduction under
various look-through methods, was
unjustifiably high in comparison to the
other weights assigned to performing
and even non-performing loans.
Publicly traded equity investments.
One commenter recommended that all
publicly traded equity investments be
treated as either available for sale or
trading. The commenter suggested that
these two methods of accounting require
the investment to be recorded at market
value, which should be easily
determined since they are publicly
traded. Thus, the commenter argued, the
300 percent risk weight assigned under
the Second Proposal would be
excessive, especially given the amount
of class B Visa shares held by a
significant number of credit unions, and
with the employee benefit funding
allowed by § 701.19 of NCUA’s
regulations.
Non-agency ABS structured securities.
One commenter suggested that collateral
utilized to secure investments included
in the non-agency ABS structured
securities category could include
automobile loans. Because the Second
Proposal requires a risk weighting of 75
percent for all current secured consumer
loans—and since the risk profile of the
underlying collateral does not differ
between secured automobile loans and
non-agency ABS structured securities
PO 00000
Frm 00050
Fmt 4701
Sfmt 4700
backed by secured auto loans—the
commenter recommended the risk
weightings for both instruments be set at
75 percent.
Subordinate tranche of any
investment. At least one commenter
complained that the Second Proposal
would assign a risk weighting of 1,250
percent, or require the use of the grossup approach to determine the overall
weighting of this category of investment.
The commenter argued that the 1,250
percent risk weighting was punitive in
nature and could not be justified from
a safety and soundness standpoint
because it may appear to represent more
than 100 percent of the monies at risk
in any one investment.
At least one commenter also objected
that, by not including the ‘‘simplified
supervisory formula approach’’ 139 in
the Second Proposal, the Board
deprived credit unions of a
measurement tool that is allowed by the
Other Banking Agencies and the Basel
Committee on Banking Supervision. The
commenter argued that this could
represent a competitive disadvantage to
credit unions who are evaluating certain
investments for inclusion in their
strategies. Given the significance of the
weighting and the exclusion of the
evaluation method, the commenter
recommended the 1,250 percent
weighting should be eliminated and the
Simplified Supervisory Formula
Approach be utilized to determine the
weighting of investment categories.
One commenter suggested that the
Board assign the subordinate tranche of
any investments the same risk weight
that applies to commercial loans.
Corporate debt. Several commenters
maintained that applying high risk
weights to investments in the corporate
system would penalize credit unions
that invest within the industry.
Commenters also suggested that the risk
weights assigned to corporate paid-in
capital should recognize how the
stricter regulatory standards for
corporate credit unions adopted in 2010
not only mitigate risks to natural-person
credit unions, but also protect the
NCUSIF from potential losses.
Accordingly, some commenters
recommended that a lower risk weight
of 125 percent be assigned to corporate
paid-in capital under the final rule.
One commenter suggested that it
would be more reasonable to generally
structure risk weights for corporate debt
into tiers similar to that of municipal
bonds because the proposed structure
would make it costly to diversify and
gain yield because the risk weights
assigned would negate the added yield
139 See,
E:\FR\FM\29OCR2.SGM
e.g., 12 CFR 324.43.
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
of these bonds. The commenter insisted
that, in order to preserve a credit
union’s ability to diversify and avoid
concentration risk in agency or
government bonds, more reasonable risk
weights should be assigned to different
forms of corporate debt. The commenter
suggested one alternative option for
structuring risk weights for corporate
debt would be to create a four-tiered risk
classification that would include
investment grade and non-investment
grade bonds. The commenter noted that
the current definition is silent on
whether bonds can be non-investment
grade. The commenter suggested further
that the investment grades could be
broken down into high, medium and
low investment grade plus noninvestment grade for four tiers.
According to the commenter, the high
grade would be equivalent to an AAA
rating, the medium grade would be
equivalent to an A rating, the low grade
would be equivalent to a BBB rating,
and the non-investment grade would be
non-investment grade. The commenter
recommended these ratings be part of
the credit union’s internal ratings
system for bonds, which would allow
for lower risk weights for high-grade
bonds at 50 percent, medium-grade
bonds at 75 percent, and low-grade
bonds at 100 percent.
Discussion
The Board disagrees with commenters
who suggested that the proposal would
unfairly penalize credit unions by using
investment risk weights to compensate
for IRR. The Board intentionally
removed the weighted average life
calculation from the assignment of risk
weights to remove the IRR components
from the Second Proposal. As stated
above, the risk weights assigned to
investments were based on credit risk,
consistent with the risk weights
assigned to investments by the Other
Banking Agencies.
The Board disagrees with the
commenters who claimed the proposed
risk weights assigned to investments
were mute on the weights for deposits
in banks and credit unions. The Second
Proposal assigned a risk weight of zero
percent to insured balances from FDICinsured depositories or federally
insured credit unions. Uninsured
balances, and all balances due from
privately insured credit unions, were
risk-weighted at 20 percent. Deposits in
a bank that are guaranteed by a state
received the same 20 percent risk
weight as an investment in a PSE.
The Board disagrees with the
commenters who suggested that a 300
percent risk weight for non-part 703
compliant investment funds would be
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
punitive compared to the 100 percent
risk weight for part 703 compliant
investment funds. The Board chose to
create standard risk weights for
investment funds to allow credit unions
a simple alternative to calculating the
risk weights for such assets using the
look-through approaches. Part 703
compliant investment funds were
assigned a 100 percent risk weight
under the Second Proposal unless they
qualified for a lower risk weight because
they were limited to holding lower riskweighted assets. The Board determined
that part 703 compliant investment
funds should qualify for a maximum
100 percent risk weight under
§ 702.104(c)(2) because the underlying
investments permitted under part 703 of
NCUA’s regulations were almost
exclusively assigned a risk weight of
100 percent or less under the proposal.
Non-part 703 investment funds, on the
other hand, are potentially more risky,
so assigning them a risk weight
equivalent to the risk weight assigned to
publicly traded equity investments is
appropriate. Under the Second
Proposal, credit unions were also given
the option to calculate the risk weight
for any investment fund using one of the
look-through approaches, which allow a
credit union to risk weight such a fund
based on its underlying assets.
The Board disagrees with commenters
who claimed the proposed risk weights
were too general because they lumped
together assets with widely varying risk,
and those who suggested including
additional risk-weight measures, such as
taking into account the specific loan-tovalue ratio or FICO scores of the
underlying assets. As with loans, the
risk weights assigned to investments
were generally determined based on the
underlying collateral or type of loan,
and the relative credit risk. The Board
chose not to apply separate risk weights
to investments based on additional riskweighting tools due to the complexity
involved and the backward-looking
nature of an analysis based on past
performance. Adding risk-weighting
factors within investment type
categories would have been inconsistent
with the approach taken by the Other
Banking Agencies.
The Board also disagrees with
commenters who suggested that credit
unions should be able use lower risk
weights if they are able to demonstrate
that an investment should qualify for a
lower-risk weight. Alternative and
individualized risk weight mechanisms
would be difficult and costly to
implement consistently, and would be
inconsistent with the Other Banking
Agencies’ regulations.
PO 00000
Frm 00051
Fmt 4701
Sfmt 4700
66675
Several commenters recommended
that the Board apply a 100 percent risk
weight to non-significant equity
exposures, which would be similar to
the approach taken by the Other
Banking Agencies. As discussed in more
detail below in the part of the preamble
associated with § 702.104(c)(3)(i), the
Board generally agrees with commenters
on this point and has amended this final
rule to assign a 100 percent risk weight
to non-significant equity exposures.
This change is consistent with the
Board’s objective of assigning risk
weights to assets that are similar to the
Other Banking Agencies’ regulations
where the level of risk exposure does
not create safety and soundness
concerns.
The Board disagrees with commenters
who suggested that lower risk weights
should be applied to certain types of
investments, such as corporate bonds
and publicly traded equities, which are
generally not available to federal credit
unions, simply because they were
purchased for employee benefit plans.
In particular, several commenters
argued that the 300 percent risk weight
assigned to publicly traded equity
investments should be much lower so
that credit unions are not limited in
their investments for employee benefits.
The proposed risk weights were
intended to be applied based on risk,
not on use. And, consistent with
commenters’ suggestions on the Original
Proposal, the Board assigned risk
weights in a manner similar to the Other
Banking Agencies’ regulations unless
the FCUA or a unique circumstance
warranted a different risk weight be
adopted. The 300 percent risk weight for
non-part 703 compliant investment
funds is appropriate when they are used
to fund employee benefits because there
are few limits on the investments in
these types of funds. A credit union
may, however, use one of the lookthrough approaches if the underlying
assets have a risk weight of less than
300 percent. Accordingly, for these
types of assets, the proposed risk weight
reasonably reflects the risks associated
with the types of assets available to fund
employee benefit plans.
The Board disagrees with the
commenter who suggested that a 300
percent risk-weight was excessive for
publicly traded equity investments
because they are treated as available for
sale or trading and recorded at market
value. The value at which an equity is
recorded does not reflect the risk of loss
and does not preclude an equity from
losing a substantial amount of its value
in the future. The lack of a maturity
date, loss position, and unknown
E:\FR\FM\29OCR2.SGM
29OCR2
66676
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
dividends make an equity riskier than
many other types of assets.
The Board generally agrees with the
commenter who suggested that a senior
asset-backed security should have the
same risk weight as a similar loan. Such
an approach is consistent with the Other
Banking Agencies’ regulations and
focuses on the risk of the underlying
collateral. By applying the gross-up
approach to a non-subordinated tranche
of an investment, a credit union can risk
weight a non-subordinated tranche of an
investment with the same risk weight as
if they had owned the loans directly.
Accordingly, this final rule adds nonsubordinated tranches of any
investments to the 100 risk-weight
category and gives credit unions the
option to use the gross-up approach.
The Board disagrees with commenters
who suggested that the proposed 1,250
percent risk weight was punitive for
subordinated tranches of investments.
Under the proposal, credit unions were
given the option to use the gross-up
approach to lower the risk weight of a
subordinated tranche of an investment if
it did not contain an excessively large
amount of leverage. The 1,250 percent
risk weight is a reasonable risk weight
for subordinated tranches if the credit
union is unable, or unwilling to use the
gross-up approach. The risk weight is
appropriate given the leveraged risk in
subordinated tranches, and is consistent
with the Other Banking Agencies’
regulations.140 As noted in the Second
Proposal, the simplified supervisory
formula approach for subordinated
tranches permitted under the Other
Banking Agencies’ capital regulations
was not included in the Second
Proposal because of its complexity and
limited applicability.
The Board also disagrees with
commenters who suggested that
subordinated tranches of investments
should receive the same risk weight as
commercial loans. Applying
subordinated tranches of investments
the same risk weights as commercial
loans would likely fail to account for
highly leveraged transactions, and
would be inconsistent with the Other
Banking Agencies’ regulations. The
Board also notes that, using the gross-up
approach, low-risk subordinated
tranches of certain investments could
receive risk weights equal to or less than
the risk weights assigned to commercial
loans.
The Board disagrees with commenters
who suggested that assigning high risk
weights to investments in the corporate
credit union system would penalize
credit unions that invest within the
industry. The proposed risk weights
assigned to nonperpetual capital and
perpetual contributed capital at
corporate credit unions are 100 percent
and 150 percent, respectively. The
proposed risk weights were not
intended to be a penalty or disincentive
for holding any particular assets. Rather,
the intent was to assign appropriate risk
weights that adequately account for the
risk associated with each particular
asset. The risk weights for corporate
capital investments did take into
consideration the stricter regulations
commenters cited when seeking lower
risk weights. And as a result, this final
rule assigns reasonable risk weights to
corporate-capital investments given the
stricter regulatory requirements
applicable to corporate credit unions as
compared to the higher risk weights
associated with non-publicly traded
equity investments under the Other
Banking Agencies’ regulations.
The Board disagrees with the
commenter who suggested that the final
rule should assign different risk-weight
tiers in corporate debt, similar to
municipal bonds. Under the Second
Proposal, the risk weight assigned to a
corporate debt was consistent with the
risk weight assigned to an industrial
development bond, which is a type of
municipal bond. An industrial
development bond is a security issued
under the auspices of a state or other
political subdivision for the benefit of a
private party or enterprise where that
party or enterprise, rather than the
government entity, is obligated to pay
the principal and interest on the
obligation. Typically the ultimate
obligation of repayment of the industrial
development bond is on a corporation.
The 100 percent risk weight for
corporate bonds is consistent with the
risk weights assigned to industrial
development bonds, a tier within
municipal bonds, where the ultimate
obligation of repayment is a corporate
entity. The proposed risk weight for
corporate debt is generally consistent
with the Other Banking Agencies’
regulations. The Board decided not to
apply tiers within investment types due
to the complexity and the inability to
apply a standard and objective
approach.
Consistent with the Dodd-Frank Wall
Street Reform and Consumer Protection
Act of 2010, which required agencies to
remove all references to credit ratings,
this final rule does not use credit ratings
to determine risk weights for part
702.141
Commercial Loans
The Second Proposal assigned risk
weights to commercial loans in a
manner generally consistent with the
Other Banking Agencies’ capital
regulations and the objectives of the
Basel Committee on Banking
Supervision.142 The proposal set a
single concentration threshold at 50
percent of total assets. Commercial
loans that were less than the 50 percent
threshold were assigned a 100 percent
risk weight, and commercial loans over
the threshold were assigned a 150
percent risk weight. Commercial loans
that were not current were assigned a
150 percent risk weight.
Commercial loan concentration
(percent of total assets)
15%
mstockstill on DSK4VPTVN1PROD with RULES2
Effective Capital Rate: 143
Current Rule .................................................................
This Proposal ................................................................
140 NCUA estimates a de minimis number of
investments would be subject to the 1,250 risk
weight.
141 Public Law 111–203, Title IX, Subtitle C,
section 939A, 124 Stat. 1376, 1887 (July 21, 2010).
142 This is comparable with the other Federal
Banking Regulatory Agencies’ capital rules. See e.g.,
12 CFR 324.32 (Assigns a 100 percent risk-weight
for commercial real estate (CRE) and includes a 150
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
20%
6.0
10.0
50%
6.5
10.0
percent risk-weight for loans defined as high
volatility commercial real estate (HVCRE)); 78 FR
55339 (Sept. 10, 2013); and Basel Committee on
Banking Supervision, International Convergence of
Capital Measurement and Capital Standards (June
2006) (‘‘In view of the experience in numerous
countries that commercial property lending has
been a recurring cause of troubled assets in the
banking industry over the past few decades,
Committee holds to the view that mortgages on
PO 00000
Frm 00052
Fmt 4701
Sfmt 4700
75%
10.4
10.0
100%
11.6
11.7
12.2
12.5
commercial real estate do not, in principle, justify
other than a 100 percent risk weight of the loans
secured.’’) available at https://www.bis.org/publ/
bcbs128.htm.
143 The effective capital rate represents the
blended percentage of capital necessary for a given
level of commercial loan concentration. The
calculation uses 10 percent as the level of riskbased capital to be well capitalized.
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
Public Comments on the Second
Proposal
A substantial number of commenters
recommended that the risk weights for
commercial loans be adjusted
downward to levels no more than those
in place for banks. Those commenters
claimed credit unions do not have
higher levels of risk associated with
holding commercial loans than banks
do. Commenters acknowledged that
lower risk weights for higher
concentrations of commercial loans
would imply lower risk weights for
lower concentrations of these loans
compared to bank risk weights, but they
insisted this disparity would be
appropriate given lower loss rates at
credit unions. One commenter
recommended assigning a lower risk
weight, of perhaps 50–75 percent, to
secured commercial loans. The
commenter explained that in locations
where there is a market for certain types
of commercial vehicles, a lower risk
weight makes more sense. Another
commenter recommended the following
risk weights for commercial loans be
assigned as an alternative: Credit card
and other unsecured loans that are less
than 50 percent of assets should be
assigned a 100 percent risk weight, and
such loans that are over 50 percent of
assets should be assigned a 150 percent
risk weight; new vehicle loans that are
less than 50 percent of assets should be
assigned a 50 percent risk weight, and
such loans that are greater than 50
percent of assets should be assigned a
75 percent risk weight; used vehicle
loans that are less than 50 percent of
assets should be assigned a 75 percent
risk weight, and such loans that are
greater than 50 percent of assets should
be assigned a 112 percent risk weight;
first-lien residential real estate loans
and lines of credit that are less than 50
percent of assets should be assigned a
75 percent risk weight, and such loans
that are greater than 50 percent of assets
should be assigned a 112 percent risk
weight; all other real estate loans and
lines of credit that are less than 50
percent of assets should be assigned a
100 percent risk weight, and such loans
that are greater than 50 percent of assets
should be assigned a 150 percent risk
weight.
At least one commenter speculated
that the vast majority of credit union
member business loans have real estate
as collateral, while commercial bank
loans are typically collateralized with
receivables, etc. The commenter noted
that under the banking agencies’ rules,
commercial loans made by banks are
assigned a 100 percent risk weight. The
commenter argued, however, that
NCUA’s risk weight for member
business loans should be lowered from
100 percent to 75 percent to account for
the fact that credit union member
business loans are safer than
commercial loans made by banks.
Some commenters complained that
the proposal did not account for the
different types of commercial loans
made by credit unions. Commenters
also speculated that credit unions
chartered for the purpose of making
MBLs would be unfairly penalized
under the proposal.
66677
Discussion
The Board disagrees that
concentration thresholds for commercial
loans should vary based on the business
purpose or underlying collateral. The
Agency did not pursue the alternative
commercial risk weights suggested by
commenters because such alternatives
would be extremely difficult to
implement consistently across all credit
unions. Utilizing specific commercial
loan type or collateral loss history is not
a reliable or consistent method for
assigning risk weights in a regulatory
model. Nor is it consistent with the
Basel framework or the Other Banking
Agencies’ capital regulations. All
commercial asset classes experience
performance fluctuations with
variations in business cycles. Some
sectors that had historically experienced
minimal losses are now pre-disposed to
heightened credit risk. Both NCUA and
FDIC have recently addressed these
types of exposures in respective Letters
to Credit Unions and Financial
Institution Letters.144
Contemporary variances between
bank and credit union losses on
commercial loans are not substantial
enough to warrant assigning lower risk
weights to commercial loans held by
credit unions. As stated in the Second
Proposal, and as further clarified below
using data to match the asset breakouts
within the FDIC Quarterly Banking
Profile, credit unions’ commercial loan
loss experience is comparable to
community banks after adjusting for
asset size. The recent loss experience for
credit unions and banks is very similar.
3 YEAR AVERAGE LOSS HISTORY
[2012, 2013, 2014]
Credit unions
>$100M in assets
Commercial & Industrial 145 ...................................................................................
Member Business Loans 146 ..................................................................................
mstockstill on DSK4VPTVN1PROD with RULES2
Further, credit unions’ long-term
historical MBL losses are somewhat
understated because NCUA’s Call
Report did not collect separate MBL
data until 1992. Thus, significant MBL
losses experienced in the late 1980s and
early 1990s are not included in the long-
144 NCUA, Taxi Medallion Lending, Letter to
Credit Unions 14–CU–06 (April 2014); FDIC,
Prudent Management of Agricultural Credits
Through Economic Cycles, Financial Institution
Letter FIL–39–2014 (July 16, 2014).
145 See Yearend FDIC Quarterly Banking Profiles
11 (2012, 2013, & 2014).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Banks
$100M to $10B
in assets
Banks
$1B to $10B
in assets
..................................
0.52
0.61
0.42
term historical credit union MBL loss
data.147
Residential Real Estate Loans
The Second Proposal assigned risk
weights to residential real estate loans
that are generally consistent with those
assigned by the Other Banking
146 See NCUA Financial Performance Report
using year end data for credit unions with assets
greater than $100 million.
147 NCUSIF losses from MBLs are a recurring
historical trend. The U.S. Treasury Report on Credit
Union Member Business Lending discusses 16
credit union failures from 1987 to 1991 that cost the
PO 00000
Frm 00053
Fmt 4701
Sfmt 4700
Agencies.148 The proposal set the firstand junior-lien residential real estate
loan concentration thresholds at 35
percent and 20 percent of total assets
respectively. Current first-lien
residential real estate loans that were
less than 35 percent of assets were
assigned a 50 percent risk weight, and
NCUSIF over $100 million. See Department of the
Treasury, Credit Union Member Business Lending
(Washington, DC January 2001).
148 See, e.g., 12 CFR 324.32(g).
E:\FR\FM\29OCR2.SGM
29OCR2
66678
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
those equal to or greater than 35 percent
of assets were assigned a 75 percent risk
weight. Current junior-lien residential
real estate loans that were less than 20
percent of assets were assigned a 100
percent risk weight, and those equal to
or greater than 20 percent of assets were
assigned a 150 percent risk weight.
PROPOSED RESIDENTIAL REAL ESTATE LOAN CONCENTRATION THRESHOLDS AND RISK WEIGHTS
50%
First-Lien ............................
Junior-Lien .........................
75%
100%
Current <35% of Assets ...
...........................................
Current ≥35% of Assets.
...........................................
Current <20% of Assets ...
In addition, under the Second
Proposal, first- and junior-lien
residential real estate loans that are not
current were assigned 100 percent and
150 percent risk weights, respectively.
Public Comments on the Second
Proposal
A majority of the commenters who
mentioned these loans recommended
that the concentration risk component
be removed entirely from the risk
weights for first- and junior-lien
residential real estate loans. One
commenter expressed concern that the
high risk weights assigned to certain
first-lien residential real estate loans
and certain junior-lien residential real
estate loans could negatively impact
mortgage lending in the communities
served by credit unions. The commenter
argued that the proposal did not appear
to address the underlying attributes of
the mortgages nor the degree in which
they may be match funded, which could
thereby restrict lending and curtail
profitability and capital growth at well
managed, risk-averse credit unions.
Accordingly, the commenter
recommended that the Board reconsider
and revise the risk weights for mortgage
loans held on balance sheet to be more
consistent with the requirements of the
Other Federal Banking Agencies.
Similarly, a substantial number of credit
union commenters suggested that the
risk weights for mortgage loans be
adjusted downward to levels no more
than those in place for banks because
they claimed credit unions do not have
higher levels of risk associated with
holding these assets. Another
commenter argued that the risk weights
assigned to real estate loans were
arbitrary because: (1) The vast majority
of MBLs are collateralized with real
estate at a loan-to-value ratio of 75
percent or less; (2) the vast majority of
home equity loans are first mortgages
with a loan-to-value ratio of 80 percent
or less; and (3) some increased risk is
associated with junior lien mortgages,
but it is not extensive or widespread.
Yet another commenter suggested that
the final rule assign risk weights to
these assets by including a study of loss
history and the market where a credit
union operates.
Several commenters recommended
further that consideration be given to
incorporating loan-to-value ratios, credit
scores, salability of the loan to
secondary mortgage market participants,
and the size of loans in the proposed
risk weighting. One commenter
suggested that both junior- and first-lien
residential real estate loans amortize
over time, lessening their credit risk
profile, and in the case of junior liens,
over time they can become first liens, at
which point the risk weightings become
too conservative. The commenter
maintained that this reduction in risk
was not accounted for under the Second
Proposal.
One commenter suggested that the
Board consider lower risk weightings for
loans with private mortgage insurance
or government guarantees.
One commenter suggested that one-tofour-family non-owner occupied realestate-backed loans should be treated as
a separate category and not count
toward the premium of 75 percent risk
weight when real estate loans comprise
over 35 percent of assets. From a
concentration risk standpoint,
commercial loans are already limited by
a statutory cap under the FCUA at 12.25
percent for the majority of credit unions.
Some commenters argued that the
proposal would exacerbate the burden
150%
Current ≥20% of Assets.
and costs credit unions are already
facing under the Dodd-Frank Act
regulations by requiring higher levels of
capital for those credit unions that hold
first-lien residential real estate loans in
excess of 35 percent of total assets.
Those commenters speculated that the
increased capital cost based upon
concentration risk will put credit unions
at a competitive disadvantage to other
financial institutions that do not have
higher risk weightings for holding
higher concentrations of loans.
Similarly, some commenters argued
that the proposal would exacerbate the
burden and costs credit unions are
already facing under the Dodd-Frank
Act regulations by requiring higher
levels of capital for those credit unions
that hold junior-lien residential real
estate loans in excess of 20 percent of
total assets. Those commenters
maintained that the increased capital
cost based upon concentration risk puts
credit unions at a competitive
disadvantage to other financial
institutions that do not have higher risk
weightings for holding higher
concentrations of loans.
Discussion
The Board has considered the
comments received, but, as stated in the
proposal, the contemporary variances
between bank and credit union losses
on real estate loans are not substantial
enough to warrant assigning lower risk
weights. As stated in the Second
Proposal and as further clarified below
using data to match the asset breakouts
within the FDIC Quarterly Banking
Profile, credit unions’ real estate loss
experience is comparable to community
banks after adjusting for asset size.
3 YEAR AVERAGE LOSS HISTORY 149
mstockstill on DSK4VPTVN1PROD with RULES2
[2012, 2013, 2014]
Credit unions
>$100M in assets
Banks
$100M to $10B
in assets
All real estate loans ...............................................................................................
0.33
149 See yearend FDIC Quarterly Banking Profiles
for 2012, 2013, and 2014, page 11 and NCUA
data for credit unions with assets greater than $100
million.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Financial Performance Report (FPR) using year end
PO 00000
Frm 00054
Fmt 4701
Sfmt 4700
E:\FR\FM\29OCR2.SGM
0.36
Banks
$1B to $10B
in assets
29OCR2
0.38
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
66679
3 YEAR AVERAGE LOSS HISTORY 149—Continued
[2012, 2013, 2014]
Credit unions
>$100M in assets
Other 1–4 family residential loans .........................................................................
First mortgage loans ..............................................................................................
Home equity loans .................................................................................................
Other real estate loans ..........................................................................................
Higher capital requirements for
concentrations of real estate loans exist
in the current rule, and completely
eliminating them would be a step
backwards in matching risks with
minimum risk-based capital
requirements. Credit unions with high
real estate loan concentrations are
particularly susceptible to changes in
the economy and housing market.
NCUA currently reviews credit
concentrations during examinations as
commenters recommended. As
discussed in the summary section,
however, the FCUA requires that
NCUA’s risk-based capital requirement
account for material risks that the 6
percent net worth ratio may not provide
adequate protection, including credit
and concentration risks.150
Credit concentration risk can be a
material risk under certain
circumstances. The Board generally
agrees that CFPB’s new ability-to-repay
regulations should improve credit
quality. However, the extent to which
this will alter loss experience rates
remains to be seen.
NCUA has also been advised by its
OIG and GAO to address credit
concentration risk. NCUA’s OIG
completed several MLRs where failed
credit unions had large real estate loan
concentrations. The NCUSIF incurred
losses of at least $25 million in each of
these cases. The credit unions reviewed
held substantial residential real estate
loan concentrations in either first-lien
mortgages, home equity lines of credit,
or both.151 In addition, in 2012, GAO
recommended that NCUA address the
credit concentration risk concerns
raised by the NCUA OIG.152 The 2012
GAO report notes credit concentration
risk contributed to 27 of 85 credit union
mstockstill on DSK4VPTVN1PROD with RULES2
150 See
12 U.S.C. 1790d(d)(2).
151 See NCUA, Material Loss Review of Cal State
9 Credit Union, OIG–10–03 (April 14, 2010); NCUA,
Material Loss Review OF Beehive Credit Union,
OIG–11–07 (July 7, 2011); and NCUA, Material Loss
Review OF Ensign Federal Credit Union, OIG–10–
15 (September 23, 2010), available at https://
www.ncua.gov/about/Leadership/CO/OIG/Pages/
MaterialLossReviews.aspx.
152 See U.S. Govt. Accountability Office, Earlier
Actions are Needed to Better Address Troubled
Credit Unions, GAO–12–247 (2012), available at
https://www.gao.gov/products/GAO-12-247.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
..................................
0.24
..................................
0.63
failures that occurred between January
1, 2008, and June 30, 2011. The report
also indicated that the Board should
revise NCUA’s PCA regulation so that
the minimum net worth levels required
under the rule emphasize credit
concentration risk. So eliminating the
concentration dimension for risk
weights entirely would be inconsistent
with the concerns raised by GAO and
the MLRs conducted by NCUA’s OIG.
The proposed risk weights would not
slow residential real estate loan
origination, stifle homeownership, or
limit credit unions’ ability to assist lowincome members because the revised
risk weights provide credit unions with
continued flexibility to assist members
in a sustainable manner while
maintaining sufficient minimum capital.
The Board agrees with commenters
that credit scores, loan underwriting,
portfolio seasoning, and portfolio
performance are appropriate measures
to evaluate a specific credit union’s
residential real estate lending program.
However, broadly applicable regulatory
capital models are portfolio invariant.
This means the capital charge for a
particular loan category is consistent
among all credit union portfolios based
on the loan characteristics, rather than
an individual credit union’s portfolio
performance or characteristics. Taking
into account each credit union’s
individual characteristics would be too
complicated for many credit unions and
unwieldy for NCUA to enforce
minimum capital requirements.153
Further, such an approach would not be
comparable to the risk weight
framework used by the Other Banking
Agencies.
NCUA will continue to take into
account loan underwriting practices,
portfolio performance and loan
seasoning as part of the examination
153 Basel Committee on Banking and Supervision,
An Explanatory Note on the Basel II IRB Risk
Weight Functions (July 2005), available at https://
www.bis.org/bcbs/irbriskweight.htm (‘‘The model
should be portfolio invariant, i.e. the capital
required for any given loan should only depend on
the risk of that loan and must not depend on the
portfolio it is added to. This characteristic has been
deemed vital in order to make the new IRB
framework applicable to a wider range of countries
and institutions.’’).
PO 00000
Frm 00055
Fmt 4701
Sfmt 4700
Banks
$100M to $10B
in assets
Banks
$1B to $10B
in assets
0.30
0.37
0.52
0.51
and supervision process. This method of
review is consistent with the Basel
three-pillar framework: Minimum
capital requirements, supervisory
review, and market discipline.154 Credit
unions should use criteria from their
own internal risk models and loan
underwriting in developing their
internal risk management systems.
The Board likewise agrees LTV ratios
are an informative measure to assess
risk. However, it is not a practical
measure to assess minimum capital
requirements because of volatility in
values and the corresponding reporting
burden for credit unions. There is no
historical data across institutions upon
which to base varying risk weights
according to LTVs and other
underwriting criteria (such as credit
scores). Examiners take LTVs into
consideration during the examination
process. Supervisory experience has
demonstrated LTV verification requires
on-site review and application of credit
analytics to validate the most current
information. On-site review also
minimizes reporting requirements on
credit unions.
Junior-lien residential real estate
loans continue to warrant a higher risk
weight based on loss history. Call
Report data indicate credit unions over
$100 million in asset size reported
nearly three times the rate of loan losses
(0.63 percent) on other real estate
loans 155 when compared to first
mortgage real estate loans (0.24 percent)
during the past three years. The final
base risk weight for junior-lien
residential real estate loans is
comparable to the risk weight assigned
by the Other Banking Agencies.156
154 Basel Committee on Banking Supervision,
International Convergence of Capital Measurement
and Capital Standards (June 2006), available at
https://www.bis.org/publ/bcbs128.htm (‘‘The
Committee notes that, in their comments on the
proposals, banks and other interested parties have
welcomed the concept and rationale of the three
pillars (minimum capital requirements, supervisory
review, and market discipline) approach on which
the revised Framework is based.’’).
155 Junior-lien real estate loans are currently
reported on the Call Report as part of ‘‘other real
estate loans.’’
156 See, e.g., 12 CFR 324.32(g)(2).
E:\FR\FM\29OCR2.SGM
29OCR2
66680
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
Current Consumer Loans
Consumer loans (unsecured credit
card loans, lines of credit, automobile
loans, and leases) are generally highly
desired credit union assets and a key
element of providing basic financial
services.157 Under the Second Proposal,
a current secured consumer loan
received a risk weight of 75 percent, and
a current unsecured consumer loan was
assigned a 100 percent risk weight.
mstockstill on DSK4VPTVN1PROD with RULES2
Public Comments on the Second
Proposal
One commenter claimed the risk
weightings assigned to secured and
unsecured consumer loans at credit
unions would be more restrictive than
the comparable risk weightings
applicable to community banks. To
remain competitive, the commenter
recommended that the proposed risk
weights should be changed to be more
in line with Basel III instead of being
more restrictive. Other commenters
argued that based on the historical
performance of credit unions in
managing consumer loan risk, the Board
should assign a 50 percent risk weight
to secured consumer loans and a 75
percent risk weight to unsecured
consumer loans. These commenters
speculated that if the risk weights
proposed for consumer loans were
adopted, some credit unions would
have to reduce the services they are
currently able to provide to members.
Discussion
The Board disagrees with the
commenter who claimed the proposed
risk weight assigned to consumer loans
that are current is more restrictive than
the corresponding risk weight assigned
to such loans for community banks. The
risk weight for secured consumer loans
in the Second Proposal and in this final
rule is 75 percent, which is less than the
100 percent risk weight assigned to such
loans held at community banks under
the Other Banking Agencies’
regulations. The risk weight for
unsecured consumer loans that are
current is identical to the corresponding
risk weight for such loans held at
community banks.
Comparisons of historical losses on
consumer loans between credit unions
and banks is difficult due to differences
in Call Report data, but generally the
difference in historical performance
measured by loss history is not
significant. Accordingly, the Board has
decided to maintain the consumer loan
157 Per Call Report data for years ending
December 31, 2012, 2013, and 2014, consumer
loans were greater than 40 percent of loans in credit
unions with total assets greater than $100 million.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
risk weights contained in the Second
Proposal.
Non-Current Consumer Loans
The risk-based net worth measure in
NCUA’s current PCA regulation does
not assign a higher risk weight to noncurrent consumer loans. Increasing
levels of non-current loans, however,
are an indicator of increased risk. To
reflect the impaired credit quality of
past-due loans, the Second Proposal
required credit unions to assign a 150
percent risk weight to loans (other than
real estate loans) that are 90 days or
more past due, in nonaccrual status, or
restructured.
Public Comments on the Second
Proposal
One commenter suggested that
consumer loans that are not current (90
days past due), could be assigned a 100
percent risk weight, instead of a 150
percent risk weight, given the
historically low default rate of these
loan types, strong underwriting and
possible further protection by
underlying collateral. At least one
commenter maintained that with ALLL
calculations already in place to account
for higher charge offs, the proposed risk
weight for non-current loans would be
unnecessarily high and would
ultimately hurt credit union members.
Other commenters speculated that the
proposed risk weights would force
credit unions to pull back lending to
low-income communities for fear of
carrying delinquent (non-current) loans
at elevated risk weightings.
Discussion
The proposed risk weight of 150
percent is warranted because noncurrent consumer loans have a higher
probability of default when compared to
current consumer loans. Non-current
consumer loans are more likely to
default because repayment is already
impaired, making them one step closer
to default compared to current
consumer loans. As stated in the Second
Proposal, the Board assigned a higher
risk weight on past-due exposures to
ensure sufficient regulatory capital for
the increased probability of unexpected
losses on these exposures, which results
in a risk-based capital measure that is
more responsive to changes in the credit
performance of the loan portfolio. The
higher risk weight will capture the risk
associated with the impaired credit
quality of these exposures. Moreover,
the 150 percent risk weight is consistent
with the risk weights used under Basel
III and the Other Banking Agencies.158
158 See,
PO 00000
e.g., 12 CFR 324.32(k).
Frm 00056
Fmt 4701
Sfmt 4700
The Board disagrees with commenters
who speculated that the proposed risk
weights would limit credit unions’
ability to assist low-income members.
The removal of the ALLL cap will
reduce the impact of non-current loans
to the risk-based capital ratio.
Accordingly, this final rule retains the
150 percent risk weight for consumer
loans that are not current.
Loans to CUSOs, and CUSO Investments
Under the Second Proposal,
investments in CUSOs were assigned a
risk weight of 150 percent and loans to
CUSOs were assigned a risk weight of
100 percent.
Public Comments on the Second
Proposal
Commenters generally maintained
that the proposed risk weight for
investments in CUSOs was too high. A
majority of the commenters who
mentioned it suggested that the risk
weight for CUSO investments was too
high and should be the same as for
CUSO loans, or less. A substantial
number of commenters argued that
given the unique position of CUSOs as
cooperative cost-saving structures in the
credit union system, the Board should
use its statutorily granted discretion to
draw distinctions between CUSOs and
private equity investments held by
banks. Commenters maintained that not
only must CUSOs provide NCUA with
open access to their books and records,
but CUSOs will be required to register
directly with NCUA and, if complex,
report audited financial statements and
customer information.159 Commenters
reasoned that this heightened
supervisory oversight compared to
general investment exposures,
combined with the limits on credit
union investment powers, makes a 100
percent risk weight more appropriate.
The commenters suggested further that,
given the limits on credit union
investment powers, the vast majority of
credit unions with unconsolidated
equity investments in CUSOs would fall
within the ‘‘non-significant’’ exception
under the banking regulations for
investments aggregating less than 10
percent of total assets, and would
receive a 100 percent risk weight.
Therefore, the commenters reasoned,
adjusting the CUSO investment
weighting to 100 percent would better
reflect the role of CUSOs in the credit
union industry while still aligning in
practice with treatment of similar
exposures in banks.
Other commenters stated that they
supported the proposed treatment of
159 12
E:\FR\FM\29OCR2.SGM
CFR part 712; and 12 CFR 741.222.
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
consolidated CUSO investments and
loans in which no separate risk
weighting would apply. One commenter
suggested that, if GAAP is followed for
the valuation of CUSOs, the proper
valuation of the asset should allow for
the lowering of the risk weight from the
proposed 150 percent risk weight.
Several commenters contended that the
150 percent risk weight assigned to
unconsolidated CUSO investments,
which applies to the accumulated and
undistributed earnings of these CUSOs
under GAAP, is inappropriate because it
would require credit unions to set aside
additional capital, beyond what they
initially invested, to cover retained
earnings to support future growth of
these CUSOs. These commenters
recommended that the Board reduce the
risk weight to 100 percent, or, if not
lowered, to risk weight only the initial
investment by the credit union and not
the appreciation of that investment over
time.
One commenter argued that the risk
weight assigned to unconsolidated
investments in CUSOs would be
counter-productive. The commenter
claimed that the Board presented only
anecdotal and unsubstantiated
references to what it considers
‘‘substantial CUSO losses’’ over the last
decade as justification for CUSO
regulations and assigning a 150 percent
risk weight to CUSO investments. The
commenter contended that no detailed
statistics have been provided to justify
these losses as substantial, and the
commenter would challenge any such
claim because they were not able to
substantiate any losses of a significant
nature through credit union investment
in CUSOs over the past 10 years. The
commenter recommended the Board
investigate the industry benefits of
CUSOs and the relatively immaterial
level of CUSO investment impact on the
NCUSIF before finalizing the current
proposed risk weights for CUSO
investments.
Other commenters suggested that
assigning a 150 percent risk weight to
multi-credit union owned CUSOs,
which are important collaborative tools
for credit unions, is not reflective of the
actual systemic risk CUSOs pose. The
commenters explained that, overall,
based on 2014 data, federally insured
credit unions in total have less than 22
basis points of their assets invested in
CUSOs, including fully consolidated
CUSO investments. Therefore, the
commenters asserted, CUSO
investments are not a systemic risk to
the NCUSIF.
One commenter pointed out that the
proposal stated that the risks associated
with CUSOs are similar to the risks
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
associated with third-party vendors.
However, the commenter could not find
any references in the proposal that
would account for the risks posed by
non-CUSO third-party vendors. The
commenter claimed that only CUSOs
were singled out for their supposed risk,
and argued that was not adequate
justification for the risk weight assigned
to CUSO investments.
Some commenters argued that the
proposal cited FDIC’s capital regulation
in saying that risk weights should be set
based on the risk of loss and not the size
of exposure. Those commenters
suggested, however, that FDIC agrees
that non-significant investment
exposures in unconsolidated equity of a
privately held company should be risk
weighted at 100 percent. The
commenters recommended the Board
look deeper into the FDIC definition of
‘‘non-significant’’ and how it translates
to unconsolidated CUSO investments.
In the commenters’ opinion, the
statutory and regulatory structure of
CUSO investments make such
investments non-significant using the
FDIC definition, and thereby should be
assigned only a 100 percent risk weight.
One commenter suggested that
investments in CUSOs should carry a
100 percent risk weighting based on the
following risk-mitigating factors: (1)
GAAP requires credit unions to evaluate
the asset for potential impairment; (2)
the majority of CUSOs are limited
liability corporations (LLCs) and the
credit union would be protected under
the LLC structure; and (3) the stated
purpose of NCUA’s CUSO rule is to
reduce risk exposure to credit unions.
Another commenter suggested that
investments in and loans to CUSOs
should be equally risk weighted. The
commenter recommended assigning a
75 percent risk weight due to the
expertise that is brought to the business
strategy within the relevant business
model that they are operating within
and to encourage the use of the
cooperative business model. Other
commenters suggested that CUSOs
should be risk weighted based on type:
Operational CUSOs should receive a 50
percent risk weight, fee-generating
CUSOs should receive a zero percent
risk weight, and start-up CUSOs should
receive a 100 percent risk weight.
Several commenters suggested that
instead of assuming that all CUSOs are
inherently risky, the proposal should be
primarily concerned with the riskiness
of the services provided by a CUSO and
how dependent a credit union is on
CUSO investments. One commenter
suggested that in order to minimize the
impacts of the proposal, CUSOs would
be required to give excess earnings back
PO 00000
Frm 00057
Fmt 4701
Sfmt 4700
66681
to the credit unions to reduce their
CUSO exposure. This would result in
reduced services for the credit union.
Discussion
The Board has carefully considered
the comments received. As discussed in
more detail below in the part of this
preamble associated with
§ 702.104(c)(3)(i), under this final rule a
credit union’s investments in CUSOs
will receive a 100 percent risk weight if
the credit union has non-significant
equity exposures.160
The Board relied on GAAP accounting
standards to determine the reporting
basis upon which any CUSO equity
investments and loans are assigned risk
weights. For CUSOs subject to
consolidation under GAAP, the amount
of CUSO equity investments and loans
are eliminated from the consolidated
financial statements because the loans
and investments are intercompany
transactions. The related CUSO assets
that are not eliminated are added to the
consolidated financial statement and
receive risk-based capital treatment as
part of the credit union’s statement of
financial condition. For CUSOs not
subject to consolidation, the recorded
value of the credit union’s equity
investment would be assigned a 100
percent risk weight if its equity
exposures are non-significant or a 150
percent risk weight if its equity
exposures are significant, and the
balance of any outstanding loan would
be assigned a 100 percent risk weight.
NCUA recognizes the uniqueness of
CUSOs and the support they provide to
many credit unions. However, an equity
investment in a CUSO is an unsecured,
at-risk equity investment in a first loss
position, which is analogous to an
investment in a non-publicly traded
entity. There is no price transparency
and extremely limited marketability
associated with CUSO equity exposures.
In addition, unlike the Other Banking
Agencies, NCUA has no enforcement
authority over third-party vendors,
including CUSOs.
The Board recognizes there are
statutory limits on how much a federal
credit union can loan to and invest in
CUSOs. However, the limitations are not
as stringent for some state charters, and
only binding for federal credit unions at
the time the loan or investment is made.
The position can grow in proportion to
assets over time. In setting capital
standards (such as Basel and FDIC), the
risk of loss—not the size of the
160 A credit union has ‘‘non-significant equity
exposures’’ if the aggregate amount of its equity
exposures does not exceed 10 percent of the sum
of the credit union’s capital elements of the riskbased capital ratio numerator.
E:\FR\FM\29OCR2.SGM
29OCR2
66682
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
exposure—is central to determining the
risk weight. In addition, while a CUSO
must predominantly serve credit unions
or their members (more than 50 percent)
to be a CUSO, it can be owned and
controlled primarily by persons and
organizations other than credit unions.
Therefore, it may not only serve noncredit unions, it can be majoritycontrolled by a party or parties with
interests not necessarily aligned with
the credit union’s interests.161
The Second Proposal noted that the
risk weight should be higher than 100
percent given that an equity investment
in a CUSO is in a first loss position, is
an unsecured equity investment in a
non-publicly traded entity, the
significant history of losses to the
NCUSIF related to CUSOs, and the fact
NCUA lacks vendor authority. Loans to
CUSOs, on the other hand, have a
higher payout priority in the event of
bankruptcy of a CUSO and therefore
warrant a lower risk weight of 100
percent, which corresponds to the base
risk weight for commercial loans. It may
be possible, however, to make more
meaningful risk distinctions in the
future between the risk various types of
CUSOs pose once NCUA’s CUSO
registry is in place and sufficient trend
information has been collected.
Under the Second Proposal, the risk
weights were derived from a review of
FDIC’s capital treatment of bank service
organizations. FDIC’s rule looks across
all equity exposures.162 If the total is
‘‘non-significant’’ (less than 10 percent
of the institution’s total capital), the
entire amount receives a risk weight of
100 percent. Otherwise, all the
exposures are matched against a
complicated risk weight framework that
runs from a minimum of 250 percent to
600 percent risk weight, with some
subsidiary equity having to be deducted
from capital. Under the Other Banking
Agencies’ regulations, an equity
investment in a CUSO would be treated
the same as an equity investment in a
non-publicly traded entity (with limited
marketability and valuation
transparency), which would receive a
400 percent risk weight unless the
cumulative level of all equity exposures
held by the institution were nonsignificant.
The Board recognizes the complexity
of FDIC’s approach and believes that a
161 Further, not all CUSOs are closely held. They
can have wider ownership distributed among many
credit unions, none of which may have significant
control. If a particular credit union has significant
control, it will likely have to consolidate under
GAAP and then there will be no risk weight
associated with the loan or investment for the
controlling credit union since it will be netted out
on a consolidated basis.
162 See, e.g., 12 CFR 324.52.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
simplified lower-risk-weight approach
is appropriate when the entire amount
of equity exposures within the credit
union are not significant.
Accordingly, this final rule retains the
proposed 100 percent risk weight
assigned to loans to CUSOs, and retains
the 150 percent risk weight assigned to
investments in CUSOs if the equity
exposure is significant. As discussed in
more detail below, however, this final
rule reduces the risk weight assigned to
investments in CUSOs to 100 percent
for complex credit unions with nonsignificant equity exposures.
Mortgage Servicing Assets (MSAs)
The Second Proposal would have
assigned a 250 percent risk weight to
MSAs to address the complexity and
volatility of these assets.
Public Comments on the Second
Proposal
A significant number of commenters
maintained that the 250 percent riskweight assigned to MSAs would reduce
the ability of credit unions to grant
mortgage loans, engage in loan
participations, and retain servicing of
their member loans, and that it would
likely also prevent credit unions from
using mortgage servicing rights as a
hedge against future rate changes.
Accordingly, they argued the proposed
risk weighting for MSAs, which would
be the same as for banks, would be too
high and should be significantly lower.
One commenter suggested that, because
much of the risk associated with
holding MSAs relates to the volatility of
their market value with changes in
interest rates, credit unions that book
MSAs at, or close to, their current
market value are at a greater risk of loss
in a falling interest rate scenario. One
commenter suggested further that those
institutions that book MSAs more
conservatively have a built-in book-tomarket value cushion to absorb normal
downward fluctuations in market value
and are in a better position to recapture
their investment over a shorter period of
time. The commenter stated that in a
rising-rate environment, the value of
MSAs and the corresponding cushion
grow and the risk declines.
Consequently, the commenter
contended, a flat 250 percent in all
circumstances would be punitive for
those credit unions that conservatively
book MSAs, particularly in a lowinterest-rate or low-refinance
environment. The commenter
maintained that it is important to note
that the operational risks associated
with MSAs are not avoided by holding
originated mortgage loans in portfolio,
yet the risk weights of portfolio
PO 00000
Frm 00058
Fmt 4701
Sfmt 4700
mortgage loans varies from 50 percent to
75 percent, despite the fact that such
assets are burdened with a multitude of
other risks not inherent in MSAs.
One commenter observed that for
sound asset, liability, and liquidity
management purposes, some credit
unions sell nearly all of their mortgage
loan production into the secondary
market and retain a sizable portion of
the servicing rights for member service
and risk mitigation purposes, the latter
in terms of the stability of earnings from
the aggregate of mortgage-related
activities over time. The commenter
maintained that these credit unions’
MSA-portfolio market values are
evaluated independently each quarter,
with the market value consistently
representing more than the stated book
values, representing sizable off-balance
sheet assets. The commenter
recommended that the risk weight for
MSAs be based on a reasonable formula
related to the ratio of book value to
market value and in any case not exceed
a 75 percent risk weight.
Several commenters argued that
MSAs are salable and, consistent with
GAAP, they are evaluated for potential
impairment. Accordingly, they argued
MSAs should be assigned a risk weight
of 100 percent. One commenter
suggested that the risk weight for MSAs
should be no more than 150 percent.
Another commenter suggested that
MSAs should be assigned the same risk
weight that is assigned to mortgage
loans held in portfolio and that are
under 35 percent of assets. At least one
commenter recommended that, if a 250
percent risk weight is adopted for
MSAs, a lower risk weight of 100
percent should be assigned to MSAs on
loans sold without recourse, but that are
serviced by the credit union.
Other commenters suggested that if a
credit union is following GAAP, it must
record mortgage servicing as an asset
that then requires a valuation be done
every year, and if as an asset it does not
meet the actual valuation reflected it
must be written down to the audited
value.
One commenter argued that weighting
MSAs at 250 percent would penalize
those credit unions who lowered their
interest rate risk on their balance sheet
by selling their longer-term, fixed-rate
real estate loans. Another commenter
suggested that the 250 percent risk
weight would pressure credit unions to
sell the servicing rights on mortgages
they originate, effectively forcing credit
unions to end a significant member
relationship many credit unions have
with their members, in order to manage
interest rate risk.
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
One commenter claimed that MSAs
only have two significant risks
associated with them: (1) Prepayment
penalties, and (2) operational/
reputational risk. Both risks, the
commenter suggested, are relatively
easily mitigated because prepayment
risk can be mitigated by maintaining a
viable origination pipeline, and
operational/reputational risk can be
mitigated by maintaining a good system
of internal controls. Moreover, the
commenter argued MSAs provide a
significant, reliable source of fee
revenue for many credit unions, which
is generated from fees that are paid by
investors, not by members.
Discussion
The 250 percent risk weight factors in
the relatively greater risks inherent in
MSAs, and maintains comparability
with the risk weight assigned to these
assets by the Other Banking
Agencies.163 As noted in the preamble
to the Second Proposal, MSAs typically
lose value when interest rates fall and
borrowers refinance or prepay their
mortgage loans, leading to earnings
volatility and erosion of capital. MSA
valuations are highly sensitive to
unexpected shifts in interest rates and
prepayment speeds. MSAs are also
sensitive to the costs associated with
servicing. These risks contribute to the
high level of uncertainty regarding the
ability of credit unions to realize value
from these assets, especially under
adverse financial conditions, and
support assigning a 250 percent risk
weight to MSAs.
While the Board agrees with
commenters that MSAs may provide
some hedge against falling rates under
certain circumstances, MSAs’
effectiveness as a hedge, relative to
particular credit unions’ balance sheets,
is subject to too many variables to
conclude that MSAs warrant a lower
risk weight. More importantly, since IRR
has been removed from the risk weights
of this proposal, the commenters’
argument is no longer directly
applicable.
NCUA does not agree with
commenters who speculated that the
proposed 250 percent risk weight
assigned to this relatively small asset
class would significantly dis-incentivize
credit unions from granting loans,
engaging in loan participations, and
retaining servicing of their member
loans. NCUA notes that banks have been
subject to at least as stringent (if not
more stringent) risk weights for MSAs
for some time and continue to sell loans
and retain MSAs.
163 See,
e.g., 12 CFR 324.32(l)(4)(i).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
The January 1, 2019 effective date for
this final rule provides credit unions
more than three years to adjust to these
new requirements and provides credit
unions with a phase-in period
comparable to that given to banks
following a similar change to the Other
Banking Agencies’ capital
regulations.164
Other On-Balance Sheet Assets
The Second Proposal assigned
specific risk weights to additional asset
classes, which are discussed in more
detail below. Under the proposal, all
assets listed on the statement of
financial condition not specifically
assigned a risk weight under proposed
§ 702.104 were assigned a 100 percent
risk weight.165
Public Comments on the Second
Proposal
The Board received several comments
regarding the proposed risk weights for
other on-balance sheet assets.
Some commenters opposed the
Second Proposal’s risk weighting of 20
percent for share-secured loan balances
and member business (commercial)
loans secured by compensating
balances. By contrast, the commenters
observed the comparable risk weight for
community banks is zero percent if the
cash is on deposit in the bank, which is
appropriate given there is no risk. Thus,
the commenters recommended that loan
balances secured by shares or
compensating balances on deposit at the
originating credit union be reduced to a
zero percent weighting, and loan
balances secured by compensating
balances on deposit at another financial
institution be weighted at the proposed
20 percent.
One commenter agreed that the
Board’s efforts to align the risk-based
capital regulation more closely with the
Other Banking Agencies’ regulations
were appropriate. The commenter
suggested that, absent a compelling
rationale for different treatment between
the two systems, regulators should
strive to maintain equal treatment for
equal risks in all depository institutions.
The commenter also recommended that
principal-only STRIPS be risk-weighted
based on the underlying guarantor or
collateral.
Some commenters suggested that
imposing risk-based capital limitations
on charitable donation accounts would
contravene the appeal for credit unions
164 See,
e.g., 12 CFR 324.1(f).
is comparable to the Other Banking
Agencies’ capital rules, which maintained the 100
percent risk weight for assets not assigned to a risk
weight category. See, e.g., 12 CFR 324.32; and 78
FR 55339 (Sept. 10, 2013).
165 This
PO 00000
Frm 00059
Fmt 4701
Sfmt 4700
66683
to put money into these investments to
fund charitable activities. Those
commenters recommended that the
Board amend the final rule to do one of
the following: (1) Exempt CDAs from
the risk-based capital regulation because
the Board effectively balanced safety
and soundness with effectuating credit
unions’ charitable intent when it passed
the CDA regulation; (2) Assign a 100
percent risk weight to any equity or
corporate bond exposure in a CDA
investment; (3) Apply a 100 percent risk
weight to non-significant equity
exposures because banks are permitted
to apply a 100 percent risk weight to
certain equity exposures deemed nonsignificant. Those commenters
suggested that such treatment would
support broader participation by credit
unions with community development
investments and enhance the goodwill
and reputation of the credit union
industry as it builds an investment
resource to support charitable
contributions.
One commenter maintained that the
Second Proposal would require a credit
union to reduce its capital (in the
numerator) by the amount of the
underfunded portion of the pension
plan, but was silent on how to reflect an
overfunded pension asset. The
commenter recommended that NCUA
provide specific guidance on the
treatment of an overfunded pension
asset. Specifically, the commenter
recommended the Board eliminate the
inconsistent treatment by removing the
overfunded pension asset from both the
numerator and the denominator.
A state supervisory authority
commenter requested clarification on
the risk weighting treatment of credit
union deposits in the Bank of North
Dakota. The commenter noted that the
Bank is state-owned, and its deposits are
neither federally nor privately insured,
but are backed by a guarantee from the
State of North Dakota. The commenter
acknowledged it is a unique institution,
and thus was unsure which risk
weighting would apply to the deposits.
The commenter suggested the deposits
are low risk due to the guarantee by the
state, and recommended it be afforded
a 20 percent or lower weighting.
At least one commenter recommend
that the Board define auto and credit
card servicing assets and assign them
risk weights consistent with the risk
weighting assigned to mortgage
servicing assets.
One commenter contended that the
‘‘full look-through’’ approach described
under the Second Proposal failed to
apply risk weights to mutual fund
investments in a consistent manner to
the holding of the same securities by
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
66684
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
credit unions directly. The commenter
explained that, for example, a credit
union that holds ‘‘U.S. Treasuries and
Government Securities’’ would assign a
risk weight of zero percent to such
holdings. By contrast, an investment
fund, with similar U.S. Treasuries and
Government Securities, would have a
risk weight of 20 percent assigned to
this asset. The commenter suggested
this disparity in the treatment of the
same asset when held by two different
entities unnecessarily discriminates
against a credit union’s investments in
mutual funds by penalizing the credit
union for making the same investment
indirectly that they could otherwise
make directly. The commenter
suggested further that the added layer of
risk that the Second Proposal assumed
will be present for indirect investments
is not a factor with mutual funds,
because they provide daily redemption
at net asset value and generally provide
sold share proceeds to the investor on
the next business day. The commenter
recommended that the Board revise the
rule so that mutual fund risk weights are
consistent with the risk weights on the
underlying instruments. The commenter
also recommended that the Board adopt
a full look-through approach that is
attuned to the distinctions between
underlying assets that would allow lowrisk mutual funds to carry risk ratios
ranging between zero percent and 20
percent based upon the actual risk ratio
of their holdings.
One commenter suggested that the
proposal was silent on how to risk
weight loans held for sale, and
recommended the Board assign a risk
weight of 25 percent to loans held for
sale.
At least one commenter suggested
that, under the Second Proposal, current
non-federally insured student loans
would be assigned a 100 percent risk
weight, despite other potential sources
of insurance. The commenter asked
whether there should be a distinction, at
least for insured private student loans,
and whether insured private student
loans should be assigned a 50 percent
risk weight and uninsured private
student loans at 100 percent. The
commenter suggested that, at some
credit unions, private student loans are
not only insured by an independent
insurance company, but reinsured with
three separate carriers. In such a
situation, the commenter suggested that
a 100 percent risk weighting seemed
excessive.
Discussion
The Board generally agrees with the
commenter who suggested that
principal-only mortgage-backed-security
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
STRIPS should be risk weighted based
on the underlying collateral, which
would more closely align NCUA’s
regulations with the Other Banking
Agencies’ rules. Principal-only
mortgage-backed-security STRIPS are
purchased at a discount to par, and par
is paid to the investor over the life of the
bond. As with other mortgage-backed
securities, the timing of the repayment
of par is the primary risk when credit
risk is not considered. Absent credit
risk, the investor receives par. This is
not the case with interest-only
mortgage-backed-security STRIPS,
where an investor can receive less than
the amount paid even without a credit
event. Accordingly, this final rule
assigns non-subordinated principal-only
mortgage-backed-security STRIPS a risk
weight based on the underlying
collateral.
The Board also agrees with
commenters who suggested the risk
weight for certain accounts used for
charitable purposes should be aligned
with the 100 percent risk weight
assigned to community development
investments under the Other Banking
Agencies’ regulations. Charitable
donation accounts are limited to 5
percent of net worth, which limits the
risks of such accounts to the Share
Insurance Fund. In addition, charitable
donation accounts are required to be
transparent segregated accounts, which
enables NCUA to ensure that such
accounts comply with applicable laws
through supervision. As explained
above and in more detail below, this
final rule would permit credit unions to
assign a 100 percent risk weight to
CDAs.
The Board disagrees with the
commenter who recommended
removing overfunded pension assets
from both the numerator and
denominator. Under the Second
Proposal, overfunded pension assets
were not included in the risk-based
capital ratio numerator or denominator,
primarily because they are not disclosed
on the financial statement as an asset, so
there is no need to remove them from
the calculation. Overfunded pension
assets were excluded completely from
the proposed risk-based capital
calculation, and their inclusion in the
final rule would add only needless
complexity and could create volatility
in the risk-based capital ratio.
The Board disagrees with the
commenter who suggested that any
investment fund holding assets that are
assigned a zero percent risk weight
should receive a zero percent risk
weight. As discussed in the Second
Proposal, assets assigned a zero percent
risk weight that are held in an
PO 00000
Frm 00060
Fmt 4701
Sfmt 4700
investment fund are considered indirect
obligations. The risk weight assigned to
an investment fund that holds zero
percent risk-weighted assets is 20
percent even though the underlying
investments consist of zero riskweighted assets due to the investment’s
structure as an investment fund. This is
consistent with the Other Banking
Agencies’ regulations.
The Board agrees with the commenter
who suggested that the final rule should
clarify the timing of holding reports
used for the full look-through approach.
As explained in more detail below, new
appendix A to part 702 now clarifies
which holding report should be used for
the full look-through approach.
The Board has decided to reduce the
risk weight in the final rule for sharesecured loans, where the shares
securing the loan are on deposit at the
credit union, to zero percent since the
risk of loss is more a function of
operational risk than credit risk. The
Board maintained the 20 percent risk
weight for share-secured loans where
the collateral deposit is at another
depository institution due to the added
credit risk of the depository institution.
The resulting risk weights for sharesecured loans are more consistent with
the Other Banking Agencies’ related risk
weights.
Loan servicing assets associated with
credit card loans or auto loans are
different than loan servicing assets
associated with mortgages because of
the much shorter duration of the
associated cash flows. Since shorterterm assets are individually assigned a
risk weight, they default to the 100
percent risk weight assigned to all other
assets, which is a reasonable risk weight
based on the general credit quality
associated with the underlying
consumer loans. The 100 percent risk
weight is appropriate for this class of
assets because the difference between
the book balance of some particular
fixed assets and the value of the assets
in the event of liquidation can be
substantial. For example, in an area that
has experienced a decline in the value
of real estate, the book value of a fairly
recently constructed credit union
headquarters could be well below the
fair value. Differentiating between the
risks of types of assets not otherwise
identified is not currently possible due
to lack of data, would add complexity
to the rule, and require even more Call
Report data. The 100 percent risk weight
is appropriate when considering that
most assets in this group are
predominately non-earning assets which
can hinder a credit union’s ability to
increase capital. Further, the proposed
risk weights match the risk weights in
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
the Other Banking Agencies’ capital
regulations.166
This final rule would include loans
held for sale within the pool of loans
subject to assignment of risk weights by
loan type to avoid the added complexity
of determining the age of the loans held
for sale. Loans held for sale carry
identical risks to the originating credit
union as other loans held in the credit
union’s portfolio until transfer to the
purchaser is final. Until the originating
credit union transfers the loan to the
purchaser, the originating credit union
bears the risk of the loan defaulting. If
the loan defaults prior to the finalization
of the transfer, the originating credit
union must account for any loss from
the defaulting loan, similar to other
loans held on the credit union’s books.
Accordingly, consistent with the Second
Proposal, this final rule assigns loans
held for sale a risk weight based on the
loan’s type.
Non-federally guaranteed student
loans are appropriately classified under
current consumer loans due to the
higher risks (default risk and extension
risk) associated with this product.
104(c)(2)(i) Category 1—Zero Percent
Risk Weight
Proposed § 702.104(c)(2)(i) provided
that a credit union must assign a zero
percent risk weight to the following onbalance sheet assets:
• The balance of cash, currency and
coin, including vault, automatic teller
machine, and teller cash.
• The exposure amount of:
Æ An obligation of the U.S.
Government, its central bank, or a U.S.
Government agency that is directly and
unconditionally guaranteed, excluding
detached security coupons, ex-coupon
securities, and principal and interest
only mortgage-backed STRIPS.
Æ Federal Reserve Bank stock and
Central Liquidity Facility stock.
• Insured balances due from FDICinsured depositories or federally
insured credit unions.
For the reasons explained above, the
Board decided to remove the proposed
language excluding directly and
unconditionally guaranteed principalonly mortgage-backed-security STRIPS
that were an obligation of the U.S.
Government, its central bank, or a U.S.
Government agency. The final rule also
adds the word ‘‘security’’ after the word
‘‘mortgage-backed’’ for clarity and
consistently.
In addition, the Board decided to
lower the risk weight for share-secured
loans, where the shares securing the
loan are on deposit with the credit
166 See,
e.g., 12 CFR 324.32(l).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
union, to zero percent. Assigning a zero
percent risk weight to share-secured
loans under such circumstances is
consistent with the risk weight assigned
to such loans under the Other Banking
Agencies.
Accordingly, § 702.104(c)(2)(i) of this
final rule provides that a credit union
must assign a zero percent risk weight
to the following on-balance sheet assets:
• The balance of
Æ Cash, currency and coin, including
vault, automatic teller machine, and
teller cash.
Æ Share-secured loans, where the
shares securing the loan are on deposit
with the credit union.
• The exposure amount of:
Æ An obligation of the U.S.
Government, its central bank, or a U.S.
Government agency that is directly and
unconditionally guaranteed, excluding
detached security coupons, ex-coupon
securities, and interest-only mortgagebacked-security STRIPS.
Æ Federal Reserve Bank stock and
Central Liquidity Facility stock.
• Insured balances due from FDICinsured depositories or federally
insured credit unions.
104(c)(2)(ii) Category 2—20 Percent Risk
Weight
Proposed § 702.104(c)(2)(ii) provided
that a credit union must assign a 20
percent risk weight to the following onbalance sheet assets:
• The uninsured balances due from
FDIC-insured depositories, federally
insured credit unions, and all balances
due from privately insured credit
unions.
• The exposure amount of:
Æ A non-subordinated obligation of
the U.S. Government, its central bank,
or a U.S. Government agency that is
conditionally guaranteed, excluding
principal- and interest-only mortgagebacked STRIPS.167
Æ A non-subordinated obligation of a
GSE other than an equity exposure or
preferred stock, excluding principal and
interest only GSE obligation STRIPS.
Æ Securities issued by public sector
entities in the United States that
represent general obligation securities.
Æ Investment funds whose portfolios
are permitted to hold only part 703
permissible investments that qualify for
the zero or 20 percent risk categories.
Æ Federal Home Loan Bank stock.
• The balances due from Federal
Home Loan Banks.
• The balance of share-secured loans.
167 This would include the NCUA Guaranteed
Notes (NGNs), which are an obligation of the NCUA
and are backed by the full faith and credit of the
United States.
PO 00000
Frm 00061
Fmt 4701
Sfmt 4700
66685
• The portions of outstanding loans
with a government guarantee.
• The portions of commercial loans
secured with contractual compensating
balances.
For the reasons explained above, the
Board has decided to remove the
proposed language excluding
conditionally guaranteed principal-only
mortgage-backed-security STRIPS that
were an obligation of the U.S.
Government, its central bank, or a U.S.
Government agency. In addition, the
Board decided to add the word
‘‘security’’ after the word ‘‘mortgagebacked’’ for clarity and consistently.
The Board also decided to revise the
language regarding investment funds to
clarify that the 20 percent risk weight
includes only investment funds with
portfolios permitted to hold only
investments that are authorized under
12 CFR 703.14(c).
Accordingly, § 702.104(c)(2)(ii) of this
final rule provides that a credit union
must assign a 20 percent risk weight to
the following on-balance sheet assets:
• The uninsured balances due from
FDIC-insured depositories, federally
insured credit unions, and all balances
due from privately insured credit
unions.
• The exposure amount of:
Æ A non-subordinated obligation of
the U.S. Government, its central bank,
or a U.S. Government agency that is
conditionally guaranteed, excluding
interest-only mortgage-backed-security
STRIPS.
Æ A non-subordinated obligation of a
GSE other than an equity exposure or
preferred stock, excluding interest only
GSE mortgage-backed-security STRIPS.
Æ Securities issued by PSEs that
represent general obligation securities.
Æ Part 703 compliant investment
funds that are restricted to holding only
investments that qualify for a zero or 20
percent risk weight under § 702.104.
Æ Federal Home Loan Bank stock.
• The balances due from Federal
Home Loan Banks.
• The balance of share-secured loans,
where the shares securing the loan are
on deposit with another depository
institution.
• The portions of outstanding loans
with a government guarantee.
• The portions of commercial loans
secured with contractual compensating
balances.
104(c)(2)(iii) Category 3—50 Percent
Risk Weight
Proposed § 702.104(c)(2)(iii) provided
that a credit union must assign a 50
percent risk weight to the following onbalance sheet assets:
• The outstanding balance (net of
government guarantees), including loans
E:\FR\FM\29OCR2.SGM
29OCR2
66686
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
held for sale, of current first-lien
residential real estate loans less than or
equal to 35 percent of assets.
• The exposure amount of:
Æ Securities issued by PSEs in the
U.S. that represent non-subordinated
revenue obligation securities.
Æ Other non-subordinated, non-U.S.
Government agency or non-GSE
guaranteed, residential mortgage-backed
security, excluding principal- and
interest-only STRIPS.
For the reasons explained above, the
Board has decided to remove the
proposed language excluding
conditionally guaranteed principal-only
mortgage-backed-security STRIPS that
were non-subordinated, non-U.S.
Government agency or non-GSE
guaranteed residential mortgage-backed
securities. In addition, the Board
decided to add the word ‘‘mortgagebacked-security’’ before the word
‘‘STRIPS’’ for clarity and consistently.
Accordingly, § 702.104(c)(2)(iii) of
this final rule provides that a credit
union must assign a 50 percent risk
weight to the following on-balance sheet
assets:
• The outstanding balance (net of
government guarantees), including loans
held for sale, of current first-lien
residential real estate loans less than or
equal to 35 percent of assets.
• The exposure amount of:
Æ Securities issued by PSEs in the
U.S. that represent non-subordinated
revenue obligation securities.
Æ Other non-subordinated, non-U.S.
Government agency or non-GSE
guaranteed, residential mortgage-backed
securities, excluding interest-only
mortgage-backed-security STRIPS.
mstockstill on DSK4VPTVN1PROD with RULES2
104(c)(2)(iv) Category 4—75 Percent
Risk Weight
Proposed § 702.104(c)(2)(iv) provided
that a credit union must assign a 75
percent risk weight to the outstanding
balance (net of government guarantees),
including loans held for sale, of the
following on-balance sheet assets:
• Current first-lien residential real
estate loans greater than 35 percent of
assets.
• Current secured consumer loans.
For the reasons explained above, the
Board has decided to retain this
proposed section in the final rule
without change.
104(c)(2)(v) Category 5—100 Percent
Risk Weight
Proposed § 702.104(c)(2)(v) provided
that a credit union must assign a 100
percent risk weight to the following onbalance sheet assets:
• The outstanding balance (net of
government guarantees), including loans
held for sale, of:
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Æ First-lien residential real estate
loans that are not current.
Æ Current junior-lien residential real
estate loans less than or equal to 20
percent of assets.
Æ Current unsecured consumer loans.
Æ Current commercial loans, less
contractual compensating balances that
comprise less than 50 percent of assets.
Æ Loans to CUSOs.
• The exposure amount of:
Æ Industrial development bonds.
Æ All stripped mortgage-backed
securities (interest-only and principalonly STRIPS).
Æ Part 703 compliant investment
funds, with the option to use the lookthrough approaches in § 702.104(c)(3)(ii)
of this section.
Æ Corporate debentures and
commercial paper.
Æ Nonperpetual capital at corporate
credit unions.
Æ General account permanent
insurance.
Æ GSE equity exposure or preferred
stock.
• All other assets listed on the
statement of financial condition not
specifically assigned a different risk
weight under this subpart.
For the reasons explained above, the
Board has decided to remove the
proposed language including principalonly mortgage-backed-security STRIPS
in the 100 percent risk-weight category.
The Board has also decided to include
the exposure amount of nonsubordinated tranches of any
investments in the 100 percent riskweight category. Credit unions also are
given the option to use the gross-up
approach as an alternative to the 100
percent risk-weight.
Accordingly, § 702.104(c)(2)(v) of this
final rule provides that a credit union
must assign a 100 percent risk weight to
the following on-balance sheet assets:
• The outstanding balance (net of
government guarantees), including loans
held for sale, of:
Æ First-lien residential real estate
loans that are not current.
Æ Current junior-lien residential real
estate loans less than or equal to 20
percent of assets.
Æ Current unsecured consumer loans.
Æ Current commercial loans, less
contractual compensating balances that
comprise less than 50 percent of assets.
Æ Loans to CUSOs.
• The exposure amount of:
Æ Industrial development bonds.
Æ Interest-only mortgage-backedsecurity STRIPS.
Æ Part 703 compliant investment
funds, with the option to use the lookthrough approaches in
§ 702.104(c)(3)(iii)(B) of this section.
PO 00000
Frm 00062
Fmt 4701
Sfmt 4700
Æ Corporate debentures and
commercial paper.
Æ Nonperpetual capital at corporate
credit unions.168
Æ General account permanent
insurance.
Æ GSE equity exposure or preferred
stock.
Æ Non-subordinated tranches of any
investment, with the option to use the
gross-up approach in paragraph
(c)(3)(iii)(A) of this section.
• All other assets listed on the
statement of financial condition not
specifically assigned a different risk
weight under this subpart.
As discussed in more detail below,
however, this final rule reduces the risk
weight assigned to CUSO investments,
corporate perpetual capital, and other
equity investments to 100 percent for
complex credit unions with nonsignificant equity exposures.169
104(c)(2)(vi) Category 6—150 Percent
Risk Weight
Proposed § 702.104(c)(2)(vi) provided
that a credit union must assign a 150
percent risk weight to the following onbalance sheet assets:
• The outstanding balance, net of
government guarantees and including
loans held for sale, of:
Æ Current junior-lien residential real
estate loans that comprise more than 20
percent of assets.
Æ Junior-lien residential real estate
loans that are not current.
Æ Consumer loans that are not
current.
Æ Current commercial loans (net of
contractual compensating balances),
which comprise more than 50 percent of
assets.
Æ Commercial loans (net of
contractual compensating balances),
which are not current.
• The exposure amount of:
Æ Perpetual contributed capital at
corporate credit unions.170
Æ Equity investments in CUSOs.171
As discussed in more detail below,
however, this final rule reduces the risk
weight assigned to CUSO investments,
and corporate perpetual capital, to 100
percent for complex credit unions with
168 Subject to non-significant equity exposure
risk-weight under § 702.104(c)(3)(i).
169 A credit union has ‘‘non-significant equity
exposures’’ if the aggregate amount of its equity
exposures does not exceed 10 percent of the sum
of the credit union’s capital elements of the riskbased capital ratio numerator.
170 Subject to the lower 100 percent nonsignificant equity exposure risk-weight under
§ 702.104(c)(3)(i).
171 Subject to the lower 100 percent nonsignificant equity exposure risk-weight under
§ 702.104(c)(3)(i).
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
non-significant equity exposures.172 For
the reasons explained above, the Board
has decided to retain this proposed
section in the final rule without change.
104(c)(2)(vii) Category 7—250 Percent
Risk Weight
Proposed § 702.104(c)(2)(vii) provided
that a credit union must assign a 250
percent risk weight to the carrying value
of mortgage servicing assets (MSAs)
held on-balance sheet.
For the reasons explained above, the
Board has decided to retain this
proposed section in the final rule
without change.
104(c)(2)(viii) Category 8—300 Percent
Risk Weight
Proposed § 702.104(c)(2)(viii)
provided that a credit union must assign
a 300 percent risk weight to the
exposure amount of the following onbalance sheet assets:
• Publicly traded equity investments,
other than a CUSO investment.
• Investment funds that are not in
compliance with 12 CFR part 703, with
the option to use the look-through
approaches in § 702.104(c)(3)(ii) of this
section.
• Separate account insurance, with
the option to use the look-through
approaches in § 702.104(c)(3)(ii).
For the reasons explained above, the
Board has decided to retain this
proposed section in the final rule with
only minor conforming changes.
Accordingly, § 702.104(c)(2)(viii) of
this final rule provides that a credit
union must assign a 300 percent risk
weight to the exposure amount of the
following on-balance sheet assets:
• Publicly traded equity investments,
other than a CUSO investment.173
• Investment funds that do not meet
the requirements under 12 CFR
703.14(c), with the option to use the
look-through approaches in
§ 702.104(c)(3)(iii)(B).
• Separate account insurance, with
the option to use the look-through
approaches in § 702.104(c)(3)(iii)(B).
mstockstill on DSK4VPTVN1PROD with RULES2
104(c)(2)(ix) Category 9—400 Percent
Risk Weight
Proposed § 702.104(c)(2)(ix) provided
that a credit union must assign a 400
percent risk weight to the exposure
amount of non-publicly traded equity
investments that are held on-balance
172 A
credit union has ‘‘non-significant equity
exposures’’ if the aggregate amount of its equity
exposures does not exceed 10 percent of the sum
of the credit union’s capital elements of the riskbased capital ratio numerator.
173 Subject to the lower 100 percent nonsignificant equity exposure risk-weight under
§ 702.104(c)(3)(i).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
sheet, other than equity investments in
CUSOs.
For the reasons discussed above, the
Board has decided to retain this
proposed section in the final rule
without change.174
104(c)(2)(x) Category 10—1,250 Percent
Risk Weight
Proposed § 702.104(c)(2)(x) provided
that a credit union must assign a 1,250
percent risk weight to the exposure
amount of any subordinated tranche of
any investment held on balance sheet,
with the option to use the gross-up
approach in § 702.104(c)(3)(i).175
For the reasons discussed above and
in additional detail below, the Board
has decided to retain this proposed
section in the final rule with only minor
conforming changes to the cross
citations.
104(c)(3) Alternative Risk Weights for
Certain On-Balance Sheet Assets
Proposed § 702.104(c)(3) provided
that instead of using the risk weights
assigned in § 702.104(c)(2), a credit
union may determine the risk weight of
investment funds and subordinated
tranches of any investment using the
approaches which are discussed in more
detail below. These alternative
approaches provide a credit union with
the ability to risk weight certain assets
based on the underlying exposure of the
subordinated tranche or investment
fund without exposing the NCUSIF to
additional risk.
Other than the comments already
discussed above, the Board received few
comments on this section of the
proposal and has decided to retain the
proposed gross-up approach and lookthrough approaches in this final rule
with only minor changes, which are
discussed in more detail below. In
addition, this final rule restructures
proposed § 702.104(c)(3).
As explained in more detail below,
this final rule restructures the
provisions in § 702.104(c)(3) to
renumber the gross-up and look-through
approaches and add in alternative riskweighting methodologies for nonsignificant equity exposures and certain
types of charitable donation accounts.
These changes are in response to public
comments received on the Second
Proposal and, as explained below,
174 Subject to lower 100 percent non-significant
equity exposure risk-weight under
§ 702.104(c)(3)(i).
175 Based on June 30, 2014, Call Report data,
NCUA estimates that 93.3 percent of all investments
for credit unions with more than $100 million in
assets would receive a risk weight of 20 percent or
less; and, 96.1 percent of all investments would
receive a risk weight of 100 percent or less.
PO 00000
Frm 00063
Fmt 4701
Sfmt 4700
66687
would only lower the risk weights
assigned to certain on-balance sheet
assets under certain circumstances.
104(c)(3)(i) Non-Significant Equity
Exposures
Under the Other Banking Agencies’
capital regulations, banks are permitted
to assign a 100 percent risk weight to
equity exposures when the aggregate
amount of the exposures does not
exceed 10 percent of the bank’s total
capital. The Board did not include a
similar approach in the Second Proposal
because it would have added significant
complexity to the rule. As previously
discussed, however, a significant
number of commenters requested that
NCUA’s risk-based capital requirement
include an alternative risk-weighting
methodology, similar to that provided
under the Other Banking Agencies’
capital regulations, for non-significant
equity exposures at credit unions.
Applying a 100 percent risk weight to
an equity exposure, provided the
exposure does not exceed 10 percent of
the sum of the credit union’s capital
elements of the risk-based capital ratio
numerator, will provide relief to certain
credit unions holding limited amounts
of higher-risk equity assets on their
books. Such an approach is generally
consistent with the Other Banking
Agencies’ regulations and will not
increase risk weights for any equity
exposures held by credit unions.
Accordingly, this final rule adds the
following provisions assigning
alternative risk weights to nonsignificant equity exposures.
104(c)(3)(i)(A) General
Section 702.104(c)(3)(i)(A) of this
final rule provides that notwithstanding
the risk weights assigned in
§ 702.104(c)(2), a credit union must
assign a 100 percent risk weight to nonsignificant equity exposures.
104(c)(3)(i)(B) Determination of NonSignificant Equity Exposures
Section 702.104(c)(3)(i)(B) of this final
rule provides that a credit union has
non-significant equity exposures if the
aggregate amount of its equity exposures
does not exceed 10 percent of the sum
of the credit union’s capital elements of
the risk-based capital ratio numerator
(as defined under paragraph
§ 702.104(b)(1)).
104(c)(3)(i)(C) Determination of the
Aggregate Amount of Equity Exposures
As discussed above,
§ 702.104(c)(3)(i)(C) of this final rule
provides that when determining the
aggregate amount of its equity
exposures, a credit union must include
E:\FR\FM\29OCR2.SGM
29OCR2
66688
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
the total amounts (as recorded on the
statement of financial condition in
accordance with GAAP) of the
following:
• Equity investments in CUSOs,
• Perpetual contributed capital at
corporate credit unions,
• Nonperpetual capital at corporate
credit unions, and
• Equity investments subject to a risk
weight in excess of 100 percent.
The Board determined that the assets
identified above encompass the extent
of funds invested in stock, equities, or
debts associated with an ownership
interest and are normally in a loss
position subordinate to unsecured
creditors. Non-perpetual capital at
corporate credit unions, despite
receiving a 100 percent risk-weight, is
included in the calculation of equity
exposure because its priority in
liquidation is subordinate to
shareholders and the NCUSIF. Limiting
the sum of these higher credit risk
accounts to 10 percent or less of the sum
of a credit union’s capital elements of
the risk-based capital ratio numerator
receiving a 100 percent risk weight
ensures that the related loss exposure
does not present a significant risk to the
credit union or the NCUSIF.
104(c)(3)(ii) Charitable Donation
Accounts
Under the Other Banking Agencies’
capital regulations, banks are permitted
to apply a 100 percent risk weight to
equity exposures that qualify as
community development investments.
The Board did not include a similar
approach in the Second Proposal
because credit unions do not hold
community development investments in
the same manner banks do. As
previously discussed, however, a
significant number of commenters
requested that NCUA’s risk-based
capital requirement include an
alternative risk-weighting methodology,
similar to that provided under the Other
Banking Agencies’ capital regulations,
for charitable donation accounts.
The Board believes charitable
donation accounts held at credit unions
are similar enough in purpose to
community development investments
held at banks to warrant a 100 percent
risk weight. Under this final rule, a
credit union can choose whether to
apply the 100 percent risk weight
because the account may be entitled to
a lower risk weight based on the
investments held in the account. As
explained in the definitions part of the
preamble, the 100 percent risk weight
would apply only to accounts that meet
the definition of a ‘‘charitable donation
account’’ and the criteria provided
therein. These limits are prudent and
provide credit unions the option of
applying the 100 percent risk weight, if
they choose.
Accordingly, this final rule revises
§ 702.104(c)(3)(ii) to provide that
notwithstanding the risk weights
assigned in § 702.104(c)(2), a credit
union may assign a 100 percent risk
weight to a charitable donation account.
104(c)(3)(iii) Alternative Approaches
As discussed above, this final rule
reorganizes § 702.104(c)(3) and moves
proposed §§ 702.104(c)(3)(i) and (ii)
under § 702.104(c)(3)(iii) with only nonsubstantive conforming changes. Instead
of citing to FDIC’s regulations, this final
rule incorporates the text explaining
how to apply the gross up approach 176
and the look through approaches 177 into
appendix A to part 702 of NCUA’s
regulations. As discussed below, to
incorporate the full text of §§ 324.43(e)
and 324.53 into NCUA’s regulations, the
Board made some minor conforming
changes to the language and numbering
used in the section. Other than the
changes discussed above, no substantive
changes are intended by these revisions.
Accordingly, § 702.104(c)(3)(iii) of
this final rule provides that,
notwithstanding the risk weights
assigned in paragraph (c)(2) of this
section, a credit union may determine
the risk weight of investment funds, and
non-subordinated or subordinated
tranches of any investment as provided
below.
104(c)(3)(iii)(A) Gross-Up Approach
Proposed § 702.104(c)(3)(i) provided
that a credit union may use the grossup approach under 12 CFR 324.43(e) to
determine the risk weight of the
carrying value of any subordinated
tranche of any investment. When
calculating the risk weight for a
subordinated tranche of any investment
using the proposed gross-up approach, a
credit union must have the following
information:
• The exposure amount of the
subordinated tranche;
• The current outstanding par value
of the credit union’s subordinated
tranche;
• The current outstanding par value
of the total amount of the entire tranche
where the credit union has exposure;
• The current outstanding par value
of the more senior positions in the
securitization that are supported by the
subordinate tranche the credit union
owns; and
• The weighted average risk weight
applicable to the assets underlying the
securitization.
The following is an example of the
application of the gross-up approach: 178
A credit union owns $4 million
(exposure amount and outstanding par
value) of a subordinated tranche of a
private-label mortgage-backed security
backed by first-lien residential
mortgages. The total outstanding par
value of the subordinated tranche that
the credit union owns part of is $10
million. The current outstanding par
value for the tranches that are senior to
and supported by the credit union’s
tranche is $90 million.
Calculation
A
B
mstockstill on DSK4VPTVN1PROD with RULES2
C
D
E
F
Current outstanding par value of the credit union’s subordinated tranche divided
by the current outstanding par value of the entire tranche where the credit union
has exposure.
Current outstanding par value of the senior positions in the securitization that are
supporting the tranche the credit union owns.
Pro-rata share of the more senior positions outstanding in the securitization that is
supported by the credit union’s subordinated tranche: (A) multiplied by (B).
Current exposure amount for the credit union’s subordinated tranche .....................
Enter the sum of (C) and (D) .....................................................................................
The higher of the weighted average risk weight applicable to the assets underlying
the securitization or 20%.
176 12
177 12
CFR 324.43(e).
CFR 324.53.
VerDate Sep<11>2014
22:13 Oct 28, 2015
$4,000,000/$10,000,000 ...................
40%
............................................................
$90,000,000
40% times $90,000,000 ....................
$36,000,000
............................................................
$36,000,000 + $4,000,000 ................
50% primary risk weight for 1st lien
residential real estate loan.
$4,000,000
$40,000,000
50%
178 More simple terminology than the FDIC rule
language is used to make this example easier to
follow.
Jkt 238001
PO 00000
Frm 00064
Fmt 4701
Sfmt 4700
Result
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
Calculation
G
Risk-weighted asset amount of the credit union’s purchased subordinated tranche:
(E) multiplied by (F).
In this example, under the gross-up
approach, the credit union would be
required to risk weight the subordinated
tranche at $20 million. Conversely,
under the 1,250 percent risk weight
approach, the credit union would be
required to risk weight the subordinated
tranche at $50 million (1,250 percent
times $4 million). This example shows
the benefit to credit unions of the
proposed inclusion of the gross-up
approach.
In the case of master trust 179 type
structures and structured products,180
credits unions should calculate the prorata share of the more senior positions
using the prospectus and current
servicing/reference pool reports.
The Board received few comments
objecting to allowing credit unions to
use the gross-up approach, and has
decided to retain the option of using the
gross-up approach in this final rule. The
final rule, however, incorporates the
text of § 324.43(e) into NCUA’s
regulations instead of simply citing to
FDIC’s regulations. As discussed above,
this final rule also would permit credit
unions to use the gross-up approach to
mstockstill on DSK4VPTVN1PROD with RULES2
179 Master trust subordinated tranches do not
support any particular senior tranche in the trust.
The subordinated tranche supports an amount of
senior tranches as defined in the prospectus and the
current servicing reports.
180 Structured products may allocate losses based
on other securities or a reference pool. The credit
union should calculate the pro-rata senior tranche
based on the amount the subordinated tranche
would support if it were an actual tranched
security.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
$40,000,000 times 50% ....................
risk-weight a non-subordinated tranche
of any investment.
Accordingly, § 702.104(c)(3)(iii)(A) of
this final rule provides that a credit
union may use the gross-up approach
under appendix A of this part to
determine the risk weight of the
carrying value of non-subordinated or
subordinated tranches of any
investment.
104(c)(3)(iii)(B) Look-Through
Approaches
Proposed § 702.104(c)(3)(ii) provided
that a credit union may use one of the
look-through approaches under 12 CFR
324.53 to determine the risk weight of
the fair value of mutual funds that are
not in compliance with part 703 of this
chapter, the recorded value of separate
account insurance, or part 703
compliant mutual funds. In particular,
for purposes of applying risk weights to
investment funds, the Board proposed
giving credit unions the option of using
the three look-through approaches that
FDIC allows its regulated institutions to
use under 12 CFR 324.53 of its
regulations, instead of using the
standard risk weights of 20, 100 and 300
percent that would be assigned under
proposed § 702.104(c)(2). The Board
included these alternative approaches to
make NCUA’s risk-based capital
requirement more comparable to the
Other Banking Agencies’ regulations
and to grant credit unions additional
flexibility.
The first of the three full look-through
approaches under 12 CFR 324.53
PO 00000
Frm 00065
Fmt 4701
Sfmt 4700
66689
Result
$20,000,000
required a credit union to look at the
underlying assets owned by the
investment fund and apply an
appropriate risk weight. The other two
approaches under 12 CFR 324.53
required a credit union to use the
information provided in the investment
fund’s prospectus. The minimum risk
weight for any investment fund asset
was 20 percent, regardless of which
approach was used.
Regardless of the look-through
approach selected, the credit union
must include any derivative contract
that is part of the investment fund,
unless the derivative contract is used for
hedging rather than speculative
purposes and does not constitute a
material portion of the fund’s
exposure.181
The following examples outline each
of the three proposed look-through
approaches:
Full look-through approach. The full
look-through approach allowed credit
unions to weight the underlying assets
in the investment fund as if they were
owned separately, with a minimum risk
weight of 20 percent for all underlying
assets. Credit unions were required to
use the most recently available holdings
reports when utilizing the full lookthrough approach.
181 At this time FCUs are not permitted to engage
in derivative contract activity for the purpose of
speculation. However, federally insured, statechartered credit unions may be permitted to use
derivative contracts for speculative purposes under
applicable state law, and thus the Board is
including this statement to address those scenarios.
E:\FR\FM\29OCR2.SGM
29OCR2
66690
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
An example of the application of the
full look-through approach is as follow:
CREDIT UNION INVESTMENT: $10,000,000
Fund holding
(% of fund)
%
Fund investment
Risk weight
%
Credit union
exposure 182
Dollar risk weight
US Treasury Notes ......................................................
FNMA PACs ................................................................
PSE Revenue Bonds ..................................................
Subordinated MBS 184 .................................................
50
30
17.5
2.5
$5,000,000
3,000,000
1,750,000
250,000
20 183 ................................
20 .....................................
50 .....................................
1,250 ................................
$1,000,000
600,000
875,000
3,125,000
Totals ....................................................................
........................
10,000,000
56 185 ................................
(Weighted average Risk
weight).
5,600,000 (Amount of
Risk Assets)
Using the above example, the
investment fund would have a weighted
average risk weight of 56 percent, which
would be lower than the 100 percent
standard risk weight for part 703
compliant investment funds or the
standard 300 percent risk weight for
investment funds not compliant with
part 703.
Simple modified look-through
approach. The simple modified lookthrough approach allowed credit unions
to risk weight their holdings in an
investment fund by the highest risk
weight of any asset permitted by the
investment fund’s prospectus. Credit
unions should use the most recently
available prospectus to determine
investment permissibility for an
investment fund. An example of the
application of the simple modified lookthrough approach is as follows:
CREDIT UNION INVESTMENT: $10,000,000
Fund limits
(% of fund)
Permissible investments
US Treasury Notes ..................................................................................................................................................
Agency MBS (non IO or PO) ...................................................................................................................................
PSE GEO Bonds .....................................................................................................................................................
PSE Revenue Bonds ...............................................................................................................................................
Non-Government/Subordinated/IO/PO MBS ...........................................................................................................
Subordinated MBS ...................................................................................................................................................
Using the above example, the
investment fund would have a risk
weight of 1,250 percent using the simple
modified look-through approach
because the investment fund can hold
1,250 percent risk-weighted
subordinated MBS. In this case, the
credit union would most likely use a
100 percent standard risk weight for the
part 703 compliant investment fund or
the standard 300 percent risk weight for
investment funds not in compliance
with part 703.
Alternative modified look-through
approach. The alternative modified
look-through approach allowed credit
unions to risk weight their holdings in
an investment fund by applying the risk
100
50
20
20
30
10
Risk weight
186 20
20
20
50
50
187 1,250
weights to the limits in the prospectus.
In the case where the aggregate limits in
the prospectus exceed 100 percent, the
credit union must assume the fund will
invest in the highest risk-weighted
assets first. An example of the
application of the simple modified lookthrough approach is as follows:
CREDIT UNION INVESTMENT: $10,000,000
Fund Limits
(% of fund)
Permissible investments
Risk weight
%
CU exposure
100
50
20
20
30
10
20 188 ................................
20 .....................................
20 .....................................
50 .....................................
50 .....................................
1,250 189 ...........................
$0
2,000,000
2,000,000
2,000,000
3,000,000
1,000,000
Total .....................................................................
mstockstill on DSK4VPTVN1PROD with RULES2
US Treasury Notes ......................................................
Agency MBS (non IO or PO) ......................................
PSE GEO Bonds .........................................................
PSE Revenue Bonds ..................................................
Non-Government/Subordinated/IO/PO MBS ...............
Subordinated MBS ......................................................
........................
158 190 (weighted average
risk weight).
10,000,000
182 Fund holdings (percent of fund) multiplied by
the credit union investment.
183 Minimum 20 percent risk weight for assets in
an investment fund, even if the individual risk
weight is zero percent.
184 Use 1,250 percent risk weight or gross-up
calculation.
185 The weighted average risk weight was
calculated by dividing the amount of risk assets
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
($5,600,000) by the credit union exposure
($10,000,000).
186 Minimum 20 percent risk weight for assets in
an investment fund, even if the individual risk
weight is zero percent.
187 Use 1,250 percent risk weight unless the
prospectus limits gross-up risk weight.
PO 00000
Frm 00066
Fmt 4701
Sfmt 4700
Dollar risk weight
400,000
400,000
1,000,000
1,500,000
12,500,000
15,800,000 (Amount of
Risk Assets)
188 Minimum 20 percent risk weight for assets in
an investment fund, even if the individual risk
weight is zero percent.
189 Use 1,250 percent risk weight unless the
prospectus limits gross-up risk weights.
190 The weighted average risk weight was
calculated by dividing the amount of risk assets
($15,800,000) by the credit union exposure
($10,000,000).
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
Using the example above, the
investment fund would have a weighted
average risk weight of 158 percent using
the alternative modified look-through
approach. In this case, the credit union
would most likely use a 100 percent
standard risk weight for part 703
compliant investment funds or the
alternative modified look-through
approach for risk weights for investment
funds that are not compliant with part
703.
Public Comments on the Second
Proposal
The Board received a few comments
relating to the proposed use of the lookthrough approaches. Most of these
comments were addressed above. At
least one commenter, however,
suggested that the Board clarify that the
timing of the most recent available
holding reports are to be used by credit
unions applying the full look-through
approach.
Discussion
The Board received no comments
objecting to allowing credit unions to
use the look-through approaches, and
has decided to retain the option of using
the gross-up approach in this final rule.
The final rule incorporates the relevant
text of § 324.53 into NCUA’s regulations
instead of simply citing to FDIC’s
regulations and makes other minor
conforming edits. In response to the
comments received, the Board has also
added language in paragraph (b)(2)(ii) of
appendix A below to clarify which
holding reports should be used when
calculating a risk-weight using the fulllook-through approach. The
methodology for applying the lookthrough approaches is added to new
appendix A to part 702, which is
discussed in more detail below.
Accordingly, § 702.104(c)(3)(iii)(B)
provides that a credit union may use
one of the look-through approaches
under appendix A part 702 to determine
the risk weight of the exposure amount
of any investment funds, the holdings of
separate account insurance, or both.
mstockstill on DSK4VPTVN1PROD with RULES2
104(c)(4) Risk Weights for Off-BalanceSheet Activities
Under the Second Proposal,
§ 702.104(c)(4) provided that the riskweighted amounts for all off-balancesheet items are determined by
multiplying the off-balance-sheet
exposure amount by the appropriate
credit conversion factor and the
assigned risk weight as follows:
• For the outstanding balance of loans
transferred to a Federal Home Loan
Bank under the MPF program, a 20
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
percent CCF and a 50 percent risk
weight.
• For other loans transferred with
limited recourse, a 100 percent CCF
applied to the off-balance-sheet
exposure and:
Æ For commercial loans, a 100
percent risk weight.
Æ For first-lien residential real estate
loans, a 50 percent risk weight.
Æ For junior-lien residential real
estate loans, a 100 percent risk weight.
Æ For all secured consumer loans, a
75 percent risk weight.
Æ For all unsecured consumer loans,
a 100 percent risk weight.
• For unfunded commitments:
Æ For commercial loans, a 50 percent
CCF with a 100 percent risk weight.
Æ For first-lien residential real estate
loans, a 10 percent CCF with a 50
percent risk weight.
Æ For junior-lien residential real
estate loans, a 10 percent CCF with a
100 percent risk weight.
Æ For all secured consumer loans, a
10 percent CCF with a 75 percent risk
weight.
Æ For all unsecured consumer loans,
a 10 percent CCF with a 100 percent risk
weight.
Public Comments on the Second
Proposal
The Board received several comments
regarding the proposed risk weights
assigned to off-balance-sheet items. At
least one commenter agreed with
requiring capital for most off-balancesheet activities. But the commenter
suggested that credit unions should not
be required to hold capital for offbalance-sheet exposures that are
unconditionally cancellable (without
cause), especially if the exposure is for
less than one year. The commenter
recommended that the Board adopt a
more bank-like off-balance-sheet riskbased capital regime for such exposures.
Another commenter stated that the
proposal identifies the use of a 10
percent credit conversion factor for all
noncommercial unused lines of credit,
but noted that community banks utilize
various credit conversion factors
ranging from zero percent to 50 percent
depending on whether the commitment
is unconditionally cancellable (zero
percent), conditionally cancellable
within one year (20 percent), or
conditionally cancellable beyond one
year (50 percent). The commenter
suggested that the design and inclusion
of cancellation language in lending
contracts is to mitigate the overall
potential risk associated with unfunded
amounts, and the type and extent of the
specific language helps outline the
extent and timeframe of the risk
PO 00000
Frm 00067
Fmt 4701
Sfmt 4700
66691
associated within each lending contract.
As such, the commenter recommended
that the credit conversion factors
utilized by the community banks be
adopted by NCUA to help ensure that
the inherent risk embedded within
specific cancellation language in
lending contracts be accurately
identified and risk weighted.
At least one commenter
recommended that the Board lower the
credit conversion factor for unfunded
consumer loans. Other commenters
recommended unfunded,
unconditionally cancellable
commitments should be risk weighted at
zero percent.
Some commenters noted that under
the proposal, the Board differentiates
between partial recourse loans executed
under the Federal Home Loan Banks’
Mortgage Partnership Finance (MPF)
Program and all other partial recourse
lending programs. Commenters
suggested that, although the MPF
program loans enjoy a lower 20 percent
credit conversion factor (CCF) compared
to the 100 percent CCF applied to other
partial recourse loans, credit unions that
hold a contractual exposure amount that
is less than 20 percent of the
outstanding loan balance will have to
hold more capital for MPF loans than
for other partial recourse arrangements.
For example, a $100,000 loan sold with
a 3 percent contractual exposure would
have an off-balance-sheet value of
$3,000 if it were a normal recourse loan
and $20,000 if it were an MPF loan.191
Since MPF loans include a fixed
contractual exposure amount, the
commenter suggested there does not
appear to be a strong justification for
differentiating this loan program from
other partial recourse loan
arrangements. Even though this adjusted
calculation may track historical losses
in the MPF program more closely,
commenters suggested that the Board
consider whether it is appropriate to
incorporate individualized risk weights
for specific counterparties.
One commenter suggested that the
proposed treatment of the MPF Program
does not address the complexity and
risks associated with the program, and
would prevent credit unions from
selling loans in the secondary market
that have no recourse at all and
therefore pose no risk to the credit
union. Under the Second Proposal, the
capital requirement (after a credit
191 The MPF program takes the outstanding loan
balance multiplied by a 20 percent CCF (100,000 *
.20 = 20,000), while other partial recourse loans
take the maximum contractual exposure multiplied
by a 100 percent CCF (3,000 * 1 = 3,000). Both loans
would be subject to a 50 percent risk-weight as a
first-lien residential real estate loan.
E:\FR\FM\29OCR2.SGM
29OCR2
66692
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
conversion factor) is derived from the
total outstanding principal balance of all
loans sold under the MPF Program. The
commenter suggested it is important to
note that the MPF Program is actually
composed of several different types of
loan purchase programs, some of which
have a limited recourse component and
some that do not. The commenter
suggested further that each loan sold
under an MPF program that includes a
credit-risk sharing component
undergoes an FHLB calculation that
assigns a specific dollar amount for
credit enhancement to that loan. And
some loans with very low credit risk
may have no credit enhancement
assigned, while other loans with
characteristics of higher credit risk are
assigned a higher credit enhancement.
According to the commenter, the total of
these credit enhancement calculations,
which is tracked by the FHLB and
available online, is the maximum
amount of risk for which a credit union
is liable. The commenter suggested that
in some cases, the results of the
calculation for a particular loan may
determine whether that loan is sold
under the MPF Xtra Program (with no
credit enhancement) or under a different
MPF program that includes some form
of credit enhancement. The commenter
contended that, by lumping all MPF
loans into one calculation, the proposal
would significantly alter an institution’s
analysis of how to price and sell
individual loans without any benefit to
the institution or to NCUA in managing
risk. As an alternative, the commenter
suggested the credit conversion and risk
weight be applied to the total credit
enhancement under the MPF program
for which a credit union is liable,
instead of to the loan balances.
Discussion
The small credit conversion factor for
unused consumer lines of credit
provides for the potential swift shift in
credit risk that can occur when
consumers access the lines. The other
alternative credit conversion factors that
include a determination of the term of
the outstanding guarantee add
additional complexity to the assignment
of credit conversion factors and could
result in a less consistent application of
assigned risk weights even with
expanded supervisory guidance.
The definition of the (MPF) Program
will provide for assignments of proper
risk weights in transactions where credit
unions receive fees for managing the
credit risk of the loans. Under the MPF
Program, credit unions retain recourse
risk through a credit enhancement
obligation to the FHLB for credit losses
on certain loans. For loans sold to the
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
FHLB that do not meet the definition of
MPF loans, the risk weight is based on
the maximum contractual amount of the
credit union’s exposure. In a loan sale
transaction that creates no contractual
exposure, the risk-weight would be zero.
Supervisory guidance and Call Report
instructions will be provided to ensure
proper treatment of loans transferred
under the FHLB programs and all other
loans transferred with limited recourse.
The proposed risk weights for offbalance-sheet activities will be retained,
as they are clear and generally
comparable to those assigned under the
Other Banking Agencies’ regulations.
104(c)(5) Derivatives
Proposed § 702.104(c)(5) would have
provided that a complex credit union
must assign a risk-weighted amount to
any derivative contracts as determined
under 12 CFR 702.105.
For the reasons discussed below, the
Board has decided to retain this
proposed section in the final rule
without change.
Current § 702.105 Weighted-Average
Life of Investments
As discussed above, proposed new
§ 702.105 would have replaced current
§ 702.105 regarding weighted-average
life of investments. The definition of
weighted-average life of investments
and the term ‘‘weighted-average life of
investments’’ would have been removed
from part 702 altogether.
The Board received no comments
objecting to this change and has decided
to retain this change in the final rule.
Section 702.105
Derivatives Contract
Under the Second Proposal, § 702.105
assigned risk weights to derivatives in a
manner generally consistent with the
approach adopted by FDIC in its interim
final rule regarding regulatory
capital.192 The NCUA Board proposed
to focus only on interest-rate-related
derivatives in the rule and referred
credit unions to FDIC’s rules for all noninterest-rate-related derivatives. The
Board made this distinction because
federal credit unions are restricted to
interest-rate-related contracts under
NCUA’s final derivatives rule, which
was approved in January 2014.
Federally insured state-chartered credit
unions, however, may have broader
authorization to use non-interest-rate
contracts if approved by the respective
state supervisory authorities.
192 See
PO 00000
78 FR 55339 (Sept. 10, 2013).
Frm 00068
Fmt 4701
Sfmt 4700
Public Comments on the Second
Proposal
The Board received a few general
comments on proposed § 702.105. One
commenter recommended that the
Board, rather than just cross-citing to
FDIC’s regulations, incorporate the FDIC
risk weights for non-interest-rate
derivatives into NCUA regulations
verbatim. The commenter suggested that
although the vast majority of credit
unions will probably not engage in this
activity, its inclusion in NCUA’s
regulations would ease the regulatory
burden for credit unions and examiners
in finding and citing the appropriate
authority. The commenter cautioned,
however, that the Board should not
create its own risk-weight system for
non-interest-rate-related derivatives.
The commenter suggested that, given
the complex nature of derivatives,
modifying the established regulatory
framework could result in unintended
consequences for credit unions engaged
in that activity. In addition, state
regulators have experience supervising
derivative activity in state-chartered
banks within the FDIC framework,
which will help facilitate effective state
supervision for credit unions with
minimum confusion.
Another commenter complained that
the risk-weight calculations for
derivatives were too complicated. The
commenter suggested that derivatives,
per GAAP, are fair valued daily,
monthly, quarterly, and yearly, and
reflected as an asset or a liability, while
their impact runs through earnings or
equity. Accordingly, the commenter
recommended the Board apply a
simpler formula to assess risk-based
capital for derivatives, using a credit
conversion factor to the notional
amount and then applying a riskweighted factor. Another commenter
suggested that the Board simplify the
calculation for derivatives based on the
percentage of potential future exposure.
Discussion
The Board has considered the
comments suggesting the derivatives
calculations be simplified. But given the
number of variables to be considered for
risk weighting—which include the type
of derivative (interest rate or other), the
legal agreement governing the
transactions (qualified master netting
agreement), the type of collateral to be
used to satisfy margin movements, the
method the credit union will use for
collateral risk mitigation, and the
counterparty approach (dealer or
exchange)—it is impractical to simplify
the calculation any further given the
number of options that need to be
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
considered. Therefore the Board has
maintained the proposed approach in
this final rule.
Consistent with NCUA’s recently
finalized derivatives rule,193 the Board
is now adopting an approach to assign
risk weights to derivatives that is
generally consistent with the approach
adopted by FDIC in its recently issued
interim final rule regarding regulatory
capital.194 Under FDIC’s interim rule,
derivatives transactions covered under
clearing arrangements are treated
differently than non-cleared
transactions. The Board addresses
clearing separately below.
The final rule focuses only on
interest-rate-related derivatives and
refers credit unions to FDIC’s rules for
all non-interest-rate-related derivatives.
The final rule makes this distinction
because federal credit unions are
restricted to interest-rate-related
contracts under the final derivatives
rule approved in January 2014;
however, federally insured, statechartered credit unions may have
broader authorization to use noninterest-rate contracts if approved by the
respective state supervisory authorities.
NCUA is not aware of any non-interestrate derivative contracts being used by
federally insured, state-chartered credit
unions (per Call Report data).
mstockstill on DSK4VPTVN1PROD with RULES2
OTC Derivatives Transaction Risk
Weight
Under the Second Proposal, a credit
union would have undertaken the
following process to determine the risk
weight for OTC derivative contracts. To
determine the risk-weighted asset
amount for a derivatives contract a
credit union must first determine its
exposure amount for the contract. The
credit union must then recognize the
credit mitigation of financial collateral,
if qualified, and apply to that amount a
risk weight based on the counterparty or
recognized collateral or exchange
(Derivatives Clearing Organization or
DCO). For a single interest rate
derivatives contract that is not subject to
a qualifying master netting agreement,
the proposal required the exposure
amount to be the sum of (1) the credit
union’s current credit exposure (CCE),
which is the greater of fair value or zero,
and (2) potential future exposure, which
is calculated by multiplying the
notional principal amount of the
derivatives contract by the appropriate
conversion factor, in accordance with
the table below. Non-interest-rate
derivative contract conversion factors
193 See
194 See
78 FR 55339 (Sept. 10, 2013).
78 FR 55339 (Sept. 10, 2013).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
can be referenced in 12 CFR 324.34 of
the FDIC rule.
66693
by the Other Banking Agencies.195
Under the Second Proposal, a credit
union was required to calculate a trade
PROPOSED CONVERSION FACTOR MA- exposure amount, determine the risk
TRIX FOR INTEREST RATE DERIVA- mitigation of any financial collateral,
and multiply that amount by the
TIVES CONTRACTS
applicable risk weight. Such an
approach allowed credit unions to take
IRR hedge
Remaining maturity
derivatives
into account the lower degree of risk
associated with cleared derivatives
One year or less ...................
0.00 transactions and the benefit of collateral
Greater than one year and
associated with these transactions. In
less than or equal to five
addition, the proposed approach also
years .................................
0.005
Greater than five years .........
0.015 accounted for the risk of loss associated
with collateral posted by a credit union.
The Board received no comments
For multiple interest rate derivatives
objecting to this particular approach and
contracts subject to a qualifying master
netting agreement, a credit union would has decided to retain the proposed
process to determine the risk weight for
calculate the exposure amount by
cleared derivatives in this final rule
adding the net CCE and the adjusted
without change.
sum of the PFE amounts for all
derivatives contracts subject to that
Trade Exposure Amount
qualifying master netting agreement.
Under the Second Proposal, the trade
Under the proposal, the net CCE
exposure amount would have been
would have been the greater of zero and equal to the amount of the derivative,
the net sum of all positive and negative
calculated as if it were an OTC
fair values of the individual derivatives
transaction under subsection (b) of this
contracts subject to the qualifying
section, added to the fair value of the
master netting agreement. The adjusted
collateral posted by the credit union and
sum of the PFE amounts would have
held by a DCO, clearing member or
been calculated as described in
custodian. This calculation took into
proposed § 702.105(a)(2)(ii)(B).
account the exposure amount of the
Under the proposal, to recognize the
derivatives transaction and the exposure
netting benefit of multiple derivatives
associated with any collateral posted by
contracts, the contracts would have to
the credit union. This is the same
be subject to the same qualifying master approach employed by the Other
netting agreement. For example, a credit Banking Agencies.196
union with multiple derivatives
The Board received no comments
contracts with a single counterparty
objecting to this particular approach and
could net the counterparty exposure if
has decided to retain the proposed
the transactions fall under the same
process to determine the trade exposure
International Swaps and Derivatives
amount in this final rule without
Association, Inc. (ISDA) Master
change.
Agreement and Schedule.
Cleared Transaction Risk Weights
Under the proposal, if a derivatives
contract were collateralized by financial
Under the Second Proposal, after a
collateral, a credit union would first
credit union determines its trade
determine the exposure amount of the
exposure amount, it would have been
derivatives contract as described in
required to apply a risk weight that is
§§ 702.105(a)(i) or (a)(ii). Next, to
based on agreements preventing risk of
recognize the credit risk mitigation
loss of the collateral posted by the
benefits of the financial collateral, the
counterparty to the transaction. The
credit union would use the approach for proposal required credit unions to apply
collateralized transactions as described
a 2 percent risk weight if the collateral
in § 702.105(c) of the proposal, which is posted by a counterparty is subject to an
discussed in more detail below.
agreement that prevents any losses
The Board received no comments
caused by the default, insolvency,
objecting to this particular approach and liquidation, or receivership of the
has decided to retain the proposed
clearing member or any of its clients. To
process to determine the risk weight for qualify for this risk weight, a credit
OTC derivatives contracts in this final
union would have been required to
rule without change.
conduct a sufficient legal review and
determine that the agreement to prevent
Cleared Derivatives Risk Weight
risk of loss is legal, valid, binding, and
Proposed § 702.105 would have
enforceable. If a credit union did not
adopted an approach to assign risk
weights to derivatives that is generally
195 See 78 FR 55339 (Sept. 10, 2013).
196 See, e.g., 12 CFR 324.35.
consistent with the approach adopted
PO 00000
Frm 00069
Fmt 4701
Sfmt 4700
E:\FR\FM\29OCR2.SGM
29OCR2
66694
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
meet either or both of these
requirements, the credit union would
have to apply a 4 percent risk weight to
the transaction.
The differing risk weights for cleared
transactions took into account the risk
that collateral will not be there because
of a default or other event, which
further exposes the credit union to loss.
However, cleared transactions pose very
low probability that collateral will not
be available in the event of a default,
which is reflected in the low overall risk
weights. This is the same approach
employed by the Other Banking
Agencies.197
The Board received no comments
objecting to this particular approach and
has decided to retain the proposed
process to determine the risk weights for
cleared transactions in this final rule
without change.
Collateralized Transactions
Under the Second Proposal, the Board
proposed to permit a credit union to
recognize risk-mitigating effects of
financial collateral in OTC transactions.
The collateralized portion of the
exposure would receive the risk weight
applicable to the collateral. In all cases,
(1) the collateral must be subject to a
collateral agreement (for example, an
ISDA Credit Support Annex) for at least
the life of the exposure; (2) the credit
union must revalue the collateral at
least every three months; and (3) the
collateral and the exposure must be
denominated in U.S. dollars.
Generally, the risk weight assigned to
the collateralized portion of the
exposure would be no less than 20
percent. However, the collateralized
portion of an exposure may be assigned
a risk weight of less than 20 percent for
the following exposures. Derivatives
contracts that are marked to fair value
on a daily basis and subject to a daily
margin maintenance agreement could
receive (1) a zero percent risk weight to
the extent that contracts are
collateralized by cash on deposit, or (2)
a 10 percent risk weight to the extent
that the contracts are collateralized by
an exposure that qualifies for a zero
percent risk weight under
§ 702.104(c)(2)(i) of this proposed rule.
In addition, a credit union could assign
a zero percent risk weight to the
collateralized portion of an exposure
where the financial collateral is cash on
deposit. It also could do so if the
financial collateral is an exposure that
197 See,
qualifies for a zero percent risk weight
under § 702.104(c)(2)(i) of this proposed
rule, and the credit union has
discounted the fair value of the
collateral by 20 percent. The credit
union would be required to use the
same approach for similar exposures or
transactions.
The Board received no comments
objecting to this particular approach
and, consistent with the proposal, has
decided to permit a credit union to
recognize risk-mitigating effects of
financial collateral in OTC transactions
in this final rule without change.
Risk Management Guidance for
Recognizing Collateral
Under the Second Proposal, before a
credit union could recognize collateral
for credit risk mitigation purposes, it
should: (1) Conduct sufficient legal
review to ensure, at the inception of the
collateralized transaction and on an
ongoing basis, that all documentation
used in the transaction is binding on all
parties and legally enforceable in all
relevant jurisdictions; (2) consider the
correlation between risk of the
underlying direct exposure and
collateral in the transaction; and (3)
fully take into account the time and cost
needed to realize the liquidation
proceeds and the potential for a decline
in collateral value over this time period.
A credit union should also ensure that
the legal mechanism under which the
collateral is pledged or transferred
ensures that the credit union has the
right to liquidate or take legal
possession of the collateral in a timely
manner in the event of the default,
insolvency, or bankruptcy (or other
defined credit event) of the counterparty
and, where applicable, the custodian
holding the collateral.
Finally, a credit union should ensure
that it (1) has taken all steps necessary
to fulfill any legal requirements to
secure its interest in the collateral so
that it has, and maintains, an
enforceable security interest; (2) has set
up clear and robust procedures to
ensure satisfaction of any legal
conditions required for declaring the
borrower’s default and prompt
liquidation of the collateral in the event
of default; (3) has established
procedures and practices for
conservatively estimating, on a regular
ongoing basis, the fair value of the
collateral, taking into account factors
that could affect that value (for example,
the liquidity of the market for the
collateral and deterioration of the
collateral); and (4) has in place systems
for promptly requesting and receiving
additional collateral for transactions
with terms requiring maintenance of
collateral values at specified thresholds.
When collateral other than cash is
used to satisfy a margin requirement,
then a haircut is applied to incorporate
the credit risk associated with collateral,
such as securities. The Board proposed
including this concept in the rule so
that credit unions could accurately
recognize the risk mitigation benefit of
collateral. This is the same approach
taken by the Other Banking Agencies.
The Board received no comments
objecting to this particular approach and
has decided to retain the proposed
approach to risk management for
recognizing collateral in this final rule
without change.
The table below illustrates an
example of the calculations for RiskWeighted Asset Amounts for both OTC
and clearing derivatives agreements. For
this example, both the OTC and clearing
are considered to be multiple contracts
under a Qualified Master Netting
Agreement. Credit unions can use this
as a guide in confirming the calculations
involved to produce a risk-weighted
asset for derivatives. (See the number
references below for each line number
of the table example.)
1. The Agreement Type indicates the
transaction legal agreement between the
credit union and the counterparty.
2. The examples provide, but are not
limited to the basis calculations required for
various collateral and agreement approaches.
3. Variation Margin (amount as basis for
margin calls which are satisfied with
collateral) collateral used for these examples.
4. The Risk Weight of Collateral is applied
when utilizing the Simple Approach in the
recognition of credit risk of collateralized
derivative contracts.
5. To recognize the risk-mitigating effects
of financial collateral, a credit union may use
the ‘‘Simple Approach’’ or the ‘‘Collateral
Haircut Approach’’.
6. The Collateral Haircut is determined by
using Table 2 to § 702.105 in the rule text:
‘‘Standard Supervisor Market Price Volatility
Haircuts.’’
7. Counterparty risk weights are
determined in § 702.104 for OTC and
§ 702.105 for clearing.
Lines 8 through 16 are calculations based
on the approach and types of agreement,
collateral, fair values and notional amounts
of the credit union derivatives transactions.
e.g., 12 CFR 324.35.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
PO 00000
Frm 00070
Fmt 4701
Sfmt 4700
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
Under the Second Proposal, the Board
included language that would require
federally insured, state-chartered credit
unions (FISCUs) to calculate risk
weights in accordance with FDIC’s rules
for derivatives transactions that are not
permissible under NCUA’s derivatives
rule. As noted above, one commenter
requested that NCUA incorporate all of
FDIC’s language into the final RBC rule.
FDIC’s rules for derivatives are very
detailed and lengthy. Incorporating
these rules into this final rule would
add unnecessary complexity. Further, as
the options available to FISCUs are
based on state laws, it would be a very
time-consuming and expensive process
to monitor FDIC’s rules to make future
conforming changes in NCUA’s riskbased capital regulations. For these
reasons, the Board is retaining the crossreference and is not incorporating the
text of FDIC’s derivatives regulations
into this final rule.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Current Section 702.106 Standard
Calculation of Risk-Based Net Worth
Requirement
The Second Proposal would eliminate
current § 702.106 regarding the standard
RBNW requirement. The current rule is
structured so that credit unions have a
standard measure and optional
alternatives for measuring a credit
union’s RBNW. The Second Proposal,
on the other hand, contained only a
single measurement for calculating a
credit union’s risk-based capital ratio.
Accordingly, current § 702.106 will no
longer be necessary.
The Board received no comments on
this particular revision and has decided
to eliminate current § 702.106 from this
final rule as proposed.
Current Section 702.107 Alternative
Component for Standard Calculation
The Second Proposal would eliminate
current § 702.107 regarding the use of
alternative risk weight measures. The
Board observed that the current
alternative risk weight measures add
PO 00000
Frm 00071
Fmt 4701
Sfmt 4700
unnecessary complexity to the rule. The
current alternative risk weights focus
almost exclusively on IRR, which has
resulted in some credit unions with
higher risk operations reducing their
regulatory minimum capital
requirement to a level inconsistent with
the risk of the credit union’s business
model. The proposed risk weights
would provide for lower risk-based
capital requirements for those credit
unions making good quality loans,
investing prudently, and avoiding
excessive concentrations of assets.
The Board received no comments on
this particular revision and has decided
to eliminate current § 702.107 from this
final rule as proposed.
Current Section 702.108
Mitigation Credit
Risk
The Second Proposal would eliminate
current § 702.108 regarding the risk
mitigation credit. The risk mitigation
credit provides a system for reducing a
credit union’s risk-based capital
requirement if it can demonstrate
E:\FR\FM\29OCR2.SGM
29OCR2
ER29OC15.002</GPH>
mstockstill on DSK4VPTVN1PROD with RULES2
Federally Insured, State-Chartered
Credit Unions’ Derivative Transactions
66695
66696
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
significant mitigation of credit risk or
IRR. Credit unions have rarely taken
advantage of risk mitigation credits;
only one credit union has ever received
a risk mitigation credit.
The Board received no comments on
this particular revision and has decided
to eliminate current § 702.107 from this
final rule as proposed.
Section 702.106 Prompt Corrective
Action for Adequately Capitalized
Credit Unions
The Second Proposal renumbered
current § 702.201 as proposed § 702.106,
and would have made only minor
conforming amendments to the text of
the section. Consistent with the
proposed elimination of the regular
reserve requirement in current
§ 702.401(b), proposed § 702.106(a)
would also remove the requirement that
adequately capitalized credit unions
transfer the earnings retention amount
from undivided earnings to their regular
reserve account.
The Board received no comments on
this section and has decided to adopt
the proposed amendments in this final
rule without change.
Section 702.107 Prompt Corrective
Action for Undercapitalized Credit
Unions
Public Comments on the Second
Proposal
One state agency commenter noted
that under the proposal, credit unions
classified as significantly
undercapitalized or worse would be
required to restrict member business
loans. The commenter acknowledged
that it may be prudent to limit member
business lending in some such cases,
but felt there could be instances in
which rational loan workout agreements
require additional loans be granted to
protect the cash flow or collateral
position on loans already granted. The
commenter suggested that forcing a
restriction without some element of
discretion on the part of the state
examiner or federal examiner and
corresponding state regulatory official
and NCUA regional office may have the
unintended consequence of artificially
creating a liquidity problem for a
borrower, and potentially jeopardizing
the collection of existing credits. The
commenter recommended that the
decision to limit any type of lending be
done on a case-by-case basis rather than
a sweeping decision to be applied to all
regardless of the circumstances.
Discussion
The Second Proposal renumbered
current § 702.202 as proposed § 702.107,
and made only minor conforming
amendments to the text of the section.
Consistent with the proposed
elimination of the regular reserve
requirement in current § 702.401(b),
proposed § 702.107(a)(1) would also
remove the requirement that
undercapitalized credit unions transfer
the earnings retention amount from
undivided earnings to their regular
reserve account.
The Board received no comments on
this section and has decided to adopt
the proposed amendments in this final
rule without change.
The Board is bound by statute because
section 216(g)(2) of the FCUA provides
in relevant part:
[A]n insured credit union that is
undercapitalized may not make any increase
in the total amount of member business loans
(as defined in section 107A(c) of this title)
outstanding at that credit union at any one
time, until such time as the credit union
becomes adequately capitalized.
The statutory language does not
preclude a credit union from entering
into loan workout agreements provided
the total amount of member business
loans outstanding, including unused
commitments, does not increase.
Accordingly, the Board has retained the
language in proposed § 702.108 in this
final rule without change.
mstockstill on DSK4VPTVN1PROD with RULES2
Section 702.108 Prompt Corrective
Action for Significantly
Undercapitalized Credit Unions
Section 702.109 Prompt Corrective
Action for Critically Undercapitalized
Credit Unions
The Second Proposal renumbered
current § 702.203 as proposed § 702.108,
and made only minor conforming
amendments to the text of the section.
Consistent with the proposed
elimination of the regular reserve
requirement in current § 702.401(b),
proposed § 702.108(a)(1) would also
remove the requirement that
significantly undercapitalized credit
unions transfer the earnings retention
amount from undivided earnings to
their regular reserve account.
The Second Proposal renumbered
current § 702.204 as proposed § 702.109,
and made only minor conforming
amendments to the text of the section.
Consistent with the proposed
elimination of the regular reserve
requirement in current § 702.401(b),
proposed § 702.109(a)(1) would also
remove the requirement that critically
undercapitalized credit unions transfer
the earnings retention amount from
undivided earnings to their regular
reserve account.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
PO 00000
Frm 00072
Fmt 4701
Sfmt 4700
The Board received no comments on
this section and has decided to adopt
the proposed amendments in this final
rule without change.
Section 702.110 Consultation With
State Official on Proposed Prompt
Corrective Action
The Second Proposal renumbered
current § 702.205 as proposed § 702.110,
and made only minor conforming
amendments to the text of the section.
Public Comments on the Second
Proposal
One state supervisory authority
commenter pointed out that, under the
proposal, authority to approve certain
actions (such as net worth restoration
plans, earnings retention waivers, etc.)
must come from the NCUA Board, after
consulting with the state regulator. The
commenter recommended, however,
that the authority to approve actions
may be better placed with NCUA
regional directors, after consulting with
the state regulator. The commenter
suggested that most states have a long
and well established working
relationship with regional offices, and
regional directors should be in a better
position to evaluate the reasonableness
of this type of request.
Discussion
The Board appreciates the
commenter’s suggestion, but declines to
make the recommended change at this
time. However, the Board may choose
delegate its authority to approve actions
under this section to regional directors
without having to change NCUA’s
regulations. Accordingly, the Board has
decided to retain proposed § 702.110 in
this final rule without change.
Section 702.111 Net Worth Restoration
Plans (NWRPs)
The Second Proposal renumbered
current § 702.206 as proposed § 702.111,
and made only minor conforming
amendments to the text of most of the
subsections, with a few exceptions
discussed in more detail below.
The Board reviewed the comments
received on this section, which are
discussed in more detail below, and has
decided to adopt proposed § 702.111 in
this final rule without change.
111(c) Contents of NWRP
Under the Second Proposal,
§ 702.111(c)(1)(i) provided that the
contents of an NWRP must specify a
quarterly timetable of steps the credit
union will take to increase its net worth
ratio and risk-based capital ratio, if
applicable, so that it becomes
adequately capitalized by the end of the
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
term of the NWRP, and will remain so
for four consecutive calendar quarters.
The Board received no comments on
this section and has decided to adopt
the proposed amendments in this final
rule without change.
111(g)(4) Submission of Multiple
Unapproved NWRPs
Under the Second Proposal,
§ 702.111(g)(4) provided that the
submission of more than two NWRPs
that are not approved is considered an
unsafe and unsound condition and may
subject the credit union to
administrative enforcement actions
under section 206 of the FCUA.198 The
proposed amendments were intended to
clarify that submitting multiple NWRPs
that are rejected by NCUA, or the
applicable state official, because of the
inability of the credit union to produce
an acceptable NWRP is an unsafe and
unsound practice and may subject the
credit union to further actions as
permitted under the FCUA.
mstockstill on DSK4VPTVN1PROD with RULES2
Public Comments on the Second
Proposal
At least one commenter claimed that
a number of credit unions are not aware
of proposed new § 702.111(g)(4) because
NCUA led them to believe that the rule
only applied to complex credit unions.
The commenter suggested that NCUA
has significant latitude to approve or
deny net worth restoration plans, even
if a credit union submits a plan that
meets the stated requirements. The
commenter opposed including the new
provision in the final rule, and
recommended the Board include
safeguards to ensure that credit unions
acting in good faith are able to
successfully submit NWRPs. Another
commenter contended that the Board
presented no evidence that submitting
multiple net worth restoration plans
represents an unsafe and unsound
condition.
Discussion
The failure of a credit union to
prepare an adequate net worth
restoration plan places the credit union
in violation of the FCUA requiring
submission of an acceptable plan within
the time allowed. The submission and
rejection of multiple plans results in
delays in resolving the problem of
insured credit unions. Accordingly, to
further ensure compliance with the
FCUA, the Board has decided to adopt
proposed § 702.111(g)(4) in this final
rule without change.
The Board clarifies, however, that
non-complex credit unions will not be
198 12
U.S.C. 1786; and 1790d.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
expected to address risk-based capital in
net worth restoration plans.
111(j) Termination of NWRP
Under the Second Proposal,
§ 702.111(j) provided that, for purposes
of part 702, an NWRP terminates once
the credit union has been classified as
adequately capitalized or well
capitalized for four consecutive
quarters. The proposed paragraph also
provided, as an example, that if a credit
union with an active NWRP attains the
classification as adequately capitalized
on December 31, 2015, this would be
quarter one and the fourth consecutive
quarter would end September 30, 2016.
The proposed paragraph was intended
to provide clarification for credit unions
on the timing of an NWRP’s
termination.
The Board received no comments on
this section and has decided to adopt
the proposed amendments in this final
rule without change.
Section 702.112 Reserves
The Second Proposal renumbered
current § 702.401 as proposed § 702.112.
Consistent with the text of current
§ 702.401(a), the proposal also would
require that each credit union establish
and maintain such reserves as may be
required by the FCUA, by state law, by
regulation, or, in special cases, by the
Board or appropriate state official.
The Board received no comments on
this section and has decided to adopt
the proposed amendments in this final
rule without change.
Regular Reserve Account
As mentioned above, the proposed
rule would eliminate current
§ 702.401(b) regarding the regular
reserve account from the earnings
retention process. The process and
substance of requesting permission for
charges to the regular reserve would be
eliminated upon the effective date of a
final rule. Upon the effective date of a
final rule, a federal credit union would
close out the regular reserve balance
into undivided earnings. A statechartered, federally insured credit union
may, however, still be required to
maintain a regular reserve account by its
respective state supervisory authority.
The Board received no comments on
the elimination of current § 702.401(b)
and has decided to adopt the proposed
revision in this final rule without
change.
Section 702.113 Full and Fair
Disclosure of Financial Condition
The Second Proposal renumbered
current § 702.402 as proposed § 702.113,
and made only minor conforming
PO 00000
Frm 00073
Fmt 4701
Sfmt 4700
66697
amendments to the text of the section
with the exception of the changes to
proposed § 702.113(d) that are discussed
in more detail below.
The Board received no comments on
this section and has decided to adopt
the proposed amendments in this final
rule without change.
113(d) Charges for Loan and Lease
Losses
Consistent with the proposed
elimination of the regular reserve
requirement which is discussed above,
proposed § 702.113(d) would remove
current § 702.402(d)(4), which provides
that the maintenance of an ALLL shall
not affect the requirement to transfer
earnings to a credit union’s regular
reserve when required under subparts B
or C of part 702.
In addition, the proposed rule would
remove current § 702.402(d)(4), which
provides that adjustments to the
valuation ALLL will be recorded in the
expense account ‘‘Provision for Loan
and Lease Losses.’’ This change is
intended to clarify that the ALLL is to
be maintained in accordance with
GAAP, as discussed above.
The Board received no comments on
these proposed revisions and has
decided to adopt the proposed
amendments in this final rule without
change.
(d)(1)
Proposed § 702.113(d)(1) would
amend current § 702.401(d)(1) to
provide that charges for loan and lease
losses shall be made timely and in
accordance with GAAP. The italicized
words ‘‘and lease’’ and ‘‘timely and’’
would be added to the language in the
current rule to clarify that the
requirement also applies to lease losses
and to require that credit unions make
charges for loan and lease losses in a
timely manner. As with the section
above, these changes are intended to
clarify that charges for potential lease
losses are to be recorded in accordance
with GAAP through the same allowance
account as loan losses. In addition,
timely recording is critical to maintain
full and fair disclosure as required
under this section.
The Board received no comments on
this section and has decided to adopt
the proposed amendments in this final
rule without change.
(d)(2)
Proposed § 702.113(d)(2) would
amend current § 702.401(d)(2) to
eliminate the detailed requirement and
simply provide that the ALLL must be
maintained in accordance with GAAP.
This change is intended to provide full
E:\FR\FM\29OCR2.SGM
29OCR2
66698
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
and fair disclosure to a credit union
member, NCUA, or, at the discretion of
a credit union’s board of directors, to
creditors to fairly inform them of the
credit union’s financial condition and
operations.
The Board received no comments on
this section and has decided to adopt
the proposed amendments in this final
rule without change.
(d)(3)
Proposed § 702.113(d)(3) retained the
language in current § 702.401(d)(5) with
no changes.
The Board received no comments on
this section and has decided to adopt
the proposed amendments in this final
rule without change.
Section 702.114 Payment of Dividends
The Second Proposal renumbered
current § 702.402 as proposed § 702.114
and made amendments to the text of
paragraphs (a) and (b).
The Board received no comments on
this section and has decided to adopt
the proposed amendments in this final
rule without change.
mstockstill on DSK4VPTVN1PROD with RULES2
114(a) Restriction on Dividends
Current § 702.402(a) permits credit
unions with a depleted undivided
earnings balance to pay dividends out of
the regular reserve account without
regulatory approval, as long as the credit
union will remain at least adequately
capitalized. Under proposed
§ 702.114(a), however, only credit
unions that have substantial net worth,
but no undivided earnings, would be
allowed to pay dividends without
regulatory approval. Because of the
removal of the regular reserve account,
and to conform to GAAP, the proposal
would amend the language to clarify
that dividends may be paid when there
is sufficient net worth. Net worth may
incorporate accounts in addition to
undivided earnings. Accordingly,
§ 702.114(a) of this proposal would
provide that dividends shall be
available only from net worth, net of
any special reserves established under
§ 702.112, if any.
The Board received no comments on
this section and has decided to adopt
the proposed amendments in this final
rule without change.
114(b) Payment of Dividends and
Interest Refunds
The Second Proposal would eliminate
the language in current § 702.403(b) and
replace it with a new provision.
Proposed new § 702.114(b) would
provide that the board of directors must
not pay a dividend or interest refund
that will cause the credit union’s capital
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
classification to fall below adequately
capitalized under subpart A of part 702
unless the appropriate regional director
and, if state-chartered, the appropriate
state official, have given prior written
approval (in an NWRP or otherwise).
Proposed paragraph (b) would have
provided further that the request for
written approval must include the plan
for eliminating any negative retained
earnings balance.
The Board received no comments on
this section and has decided to adopt
the proposed amendments in this final
rule without change.
B. Subpart B—Alternative Prompt
Corrective Action for New Credit Unions
Consistent with the Second Proposal,
this final rule adds new subpart B,
which contains most of the capital
adequacy rules that apply to ‘‘new’’
credit unions. The current net worth
measures, net worth classification, and
text of the PCA requirements applicable
to new credit unions are renumbered.
They remain mostly unchanged from
the current rule, except for minor
conforming changes and the following
substantive amendments:
(1) Clarification of the language in
current § 702.301(b) regarding the
ability of credit unions to become
‘‘new’’ again due to a decrease in asset
size after having exceeded the $10
million threshold.
(2) Elimination of the regular reserve
account requirement in current
§ 702.401(b) and all cross-references to
the requirement.
(3) Addition of new § 701.206(f)(3)
clarifying that the submission of more
than two revised business plans would
be considered an unsafe and unsound
condition.
(4) Amendment of the language of
current § 702.402 regarding the full and
fair disclosure of financial condition.
(5) Amendment of the requirements of
current § 702.403 regarding the payment
of dividends.
Section 702.201 Scope
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, this final rule
renumbers current § 702.301 as
§ 702.201. The final rule also clarifies
that a credit union may not regain a
designation of ‘‘new’’ after reporting
total assets in excess of $10 million.
Section 702.202 Net Worth Categories
for New Credit Unions
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, this final rule
renumbers current § 702.302 as
§ 702.202, and makes only minor
PO 00000
Frm 00074
Fmt 4701
Sfmt 4700
technical edits and conforming
amendments to the text of the section.
Section 702.203 Prompt Corrective
Action for Adequately Capitalized New
Credit Unions
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, this final rule
renumbers current § 702.303 as
§ 702.203, and makes only minor
conforming amendments to the text of
the section. Consistent with the
proposed elimination of the regular
reserve requirement in current
§ 702.401(b), this final rule also removes
the requirement that adequately
capitalized credit unions transfer the
earnings retention amount from
undivided earnings to their regular
reserve account.
Section 702.204 Prompt Corrective
Action for Moderately Capitalized,
Marginally Capitalized or Minimally
Capitalized New Credit Unions
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, this final rule
renumbers current § 702.304 as
§ 702.204, and makes only minor
conforming amendments to the text of
the section. Consistent with the
proposed elimination of the regular
reserve requirement in current
§ 702.401(b), this final rule removes the
requirement that such credit unions
transfer the earnings retention amount
from undivided earnings to their regular
reserve account.
Section 702.205 Prompt Corrective
Action for Uncapitalized New Credit
Unions
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, this final rule
renumbers current § 702.305 as
proposed § 702.205, and makes only
minor conforming amendments to the
text of the section.
Section 702.206 Revised Business
Plans (RBPs) for New Credit Unions
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, this final rule
renumbers current § 702.306 as
§ 702.206, makes mostly minor
conforming amendments to the text of
the section, and adds new
§ 702.206(g)(3). Consistent with the
proposed elimination of the regular
reserve requirement in current
§ 702.401(b), this final rule also removes
the requirement that new credit unions
transfer the earnings retention amount
from undivided earnings to their regular
reserve account.
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
206(g)(3) Submission of Multiple
Unapproved Revised Business Plans
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal,
§ 702.206(g)(3) of this final rule provides
that the submission of more than two
RBPs that were not approved is
considered an unsafe and unsound
condition and may subject the credit
union to administrative enforcement
actions under section 206 of the
FCUA.199 As explained in the preamble
to the Second Proposal, NCUA regional
directors have expressed concerns that
some credit unions have in the past
submitted multiple RBPs that could not
be approved due to non-compliance
with the requirements of the current
rule, resulting in delayed
implementation of actions to improve
the credit union’s net worth. This
amendment is intended clarify that
submitting multiple RBPs that are
rejected by NCUA, or a state official,
because of the failure of the credit union
to produce an acceptable RBP is an
unsafe and unsound practice and may
subject the credit union to further
actions as permitted under the FCUA.
mstockstill on DSK4VPTVN1PROD with RULES2
Section 702.207 Incentives for New
Credit Unions
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, this final rule
renumbers current § 702.307 as
proposed § 702.207, and makes only
minor conforming amendments to the
text of the section.
Section 702.208 Reserves
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, this final rule
adds new § 702.208 regarding reserves
for new credit unions. Also, consistent
with the text of the current reserve
requirement in § 702.401(a), this final
rule requires that each new credit union
establish and maintain such reserves as
may be required by the FCUA, by state
law, by regulation, or in special cases,
by the Board or appropriate state
official.
As explained under the part of the
preamble associated with § 702.112
above, this final rule eliminates the
regular reserve account under current
§ 702.402(b) from the earnings retention
requirement. Additionally, the process
and substance of requesting permission
for charges to the regular reserve will be
eliminated upon the effective date of
this final rule. Upon the effective date
of this final rule, a federal credit union
should close out its regular reserve
199 12
U.S.C. 1786 and 1790d.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
balance into undivided earnings. A
federally insured state-chartered credit
union, however, may still maintain a
regular reserve account if required
under state law or by its state
supervisory authority.
Section 702.209 Full and Fair
Disclosure of Financial Condition
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, this final rule
renumbers current § 702.402 as
§ 702.209 and makes only minor
conforming amendments to the text of
this section with the exception of the
changes to paragraph (d) that are
discussed in more detail below.
209(d) Charges for Loan and Lease
Losses
The Board received no comments on
this section. Accordingly, consistent
with the proposed elimination of the
regular reserve requirement,
§ 702.209(d) of this final rule removes
the language in current § 702.402(d)(4),
which provides that the maintenance of
an ALLL shall not affect the requirement
to transfer earnings to a credit union’s
regular reserve when required under
subparts B or C of part 702. In addition,
this final rule removes current
§ 702.402(d)(3), which provides that
adjustments to the valuation ALLL will
be recorded in the expense account
‘‘Provision for Loan and Lease Losses.’’
As discussed in the part of the preamble
associated with § 702.113, the changes
to this section emphasize the need to
record the ALLL in accordance with
GAAP.
(d)(1)
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, current
§ 702.401(d)(1) is renumbered as
§ 702.209(d)(1) and amended to provide
that charges for loan and lease losses
shall be made timely and in accordance
with GAAP. This final rule adds the
italicized words ‘‘and lease’’ and
‘‘timely and’’ to the language in the
current rule to clarify that the
requirement also applies to lease losses
and to require that credit unions make
charges for loan and lease losses in a
timely manner. As with the section
above, this section is changed to clarify
that charges for potential lease losses
should be recorded in accordance with
GAAP through the same allowance
account as loan losses. In addition,
timely recording is critical to maintain
full and fair disclosure as required
under this section.
PO 00000
Frm 00075
Fmt 4701
Sfmt 4700
66699
(d)(2)
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, current
§ 702.401(d)(2) is renumbered as
§ 702.209(d)(2) and is amended to
provide that the ALLL must be
maintained in accordance with GAAP.
This change is intended to provide full
and fair disclosure to credit union
members, NCUA, or, at the discretion of
a credit union’s board of directors, to
creditors to fairly inform them of the
credit union’s financial condition and
operations.
(d)(3)
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, current
§ 702.401(d)(5) is renumbered as
§ 702.209(d)(3) and retains the language
with no changes.
Section 702.210 Payment of Dividends
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, the language
in current § 702.403 is incorporated into
new § 702.210 of this final rule.
210(a) Restriction on Dividends
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, § 702.210(a)
provides that, for new credit unions,
dividends shall be available only from
net worth, net of any special reserves
established under § 702.208, if any.
210(b) Payment of Dividends if Retained
Earnings Depleted
The Board received no comments on
this section. Accordingly, consistent
with the Second Proposal, § 702.210
provides that the board of directors
must not pay a dividend or interest
refund that will cause the credit union’s
capital classification to fall below
adequately capitalized under subpart B
of part 702 unless the appropriate
regional director and, if state-chartered,
the appropriate state official, has given
prior written approval (in an RBP or
otherwise). Paragraph (b) provides
further that the request for written
approval must include the plan for
eliminating any negative retained
earnings balance.
C. Appendix A to Part 702—Alternative
Risk Weights for Certain On-Balance
Sheet Assets
As discussed in the part of the
preamble that discusses § 702.104(c)(3)
of this final rule, the Board is adding
new appendix A to part 702 of NCUA’s
regulations. As previously stated, this
final rule allows credit unions to
E:\FR\FM\29OCR2.SGM
29OCR2
66700
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
determine the risk weight of certain
investment funds, and the risk weight of
a subordinated tranche of any
investment instead of using the risk
weights assigned in § 702.104(c)(2). This
final rule incorporates the relevant
portions of §§ 324.43(e) and 324.53 of
FDIC’s regulations, which were
incorporated only by reference in the
Second Proposal, into new appendix A
of part 702 of NCUA’s regulations. To
incorporate the text of FDIC’s
regulations into NCUA’s regulations, the
Board had to make some minor
conforming changes to the proposed
language incorporated into appendix A.
No substantive changes to the proposed
methodology for calculating the grossup and look-through approaches are
intended.
Accordingly, Appendix A to part 702
of this final rule provides that instead of
using the risk weights assigned in
§ 702.104(c)(2), a credit union may
determine the risk weight of certain
investment funds, and the risk weight of
non-subordinated or subordinated
tranches of any investment as provided
below.
(a) Gross Up-Approach
mstockstill on DSK4VPTVN1PROD with RULES2
(a)(1) Applicability
Paragraph (a)(1) of appendix A
provides that: Section
702.104(c)(3)(iii)(A) of part 702 provides
that, a credit union may use the grossup approach in this appendix to
determine the risk weight of the
carrying value of non-subordinated or
subordinated tranches of any
investment.
(a)(2) Calculation
Paragraph (a)(2) of appendix A
provides, to use the gross-up approach,
a credit union must calculate the
following four inputs:
• Pro rata share, which is the par
value of the credit union’s exposure as
a percent of the par value of the tranche
in which the securitization exposure
resides;
• Enhanced amount, which is the par
value of tranches that are more senior to
the tranche in which the credit union’s
securitization resides;
• Exposure amount, which is the
amortized cost for investments
classified as held-to-maturity and
available-for-sale, and the fair value for
trading securities; and
• Risk weight, which is the weightedaverage risk weight of underlying
exposures of the securitization as
calculated under this appendix.
(a)(3) Credit Equivalent Amount
Paragraph (a)(3) of appendix A
provides that the ‘‘credit equivalent
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
amount’’ of a securitization exposure
under this part equals the sum of:
• The exposure amount of the credit
union’s exposure; and
• The pro rata share multiplied by the
enhanced amount, each calculated in
accordance with paragraph (a)(2) of
appendix A to part 702.
(a)(4) Risk-Weighted Assets
Paragraph (a)(4) of appendix A
provides, to calculate risk-weighted
assets for a securitization exposure
under the gross-up approach, a credit
union must apply the risk weight
required under paragraph (a)(2) of
appendix A to part 702 to the credit
equivalent amount calculated in
paragraph (a)(3) of appendix A to part
702.
(a)(5) Securitization Exposure Defined
Paragraph (a)(5) of appendix A
provides, for purposes of paragraph (a)
of appendix A to part 702,
‘‘securitization exposure’’ means:
• A credit exposure that arises from a
securitization; or
• An exposure that directly or
indirectly references a securitization
exposure described in first element of
this definition.
(a)(6) Securitization Defined
Paragraph (a)(6) of appendix A
provides, for purposes of paragraph (a)
of appendix A to part 702,
‘‘securitization’’ means a transaction in
which:
• The credit risk associated with the
underlying exposures has been
separated into at least two tranches
reflecting different levels of seniority;
• Performance of the securitization
exposures depends upon the
performance of the underlying
exposures; and
• All or substantially all of the
underlying exposures are financial
exposures (such as loans, receivables,
asset-backed securities, mortgagebacked securities, or other debt
securities).
(b) Look-Through Approaches
(b)(1) Applicability
Paragraph (b)(1) of appendix A
provides: Section 702.104(c)(3)(iii)(B)
provides that, a credit union may use
one of the look-through approaches in
appendix A to part 702 to determine the
risk weight of the exposure amount of
any investment fund, or the holding of
separate account insurance.
(b)(2) Full Look-Through Approach
(b)(2)(i) General
Paragraph (b)(2)(i) of appendix A
provides, a credit union that is able to
PO 00000
Frm 00076
Fmt 4701
Sfmt 4700
calculate a risk-weighted asset amount
for its proportional ownership share of
each exposure held by the investment
fund may set the risk-weighted asset
amount of the credit union’s exposure to
the fund equal to the product of:
• The aggregate risk-weighted asset
amounts of the exposures held by the
fund as if they were held directly by the
credit union; and
• The credit union’s proportional
ownership share of the fund.
(b)(2)(ii) Holding Report
Paragraph (b)(2)(ii) of appendix A
provides, to calculate the risk-weighted
amount under paragraph (b)(2)(i) of
appendix A, a credit union should:
• Use the most recently issued
investment fund holding report; and
• Use an investment fund holding
report that reflects holdings that are not
older than six months from the quarterend effective date (as defined in
§ 702.101(c)(1) of part 702).
(b)(3) Simple Modified Look-Through
Approach
Paragraph (b)(3) of appendix A
provides that under the simple modified
look-through approach, the riskweighted asset amount for a credit
union’s exposure to an investment fund
equals the exposure amount multiplied
by the highest risk weight that applies
to any exposure the fund is permitted to
hold under the prospectus, partnership
agreement, or similar agreement that
defines the fund’s permissible
investments (excluding derivative
contracts that are used for hedging
rather than speculative purposes and
that do not constitute a material portion
of the fund’s exposures).
(b)(4) Alternative Modified LookThrough Approach
Paragraph (b)(4) of appendix A
provides that under the alternative
modified look-through approach, a
credit union may assign the credit
union’s exposure amount to an
investment fund on a pro rata basis to
different risk weight categories under
subpart A of part 702 based on the
investment limits in the fund’s
prospectus, partnership agreement, or
similar contract that defines the fund’s
permissible investments. The paragraph
provides further that the risk-weighted
asset amount for the credit union’s
exposure to the investment fund equals
the sum of each portion of the exposure
amount assigned to an exposure type
multiplied by the applicable risk weight
under subpart A of this part. The
paragraph also notes that if the sum of
the investment limits for all exposure
types within the fund exceeds 100
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
percent, the credit union must assume
that the fund invests to the maximum
extent permitted under its investment
limits in the exposure type with the
highest applicable risk weight under
subpart A of this part and continues to
make investments in order of the
exposure type with the next highest
applicable risk weight under subpart A
of this part until the maximum total
investment level is reached. The
paragraph also provides that if more
than one exposure type applies to an
exposure, the credit union must use the
highest applicable risk weight. Finally,
the paragraph provides that a credit
union may exclude derivative contracts
held by the fund that are used for
hedging rather than for speculative
purposes and do not constitute a
material portion of the fund’s exposures.
D. Other Conforming Changes to the
Regulations
The Board received only one
comment on this section. The
commenter expressed concern that the
references to the risk weightings for
member business loans under § 723.1(d)
and (e) were confusing and should be
eliminated because of the proposed
rule’s use of the term ‘‘commercial
loan,’’ instead of member business
loans, in assigning risk weights. The
Board generally agrees with the
commenter’s concerns and has revised
§ 723.1(d) and (e) to remove the words
referring to the risk-weighting standards
for member business loans.
Accordingly, consistent with the Second
Proposal, this final rule makes minor
conforming amendments to §§ 700.2,
701.21, 701.23, 701.34, 703.14, 713.6,
723.1, 723.7, 747.2001, 747.2002, and
747.2003.
V. Effective Date
How much time would credit unions
have to implement these new
requirements?
mstockstill on DSK4VPTVN1PROD with RULES2
In the preamble to the Second
Proposal, the Board proposed an
effective date of January 1, 2019 to
provide credit unions and NCUA a
lengthy implementation period to make
the necessary adjustments, such as
systems, processes, and procedures, and
to reduce the burden on affected credit
unions in meeting the new
requirements.
Public Comments on the Second
Proposal
The Board received many comments
regarding the proposed effective date of
the final rule. Several commenters
suggested that given the significant
operational implications for both credit
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
unions and the NCUA, a 2019 effective
date is appropriate. Those commenters
suggested the proposed effective date
would allow credit unions to adjust
their balance sheets and strategic plans
to achieve a well-capitalized standard
under the rule without disrupting
member products and services.
Commenters also noted that the
proposed effective date aligns with the
implementation timeframe of the Other
Banking Agencies and, thus, would
avoid creating a competitive
disadvantage across competing financial
services entities.
A substantial number of other
commenters, however, requested that
the effective date be delayed until 2021
to coincide with refunds the
commenters expect to receive from the
Corporate Stabilization Fund. The
commenters suggested the refunds will
be important to those credit unions that
will need to increase capital levels in
order to comply with the new
regulation.
Other commenters argued that the
proposed timeframe was insufficient
given the significance of the impact of
the proposed requirements and the
length of time it would take credit
unions to adjust their business
strategies, portfolios and capital to best
position themselves relative to the rule.
Commenters complained the task would
be burdensome for credit unions given
their limited options for raising capital
when compared to banks, which were
afforded seven years to fully implement
BASEL III. Accordingly, those
commenters recommended various
extended implementation periods
ranging from five years to seven years,
or phase-in periods over a similar
timeframe.
One commenter speculated that
extending the implementation until
2019 would create a dual standard for
credit unions near threshold levels. The
commenter asked: What measure should
be the plan for the coming 2–3 years?
The commenter acknowledged that for
some credit unions, the change will
result in better risk-based capital levels
than under the current rule. But the
commenter argued that fixing the
current capital levels under rules being
phased out could cause real harm to
memberships and credit union health.
Several commenters noted that the
Financial Accounting Standards Board
(FASB) plans to replace the current
credit impairment model with a current
expected credit loss model. Commenters
suggested further that any final rule
issued by FASB will require NCUA and
FASB harmonization with respect to
forecasting models utilized by credit
unions to reduce conflicts between
PO 00000
Frm 00077
Fmt 4701
Sfmt 4700
66701
examination guidance. Accordingly,
commenters recommended that the
NCUA Board delay implementation of
any final risk-based capital rule until
the final FASB rule has been fully
implemented by credit unions.
One commenter recommended that if
IRR, access to additional supplemental
forms of capital, and risk-based share
insurance premium changes are likely
in the near future, the Board should
delay finalization and implementation
of the proposed rule until a
comprehensive analysis can be
conducted to ensure an integrated,
aligned approach to risk-based capital.
The commenter contended that
addressing interest rate risk,
supplemental capital, risk-based share
insurance premiums and risk-based
capital in silos will not create the most
efficient and effective solution.
Discussion
The proposed January 1, 2019
effective date provides credit unions
with more than three years to ramp up
implementation, which should be more
than sufficient time to make the
necessary adjustments to systems and
operations before the effective date of
this final rule. In addition, as noted
above, the effective date generally
coincides with the full phase-in of
FDIC’s capital regulations. In response
to commenters who asked the Board to
phase in the implementation, the Board
found that phasing in the new capital
rules for credit unions would add
additional complexity with minimal
benefit.
Further, it would be inappropriate to
delay implementation due to potential
changes in accounting that may be
forthcoming, and the elimination of the
cap on the amount of the ALLL will
reduce the impact of the announced
change in maintaining the ALLL.
Accordingly, this final rule will
become effective on January 1, 2019.
VI. Impact of This Final Rule
This final rule will apply to credit
unions with $100 million or greater in
total assets. As of December 31, 2014,
there were 1,489 credit unions (23.7
percent of all credit unions) with assets
of $100 million or greater. As a result,
approximately 76 percent of all credit
unions will be exempt from the riskbased capital requirement.200 A net of
16 complex credit unions with total
assets of $9.8 billion would have a
200 The proposed risk-based capital requirements
applied only to credit unions with assets of $100
million or more, compared to the Other Banking
Agencies’ rules that apply to banks of all sizes.
There were 1,872 FDIC-insured banks with assets
less than $100 million as of December 2014.
E:\FR\FM\29OCR2.SGM
29OCR2
66702
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
lower capital classification as a result
this rule with a capital shortfall of
approximately $67 million.201
Approximately 98.5 percent of all
complex credit unions will remain well
capitalized.202 The aggregate and
average RBC ratios for complex credit
unions are 17.9 and 19.2 percent
respectively.203 As shown in the table
below most complex credit unions will
have a risk-based capital ratio well in
excess of the 10 percent needed to be
well capitalized.
DISTRIBUTION OF NET WORTH RATIO AND FINAL RISK-BASED CAPITAL RATIO
Number of CUs
Less than well
capitalized
Well capitalized to
well +2%
Well capitalized
+2% to +3.5%
Well capitalized
+3.5% to +5%
Greater than well
capitalized +5%
Net Worth Ratio
RBC Ratio
<7%
<10%
7%–9%
10%–12%
9%–10.5%
12%–13.5%
10.5%–12%
13.5%–15%
>12%
>15%
Net Worth Ratio ...................................
Final RBC Ratio ...................................
14
23
mstockstill on DSK4VPTVN1PROD with RULES2
Public Comments on the Second
Proposal
The Board received a substantial
number of comments regarding NCUA’s
estimates of the impacts of the Second
Proposal. Most commenters who
mentioned the impacts of the proposal
suggested the rule would have negative
impacts on the credit union industry.
Numerous commenters speculated that
the proposal would unjustifiably slow
credit union growth in the future, and
that the funds used to meet the newly
proposed requirements could otherwise
be used to make loans to consumers or
small businesses, or be used in other
productive ways. Commenters also
speculated that the requirements in the
proposal would restrict credit union
lending to consumers by forcing credit
unions to maintain capital on their
books rather than lending to their
members. At least one commenter
recommended that the Board more
thoughtfully consider the actual market
effect on the credit union industry and
produce more reasonably calibrated risk
weights based on the cooperative nature
of credit unions. The commenter
recommended that the Board also
reconsider the value of concentration
escalators and provide empirical data
that reflect what actual additional risk is
created based on concentration of
certain asset categories. Other
commenters claimed the higher capital
levels that would be required under the
proposal would reduce the amount of
support, both monetary and operational,
that larger credit unions have
historically provided to their smaller
counterparts, which would put
additional strain on the finances and
operations of many smaller credit
unions.
201 In the second proposal using data as of
December 31, 2013, NCUA estimated less than 20
credit unions would experience a decline in their
capital classification with a capital shortfall of
$53.6 million.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
297
107
449
140
334
194
395
1,025
One credit union trade association
commenter speculated that under the
proposal, the number of credit unions
downgraded would more than double
during a downturn in the business
cycle. Under the commenter’s analysis,
45 credit unions would have been
downgraded during the most 2007–2009
financial crisis if this proposal had been
in place in 2009. According to the
commenter, of those 45 credit unions,
41 would be well capitalized today. The
commenter suggested that to have
avoided a downgrade, those credit
unions would have had to increase their
capital by $145 million, or an average of
$3.2 million per credit union. The
commenter stated that almost all of the
credit unions that would have been
downgraded (95 percent) are well
capitalized or adequately capitalized
today. The commenter claimed this
empirically proves that the proposal is
unnecessary and unduly burdensome,
as it would further strain the credit
union system during a financial
downturn. The commenter estimated
that, in order to satisfy the proposal’s
well capitalized threshold, credit unions
would need to hold at least an
additional $729 million. The commenter
estimated further that, to satisfy the
proposal’s adequately capitalized
threshold, credit unions would need to
hold at least an additional $260 million.
Another commenter argued that the
Board’s cost estimates failed to include
the one-time costs that would be
incurred by the entire credit union
industry in system changes, additional
reports, potential additional segregation
and segmentation of the balance sheet,
etc. in order to fill out the new Call
Report forms. The commenter
speculated that such costs will far
outweigh the costs that the Board has
identified in the proposal.
Yet another commenter maintained
that, according to the proposal, most
complex credit unions are currently
well capitalized under both the net
worth ratio and the proposed risk-based
capital ratio. The commenter calculated
that as of September 30, 2014, complex
credit unions had an average net worth
ratio of 10.7 percent and a risk-based
capital ratio of 19.3 percent, both well
in excess of guidelines identifying well
capitalized status. The commenter
suggested that only 19 complex credit
unions would fall from well capitalized
status under the proposal. Thus, the
commenter concluded that the costs
associated with the proposal seemed
excessive given how extremely well
capitalized the credit union industry is
today under current guidelines.
One credit union commenter
suggested that for the risk-based capital
requirement to be effective, it would
have to be more complex. The
commenter explained that this would
mean requiring more information on the
Call Report and adding new categories
of loans in the final rule. Another credit
union commenter supported making the
risk-based capital framework as
complicated as it needs to be to more
accurately reflect the unique needs and
structure of the credit union industry.
Several commenters noted that in
March 2015, FASB announced
expectations to finalize the standard for
timely financial reporting of credit
losses in the third quarter of 2015.
Commenters recommended the Board
consider the possible effects of the
FASB proposal in relation to NCUA’s
risk-based capital regulations and
remove any duplicative regulatory
burdens that may be created.
202 Of the 1,489 impacted credit unions, only 23,
or 1.54 percent, would have less than the 10 percent
risk-based capital requirement to be well
capitalized. Of these, seven have net worth ratios
less than 7 percent and therefore are already
categorized as less than well capitalized.
203 In the second proposal, based on December
2013 Call Report data, NCUA estimated the
aggregate average risk-based capital ratio would be
18.2 percent with an average risk-based capital ratio
of 19.3 percent.
PO 00000
Frm 00078
Fmt 4701
Sfmt 4700
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
A significant number of commenters
requested that the Board minimize the
burden on credit unions of expanding
the Call Report. Several commenters
suggested the Board consider an
approach where credit unions would
have the option of providing the
additional, detailed information
required under the proposal. One
commenter suggested such an approach
could be accomplished by including
additional optional data fields within
the Call Report, similar to the approach
used by FDIC. The commenter suggested
further that any changes required of a
credit union require the expenditure of
resources, and in a time when many
credit unions are struggling to comply
with existing rules from NCUA and
other regulators, the Board should
consider any alternatives that will
reduce the burden of this rule on credit
unions. Another commenter contended
that NCUA’s current estimate of the
public burden of collecting information
for the Call Report grossly understates
the actual amount of time required. The
commenter suggested that the variety of
data needed to generate a quarterly Call
Report takes employees from some
credit unions 66 hours (10 times
NCUA’s current 6.6 hour estimate). The
commenter recommended the Board
consider the time and resources
dedicated to producing the additional
Call Report data required by the
proposal and focus on minimizing that
burden and impact to credit unions. At
least one commenter recommended that
any Call Report updates required by this
rulemaking be made available to credit
unions at least six months before the
effective date of the final rule.
Discussion
The Board has considered the
comments received and recognizes that
unduly high minimum regulatory
capital requirements and unnecessary
burdens could lead to less-than-optimal
outcomes. Thus, as discussed
throughout this preamble and in the
Paperwork Reduction Act section to
follow, the Board has made appropriate
efforts to target the impacts and reduce
the burdens of this final rule. This final
rule only targets outlier credit unions
with insufficient capital relative to their
risk. The final rule meets Congress’
express purpose of prompt corrective
action ‘‘. . . to resolve the problems of
insured credit unions at the least
possible long-term cost to the Fund,’’ 204
by establishing a risk-based capital
requirement which will reduce the
likelihood that a credit union will
become undercapitalized and eventually
fail at a cost to the Fund.
The Board’s elimination of the 1.25
percent of risk-assets cap on the amount
of ALLL in the risk-based capital ratio
numerator will reduce the impact of the
66703
risk-based capital ratio during economic
downturns when credit unions are more
likely to be funding higher levels of loan
losses. Removal of the ALLL cap will
also mitigate concerns with FASB’s
proposed related changes to GAAP.205 A
reduction in capital ratios during
economic downturns is a normal result
for both the risk-based capital ratio and
the net worth ratio. The capital
adequacy requirement will enhance a
credit union’s ability to measure and
plan for economic downturns.
Sound capital levels are vital to the
long-term health of all financial
institutions. Credit unions are already
expected to incorporate into their
business models and strategic plans
provisions for maintaining prudent
levels of capital. This final rule ensures
minimum regulatory capital levels for
complex credit unions will be more
accurately correlated to risk. The final
rule achieves a reasonable balance
between requiring credit unions posing
an elevated risk to hold more capital,
while not overburdening lower-risk
credit unions.
As indicated in the table below,
according to the impact measure used in
the Second Proposal, 72 complex credit
unions would have had higher capital
requirements due to the risk-based
capital ratio requirement based on
December 31, 2014 data.206
DISTRIBUTION OF RISK-BASED LEVERAGE EQUIVALENT RATIO 207
RBC ratio—leverage
equivalent
<6%
6–7.5%
7.5–8.5%
8.5–9.5%
9.5–11%
>11%
Average
Number of CUs ............
816
601
57
11
4
0
5.90%
Using another more conservative
measure developed based on
suggestions received from commenters,
NCUA identified 308 credit unions, or
20 percent of all complex credit unions,
that are likely to have a higher
minimum capital requirement under the
risk-based capital ratio requirement
being adopted under this final rule.208
While up to 20 percent of credit unions
are likely to have the risk-based capital
204 12
U.S.C. 1790d(a)(1).
Financial Standards Accounting Board,
Proposed Accounting Standards Update, Financial
Instruments—Credit Losses, Subtopic 825–15 (Dec.
20, 2012).
206 The method used in the Second Proposal was
calculated by taking 10 percent of estimated risk
assets divided by total assets with results exceeding
7.5 percent indicating the risk-based capital
requirement is the higher minimum-capital
requirement.
mstockstill on DSK4VPTVN1PROD with RULES2
205 See
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
ratio as the binding constraint, only 20
of those credit unions have an estimated
risk-based capital ratio below 10
percent.209
NCUA’s latest analysis concludes it is
reasonable for the risk-based capital
ratio requirement to be the primary
determiner of the capital requirement
for about 20 percent of complex credit
unions because these 308 credit unions
have an average risk-weighted assets to
total assets ratio of 72 percent—which is
significantly higher than the 59 percent
average ratio for all complex credit
unions.
As noted earlier, concentration risk is
a material risk addressed in this final
rule. Based on December 31, 2014 Call
Report data, if this final rule were
effective today, NCUA estimates that the
additional capital required for
concentration risk would have the
following impact:
207 This computation calculates the amount of
capital required by multiplying the estimated
proposed risk weighted assets by 10 percent (the
level to be well capitalized), and then dividing this
result by total assets. This provides a measure
comparable to the net worth ratio. Since the riskbased capital provisions provide for a broader
definition of capital included in the risk-based
capital ratio numerator, which on average benefits
credit unions by approximately 50 basis points, the
appropriate comparison point for the leverage
equivalent is 7.5 percent, not the 7 percent level for
well capitalized for the net worth ratio.
208 Calculated based on a positive result to the
following formula: ((risk-weighted assets times 10
percent) ¥ allowance for loan losses ¥ equity
acquired in merger ¥ total adjusted retained
earnings acquired through business combinations +
NCUA share insurance capitalization deposit +
goodwill + identifiable intangible assets) ¥ (total
assets times 7 percent).
209 Also, given the new treatment of nonsignificant equity exposures, which could not be
estimated due to existing data limitations, this
impact may be further reduced.
PO 00000
Frm 00079
Fmt 4701
Sfmt 4700
E:\FR\FM\29OCR2.SGM
29OCR2
66704
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
Number of credit
unions with total
assets greater than
$100 million as of
12/31/2014
Concentration threshold
First-Lien Residential Real Estate (>35% of Total Assets) .................................................................
Junior-Lien Residential Real Estate (>20% of Total Assets) ..............................................................
Commercial Loans (using MBLs as a proxy) 210 (>50% of Total Assets) ..........................................
The Board considered the impact of
the individual data items necessary to
compute the risk-based capital ratio.
Many commenters’ requests for further
stratification of risk weights were
determined to create a data burden in
excess of the benefits. All revisions to
the Call Report will be subject to the
publication and opportunity for
comment process in accordance with
the requirements of the Paperwork
Reduction Act of 1994 to obtain a valid
control number from the U.S. Office of
Management and Budget (OMB).
Interested parties are invited to submit
written comments to each notice of
information collection that NCUA will
submit to OMB for review.
VII. Regulatory Procedures
Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA)
generally requires that, in connection
with a final rulemaking, an agency
prepare and make available a final
regulatory flexibility analysis that
describes the impact of the final rule on
small entities. A regulatory flexibility
analysis is not required, however, if the
agency certifies that the rule will not
have a significant economic impact on
a substantial number of small entities
(defined for purposes of the RFA to
include credit unions with assets less
than $50 million 211) and publishes its
certification and a short, explanatory
statement in the Federal Register
together with the rule.
mstockstill on DSK4VPTVN1PROD with RULES2
Public Comments on the Second
Proposal
A small credit union commenter
suggested that while credit unions with
less than $100 million in assets are not
subject to the requirements of this
proposal, there is great apprehension
among small credit unions that NCUA
examiners will require them to meet the
210 Using MBL data as the current Call Report
does not capture ‘‘commercial loan’’ data as defined
in this final rule.
211 On September 24, 2015, the Board published
Interpretative Ruling and Policy Statement 15–1,
which amends the definition of small credit unions
for purposes of the RFA to credit unions with assets
of less than $100 million. 80 FR 57512 (Sept. 24,
2015). This change, however, does not take effect
until November 23, 2015, which is after the date
this rule is scheduled to be voted on by the Board.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
basic requirements in the risk-based
capital rule.
Several commenters contended that
NCUA’s current estimate of the public
burden of collecting information for the
Call Report grossly understates the
actual amount of time required. At least
one commenter suggested that the
variety of data needed to generate a
quarterly Call Report takes employees
from some credit unions 66 hours (10
times NCUA’s estimate of 6.6 hours).
Discussion
The amendments this final rule makes
to part 702 primarily affect complex
credit unions, which are those with
$100 million or more in assets. The
revised risk-based capital requirement
and capital adequacy plan under this
final rule do not apply to small credit
unions.
NCUA recognizes that because many
commenters suggested NCUA collect
more granular data for credit union Call
Reports, small credit unions with assets
less than $50 million could be affected
if they are asked to assemble and report
additional data. NCUA, however, will
make every reasonable effort to redesign
the Call Report system so that all credit
unions with $100 million or less in
assets are not unnecessarily burdened
by the data requirements that apply to
complex credit unions. NCUA plans to
propose information collection changes
to reflect the new requirements of this
final rule in the future, and publish the
regulatory reporting requirements
separately—including the steps NCUA
has taken to minimize the impact of the
reporting burden on small credit
unions—for comment.
In addition, this final rule makes a
number of minor changes to current part
702 of NCUA’s regulations including:
• Part 702—Reorganizing and
renumbering part 702, including
sections of the part applicable to small
credit unions.
• Section 702.2—Making minor
amendments to certain definitions
applicable to all credit unions under
part 702.
• Section 702.111(g)(4) &
702.206(g)(3)—Making minor
clarifications regarding the submission
of multiple unapproved NWRPs or
RBPs.
PO 00000
Frm 00080
Fmt 4701
Sfmt 4700
Percentage of 1,489
credit unions with
total assets greater
than $100 million
135
57
12
9.1
3.8
0.8
• Sections 702.112 & 702.208—
Eliminating the regular reserve account
requirement for all credit unions.
• Sections 702.113(d) & 702.209(d)—
Making minor amendments to the
treatment of loan and lease losses.
• Section 702.114 & 702.210—Making
minor amendments to part 702
regarding the payments of dividends for
all credit unions.
• Section 702.201—Making minor
revisions to the definition of ‘‘new
credit union.’’
NCUA believes the one time burden
associated with the policy review and
revisions related to these amended
provisions will be one hour for small
credit unions. Accordingly, the effects
of this final rule on small credit unions
are minor.
Based on the above assessment, the
Board certifies that this final rule will
not have a significant economic impact
on a substantial number of small credit
unions.
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 increases an existing burden.212 For
purposes of the PRA, a paperwork
burden may take the form of a reporting,
disclosure or recordkeeping
requirement, each referred to as an
information collection. The changes
made to part 702 by this final rule will
impose new information collection
requirements.
NCUA determined that the proposed
changes to part 702 would have costs
associated with updating internal
policies, and updating data collection
and reporting systems for preparing Call
Reports. Based on December 2013 Call
Report data, NCUA in the Second
Proposal estimated that all 6,554 credit
unions would have to amend their
procedures and systems for preparing
Call Reports. NCUA proposed
addressing the costs and providing
notice of the particular changes that
would be made in other collections,
such as the NCUA Call Report and
Profile as part of its regular amendments
separate from this proposed rule.
212 44
E:\FR\FM\29OCR2.SGM
U.S.C. 3507(d); 5 CFR part 1320.
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
mstockstill on DSK4VPTVN1PROD with RULES2
NCUA also estimated that
approximately 21.5 percent, or 1,455
credit unions, would be defined as
‘‘complex’’ under the proposed rule and
would have additional data collection
requirements related to the new riskbased capital requirements.
NCUA’s Total Estimated One-Time
Costs of the Second Proposal:
One-time burden for policy review
and revision, (20 hours times 5,099
credit unions (non-complex), or 40
hours times 1,455 credit unions
(complex)). The total one-time cost for
non-complex credit unions totals
101,980 hours or $3,252,142, an average
of $638 per credit union. The total onetime cost for complex credit unions
totals 58,200 hours or $1,855,998, an
average of $1,276 per credit union.
Public Comments on the Second
Proposal
A significant number of commenters
maintained that the proposal did not
incorporate the estimated burden for
establishing a comprehensive written
strategy for maintaining an appropriate
level of capital and other changes to a
complex credit union’s operations other
than data collection. Commenters
suggested the effects of the proposal
would be a greater burden for complex
credit unions upon the implementation
year and for ongoing years. Commenters
noted that NCUA’s final rule on Capital
Planning and Stress Testing estimated
750 hours of paperwork burden in the
initial year and 250 hours in subsequent
years, and suggested it was unclear how
the requirements of the Second Proposal
would differ from the final rule on
Capital Planning and Stress Testing in
terms of burden. Using the cost estimate
previously utilized by NCUA for the
final rule on Capital Planning and Stress
Testing, one commenter suggested a
more reasonable estimate for this
proposal would be $23,926 per credit
union or $34.8 million to the industry
for the initial year of the final RBC rule.
The commenter also suggested there
would be an ongoing annual cost of
$7,975 per credit union or $11.6 million
to the industry, which, over a five-year
period, would have a cumulative cost to
the industry of approximately $81.2
million.
In addition, several commenters
contended that NCUA’s current estimate
of the public burden of collecting
information for the Call Report grossly
understates the actual amount of time
required. At least one commenter
suggested that the variety of data needed
to generate a quarterly Call Report takes
employees from some credit unions 66
hours (10 times NCUA’s estimate 6.6
hours).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Discussion
The final changes will result in some
costs for complex credit unions
associated with updating internal
policies, including a comprehensive
strategy for maintaining an appropriate
level of capital, the cost estimates for
which are discussed in more detail
below. Further, there will be marginal
costs associated with updating data
collection and reporting systems for the
NCUA Call Reports. The changes to the
Call Reporting requirements, however,
will be handled as part of NCUA’s
regular Call Report updates separately
from this proposed rule. The
information collection requirements for
the Call Report are approved by OMB
under Control No. 3133–004.
In response to commenters who
believe all complex credit unions will
need substantial time to establish and
maintain a comprehensive written
capital strategy, NCUA field staff report
that many well-managed complex credit
unions already have comprehensive
strategies for maintaining appropriate
levels of capital. Further, commenters
compared the burden of the Capital
Planning and Stress Testing hours;
however, for the vast majority of
complex credit unions, the written
capital strategy will not necessarily
approach the complexity and more
rigorous requirements associated with
stress testing.
NCUA has updated its PRA analysis
based on December 2014 Call Report
data. Again, NCUA will make every
effort to redesign the Call Report system
so that small credit unions are not
unnecessarily burdened by the data
requirements that apply to complex
credit unions.
The final rule contains minor changes
to §§ 702.2, 702.111(g)(4), 702.206(g)(3),
702.112, 702.208, 702.113(d),
702.209(d), 702.114, 702.210, and
702.201 for which all credit union’s
should be aware. The information
collection requirements contained in
702.111(g)(4) and 702.206(g)(3) are
generally related to information
collected under OMB Control No. 3133–
0154.
NCUA estimates that 1,489 credit
unions defined as ‘‘complex’’ will have
additional data collection requirements
related to the new risk-based capital
requirements. This slight increase from
1,455 credit unions in the Second
Proposal occurred as some credit unions
that had assets of less than $100 million
grew in size and now meet the
definition of ‘‘complex.’’
As a result, NCUA’s Total Estimated
One-Time Costs based on the December
PO 00000
Frm 00081
Fmt 4701
Sfmt 4700
66705
2014 Call Report data have changed
slightly:
One-time burden for policy review
and revision:
• 40 hours times 1,489 complex
credit unions. The total one-time cost
for complex credit unions totals 59,560
hours or $1,898,174, an average of
$1,275 per credit union.
• 1 hour times 4,784 non-complex
credit unions. The total one-time cost
for credit unions with $100 million or
less in assets totals 4,784 hours, for a
total estimated cost of $152,562.
Executive Order 13132
Executive Order 13132 encourages
independent regulatory agencies to
consider the impact of their actions on
state and local interests. NCUA, an
independent regulatory agency as
defined in 44 U.S.C. 3502(5), voluntarily
complies with the principles of the
executive order to adhere to
fundamental federalism principles. This
final rule will apply to all federally
insured natural-person credit unions,
including federally insured, statechartered natural-person credit unions.
Accordingly, it may have, to some
degree, a direct effect on the states, on
the relationship between the national
government and the states, or on the
distribution of power and
responsibilities among the various
levels of government. The Board
believes this impact is minor, and it is
an unavoidable consequence of carrying
out the statutory mandate to adopt a
system of PCA to apply to all federally
insured, natural-person credit unions.
Throughout the rulemaking process,
NCUA has consulted with
representatives of state regulators
regarding the impact of PCA on statechartered credit unions. Comments and
suggestions of those state regulators are
reflected in this final rule.
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).
List of Subjects
12 CFR Part 700
Credit unions.
12 CFR Part 701
Credit, Credit unions, Insurance,
Reporting and recordkeeping
requirements.
E:\FR\FM\29OCR2.SGM
29OCR2
66706
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
12 CFR Part 702
Credit unions, Reporting and
recordkeeping requirements.
12 CFR Part 703
Credit unions, Investments, Reporting
and recordkeeping requirements.
12 CFR Part 713
Bonds, Credit unions, Insurance.
12 CFR Part 723
Credit unions, Loan programsbusiness, Reporting and recordkeeping
requirements.
12 CFR Part 747
Administrative practice and
procedure, Bank deposit insurance,
Claims, Credit unions, Crime, Equal
access to justice, Investigations,
Lawyers, Penalties.
By the National Credit Union
Administration Board on October 15, 2015.
Gerard Poliquin,
Secretary of the Board.
For the reasons discussed above, the
Board proposes to amend 12 CFR parts
700, 701, 702, 703, 713, 723, and 747 as
follows:
PART 700—DEFINITIONS
1. The authority citation for part 700
continues to read as follows:
Authority: 12 U.S.C. 1752, 1757(6), 1766.
[Amended]
2. Amend the definition of ‘‘net
worth’’ in § 700.2 by removing
‘‘§ 702.2(f)’’ and adding in its place
‘‘§ 702.2’’.
■
PART 701—ORGANIZATION AND
OPERATION OF FEDERAL CREDIT
UNIONS
3. The authority citation for part 701
continues to read as follows:
■
Authority: 12 U.S.C. 1752(5), 1755, 1756,
1757, 1758, 1759, 1761a, 1761b, 1766, 1767,
1782, 1784, 1786, 1787, 1789. Section 701.6
is also authorized by 15 U.S.C. 3717. Section
701.31 is also authorized by 15 U.S.C. 1601
et seq.; 42 U.S.C. 1981 and 3601–3610.
Section 701.35 is also authorized by 42
U.S.C. 4311–4312.
§ 701.21
[Amended]
4. Amend § 701.21(h)(4)(iv) by
removing ‘‘§ 702.2(f)’’ and adding in its
place ‘‘§ 702.2’’.
mstockstill on DSK4VPTVN1PROD with RULES2
■
§ 701.23
[Amended]
5. Amend § 701.23(b)(2) by removing
the words ‘‘net worth’’ and adding in
their place the word ‘‘capital’’, and
removing the words ‘‘or, if subject to a
risk-based net worth (RBNW)
■
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
§ 701.34
[Amended]
6. Amend § 701.34 as follows:
a. In paragraph (b)(12) remove the
words ‘‘§§ 702.204(b)(11), 702.304(b)
and 702.305(b)’’ and add in their place
the words ‘‘part 702’’.
■ b. In paragraph (d)(1)(i) remove the
words ‘‘net worth’’ and add in their
place the word ‘‘capital’’.
■ c. In the appendix to § 701.34, amend
the paragraph beginning ‘‘8. Prompt
Corrective Action’’ by removing the
words ‘‘net worth classifications (see 12
CFR 702.204(b)(11), 702.304(b) and
702.305(b), as the case may be)’’ and
adding in their place the words ‘‘capital
classifications (see 12 CFR part 702)’’.
■
■
PART 702—CAPITAL ADEQUACY
7. The authority citation for part 702
continues to read as follows:
■
Authority: 12 U.S.C. 1766(a), 1790d.
8. Revise §§ 702.101, 702.202, and
subparts A and B to read as follows:
■
Sec.
702.1 Authority, purpose, scope, and other
supervisory authority.
702.2 Definitions.
■
§ 700.2
requirement under part 702 of this
chapter, has remained ‘well capitalized’
for the six (6) immediately preceding
quarters after applying the applicable
RBNW requirement’’.
Subpart A—Prompt Corrective Action
702.101 Capital measures, capital adequacy,
effective date of classification, and notice
to NCUA.
702.102 Capital classification.
702.103 Applicability of the risk-based
capital ratio measure.
702.104 Risk-based capital ratio.
702.105 Derivative contracts.
702.106 Prompt corrective action for
adequately capitalized credit unions.
702.107 Prompt corrective action for
undercapitalized credit unions.
702.108 Prompt corrective action for
significantly undercapitalized credit
unions.
702.109 Prompt corrective action for
critically undercapialized credit unions.
702.110 Consultation with state officials on
proposed prompt corrective action.
702.111 Net worth restoration plans
(NWRP).
702.112 Reserves.
702.113 Full and fair disclosure of financial
condition.
702.114 Payment of dividends.
Subpart B—Alternative Prompt Corrective
Action for New Credit Unions
702.201 Scope and definition.
702.202 Net worth categories for new credit
unions.
702.203 Prompt corrective action for
adequately capitalized new credit
unions.
702.204 Prompt corrective action for
moderately capitalized, marginally
PO 00000
Frm 00082
Fmt 4701
Sfmt 4700
capitalized, or minimally capitalized
new credit unions.
702.205 Prompt corrective action for
uncapitalized new credit unions.
702.206 Revised business plans (RBP) for
new credit unions.
702.207 Incentives for new credit unions.
702.208 Reserves
702.209 Full and fair disclosure of financial
condition.
702.210 Payment of dividends.
Subpart A—Prompt Corrective Action
§ 702.1 Authority, purpose, scope, and
other supervisory authority.
(a) Authority. Subparts A and B of this
part and subpart L of part 747 of this
chapter are issued by the National
Credit Union Administration (NCUA)
pursuant to sections 120 and 216 of the
Federal Credit Union Act (FCUA), 12
U.S.C. 1776 and 1790d (section 1790d),
as revised by section 301 of the Credit
Union Membership Access Act, Public
Law 105–219, 112 Stat. 913 (1998).
(b) Purpose. The express purpose of
prompt corrective action under section
1790d is to resolve the problems of
federally insured credit unions at the
least possible long-term loss to the
National Credit Union Share Insurance
Fund. Subparts A and B of this part
carry out the purpose of prompt
corrective action by establishing a
framework of minimum capital
requirements, and mandatory and
discretionary supervisory actions
applicable according to a credit union’s
capital classification, designed
primarily to restore and improve the
capital adequacy of federally insured
credit unions.
(c) Scope. Subparts A and B of this
part implement the provisions of section
1790d as they apply to federally insured
credit unions, whether federally- or
state-chartered; to such credit unions
defined as ‘‘new’’ pursuant to section
1790d(b)(2); and to such credit unions
defined as ‘‘complex’’ pursuant to
section 1790d(d). Certain of these
provisions also apply to officers and
directors of federally insured credit
unions. Subpart C applies capital
planning and stress testing to credit
unions with $10 billion or more in total
assets. This part does not apply to
corporate credit unions. Unless
otherwise provided, procedures for
issuing, reviewing and enforcing orders
and directives issued under this part are
set forth in subpart L of part 747 of this
chapter.
(d) Other supervisory authority.
Neither section 1790d nor this part in
any way limits the authority of the
NCUA Board or appropriate state
official under any other provision of law
to take additional supervisory actions to
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
address unsafe or unsound practices or
conditions, or violations of applicable
law or regulations. Action taken under
this part may be taken independently of,
in conjunction with, or in addition to
any other enforcement action available
to the NCUA Board or appropriate state
official, including issuance of cease and
desist orders, orders of prohibition,
suspension and removal, or assessment
of civil money penalties, or any other
actions authorized by law.
mstockstill on DSK4VPTVN1PROD with RULES2
§ 702.2
Definitions.
Unless otherwise provided in this
part, the terms used in this part have the
same meanings as set forth in FCUA
sections 101 and 216, 12 U.S.C. 1752,
1790d. The following definitions apply
to this part:
Allowances for loan and lease losses
(ALLL) means valuation allowances that
have been established through a charge
against earnings to cover estimated
credit losses on loans, lease financing
receivables or other extensions of credit
as determined in accordance with
GAAP.
Amortized cost means the purchase
price of a security adjusted for
amortizations of premium or accretion
of discount if the security was
purchased at other than par or face
value.
Appropriate state official means the
state commission, board or other
supervisory authority that chartered the
affected credit union.
Call Report means the Call Report
required to be filed by all credit unions
under § 741.6(a)(2) of this chapter.
Carrying value means the value of the
asset or liability on the statement of
financial condition of the credit union,
determined in accordance with GAAP.
Central counterparty (CCP) means a
counterparty (for example, a clearing
house) that facilitates trades between
counterparties in one or more financial
markets by either guaranteeing trades or
novating contracts.
Charitable donation account means
an account that satisfies all of the
conditions in § 721.3(b)(2)(i), (b)(2)(ii),
and (b)(2)(v) of this chapter.
Commercial loan means any loan, line
of credit, or letter of credit (including
any unfunded commitments) for
commercial, industrial, and professional
purposes, but not for investment or
personal expenditure purposes.
Commercial loan excludes loans to
CUSOs, first- or junior-lien residential
real estate loans, and consumer loans.
Commitment means any legally
binding arrangement that obligates the
credit union to extend credit, purchase
or sell assets, enter into a borrowing
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
agreement, or enter into a financial
transaction.
Consumer loan means a loan for
household, family, or other personal
expenditures, including any loans that,
at origination, are wholly or
substantially secured by vehicles
generally manufactured for personal,
family, or household use regardless of
the purpose of the loan. Consumer loan
excludes commercial loans, loans to
CUSOs, first- and junior-lien residential
real estate loans, and loans for the
purchase of one or more vehicles to be
part of a fleet of vehicles.
Contractual compensating balance
means the funds a commercial loan
borrower must maintain on deposit at
the lender credit union as security for
the loan in accordance with the loan
agreement, subject to a proper account
hold and on deposit as of the
measurement date.
Credit conversion factor (CCF) means
the percentage used to assign a credit
exposure equivalent amount for selected
off-balance sheet accounts.
Credit union means a federally
insured, natural person credit union,
whether federally- or state-chartered.
Current means, with respect to any
loan, that the loan is less than 90 days
past due, not placed on non-accrual
status, and not restructured.
CUSO means a credit union service
organization as defined in part 712 and
741 of this chapter.
Custodian means a financial
institution that has legal custody of
collateral as part of a qualifying master
netting agreement, clearing agreement,
or other financial agreement.
Depository institution means a
financial institution that engages in the
business of providing financial services;
that is recognized as a bank or a credit
union by the supervisory or monetary
authorities of the country of its
incorporation and the country of its
principal banking operations; that
receives deposits to a substantial extent
in the regular course of business; and
that has the power to accept demand
deposits. Depository institution
includes all federally insured offices of
commercial banks, mutual and stock
savings banks, savings or building and
loan associations (stock and mutual),
cooperative banks, credit unions and
international banking facilities of
domestic depository institutions, and all
privately insured state chartered credit
unions.
Derivatives Clearing Organization
(DCO) means the same as defined by the
Commodity Futures Trading
Commission in 17 CFR 1.3(d).
Derivative contract means a financial
contract whose value is derived from
PO 00000
Frm 00083
Fmt 4701
Sfmt 4700
66707
the values of one or more underlying
assets, reference rates, or indices of asset
values or reference rates. Derivative
contracts include interest rate derivative
contracts, exchange rate derivative
contracts, equity derivative contracts,
commodity derivative contracts, and
credit derivative contracts. Derivative
contracts also include unsettled
securities, commodities, and foreign
exchange transactions with a
contractual settlement or delivery lag
that is longer than the lesser of the
market standard for the particular
instrument or five business days.
Equity investment means investments
in equity securities and any other
ownership interests, including, for
example, investments in partnerships
and limited liability companies.
Equity investment in CUSOs means
the unimpaired value of the credit
union’s equity investments in a CUSO
as recorded on the statement of financial
condition in accordance with GAAP.
Exchange means a central financial
clearing market where end users can
enter into derivative transactions.
Excluded goodwill means the
outstanding balance, maintained in
accordance with GAAP, of any goodwill
originating from a supervisory merger or
combination that was completed on or
before December 28, 2015. This term
and definition expire on January 1,
2029.
Excluded other intangible assets
means the outstanding balance,
maintained in accordance with GAAP,
of any other intangible assets such as
core deposit intangible, member
relationship intangible, or trade name
intangible originating from a
supervisory merger or combination that
was completed on or before December
28, 2015. This term and definition
expire on January 1, 2029.
Exposure amount means:
(1) The amortized cost for investments
classified as held-to-maturity and
available-for-sale, and the fair value for
trading securities.
(2) The outstanding balance for
Federal Reserve Bank Stock, Central
Liquidity Facility Stock, Federal Home
Loan Bank Stock, nonperpetual capital
and perpetual contributed capital at
corporate credit unions, and equity
investments in CUSOs.
(3) The carrying value for non-CUSO
equity investments, and investment
funds.
(4) The carrying value for the credit
union’s holdings of general account
permanent insurance, and separate
account insurance.
(5) The amount calculated under
§ 702.105 of this part for derivative
contracts.
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
66708
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
Fair value has the same meaning as
provided in GAAP.
Financial collateral means collateral
approved by both the credit union and
the counterparty as part of the collateral
agreement in recognition of credit risk
mitigation for derivative contracts.
First-lien residential real estate loan
means a loan or line of credit primarily
secured by a first-lien on a one-to-four
family residential property where:
(1) The credit union made a
reasonable and good faith determination
at or before consummation of the loan
that the member will have a reasonable
ability to repay the loan according to its
terms; and
(2) In transactions where the credit
union holds the first-lien and junior
lien(s), and no other party holds an
intervening lien, for purposes of this
part the combined balance will be
treated as a single first-lien residential
real estate loan.
GAAP means generally accepted
accounting principles in the United
States as set forth in the Financial
Accounting Standards Board’s (FASB)
Accounting Standards Codification
(ASC).
General account permanent insurance
means an account into which all
premiums, except those designated for
separate accounts are deposited,
including premiums for life insurance
and fixed annuities and the fixed
portfolio of variable annuities, whereby
the general assets of the insurance
company support the policy.
General obligation means a bond or
similar obligation that is backed by the
full faith and credit of a public sector
entity.
Goodwill means an intangible asset,
maintained in accordance with GAAP,
representing the future economic
benefits arising from other assets
acquired in a business combination
(e.g., merger) that are not individually
identified and separately recognized.
Goodwill does not include excluded
goodwill.
Government guarantee means a
guarantee provided by the U.S.
Government, FDIC, NCUA or other U.S.
Government agency, or a public sector
entity.
Government-sponsored enterprise
(GSE) means an entity established or
chartered by the U.S. Government to
serve public purposes specified by the
U.S. Congress, but whose debt
obligations are not explicitly guaranteed
by the full faith and credit of the U.S.
Government.
Guarantee means a financial
guarantee, letter of credit, insurance, or
similar financial instrument that allows
one party to transfer the credit risk of
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
one or more specific exposures to
another party.
Identified losses means those items
that have been determined by an
evaluation made by NCUA, or in the
case of a state chartered credit union the
appropriate state official, as measured
on the date of examination in
accordance with GAAP, to be chargeable
against income, equity or valuation
allowances such as the allowances for
loan and lease losses. Examples of
identified losses would be assets
classified as losses, off-balance sheet
items classified as losses, any provision
expenses that are necessary to replenish
valuation allowances to an adequate
level, liabilities not shown on the books,
estimated losses in contingent
liabilities, and differences in accounts
that represent shortages.
Industrial development bond means a
security issued under the auspices of a
state or other political subdivision for
the benefit of a private party or
enterprise where that party or
enterprise, rather than the government
entity, is obligated to pay the principal
and interest on the obligation.
Intangible assets mean assets,
maintained in accordance with GAAP,
other than financial assets, that lack
physical substance.
Investment fund means an investment
with a pool of underlying investment
assets. Investment fund includes an
investment company that is registered
under section 8 of the Investment
Company Act of 1940, and collective
investment funds or common trust
investments that are unregistered
investment products that pool fiduciary
client assets to invest in a diversified
pool of investments.
Junior-lien residential real estate loan
means a loan or line of credit secured
by a subordinate lien on a one-to-four
family residential property.
Loan secured by real estate means a
loan that, at origination, is secured
wholly or substantially by a lien(s) on
real property for which the lien(s) is
central to the extension of the credit. A
lien is ‘‘central’’ to the extension of
credit if the borrowers would not have
been extended credit in the same
amount or on terms as favorable without
the liens on real property. For a loan to
be ‘‘secured wholly or substantially by
a lien(s) on real property,’’ the estimated
value of the real estate collateral at
origination (after deducting any more
senior liens held by others) must be
greater than 50 percent of the principal
amount of the loan at origination.
Loan to a CUSO means the
outstanding balance of any loan from a
credit union to a CUSO as recorded on
PO 00000
Frm 00084
Fmt 4701
Sfmt 4700
the statement of financial condition in
accordance with GAAP.
Loans transferred with limited
recourse means the total principal
balance outstanding of loans transferred,
including participations, for which the
transfer qualified for true sale
accounting treatment under GAAP, and
for which the transferor credit union
retained some limited recourse (i.e.,
insufficient recourse to preclude true
sale accounting treatment). Loans
transferred with limited recourse
excludes transfers that qualify for true
sale accounting treatment but contain
only routine representation and
warranty clauses that are standard for
sales on the secondary market, provided
the credit union is in compliance with
all other related requirements, such as
capital requirements.
Mortgage-backed security (MBS)
means a security backed by first- or
junior-lien mortgages secured by real
estate upon which is located a dwelling,
mixed residential and commercial
structure, residential manufactured
home, or commercial structure.
Mortgage partnership finance
program means a Federal Home Loan
Bank program through which loans are
originated by a depository institution
that are purchased or funded by the
Federal Home Loan Banks, where the
depository institution receives fees for
managing the credit risk of the loans.
The credit risk must be shared between
the depository institution and the
Federal Home Loan Banks.
Mortgage servicing assets mean those
assets, maintained in accordance with
GAAP, resulting from contracts to
service loans secured by real estate (that
have been securitized or owned by
others) for which the benefits of
servicing are expected to more than
adequately compensate the servicer for
performing the servicing.
NCUSIF means the National Credit
Union Share Insurance Fund as defined
by 12 U.S.C. 1783.
Net worth means:
(1) The retained earnings balance of
the credit union at quarter-end as
determined under GAAP, subject to
paragraph (3) of this definition.
(2) For a low income-designated
credit union, net worth also includes
secondary capital accounts that are
uninsured and subordinate to all other
claims, including claims of creditors,
shareholders, and the NCUSIF.
(3) For a credit union that acquires
another credit union in a mutual
combination, net worth also includes
the retained earnings of the acquired
credit union, or of an integrated set of
activities and assets, less any bargain
purchase gain recognized in either case
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
to the extent the difference between the
two is greater than zero. The acquired
retained earnings must be determined at
the point of acquisition under GAAP. A
mutual combination, including a
supervisory combination, is a
transaction in which a credit union
acquires another credit union or
acquires an integrated set of activities
and assets that is capable of being
conducted and managed as a credit
union.
(4) The term ‘‘net worth’’ also
includes loans to and accounts in an
insured credit union, established
pursuant to section 208 of the Act [12
U.S.C. 1788], provided such loans and
accounts:
(i) Have a remaining maturity of more
than 5 years;
(ii) Are subordinate to all other claims
including those of shareholders,
creditors, and the NCUSIF;
(iii) Are not pledged as security on a
loan to, or other obligation of, any party;
(iv) Are not insured by the NCUSIF;
(v) Have non-cumulative dividends;
(vi) Are transferable; and
(vii) Are available to cover operating
losses realized by the insured credit
union that exceed its available retained
earnings.
Net worth ratio means the ratio of the
net worth of the credit union to the total
assets of the credit union rounded to
two decimal places.
New credit union has the same
meaning as in § 702.201.
Nonperpetual capital has the same
meaning as in § 704.2 of this chapter.
Off-balance sheet exposure means:
(1) For loans transferred under the
Federal Home Loan Bank mortgage
partnership finance program, the
outstanding loan balance as of the
reporting date, net of any related
valuation allowance.
(2) For all other loans transferred with
limited recourse or other seller-provided
credit enhancements and that qualify for
true sales accounting, the maximum
contractual amount the credit union is
exposed to according to the agreement,
net of any related valuation allowance.
(3) For unfunded commitments, the
remaining unfunded portion of the
contractual agreement.
Off-balance sheet items means items
such as commitments, contingent items,
guarantees, certain repo-style
transactions, financial standby letters of
credit, and forward agreements that are
not included on the statement of
financial condition, but are normally
reported in the financial statement
footnotes.
On-balance sheet means a credit
union’s assets, liabilities, and equity, as
disclosed on the statement of financial
condition at a specific point in time.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Other intangible assets means
intangible assets, other than servicing
assets and goodwill, maintained in
accordance with GAAP. Other
intangible assets does not include
excluded other intangible assets.
Over-the-counter (OTC) interest rate
derivative contract means a derivative
contract that is not cleared on an
exchange.
Part 703 compliant investment fund
means an investment fund that is
restricted to holding only investments
that are permissible under § 703.14(c) of
this chapter.
Perpetual contributed capital has the
same meaning as in § 704.2 of this
chapter.
Public sector entity (PSE) means a
state, local authority, or other
governmental subdivision of the United
States below the sovereign level.
Qualifying master netting agreement
means a written, legally enforceable
agreement, provided that:
(1) The agreement creates a single
legal obligation for all individual
transactions covered by the agreement
upon an event of default, including
upon an event of conservatorship,
receivership, insolvency, liquidation, or
similar proceeding, of the counterparty;
(2) The agreement provides the credit
union the right to accelerate, terminate,
and close out on a net basis all
transactions under the agreement and to
liquidate or set off collateral promptly
upon an event of default, including
upon an event of conservatorship,
receivership, insolvency, liquidation, or
similar proceeding, of the counterparty,
provided that, in any such case, any
exercise of rights under the agreement
will not be stayed or avoided under
applicable law in the relevant
jurisdictions, other than in receivership,
conservatorship, resolution under the
Federal Deposit Insurance Act, Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, or under
any similar insolvency law applicable to
GSEs;
(3) The agreement does not contain a
walkaway clause (that is, a provision
that permits a non-defaulting
counterparty to make a lower payment
than it otherwise would make under the
agreement, or no payment at all, to a
defaulter or the estate of a defaulter,
even if the defaulter or the estate is a net
creditor under the agreement); and
(4) In order to recognize an agreement
as a qualifying master netting agreement
for purposes of this part, a credit union
must conduct sufficient legal review, at
origination and in response to any
changes in applicable law, to conclude
with a well-founded basis (and maintain
PO 00000
Frm 00085
Fmt 4701
Sfmt 4700
66709
sufficient written documentation of that
legal review) that:
(i) The agreement meets the
requirements of paragraph (2) of this
definition; and
(ii) In the event of a legal challenge
(including one resulting from default or
from conservatorship, receivership,
insolvency, liquidation, or similar
proceeding), the relevant court and
administrative authorities would find
the agreement to be legal, valid, binding,
and enforceable under the law of
relevant jurisdictions.
Recourse means a credit union’s
retention, in form or in substance, of
any credit risk directly or indirectly
associated with an asset it has
transferred that exceeds a pro rata share
of that credit union’s claim on the asset
and disclosed in accordance with
GAAP. If a credit union has no claim on
an asset it has transferred, then the
retention of any credit risk is recourse.
A recourse obligation typically arises
when a credit union transfers assets in
a sale and retains an explicit obligation
to repurchase assets or to absorb losses
due to a default on the payment of
principal or interest or any other
deficiency in the performance of the
underlying obligor or some other party.
Recourse may also exist implicitly if the
credit union provides credit
enhancement beyond any contractual
obligation to support assets it has
transferred.
Residential mortgage-backed security
means a mortgage-backed security
backed by loans secured by a first-lien
on residential property.
Residential property means a house,
condominium unit, cooperative unit,
manufactured home, or the construction
thereof, and unimproved land zoned for
one-to-four family residential use.
Residential property excludes boats or
motor homes, even if used as a primary
residence, or timeshare property.
Restructured means, with respect to
any loan, a restructuring of the loan in
which a credit union, for economic or
legal reasons related to a borrower’s
financial difficulties, grants a
concession to the borrower that it would
not otherwise consider. Restructured
excludes loans modified or restructured
solely pursuant to the U.S. Treasury’s
Home Affordable Mortgage Program.
Revenue obligation means a bond or
similar obligation that is an obligation of
a PSE, but which the PSE is committed
to repay with revenues from the specific
project financed rather than general tax
funds.
Risk-based capital ratio means the
percentage, rounded to two decimal
places, of the risk-based capital ratio
numerator to risk-weighted assets, as
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
66710
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
calculated in accordance with
§ 702.104(a).
Risk-weighted assets means the total
risk-weighted assets as calculated in
accordance with § 702.104(c).
Secured consumer loan means a
consumer loan associated with
collateral or other item of value to
protect against loss where the creditor
has a perfected security interest in the
collateral or other item of value.
Senior executive officer means a
senior executive officer as defined by
§ 701.14(b)(2) of this chapter.
Separate account insurance means an
account into which a policyholder’s
cash surrender value is supported by
assets segregated from the general assets
of the carrier.
Shares means deposits, shares, share
certificates, share drafts, or any other
depository account authorized by
federal or state law.
Share-secured loan means a loan fully
secured by shares, and does not include
the imposition of a statutory lien under
§ 701.39 of this chapter.
STRIPS means a separately traded
registered interest and principal
security.
Structured product means an
investment that is linked, via return or
loss allocation, to another investment or
reference pool.
Subordinated means, with respect to
an investment, that the investment has
a junior claim on the underlying
collateral or assets to other investments
in the same issuance. An investment
that does not have a junior claim to
other investments in the same issuance
on the underlying collateral or assets is
non-subordinated. A Security that is
junior only to money market eligible
securities in the same issuance is also
non-subordinated.
Supervisory merger or combination
means a transaction that involved the
following:
(1) An assisted merger or purchase
and assumption where funds from the
NCUSIF were provided to the
continuing credit union;
(2) A merger or purchase and
assumption classified by NCUA as an
‘‘emergency merger’’ where the acquired
credit union is either insolvent or ‘‘in
danger of insolvency’’ as defined under
appendix B to Part 701 of this chapter;
or
(3) A merger or purchase and
assumption that included NCUA’s or
the appropriate state official’s
identification and selection of the
continuing credit union.
Swap dealer has the meaning as
defined by the Commodity Futures
Trading Commission in 17 CFT 1.3(ggg).
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Total assets means a credit union’s
total assets as measured 1 by either:
(1) Average quarterly balance. The
credit union’s total assets measured by
the average of quarter-end balances of
the current and three preceding
calendar quarters;
(2) Average monthly balance. The
credit union’s total assets measured by
the average of month-end balances over
the three calendar months of the
applicable calendar quarter;
(3) Average daily balance. The credit
union’s total assets measured by the
average daily balance over the
applicable calendar quarter; or
(4) Quarter-end balance. The credit
union’s total assets measured by the
quarter-end balance of the applicable
calendar quarter as reported on the
credit union’s Call Report.
Tranche means one of a number of
related securities offered as part of the
same transaction. Tranche includes a
structured product if it has a loss
allocation based off of an investment or
reference pool.
Unsecured consumer loan means a
consumer loan not secured by collateral.
U.S. Government agency means an
instrumentality of the U.S. Government
whose obligations are fully and
explicitly guaranteed as to the timely
payment of principal and interest by the
full faith and credit of the U.S.
Government. U.S. Government agency
includes NCUA.
(c) Effective date of capital
classification. For purposes of this part,
the effective date of a federally insured
credit union’s capital classification shall
be the most recent to occur of:
(1) Quarter-end effective date. The
last day of the calendar month following
the end of the calendar quarter;
(2) Corrected capital classification.
The date the credit union received
subsequent written notice from NCUA
or, if state-chartered, from the
appropriate state official, of a decline in
capital classification due to correction
of an error or misstatement in the credit
union’s most recent Call Report; or
(3) Reclassification to lower category.
The date the credit union received
written notice from NCUA or, if statechartered, the appropriate state official,
of reclassification on safety and
soundness grounds as provided under
§§ 702.102(b) or 702. 202(d).
(d) Notice to NCUA by filing Call
Report. (1) Other than by filing a Call
Report, a federally insured credit union
need not notify the NCUA Board of a
change in its capital measures that
places the credit union in a lower
capital category;
(2) Failure to timely file a Call Report
as required under this section in no way
alters the effective date of a change in
capital classification under paragraph
(b) of this section, or the affected credit
union’s corresponding legal obligations
under this part.
Subpart A—Prompt Corrective Action
§ 702.102
§ 702.101 Capital measures, capital
adequacy, effective date of classification,
and notice to NCUA.
(a) Capital measures. For purposes of
this part, a credit union must determine
its capital classification at the end of
each calendar quarter using the
following measures:
(1) The net worth ratio; and
(2) If determined to be applicable
under § 702.103, the risk-based capital
ratio.
(b) Capital adequacy. (1)
Notwithstanding the minimum
requirements in this part, a credit union
defined as complex must maintain
capital commensurate with the level
and nature of all risks to which the
institution is exposed.
(2) A credit union defined as complex
must have a process for assessing its
overall capital adequacy in relation to
its risk profile and a comprehensive
written strategy for maintaining an
appropriate level of capital.
1 For each quarter, a credit union must elect one
of the measures of total assets listed in paragraph
(2) of this definition to apply for all purposes under
this part except §§ 702.103 through 702.106 (riskbased capital requirement).
PO 00000
Frm 00086
Fmt 4701
Sfmt 4700
Capital classification.
(a) Capital categories. Except for
credit unions defined as ‘‘new’’ under
subpart B of this part, a credit union
shall be deemed to be classified (Table
1 of this section)—
(1) Well capitalized if:
(i) Net worth ratio. The credit union
has a net worth ratio of 7.0 percent or
greater; and
(ii) Risk-based capital ratio. The
credit union, if complex, has a riskbased capital ratio of 10 percent or
greater.
(2) Adequately capitalized if:
(i) Net worth ratio. The credit union
has a net worth ratio of 6.0 percent or
greater; and
(ii) Risk-based capital ratio. The
credit union, if complex, has a riskbased capital ratio of 8.0 percent or
greater; and
(iii) Does not meet the definition of a
well capitalized credit union.
(3) Undercapitalized if:
(i) Net worth ratio. The credit union
has a net worth ratio of 4.0 percent or
more but less than 6.0 percent; or
(ii) Risk-based capital ratio. The
credit union, if complex, has a riskbased capital ratio of less than 8.0
percent.
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
(4) Significantly undercapitalized if:
(i) The credit union has a net worth
ratio of 2.0 percent or more but less than
4.0 percent; or
(ii) The credit union has a net worth
ratio of 4.0 percent or more but less than
5.0 percent, and either—
(A) Fails to submit an acceptable net
worth restoration plan within the time
prescribed in § 702.110;
(B) Materially fails to implement a net
worth restoration plan approved by the
NCUA Board; or
66711
(C) Receives notice that a submitted
net worth restoration plan has not been
approved.
(5) Critically undercapitalized if it has
a net worth ratio of less than 2.0
percent.
TABLE 1 TO § 702.102—CAPITAL CATEGORIES
Net worth ratio
Well Capitalized ................
Adequately Capitalized .....
7% or greater ..................
6% or greater ..................
And
And
10.0% or greater
8% or greater ..................
Undercapitalized ...............
Significantly Undercapitalized.
4% to 5.99% ....................
2% to 3.99% ....................
Or
........
Less than 8% ..................
N/A ..................................
Critically Undercapitalized
mstockstill on DSK4VPTVN1PROD with RULES2
A credit union’s capital
classification is . . .
Less than 2% ..................
........
N/A
(b) Reclassification based on
supervisory criteria other than net
worth. The NCUA Board may reclassify
a well capitalized credit union as
adequately capitalized and may require
an adequately capitalized or
undercapitalized credit union to comply
with certain mandatory or discretionary
supervisory actions as if it were
classified in the next lower capital
category (each of such actions
hereinafter referred to generally as
‘‘reclassification’’) in the following
circumstances:
(1) Unsafe or unsound condition. The
NCUA Board has determined, after
providing the credit union with notice
and opportunity for hearing pursuant to
§ 747.2003 of this chapter, that the
credit union is in an unsafe or unsound
condition; or
(2) Unsafe or unsound practice. The
NCUA Board has determined, after
providing the credit union with notice
and opportunity for hearing pursuant to
§ 747.2003 of this chapter, that the
credit union has not corrected a material
unsafe or unsound practice of which it
was, or should have been, aware.
(c) Non-delegation. The NCUA Board
may not delegate its authority to
reclassify a credit union under
paragraph (b) of this section.
(d) Consultation with state officials.
The NCUA Board shall consult and seek
to work cooperatively with the
appropriate state official before
reclassifying a federally insured statechartered credit union under paragraph
(b) of this section, and shall promptly
notify the appropriate state official of its
decision to reclassify.
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Risk-based capital ratio
also applicable if complex
And subject to following condition(s) . . .
And does not meet the criteria to be classified as
well capitalized.
Or if ‘‘undercapitalized at <5% net worth and (a)
fails to timely submit, (b) fails to materially implement, or (c) receives notice of the rejection of a
net worth restoration plan.
§ 702.103 Applicability of the risk-based
capital ratio measure.
For purposes of § 702.102, a credit
union is defined as ‘‘complex’’ and the
risk-based capital ratio measure is
applicable only if the credit union’s
quarter-end total assets exceed one
hundred million dollars ($100,000,000),
as reflected in its most recent Call
Report.
§ 702.104
Risk-based capital ratio.
A complex credit union must
calculate its risk-based capital ratio in
accordance with this section.
(a) Calculation of the risk-based
capital ratio. To determine its risk-based
capital ratio, a complex credit union
must calculate the percentage, rounded
to two decimal places, of its risk-based
capital ratio numerator as described in
paragraph (b) of this section, to its total
risk-weighted assets as described in
paragraph (c) of this section.
(b) Risk-based capital ratio
numerator. The risk-based capital ratio
numerator is the sum of the specific
capital elements in paragraph (b)(1) of
this section, minus the regulatory
adjustments in paragraph (b)(2) of this
section.
(1) Capital elements of the risk-based
capital ratio numerator. The capital
elements of the risk-based capital
numerator are:
(i) Undivided earnings;
(ii) Appropriation for non-conforming
investments;
(iii) Other reserves;
(iv) Equity acquired in merger;
(v) Net income
(vi) ALLL, maintained in accordance
with GAAP;
(vii) Secondary capital accounts
included in net worth (as defined in
§ 702.2); and
PO 00000
Frm 00087
Fmt 4701
Sfmt 4700
(viii) Section 208 assistance included
in net worth (as defined in § 702.2).
(2) Risk-based capital ratio numerator
deductions. The elements deducted
from the sum of the capital elements of
the risk-based capital ratio numerator
are:
(i) NCUSIF Capitalization Deposit;
(ii) Goodwill;
(iii) Other intangible assets; and
(iv) Identified losses not reflected in
the risk-based capital ratio numerator.
(c) Risk-weighted assets. (1) General.
Risk-weighted assets includes riskweighted on-balance sheet assets as
described in paragraphs (c)(2) and (3) of
this section, plus the risk-weighted offbalance sheet assets in paragraph (c)(4)
of this section, plus the risk-weighted
derivatives in paragraph (c)(5) of this
section, less the risk-based capital ratio
numerator deductions in paragraph
(b)(2) of this section. If a particular
asset, derivative contract, or off balance
sheet item has features or characteristics
that suggest it could potentially fit into
more than one risk weight category,
then a credit union shall assign the
asset, derivative contract, or off balance
sheet item to the risk weight category
that most accurately and appropriately
reflects its associated credit risk.
(2) Risk weights for on-balance sheet
assets. The risk categories and weights
for assets of a complex credit union are
as follows:
(i) Category 1—zero percent risk
weight. A credit union must assign a
zero percent risk weight to:
(A) The balance of:
(1) Cash, currency and coin, including
vault, automatic teller machine, and
teller cash.
(2) share-secured loans, where the
shares securing the loan are on deposit
with the credit union.
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
66712
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
(B) The exposure amount of:
(1) An obligation of the U.S.
Government, its central bank, or a U.S.
Government agency that is directly and
unconditionally guaranteed, excluding
detached security coupons, ex-coupon
securities, and interest-only mortgagebacked-security STRIPS.
(2) Federal Reserve Bank stock and
Central Liquidity Facility stock.
(C) Insured balances due from FDICinsured depositories or federally
insured credit unions.
(ii) Category 2—20 percent risk
weight. A credit union must assign a 20
percent risk weight to:
(A) The uninsured balances due from
FDIC-insured depositories, federally
insured credit unions, and all balances
due from privately-insured credit
unions.
(B) The exposure amount of:
(1) A non-subordinated obligation of
the U.S. Government, its central bank,
or a U.S. Government agency that is
conditionally guaranteed, excluding
interest-only mortgage-backed-security
STRIPS.
(2) A non-subordinated obligation of a
GSE other than an equity exposure or
preferred stock, excluding interest-only
GSE mortgage-backed-security STRIPS.
(3) Securities issued by PSEs that
represent general obligation securities.
(4) Part 703 compliant investment
funds that are restricted to holding only
investments that qualify for a zero or 20
percent risk-weight under this section.
(5) Federal Home Loan Bank stock.
(C) The balances due from Federal
Home Loan Banks.
(D) The balance of share-secured
loans, where the shares securing the
loan are on deposit with another
depository institution.
(E) The portions of outstanding loans
with a government guarantee.
(F) The portions of commercial loans
secured with contractual compensating
balances.
(iii) Category 3—50 percent risk
weight. A credit union must assign a 50
percent risk weight to:
(A) The outstanding balance (net of
government guarantees), including loans
held for sale, of current first-lien
residential real estate loans less than or
equal to 35 percent of assets.
(B) The exposure amount of:
(1) Securities issued by PSEs in the
U.S. that represent non-subordinated
revenue obligation securities.
(2) Other non-subordinated, non-U.S.
Government agency or non-GSE
guaranteed, residential mortgage-backed
security, excluding interest-only
mortgage-backed security STRIPS.
(iv) Category 4—75 percent risk
weight. A credit union must assign a 75
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
percent risk weight to the outstanding
balance (net of government guarantees),
including loans held for sale, of:
(A) Current first-lien residential real
estate loans greater than 35 percent of
assets.
(B) Current secured consumer loans.
(v) Category 5—100 percent risk
weight. A credit union must assign a 100
percent risk weight to:
(A) The outstanding balance (net of
government guarantees), including loans
held for sale, of:
(1) First-lien residential real estate
loans that are not current.
(2) Current junior-lien residential real
estate loans less than or equal to 20
percent of assets.
(3) Current unsecured consumer
loans.
(4) Current commercial loans, less
contractual compensating balances that
comprise less than 50 percent of assets.
(5) Loans to CUSOs.
(B) The exposure amount of:
(1) Industrial development bonds.
(2) Interest-only mortgage-backed
security STRIPS.
(3) Part 703 compliant investment
funds, with the option to use the lookthrough approaches in paragraph
(c)(3)(iii)(B) of this section.
(4) Corporate debentures and
commercial paper.
(5) Nonperpetual capital at corporate
credit unions.
(6) General account permanent
insurance.
(7) GSE equity exposure or preferred
stock.
(8) Non-subordinated tranches of any
investment, with the option to use the
gross-up approach in paragraph
(c)(3)(iii)(A) of this section.
(C) All other assets listed on the
statement of financial condition not
specifically assigned a different risk
weight under this subpart.
(vi) Category 6—150 percent risk
weight. A credit union must assign a 150
percent risk weight to:
(A) The outstanding balance, net of
government guarantees and including
loans held for sale, of:
(1) Current junior-lien residential real
estate loans that comprise more than 20
percent of assets.
(2) Junior-lien residential real estate
loans that are not current.
(3) Consumer loans that are not
current.
(4) Current commercial loans (net of
contractual compensating balances),
which comprise more than 50 percent of
assets.
(5) Commercial loans (net of
contractual compensating balances),
which are not current.
(B) The exposure amount of:
PO 00000
Frm 00088
Fmt 4701
Sfmt 4700
(1) Perpetual contributed capital at
corporate credit unions.
(2) Equity investments in CUSOs.
(vii) Category 7—250 percent risk
weight. A credit union must assign a 250
percent risk weight to the carrying value
of mortgage servicing assets.
(viii) Category 8—300 percent risk
weight. A credit union must assign a 300
percent risk weight to the exposure
amount of:
(A) Publicly traded equity
investments, other than a CUSO
investment.
(B) Investment funds that do not meet
the requirements under § 703.14(c) of
this chapter, with the option to use the
look-through approaches in paragraph
(c)(3)(iii)(B) of this section.
(C) Separate account insurance, with
the option to use the look-through
approaches in paragraph (c)(3)(iii)(B) of
this section.
(ix) Category 9—400 percent risk
weight. A credit union must assign a
400 percent risk weight to the exposure
amount of non-publicly traded equity
investments, other than equity
investments in CUSOs.
(x) Category 10—1,250 percent risk
weight. A credit union must assign a
1,250 percent risk weight to the
exposure amount of any subordinated
tranche of any investment, with the
option to use the gross-up approach in
paragraph (c)(3)(iii)(A) of this section.
(3) Alternative risk weights for certain
on-balance sheet assets—(i) Nonsignificant equity exposures.— (A)
General. Notwithstanding the risk
weights assigned in paragraph (c)(2) of
this section, a credit union must assign
a 100 percent risk weight to nonsignificant equity exposures.
(B) Determination of non-significant
equity exposures. A credit union has
non-significant equity exposures if the
aggregate amount of its equity exposures
does not exceed 10 percent of the sum
of the credit union’s capital elements of
the risk-based capital ratio numerator
(as defined under paragraph (b)(1) of
this section).
(C) Determination of the aggregate
amount of equity exposures. When
determining the aggregate amount of its
equity exposures, a credit union must
include the total amounts (as recorded
on the statement of financial condition
in accordance with GAAP) of the
following:
(1) Equity investments in CUSOs,
(2) Perpetual contributed capital at
corporate credit unions,
(3) Nonperpetual capital at corporate
credit unions, and
(4) Equity investments subject to a
risk weight in excess of 100 percent.
(ii) Charitable donation accounts.
Notwithstanding the risk weights
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
assigned in paragraph (c)(2) of this
section, a credit union may assign a 100
percent risk weight to a charitable
donation account.
(iii) Alternative approaches.
Notwithstanding the risk weights
assigned in paragraph (c)(2) of this
section, a credit union may determine
the risk weight of investment funds, and
non-subordinated or subordinated
tranches of any investment as follows:
(A) Gross-up approach. A credit
union may use the gross-up approach
under appendix A of this part to
determine the risk weight of the
carrying value of non-subordinated or
subordinated tranches of any
investment.
(B) Look-through approaches. A credit
union may use one of the look-through
approaches under appendix A of this
part to determine the risk weight of the
exposure amount of any investment
funds, the holdings of separate account
insurance, or both.
(4) Risk weights for off-balance sheet
activities. The risk weighted amounts
for all off-balance sheet items are
determined by multiplying the offbalance sheet exposure amount by the
appropriate CCF and the assigned risk
weight as follows:
(i) For the outstanding balance of
loans transferred to a Federal Home
Loan Bank under the mortgage
partnership finance program, a 20
percent CCF and a 50 percent risk
weight.
(ii) For other loans transferred with
limited recourse, a 100 percent CCF
applied to the off-balance sheet
exposure and:
(A) For commercial loans, a 100
percent risk weight.
(B) For first-lien residential real estate
loans, a 50 percent risk weight.
(C) For junior-lien residential real
estate loans, a 100 percent risk weight.
(D) For all secured consumer loans, a
75 percent risk weight.
(E) For all unsecured consumer loans,
a 100 percent risk weight.
(iii) For unfunded commitments:
(A) For commercial loans, a 50
percent CCF with a 100 percent risk
weight.
(B) For first-lien residential real estate
loans, a 10 percent CCF with a 50
percent risk weight.
(C) For junior-lien residential real
estate loans, a 10 percent CCF with a
100 percent risk weight.
(D) For all secured consumer loans, a
10 percent CCF with a 75 percent risk
weight.
(E) For all unsecured consumer loans,
a 10 percent CCF with a 100 percent risk
weight.
(5) Derivative contracts. A complex
credit union must assign a risk-weighted
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
amount to any derivative contracts as
determined under § 702.105.
§ 702.105
Derivative contracts.
(a) OTC interest rate derivative
contracts—(1) Exposure amount—(i)
Single OTC interest rate derivative
contract. Except as modified by
paragraph (a)(2) of this section, the
exposure amount for a single OTC
interest rate derivative contract that is
not subject to a qualifying master
netting agreement is equal to the sum of
the credit union’s current credit
exposure and potential future credit
exposure (PFE) on the OTC interest rate
derivative contract.
(A) Current credit exposure. The
current credit exposure for a single OTC
interest rate derivative contract is the
greater of the fair value of the OTC
interest rate derivative contract or zero.
(B) PFE. (1) The PFE for a single OTC
interest rate derivative contract,
including an OTC interest rate
derivative contract with a negative fair
value, is calculated by multiplying the
notional principal amount of the OTC
interest rate derivative contract by the
appropriate conversion factor in Table 1
of this section.
(2) A credit union must use an OTC
interest rate derivative contract’s
effective notional principal amount (that
is, the apparent or stated notional
principal amount multiplied by any
multiplier in the OTC interest rate
derivative contract) rather than the
apparent or stated notional principal
amount in calculating PFE.
TABLE 1 TO § 702.105—CONVERSION
FACTOR MATRIX FOR INTEREST
RATE DERIVATIVE CONTRACTS 2
Remaining maturity
Conversion
factor
One year or less .......................
Greater than one year and less
than or equal to five years ....
Greater than five years .............
0.00
0.005
0.015
(ii) Multiple OTC interest rate
derivative contracts subject to a
qualifying master netting agreement.
Except as modified by paragraph (a)(2)
of this section, the exposure amount for
multiple OTC interest rate derivative
contracts subject to a qualifying master
netting agreement is equal to the sum of
the net current credit exposure and the
adjusted sum of the PFE amounts for all
OTC interest rate derivative contracts
subject to the qualifying master netting
agreement.
2 Non-interest rate derivative contracts are
addressed in paragraph (d) of this section.
PO 00000
Frm 00089
Fmt 4701
Sfmt 4700
66713
(A) Net current credit exposure. The
net current credit exposure is the greater
of the net sum of all positive and
negative fair value of the individual
OTC interest rate derivative contracts
subject to the qualifying master netting
agreement or zero.
(B) Adjusted sum of the PFE amounts
(Anet). The adjusted sum of the PFE
amounts is calculated as Anet = (0.4 ×
Agross) + (0.6 × NGR × Agross), where:
(1) Agross equals the gross PFE (that
is, the sum of the PFE amounts as
determined under paragraph (a)(1)(i)(B)
of this section for each individual
derivative contract subject to the
qualifying master netting agreement);
and
(2) Net-to-gross Ratio (NGR) equals
the ratio of the net current credit
exposure to the gross current credit
exposure. In calculating the NGR, the
gross current credit exposure equals the
sum of the positive current credit
exposures (as determined under
paragraph (a)(1)(i) of this section) of all
individual derivative contracts subject
to the qualifying master netting
agreement.
(2) Recognition of credit risk
mitigation of collateralized OTC
derivative contracts. A credit union may
recognize credit risk mitigation benefits
of financial collateral that secures an
OTC derivative contract or multiple
OTC derivative contracts subject to a
qualifying master netting agreement
(netting set) by following the
requirements of paragraph (c) of this
section.
(b) Cleared transactions for interest
rate derivatives. (1) General
requirements—A credit union must use
the methodologies described in
paragraph (b) of this section to calculate
risk-weighted assets for a cleared
transaction.
(2) Risk-weighted assets for cleared
transactions. (i) To determine the risk
weighted asset amount for a cleared
transaction, a credit union must
multiply the trade exposure amount for
the cleared transaction, calculated in
accordance with paragraph (b)(3) of this
section, by the risk weight appropriate
for the cleared transaction, determined
in accordance with paragraph (b)(4) of
this section.
(ii) A credit union’s total riskweighted assets for cleared transactions
is the sum of the risk-weighted asset
amounts for all its cleared transactions.
(3) Trade exposure amount. For a
cleared transaction the trade exposure
amount equals:
(i) The exposure amount for the
derivative contract or netting set of
derivative contracts, calculated using
the methodology used to calculate
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
66714
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
exposure amount for OTC interest rate
derivative contracts under paragraph (a)
of this section; plus
(ii) The fair value of the collateral
posted by the credit union and held by
the, clearing member, or custodian.
(4) Cleared transaction risk weights. A
credit union must apply a risk weight
of:
(i) Two percent if the collateral posted
by the credit union to the DCO or
clearing member is subject to an
arrangement that prevents any losses to
the credit union due to the joint default
or a concurrent insolvency, liquidation,
or receivership proceeding of the
clearing member and any other clearing
member clients of the clearing member;
and the clearing member credit union
has conducted sufficient legal review to
conclude with a well-founded basis
(and maintains sufficient written
documentation of that legal review) that
in the event of a legal challenge
(including one resulting from an event
of default or from liquidation,
insolvency, or receivership proceedings)
the relevant court and administrative
authorities would find the arrangements
to be legal, valid, binding and
enforceable under the law of the
relevant jurisdictions; or
(ii) Four percent if the requirements of
paragraph (b)(4)(i) are not met.
(5) Recognition of credit risk
mitigation of collateralized OTC
derivative contracts. A credit union may
recognize the credit risk mitigation
benefits of financial collateral that
secures a cleared derivative contract by
following the requirements of paragraph
(c) of this section.
(c) Recognition of credit risk
mitigation of collateralized interest rate
derivative contracts. (1) A credit union
may recognize the credit risk mitigation
benefits of financial collateral that
secures an OTC interest rate derivative
contract or multiple interest rate
derivative contracts subject to a
qualifying master netting agreement
(netting set) or clearing arrangement by
using the simple approach in paragraph
(c)(3) of this section.
(2) As an alternative to the simple
approach, a credit union may recognize
the credit risk mitigation benefits of
financial collateral that secures such a
contract or netting set if the financial
collateral is marked-to-fair value on a
daily basis and subject to a daily margin
maintenance requirement by applying a
risk weight to the exposure as if it were
uncollateralized and adjusting the
exposure amount calculated under
paragraph (a) or (b) of this section using
the collateral approach in paragraph
(c)(3) of this section. The credit union
must substitute the exposure amount
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
calculated under paragraphs (b) or (c) of
this section in the equation in paragraph
(c)(3) of this section.
(3) Collateralized transactions—(i)
General. A credit union may use the
approach in paragraph (c)(3)(ii) of this
section to recognize the risk-mitigating
effects of financial collateral.
(ii) Simple collateralized derivatives
approach. To qualify for the simple
approach, the financial collateral must
meet the following requirements:
(A) The collateral must be subject to
a collateral agreement for at least the life
of the exposure;
(B) The collateral must be revalued at
least every six months; and
(C) The collateral and the exposure
must be denominated in the same
currency.
(iii) Risk weight substitution. (A) A
credit union may apply a risk weight to
the portion of an exposure that is
secured by the fair value of financial
collateral (that meets the requirements
for the simple collateralized approach of
this section) based on the risk weight
assigned to the collateral as established
under § 702.104(c).
(B) A credit union must apply a risk
weight to the unsecured portion of the
exposure based on the risk weight
applicable to the exposure under this
subpart.
(iv) Exceptions to the 20 percent risk
weight floor and other requirements.
Notwithstanding the simple
collateralized derivatives approach in
paragraph (c)(3)(ii) of this section:
(A) A credit union may assign a zero
percent risk weight to an exposure to a
derivatives contract that is marked-tomarket on a daily basis and subject to
a daily margin maintenance
requirement, to the extent the contract
is collateralized by cash on deposit.
(B) A credit union may assign a 10
percent risk weight to an exposure to a
derivatives contract that is marked-tomarket daily and subject to a daily
margin maintenance requirement, to the
extent that the contract is collateralized
by an exposure that qualifies for a zero
percent risk weight under
§ 702.104(c)(2)(i).
(v) A credit union may assign a zero
percent risk weight to the collateralized
portion of an exposure where:
(A) The financial collateral is cash on
deposit; or
(B) The financial collateral is an
exposure that qualifies for a zero
percent risk weight under
§ 702.104(c)(2)(i), and the credit union
has discounted the fair value of the
collateral by 20 percent.
(4) Collateral haircut approach. (i) A
credit union may recognize the credit
risk mitigation benefits of financial
PO 00000
Frm 00090
Fmt 4701
Sfmt 4700
collateral that secures a collateralized
derivative contract by using the
standard supervisory haircuts in
paragraph (c)(3) of this section.
(ii) The collateral haircut approach
applies to both OTC and cleared interest
rate derivatives contracts discussed in
this section.
(iii) A credit union must determine
the exposure amount for a collateralized
derivative contracts by setting the
exposure amount equal to the max
{0,[(exposure amount ¥ value of
collateral) + (sum of current fair value
of collateral instruments * market price
volatility haircut of the collateral
instruments)]}, where:
(A) The value of the exposure equals
the exposure amount for OTC interest
rate derivative contracts (or netting set)
calculated under paragraphs (a)(1)(i)
and (ii) of this section.
(B) The value of the exposure equals
the exposure amount for cleared interest
rate derivative contracts (or netting set)
calculated under paragraph (b)(3) of this
section.
(C) The value of the collateral is the
sum of cash and all instruments under
the transaction (or netting set).
(D) The sum of current fair value of
collateral instruments as of the
measurement date.
(E) A credit union must use the
standard supervisory haircuts for market
price volatility in Table 2 to this section.
TABLE 2 TO § 702.105—STANDARD
SUPERVISORY MARKET PRICE VOLATILITY HAIRCUTS
[Based on a 10 business-day holding period]
Haircut (in percent)
assigned based on:
Residual maturity
Collateral risk weight
(in percent)
Zero
Less than or equal to
1 year ....................
Greater than 1 year
and less than or
equal to 5 years ....
Greater than 5 years
Cash collateral held ..
Other exposure types
20 or 50
0.5
1.0
2.0
4.0
3.0
6.0
Zero
25.0
(d) All other derivative contracts and
transactions. Credit unions must follow
the requirements of the applicable
provisions of 12 CFR part 324, when
assigning risk weights to exposure
amounts for derivatives contracts not
addressed in paragraphs (a) or (b) of this
section.
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
§ 702.106 Prompt corrective action for
adequately capitalized credit unions.
(a) Earnings retention. Beginning on
the effective date of classification as
adequately capitalized or lower, a
federally insured credit union must
increase the dollar amount of its net
worth quarterly either in the current
quarter, or on average over the current
and three preceding quarters, by an
amount equivalent to at least 1/10th
percent (0.1%) of its total assets (or
more by choice), until it is well
capitalized.
(b) Decrease in retention. Upon
written application received no later
than 14 days before the quarter end, the
NCUA Board, on a case-by-case basis,
may permit a credit union to increase
the dollar amount of its net worth by an
amount that is less than the amount
required under paragraph (a) of this
section, to the extent the NCUA Board
determines that such lesser amount:
(1) Is necessary to avoid a significant
redemption of shares; and
(2) Would further the purpose of this
part.
(c) Decrease by FISCU. The NCUA
Board shall consult and seek to work
cooperatively with the appropriate state
official before permitting a federally
insured state-chartered credit union to
decrease its earnings retention under
paragraph (b) of this section.
(d) Periodic review. A decision under
paragraph (b) of this section to permit a
credit union to decrease its earnings
retention is subject to quarterly review
and revocation except when the credit
union is operating under an approved
net worth restoration plan that provides
for decreasing its earnings retention as
provided under paragraph (b) of this
section.
mstockstill on DSK4VPTVN1PROD with RULES2
§ 702.107 Prompt corrective action for
undercapitalized credit unions.
(a) Mandatory supervisory actions by
credit union. A credit union which is
undercapitalized must—
(1) Earnings retention. Increase net
worth in accordance with § 702.106;
(2) Submit net worth restoration plan.
Submit a net worth restoration plan
pursuant to § 702.111, provided
however, that a credit union in this
category having a net worth ratio of less
than five percent (5%) which fails to
timely submit such a plan, or which
materially fails to implement an
approved plan, is classified significantly
undercapitalized pursuant to
§ 702.102(a)(4)(i);
(3) Restrict increase in assets.
Beginning the effective date of
classification as undercapitalized or
lower, not permit the credit union’s
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
assets to increase beyond its total assets
for the preceding quarter unless—
(i) Plan approved. The NCUA Board
has approved a net worth restoration
plan which provides for an increase in
total assets and—
(A) The assets of the credit union are
increasing consistent with the approved
plan; and
(B) The credit union is implementing
steps to increase the net worth ratio
consistent with the approved plan;
(ii) Plan not approved. The NCUA
Board has not approved a net worth
restoration plan and total assets of the
credit union are increasing because of
increases since quarter-end in balances
of:
(A) Total accounts receivable and
accrued income on loans and
investments; or
(B) Total cash and cash equivalents;
or
(C) Total loans outstanding, not to
exceed the sum of total assets plus the
quarter-end balance of unused
commitments to lend and unused lines
of credit provided however that a credit
union which increases a balance as
permitted under paragraphs (a)(3)(ii)(A),
(B) or (C) of this section cannot offer
rates on shares in excess of prevailing
rates on shares in its relevant market
area, and cannot open new branches;
(4) Restrict member business loans.
Beginning the effective date of
classification as undercapitalized or
lower, not increase the total dollar
amount of member business loans
(defined as loans outstanding and
unused commitments to lend) as of the
preceding quarter-end unless it is
granted an exception under 12 U.S.C.
1757a(b).
(b) Second tier discretionary
supervisory actions by NCUA. Subject to
the applicable procedures for issuing,
reviewing and enforcing directives set
forth in subpart L of part 747 of this
chapter, the NCUA Board may, by
directive, take one or more of the
following actions with respect to an
undercapitalized credit union having a
net worth ratio of less than five percent
(5%), or a director, officer or employee
of such a credit union, if it determines
that those actions are necessary to carry
out the purpose of this part:
(1) Requiring prior approval for
acquisitions, branching, new lines of
business. Prohibit a credit union from,
directly or indirectly, acquiring any
interest in any business entity or
financial institution, establishing or
acquiring any additional branch office,
or engaging in any new line of business,
unless the NCUA Board has approved
the credit union’s net worth restoration
plan, the credit union is implementing
PO 00000
Frm 00091
Fmt 4701
Sfmt 4700
66715
its plan, and the NCUA Board
determines that the proposed action is
consistent with and will further the
objectives of that plan;
(2) Restricting transactions with and
ownership of a CUSO. Restrict the credit
union’s transactions with a CUSO, or
require the credit union to reduce or
divest its ownership interest in a CUSO;
(3) Restricting dividends paid. Restrict
the dividend rates the credit union pays
on shares to the prevailing rates paid on
comparable accounts and maturities in
the relevant market area, as determined
by the NCUA Board, except that
dividend rates already declared on
shares acquired before imposing a
restriction under this paragraph may not
be retroactively restricted;
(4) Prohibiting or reducing asset
growth. Prohibit any growth in the
credit union’s assets or in a category of
assets, or require the credit union to
reduce its assets or a category of assets;
(5) Alter, reduce or terminate activity.
Require the credit union or its CUSO to
alter, reduce, or terminate any activity
which poses excessive risk to the credit
union;
(6) Prohibiting nonmember deposits.
Prohibit the credit union from accepting
all or certain nonmember deposits;
(7) Dismissing director or senior
executive officer. Require the credit
union to dismiss from office any
director or senior executive officer,
provided however, that a dismissal
under this clause shall not be construed
to be a formal administrative action for
removal under 12 U.S.C. 1786(g);
(8) Employing qualified senior
executive officer. Require the credit
union to employ qualified senior
executive officers (who, if the NCUA
Board so specifies, shall be subject to its
approval); and
(9) Other action to carry out prompt
corrective action. Restrict or require
such other action by the credit union as
the NCUA Board determines will carry
out the purpose of this part better than
any of the actions prescribed in
paragraphs (b)(1) through (8) of this
section.
(c) First tier application of
discretionary supervisory actions. An
undercapitalized credit union having a
net worth ratio of five percent (5%) or
more, or which is classified
undercapitalized by reason of failing to
maintain a risk-based capital ratio equal
to or greater than 8 percent under
§ 702.104, is subject to the discretionary
supervisory actions in paragraph (b) of
this section if it fails to comply with any
mandatory supervisory action in
paragraph (a) of this section or fails to
timely implement an approved net
worth restoration plan under § 702.111,
E:\FR\FM\29OCR2.SGM
29OCR2
66716
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
including meeting its prescribed steps to
increase its net worth ratio.
mstockstill on DSK4VPTVN1PROD with RULES2
§ 702.108 Prompt corrective action for
significantly undercapitalized credit unions.
(a) Mandatory supervisory actions by
credit union. A credit union which is
significantly undercapitalized must—
(1) Earnings retention. Increase net
worth in accordance with § 702.106;
(2) Submit net worth restoration plan.
Submit a net worth restoration plan
pursuant to § 702.111;
(3) Restrict increase in assets. Not
permit the credit union’s total assets to
increase except as provided in
§ 702.107(a)(3); and
(4) Restrict member business loans.
Not increase the total dollar amount of
member business loans (defined as
loans outstanding and unused
commitments to lend) as provided in
§ 702.107(a)(4).
(b) Discretionary supervisory actions
by NCUA. Subject to the applicable
procedures for issuing, reviewing and
enforcing directives set forth in subpart
L of part 747 of this chapter, the NCUA
Board may, by directive, take one or
more of the following actions with
respect to any significantly
undercapitalized credit union, or a
director, officer or employee of such
credit union, if it determines that those
actions are necessary to carry out the
purpose of this part:
(1) Requiring prior approval for
acquisitions, branching, new lines of
business. Prohibit a credit union from,
directly or indirectly, acquiring any
interest in any business entity or
financial institution, establishing or
acquiring any additional branch office,
or engaging in any new line of business,
except as provided in § 702.107(b)(1);
(2) Restricting transactions with and
ownership of CUSO. Restrict the credit
union’s transactions with a CUSO, or
require the credit union to divest or
reduce its ownership interest in a
CUSO;
(3) Restricting dividends paid. Restrict
the dividend rates that the credit union
pays on shares as provided in
§ 702.107(b)(3);
(4) Prohibiting or reducing asset
growth. Prohibit any growth in the
credit union’s assets or in a category of
assets, or require the credit union to
reduce assets or a category of assets;
(5) Alter, reduce or terminate activity.
Require the credit union or its CUSO(s)
to alter, reduce, or terminate any
activity which poses excessive risk to
the credit union;
(6) Prohibiting nonmember deposits.
Prohibit the credit union from accepting
all or certain nonmember deposits;
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
(7) New election of directors. Order a
new election of the credit union’s board
of directors;
(8) Dismissing director or senior
executive officer. Require the credit
union to dismiss from office any
director or senior executive officer,
provided however, that a dismissal
under this clause shall not be construed
to be a formal administrative action for
removal under 12 U.S.C. 1786(g);
(9) Employing qualified senior
executive officer. Require the credit
union to employ qualified senior
executive officers (who, if the NCUA
Board so specifies, shall be subject to its
approval);
(10) Restricting senior executive
officers’ compensation. Except with the
prior written approval of the NCUA
Board, limit compensation to any senior
executive officer to that officer’s average
rate of compensation (excluding
bonuses and profit sharing) during the
four (4) calendar quarters preceding the
effective date of classification of the
credit union as significantly
undercapitalized, and prohibit payment
of a bonus or profit share to such officer;
(11) Other actions to carry out prompt
corrective action. Restrict or require
such other action by the credit union as
the NCUA Board determines will carry
out the purpose of this part better than
any of the actions prescribed in
paragraphs (b)(1) through (10) of this
section; and
(12) Requiring merger. Require the
credit union to merge with another
financial institution if one or more
grounds exist for placing the credit
union into conservatorship pursuant to
12 U.S.C. 1786(h)(1)(F), or into
liquidation pursuant to 12 U.S.C.
1787(a)(3)(A)(i).
(c) Discretionary conservatorship or
liquidation if no prospect of becoming
adequately capitalized.
Notwithstanding any other actions
required or permitted to be taken under
this section, when a credit union
becomes significantly undercapitalized
(including by reclassification under
§ 702.102(b)), the NCUA Board may
place the credit union into
conservatorship pursuant to 12 U.S.C.
1786(h)(1)(F), or into liquidation
pursuant to 12 U.S.C. 1787(a)(3)(A)(i),
provided that the credit union has no
reasonable prospect of becoming
adequately capitalized.
§ 702.109 Prompt corrective action for
critically undercapitalized credit unions.
(a) Mandatory supervisory actions by
credit union. A credit union which is
critically undercapitalized must—
(1) Earnings retention. Increase net
worth in accordance with § 702.106;
PO 00000
Frm 00092
Fmt 4701
Sfmt 4700
(2) Submit net worth restoration plan.
Submit a net worth restoration plan
pursuant to § 702.111;
(3) Restrict increase in assets. Not
permit the credit union’s total assets to
increase except as provided in
§ 702.107(a)(3); and
(4) Restrict member business loans.
Not increase the total dollar amount of
member business loans (defined as
loans outstanding and unused
commitments to lend) as provided in
§ 702.107(a)(4).
(b) Discretionary supervisory actions
by NCUA. Subject to the applicable
procedures for issuing, reviewing and
enforcing directives set forth in subpart
L of part 747 of this chapter, the NCUA
Board may, by directive, take one or
more of the following actions with
respect to any critically
undercapitalized credit union, or a
director, officer or employee of such
credit union, if it determines that those
actions are necessary to carry out the
purpose of this part:
(1) Requiring prior approval for
acquisitions, branching, new lines of
business. Prohibit a credit union from,
directly or indirectly, acquiring any
interest in any business entity or
financial institution, establishing or
acquiring any additional branch office,
or engaging in any new line of business,
except as provided by § 702.107(b)(1);
(2) Restricting transactions with and
ownership of CUSO. Restrict the credit
union’s transactions with a CUSO, or
require the credit union to divest or
reduce its ownership interest in a
CUSO;
(3) Restricting dividends paid. Restrict
the dividend rates that the credit union
pays on shares as provided in
§ 702.107(b)(3);
(4) Prohibiting or reducing asset
growth. Prohibit any growth in the
credit union’s assets or in a category of
assets, or require the credit union to
reduce assets or a category of assets;
(5) Alter, reduce or terminate activity.
Require the credit union or its CUSO(s)
to alter, reduce, or terminate any
activity which poses excessive risk to
the credit union;
(6) Prohibiting nonmember deposits.
Prohibit the credit union from accepting
all or certain nonmember deposits;
(7) New election of directors. Order a
new election of the credit union’s board
of directors;
(8) Dismissing director or senior
executive officer. Require the credit
union to dismiss from office any
director or senior executive officer,
provided however, that a dismissal
under this clause shall not be construed
to be a formal administrative action for
removal under 12 U.S.C. 1786(g);
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
(9) Employing qualified senior
executive officer. Require the credit
union to employ qualified senior
executive officers (who, if the NCUA
Board so specifies, shall be subject to its
approval);
(10) Restricting senior executive
officers’ compensation. Reduce or, with
the prior written approval of the NCUA
Board, limit compensation to any senior
executive officer to that officer’s average
rate of compensation (excluding
bonuses and profit sharing) during the
four (4) calendar quarters preceding the
effective date of classification of the
credit union as critically
undercapitalized, and prohibit payment
of a bonus or profit share to such officer;
(11) Restrictions on payments on
uninsured secondary capital. Beginning
60 days after the effective date of
classification of a credit union as
critically undercapitalized, prohibit
payments of principal, dividends or
interest on the credit union’s uninsured
secondary capital accounts established
after August 7, 2000, except that unpaid
dividends or interest shall continue to
accrue under the terms of the account to
the extent permitted by law;
(12) Requiring prior approval. Require
a critically undercapitalized credit
union to obtain the NCUA Board’s prior
written approval before doing any of the
following:
(i) Entering into any material
transaction not within the scope of an
approved net worth restoration plan (or
approved revised business plan under
subpart C of this part);
(ii) Extending credit for transactions
deemed highly leveraged by the NCUA
Board or, if state-chartered, by the
appropriate state official;
(iii) Amending the credit union’s
charter or bylaws, except to the extent
necessary to comply with any law,
regulation, or order;
(iv) Making any material change in
accounting methods; and
(v) Paying dividends or interest on
new share accounts at a rate exceeding
the prevailing rates of interest on
insured deposits in its relevant market
area;
(13) Other action to carry out prompt
corrective action. Restrict or require
such other action by the credit union as
the NCUA Board determines will carry
out the purpose of this part better than
any of the actions prescribed in
paragraphs (b)(1) through (12) of this
section; and
(14) Requiring merger. Require the
credit union to merge with another
financial institution if one or more
grounds exist for placing the credit
union into conservatorship pursuant to
12 U.S.C. 1786(h)(1)(F), or into
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
liquidation pursuant to 12 U.S.C.
1787(a)(3)(A)(i).
(c) Mandatory conservatorship,
liquidation or action in lieu thereof —(1)
Action within 90 days. Notwithstanding
any other actions required or permitted
to be taken under this section (and
regardless of a credit union’s prospect of
becoming adequately capitalized), the
NCUA Board must, within 90 calendar
days after the effective date of
classification of a credit union as
critically undercapitalized—
(i) Conservatorship. Place the credit
union into conservatorship pursuant to
12 U.S.C. 1786(h)(1)(G); or
(ii) Liquidation. Liquidate the credit
union pursuant to 12 U.S.C.
1787(a)(3)(A)(ii); or
(iii) Other corrective action. Take
other corrective action, in lieu of
conservatorship or liquidation, to better
achieve the purpose of this part,
provided that the NCUA Board
documents why such action in lieu of
conservatorship or liquidation would do
so, provided however, that other
corrective action may consist, in whole
or in part, of complying with the
quarterly timetable of steps and meeting
the quarterly net worth targets
prescribed in an approved net worth
restoration plan.
(2) Renewal of other corrective action.
A determination by the NCUA Board to
take other corrective action in lieu of
conservatorship or liquidation under
paragraph (c)(1)(iii) of this section shall
expire after an effective period ending
no later than 180 calendar days after the
determination is made, and the credit
union shall be immediately placed into
conservatorship or liquidation under
paragraphs (c)(1)(i) and (ii) of this
section, unless the NCUA Board makes
a new determination under paragraph
(c)(1)(iii) of this section before the end
of the effective period of the prior
determination;
(3) Mandatory liquidation after 18
months —(i) Generally.
Notwithstanding paragraphs (c)(1) and
(2) of this section, the NCUA Board
must place a credit union into
liquidation if it remains critically
undercapitalized for a full calendar
quarter, on a monthly average basis,
following a period of 18 months from
the effective date the credit union was
first classified critically
undercapitalized.
(ii) Exception. Notwithstanding
paragraph (c)(3)(i) of this section, the
NCUA Board may continue to take other
corrective action in lieu of liquidation if
it certifies that the credit union—
(A) Has been in substantial
compliance with an approved net worth
restoration plan requiring consistent
PO 00000
Frm 00093
Fmt 4701
Sfmt 4700
66717
improvement in net worth since the
date the net worth restoration plan was
approved;
(B) Has positive net income or has an
upward trend in earnings that the
NCUA Board projects as sustainable;
and
(C) Is viable and not expected to fail.
(iii) Review of exception. The NCUA
Board shall, at least quarterly, review
the certification of an exception to
liquidation under paragraph (c)(3)(ii) of
this section and shall either—
(A) Recertify the credit union if it
continues to satisfy the criteria of
paragraph (c)(3)(ii) of this section; or
(B) Promptly place the credit union
into liquidation, pursuant to 12 U.S.C.
1787(a)(3)(A)(ii), if it fails to satisfy the
criteria of paragraph (c)(3)(ii) of this
section.
(4) Nondelegation. The NCUA Board
may not delegate its authority under
paragraph (c) of this section, unless the
credit union has less than $5,000,000 in
total assets. A credit union shall have a
right of direct appeal to the NCUA
Board of any decision made by
delegated authority under this section
within ten (10) calendar days of the date
of that decision.
(d) Mandatory liquidation of insolvent
federal credit union. In lieu of
paragraph (c) of this section, a critically
undercapitalized federal credit union
that has a net worth ratio of less than
zero percent (0%) may be placed into
liquidation on grounds of insolvency
pursuant to 12 U.S.C. 1787(a)(1)(A).
§ 702.110 Consultation with state officials
on proposed prompt corrective action.
(a) Consultation on proposed
conservatorship or liquidation. Before
placing a federally insured statechartered credit union into
conservatorship (pursuant to 12 U.S.C.
1786(h)(1)(F) or (G)) or liquidation
(pursuant to 12 U.S.C. 1787(a)(3)) as
permitted or required under subparts A
or B of this part to facilitate prompt
corrective action—
(1) The NCUA Board shall seek the
views of the appropriate state official (as
defined in § 702.2), and give him or her
an opportunity to take the proposed
action;
(2) The NCUA Board shall, upon
timely request of the appropriate state
official, promptly provide him or her
with a written statement of the reasons
for the proposed conservatorship or
liquidation, and reasonable time to
respond to that statement; and
(3) If the appropriate state official
makes a timely written response that
disagrees with the proposed
conservatorship or liquidation and gives
reasons for that disagreement, the
E:\FR\FM\29OCR2.SGM
29OCR2
66718
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
NCUA Board shall not place the credit
union into conservatorship or
liquidation unless it first considers the
views of the appropriate state official
and determines that—
(i) The NCUSIF faces a significant risk
of loss if the credit union is not placed
into conservatorship or liquidation; and
(ii) Conservatorship or liquidation is
necessary either to reduce the risk of
loss, or to reduce the expected loss, to
the NCUSIF with respect to the credit
union.
(b) Nondelegation. The NCUA Board
may not delegate any determination
under paragraph (a)(3) of this section.
(c) Consultation on proposed
discretionary action. The NCUA Board
shall consult and seek to work
cooperatively with the appropriate state
official before taking any discretionary
supervisory action under §§ 702.107(b),
702.108(b), 702.109(b), 702.204(b) and
702.205(b) with respect to a federally
insured state-chartered credit union;
shall provide prompt notice of its
decision to the appropriate state official;
and shall allow the appropriate state
official to take the proposed action
independently or jointly with NCUA.
mstockstill on DSK4VPTVN1PROD with RULES2
§ 702.111
(NWRP).
Net worth restoration plans
(a) Schedule for filing—(1) Generally.
A credit union shall file a written net
worth restoration plan (NWRP) with the
appropriate Regional Director and, if
state-chartered, the appropriate state
official, within 45 calendar days of the
effective date of classification as either
undercapitalized, significantly
undercapitalized or critically
undercapitalized, unless the NCUA
Board notifies the credit union in
writing that its NWRP is to be filed
within a different period.
(2) Exception. An otherwise
adequately capitalized credit union that
is reclassified undercapitalized on
safety and soundness grounds under
§ 702.102(b) is not required to submit a
NWRP solely due to the reclassification,
unless the NCUA Board notifies the
credit union that it must submit an
NWRP.
(3) Filing of additional plan.
Notwithstanding paragraph (a)(1) of this
section, a credit union that has already
submitted and is operating under a
NWRP approved under this section is
not required to submit an additional
NWRP due to a change in net worth
category (including by reclassification
under § 702.102(b)), unless the NCUA
Board notifies the credit union that it
must submit a new NWRP. A credit
union that is notified to submit a new
or revised NWRP shall file the NWRP in
writing with the appropriate Regional
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
Director within 30 calendar days of
receiving such notice, unless the NCUA
Board notifies the credit union in
writing that the NWRP is to be filed
within a different period.
(4) Failure to timely file plan. When
a credit union fails to timely file an
NWRP pursuant to this paragraph, the
NCUA Board shall promptly notify the
credit union that it has failed to file an
NWRP and that it has 15 calendar days
from receipt of that notice within which
to file an NWRP.
(b) Assistance to small credit unions.
Upon timely request by a credit union
having total assets of less than $10
million (regardless how long it has been
in operation), the NCUA Board shall
provide assistance in preparing an
NWRP required to be filed under
paragraph (a) of this section.
(c) Contents of NWRP. An NWRP
must—
(1) Specify—
(i) A quarterly timetable of steps the
credit union will take to increase its net
worth ratio, and risk-based capital ratio
if applicable, so that it becomes
adequately capitalized by the end of the
term of the NWRP, and to remain so for
four (4) consecutive calendar quarters;
(ii) The projected amount of net worth
increases in each quarter of the term of
the NWRP as required under
§ 702.106(a), or as permitted under
§ 702.106(b);
(iii) How the credit union will comply
with the mandatory and any
discretionary supervisory actions
imposed on it by the NCUA Board
under this subpart;
(iv) The types and levels of activities
in which the credit union will engage;
and
(v) If reclassified to a lower category
under § 702.102(b), the steps the credit
union will take to correct the unsafe or
unsound practice(s) or condition(s);
(2) Include pro forma financial
statements, including any off-balance
sheet items, covering a minimum of the
next two years; and
(3) Contain such other information as
the NCUA Board has required.
(d) Criteria for approval of NWRP.
The NCUA Board shall not accept a
NWRP plan unless it—
(1) Complies with paragraph (c) of
this section;
(2) Is based on realistic assumptions,
and is likely to succeed in restoring the
credit union’s net worth; and
(3) Would not unreasonably increase
the credit union’s exposure to risk
(including credit risk, interest-rate risk,
and other types of risk).
(e) Consideration of regulatory
capital. To minimize possible long-term
losses to the NCUSIF while the credit
PO 00000
Frm 00094
Fmt 4701
Sfmt 4700
union takes steps to become adequately
capitalized, the NCUA Board shall, in
evaluating an NWRP under this section,
consider the type and amount of any
form of regulatory capital which may
become established by NCUA
regulation, or authorized by state law
and recognized by NCUA, which the
credit union holds, but which is not
included in its net worth.
(f) Review of NWRP—(1) Notice of
decision. Within 45 calendar days after
receiving an NWRP under this part, the
NCUA Board shall notify the credit
union in writing whether the NWRP has
been approved, and shall provide
reasons for its decision in the event of
disapproval.
(2) Delayed decision. If no decision is
made within the time prescribed in
paragraph (f)(1) of this section, the
NWRP is deemed approved.
(3) Consultation with state officials. In
the case of an NWRP submitted by a
federally insured state-chartered credit
union (whether an original, new,
additional, revised or amended NWRP),
the NCUA Board shall, when evaluating
the NWRP, seek and consider the views
of the appropriate state official, and
provide prompt notice of its decision to
the appropriate state official.
(g) NWRP not approved —(1)
Submission of revised NWRP. If an
NWRP is rejected by the NCUA Board,
the credit union shall submit a revised
NWRP within 30 calendar days of
receiving notice of disapproval, unless it
is notified in writing by the NCUA
Board that the revised NWRP is to be
filed within a different period.
(2) Notice of decision on revised
NWRP. Within 30 calendar days after
receiving a revised NWRP under
paragraph (g)(1) of this section, the
NCUA Board shall notify the credit
union in writing whether the revised
NWRP is approved. The Board may
extend the time within which notice of
its decision shall be provided.
(3) Disapproval of reclassified credit
union’s NWRP. A credit union which
has been classified significantly
undercapitalized shall remain so
classified pending NCUA Board
approval of a new or revised NWRP.
(4) Submission of multiple
unapproved NWRPs. The submission of
more than two NWRPs that are not
approved is considered an unsafe and
unsound condition and may subject the
credit union to administrative
enforcement actions under section 206
of the FCUA, 12 U.S.C. 1786 and 1790d.
(h) Amendment of NWRP. A credit
union that is operating under an
approved NWRP may, after prior written
notice to, and approval by the NCUA
Board, amend its NWRP to reflect a
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
change in circumstance. Pending
approval of an amended NWRP, the
credit union shall implement the NWRP
as originally approved.
(i) Publication. An NWRP need not be
published to be enforceable because
publication would be contrary to the
public interest.
(j) Termination of NWRP. For
purposes of this part, an NWRP
terminates once the credit union is
classified as adequately capitalized and
remains so for four consecutive quarters.
For example, if a credit union with an
active NWRP attains the classification as
adequately classified on December 31,
2015 this would be quarter one and the
fourth consecutive quarter would end
September 30, 2016.
§ 702.112
Reserves.
Each credit union shall establish and
maintain such reserves as may be
required by the FCUA, by state law, by
regulation, or in special cases by the
NCUA Board or appropriate state
official.
mstockstill on DSK4VPTVN1PROD with RULES2
§ 702.113 Full and fair disclosure of
financial condition.
(a) Full and fair disclosure defined.
‘‘Full and fair disclosure’’ is the level of
disclosure which a prudent person
would provide to a member of a credit
union, to NCUA, or, at the discretion of
the board of directors, to creditors to
fairly inform them of the financial
condition and the results of operations
of the credit union.
(b) Full and fair disclosure
implemented. The financial statements
of a credit union shall provide for full
and fair disclosure of all assets,
liabilities, and members’ equity,
including such valuation (allowance)
accounts as may be necessary to present
fairly the financial condition; and all
income and expenses necessary to
present fairly the statement of income
for the reporting period.
(c) Declaration of officials. The
Statement of Financial Condition, when
presented to members, to creditors or to
NCUA, shall contain a dual declaration
by the treasurer and the chief executive
officer, or in the latter’s absence, by any
other officer designated by the board of
directors of the reporting credit union to
make such declaration, that the report
and related financial statements are true
and correct to the best of their
knowledge and belief and present fairly
the financial condition and the
statement of income for the period
covered.
(d) Charges for loan and lease losses.
Full and fair disclosure demands that a
credit union properly address charges
for loan losses as follows:
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
(1) Charges for loan and lease losses
shall be made timely and in accordance
with GAAP;
(2) The ALLL must be maintained in
accordance with GAAP; and
(3) At a minimum, adjustments to the
ALLL shall be made prior to the
distribution or posting of any dividend
to the accounts of members.
§ 702.114
Payment of dividends.
(a) Restriction on dividends.
Dividends shall be available only from
net worth, net of any special reserves
established under § 702.112, if any.
(b) Payment of dividends and interest
refunds. The board of directors must not
pay a dividend or interest refund that
will cause the credit union’s capital
classification to fall below adequately
capitalized under this subpart unless
the appropriate Regional Director and, if
state-chartered, the appropriate state
official, have given prior written
approval (in an NWRP or otherwise).
The request for written approval must
include the plan for eliminating any
negative retained earnings balance.
Subpart B—Alternative Prompt
Corrective Action for New Credit
Unions
§ 702.201
Scope and definition.
(a) Scope. This subpart B applies in
lieu of subpart A of this part exclusively
to credit unions defined in paragraph (b)
of this section as ‘‘new’’ pursuant to
section 216(b)(2) of the FCUA, 12 U.S.C.
1790d(b)(2).
(b) New credit union defined. A
‘‘new’’ credit union for purposes of this
subpart is a credit union that both has
been in operation for less than ten (10)
years and has total assets of not more
than $10 million. Once a credit union
reports total assets of more than $10
million on a Call Report, the credit
union is no longer new, even if its assets
subsequently decline below $10 million.
(c) Effect of spin-offs. A credit union
formed as the result of a ‘‘spin-off’’ of
a group from the field of membership of
an existing credit union is deemed to be
in operation since the effective date of
the spin-off. A credit union whose total
assets decline below $10 million
because a group within its field of
membership has been spun-off is
deemed ‘‘new’’ if it has been in
operation less than 10 years.
(d) Actions to evade prompt corrective
action. If the NCUA Board determines
that a credit union was formed, or was
reduced in asset size as a result of a
spin-off, or was merged, primarily to
qualify as ‘‘new’’ under this subpart, the
credit union shall be deemed subject to
prompt corrective action under subpart
A of this part.
PO 00000
Frm 00095
Fmt 4701
Sfmt 4700
66719
§ 702.202 Net worth categories for new
credit unions.
(a) Net worth measures. For purposes
of this part, a new credit union must
determine its capital classification
quarterly according to its net worth
ratio.
(b) Effective date of net worth
classification of new credit union. For
purposes of subpart B of this part, the
effective date of a new credit union’s
classification within a capital category
in paragraph (c) of this section shall be
determined as provided in § 702.101(c);
and written notice of a decline in net
worth classification in paragraph (c) of
this section shall be given as required by
§ 702.101(c).
(c) Net worth categories. A credit
union defined as ‘‘new’’ under this
section shall be classified—
(1) Well capitalized if it has a net
worth ratio of seven percent (7%) or
greater;
(2) Adequately capitalized if it has a
net worth ratio of six percent (6%) or
more but less than seven percent (7%);
(3) Moderately capitalized if it has a
net worth ratio of three and one-half
percent (3.5%) or more but less than six
percent (6%);
(4) Marginally capitalized if it has a
net worth ratio of two percent (2%) or
more but less than three and one-half
percent (3.5%);
(5) Minimally capitalized if it has a
net worth ratio of zero percent (0%) or
greater but less than two percent (2%);
and
(6) Uncapitalized if it has a net worth
ratio of less than zero percent (0%).
TABLE 1 TO § 702.202—CAPITAL
CATEGORIES FOR NEW CREDIT UNIONS
A new credit union’s capital
classification is
If it’s net worth
ratio is
Well Capitalized ..................
Adequately Capitalized .......
Moderately Capitalized .......
Marginally Capitalized ........
Minimally Capitalized ..........
Uncapitalized ......................
7% or above.
6 to 7%.
3.5% to 5.99%.
2% to 3.49%.
0% to 1.99%.
Less than 0%.
(d) Reclassification based on
supervisory criteria other than net
worth. Subject to § 702.102(b), the
NCUA Board may reclassify a well
capitalized, adequately capitalized or
moderately capitalized new credit union
to the next lower capital category (each
of such actions is hereinafter referred to
generally as ‘‘reclassification’’) in either
of the circumstances prescribed in
§ 702.102(b).
(e) Consultation with state officials.
The NCUA Board shall consult and seek
to work cooperatively with the
appropriate state official before
E:\FR\FM\29OCR2.SGM
29OCR2
66720
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
reclassifying a federally insured statechartered credit union under paragraph
(d) of this section, and shall promptly
notify the appropriate state official of its
decision to reclassify.
§ 702.203 Prompt corrective action for
adequately capitalized new credit unions.
Beginning on the effective date of
classification, an adequately capitalized
new credit union must increase the
dollar amount of its net worth by the
amount reflected in its approved initial
or revised business plan in accordance
with § 702.204(a)(2), or in the absence of
such a plan, in accordance with
§ 702.106 until it is well capitalized.
mstockstill on DSK4VPTVN1PROD with RULES2
§ 702.204 Prompt corrective action for
moderately capitalized, marginally
capitalized, or minimally capitalized new
credit unions.
(a) Mandatory supervisory actions by
new credit union. Beginning on the date
of classification as moderately
capitalized, marginally capitalized or
minimally capitalized (including by
reclassification under § 702.202(d)), a
new credit union must—
(1) Earnings retention. Increase the
dollar amount of its net worth by the
amount reflected in its approved initial
or revised business plan;
(2) Submit revised business plan.
Submit a revised business plan within
the time provided by § 702.206 if the
credit union either:
(i) Has not increased its net worth
ratio consistent with its then-present
approved business plan;
(ii) Has no then-present approved
business plan; or
(iii) Has failed to comply with
paragraph (a)(3) of this section; and
(3) Restrict member business loans.
Not increase the total dollar amount of
member business loans (defined as
loans outstanding and unused
commitments to lend) as of the
preceding quarter-end unless it is
granted an exception under 12 U.S.C.
1757a(b).
(b) Discretionary supervisory actions
by NCUA. Subject to the applicable
procedures set forth in subpart L of part
747 of this chapter for issuing,
reviewing and enforcing directives, the
NCUA Board may, by directive, take one
or more of the actions prescribed in
§ 702.109(b) if the credit union’s net
worth ratio has not increased consistent
with its then-present business plan, or
the credit union has failed to undertake
any mandatory supervisory action
prescribed in paragraph (a) of this
section.
(c) Discretionary conservatorship or
liquidation. Notwithstanding any other
actions required or permitted to be
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
taken under this section, the NCUA
Board may place a new credit union
which is moderately capitalized,
marginally capitalized or minimally
capitalized (including by
reclassification under § 702.202(d)) into
conservatorship pursuant to 12 U.S.C.
1786(h)(1)(F), or into liquidation
pursuant to 12 U.S.C. 1787(a)(3)(A)(i),
provided that the credit union has no
reasonable prospect of becoming
adequately capitalized.
§ 702.205 Prompt corrective action for
uncapitalized new credit unions.
(a) Mandatory supervisory actions by
new credit union. Beginning on the
effective date of classification as
uncapitalized, a new credit union
must—
(1) Earnings retention. Increase the
dollar amount of its net worth by the
amount reflected in the credit union’s
approved initial or revised business
plan;
(2) Submit revised business plan.
Submit a revised business plan within
the time provided by § 702.206,
providing for alternative means of
funding the credit union’s earnings
deficit, if the credit union either:
(i) Has not increased its net worth
ratio consistent with its then-present
approved business plan;
(ii) Has no then-present approved
business plan; or
(iii) Has failed to comply with
paragraph (a)(3) of this section; and
(3) Restrict member business loans.
Not increase the total dollar amount of
member business loans as provided in
§ 702.204(a)(3).
(b) Discretionary supervisory actions
by NCUA. Subject to the procedures set
forth in subpart L of part 747 of this
chapter for issuing, reviewing and
enforcing directives, the NCUA Board
may, by directive, take one or more of
the actions prescribed in § 702.109(b) if
the credit union’s net worth ratio has
not increased consistent with its thenpresent business plan, or the credit
union has failed to undertake any
mandatory supervisory action
prescribed in paragraph (a) of this
section.
(c) Mandatory liquidation or
conservatorship. Notwithstanding any
other actions required or permitted to be
taken under this section, the NCUA
Board—
(1) Plan not submitted. May place into
liquidation pursuant to 12 U.S.C.
1787(a)(3)(A)(ii), or conservatorship
pursuant to 12 U.S.C. 1786(h)(1)(F), an
uncapitalized new credit union which
fails to submit a revised business plan
within the time provided under
paragraph (a)(2) of this section; or
PO 00000
Frm 00096
Fmt 4701
Sfmt 4700
(2) Plan rejected, approved,
implemented. Except as provided in
paragraph (c)(3) of this section, must
place into liquidation pursuant to 12
U.S.C. 1787(a)(3)(A)(ii), or
conservatorship pursuant to 12 U.S.C.
1786(h)(1)(F), an uncapitalized new
credit union that remains uncapitalized
one hundred twenty (120) calendar days
after the later of:
(i) The effective date of classification
as uncapitalized; or
(ii) The last day of the calendar month
following expiration of the time period
provided in the credit union’s initial
business plan (approved at the time its
charter was granted) to remain
uncapitalized, regardless whether a
revised business plan was rejected,
approved or implemented.
(3) Exception. The NCUA Board may
decline to place a new credit union into
liquidation or conservatorship as
provided in paragraph (c)(2) of this
section if the credit union documents to
the NCUA Board why it is viable and
has a reasonable prospect of becoming
adequately capitalized.
(d) Mandatory liquidation of
uncapitalized federal credit union. In
lieu of paragraph (c) of this section, an
uncapitalized federal credit union may
be placed into liquidation on grounds of
insolvency pursuant to 12 U.S.C.
1787(a)(1)(A).
§ 702.206 Revised business plans (RBP)
for new credit unions.
(a) Schedule for filing—(1) Generally.
Except as provided in paragraph (a)(2)
of this section, a new credit union
classified moderately capitalized or
lower must file a written revised
business plan (RBP) with the
appropriate Regional Director and, if
state-chartered, with the appropriate
state official, within 30 calendar days of
either:
(i) The last of the calendar month
following the end of the calendar
quarter that the credit union’s net worth
ratio has not increased consistent with
the-present approved business plan;
(ii) The effective date of classification
as less than adequately capitalized if the
credit union has no then-present
approved business plan; or
(iii) The effective date of classification
as less than adequately capitalized if the
credit union has increased the total
amount of member business loans in
violation of § 702.204(a)(3).
(2) Exception. The NCUA Board may
notify the credit union in writing that its
RBP is to be filed within a different
period or that it is not necessary to file
an RBP.
(3) Failure to timely file plan. When
a new credit union fails to file an RBP
E:\FR\FM\29OCR2.SGM
29OCR2
mstockstill on DSK4VPTVN1PROD with RULES2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
as provided under paragraphs (a)(1) or
(a)(2) of this section, the NCUA Board
shall promptly notify the credit union
that it has failed to file an RBP and that
it has 15 calendar days from receipt of
that notice within which to do so.
(b) Contents of revised business plan.
A new credit union’s RBP must, at a
minimum—
(1) Address changes, since the new
credit union’s current business plan was
approved, in any of the business plan
elements required for charter approval
under chapter 1, section IV.D. of
appendix B to part 701 of this chapter,
or for state-chartered credit unions
under applicable state law;
(2) Establish a timetable of quarterly
targets for net worth during each year in
which the RBP is in effect so that the
credit union becomes adequately
capitalized by the time it no longer
qualifies as ‘‘new’’ per § 702.201;
(3) Specify the projected amount of
earnings of net worth increases as
provided under § 702.204(a)(1) or
702.205(a)(1);
(4) Explain how the new credit union
will comply with the mandatory and
discretionary supervisory actions
imposed on it by the NCUA Board
under this subpart;
(5) Specify the types and levels of
activities in which the new credit union
will engage;
(6) In the case of a new credit union
reclassified to a lower category under
§ 702.202(d), specify the steps the credit
union will take to correct the unsafe or
unsound condition or practice; and
(7) Include such other information as
the NCUA Board may require.
(c) Criteria for approval. The NCUA
Board shall not approve a new credit
union’s RBP unless it—
(1) Addresses the items enumerated in
paragraph (b) of this section;
(2) Is based on realistic assumptions,
and is likely to succeed in building the
credit union’s net worth; and
(3) Would not unreasonably increase
the credit union’s exposure to risk
(including credit risk, interest-rate risk,
and other types of risk).
(d) Consideration of regulatory
capital. To minimize possible long-term
losses to the NCUSIF while the credit
union takes steps to become adequately
capitalized, the NCUA Board shall, in
evaluating an RBP under this section,
consider the type and amount of any
form of regulatory capital which may
become established by NCUA
regulation, or authorized by state law
and recognized by NCUA, which the
credit union holds, but which is not
included in its net worth.
(e) Review of revised business plan—
(1) Notice of decision. Within 30
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
calendar days after receiving an RBP
under this section, the NCUA Board
shall notify the credit union in writing
whether its RBP is approved, and shall
provide reasons for its decision in the
event of disapproval. The NCUA Board
may extend the time within which
notice of its decision shall be provided.
(2) Delayed decision. If no decision is
made within the time prescribed in
paragraph (e)(1) of this section, the RBP
is deemed approved.
(3) Consultation with state officials.
When evaluating an RBP submitted by
a federally insured state-chartered new
credit union (whether an original, new
or additional RBP), the NCUA Board
shall seek and consider the views of the
appropriate state official, and provide
prompt notice of its decision to the
appropriate state official.
(f) Plan not approved—(1) Submission
of new revised plan. If an RBP is
rejected by the NCUA Board, the new
credit union shall submit a new RBP
within 30 calendar days of receiving
notice of disapproval of its initial RBP,
unless it is notified in writing by the
NCUA Board that the new RBP is to be
filed within a different period.
(2) Notice of decision on revised plan.
Within 30 calendar days after receiving
an RBP under paragraph (f)(1) of this
section, the NCUA Board shall notify
the credit union in writing whether the
new RBP is approved. The Board may
extend the time within which notice of
its decision shall be provided.
(3) Submission of multiple
unapproved RBPs. The submission of
more than two RBPs that are not
approved is considered an unsafe and
unsound condition and may subject the
credit union to administrative
enforcement action pursuant to section
206 of the FCUA, 12 U.S.C. 1786 and
1790d.
(g) Amendment of plan. A credit
union that has filed an approved RBP
may, after prior written notice to and
approval by the NCUA Board, amend it
to reflect a change in circumstance.
Pending approval of an amended RBP,
the new credit union shall implement
its existing RBP as originally approved.
(h) Publication. An RBP need not be
published to be enforceable because
publication would be contrary to the
public interest.
§ 702.207
Incentives for new credit unions.
(a) Assistance in revising business
plans. Upon timely request by a credit
union having total assets of less than
$10 million (regardless how long it has
been in operation), the NCUA Board
shall provide assistance in preparing a
revised business plan required to be
filed under § 702.206.
PO 00000
Frm 00097
Fmt 4701
Sfmt 4700
66721
(b) Assistance. Management training
and other assistance to new credit
unions will be provided in accordance
with policies approved by the NCUA
Board.
(c) Small credit union program. A
new credit union is eligible to join and
receive comprehensive benefits and
assistance under NCUA’s Small Credit
Union Program.
§ 702.208
Reserves.
Each new credit union shall establish
and maintain such reserves as may be
required by the FCUA, by state law, by
regulation, or in special cases by the
NCUA Board or appropriate state
official.
§ 702.209 Full and fair disclosure of
financial condition.
(a) Full and fair disclosure defined.
‘‘Full and fair disclosure’’ is the level of
disclosure which a prudent person
would provide to a member of a new
credit union, to NCUA, or, at the
discretion of the board of directors, to
creditors to fairly inform them of the
financial condition and the results of
operations of the credit union.
(b) Full and fair disclosure
implemented. The financial statements
of a new credit union shall provide for
full and fair disclosure of all assets,
liabilities, and members’ equity,
including such valuation (allowance)
accounts as may be necessary to present
fairly the financial condition; and all
income and expenses necessary to
present fairly the statement of income
for the reporting period.
(c) Declaration of officials. The
Statement of Financial Condition, when
presented to members, to creditors or to
NCUA, shall contain a dual declaration
by the treasurer and the chief executive
officer, or in the latter’s absence, by any
other officer designated by the board of
directors of the reporting credit union to
make such declaration, that the report
and related financial statements are true
and correct to the best of their
knowledge and belief and present fairly
the financial condition and the
statement of income for the period
covered.
(d) Charges for loan and lease losses.
Full and fair disclosure demands that a
new credit union properly address
charges for loan losses as follows:
(1) Charges for loan and lease losses
shall be made timely in accordance with
generally accepted accounting
principles (GAAP);
(2) The ALLL must be maintained in
accordance with GAAP; and
(3) At a minimum, adjustments to the
ALLL shall be made prior to the
distribution or posting of any dividend
to the accounts of members.
E:\FR\FM\29OCR2.SGM
29OCR2
66722
§ 702.210
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
Payment of dividends.
(a) Restriction on dividends.
Dividends shall be available only from
net worth, net of any special reserves
established under § 702.208, if any.
(b) Payment of dividends and interest
refunds. The board of directors may not
pay a dividend or interest refund that
will cause the credit union’s capital
classification to fall below adequately
capitalized under subpart A of this part
unless the appropriate regional director
and, if state-chartered, the appropriate
state official, have given prior written
approval (in an RBP or otherwise). The
request for written approval must
include the plan for eliminating any
negative retained earnings balance.
Subparts C and D—[Removed]
■
9. Remove subparts C and D.
Subpart E—[Redesignated as Subpart
C]
10. Redesignate subpart E, consisting
of §§ 702.501–702.506, as subpart C,
consisting of §§ 702.301–702.306.
■
§ 702.504
[Amended]
11. Amend newly redesignated
§ 702.504(b)(4) by removing the citation
‘‘§ 702.506(c)’’ and adding in its place
‘‘§ 702.306(c)’’.
■
§ 702.505
[Amended]
12. Amend newly redesignated
§ 702.505(b)(4) by removing the citation
‘‘§ 702.504’’ and adding in its place
‘‘§ 702.304’’.
■ 13. Appendix A to part 702 is added
to read as follows:
■
mstockstill on DSK4VPTVN1PROD with RULES2
Appendix A to Part 702—Gross-Up
Approach, and Look-Through
Approaches
Instead of using the risk weights assigned
in § 702.104(c)(2) a credit union may
determine the risk weight of certain
investment funds, and the risk weight of a
non-subordinated or subordinated tranche of
any investment as follows:
(a) Gross-up approach—(1) Applicability.
Section 702.104(c)(3)(iii)(A) of this part
provides that, a credit union may use the
gross-up approach in this appendix to
determine the risk weight of the carrying
value of non-subordinated or subordinated
tranches of any investment.
(2) Calculation. To use the gross-up
approach, a credit union must calculate the
following four inputs:
(i) Pro rata share, which is the par value
of the credit union’s exposure as a percent of
the par value of the tranche in which the
securitization exposure resides;
(ii) Enhanced amount, which is the par
value of tranches that are more senior to the
tranche in which the credit union’s
securitization resides;
VerDate Sep<11>2014
22:13 Oct 28, 2015
Jkt 238001
(iii) Exposure amount, which is the
amortized cost for investments classified as
held-to-maturity and available-for-sale, and
the fair value for trading securities; and
(iv) Risk weight, which is the weightedaverage risk weight of underlying exposures
of the securitization as calculated under this
appendix.
(3) Credit equivalent amount. The ‘‘credit
equivalent amount’’ of a securitization
exposure under this part equals the sum of:
(i) The exposure amount of the credit
union’s exposure; and
(ii) The pro rata share multiplied by the
enhanced amount, each calculated in
accordance with paragraph (a)(2) of this
appendix.
(4) Risk-weighted assets. To calculate riskweighted assets for a securitization exposure
under the gross-up approach, a credit union
must apply the risk weight required under
paragraph (a)(2) of this appendix to the credit
equivalent amount calculated in paragraph
(a)(3) of this appendix.
(5) Securitization exposure defined. For
purposes of this this paragraph (a),
‘‘securitization exposure’’ means:
(i) A credit exposure that arises from a
securitization; or
(ii) An exposure that directly or indirectly
references a securitization exposure
described in paragraph (a)(5)(i) of this
appendix.
(6) Securitization defined. For purposes of
this paragraph (a), ‘‘securitization’’ means a
transaction in which:
(i) The credit risk associated with the
underlying exposures has been separated into
at least two tranches reflecting different
levels of seniority;
(ii) Performance of the securitization
exposures depends upon the performance of
the underlying exposures; and
(iii) All or substantially all of the
underlying exposures are financial exposures
(such as loans, receivables, asset-backed
securities, mortgage-backed securities, or
other debt securities).
(b) Look-through approaches.—(1)
Applicability. Section 702.104(c)(3)(iii)(B)
provides that, a credit union may use one of
the look-through approaches in this appendix
to determine the risk weight of the exposure
amount of any investment fund, or the
holding of separate account insurance.
(2) Full look-through approach. (i) General.
A credit union that is able to calculate a riskweighted asset amount for its proportional
ownership share of each exposure held by
the investment fund may set the riskweighted asset amount of the credit union’s
exposure to the fund equal to the product of:
(A) The aggregate risk-weighted asset
amounts of the exposures held by the fund
as if they were held directly by the credit
union; and
(B) The credit union’s proportional
ownership share of the fund.
(ii) Holding report. To calculate the riskweighted amount under paragraph (b)(2)(i) of
this appendix, a credit union should:
(A) Use the most recently issued
investment fund holding report; and
(B) Use an investment fund holding report
that reflects holding that are not older than
6-months from the quarter-end effective date
(as defined in § 702.101(c)(1).
PO 00000
Frm 00098
Fmt 4701
Sfmt 4700
(3) Simple modified look-through
approach. Under the simple modified lookthrough approach, the risk-weighted asset
amount for a credit union’s exposure to an
investment fund equals the exposure amount
multiplied by the highest risk weight that
applies to any exposure the fund is permitted
to hold under the prospectus, partnership
agreement, or similar agreement that defines
the fund’s permissible investments
(excluding derivative contracts that are used
for hedging rather than speculative purposes
and that do not constitute a material portion
of the fund’s exposures).
(4) Alternative modified look-through
approach. Under the alternative modified
look-through approach, a credit union may
assign the credit union’s exposure amount to
an investment fund on a pro rata basis to
different risk weight categories under subpart
A of this part based on the investment limits
in the fund’s prospectus, partnership
agreement, or similar contract that defines
the fund’s permissible investments. The riskweighted asset amount for the credit union’s
exposure to the investment fund equals the
sum of each portion of the exposure amount
assigned to an exposure type multiplied by
the applicable risk weight under subpart A of
this part. If the sum of the investment limits
for all exposure types within the fund
exceeds 100 percent, the credit union must
assume that the fund invests to the maximum
extent permitted under its investment limits
in the exposure type with the highest
applicable risk weight under subpart A of
this part and continues to make investments
in order of the exposure type with the next
highest applicable risk weight under subpart
A of this part until the maximum total
investment level is reached. If more than one
exposure type applies to an exposure, the
credit union must use the highest applicable
risk weight. A credit union may exclude
derivative contracts held by the fund that are
used for hedging rather than for speculative
purposes and do not constitute a material
portion of the fund’s exposures.
PART 703—INVESTMENT AND
DEPOSIT ACTIVITIES
14. The authority citation for part 703
continues to read as follows:
■
Authority: 12 U.S.C. 1757(7), 1757(8),
1757(15).
§ 703.14
[Amended]
15. Amend § 703.14 as follows:
a. In paragraph (i) remove the words
‘‘net worth classification’’ and add in
their place the words ‘‘capital
classification’’, and remove the words
‘‘or, if subject to a risk-based net worth
(RBNW) requirement under part 702 of
this chapter, has remained ‘well
capitalized’ for the six (6) immediately
preceding quarters after applying the
applicable RBNW requirement,’’.
■ b. In paragraph (j)(4) remove the
words ‘‘net worth classification’’ and
add in their place the words ‘‘capital
classification’’, and remove the words
‘‘or, if subject to a risk-based net worth
■
■
E:\FR\FM\29OCR2.SGM
29OCR2
Federal Register / Vol. 80, No. 209 / Thursday, October 29, 2015 / Rules and Regulations
(RBNW) requirement under part 702 of
this chapter, has remained ‘well
capitalized’ for the six (6) immediately
preceding quarters after applying the
applicable RBNW requirement,’’.
PART 713—FIDELITY BOND AND
INSURANCE COVERAGE FOR
FEDERAL CREDIT UNIONS
16. The authority citation for part 713
continues to read as follows:
■
Authority: 12 U.S.C. 1761a, 1761b, 1766(a),
1766(h), 1789(a)(11).
17. Amend § 713.6 as follows:
a. In paragraph (a)(1), revise the table;
and
■ b. In paragraph (c) remove the words
‘‘net worth’’ each place they appear and
add in their place the word ‘‘capital’’,
and remove the words ‘‘or, if subject to
a risk-based net worth (RBNW)
requirement under part 702 of this
■
■
66723
chapter, has remained ‘well capitalized’
for the six (6) immediately preceding
quarters after applying the applicable
RBNW requirement,’’.
§ 713.6 What is the permissible
deductible?
(a)(1) * * *
Assets
Maximum deductible
$0 to $100,000 ...................
$100,001 to $250,000 ........
$250,000 to $1,000,000 .....
Over $1,000,000 .................
No deductible allowed.
$1,000.
$2,000.
$2,000 plus 1/1000 of total assets up to a maximum of $200,000; for credit unions that have received a composite
CAMEL rating of ‘‘1’’ or ‘‘2’’ for the last two (2) full examinations and maintained a capital classification of ‘‘well
capitalized’’ under part 702 of this chapter for the six (6) immediately preceding quarters the maximum deductible is $1,000,000.
*
*
*
*
§ 723.7
*
PART 723—MEMBER BUSINESS
LOANS
18. The authority citation for part 723
continues to read as follows:
■
Authority: 12 U.S.C. 1756, 1757, 1757A,
1766, 1785, 1789.
§ 723.1
[Amended]
mstockstill on DSK4VPTVN1PROD with RULES2
22:13 Oct 28, 2015
§ 747.2002
PART 747—ADMINSTRATIVE
ACTIONS, ADJUDICATIVE HEARINGS,
RULES OF PRACTICE AND
PROCEDURE, AND INVESTIGATIONS
21. The authority citation for part 747
continues to read as follows:
■
19. Amend § 723.1 as follows:
■ a. In paragraph (d) remove the words
‘‘and the risk weighting standards of
part 702 of this chapter’’; and
■ b. In paragraph (e) remove the words
‘‘and the risk weighting standards under
part 702 of this chapter’’.
■
VerDate Sep<11>2014
[Amended]
20. Amend § 723.7(c)(1) by removing
the words ‘‘as defined by
§ 702.102(a)(1)’’ and adding in their
place the words ‘‘under part 702’’.
■
Jkt 238001
Authority: 12 U.S.C. 1766, 1782, 1784,
1785, 1786, 1787, 1790a, 1790d; 42 U.S.C.
4012a; Pub. L. 101–410; Pub. L. 104–134;
Pub. L. 109–351; 120 Stat. 1966.
§ 747.2001
[Amended]
23. Amend § 747.2002(a) by removing
the words ‘‘§§ 702.202(b), 702.203(b)
and 702.204(b)’’ and adding in their
place the words ‘‘§§ 702.107 (b),
702.108(b) or 702.109(b)’’, and by
removing the words ‘‘§ 702.304(b) or
§ 702.305(b)’’ and adding in their place
the words ‘‘§ 702.204(b) or
§ 702.205(b)’’.
■
§ 747.2003
[Amended]
24. Amend § 747.2003(a) by removing
the citation ‘‘702.302(d)’’ and adding in
its place the citation ‘‘702.202(d)’’.
■
[FR Doc. 2015–26790 Filed 10–28–15; 8:45 am]
[Amended]
BILLING CODE 7535–01–P
22. Amend § 747.2001(a) by removing
the citation ‘‘702.302(d)’’ and adding in
its place the citation ‘‘702.202(d)’’.
■
PO 00000
Frm 00099
Fmt 4701
Sfmt 9990
E:\FR\FM\29OCR2.SGM
29OCR2
]]>Agencies
[Federal Register Volume 80, Number 209 (Thursday, October 29, 2015)]
[Rules and Regulations]
[Pages 66625-66723]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-26790]
[[Page 66625]]
Vol. 80
Thursday,
No. 209
October 29, 2015
Part II
National Credit Union Administration
-----------------------------------------------------------------------
12 CFR Parts 700, 701, 702, 703, et al.
Risk-Based Capital; Final Rule
Federal Register / Vol. 80 , No. 209 / Thursday, October 29, 2015 /
Rules and Regulations
[[Page 66626]]
-----------------------------------------------------------------------
NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Parts 700, 701, 702, 703, 713, 723, and 747
RIN 3133-AD77
Risk-Based Capital
AGENCY: National Credit Union Administration (NCUA).
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The NCUA Board (Board) is amending NCUA's current regulations
regarding prompt corrective action (PCA) to require that credit unions
taking certain risks hold capital commensurate with those risks. The
risk-based capital provisions of this final rule apply only to
federally insured, natural-person credit unions with assets over $100
million.
The overarching intent is to reduce the likelihood of a relatively
small number of high-risk outliers exhausting their capital and causing
systemic losses--which, by law, all federally insured credit unions
would have to pay through the National Credit Union Share Insurance
Fund (NCUSIF).
This final rule restructures NCUA's PCA regulations and makes
various revisions, including amending the agency's current risk-based
net worth requirement by replacing it with a new risk-based capital
ratio for federally insured, natural-person credit unions (credit
unions).
The risk-based capital requirement set forth in this final rule is
more consistent with NCUA's risk-based capital measure for corporate
credit unions and, as the law requires, more comparable to the
regulatory risk-based capital measures used by the Federal Deposit
Insurance Corporation (FDIC), Board of Governors of the Federal Reserve
System, and Office of the Comptroller of Currency (Other Banking
Agencies). The effective date is intended to coincide with the full
phase-in of FDIC's risk-based capital measures in 2019.
The final rule also eliminates several provisions in NCUA's current
PCA regulations, including provisions relating to the regular reserve
account, risk-mitigation credits, and alternative risk weights.
DATES: This final rule is effective on January 1, 2019.
FOR FURTHER INFORMATION CONTACT: Policy and Accounting: Larry Fazio,
Director, Office of Examination and Insurance, at (703) 518-6360;
JeanMarie Komyathy, Director, Division of Risk Management, Office of
Examination and Insurance, at (703) 518-6360; John Shook, Loss/Risk
Analyst, Division of Risk Management, Office of Examination and
Insurance, at (703) 518-3799; Steven Farrar, Supervisory Financial
Analyst, Division of Capital and Credit Markets, Office of Examination
and Insurance, at (703) 518-6393; Tom Fay, Senior Capital Markets
Specialist, Division of Capital and Credit Markets, Office of
Examination and Insurance, at (703) 518-1179; Rick Mayfield, Senior
Capital Markets Specialist, Division of Capital and Credit Markets,
Office of Examination and Insurance, at (703) 518-6501; Aaron Langley,
Risk Management Officer, Division of Analytics and Surveillance; Office
of Examination and Insurance, at (703) 518-6360; or Legal: John H.
Brolin or Justin Anderson, Senior Staff Attorneys, Office of General
Counsel, at (703) 518-6540; or by mail at National Credit Union
Administration, 1775 Duke Street, Alexandria, VA 22314.
SUPPLEMENTARY INFORMATION:
I. Background
II. Summary of the Final Rule
III. Legal Authority
IV. Section-by-Section Analysis
V. Effective Date
VI. Impact of This Final Rule
VII. Regulatory Procedures
I. Background
NCUA's primary mission is to ensure the safety and soundness of
federally insured credit unions. NCUA performs this function by
examining and supervising federally chartered credit unions,
participating in the examination and supervision of federally insured,
state-chartered credit unions in coordination with state regulators,
and insuring members' accounts at all federally insured credit
unions.\1\ In its role as the administrator of the NCUSIF, NCUA insures
and regulates approximately 6,270 federally insured credit unions,
holding total assets exceeding $1.1 trillion and representing
approximately 99 million members.
---------------------------------------------------------------------------
\1\ Within the nine states that allow privately insured credit
unions, approximately 129 state-chartered credit unions are
privately insured and are not subject to NCUA regulation or
oversight.
---------------------------------------------------------------------------
At its January 2014 meeting, the Board issued a proposed rule (the
Original Proposal) \2\ to amend NCUA's PCA regulations, part 702. The
proposed amendments were intended to implement the statutory
requirements of the Federal Credit Union Act (FCUA) and follow
recommendations made by the Government Accountability Office (GAO) and
NCUA's Inspector General. The proposal was also intended to amend
NCUA's risk-based capital regulations to be more consistent with NCUA's
risk-based capital measure for corporate credit unions and comparable
to the new regulatory risk-based capital regulations finalized by the
Other Banking Agencies in 2013.\3\ In response to the Original
Proposal, the Board received over 2,000 comments with many suggestions
on how to improve the proposed regulation. The comments received
addressed a wide range of issues. In general, however, the commenters
nearly all agreed that, because the proposal assigned higher risk
weights to some credit union asset classes, it would have placed credit
unions at a competitive disadvantage to banks. The change most
frequently recommended by commenters to address this concern was to
adopt the same risk weights as the Other Banking Agencies. The Board
generally agreed and, after reviewing all of the comments received,
determined that it was appropriate to issue a second proposed rule.
---------------------------------------------------------------------------
\2\ 79 FR 11183 (Feb. 27, 2014).
\3\ The Office of the Comptroller of Currency, and the Board of
Governors of the Federal Reserve System: 78 FR 62017 (Oct. 11,
2013); and the Federal Deposit Insurance Corporation: 78 FR 55339
(Sept. 10, 2013).
---------------------------------------------------------------------------
So, at its January 2015 meeting, the Board issued a second proposed
rule (the Second Proposal) \4\ to amend NCUA's PCA regulations, part
702. The Second Proposal, which was based largely on the comments NCUA
received on the Original Proposal, addressed the competitive
disadvantage concerns raised by commenters and made the proposal more
comparable to the Other Banking Agencies' risk-based capital
requirements. Particular changes from the Original Proposal included:
(1) Amending the definition of ``complex'' credit union, resulting in
an increase in the asset threshold from $50 million to $100 million;
(2) reducing the number of asset concentration thresholds for
residential real estate loans and commercial loans (formerly classified
as member business loans); (3) assigning the same risk weights to one-
to-four family non-owner-occupied residential real estate loans and
other types of residential real estate loans; (4) eliminating
provisions intended to address interest rate risk (IRR); (5)
eliminating the proposed individual minimum capital requirement; and
(6) extending the effective date to January 1, 2019. These changes
would have, among other things, substantially reduced the number of
credit unions subject to the rule, and would have provided credit
unions significantly
[[Page 66627]]
more time to prepare to implement the rule's requirements.
---------------------------------------------------------------------------
\4\ 80 FR 4339 (Jan. 27, 2015).
---------------------------------------------------------------------------
Summary of Public Comments on the Second Proposal
In response to the Second Proposal, the Board received over 2,100
comments. While the total number of comment letters received was higher
than the number received in response to the Original Proposal, the
comment letters responding to the Second Proposal were significantly
shorter and raised fewer distinct concerns regarding the rule's
provisions. In addition, significantly fewer credit unions sent in
comment letters in response to the Second Proposal. In response to the
Original Proposal, NCUA received comment letters from more than 1,100
different credit unions, while only 514 different credit unions sent in
comment letters in response to the Second Proposal. In addition, more
than 900 of the comment letters received in response to the Second
Proposal provided no substantive input on the rule. Nearly all of these
non-substantive letters simply stated that the commenter believed
Congress should ``approve'' the rule, or that the commenter wanted to
``vote no'' on the rule.
A majority of significant comment letters received stated that the
commenter opposed the proposal in its entirety and suggested that the
Second Proposal be withdrawn. Most of these commenters stated they
opposed the rule for one or more of the following reasons: A
substantial number of commenters suggested that the strong performance
of credit unions and the NCUSIF during and after the 2007-2009
financial crisis demonstrated there was no need for the proposal, and
that the Board provided no evidence that the proposal would have
reduced material losses to the NCUSIF if it had been in place before
the financial crisis. Other commenters maintained that the proposal was
unnecessary given how extremely well capitalized the industry is today.
Commenters contended further that, given NCUA's own estimates that
fewer than 30 credit unions would be less than well capitalized under
the proposed risk-based capital ratio if it went into effect
immediately, NCUA's current risk-based capital regulations and other
supervisory tools seem to be doing an adequate job. Several commenters
claimed that most credit union failures, including the corporate credit
unions (Corporates), and significant losses to the NCUSIF were the
result of high concentration levels in risky loans and investments, or
were otherwise related to a lack of internal controls that should have
been identified through the examination process. Commenters suggested
that, instead of updating NCUA's risk-based capital regulations, the
Board should focus on enhanced training to improve examiner skills. A
substantial number of commenters also claimed that the proposal would
regulate credit unions in the same general manner as banks. They argued
credit unions should be regulated differently than banks because they
are structured and operate differently. Other commenters argued the
proposed rule would place credit unions at a competitive disadvantage
to banks, because in these commenters' opinion, the proposed rule would
require credit unions to hold incrementally more capital than banks
given similar levels of asset concentration. At least one commenter
suggested that the proposal would drive the largest credit unions to
convert to bank charters. Other commenters argued that risk-based
capital requirements, to which banks have been subject for
approximately 25 years, have not worked well. In addition, they argued
that bank regulators are now moving away from risk-based capital
structures after they failed to help banks during the 2007-2009
recession. In support of this argument, many commenters cited a
statement in which one FDIC Board Member, the FDIC's Vice Chairman,
stated publicly that he believed the risk-based capital approach to
regulation was a bad idea. A substantial number of commenters expressed
concern that the proposal would stifle growth, innovation,
diversification, and member services within credit unions by
restricting credit unions' use of capital, and would impose excessive
costs on credit unions and their members. At least one commenter
suggested that the proposal would likely cause more risk, not less
risk, to the system as a whole because the lower risk weightings
assigned in some asset classes compared to others would force credit
unions to take on excessive concentrations of lower risk-weighted
assets. This, the commenter argued, would increase concentration risk
compared to a diverse balance sheet.
Other commenters expressed concern that the proposal would be
detrimental to the interests of many credit union members because
credit unions would have to charge their members higher interest rates
and fees and pay lower interest on deposits to raise the additional
capital required under the proposal. A significant number of commenters
maintained that the benefits of the proposal did not outweigh its costs
to the credit union industry.
A significant number of commenters opposing the rule also argued
that the Board failed to adequately justify the proposed changes to
NCUA's current risk-based net worth requirement. At least one commenter
suggested that the Board should not base its justification for the
risk-based capital regulation on global financial trends. Other
commenters claimed that the historical loss data and other information
provided by NCUA in the proposed rule did not support establishing a
higher capital standard for credit unions than banks. Some commenters
disagreed with the Board's statutory justification for NCUA to maintain
comparability with the capital rules of FDIC, and argued that the Board
overemphasized the need for the regulation to be comparable to the
other banking agency regulations. Commenters acknowledged that
comparability is commendable where there are truly comparable
institutions. Commenters suggested, however, that the fundamental
structure of credit unions as not-for profit financial cooperatives is
not comparable with the for-profit banking system. Commenters suggested
further that member-owned credit unions generally have a different risk
model than the profit-oriented banks, so if anything credit unions
should have lower risk-based capital requirements than banks. Those
commenters argued that the narrative accompanying the Second Proposal
did not indicate sufficient research and analysis into the differences
between banks and credit unions had been done or, if it had, that it
was not presented in a transparent manner that adequately justified the
structure of the proposal.
A substantial number of commenters pointed out that, of the 1,400
credit unions with more than $100 million in assets, only 27 would have
a risk-based capital ratio below the 10 percent level proposed for a
credit union to be well capitalized. Commenters contended that, based
on these numbers, the current rule and other supervisory tools already
at NCUA's disposal were already doing an adequate job. Other commenters
argued that only 112 credit unions failed during the 2007-2009
recession, costing the insurance fund less than $1 billion, which they
suggested was remarkable considering the dollars and number of
commercial banks that failed. Of the natural-person credit unions that
did fail during the crisis, the commenters acknowledged that most were
under the $100 million asset size threshold proposed. Commenters
contended that, from 1998
[[Page 66628]]
to 2012, the NCUSIF fund losses were only $989 million; $513 million
came from 7 credit unions in the $200 million to $500 million asset
range, and $343 million came from credit unions under $100 million that
would not have been covered under the Second Proposal. At least one
commenter claimed that its analysis of the 26 credit unions with more
than $80 million in assets just before the crisis (as of December 2007)
that subsequently failed revealed that only seven would have had a
lower capital classification under Second Proposal. The commenter
suggested that six of the 21 well-capitalized credit unions under
current rules would have been downgraded--four to adequately
capitalized and two to undercapitalized--and that one adequately
capitalized credit union under the current rules would have been
classified as undercapitalized under the proposal. In other words, the
commenter maintained, of the 26 failures, a total of three credit
unions would have been demoted to undercapitalized if the Second
Proposal had been in effect before the crisis. And the amount of
capital they would have been required to obtain to become adequately
capitalized was only $7 million, as compared to the insurance loss of
over $700 million. The commenter claimed that the amount of capital
that would have been necessary for all seven downgraded credit unions
to regain their previous capital classifications (six to well-
capitalized, one to adequately-capitalized) would have totaled $43
million.
While most commenters did oppose finalizing the proposal, a
substantial number of the commenters who opposed the rule acknowledged
that the Board, in response to comments received on the Original
Proposal, had made significant improvements to Second Proposal.
Specific improvements mentioned included: The removal of the IRR
provisions; the new zero percent risk weight assigned to cash held at
the Federal Reserve; the reduction of the concentration thresholds from
three to two tiers for residential mortgages, junior liens, and
commercial loans; the removal of the 1.25 percent cap on allowance for
loan and lease losses (ALLL); the lower 10 percent risk-based capital
ratio threshold level required for credit unions to be classified as
well capitalized; the removal of the enumerated processes to require
that individual credit unions hold higher levels of capital under
certain circumstances; the increase in the asset size threshold for
defining credit unions as ``complex''; the extended implementation
period; the lower risk-weights assigned to many categories of assets;
and the designation of one-to-four family non-owner occupied mortgage
loans as residential loans.
A small number of commenters stated that they supported the Second
Proposal. These commenters generally agreed that the credit union
system should have risk-based capital requirements that protect the
Share Insurance Fund and other well run credit unions by requiring that
credit unions with more complex balance sheets hold modestly more
capital. Several commenters supported the proposal because they felt
that the Board had listened to commenters following the Original
Proposal and had made substantial improvements to the Second Proposal.
Several commenters supported the proposal for various other reasons:
One financial services consulting firm suggested that, overall, the
proposal presented a fair alternative to the risk-based capital
requirements applicable to banks. At least one state supervisory
authority suggested that, on the whole, the proposal was sound and
substantially better than NCUA's current risk-based capital rule. One
credit union commenter stated that it supported the proposal because
insured credit unions, which together hold assets of $1.1 trillion, are
backed by the full faith and credit of the United States. And if
insured credit unions engaging in high-risk lending fail in significant
enough numbers, then the taxpayer is left holding the bill. One
individual stated that he supported the proposal because, in his
opinion, it would lower the number of loans credit unions could make by
imposing higher risk weights on loans made to higher-risk persons.
Another individual supported the proposal because he believed it would
lower rates for consumers who utilize credit unions. Yet another
individual suggested that he supported the proposal because credit
unions should be given the same scrutiny as other major lenders and not
be given a free pass because they have good intentions as non-profits.
The commenter suggested further that credit unions should be subject to
tough and robust regulations such as the proposed risk-based capital
rule.
In addition to the comments on the Second Proposal discussed above,
NCUA received the following general comments: At least one commenter
agreed that NCUA's current risk-based net worth regulation is outdated
and does not accurately reflect the level of risk in individual credit
unions, but criticized that the statutory net worth ratio level is
fixed at 7 percent. The commenter suggested that if the 7 percent net
worth ratio level is inadequate, the Board should convince Congress to
arrive at an appropriate net worth level rather than address risks
through revisions to NCUA's risk-based capital regulations. Another
commenter recommended that a risk-based capital requirement be
developed to replace the statutory net worth ratio, instead of imposing
a risk-based capital requirement in addition to the statutory net worth
ratio requirement. The commenter argued that managing two different
capital limits would place an unnecessary burden on credit unions and
serve as an additional competitive disadvantage to the credit union
charter. A significant number of commenters suggested that the proposed
rule went too far in treating credit unions like banks, and that if
credit unions are regulated and supervised as banks they will be forced
to act more like banks, which would be to the detriment of their
members. At least one state supervisory authority agreed with using a
Basel III style capital model, but remained concerned that notable
differences continued to exist between NCUA's proposed model and the
one employed by FDIC and other federal bank regulators. In particular,
the commenter suggested that the differences between the risk
weightings for a number of the proposed asset categories represented a
missed opportunity to reduce public confusion, and might actually
increase confusion. The commenter explained that public users of
government-provided Call Report data could assume that NCUA's risk-
based capital ratio is the same as other institutions' measurements of
capital using the same terminology, but, under the Second Proposal, the
ratios could be materially different for banks and credit unions. A
bank trade association recommended the Board adopt the same Basel III
model adopted by the Other Banking Agencies because without comparable
capital requirements, credit unions will be undercapitalized relative
to community banks, and such undercapitalization, along with credit
unions' limited access to alternative forms of capital when needed,
could increase the bailout risk faced by the American taxpayer. The
commenter suggested that because credit unions are not required to pay
federal income taxes on earnings and can retain a larger percentage of
their earnings than community banks, they should have little or no
difficulty in maintaining very high levels of Tier 1 capital. The
commenter also suggested
[[Page 66629]]
that the Board impose a capital surcharge of 5 percent on credit unions
when they exceed total consolidated assets of $10 billion because large
credit unions, with their limited ability to react to depleted capital
levels in times of economic uncertainty, should be subjected to
increased scrutiny and additional capital reserves. Other commenters
suggested that, before issuing a proposed rule, NCUA test regulatory
approaches of the type included in the Second Proposal through the
examination process and share the results with the industry. Some
commenters suggested that the rule does not take into account that the
vast majority of credit unions already have written policies to deal
with balance sheet risk. At least one commenter suggested that the rule
would not protect credit unions or NCUA in the event of another crisis
that requires natural-person credit unions to pay out huge assessments.
A few commenters recommended that the proposed risk-based capital ratio
measure should be used as a modeling tool rather than a rigid rule,
similar to interest rate risk monitoring tools. The commenters
suggested that this would allow credit union risk to be calculated as a
model by examiners using risk weights appropriate for each credit
union's environment, and discuss with boards and management their views
of risk for various asset classes. A model, the commenters suggested,
would be far more flexible than a rule, and would allow for the
pragmatic management of risk rather than through rule-based estimates
of risk, which may or may not be accurate. Finally, one credit union
supported making the risk-based capital framework as complicated as it
needs to be to more accurately reflect the unique needs and structure
of the credit union industry. The commenter suggested that the Board,
for example, took a step in that direction in the Second Proposal when
it created a risk-weight category for ``commercial loans'' as distinct
from traditional member business loans for purposes of the risk-based
capital ratio measure.
Discussion
Commenters calling for a withdrawal of the proposed rule altogether
are ignoring NCUA's general statutory requirement to maintain a risk-
based system comparable to the Other Banking Agencies' requirements.\5\
In 2013, the Other Banking Agencies issued final rules updating the
risk-based capital regulations for insured banks.\6\ The changes to the
Other Banking Agencies' risk-based capital regulations, the lessons
learned from the 2007-2009 recession, and the fact that NCUA's current
risk-based net worth requirement is ineffective and has not been
materially updated since 2002, prompted the Board to propose revisions
to NCUA's current risk-based net worth ratio requirement and other
aspects of NCUA's current PCA regulations. The proposed changes were
also prompted by specific recommendations to NCUA made by GAO in its
January 2012 review of NCUA's system of PCA. In particular, GAO
recommended that NCUA design a more forward-looking system to detect
problems earlier.\7\
---------------------------------------------------------------------------
\5\ See 12 U.S.C. 1790d(b)(1)(A)(ii), which requires that the
NCUA's system of PCA be ``comparable'' to the PCA requirements in
section 1831o of the Federal Deposit Insurance Act.
\6\ 78 FR 55339 (Sept. 10, 2013) (FDIC published an interim
final rule regarding regulatory capital for their regulated
institutions separately from the Other Banking Agencies.) and 78 FR
62017 (Oct. 11, 2013) (The Office of the Comptroller of the Currency
and the Board of Governors of the Federal Reserve System later
published a regulatory capital final rule for their regulated
institutions, which is consistent with the requirements in FDIC's
IFR.).
\7\ See U.S. Govt. Accountability Office, GAO-12-247, Earlier
Actions Are Needed to Better Address Troubled Credit Unions (Jan.
2012), available at https://www.gao.gov/products/GAO-12-247.
---------------------------------------------------------------------------
The Second Proposal addressed the important role and benefits of
capital. The proposal discussed the impact of a financial crisis and
the benefit a higher level of capital provided to insulate certain
financial institutions from the effects of unexpected adverse
developments in assets and liabilities. Higher levels of capital can
reduce the probability of a systemic crisis, allow credit unions to
continue to serve as credit providers during times of stress without
government intervention, and produce benefits that outweigh the
associated costs. The proposal also emphasized that credit unions'
senior management and boards are accountable for ensuring that
appropriate capital levels are in place based on the credit union's
risk exposure.
Capital is the buffer that depository institutions, including
credit unions, use to prevent institutional failure or dramatic
deleveraging during times of strees. As evidenced by the 2007-2009
recession, during a financial crisis a buffer can mean the difference
between the survival or failure of a financial insitution. Financial
crises are very costly, both to the economy in general and to
individual depository institutions.\8\ While the onset of a financial
crisis is inherently unpredictable, a review of the historical record
over a range of countries and recent time periods has suggested that a
significant crisis involving depository institutions occurs about once
every 20 to 25 years, and has a typical cumulative discounted cost in
terms of lost aggregate output relative to the precrisis trend of about
60 percent of precrisis annual output.\9\ In other words, the typical
crisis results in losses over time, relative to the precrisis trend
economic growth, that amount to more than half of the economy's output
before the onset of the crisis.
---------------------------------------------------------------------------
\8\ Credit unions play a sizable role in the U.S. depository
system. Assets in the credit union system amount to more than $1.1
trillion, roughly 8 percent of U.S. chartered depository institution
assets (source: NCUA Calculation using the financial accounts of the
United States, Federal Reserve Statistical Release Z.1, Table L.110,
September 18, 2014). Data from the Federal Reserve indicate that
credit unions account for about 12 percent of private consumer
installment lending. (Source: NCUA calculations using data from the
Federal Reserve Statistical Release G.19, Consumer Credit, September
2014. Total consumer credit outstanding (not mortgages) was $3,246.8
billion of which $826.2 billion was held by the federal government
and $293.1 billion was held by credit unions. The 12 percent figure
is the $293.1 billion divided by the total outstanding less the
federal government total). Just over a third of households have some
financial affiliation with a credit union. (Source: NCUA
calculations using data from the Federal Reserve 2013 survey of
Consumer Finance.) All Federal Reserve Statistical Releases are
available at
http:\\www.federalreserve.gov\econresdata\statisticsdata.htm.
\9\ Basel Committee on Banking Supervision, An assessment of the
long-term economic impact of stronger capital and liquidity
requirements 3-4 (August 2010), available at https://www.bis.org/publ/bcbs173.pdf. These losses do not explicitly account for
government interventions that ameliorated the observed economic
impact. This is the median loss estimate.
---------------------------------------------------------------------------
The 2007-2009 financial crisis and the associated economic
dislocations during the Great Recession were particularly costly to the
United States in terms of lost output and jobs. Real GDP declined more
than four percent, almost nine million jobs were lost, and the
unemployment rate rose to 10 percent.\10\ The cited figures are just
the
[[Page 66630]]
direct losses. Compared to where the economy would have been had it
followed the precrisis trend, the losses in terms of GDP and jobs would
be higher. For example, using the results described in the previous
paragraph as a guide, the cumulative loss of output from the 2007-2009
financial crisis is roughly $10 trillion (2014 dollars).\11\ Other
estimates of the total loss, derived using approaches different than
described in the previous paragraph, are similar. For example,
researchers at the Federal Reserve Bank of Dallas, using a different
approach that achieved results within the same range, estimated a range
of loss of $6 trillion to $14 trillion due to the crisis.\12\
---------------------------------------------------------------------------
\10\ The National Bureau of Economic Research Business Cycle
Dating Committee defines the beginning date of the recession as
December 2007 (2007Q4) and the ending date of the recession as June
2009 (2009Q2). See the National Bureau of Economic Research Web
site: https://www.nber.org/cycles/cyclesmain.html. The real GDP
decline was calculated by NCUA using data for 2007Q4 and 2009Q2 from
the National Income and Product Accounts, Bureau of Economic
Analysis, U.S. Department of Commerce; see Table 1.1.3. Data are
available at https://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=1&isuri=1. Data accessed
November 11, 2014. The jobs lost figure was calculated by NCUA using
data from the Bureau of Labor Statistics (BLS), U.S. Department of
Labor, Current Employment Statistics, CES Peak-Trough Tables. The
statistic cited is the decline in total nonfarm employees from
December 2007 through February 2010, which BLS defines as the trough
of the employment series. Data available at: https://www.bls.gov/ces/cespeaktrough.htm and accessed on November 11, 2014. The
unemployment rate was taken from the Bureau of Labor Statistics,
U.S. Department of Labor, Current Population Survey, series
LNS14000000. Accessed November 11, 2014 at https://data.bls.gov/pdq/SurveyOutputServlet. The unemployment rate peaked at 10 percent in
October 2009.
\11\ NCUA calculations based on from the National Income and
Product Accounts, Bureau of Economic Analysis, U.S. Department of
Commerce. Data from Table 1.1.6 show real GDP at $14.992 trillion in
2007Q4 in chained 2009 dollars. Adjusting to 2014 dollars using the
GDP price index and using the 60 percent loss figure cited yields an
estimated loss of approximately $10 trillion in 2014 dollars. Data
are available at https://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=1&isuri=1.
\12\ Tyler Atkinson, David Luttrell & Harvey Rosenblum, Fed.
Reserve Bank of Dall, How Bad Was It? The Costs and Consequences of
the 2007-2009 Financial Crisis (July 2013), available at https://dallasfed.org/assets/documents/research/staff/staff1301.pdf.
---------------------------------------------------------------------------
Research using bank data across several countries and time periods
indicates that higher levels of capital insulate financial institutions
from the effects of unexpected adverse developments in their asset
portfolio or their deposit liabilities.\13\ For the financial system as
a whole, research on the banking sector has shown that higher levels of
capital can reduce the probability of a systemic crisis.\14\ By
reducing the probability of a systemic financial crisis and insulating
individual institutions from failure, higher capital requirements
confer very large benefits to the overall economy.\15\ With the median
long-term output loss associated with a crisis in the range of 60
percent of precrisis GDP, a one percentage point reduction in the
probability of a crisis would add roughly 0.6 percent to GDP each year
(permanently).\16\
---------------------------------------------------------------------------
\13\ See An Assessment of the Long-Term Economic Impact of
Stronger Capital and Liquidity Requirements, Basel Committee on
Banking Supervision, August 2010. Pages 14-17. The study indicates
that the seven percent TCE/RWA ratio is equivalent to a five percent
ratio of equity to total assets. The average ratio of equity to
total assets for the 14 largest OECD countries from 1980 to 2007 was
5.3 percent.
\14\ Id.
\15\ Id.
\16\ Id.
---------------------------------------------------------------------------
While higher levels of capital can insulate depository institutions
from adverse shocks, holding higher levels of capital does have costs,
both to individual institutions and to the economy as a whole. For the
most part, the largest cost associated with holding higher levels of
capital, in the long term, is foregone opportunities; that is, from the
loss of potential earnings from making loans, from the cost to bank
customers and credit union members of higher loan rates and lower
deposit rates, and the downstream costs from the customers' and
members' reduced spending.\17\ Estimating the size of these effects is
difficult. However, despite limitations on the ability to quantify
these effects, the annual costs appear to be significantly smaller than
the losses avoided by reducing the probability of a systemic crisis.
For example, research using data on banking systems across developed
countries indicates that a one percentage point increase in the capital
ratio increases lending spreads (the spread between lending rates and
deposit rates) by 13 basis points.\18\ The research also shows that the
long-run reduction in output (real GDP) consistent with a one
percentage point increase in the Tier 1 common equity \19\ to risks
assets ratio would be on the order of 0.1 percent.\20\ Thus, it is
clear that the relatively large potential long-term benefits of holding
higher levels of capital outweigh the relatively small long-term costs.
---------------------------------------------------------------------------
\17\ See An Assessment of the Long-Term Economic Impact of
Stronger Capital and Liquidity Requirements, Basel Committee on
Banking Supervision, August 2010. Pages 21-27.
\18\ There are a number of simplifying assumptions involved in
the calculation, including the assumption that banks fully pass
through the increase in the cost of capital to their borrowers. See
Basel Committee on Banking Supervision, An Assessment of the Long-
Term Economic Impact of Stronger Capital and Liquidity Requirements
21-27 (Aug. 2010).
\19\ Tier 1 common equity is made up of common stock, retained
earnings, accumulated other comprehensive income, and some
miscellaneous minority interests and common stock as part of an
employee stock ownership plan.
\20\ To be clear, the 0.1 percent figure represents the one-
time, long-term loss, which should be compared with the 60 percent
loss potentially avoided by reducing the probability of a financial
crisis by a little more than one percentage point. See An Assessment
of the Long-Term Economic Impact of Stronger Capital and Liquidity
Requirements, Basel Committee on Banking Supervision, August 2010.
Pages 21-27.
---------------------------------------------------------------------------
The 2007-2009 financial crisis revealed a number of inadequacies in
the current approach to capital requirements. Banks, in particular,
experienced an elevated number of failures and the need for federal
intervention in the form of capital infusions.\21\
---------------------------------------------------------------------------
\21\ For a readable overview of the 2007-2009 financial crisis
and the government response see, The Final Report of the
Congressional Oversight Panel, Congressional Oversight Panel, March
16, 2011. See also Ben S. Bernanke, ``Some Reflections on the Crisis
and the Policy Response,'' Speech at the Russell Sage Foundation and
The Century Foundation Conference on ``Rethinking Finance,'' New
York, New York, April 13, 2012. Available at: https://www.federalreserve.gov/newsevents/speech/2012speech.htm.
---------------------------------------------------------------------------
Credit unions also experienced elevated losses and the need for
government intervention. From 2008 through 2012, five corporate credit
unions failed. Had NCUA not intervened in 2009 and 2010 by providing
over $20 billion in liquidity assistance, over $100 billion in
guarantees, and borrowing over $5 billion from the U.S. Treasury, the
resulting losses to consumer credit unions on their uninsured funds
invested at these institutions would have exceeded $30 billion. NCUA
estimates as many as 2,500 consumer credit unions would have failed at
additional cost to the Share Insurance Fund.
In addition, during that same period, 27 consumer credit unions
with assets greater than $50 million failed at a cost of $728 million
to the NCUSIF.\22\ NCUA performed back-testing of the 9 complex credit
unions (those with over $100 million in assets) that failed during this
period to determine whether this final rule would have resulted in
earlier identification of emerging risks and reduced losses to the
NCUSIF. The back-testing revealed that maintaining a risk-based capital
ratio in excess of 10 percent would have required 8 of the 9 complex
credit unions that failed to hold additional capital.
---------------------------------------------------------------------------
\22\ These figures are based on data collected by NCUA
throughout the crisis, and do not include the costs associated with
failures of corporate credit unions.
---------------------------------------------------------------------------
The failure of the 27 consumer credit unions was due in large part
to holding inadequate levels of capital relative to the levels of risk
associated with their assets and operations. In many cases, the capital
deficiencies relative to elevated risk levels were identified by
examiners and communicated through the examination process to officials
at these credit unions.\23\ Although the credit union officials were
provided with notice of the capital deficiencies, they ignored the
supervisory concerns
[[Page 66631]]
or did not act in a timely manner to address the concerns raised.
Furthermore, NCUA's ability to take enforcement actions to address
supervisory concerns in a timely manner was cited by GAO as limited
under NCUA's current regulations.
---------------------------------------------------------------------------
\23\ See, e.g., OIG-13-10, Material Loss Review of Chetco
Federal Credit Union (October 1, 2013), OIG-13-05, Material Loss
Review of Telesis Community Credit Union (March 15, 2013), OIG-10-
15, Material Loss Review of Ensign Federal Credit Union, (Sept. 23,
2010), OIG-10-03, Material Loss Reviews of Cal State 9 Credit union
(April 14, 2010).
---------------------------------------------------------------------------
From 2008 to 2012, over a dozen very large consumer credit unions,
and numerous smaller ones, also were in danger of failing and required
extensive NCUA intervention, financial assistance, or both, along with
increased reserve levels for the NCUSIF.\24\ NCUA estimates these
actions saved the NCUSIF over $1 billion in losses.
---------------------------------------------------------------------------
\24\ As most of these credit unions are still active
institutions, or have merged into other active institutions, NCUA
cannot provide additional details publicly.
---------------------------------------------------------------------------
The clear implication from the impact of the 2007-2009 recession on
the credit unions noted above is that capital levels in these cases
were inadequate, especially relative to the riskiness of the assets
that some institutions were holding on their books.
Unlike banks that can issue other forms of capital like common
stock, credit unions that need to raise additional capital when faced
with a capital shortfall generally have no choice except to reduce
member dividends or other interest payments, raise lending rates, or
cut non-interest expenses in an attempt to direct more income to
retained earnings.\25\ Thus, the first round impact of falling or low
capital levels at credit unions is likely a direct reduction in credit
union members' access to credit or interest bearing accounts. Hence, an
important policy objective of capital standards is to ensure that
financial institutions build sufficient capital to continue functioning
as financial intermediaries during times of stress without government
intervention or assistance.
---------------------------------------------------------------------------
\25\ Low-income designated credit unions can issue secondary
capital accounts that count as net worth for PCA purposes. As of
June 30, 2014, there are 2,107 low-income designated credit unions.
Given the nature (e.g., size) of these credit unions and the types
of instruments they can offer, however, there is often a very
limited market for these accounts.
---------------------------------------------------------------------------
NCUA's analysis of credit union Call Report data from 2006 forward,
as detailed below, also makes it clear that higher capital levels keep
credit unions from becoming undercapitalized during periods of economic
stress. The table below summarizes the changes in the net worth ratio
that occurred during the recent economic crisis. Of credit unions with
a net worth ratio of less than eight percent in the fourth quarter of
2006, 80 percent fell below seven percent at some time during the 2007-
2009 financial crisis and its immediate aftermath. Of credit unions
with 8 percent to 10 percent net worth ratios in the fourth quarter of
2006, just under 33 percent fell below seven percent during the crisis
period. However, of credit unions that entered the crisis with at least
10 percent net worth ratios, less than five percent fell below the
seven percent well capitalized standard during the crisis or its
immediate aftermath.
Distribution of Net Worth Ratios of Credit Unions With At Least $100 Million in Assets by Lowest Net Worth Ratio
During the Financial Crisis
----------------------------------------------------------------------------------------------------------------
Lowest net worth ratio between 2007Q1 and 2010Q4
----------------------------------------------------------------------------
Net worth ratio in 2006Q4 Number of
<6% 6-7% 7-8% 8-10% >=10% Total credit
unions
----------------------------------------------------------------------------------------------------------------
<8 percent......................... 44.0 36.0 20.0 0.0 0.0 100.0 50
8-10 percent....................... 13.0 19.6 38.0 29.4 0.0 100.0 316
>=10 percent....................... 1.9 2.8 9.4 38.8 47.1 100.0 830
----------------------------------------------------------------------------------------------------------------
Similarly, the table below shows how credit unions with at least
$100 million in assets in the fourth quarter of 2006 fared during the
five years after the fourth quarter of 2007, which was the period that
encompassed the 2007-2009 recession. The table shows that the credit
unions that survived the crisis and recession had higher net worth
ratios going into the Great Recession. In particular, credit unions
with more than $100 million in assets before the crisis began, but
failed during the crisis, had a median precrisis net worth ratio of
less than nine percent, while similarly sized institutions that
survived the crisis had, on average, precrisis net worth ratios in
excess of 11 percent.
Characteristics of FICUs With Assets >$100 Million at the End of 2006 by Five Year Survival Beginning 2007Q4
--------------------------------------------------------------------------------------------------------------------------------------------------------
Median
-------------------------------------------------------------------------------
Number of Member
institutions Net worth Loan to asset Real estate business loan
Assets ($M) ratio ratio loan share share
(percent) (percent) (percent) (percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Failures................................................ 27 162.7 8.97 84.0 58.0 8.3
Survivors............................................... 1138 237.9 11.20 71.0 49.0 0.7
--------------------------------------------------------------------------------------------------------------------------------------------------------
Survivorship is determined based on whether a FICU stopped filing a Call Report over the five years starting in the fourth quarter of 2007. Failures
exclude credit unions that merged or voluntarily liquidated. Note: All failures had precrisis net worth ratios in excess of seven percent.
Aside from demonstrating the differences in the capital positions
of credit unions that failed from those that did not fail, the table
above highlights two additional considerations. First, the table shows
that other performance indicators were different between the two groups
of credit unions. In particular, the survivors had a lower median loan-
to-asset ratio, a lower median share of total loans in real estate
loans, and a lower share of member business loans in their overall loan
portfolio.
[[Page 66632]]
A key limitation of the leverage ratio is that it is a lagging
indicator because it is based largely on accounting standards.
Accounting figures are point-in-time values largely based on historical
performance to date. Further, the leverage ratio does not discriminate
between low-risk and high-risk assets or changes in the composition of
the balance sheet. A risk-based capital ratio measure is more
prospective in that, as a credit union makes asset allocation choices,
it drives capital requirements before losses occur and capital levels
decline. The differences in indicators between the failure group and
the survivors in the table above demonstrate that factors in addition
to capital levels play an important role in preventing failure. For
example, all of the failures listed in the table above had net worth
ratios in excess of the well capitalized level at the end of 2006. The
severe weakness of NCUA's current risk-based net worth requirement is
further demonstrated by the fact that, of the 27 credit unions that
failed during the Great Recession, only two of those credit unions were
considered less than well capitalized due to the existing RBNW
requirement.\26\ A well designed risk-based capital ratio standard
would have been more successful in helping credit unions avoid failure
precisely because such standards are targeted at activities that result
in elevated risk.
---------------------------------------------------------------------------
\26\ See table above (referencing the 27 failures of credit
unions over $100 million in assets).
---------------------------------------------------------------------------
The need for a risk-based capital standard beyond a leverage ratio
is further supported when considering a more comprehensive review of
credit union failures. The figures below present data from NCUA's
review of the 192 credit union failures that occurred over the past 10
years and indicates that 160 failed credit unions had net worth ratios
greater than seven percent two years prior to their failure. Further,
the failed credit unions exhibited a 12 percent average net worth ratio
two years prior to their failure.
BILLING CODE 7535-01-P
[GRAPHIC] [TIFF OMITTED] TR29OC15.000
[[Page 66633]]
[GRAPHIC] [TIFF OMITTED] TR29OC15.001
BILLING CODE 7535-01-C
The table above shows that credit unions with high net worth ratios
can and have failed, demonstrating that a leverage ratio alone has not
always proven to be an adequate predictor of a credit union's future
viability. However, a more robust risk-based capital standard would
reflect the presence of elevated balance sheet risk sooner, and in
relevant cases would improve a credit union's odds of survival.
A recession or other source of financial stress poses more
difficulties for credit unions with limited capital options and with
capital levels lower than what their risks warrant. A capital shortfall
reduces a credit union's ability to effectively serve its members. At
the same time, the shortfall can cascade to the rest of the credit
union system through the NCUSIF, potentially affecting an even broader
number of credit union members. Credit unions are an important source
of consumer credit and a capital shortfall that affects the credit
union system could reduce general consumer access to credit for
millions of credit union members.\27\ Accordingly, a risk-based capital
rule that is effective in requiring credit unions with low capital
ratios and a large share of high-risk assets to hold more capital
relative to their risk profile, while limiting the burden on already
well capitalized credit unions, should provide positive net benefits to
the credit union system and the United States economy. Improved
resilience enhances credit unions' ability to function during periods
of financial stress and reduce risks to the NCUSIF.
---------------------------------------------------------------------------
\27\ Credit unions play a sizable role in the U.S. depository
system. Assets in the credit union system amount to more than $1.1
trillion, roughly eight percent of U.S. chartered depository
institution assets (source: NCUA calculation using the financial
accounts of the United States, Federal Reserve Statistical Release
Z.1, Table L.110, September 18, 2014). Data from the Federal Reserve
indicate that credit unions account for about 12 percent of private
consumer installment lending. (Source: NCUA calculations using data
from the Federal Reserve Statistical Release G.19, Consumer Credit,
September 2014. Total consumer credit outstanding (not mortgages)
was $3,246.8 billion of which $826.2 billion was held by the federal
government and $293.1 billion was held by credit unions. The 12
percent figure is the $293.1 billion divided by the total
outstanding less the federal government total). Just over a third of
households have some financial affiliation with a credit union.
(Source: NCUA calculations using data from the Federal Reserve 2013
survey of Consumer Finance.) All Federal Reserve Statistical
Releases are available at https://www.federalreserve.gov/econresdata/statisticsdata.htm.
---------------------------------------------------------------------------
In a risk-based capital system, institutions that are holding
assets that have historically shown higher levels of risk are generally
required to hold more capital against those assets. At the same time,
an institution's leverage ratio, which does not account for the
riskiness of assets, can provide a baseline level of capital adequacy
in the event that the approach to assigning risk weights does not
capture all risks. A system including well-designed and well-calibrated
risk-based capital standards is generally more efficient from the point
of view of the overall economy, as well as for individual institutions.
In general, risk-based capital standards increase capital requirements
at those institutions whose asset portfolios have, on average, higher
risk.
Conversely, risk-based capital standards generally decrease the
cost of holding capital for institutions whose strategies focus on
lower risk activities. In that way, risk-based capital standards
generate the benefits of helping to insulate the economy from financial
crises, while also preventing some of the potential costs that would
occur from holding unnecessarily high levels of capital at low-risk
institutions.
[[Page 66634]]
This final rule replaces the current method for calculating a
credit union's risk-based net worth ratio with a new method for
calculating a credit union's risk-based capital ratio. Under the
current risk-based net worth ratio measure, a lower ratio is reflective
of financial strength. So the current measure is not intuitive, and,
more importantly, can't be compared against the risk-based capital
measures of other financial institutions. The new risk-based capital
ratio, however, is more commonly applied to depository institutions
worldwide. Generally, the new risk-based capital ratio is the
percentage of equity and accounts available to cover losses divided by
risk-weighted assets. Under this approach, a higher risk-based capital
ratio is an indicator of financial strength.
The new risk-based capital ratio adopted in this final rule is
designed to complement the statutory net worth ratio, which is often
referred to as the leverage ratio. The net worth ratio is a measure of
statutorily defined capital divided by total assets. The net worth
ratio does not assign relative risk weights among asset classes, making
it more difficult to manipulate and provides a simple picture of a
financial institution's ability to absorb losses, regardless of the
source of the loss. The new risk-based capital ratio, on the other
hand, is a measure of loss absorption ability to assets weighted based
on the associated risk, and is intended to be more forward looking and
reactive to changes in the risk profile of a credit union. In general,
a risk-based capital requirement increases capital requirements at
those institutions with asset portfolios that are, on average, higher
risk. Conversely, risk-based capital standards generally decrease
capital requirements at institutions with lower risk profiles. In that
way, risk-based capital standards generate the benefits of helping to
insulate the economy from financial crises, while also preventing some
of the potential costs that would occur from holding unnecessarily high
levels of capital at low-risk institutions.
Many commenters suggested that the Board withdraw the Second
Proposal and retain the existing risk-based capital requirement and the
related risk-weights, which are based largely on interest rate risk and
liquidity risk. Ironically, most of the commenters objected to the
Original Proposal because it included IRR and liquidity risk in the
proposed risk weights. As discussed in the Original Proposal, since its
implementation, the current risk-based net worth requirement has
required less than a handful of credit unions to hold higher levels of
capital than required by the net worth ratio. Under the current risk-
based net worth requirement, those credit unions that invest in longer-
term, low-credit risk investments experience a higher risk-based net
worth requirement and thus have a lower buffer above the net worth
ratio than they will have under the final rule.
The current risk-based net worth requirement also fails to allow
for comparison of capital adequacy on a risk-weighted level across
financial institutions. A creditor or uninsured depositor is able to
obtain and understand the capital measures available for all banks.
Creditors generally know that, for banks, a higher capital ratio is an
indication of better financial strength and a reduction in their risk
of loss. Creditors and uninsured shareholders in credit unions,
however, generally do not understand the application of the risk-based
net worth requirement where a lower ratio is an indicator of financial
strength; nor are they generally aware that the risk-based net worth
requirement is only available by reviewing a specific page of the Call
Report. The current lack of a comparable risk-based capital measure for
credit unions deprives creditors and uninsured shareholders of a useful
measure in determining the financial strength of credit unions.
The Board also disagrees with commenters who called for a
withdrawal of the Second Proposal because a limited number of credit
unions may experience a decline in their capital classification, or
because commenters claimed that back-testing the proposal would have
resulted in only minor savings to the NCUSIF had the proposal's capital
requirement been in place during the 2007-2009 recession. The Original
Proposal would have imposed higher risk-weights for concentrations of
MBLs, junior-lien real estate loans, and equity investments, which
would have resulted in approximately 199 credit unions experiencing a
decline in their capital classification and could have reduced losses
to the NCUSIF to a greater degree had those requirements been in place
prior to the 2007-2009 recession. Due to legitimate concerns raised by
commenters regarding the impacts of the Original Proposal, however, the
Board reduced the risk-weights for concentrations of MBLs and real
estate loan concentrations in the Second Proposal. Thus, the potential
impacts of the Second Proposal were lower, but still require that
credit unions taking higher levels of risk hold higher levels of
capital. Based on the comments received on the Original Proposal and
the Second Proposal, the risk weights in the Second Proposal are
calibrated to appropriately balance the impact of the proposed changes
on credit unions while also providing meaningful improvement to the
risk-based capital standards to which credit unions will be held in the
future.
The Board disagrees with commenters who suggested that the Board
not finalize the proposal and instead focus on enhancing training to
improve examiner skills to reduce the number of failures and losses to
the NCUSIF. NCUA already continually seeks to enhance the training and
skills of examiner staff within budget limitations. NCUA already
performs analyses of all material losses to the NCUSIF, including
material loss reviews prepared by NCUA's Inspector General on losses
that exceed $25 million. The loss reviews include analyses of NCUA's
and the State Supervisory Authorities' supervision of credit unions and
include recommendations to addresses any weaknesses in related
supervision policies and approaches. Additionally, not issuing a final
rule would result in retention of the current risk-based net worth
measure, which is not a comparable measure across financial
institutions and contains risk-weights that are less closely associated
with credit risk.
Moreover, the Board disagrees with commenters who suggested that
credit unions should have less stringent regulatory capital standards
than banks. The combined statutory requirement for a minimum net worth
ratio and the risk-based capital requirement, supported by the
supervision process, is the backbone of protection for both the credit
union and bank insurance funds. In addition, prudent capital standards
serve to protect taxpayers who ultimately must fund any reliance by the
insurance funds on the full faith and credit of the United States.
Commenters claimed that the Second Proposal would place credit
unions at a competitive disadvantage to banks by requiring credit
unions to hold incrementally more capital than banks given similar
asset-concentration levels. The net worth ratio, which is defined by
statute, requires credit unions to hold more capital than banks are
required to hold using the comparable Tier 1 leverage ratio for
banks.\28\ Congress
[[Page 66635]]
required NCUA to develop PCA regulations that are comparable to those
of banks, including the risk-based net worth requirement for complex
credit unions. The Board ensured compliance with the law while issuing
the Second Proposal, which would not place credit unions at a
competitive disadvantage to banks. The vast majority of risk weights
for credit unions would be comparable to the risk weights for banks,
and some risk weights for credit unions would actually be lower than
the risk weights for banks. Because the Second Proposal generally used
the same overall risk-based capital levels as banks, the differences in
the individual elements of the calculation can be easily identified and
understood. For example, the proposed risk weight for secured consumer
loans, which represent about 20 percent of total assets for complex
credit unions, is 25 basis points less than the corresponding risk
weight for banks. The Second Proposal also would not cap credit unions'
allowance for loan and lease losses at 1.25 percent of risk assets,
while the Other Banking Agencies impose such a cap in the risk-based
capital ratio calculation for banks. In the few instances where the
risk weights are higher for credit unions, they apply to a very low
percentage of total assets and are directly tied to sources of higher
losses to the NCUSIF, primarily concentrations of real estate and
business assets.
---------------------------------------------------------------------------
\28\ The net worth ratio and a bank's Tier 1 leverage ratio are
both based on the total assets of the institution. Congress set the
net worth ratio 200 basis points higher than the Tier 1 leverage
ratio level for banks due to the nature of the 1 percent NCUSIF
deposit, the level of investment within the corporate credit union
system, and credit unions' limited access to capital other than
retained earnings. U.S. Department of Treasury, Credit Unions
(1997).
---------------------------------------------------------------------------
The table below contains an estimate of how risk-weights generally
compare between the risk-weights in this final rule to the risk-weights
applied to FDIC insured institutions.
------------------------------------------------------------------------
Sub-category Category as %
as % of total of total
assets assets
------------------------------------------------------------------------
Lower Risk Weight Than FDIC
------------------------------------------------------------------------
Secured Consumer Loans.................. .............. 21.09%
------------------------------------------------------------------------
More Conservative Risk Weight Than FDIC
------------------------------------------------------------------------
First-Lien Real Estate Loans >35 percent 1.19% ..............
of assets..............................
Junior-Lien Real Estate Loans >20 0.11% ..............
percent of assets......................
Commercial Loans >50 percent of assets.. 0.13% ..............
Non-Current Junior-Lien Real Estate 0.02% ..............
Loans..................................
Unfunded Non-Commercial Loans........... 1.46% 2.91%
------------------------------------------------------------------------
Not Directly Comparable to FDIC
------------------------------------------------------------------------
CUSO Investments and Corporate Capital.. .............. 0.34%
------------------------------------------------------------------------
Comparable Risk Weight to FDIC
------------------------------------------------------------------------
All Other Assets........................ .............. 75.66%
------------------------------------------------------------------------
Commenters asserted that bank regulators are moving away from risk-
based capital structures and referenced the FDIC Vice Chairman's
related statements. The FDIC Vice Chairman, however, has favored higher
generally accepted accounting principles (GAAP) equity ratios at banks
of at least 10 percent of assets as an alternative to risk-based
capital structures.\29\ The NCUA Board lacks authority to impose higher
GAAP equity-to-asset ratios because the FCUA specifically defines the
net worth ratio for credit unions and sets forth the minimum ratio
levels required. Moreover, the current statutory net worth ratio
requirement, combined with a reasonable risk-based capital ratio
requirement to address institutions taking higher levels of risk,
provides a well targeted level of protection to the NCUSIF.
---------------------------------------------------------------------------
\29\ Thomas M. Hoening, American Banker, The Safe Way to Give
Traditional Banks Regulatory Relief, (June 22, 2015), available at
https://www.fdic.gov/news/letters/reg-relief.html.
---------------------------------------------------------------------------
The Board disagrees with commenters who suggested that the proposal
would stifle growth, innovation, diversification, and member services.
The commenters' suggested revisions to the proposal revealed there is
clear disagreement among credit unions and other interested parties
regarding how the proposal would have impacted factors such as growth,
innovation, diversification, and member services at credit unions. This
final rule better reflects each individual credit union's risk profile,
provides for more active management of risk in relation to capital,
further ensures individual credit unions can continue to serve as
credit providers even during times of stress, and promotes the safety
and soundness of the credit union system.
Commenters asserted that credit unions would need to charge higher
interest rates, higher fees, and pay lower rates on deposits to raise
capital because of the new risk-based capital measure. Credit unions,
however, would have more than three years before the new risk-based
capital requirement goes into effect. A credit union that determines it
is in danger of having a risk-based capital ratio level below the
required minimum level has the option of: Reducing the amount of risk-
weighted assets it holds; raising additional capital, primarily through
earnings; or both.
NCUA's analysis of credit union Call Report data indicates that the
overwhelming majority of complex credit unions already have sufficient
capital to comply with the proposed risk-based capital regulation. In
particular, NCUA estimates that over 98 percent of complex credit
unions would be in compliance with the regulatory capital minimums
under the final rule if it were in effect today. The final rule is
designed to ensure that these credit unions maintain their capacity to
absorb losses in the future. A few credit unions, however, will likely
want to take advantage of the three-year implementation period provided
in this final rule to accumulate retained earnings, reduce their level
of risk-assets, or both. As noted above, the overwhelming majority of
credit unions have sufficient capital to comply with the revised
capital rules, and the resulting improvements to the stability and
resilience of the credit union
[[Page 66636]]
system outweigh any costs associated with its implementation.
In this final rule, the Board complied with the statutory
requirement to take into account the cooperative character of credit
unions in that they are not-for-profit, do not issue capital stock,
must rely on retained earnings to build net worth, and have boards of
directors that consist primarily of volunteers. To do this, the Board
avoided undue complexity within the rule by, among other things, not
implementing a complex conservation buffer requirement; establishing a
simple and straightforward proxy for the definition of a complex credit
union; reducing the number of asset concentration thresholds; and
requiring only complex credit unions to have a written strategy for
maintaining an appropriate level of capital.
Accordingly, and for the reasons discussed in more detail below,
the Board is now adopting this final rule to revise NCUA's current
regulations regarding PCA to require that complex credit unions taking
certain risks hold capital commensurate with those risks.
II. Summary of the Final Rule
This final rule replaces the method currently used by complex
credit unions to apply risk weights to their assets with a new risk-
based capital ratio measure that is generally comparable to that
applied to depository institutions worldwide. As discussed in more
detail in the Legal Authority part of this preamble, the FCUA gives
NCUA broad discretion in designing the risk-based net worth requirement
applicable to complex credit unions. Accordingly, this final rule
revises part 702 of NCUA's current regulations to establish a risk-
based capital ratio measure that is the percentage of a credit union's
capital available to cover losses, divided by the credit union's
defined risk-weighted asset base.
This final rule adopts a broadened definition of capital to be used
as the numerator in the new risk-based capital ratio measure. The Board
is adopting this change to provide a more comparable measure of capital
across all financial institutions and to better account for related
elements of the financial statement that are specifically available to
cover losses and protect the NCUSIF. This broader definition of capital
more accurately reflects the amount of capital that is actually
available at a credit union to absorb losses.
In terms of the denominator for the risk-based capital ratio
measure, section 216(d)(2) of the FCUA requires that the Board, in
designing a risk-based net worth requirement, ``take account of any
material risks against which the net worth ratio required for [a
federally] insured credit union to be adequately capitalized may not
provide adequate protection.'' \30\ Section 216(d)(2) of the FCUA
differs from the corresponding provision in section 38 of the FDI
Act,\31\ which requires the Other Banking Agencies to implement risk-
based capital requirements, because section 216(d)(2) specifically
requires that NCUA's risk-based requirement address ``any material
risks.'' Accordingly, the Board is required to account for any material
risks in the risk-based requirement unless the risk is deemed
immaterial because of the existence of another mechanism that the Board
believes adequately accounts for the risk.
---------------------------------------------------------------------------
\30\ 12 U.S.C. 1790d(d)(2) (emphasis added).
\31\ 12 U.S.C. 1831o.
---------------------------------------------------------------------------
NCUA's risk-based net worth requirement has included some aspect of
IRR since its inception in 2000. Further, IRR, if not adequately
addressed through some regulatory, statutory or supervisory mechanism,
can represent a material risk for purposes of NCUA's risk-based
requirement. Based on long-term balance sheet trends at credit unions,
the comments received on the Second Proposal, and NCUA's experiences
dealing with problem institutions, however, the Board concluded that
NCUA can adequately address IRR through its other regulations and
supervisory processes. Accordingly, the final rule generally excludes
IRR from NCUA's risk-based capital ratio calculation. But the Board may
consider adopting additional regulatory or supervisory approaches for
addressing IRR at credit unions if the need arises in the future.
With the removal of the IRR component from the current rule, this
final rule narrows the list of risks accounted for in the denominator
of the new risk-based capital ratio measure. The methodology for
assigning risk weights in this final rule primarily accounts for credit
risk and concentration risk.
This final rule incudes a tiered risk weight framework \32\ for
high concentrations of residential real estate loans and commercial
loans \33\ in NCUA's risk-based capital ratio measure. As a credit
union's concentration in these asset classes increases, incrementally
higher levels of capital are required. This approach addresses
concentration risk as it relates to minimum required capital levels
through a transparent, standardized, regulatory requirement. The
concentration thresholds do not limit a credit union's lending
activity; rather, the thresholds merely require the credit union to
hold additional capital to account for the elevated concentration risk.
The inclusion of concentration risk in the final rule does not put
credit unions at a competitive disadvantage to banks because most real
estate and member business loans (except for loans held in high
concentrations) would still be assigned risk weights similar to those
applicable to banks.
---------------------------------------------------------------------------
\32\ The tiered framework would provide for an incrementally
higher capital requirement resulting in a blended rate for the
corresponding portfolio. That is, the portion of the portfolio below
the threshold would receive a lower risk weight, and the portion
above the threshold would receive a higher risk weight. The higher
risk weight would be consistent across asset categories as a 50
percent increase from the base rate. Some comments on the Original
Proposal suggested NCUA should have combined similar exposures
across asset classes, such as investments and loans. For example,
residential mortgage-backed security concentrations could have been
included with the real estate loan thresholds due to the similarity
of the underlying assets. However, given the more liquid nature and
price transparency of a security, the Board believes including this
with the risk thresholds for real estate lending is not necessary.
\33\ The definition of commercial loans and the differences
between commercial loans and MBLs are discussed in more detail in
the section-by-section analysis.
---------------------------------------------------------------------------
Consistent with many commenters and with section 216(b)(1)(A)(ii)
of the FCUA, which requires NCUA's PCA requirement be comparable to the
Other Banking Agencies' PCA requirements, the Board relied primarily on
the risk weights assigned to various asset classes under the Basel
Accords and the Other Banking Agencies' risk-based capital regulations
for this final rule.\34\ So this final rule provides for greater
comparability to the Other Banking Agencies' risk weights than NCUA's
current risk-based net worth regulation. The Board, however, has
tailored the risk weights in this final rule for certain assets that
are unique to credit unions or where a demonstrable and compelling case
exists, based on contemporary and sustained performance differences, to
differentiate for certain asset classes (such as consumer loans)
between banks and credit unions, or where a provision of the FCUA
requires doing so.
---------------------------------------------------------------------------
\34\ The Board has simplified certain aspects of this final rule
to take into account the cooperative character of credit unions
while still imposing risk-based capital standards that are
substantially similar and equivalent in rigor to the standards
imposed on banks. See 12 U.S.C. 1790d(b)(1)(B).
---------------------------------------------------------------------------
[[Page 66637]]
The following is a table showing a summary of the risk weights
included in this final rule. See the section-by-section analysis part
of the preamble below for more details on the changes to the asset
classes and risk weights.
---------------------------------------------------------------------------
\35\ The ``look-through'' approaches are discussed in more
detail in the part of this preamble discussing Sec.
702.104(c)(3)(iii)(B).
\36\ The ``gross-up'' approach is discussed in more detail in
the part of this preamble discussing Sec. 702.104(c)(3)(iii)(A).
\37\ Under Sec. 702.104(c)(3)(i) of this final rule, a credit
union has non-significant equity exposures if the aggregate amount
of its equity exposures does not exceed 10 percent of the sum of the
credit union's capital elements of the risk-based capital ratio
numerator (as defined under paragraph Sec. 702.104(b)(1)). To
determine its aggregate amount of its equity exposures, the credit
union must include the total amounts (as recorded on the statement
of financial condition in accordance with GAAP) of the following (1)
equity investments in CUSOs, (2) perpetual contributed capital at
corporate credit unions, (3) nonperpetual capital at corporate
credit unions, and (3) equity investments subject to a risk weight
in excess of 100 percent.
Summary of the Risk Weights
--------------------------------------------------------------------------------------------------------------------------------------------------------
0% 20% 50% 75% 100% 150% 250% 300% 400% 1250%
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cash/Currency/Coin............................................ X ....... ....... ....... ....... ....... ....... ....... ....... .......
Investments:
Unconditional Claims--U.S. Government..................... X ....... ....... ....... ....... ....... ....... ....... ....... .......
Balances Due from Federal Reserve Banks................... X ....... ....... ....... ....... ....... ....... ....... ....... .......
Federally Insured Deposits in Financial Institutions...... X ....... ....... ....... ....... ....... ....... ....... ....... .......
Debt Instruments issued by NCUA and FDIC.................. X ....... ....... ....... ....... ....... ....... ....... ....... .......
Central Liquidity Facility Stock.......................... X ....... ....... ....... ....... ....... ....... ....... ....... .......
Uninsured deposits at U.S. Federally Insured Institutions. ....... X ....... ....... ....... ....... ....... ....... ....... .......
Agency Obligations........................................ ....... X ....... ....... ....... ....... ....... ....... ....... .......
FNMA and FHLMC pass through Mortgage Backed Securities ....... X ....... ....... ....... ....... ....... ....... ....... .......
(MBS)....................................................
General Obligation Bonds Issued by State or Political ....... X ....... ....... ....... ....... ....... ....... ....... .......
Subdivisions.............................................
Federal Home Loan Bank Stock and Balances................. ....... X ....... ....... ....... ....... ....... ....... ....... .......
Senior Agency Residential MBS or Asset-Backed Securities ....... X ....... ....... ....... ....... ....... ....... ....... .......
(ABS) Structured.........................................
Revenue Bonds Issued by State or Political Subdivisions... ....... ....... X ....... ....... ....... ....... ....... ....... .......
Senior Non-Agency Residential MBS Structured.............. ....... ....... X ....... ....... ....... ....... ....... ....... .......
Corporate Membership Capital.............................. ....... ....... ....... ....... X \c\ ....... ....... ....... ....... .......
Industrial Development Bonds.............................. ....... ....... ....... ....... X ....... ....... ....... ....... .......
Agency Stripped MBS (Interest Only)....................... ....... ....... ....... ....... X ....... ....... ....... ....... .......
Part 703 Compliant Investment Funds \a\................... ....... ....... ....... ....... X ....... ....... ....... ....... .......
Value of General Account Insurance (bank owned life ....... ....... ....... ....... X ....... ....... ....... ....... .......
insurance, and credit union owned life insurance) \a\....
Corporate Perpetual Capital............................... ....... ....... ....... ....... X \c\ X \c\ ....... ....... ....... .......
Mortgage Servicing Assets................................. ....... ....... ....... ....... ....... ....... X ....... ....... .......
Separate Account Life Insurance \a\....................... ....... ....... ....... ....... ....... ....... ....... X ....... .......
Publicly Traded Equity Investment (non-CUSO).............. ....... ....... ....... ....... X \c\ ....... ....... X \c\ ....... .......
Mutual Funds Part 703 Non-Compliant \a\................... ....... ....... ....... ....... ....... ....... ....... X ....... .......
Non-Publicly Traded Equity Investments (non-CUSO)......... ....... ....... ....... ....... X \c\ ....... ....... ....... X \c\ .......
Subordinated Tranche of Any Investment \b\................ ....... ....... ....... ....... ....... ....... ....... ....... ....... X
Consumer Loans:
Share-Secured (shares held at the credit union)........... X ....... ....... ....... ....... ....... ....... ....... ....... .......
Share-Secured (shares held at another depository ....... X ....... ....... ....... ....... ....... ....... ....... .......
institution).............................................
Current Secured........................................... ....... ....... ....... X ....... ....... ....... ....... ....... .......
Current Unsecured......................................... ....... ....... ....... ....... X ....... ....... ....... ....... .......
Non-Current............................................... ....... ....... ....... ....... ....... X ....... ....... ....... .......
Real Estate Loans:
Share-Secured (shares held at the credit union)........... X ....... ....... ....... ....... ....... ....... ....... ....... .......
Share-Secured (shares held at another depository ....... X ....... ....... ....... ....... ....... ....... ....... .......
institution).............................................
Current First Lien <35% of Assets......................... ....... ....... X ....... ....... ....... ....... ....... ....... .......
Current First Lien >35% of Assets......................... ....... ....... ....... X ....... ....... ....... ....... ....... .......
Not Current First Lien.................................... ....... ....... ....... ....... X ....... ....... ....... ....... .......
Current Junior Lien <20% of Assets........................ ....... ....... ....... ....... X ....... ....... ....... ....... .......
Current Junior Lien >20% of Assets........................ ....... ....... ....... ....... ....... X ....... ....... ....... .......
Noncurrent Junior Lien.................................... ....... ....... ....... ....... ....... X ....... ....... ....... .......
Commercial Loans:
Share-Secured (shares held at the credit union)........... X ....... ....... ....... ....... ....... ....... ....... ....... .......
Share-Secured (shares held at another depository ....... X ....... ....... ....... ....... ....... ....... ....... .......
institution).............................................
Portion of Commercial Loans with Compensating Balance..... ....... X ....... ....... ....... ....... ....... ....... ....... .......
Commercial Loans <50% of Assets........................... ....... ....... ....... ....... X ....... ....... ....... ....... .......
Commercial Loans >50% of Assets........................... ....... ....... ....... ....... ....... X ....... ....... ....... .......
Non-current............................................... ....... ....... ....... ....... ....... X ....... ....... ....... .......
Miscellaneous:
Loans to CUSOs............................................ ....... ....... ....... ....... X ....... ....... ....... ....... .......
Equity Investment in CUSO................................. ....... ....... ....... ....... X \c\ X \c\ ....... ....... ....... .......
Other Balance Sheet Items not Assigned.................... ....... ....... ....... ....... X ....... ....... ....... ....... .......
--------------------------------------------------------------------------------------------------------------------------------------------------------
\a\ With the option to use the look-through options.\35\
\b\ With the option to use the gross-up approach.\36\
\c\ If a credit union's total equity exposures are ``non-significant'' \37\ under Sec. 702.104(c)(3)(i), then the risk weight is 100 percent. This
lowers the risk weight to 100 percent for CUSO equity exposures, corporate perpetual capital, and all other equity investments when they are part of a
credit union's non-significant equity exposures.
[[Page 66638]]
The following table provides an estimate of the risk weighting for
aggregate assets held by complex credit union assets as of December 31,
2014.
---------------------------------------------------------------------------
\38\ Includes off-balance sheet items after application of the
credit conversion factor.
----------------------------------------------------------------------------------------------------------------
Complex credit Cumulative
union assets Percent of percent of
Risk weight (in millions) complex credit complex credit
\38\ union assets union assets
----------------------------------------------------------------------------------------------------------------
0%.............................................................. $18,713 1.82 1.82
20%............................................................. 289,932 28.15 29.97
50%............................................................. 224,618 21.81 51.78
75%............................................................. 270,440 26.24 78.02
100%............................................................ 217,159 21.08 99.01
150%............................................................ 8,017 0.78 99.88
250% or greater................................................. 1,195 0.12 100.00
----------------------------------------------------------------------------------------------------------------
The following table compares on-balance sheet risk weights in this
final rule to the applicable risk weights assigned by other federal
banking agencies:
------------------------------------------------------------------------
NCUA Risk- FDIC Risk-
weight weight
------------------------------------------------------------------------
Cash/Currency/Coin...................... 0% 0%
Investments:
Unconditional Claims--U.S. 0% 0%
Government.........................
Balances Due from Federal Reserve 0% 0%
Banks..............................
Federally Insured Deposits in 0% 0%
Financial Institutions.............
Debt Instruments issued by NCUA and 0% 0%
FDIC...............................
Central Liquidity Facility Stock.... 0% n/a
Uninsured deposits at U.S. Federally 20% 20%
Insured Institutions...............
Agency Obligations.................. 20% 20%
FNMA and FHLMC pass through Mortgage 20% 20%
Backed Securities (MBS)............
General Obligation Bonds Issued by 20% 20%
State or Political Subdivisions....
Federal Home Loan Bank Stock and 20% 20%
Balances...........................
Senior Agency Residential MBS or 20% 20%
Asset-Backed Securities (ABS)
Structured.........................
Revenue Bonds Issued by State or 50% 50%
Political Subdivisions.............
Senior Non-Agency Residential MBS 50% Gross-up or
Structured......................... Simplified
Supervisory
Formula
Corporate Membership Capital........ 100% n/a
Industrial Development Bonds........ 100% 100%
Agency Stripped MBS (Interest Only). 100% 100%
Part 703 Compliant Investment Funds. 100% \a\ n/a
Value of General Account Insurance 100% 100%
(bank owned life insurance, and
credit union owned life insurance)
\a\................................
Corporate Perpetual Capital......... 100%/150% \c\ n/a
Mortgage Servicing Assets........... 250% 250%
Separate Account Life Insurance..... 300% \a\ Look-through
Publicly Traded Equity Investment 100%/300% \c\ 300%
(non-CUSO).........................
Mutual Funds Part 703 Non-Compliant. 300% \a\ n/a
Non-Publicly Traded Equity 100%/400% \c\ 400%
Investments (non-CUSO).............
Subordinated Tranche of Any 1,250% \b\ Gross-up or
Investment......................... Simplified
Supervisory
Formula
Consumer Loans:
Share-Secured (shares held at the 0% 0%
credit union)......................
Share-Secured (shares held at 20% 20%
another depository institution)....
Current Secured..................... 75% 100%
Current Unsecured................... 100% 100%
Non-Current Consumer................ 150% 150%
Real Estate Loans:
Share-Secured (shares held at the 0% 0%
credit union)......................
Share-Secured (shares held at 20% 20%
another depository institution)....
Current First Lien <35% of Assets... 50% 50%
Current First Lien >35% of Assets... 75% 50%
Not Current First Lien.............. 100% 100%
Current Junior Lien <20% of Assets.. 100% 100%
Current Junior Lien >20% of Assets.. 150% 100%
Noncurrent Junior Lien.............. 150% 100%
Commercial Loans:
[[Page 66639]]
Share-Secured (shares held at the 0% 0%
credit union)......................
Share-Secured (shares held at 20% 20%
another depository institution)....
Portion of Commercial Loans with 20% n/a
Compensating Balance...............
Commercial Loans <50% of Assets..... 100% 100%/150% \d\
Commercial Loans >50% of Assets..... 150% 100/150% \d\
Non-current Commercial.............. 150% 150%
Miscellaneous:
Loans to CUSOs...................... 100% 100%
Equity Investment in CUSO........... 100%/150% \c\ 100%-600%
Other Balance Sheet Items not 100% 100%
Assigned...........................
------------------------------------------------------------------------
\a\ With the option to use the look-through options.
\b\ With the option to use the gross-up approach.
\c\ If a credit union's total equity exposures are ``non-significant''
under Sec. 702.104(c)(3)(i), then the risk weight is 100 percent.
This lowers the risk weight to 100 percent for CUSO equity exposures,
corporate perpetual capital, and all other equity investments when
they are part of a credit union's non-significant equity exposures.
\d\ FDIC identifies certain commercial loans as High Volatility
Commercial Real Estate (HVCRE) and assigns a 150% risk weight.
The Board notes that FDIC's capital standards are the ``minimum
capital requirements and overall capital adequacy standards for FDIC-
supervised institutions . . . include[ing] methodologies for
calculating minimum capital requirements . . . .'' \39\ In other words,
FDIC may require an FDIC-supervised institution to hold an amount of
regulatory capital greater than otherwise required under its capital
rules if FDIC determines that the institution's capital requirements
under its capital rules are not commensurate with the institution's
credit, market, operational, or other risks.\40\
---------------------------------------------------------------------------
\39\ See, e.g., 12 CFR 324.1(a).
\40\ See, e.g., 12 CFR 324.1(d).
---------------------------------------------------------------------------
As indicated above, FDIC's approach to risk weights is calibrated
to be the minimum regulatory capital standard. Similarly, this final
rule is calibrated to be the minimum regulatory capital standard.
Accordingly, the final rule incorporates a broader regulatory provision
reminding complex credit unions that, as a matter of safety and
soundness, they are required to maintain capital commensurate with the
level and nature of all risks to which they are exposed.\41\ In
addition, the final rule adds a new provision requiring complex credit
unions to maintain a written strategy for assessing capital adequacy
and maintaining an appropriate level of capital.
---------------------------------------------------------------------------
\41\ See, e.g., 12 U.S.C. 1786.
---------------------------------------------------------------------------
Capital ratio thresholds are largely a function of risk weights;
and this final rule more closely aligns NCUA's risk weights with those
assigned by the Other Banking Agencies.\42\ Accordingly, the final rule
adopts a 10 percent risk-based capital ratio level for well capitalized
credit unions, and an 8 percent risk-based capital ratio level for
adequately capitalized credit unions. To take into account the
cooperative character of credit unions, the Board set the risk-based
capital ratio level for well capitalized credit unions at 10 percent,
and omitted the capital conservation buffer imposed on banks.\43\ The
omission of the capital conservation buffer simplifies NCUA's risk-
based capital requirement relative to the Other Banking Agencies' rules
without appreciably lowering the protections provided by NCUA's risk-
based capital regulations.\44\
---------------------------------------------------------------------------
\42\ See, e.g., 12 CFR 324.32; and 12 CFR 324.403.
\43\ The ``capital conservation buffer'' is explained in more
detail in the discussion on Sec. 702.102(a) in the section-by-
section analysis part of this preamble.
\44\ See, e.g., 12 CFR 324.403.
---------------------------------------------------------------------------
The final rule defines a credit union as ``complex'' if it has
assets of more than $100 million.\45\ Credit unions meeting this
threshold have a portfolio of assets and liabilities that is complex,
based upon the products and services in which they are engaged. As
discussed later in this document, the $100 million asset threshold is a
proxy measure based on detailed analysis, and a clear demarcation line
above which all credit unions engage in complex activities and where
almost all such credit unions (99 percent) are involved in multiple
complex activities.
---------------------------------------------------------------------------
\45\ There is no exemption for banks from the risk-based capital
requirements of the other banking agencies. There are 1,872 FDIC-
insured banks with assets less than $100 million as of December
2014.
---------------------------------------------------------------------------
An asset size threshold is clear, logical, and easy to administer
when compared with the more complicated formula used to determine
whether a credit union is complex under the current rule.\46\ Using a
more straightforward proxy for determining complexity also helps
account for the cooperative character of credit unions, particularly,
the fact that credit unions have boards of directors that consist
primarily of volunteers. The $100 million asset size threshold exempts
approximately 76 percent of credit unions \47\ from many of the
regulatory burdens associated with complying with this rule; yet it
will cover almost 90 percent of the assets in the credit union system.
The threshold is consistent with the fact that the majority of losses
(as measured as a proportion of the total dollar cost) to the NCUSIF
result from credit unions with assets greater than $100 million. For a
more detailed discussion of the rationale the Board considered in
defining complex, see the detailed discussion associated with section
702.103 in the Section-By-Section Analysis part of the preamble below.
---------------------------------------------------------------------------
\46\ 12 CFR 702.106.
\47\ Based upon December 31, 2014 Call Report data.
---------------------------------------------------------------------------
In response to public comments received, the final rule also makes
a number of changes to the Second Proposal. These changes include:
Assigning a lower risk weight to non-significant equity exposures and
certain share-secured loans; giving credit unions the option to assign
a 100 percent risk weight to certain charitable donation accounts;
permitting credit unions to use the gross-up approach for non-
subordinated investment tranches; assigning principal-only mortgage-
backed-security STRIPS a risk-weight based on the underlying
collateral; extending the period during which credit unions can count
supervisory goodwill and supervisory other intangible assets in the
risk-based capital ratio numerator; and incorporating the text of the
gross-up and look-through approaches into a new appendix A to the PCA
regulation. As discussed in more detail below, for certain assets,
these changes will lower the risk weights that would have been assigned
under the Second Proposal, extend the period during which certain
assets can be included in a credit union's risk-based capital ratio
[[Page 66640]]
numerator--effectively lowering certain credit unions' overall capital
requirement for 10 years--and lower the impact of the rule for certain
complex credit unions. The final rule also makes conforming and other
minor changes to NCUA's regulations, which are also discussed in more
detail below.
To provide credit unions and NCUA sufficient time to make the
necessary adjustments, such as systems, processes, and procedures, and
to reduce the burden on affected credit unions, the revisions adopted
in this final rule will not become effective until January 1, 2019.
This effective date is intended to coincide with the full phase-in of
FDIC's risk-based capital measures in 2019.
III. Legal Authority
In 1998, Congress enacted the Credit Union Membership Access Act
(CUMAA).\48\ Section 301 of CUMAA added new section 216 to the
FCUA,\49\ which requires the Board to maintain, by regulation, a system
of PCA to restore the net worth of credit unions that become
inadequately capitalized. Section 216(b)(1)(A) requires that NCUA's
system of PCA for federally insured credit unions be ``consistent
with'' section 216 of the FCUA, and ``comparable to'' section 38 of the
Federal Deposit Insurance Act (FDI Act).\50\ Section 216(b)(1)(B)
requires that the Board, in designing the PCA system, take into account
credit unions' cooperative character: That credit unions are not-for-
profit cooperatives that do not issue capital stock, must rely on
retained earnings to build net worth, and have boards of directors that
consist primarily of volunteers.\51\ In 2000, the Board first
implemented the required system of PCA \52\ and, prior to this
rulemaking, had made only minor adjustments to the rule's original
requirements.\53\
---------------------------------------------------------------------------
\48\ Public Law 105-219, 112 Stat. 913 (1998).
\49\ 12 U.S.C. 1790d.
\50\ 12 U.S.C. 1790d(b)(1)(A); see also 12 U.S.C. 1831o (Section
38 of the FDI Act setting forth the PCA requirements for banks).
\51\ 12 U.S.C. 1790d(b)(1)(B).
\52\ See 65 FR 8584 (Feb. 18, 2000); and 65 FR 44950 (July 20,
2000) (The risk-based net worth requirement for credit unions
meeting the definition of ``complex'' was first applied on the basis
of data in the Call Report reflecting activity in the first quarter
of 2001.)
\53\ NCUA's risk-based net worth requirement has been largely
unchanged since its implementation, with the following limited
exceptions: Revisions were made to the rule in 2003 to amend the
risk-based net worth requirement for MBLs. 68 FR 56537 (Oct. 1,
2003). Revisions were made to the rule in 2008 to incorporate a
change in the statutory definition of ``net worth.'' 73 FR 72688
(Dec. 1, 2008). Revisions were made to the rule in 2011 to expand
the definition of ``low-risk assets'' to include debt instruments on
which the payment of principal and interest is unconditionally
guaranteed by NCUA. 76 FR 16234 (Mar. 23, 2011). Revisions were made
in 2013 to exclude credit unions with total assets of $50 million or
less from the definition of ``complex'' credit union. 78 FR 4033
(Jan. 18, 2013).
---------------------------------------------------------------------------
The stated purpose of section 216 of the FCUA is to ``resolve the
problems of [federally] insured credit unions at the least possible
long-term loss to the [NCUSIF].'' \54\ To carry out that purpose,
Congress set forth a basic structure for PCA in section 216 that
consists of three principal components: (1) A statutory framework that
requires certain mandatory classifications of credit unions and that
NCUA take certain mandatory and discretionary actions against credit
unions based on their classification; (2) an alternative system of PCA
to be developed by NCUA for credit unions defined as ``new''; and (3) a
``risk-based net worth requirement'' that applies to credit unions that
NCUA defines as ``complex.'' This final rule focuses primarily on
principal components (1) and (3), although amendments to part 702 of
NCUA's regulations relating to principal component (2) are also
included as part of this final rule.
---------------------------------------------------------------------------
\54\ 12 U.S.C. 1790d(a)(1).
---------------------------------------------------------------------------
Among other things, section 216(c) of the FCUA requires that NCUA
use a credit union's net worth ratio to determine its classification
among the five ``net worth categories'' set forth in the FCUA.\55\
Section 216(o) generally defines a credit union's ``net worth'' as its
retained earnings balance,\56\ and a credit union's ``net worth ratio''
\57\ as the ratio of its net worth to its total assets.\58\ As a credit
union's net worth ratio declines, so does its classification among the
five net worth categories, thus subjecting it to an expanding range of
mandatory and discretionary supervisory actions.\59\
---------------------------------------------------------------------------
\55\ 12 U.S.C. 1790d(c).
\56\ 12 U.S.C. 1790d(o)(2).
\57\ Throughout this document the terms ``net worth ratio'' and
``leverage ratio'' are used interchangeably.
\58\ 12 U.S.C. 1790d(o)(3).
\59\ 12 U.S.C. 1790d(c)-(g); and 12 CFR 702.204(a) & (b).
---------------------------------------------------------------------------
Section 216(d)(1) of the FCUA requires that NCUA's system of PCA
include, in addition to the statutorily defined net worth ratio
requirement, ``a risk-based net worth requirement \60\ for insured
credit unions that are complex, as defined by the Board . . . .'' \61\
Unlike the terms ``net worth'' and ``net worth ratio,'' which are
specifically defined in section 216(o), the term ``risk-based net
worth'' is not defined in the FCUA.\62\ While Congress prescribed the
net worth ratio requirement in detail in section 216, it elected not to
define the term ``risk-based net worth,'' leaving the details of the
risk-based net worth requirement to be filled in by the Board through
the notice and comment rulemaking process. Section 216, when read as a
whole, grants the Board broad authority to design reasonable PCA
regulations, including a risk-based net worth requirement, so long as
the regulations are comparable to the Other Banking Agencies' PCA
requirements, are consistent with the requirements of section 216 of
the FCUA, and take into account the cooperative character of credit
unions.
---------------------------------------------------------------------------
\60\ For purposes of this rulemaking, the term ``risk-based net
worth requirement'' is used in reference to the statutory
requirement for the Board to design a capital standard that accounts
for variations in the risk profile of complex credit unions. The
term ``risk-based capital ratio'' is used to refer to the specific
standards this rulemaking proposes to function as criteria for the
statutory risk-based net worth requirement. For example, this
rulemaking's proposed risk-based capital ratio would replace the
risk-based net worth ratio in the current rule. The term ``risk-
based capital ratio'' is also used by the Other Banking Agencies and
the international banking community when referring to the types of
risk-based requirements that are addressed in this proposal. This
change in terminology throughout the proposal would have no
substantive effect on the requirements of the FCUA, and is intended
only to reduce confusion for the reader.
\61\ 12 U.S.C. 1790d(d)(1).
\62\ See 12 U.S.C. 1790d(o) (Congress specifically defined the
terms ``net worth'' and ``net worth ratio'' in the FCUA, but did not
define the statutory term ``risk-based net worth.'').
---------------------------------------------------------------------------
Section 216(d)(1) of the FCUA directs NCUA, in determining which
credit unions will be subject to the risk-based net worth requirement,
to base its definition of complex ``on the portfolios of assets and
liabilities of credit unions.'' \63\ The statute does not require, as
some commenters have argued, that the Board adopt a definition of
``complex'' that takes into account the portfolio of assets and
liabilities of each credit union on an individualized basis. Rather,
section 216(d)(1) authorizes the Board to develop a single definition
of complex that takes into account the portfolios of assets and
liabilities of all credit unions.
---------------------------------------------------------------------------
\63\ 12 U.S.C. 1790d(d).
---------------------------------------------------------------------------
In addition, section 216(d)(2) specifies that the risk-based net
worth requirement must ``take account of any material risks against
which the net worth ratio required for [a federally] insured credit
union to be adequately capitalized [(six percent)] may not provide
adequate protection.'' \64\ In the Senate Report on CUMAA, Congress
expressed its intent with regard to the design of the risk-based net
worth requirement and the meaning of section 216(d)(2) by providing:
---------------------------------------------------------------------------
\64\ 12 U.S.C. 1790d(d)(2) (emphasis added).
The NCUA must design the risk-based net worth requirement to
take into account any
[[Page 66641]]
material risks against which the 6 percent net worth ratio required
for a credit union to be adequately capitalized may not provide
adequate protection. Thus the NCUA should, for example, consider
whether the 6 percent requirement provides adequate protection
against interest-rate risk and other market risks, credit risk, and
the risks posed by contingent liabilities, as well as other relevant
risks. The design of the risk-based net worth requirement should
reflect a reasoned judgment about the actual risks involved.\65\
---------------------------------------------------------------------------
\65\ S. Rep. No. 193, 105th Cong., 2d Sess. 13 (1998).
As indicated by the language above, Congress intended the Board, in
designing the risk-based net worth requirement, to address any risks
that may not be adequately accounted for by the statutory 6 percent net
worth ratio requirement. The legislative history is silent on why
Congress chose to tie the provision in section 216(d)(2) to the
statutory 6 percent net worth ratio requirement for adequately
capitalized credit unions and not the 7 percent net worth ratio
requirement for well capitalized credit unions.
Section 216(c) of the FCUA provides that, if a credit union meets
the definition of ``complex'' and it meets or exceeds the net worth
ratio requirement to be classified as either adequately capitalized or
well capitalized, the credit union must also satisfy the corresponding
risk-based net worth requirement to be classified as either adequately
capitalized or well capitalized.\66\ Accordingly, under the separate
risk-based net worth requirement, a complex credit union must, in
addition to meeting the statutory net worth ratio requirement, also
meet or exceed the corresponding minimum risk-based net worth
requirement in order to receive a capital classification of adequately
capitalized or well capitalized, as the case may be.\67\ For example, a
complex credit union must meet or exceed both the applicable net worth
ratio requirement and the applicable risk-based net worth requirement
to be classified as well capitalized. If the credit union fails to meet
either requirement, it is classified in the lowest category for which
it meets both the net worth ratio requirement and the risk-based net
worth requirement.
---------------------------------------------------------------------------
\66\ See 12 U.S.C. 1790d(c)(1)(A) & (c)(1)(B).
\67\ The risk-based net worth requirement also indirectly
impacts credit unions in the ``undercapitalized'' and lower net
worth categories, which are required to operate under an approved
net worth restoration plan. The plan must provide the means and a
timetable to reach the ``adequately capitalized'' category. See 12
U.S.C. 1790d(f)(5) and 12 CFR 702.206(c). However, for ``complex''
credit unions in the ``undercapitalized'' or lower net worth
categories, the minimum net worth ratio ``gate'' to that category
will be six percent or the credit union's risk-based net worth
requirement, if higher than 6 percent. In that event, a complex
credit union's net worth restoration plan will have to prescribe the
steps a credit union will take to reach a higher net worth ratio
``gate'' to that category. See 12 CFR 702.206(c)(1)(i)(A) and 12
U.S.C. 1790d(c)(1)(A)(ii) & (c)(1)(B)(ii).
---------------------------------------------------------------------------
If a complex credit union meets or exceeds the net worth ratio
requirement to be classified as well capitalized or adequately
capitalized, but fails to meet the corresponding minimum risk-based net
worth requirement to be adequately capitalized, then the credit union's
capital classification is ``undercapitalized'' based on the risk-based
net worth requirement. Similarly, if a complex credit union's net worth
ratio meets or exceeds the requirement that corresponds to the well
capitalized category, but its risk-based net worth ratio meets only the
requirement that corresponds with the adequately capitalized capital
category, then that credit union's capital classification is adequately
capitalized. In either case, the credit union is subject to the
mandatory supervisory and discretionary supervisory actions applicable
to its capital classification category.\68\
---------------------------------------------------------------------------
\68\ 12 U.S.C. 1790d(c)(1)(c)(ii).
---------------------------------------------------------------------------
In response to the Second Proposal, a significant number of
commenters questioned the Board's legal authority to impose a risk-
based net worth requirement on both well capitalized and adequately
capitalized credit unions. As also discussed in the Section-by-Section
part of the preamble below, the commenters' selective reading of
section 216 of the FCUA is a misinterpretation. NCUA is legally
authorized to impose a risk-based net worth requirement on both well
capitalized and adequately capitalized credit unions under the FCUA.
Section 216(c)(1)(A) specifically provides that, to be classified as
well capitalized, a complex credit union must meet the statutory net
worth ratio requirement and any applicable risk-based net worth
requirement. Section 216(c)(1)(A)(ii) provides that a credit union must
meet any applicable risk-based net worth requirement under section
216(d) of this section to be classified as well capitalized. The plain
language of sections 216(c)(1)(A)(ii) and (c)(1)(B)(ii),, read in
conjunction with the language in section 216(d), indicates Congress'
intent to authorize the Board to impose risk-based net worth
requirements on both well capitalized and adequately capitalized credit
unions.
Section 216(d)(2) of the FCUA sets forth specific requirements for
the design of the risk-based net worth requirement mandated under
section 216(d)(1).\69\ Specifically, section 216(d)(2) requires that
the Board ``design the risk-based net worth requirement to take account
of any material risks against which the net worth ratio required for an
insured credit union to be adequately capitalized may not provide
adequate protection.''\70\ Under section 216(c)(1)(B) of the FCUA, the
net worth ratio required for an insured credit union to be adequately
capitalized is six percent.\71\ The plain language of section 216(d)(2)
supports NCUA's interpretation that Congress intended for the Board to
design a risk-based net worth requirement to take into account any
material risks that may not be addressed adequately through the
statutory 6 percent net worth ratio required for a credit union to be
adequately capitalized.\72\
---------------------------------------------------------------------------
\69\ 12 U.S.C. 1790d(d).
\70\ 12 U.S.C. 1790d(d)(2) (emphasis added).
\71\ 12 U.S.C. 1790d(c)(1)(B).
\72\ See S. Rep. No. 193, 105th Cong., 2d Sess. (1998)
(providing in relevant part: ``The NCUA must design the risk-based
net worth requirement to take into account any material risks
against which the 6 percent net worth ratio required for an insured
credit union to be adequately capitalized may not provide adequate
protection.'').
---------------------------------------------------------------------------
In other words, the language in section 216(d)(2) of the FCUA
simply identifies the types of risks that NCUA's risk-based net worth
requirement should address (i.e., those risks not already addressed by
the statutory six percent net worth ratio requirement). It is a
misinterpretation of section 216(d)(2) to argue, as some commenters
have, that Congress's use of the term ``adequately capitalized'' in
section 216(d)(2) somehow limits the Board's authority to require that
complex credit unions maintain a higher risk-based capital ratio level
to be classified as well capitalized. Rather than prohibiting the Board
from imposing a higher risk-based capital ratio level for credit unions
to be classified as well capitalized, section 216(d)(2) simply requires
that the Board design the risk-based net worth requirement to take into
account those risks that may not adequately be addressed by the
statute's six percent net worth ratio requirement. Thus, the plain
language of section 216(d) does not support those commenters'
interpretation.
The Board's legal authority to impose a risk-based net worth
requirement on both well capitalized and adequately capitalized credit
unions is further supported by the Other Banking
[[Page 66642]]
Agencies' PCA statute and regulations.\73\ Some commenters have argued
that Congress's use of the singular noun ``requirement'' in Section
216(d) of the FCUA indicates its intent that there be only one risk-
based net worth ration level tied to the adequately capitalized level.
Section 38(c)(1)(A) of the FDI Act, upon which section 216 of the FCUA
was modeled,\74\ however, requires that the Other Banking Agencies'
``relevant capital measures'' include ``(i) a leverage limit; and (ii)
a risk-based capital requirement.'' \75\ Despite Congress' use of the
singular noun ``requirement'' in section 38 of the FDI Act, the Other
Banking Agencies' PCA regulations, which went into effect before
Congress passed CUMAA, have long required that their regulated
institutions meet different risk-based capital ratio levels to be
classified as well capitalized, adequately capitalized,
undercapitalized, or significantly undercapitalized. Moreover, the
United States Code addresses the singular--plural question in its rules
of statutory construction: ``In determining the meaning of any Act of
Congress, unless the context indicates otherwise . . . words importing
the singular include and apply to several persons, parties, or things;
words importing the plural include the singular . . .'' \76\ Therefore,
setting different risk-based capital ratio levels for credit unions to
be adequately and well capitalized, is consistent with the requirements
of section 216 of the FCUA and is ``comparable'' to the Other Banking
Agencies' PCA regulations.
---------------------------------------------------------------------------
\73\ See 12 U.S.C. 1831o, and, e.g., 12 CFR 324.403(b).
\74\ See S. Rep. No. 193, 105th Cong., 2d Sess., 12 (1998)
(Providing in relevant part: ``New section 216 [of the FCUA] is
modeled on section 38 of the Federal Deposit Insurance Act, which
has applied to FDIC-insured depository institutions since 1992.'').
\75\ 12 U.S.C. 1831o(c)(1)(A) (emphasis added).
\76\ 1 U.S.C. 1.
---------------------------------------------------------------------------
As explained in the Second Proposal, the FCUA requires NCUA to
establish a risk-based capital system that is comparable to that in
place for FDIC insured banks, and to take into account the cooperative
character of credit unions. Some commenters criticized, however, that
the Second Proposal took into account only the comparability
requirement, and ignored the requirement to take into consideration the
cooperative nature of credit unions. In support of their assertion, the
commenters suggested that, because of their unique cooperative
structure, strong member focus, and the absence of stock options for
executives or pressure from stockholders, credit unions eschew
excessive risk taking. The commenters suggested further, that in the
face of the 2007-2009 financial crisis, credit unions--unlike their
counterparts in the for-profit banking sector--served as both a
counter-cyclical force and a safe haven, with much stronger loan and
deposit growth than banking institutions. Accordingly, many commenters
suggested that the Board, to take into account the cooperative
character of credit unions, must impose risk-based capital requirements
that are equal to or lower than the standards applicable to banks.
The Board disagrees with the claim that NCUA failed to take into
account the cooperative character of credit unions in designing the
risk-based capital requirement. In the Original Proposal, which varied
to a greater degree from the Other Banking Agencies' capital
regulations than the Second Proposal, the Board proposed a significant
number of alternative provisions, many of which were specifically
intended to take into account the cooperative character of credit
unions. The overwhelming response from credit unions in relation to
that proposed approach, however, was to recommend that the Board revise
the proposal to be more like the capital requirements adopted by the
Other Banking Agencies to avoid putting credit unions at a competitive
disadvantage to banks. As discussed in more detail below, the Board
generally agreed with commenters' recommendations in that regard, and
designed the Second Proposal to be more like the Other Banking
Agencies' capital regulations. In the preamble to the Second Proposal,
however, the Board specifically discussed ways in which the proposal
continued to deviate from the Other Banking Agencies' capital
requirements to take into account the cooperative character of credit
unions. Furthermore, while it may generally be true that ``credit
unions eschew excessive risk taking,'' as suggested by some commenters,
that fact alone does not support assigning lower risk weights to credit
union assets, or requiring that credit unions meet lower risk-based
capital ratio levels to be adequately or well capitalized. To the
contrary, for reasons explained in more detail below, a credit union
that eschews excessive risk taking should have no trouble maintaining a
high risk-based capital ratio level under this final rule.
At least one commenter also suggested that credit unions' reliance
primarily on retained earnings to build capital and operate make their
operational structures both unique and challenging. Thus, the commenter
concluded that, by requiring a higher risk-based capital ratio level
for well capitalized credit unions, the Second Proposal failed to take
these factors into consideration, as required by section 216(b)(1)(B)
of the FCUA. The Board disagrees. Credit unions' limited access to
supplemental forms of capital and reliance primarily on retained
earnings for building capital suggests, if anything, that requiring
credit unions to maintain higher levels of capital is appropriate. In a
financial downturn, the retained earnings of a financial institution
are likely to decrease. Under such circumstances, an institution with
limited access to other alternative forms of capital needs a higher
level of capital on hand to ensure its survival. In the case of NCUA's
capital requirements, that higher level of capital is already required
under the statutory net worth ratio requirement, which requires credit
unions maintain higher leverage (net worth) ratios than banks.
Accordingly, consistent with the Second Proposal, the risk-based
capital ratio levels adopted in this final rule for adequately and well
capitalized credit unions are designed to be generally equivalent to
the corresponding risk-based capital ratio levels required for banks.
IV. Section-by-Section Analysis
Part 702--Capital Adequacy
Revised Structure of Part 702
Consistent with the Second Proposal, this final rule reorganizes
part 702 by consolidating NCUA's PCA requirements, which are currently
included under subsections A, B, C, and D, under new subparts A and B.
New subpart A is titled ``Prompt Corrective Action'' and new subpart B
is titled ``Alternative Prompt Corrective Action for New Credit
Unions.'' The reorganization is designed so that a credit union need
only reference the subpart that applies to its institution, rather than
having to flip back-and-forth between multiple subparts in part 702 to
identify the applicable minimum capital standards and PCA regulations.
Consolidating these sections reduces confusion and will save credit
union staff from having to frequently flip back and forth through the
four subparts of the current PCA rule.
In general, this final rule restructures part 702 by consolidating
most of the sections relating to capital and PCA that are applicable to
only credit unions that are not ``new'' under new subpart A. The
specific sections that would be included in new subpart A and the
changes to those sections are discussed in more detail below.
[[Page 66643]]
Similarly, this final rule consolidates most of NCUA's rules
relating to alternative capital and PCA requirements for ``new'' credit
unions under new subpart B. The sections under new subpart B remain
largely unchanged from the requirements of current part 702 relating to
alternative capital and PCA, except for revisions to the sections
relating to reserves and the payment of dividends. The specific
sections included in new subpart B and the specific changes to the
sections are discussed in more detail below.
Finally, this final rule retains subpart E of part 702, Stress
Testing, but re-designates and re-numbers the current subpart as
subpart C. Other than re-designating and re-numbering the subpart, the
language and requirements of current subpart E are unchanged by this
final rule.
Section 702.1 Authority, Purpose, Scope, and Other Supervisory
Authority
Consistent with the Proposal, Sec. 702.1 of the final rule remains
substantially similar to current Sec. 702.1, but is amended to update
terminology and internal cross references within the section,
consistent with the changes that are being made in other sections of
part 702. No substantive changes to the section are intended.
Section 216(b)(1) of the FCUA requires the Board to adopt by
regulation a system of PCA for insured credit unions that is
``comparable to'' the system of PCA prescribed in the FDI Act, that is
also ``consistent'' with the requirements of section 216 of the FCUA,
and that takes into account the cooperative character of credit
unions.\77\ Paragraph (d)(1) of the same section requires that NCUA's
system of PCA include ``a risk-based net worth requirement for insured
credit unions that are complex . . .'' When read together, these
sections grant the Board broad authority to design reasonable risk-
based capital regulations to carry out the stated purpose of section
216, which is to ``resolve the problems of [federally] insured credit
unions at the least possible long-term loss to the [National Credit
Union Share Insurance] Fund.'' \78\ As explained in more detail below,
this final rule is comparable, although not identical in detail, to the
PCA and risk-based capital requirements for banks. In addition, as
explained throughout the preamble to this final rule, this rule
deviates from the PCA and risk-based capital requirements applicable to
banks as required by section 216 of the FCUA, and to take into account
the cooperative character of credit unions. Accordingly, the revised
risk-based net worth requirement and this final rule are consistent
with section 216 of the FCUA.
---------------------------------------------------------------------------
\77\ 12 U.S.C. 1790d(b)(1).
\78\ 12 U.S.C. 1790d(a)(1).
---------------------------------------------------------------------------
Section 702.2--Definitions
The Second Proposal would have removed the paragraph numbers
assigned to each of the definitions under current Sec. 702.2 and would
have reorganized the section so the new and existing definitions were
listed in alphabetic order. Many of the definitions in current Sec.
702.2 were retained, however, with no substantive changes. The
reorganization of the section and the removal of the paragraph
numbering made proposed Sec. 702.2 more consistent with current
Sec. Sec. 700.2, 703.2 and 704.2 of NCUA's regulations.\79\ In
addition, proposed Sec. 702.2 included a number of new definitions,
and would have amended some of the definitions in current Sec. 702.2.
---------------------------------------------------------------------------
\79\ 12 CFR 700.2; 12 CFR 703.2; and 12 CFR 704.2.
---------------------------------------------------------------------------
Consistent with section 202 of the FCUA,\80\ the Second Proposal
also incorporated the phrase `in accordance with GAAP' into many of the
definitions to clarify that generally accepted accounting principles
must be used determine how an item is recorded on the statement of
financial condition from which it would be incorporated into the risk-
based capital calculation. This proposed change was intended to help
clarify the meaning of terms used in the Second Proposal.
---------------------------------------------------------------------------
\80\ 12 U.S.C. 1782(a)(6)(C)(i).
---------------------------------------------------------------------------
The Board received no comments on the proposed technical changes to
Sec. 702.2. The Board did, however, receive one general comment on the
definitions section: At least one commenter stated that the revisions
to the definitions, particularly those that now rely on GAAP
definitions, seemed fair and reasonable. At least one commenter also
suggested that the proposed changes to the definitions were all for the
better and made the rule much clearer. The Board agrees with the
commenters and has decided to retain the changes described above in
this final rule.
The following definitions, consistent with the Second Proposal, are
also added to, amended in, or removed from Sec. 702.2 by this final
rule:
Allowances for loan and lease losses (ALLL). The Second Proposal
defined the term ``allowances for loan and lease losses'' as valuation
allowances that have been established through a charge against earnings
to cover estimated credit losses on loans, lease financing receivables
or other extensions of credit as determined in accordance with GAAP.
The Board received no comments on the proposed definition and has
decided to retain the definition in this final rule without change.
Amortized cost. The Second Proposal defined the term ``amortized
cost'' as the purchase price of a security adjusted for amortizations
of premium or accretion of discount if the security was purchased at
other than par or face value.
The Board received no comments on the proposed definition and has
decided to retain the definition in this final rule without change.
Appropriate regional director. The Second Proposal would have
amended current Sec. 702.2 to remove the definition of the term
``appropriate regional director'' from the current rule.
The Board received no comments on this proposed revision and has
decided to retain the revision in this final rule without change.
Appropriate state official. Under the Second Proposal, the Board
proposed revising the definition of the term ``appropriate state
official'' by adding the italicized words (``state'' and ``the'') to
the current definition, and by removing the words ``chartered by the
state which chartered the affected credit union.'' The revised
definition would have provided that the term ``appropriate state
official'' means the state commission, board or other supervisory
authority having jurisdiction over the credit union.
Public Comments on the Second Proposal
One commenter suggested that, although the proposed revision to the
definition was meant to provide clarity, it might obfuscate the role of
state supervisors in the PCA process because several states could have
``jurisdiction'' over a given credit union on a particular issue. In
contemplating the possible effects of the proposed revision, the
commenter asked a number of questions: Will NCUA consult with all state
regulators where an affected credit union has a branch or member when
taking discretionary supervisory action? \81\ Will a credit union have
to obtain approval from all states that it operates in before issuing
dividends when less than adequately capitalized? \82\ The commenter
suggested further that while timely sharing of information across all
[[Page 66644]]
affected regulators was a laudable goal, crucial and time sensitive
decisions regarding the reclassification or conservatorship of a credit
union should be made by only the primary chartering authority of the
institution in consultation with the deposit insurer. Accordingly, the
commenter recommended that the Board should amend this definition to
read ``the state commission, board or other supervisory authority which
chartered the affected credit union.''
---------------------------------------------------------------------------
\81\ 12 CFR 702.110(c).
\82\ 12 CFR 702.114(b).
---------------------------------------------------------------------------
Discussion
The Board generally agrees with the commenter and is adopting the
proposed revisions to the definition of ``appropriate state official''
by making the following changes: At the end of the proposed the
definition, the final rule deletes the words ``having jurisdiction over
the'' from the proposed definition, and adds in their place the words
``that chartered the affected.'' This change clarifies that NCUA must
consult with only the state authority that chartered the credit union;
not every state agency having some form of jurisdiction over the credit
union.
Accordingly, the final rule defines ``appropriate state official''
as the state commission, board or other supervisory authority that
chartered the affected credit union.
Call Report. The Second Proposal defined the term ``Call Report''
as the Call Report required to be filed by all credit unions under
Sec. 741.6(a)(2).
The Board received no comments on the definition and has decided to
retain the proposed definition in this final rule without change.
Carrying value. The Second Proposal defined the term ``carrying
value,'' with respect to an asset, as the value of the asset on the
statement of financial condition of the credit union, determined in
accordance with GAAP.
The Board received no comments on the proposed definition, but is
clarifying in this final rule that ``carrying value'' applies to both
assets and liabilities. Accordingly, this final rule defines ``carrying
value'' as the value of the asset or liability on the statement of
financial condition of the credit union, determined in accordance with
GAAP.
Central counterparty (CCP). The Second Proposal defined the term
``central counterparty'' as a counterparty (for example, a clearing
house) that facilitates trades between counterparties in one or more
financial markets by either guaranteeing trades or novating contracts.
The Board received no comments on the definition and has decided to
retain the proposed definition in this final rule without change.
Charitable donation account. The Second Proposal did not use or
define the term ``charitable donation account.'' Under the proposal,
such accounts, which federal credit unions are authorized to establish
under Sec. 721.3(b)(2) of NCUA's regulations, would have been assigned
a risk weight based on the risk-weight of each individual asset type in
the account.
Public Comments on the Second Proposal
NCUA received several comments regarding the risk weights assigned
to charitable donation accounts under the Second Proposal. Commenters
suggested that the proposed risk weights assigned to charitable
donation accounts would contravene the appeal for credit unions to put
money into these investments to fund charitable activities. The
commenters pointed out that the risk-based capital regulation from the
Office of the Comptroller of the Currency (OCC) recognizes the
importance of community development investments and assigns a risk
weight of 100 percent to such assets. Commenters suggested that the
NCUA Board should adopt a similar approach to encourage charitable
donation accounts to support charitable goals and purposes.
Discussion
The Board generally agrees with the commenters and, as also
discussed in the part of the preamble associated with Sec. 702.104(c),
has decided to assign a 100 percent risk weight to certain charitable
donation accounts under this final rule, at the credit union's option.
Under the Second Proposal, the assets held in a charitable donation
account were each assigned a risk weight based on each individual asset
type in the account. After reviewing the comments received, however,
the Board generally agrees with commenters who suggested that
charitable donation account equity exposures, which are held at credit
unions, have a role analogous to community development equity
exposures, which are held at banks, and therefore warrant assigning
such accounts an equivalent risk weight. Community development equity
exposures are assigned a 100 percent risk weight under the Other
Banking Agencies' regulations. Thus, this final rule gives credit
unions the option for risk weighting charitable donation accounts in a
manner that is generally equivalent to the Other Banking Agencies' 100
percent risk weight for community development investment equity
exposures. Under this final rule, a credit union has the option of
applying risk weights to the individual assets within a charitable
donation account, or just applying a 100 percent risk weight to the
whole charitable donation account. A credit union cannot, however, use
a combination of the two methods described to assign a risk weight to
the same charitable donation account.
In defining ``charitable donation account,'' the Board chose to
limit the types of accounts that would qualify for the 100 percent risk
weight. In particular, the Board chose allow such treatment for
accounts only if they met certain restrictions in 12 CFR
721.3(b)(2)(i), (b)(2)(ii), and (b)(2)(v). Thus, to qualify for the
optional 100 percent risk weight under Sec. 702.104(c)(3)(ii) of this
final rule, an account must meet the following criteria:
The book value of the credit union's investments in all
charitable donation accounts (CDAs), in the aggregate, as carried on
its statement of financial condition prepared in accordance with
generally accepted accounting principles, must be limited to 5 percent
of the credit union's net worth at all times for the duration of the
accounts, as measured every quarterly Call Report cycle. This means
that regardless of how many CDAs the credit union invests in, the
combined book value of all such investments must not exceed 5 percent
of its net worth. The credit union must bring its aggregate accounts
into compliance with the maximum aggregate funding limit within 30 days
of any breach of this limit.
The assets of a charitable donation account must be held
in a segregated custodial account or special purpose entity and must be
specifically identified as a charitable donation account.
The credit union is required to distribute to one or more
qualified charities, no less frequently than every 5 years, and upon
termination of a charitable donation account regardless of the length
of its term, a minimum of 51 percent of the account's total return on
assets over the period of up to 5 years. Other than upon termination,
the credit union may choose how frequently charitable donation account
distributions to charity will be made during each period of up to 5
years. For example, the credit union may choose to make periodic
distributions over a period of up to 5 years, or only a single
distribution as required at the end of that period. The credit union
may choose to donate in excess of the minimum distribution frequency
and amount;
[[Page 66645]]
The three criteria above are included in the definition of
charitable donation account to ensure that such accounts, if assigned a
100 percent risk weight, will be used primarily for charitable purposes
and not present a material risk to a credit union regardless of the
types of assets held in the accounts. The definition includes a 5
percent of net worth limit on charitable donation accounts to reflect
an amount that allows a credit union to generate income for the charity
while ensuring any risks associated with such accounts do not pose
safety and soundness issues. In determining the 5 percent of net worth
limit, the Board considered the investment types a credit union could
purchase in a charitable donation account, which can include
investments with significant credit risk. The Board determined that a 5
percent of net worth limit was reasonable given NCUA's charitable
donation account regulations and necessary to ensure that the accounts
were small enough to not pose a safety and soundness issue to the
NCUSIF if assigned a 100 percent risk weight.
The definition also specifies that charitable donation accounts
must be held in segregated custodial accounts or special purpose
entities, and must be specifically identified as charitable donation
accounts, to ensure holdings can be measured for exposure and monitored
for performance and distribution. The Board determined the segregation
of accounts is necessary to ensure a credit union and NCUA could
measure compliance with the net worth and distribution criteria,
consistent with safety and soundness and the account's purpose.
Finally, the definition specifies that distributions must be made
in a particular manner to ensure such accounts are used primarily for
charitable giving. By specifying the distribution manner, the
definition of charitable donation account ensures that the account will
primarily be used for charitable giving. This distinction is generally
consistent with the Other Banking Agencies' regulations, which assign a
100 percent risk-weight to community development investment equity
exposures.
Without each of the three criteria discussed above, a charitable
donation account would primarily be an investment vehicle for a credit
union and could present a material risk to the credit union and the
NCUSIF. Accordingly, this final rule defines ``charitable donation
account'' as an account that satisfies all of the conditions in 12 CFR
721.3(b)(2)(i), (b)(2)(ii), and (b)(2)(v).
Commercial loan. The Second Proposal defined the new term
``commercial loan'' as any loan, line of credit, or letter of credit
(including any unfunded commitments) to individuals, sole
proprietorships, partnerships, corporations, or other business
enterprises for commercial, industrial, and professional purposes, but
not for investment or personal expenditure purposes. The definition
would have also provided that the term commercial loan excludes loans
to CUSOs, first- or junior-lien residential real estate loans, and
consumer loans.
Public Comments on the Second Proposal
The Board received many comments regarding the proposed new term
``commercial loan'' and its definition. Several commenters agreed with
creating a category of ``commercial loans'' as distinct from
traditional member business loans for purposes of the risk-based
capital ratio requirement. At least one commenter stated that, while
differentiating between ``commercial loans'' for risk-based capital
purposes and ``member-business loans'' as defined for lending purposes
is appropriate, the subtle differences in these definitions may cause
confusion. Similarly, another commenter suggested that even though it
would require changes to the call report and how credit union classify
these loans, the Board was right to use the broader definition of
commercial loans in the proposal because there is no difference in the
credit risk of member business loans and commercial loans.
Conversely, other commenters suggested that replacing the term
``member business loan,'' which credit unions and NCUA's regulations
already use, with the new term ``commercial loan'' for purposes of the
risk-based capital regulation would cause unnecessary confusion. Other
commenters suggested that the proposed definition of ``commercial
loan'' should be revised to be consistent with the definition of
``member business loan'' in part 723 of NCUA's regulations because they
believed the differences between the two definitions were immaterial to
a credit union's capital requirement, but would add unnecessary
administrative burden to the Call Report.
In addition, a trade association commenter pointed out that the
proposed definition of a ``commercial loan'' specifies that it is a
loan ``to individuals, sole proprietorships, partnerships,
corporations, or other business enterprises,'' and explicitly excludes
loans to CUSOs, first- or junior-lien residential real estate loans,
and consumer loans. The commenter pointed out, however, that the
preamble to the Second Proposal seemed to indicate that whether or not
a loan is ``commercial'' will be based exclusively on the purpose of
the loan, use of the proceeds, and type of collateral. The Commenter
suggested that if a loan can be considered commercial regardless of the
type of borrower, the Board should consider removing the list of
potential borrowers and simply retaining the exclusions of specific
loan types. The commenter suggested further that the proposal specified
that a commercial loan is a loan made for ``commercial, industrial, and
professional purposes, but not for investment or personal expenditure
purposes.'' But, under part 723 of NCUA's regulations, MBLs are made
for commercial, corporate, other business investment property or
venture, or agricultural purposes.\83\ The commenter recommending
clarifying the alignment of these two definitions in the final rule,
and that if the only intended differences in treatment arise from the
definitions of loans to CUSOs, first- or junior-lien residential real
estate loans, and consumer loans, then the Board should consider
adopting the member business loan language and retaining those explicit
exclusions. At least one commenter also pointed out that current Sec.
723.1(d) and (e) of NCUA's member business lending regulations
reference treatment of purchased member and non-member loans and loan
participations for risk-weight purposes under part 702, and encouraged
the Board to review those sections for consistency with the proposed
definition of commercial loan. Another commenter requested that the
Board clarify whether the definition of ``commercial loans'' includes
loans to non-profits. One state supervisory authority commenter
requested clarification on whether the definition, which lists a number
of specific asset types, would include agricultural loans.
---------------------------------------------------------------------------
\83\ 12 CFR 723.1(a).
---------------------------------------------------------------------------
Discussion
As stated in the Second Proposal, the new term ``commercial loan''
and its proposed definition more accurately capture the risks these
loans present than the term MBL, and better identifies loans that are
made for a commercial purpose and have similar risk characteristics.
While there could be some initial confusion associated with the use of
this new term, the Board notes that such confusion can be addressed
during the implementation period and in guidance before the final rule
becomes effective in 2019.
[[Page 66646]]
Guidance contained in the Call Report for the proper reporting of
commercial loans will also provide information to credit unions to
ensure proper reporting of both ``commercial'' loans for the purpose of
assigning risk weights and the reporting of MBLs for the purpose of
monitoring compliance with the statutory limit.
The Board agrees, however, with commenters who suggested that the
purpose of a loan determine its classification as a ``commercial''
loan. The risks associated with a commercial loan are related to its
purpose. Moreover, the proposed list of entities that could have
received the loans encompassed all possibilities, including non-profit
organizations. Thus the removal of the list of parties who could
receive the loans would be inconsequential. Accordingly, the Board is
amending the definition of ``commercial loan'' to remove the words ``to
individuals, sole proprietorships, partnerships, corporations, or other
business enterprises.''
The Board maintains, however, that the listing of commercial
purposes in the proposed definition was adequate and plainly included
agricultural loans if they are granted for a commercial or industrial
purpose. Similarly, it is clear that a loan purchased by a credit
union, which was made for a commercial purpose, was also included
within the proposed definition of a commercial loan, whether it is a
loan to member or non-member. Thus no additional changes to the
definition are necessary.
Accordingly, this final rule defines ``commercial loan'' as any
loan, line of credit, or letter of credit (including any unfunded
commitments) for commercial, industrial, and professional purposes, but
not for investment or personal expenditure purposes. The definition
provides further that the term commercial loan excludes loans to CUSOs,
first- or junior-lien residential real estate loans, and consumer
loans.
Commitment. The Second Proposal defined the term ``commitment'' as
any legally binding arrangement that obligates the credit union to
extend credit, to purchase or sell assets, or enter into a financial
transaction.
The Board received no comments on the proposed definition, but has
decided to clarify in this final rule that a ``commitment'' can also
refer to funding transactions. Accordingly, this final rule would
define ``commitment'' as any legally binding arrangement that obligates
the credit union to extend credit, purchase or sell assets, enter into
a borrowing agreement, or enter into a financial transaction.
Consumer loan. The Second Proposal defined the term ``consumer
loan'' as a loan to one or more individuals for household, family, or
other personal expenditures, including any loans secured by vehicles
generally manufactured for personal, family, or household use
regardless of the purpose of the loan. The proposed definition would
have provided further that the term consumer loan excludes commercial
loans, loans to CUSOs, first- and junior-lien residential real estate
loans, and loans for the purchase of fleet vehicles.
Public Comments on the Second Proposal
The proposed definition of ``consumer loan'' referenced loans ``to
one or more individuals . . . including any loans secured by vehicles
generally manufactured for personal, family, or household use
regardless of the purpose of the loan.'' At least one commenter
requested that the Board clarify whether the same loan would still be
considered a consumer loan if made to an incorporated entity. If the
definition is not dependent on the type of borrower, the commenter
suggested that the words ``one or more individuals'' were not
necessary. The commenter also requested that the Board clarify the
definition of a loan ``for the purchase of fleet vehicles,'' and, to
maximize ease of compliance, recommended the Board incorporate the
definition of ``fleet'' contained in a 2012 NCUA legal opinion directly
into the definition.\84\
---------------------------------------------------------------------------
\84\ NCUA, Definition of Fleet, Legal Opinion Letter 12-0764
(Sept. 13, 2012), available at https://www.ncua.gov/Legal/Pages/OL2012-12-0764.aspx.
---------------------------------------------------------------------------
Discussion
The Board agrees with the commenter who suggested that a consumer
loan should be defined by the purpose of the loan and not depend on the
type of entity receiving the loan, be it an individual, corporation, or
some other business. The material risks associated with holding a
prudently underwritten consumer loan are related to its purpose, not on
the type of borrower. Accordingly, this final rule amends the proposed
definition of consumer loan to remove the words ``to one or more
individuals'' from the definition.
The Board also generally agrees with the commenter who suggested
the final rule should further clarify the reference to ``fleet
vehicles'' in the proposed definition of consumer loans. As pointed out
by the commenter, NCUA's General Counsel issued a legal opinion letter
in 2012 that interprets the term ``fleet'' for purposes of Sec.
723.7(e) of NCUA's regulations.\85\ The letter provides that a fleet
means ``five or more vehicles that are centrally controlled and used
for a business purpose, including for the purpose of transporting
persons or property for commission or hire.'' The meaning of the term
``fleet,'' as used in the proposed definition of consumer loan, should
be consistent with the use of the term in Sec. 723.7(e). While the
Second Proposal did not propose adopting the definition of ``fleet''
provided in the 2012 legal opinion letter, the term should have the
same meaning. The term does not need to be defined in this final rule.
Future changes in market realities surrounding the use of the term
``fleet'' make adopting a fixed definition of the term impractical. The
Board agrees, however, that revising the proposed use of the term
``fleet'' in the definition of consumer loan to be more consistent with
the use of the term fleet in Sec. 723.7(e) will help avoid confusion
regarding the term's meaning. Accordingly, the final rule revises the
last clause in the second sentence of the definition of the term
``consumer loan'' to provide, ``and loans for the purchase of one for
more vehicles to be part of a fleet of vehicles.''
---------------------------------------------------------------------------
\85\ NCUA, Definition of Fleet, Legal Opinion Letter 12-0764
(Sept. 13, 2012), available at https://www.ncua.gov/Legal/Pages/OL2012-12-0764.aspx.
---------------------------------------------------------------------------
NCUA will provide separate examiner guidance on the application of
the definition of consumer loans to ensure consistent interpretation of
the definition in the future. NCUA's Call Report instructions will also
contain appropriate guidance for the proper reporting of consumer
loans. For the reasons discussed above, this final rule defines the
term ``consumer loan'' as a loan for household, family, or other
personal expenditures, including any loans that, at origination, are
wholly or substantially secured by vehicles generally manufactured for
personal, family, or household use regardless of the purpose of the
loan. The definition provides further that the term consumer loan
excludes commercial loans, loans to CUSOs, first- and junior-lien
residential real estate loans, and loans for the purchase of one or
more vehicles to be part of a fleet of vehicles.
Contractual compensating balance. The Second Proposal defined the
term ``contractual compensating balance'' as the funds a commercial
loan borrower must maintain on deposit at the lender credit union as
security for the loan in accordance with the loan agreement, subject to
a proper account hold and on deposit as of the measurement date.
[[Page 66647]]
The Board received no comments on the definition and has decided to
retain the proposed definition in this final rule without change.
Credit conversion factor (CCF). The Second Proposal defined the
term ``credit conversion factor'' as the percentage used to assign a
credit exposure equivalent amount for selected off-balance sheet
accounts.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Credit union. The Second Proposal defined the term ``credit union''
as a federally insured, natural-person credit union, whether federally
or state-chartered. The proposal would have amended the current
definition of the term ``credit union'' to remove the words ``as
defined by 12 U.S.C. 1752(6)'' from the end of the definition because
they were unnecessary, and could mistakenly be read to limit the
definition of ``credit unions'' to state-chartered credit unions.
The Board received no comments on the proposed revisions to the
definition of ``credit union'' and has decided to retain the proposed
definition in this final rule without change.
Current. The Second Proposal defined the term ``current,'' with
respect to any loan, as less than 90 days past due, not placed on non-
accrual status, and not restructured.
Public Comments on the Second Proposal
The Board received only a small number of comments on the proposed
definition of the term ``current.'' Most commenters who mentioned it
supported the proposed definition of ``current.'' One credit union
commenter, however, suggested that the Board should define ``current''
as loans that are 60 days past due, which was the period provided in
the Original Proposal, because expanding the delinquency loans to 90
days has more risk and greater exposer to potential loss. Another
commenter recommended that the definition of ``current'' be revised so
it does not automatically exclude all restructured loans. Another
commenter argued that while it is understandable to require a higher
risk-weighting for non-current loans, lumping restructured loans into
this same category and treatment would be punitive. The commenter
suggested that the definition of ``restructured loans'' be amended to
specifically address loans that the commenter referred to as ``troubled
debt relief assets,'' which are loans that have been modified because
of financial hardship in the face of some type of credit impairment.
According to the commenter, the Financial Accounting Standards Board
already requires excess reserves be held for these assets based on the
difference between the net present value of the loans under the
original terms versus the modified terms. The commenter contended that
credit unions currently hold reserves of over 10 percent against loans
that are performing and have very low incidents of future default.
Therefore, the commenter concluded, treating a ``troubled debt relief
asset'' as a non-current loan would not reflect the fact that a
modification has been made to a loan and it is performing. The
commenter suggested that such restructurings aid the future performance
of such loans.
Discussion
The Board believes that the proposed definition of ``current'' is
consistent with Sec. 741.3(b)(2), which specifies that a credit
union's written lending policies must include ``loan workout
arrangements and nonaccrual standards that include the discontinuance
of interest accrual on loans past due by 90 days or more,'' and aligns
well with the definition of ``current loan'' under the Other Banking
Agencies' regulations.\86\ In general, loans that are more than 90 days
past due, or restructured, tend to have higher incidences of default
resulting in losses. The proposed definition is consistent with the
definition used under the Other Banking Agencies' risk-based capital
rules and is not dependent upon, nor contradictory to, related
accounting pronouncements. Additional guidance will be provided to
credit unions in the future regarding reporting troubled debt
restructuring (TDR) loans through supervisory guidance and in the
instructions on the Call Report. Accordingly, the Board has decided to
retain the proposed definition in this final rule without change.
---------------------------------------------------------------------------
\86\ See, e.g., 12 CFR 324.32(k).
---------------------------------------------------------------------------
CUSO. The Second Proposal defined the term ``CUSO'' as a credit
union service organization as defined in parts 712 and 741.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Custodian. The Second Proposal defined the term ``custodian'' as a
financial institution that has legal custody of collateral as part of a
qualifying master netting agreement, clearing agreement or other
financial agreement.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Depository institution. The Second Proposal defined the term
``depository institution'' as a financial institution that engages in
the business of providing financial services; that is recognized as a
bank or a credit union by the supervisory or monetary authorities of
the country of its incorporation and the country of its principal
banking operations; that receives deposits to a substantial extent in
the regular course of business; and that has the power to accept demand
deposits. The definition provided further that the term depository
institution includes all federally insured offices of commercial banks,
mutual and stock savings banks, savings or building and loan
associations (stock and mutual), cooperative banks, credit unions and
international banking facilities of domestic depository institutions,
and all privately insured state-chartered credit unions.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Derivatives Clearing Organization (DCO). The Second Proposal
defined the term ``Derivatives Clearing Organization (DCO)'' as having
the same definition as provided by the Commodity Futures Trading
Commission in 17 CFR 1.3(d).
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Derivative contract. The Second Proposal defined the term
``derivative contract'' as a financial contract whose value is derived
from the values of one or more underlying assets, reference rates, or
indices of asset values or reference rates. The definition provided
further that the term derivative contract includes interest rate
derivative contracts, exchange rate derivative contracts, equity
derivative contracts, commodity derivative contracts, and credit
derivative contracts. The definition also provided that the term
derivative contract also includes unsettled securities, commodities,
and foreign exchange transactions with a contractual settlement or
delivery lag that is longer than the lesser of the market standard for
the particular instrument or five business days.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Equity investment. The Second Proposal defined the term ``equity
[[Page 66648]]
investment'' as investments in equity securities, and any other
ownership interests, including, for example, investments in
partnerships and limited liability companies.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Equity investment in CUSOs. The Second Proposal defined the term
``equity investment in CUSOs'' as the unimpaired value of the credit
union's equity investments in a CUSO as recorded on the statement of
financial condition in accordance with GAAP.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Exchange. The Second Proposal defined the term ``exchange'' as a
central financial clearing market where end users can trade
derivatives.
The Board received no comments on this definition, but has decided
to clarify in this final rule that derivatives are engaged in through
agreements and not traded like securities. Accordingly, this final rule
would define ``exchange'' as a central financial clearing market where
end users can enter into derivative transactions.
Excluded goodwill, and excluded other intangible assets. The Second
Proposal defined the term ``excluded goodwill'' as the outstanding
balance, maintained in accordance with GAAP, of any goodwill
originating from a supervisory merger or combination that was completed
no more than 29 days after publication of this rule in final form in
the Federal Register. The definition provided further that the term
excluded goodwill and its accompanying definition would expire on
January 1, 2025.
The Second Proposal would have also defined the term ``excluded
other intangible assets'' as the outstanding balance, maintained in
accordance with GAAP, of any other intangible assets such as core
deposit intangibles, member relationship intangibles, or trade name
intangible originating from a supervisory merger or combination that
was completed no more than 29 days after publication of this rule in
final form in the Federal Register. The definition provided further
that the term excluded other intangible assets and its accompanying
definition would expire on January 1, 2025.
Public Comments on the Second Proposal
The Board received many comments regarding the proposed treatment
of goodwill and other intangible assets under NCUA's risk-based capital
requirement. A significant number of commenters requested that the
terms ``excluded goodwill'' and ``excluded intangible assets'' and
their proposed treatment be retained permanently (or, if not retained
permanently, commenters requested that the time period during which
they are allowed be extended). The specific comments received and a
more detailed description of the Board's response are provided below in
the part of the preamble associated with Sec. 702.104(b)(2).
Discussion
The Board generally agrees with commenters who suggested the time
periods allowed for these proposed exclusions be extended. The Board
added these two definitions to take into account the impact goodwill or
other intangible assets recorded from transactions defined as
supervisory mergers or combinations have on the calculation of the
risk-based capital ratio upon implementation. The proposed exclusions
would have applied to supervisory mergers or combinations that were
completed prior to the date of publication of this final rule in the
Federal Register. The proposed exclusion would have ended on January 1,
2025. For the reasons discussed below in the part of the preamble
associated with Sec. 702.104(b)(2), the Board has decided to revise
the proposed definitions of ``excluded goodwill'' and ``excluded other
intangible assets'' to extend the period during which credit unions can
count these assets in the risk-based capital ratio numerator to January
1, 2029. In addition, the Board is extending the period, after the
publication of this final rule in the Federal Register, during which
credit unions can obtain ``excluded goodwill'' and ``excluded other
intangible assets'' to 60 days to allow credit unions additional time
to adjust to the changes made by this final rule.
Accordingly, this final rule defines ``excluded goodwill'' as the
outstanding balance, maintained in accordance with GAAP, of any
goodwill originating from a supervisory merger or combination that was
completed on or before a date to be set upon publication, which will be
60 days after publication of this final rule in the Federal Register.
The definition provides further that the term and definition expire on
January 1, 2029.
Similarly, this final rule also defines ``excluded other intangible
assets'' as the outstanding balance, maintained in accordance with
GAAP, of any other intangible assets such as core deposit intangible,
member relationship intangible, or trade name intangible originating
from a supervisory merger or combination that was completed on or
before a date to be set upon publication, which will be 60 days after
publication of this final rule in the Federal Register. The definition
provides further that the term and definition expire on January 1,
2029.
Exposure amount. The Second Proposal defined the term ``exposure
amount'' as:
The amortized cost for investments classified as held-to-
maturity and available-for-sale, and the fair value for trading
securities.
The outstanding balance for Federal Reserve Bank stock,
Central Liquidity Facility stock, Federal Home Loan Bank stock,
nonperpetual capital and perpetual contributed capital at corporate
credit unions, and equity investments in CUSOs.
The carrying value for non-CUSO equity investments, and
investment funds.
The carrying value for the credit union's holdings of
general account permanent insurance, and separate account insurance.
The amount calculated under Sec. 702.105 of this part for
derivative contracts.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Fair value. The Second Proposal defined the term ``fair value'' as
having the same meaning as provided in GAAP.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Financial collateral. The Second Proposal defined the term
``financial collateral'' as collateral approved by both the credit
union and the counterparty as part of the collateral agreement in
recognition of credit risk mitigation for derivative contracts.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
First-lien residential real estate loan. The Second Proposal
defined the term ``first-lien residential real estate loan'' as a loan
or line of credit primarily secured by a first-lien on a one-to-four
family residential property where: (1) The credit union made a
reasonable and good faith determination at or before consummation of
the loan that the member will have a reasonable ability to repay the
loan according to its terms; and (2) in transactions where the credit
union holds the first-lien and junior-
[[Page 66649]]
lien(s), and no other party holds an intervening lien, for purposes of
this part the combined balance will be treated as a single first-lien
residential real estate loan.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
GAAP. The Second Proposal defined the term ``GAAP'' as generally
accepted accounting principles in the United States as set forth in the
Financial Accounting Standards Board's (FASB) Accounting Standards
Codification (ASC).
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
General account permanent insurance. The Second Proposal defined
the term ``general account permanent insurance'' as an account into
which all premiums, except those designated for separate accounts are
deposited, including premiums for life insurance and fixed annuities
and the fixed portfolio of variable annuities, whereby the general
assets of the insurance company support the policy. Under the proposed
definition, general account permanent insurance would have included
direct obligations to the insurance provider. This would have meant
that the credit risk associated with general account permanent
insurance was to the insurance company, which generally makes such
insurance accounts have a lower credit risk than separate account
insurance. A separate account insurance is a segregated accounting and
reporting account held separately from the insurer's general assets.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
General obligation. The Second Proposal defined the term ``general
obligation'' as a bond or similar obligation that is backed by the full
faith and credit of a public sector entity.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Goodwill. The Second Proposal defined the term ``goodwill'' as an
intangible asset, maintained in accordance with GAAP, representing the
future economic benefits arising from other assets acquired in a
business combination (e.g., merger) that are not individually
identified and separately recognized. The Proposed definition provided
further that goodwill does not include excluded goodwill.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Government guarantee. The Second Proposal defined the term
``government guarantee'' as a guarantee provided by the U.S.
Government, FDIC, NCUA or other U.S. Government agencies, or a public
sector entity.
Public Comments on the Second Proposal
One state supervisory authority commenter requested clarification
on the definition of ``government guarantee,'' and whether the
definition includes any type of guarantee from a state government,
state government agency, or municipality.
Discussion
The Board definition of ``government guarantee'' does include
guarantees from a state government, state government agency, or
municipality. The definition expressly includes a guarantee provided by
a ``public sector entity,'' which the second proposal defines
separately in Sec. 702.2 as a state, local authority, or other
governmental subdivision of the United States below the sovereign
level. The proposed definition of ``public sector entity'' would
include state governments, state government agencies, and
municipalities. Accordingly, the Board has decided to retain the
proposed definition of ``government guarantee'' in this final rule
without change.
Government-sponsored enterprise (GSE). The Second Proposal defined
the term ``government-sponsored enterprise'' as an entity established
or chartered by the U.S. Government to serve public purposes specified
by the U.S. Congress, but whose debt obligations are not explicitly
guaranteed by the full faith and credit of the U.S. Government.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Guarantee. The Second proposal defined the term ``guarantee'' as a
financial guarantee, letter of credit, insurance, or similar financial
instrument that allows one party to transfer the credit risk of one or
more specific exposures to another party.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Identified losses. The Second Proposal defined the term
``identified losses'' as those items that have been determined by an
evaluation made by NCUA, or in the case of a state-chartered credit
union, the appropriate state official, as measured on the date of
examination in accordance with GAAP, to be chargeable against income,
equity or valuation allowances such as the allowances for loan and
lease losses. The definition provided further that examples of
identified losses would be assets classified as losses, off-balance
sheet items classified as losses, any provision expenses that are
necessary to replenish valuation allowances to an adequate level,
liabilities not shown on the books, estimated losses in contingent
liabilities, and differences in accounts that represent shortages.
Public Comments on the Second Proposal
At least one commenter requested that the Board specify in the
definition of ``identified losses'' that such losses are only
chargeable against losses.
Discussion
The commenter's suggested revision to the proposed definition is
not consistent with generally accepted accounting principles. The
definition of ``identified losses'' specifies that it be recorded in
accordance with GAAP to appropriately address this matter and any
further limiting conditions could run afoul of GAAP reporting.
Accordingly, the Board has decided to retain the proposed definition in
this final rule without change.
Industrial development bond. The Second Proposal defined the term
``industrial development bond'' as a security issued under the auspices
of a state or other political subdivision for the benefit of a private
party or enterprise where that party or enterprise, rather than the
government entity, is obligated to pay the principal and interest on
the obligation.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Intangible assets. The Second Proposal defined the term
``intangible assets'' as assets, maintained in accordance with GAAP,
other than financial assets, that lack physical substance.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Investment fund. The Second Proposal defined the term ``investment
fund'' as an investment with a pool of underlying investment assets.
The proposed definition provided further that the term investment fund
includes an investment company that is
[[Page 66650]]
registered under section 8 of the Investment Company Act of 1940, as
amended, and collective investment funds or common trust investments
that are unregistered investment products that pool fiduciary client
assets to invest in a diversified pool of investments.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Junior-lien residential real estate loan. The Second Proposal
defined the term ``junior-lien residential real estate loan'' as a loan
or line of credit secured by a subordinate lien on a one-to-four family
residential property. The proposed definition generally included all
residential real estate loans that did not meet the definition of a
first-lien residential real estate loan because the credit union is
secured by a second or subsequent lien on the residential property
loan.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Limited Recourse. The Second Proposal did not define the term
``limited recourse.''
Public Comments on the Second Proposal
At least one commenter suggested that the Board define ``limited
recourse'' as provided under GAAP and clarify that the definition
excludes normal reps and warranties in a loan sale transaction.
Discussion
There is no need to define ``limited recourse'' because the Second
Proposal and this final rule define the term ``loans transferred with
limited recourse.'' That definition provides sufficient information
regarding the rule's use of the term ``limited recourse,'' and
adequately addresses the normal representations and warranties
associated with limited recourse. Accordingly, the Board has decided
not to separately define the term ``limited recourse'' in this final
rule.
Loan to a CUSO. The Second Proposal defined the term ``loan to a
CUSO'' as the outstanding balance of any loan from a credit union to a
CUSO as recorded on the statement of financial condition in accordance
with GAAP.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
For an unconsolidated CUSO, a credit union must assign the risk weight
to the outstanding balance of the loans to the CUSO as presented on the
statement of financial condition. For a consolidated CUSO, the risk
weight of a loan to a CUSO is normally zero since the consolidation
entries eliminate the intercompany transaction.
Loan secured by real estate. The Second Proposal defined the term
``loan secured by real estate'' as a loan that, at origination, is
secured wholly or substantially by a lien(s) on real property for which
the lien(s) is central to the extension of the credit. The definition
provided further that a lien is ``central'' to the extension of credit
if the borrowers would not have been extended credit in the same amount
or on terms as favorable without the lien(s) on real property. The
definition also provided that, for a loan to be ``secured wholly or
substantially by a lien(s) on real property,'' the estimated value of
the real estate collateral at origination (after deducting any more
senior liens held by others) must be greater than 50 percent of the
principal amount of the loan at origination.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Loans transferred with limited recourse. The Second Proposal
defined the term ``Loans transferred with limited recourse'' as the
total principal balance outstanding of loans transferred, including
participations, for which the transfer qualified for true sale
accounting treatment under GAAP, and for which the transferor credit
union retained some limited recourse (i.e., insufficient recourse to
preclude true sale accounting treatment). The definition provided
further that the term loans transferred with limited recourse excludes
transfers that qualify for true sale accounting treatment but contain
only routine representation and warranty clauses that are standard for
sales on the secondary market, provided the credit union is in
compliance with all other related requirements, such as capital
requirements.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Mortgage-backed security (MBS). The Second Proposal defined the
term ``mortgage-backed security'' as a security backed by first- or
junior-lien mortgages secured by real estate upon which is located a
dwelling, mixed residential and commercial structure, residential
manufactured home, or commercial structure.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Mortgage partnership finance program. The Second Proposal defined
the term ``mortgage partnership finance program'' as any Federal Home
Loan Bank program through which loans are originated by a depository
institution that are purchased or funded by the Federal Home Loan
Banks, where the depository institutions receive fees for managing the
credit risk of the loans and servicing them. The definition would
provide further that the credit risk must be shared between the
depository institutions and the Federal Home Loan Banks.
Public Comments on the Second Proposal
The Board received several comments on the proposed definition of
``mortgage partnership finance program.'' One commenter explained that
the Federal Home Loan Banks have programs through which they acquire
conventional and government-issued residential mortgage loans from
certain of their members, called Participating Financial Institutions
(PFIs). The commenter explained that the Mortgage Partnership Finance
(MPF) Program is offered today by most Federal Home Loan Banks, but
that the Federal Home Loan Banks of Cincinnati and Indianapolis each
independently operate a similar member product called the Mortgage
Purchase Program (MPP). According to the commenter, both the MPP and
MPF Programs operate pursuant to Federal Housing Finance Agency
regulation and the majority of PFIs that sell mortgage loans under
these programs are small to mid-sized community banks, thrifts, and
credit unions. Several commenters suggested that NCUA's proposed
definition of ``Mortgage Partnership Finance Program,'' could be
reasonably construed to only apply to MPF Program loans that a credit
union services. If the intent of the rule is to treat all MPF program
loans the same, regardless of whether the credit union retains or sells
the servicing, then the commenters recommended the Board clarify the
definition by deleting the words ``and servicing them'' from the
definition of ``Mortgage Partnership Finance Program.''
Commenters also suggested that, although the MPP and the MPF
Programs are similar in many respects, there is an important difference
regarding recourse risk. According to the commenters, the MPF Program
achieves credit enhancement by creating a contingent liability for PFIs
while the MPP achieves credit enhancement by creating a contingent
asset for the PFI. Because credit unions retain recourse risk on MPF
loans but not on MPP loans, the commenters recommended
[[Page 66651]]
that the Board amend the proposed definition of ``Mortgage Partnership
Finance Program'' to clarify that the term expressly excludes MPP
loans. In particular, the commenters recommended that the Board add the
words ``in a manner other than by establishing a contingent asset for
the benefit of or payable to the depository institution'' at the end of
the definition of Member Partnership Finance Program.
Discussion
The Board generally agrees with the commenters who suggested
removing the words ``and servicing them'' from the proposed definition
of ``mortgage partnership finance program.'' The Board's intent is to
treat all MPF program loans the same under the final rule regardless of
whether the credit union retains or sells the servicing. Accordingly,
this final rule revises the definition of mortgage partnership finance
program to remove the words ``and servicing them.''
The Board also agrees with commenters who suggested there is an
important difference between the MPP and the MPF Programs regarding
recourse risk. MPF loans are not the same as MPP loans with regard to
risk because credit unions retain recourse risk through a credit
enhancement obligation to the Federal Home Loan Bank for credit losses
on MPF loans. Loans sold under the MPP program are risk-weighted based
on the contractual recourse obligation, if any. Thus the commenters'
suggested change to the definition of MPF Programs is necessary.
Accordingly, this final rule defines ``mortgage partnership finance
program'' as any Federal Home Loan Bank program through which loans are
originated by a depository institution that are purchased or funded by
the Federal Home Loan Banks, where the depository institution receives
fees for managing the credit risk of the loans. The definition provides
further that the credit risk must be shared between the depository
institution and the Federal Home Loan Banks.
Mortgage servicing assets. The Second Proposal defined the term
``mortgage servicing asset'' as those assets, maintained in accordance
with GAAP, resulting from contracts to service loans secured by real
estate (that have been securitized or owned by others) for which the
benefits of servicing are expected to more than adequately compensate
the servicer for performing the servicing.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
NCUSIF. The Second Proposal defined the term ``NCUSIF'' as the
National Credit Union Share Insurance Fund as defined by 12 U.S.C.
1783.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Net worth. Generally consistent with the current rule, the Second
Proposal defined the term ``net worth'' as:
The retained earnings balance of the credit union at
quarter-end as determined under GAAP, subject to bullet 3 of this
definition.
For a low-income-designated credit union, net worth also
includes secondary capital accounts that are uninsured and subordinate
to all other claims, including claims of creditors, shareholders, and
the NCUSIF.
For a credit union that acquires another credit union in a
mutual combination, net worth also includes the retained earnings of
the acquired credit union, or of an integrated set of activities and
assets, less any bargain purchase gain recognized in either case to the
extent the difference between the two is greater than zero. The
acquired retained earnings must be determined at the point of
acquisition under GAAP. A mutual combination, including a supervisory
combination, is a transaction in which a credit union acquires another
credit union or acquires an integrated set of activities and assets
that is capable of being conducted and managed as a credit union.
The term ``net worth'' also includes loans to and accounts
in an insured credit union, established pursuant to section 208 of the
FCUA, provided such loans and accounts:
[cir] Have a remaining maturity of more than five years;
[cir] Are subordinate to all other claims including those of
shareholders, creditors, and the NCUSIF;
[cir] Are not pledged as security on a loan to, or other obligation
of, any party;
[cir] Are not insured by the NCUSIF;
[cir] Have non-cumulative dividends;
[cir] Are transferable; and
[cir] Are available to cover operating losses realized by the
insured credit union that exceed its available retained earnings.''
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Net worth ratio. The Second Proposal defined the term ``net worth
ratio'' as the ratio of the net worth of the credit union to the total
assets of the credit union rounded to two decimal places.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
New credit union. The Second Proposal would have revised the
definition of ``new credit union'' by removing the definition provided
in current Sec. 702.2 and providing that the term has the same meaning
as in Sec. 702.201.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Nonperpetual capital. The Second Proposal defined the term
``nonperpetual capital'' as having the same meaning as in 12 CFR 704.2.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Off-balance sheet items. The Second Proposal defined the term
``off-balance sheet items'' as items such as commitments, contingent
items, guarantees, certain repo-style transactions, financial standby
letters of credit, and forward agreements that are not included on the
statement of financial condition, but are normally reported in the
financial statement footnotes.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Off-balance sheet exposure. The Second Proposal defined the term
``off-balance sheet exposure'' as: (1) For loans sold under the Federal
Home Loan Bank mortgage partnership finance (MPF) program, the
outstanding loan balance as of the reporting date, net of any related
valuation allowance. (2) For all other loans transferred with limited
recourse or other seller-provided credit enhancements and that qualify
for true sales accounting, the maximum contractual amount the credit
union is exposed to according to the agreement, net of any related
valuation allowance. (3) For unfunded commitments, the remaining
unfunded portion of the contractual agreement.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
On-balance sheet. The Second Proposal defined the term ``on-balance
sheet'' as a credit union's assets, liabilities, and equity, as
disclosed on the statement of financial condition at a specific point
in time.
The Board received no comments on this definition and has decided
to retain
[[Page 66652]]
the proposed definition in this final rule without change.
Other intangible assets. The Second Proposal defined the term
``other intangible assets'' as intangible assets, other than servicing
assets and goodwill, maintained in accordance with GAAP. The definition
provided further that other intangible assets does not include excluded
other intangible assets.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Over-the-counter (OTC) interest rate derivative contract. The
Second Proposal defined the term ``over-the-counter (OTC) interest rate
derivative contract'' as a derivative contract that is not cleared on
an exchange.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Part 703 compliant investment fund. The Second proposal used the
term ``part 703 compliant investment fund,'' but did not specifically
define the term in Sec. 702.2. The discussion in the preamble to the
proposal, however, used the term to mean an investment fund that is
restricted to holding only investments that are permissible under 12
CFR 703.14(c).
Public Comments on the Second Proposal
The Board received many comments on the risk weights assigned to
``part 703 compliant investment funds.'' Some of the comments received
seemed to indicate that credit unions and other interested parties were
unclear regarding the rule's use of the term. The specific comments
received regarding investment funds and part 703 compliance are
discussed in more detail below in the part of preamble associated with
Sec. 702.104(c).
Discussion
The Board has decided to define the term ``part 703 compliant
investment funds'' in Sec. 702.2 to clarify the meaning of the term
and avoid possible confusion in the future. Accordingly, this final
rule defines ``part 703 compliant investment fund'' as an investment
fund that is restricted to holding only investments that are
permissible under 12 CFR 703.14(c).
Perpetual contributed capital. The Second Proposal defined the term
``perpetual contributed capital'' as having the same meaning as in 12
CFR 704.2.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Public sector entity (PSE). The Second Proposal defined the term
``public sector entity'' as a state, local authority, or other
governmental subdivision of the United States below the sovereign
level.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Qualifying master netting agreement. The Second Proposal defined
the term ``qualifying master netting agreement'' as a written, legally
enforceable agreement, provided that:
The agreement creates a single legal obligation for all
individual transactions covered by the agreement upon an event of
default, including upon an event of conservatorship, receivership,
insolvency, liquidation, or similar proceeding, of the counterparty;
The agreement provides the credit union the right to
accelerate, terminate, and close out on a net basis all transactions
under the agreement and to liquidate or set off collateral promptly
upon an event of default, including upon an event of conservatorship,
receivership, insolvency, liquidation, or similar proceeding, of the
counterparty, provided that, in any such case, any exercise of rights
under the agreement will not be stayed or avoided under applicable law
in the relevant jurisdictions, other than in receivership,
conservatorship, resolution under the Federal Deposit Insurance Act,
Title II of the Dodd-Frank Wall Street Reform and Consumer Protection
Act, or under any similar insolvency law applicable to GSEs;
The agreement does not contain a walkaway clause (that is,
a provision that permits a non-defaulting counterparty to make a lower
payment than it otherwise would make under the agreement, or no payment
at all, to a defaulter or the estate of a defaulter, even if the
defaulter or the estate is a net creditor under the agreement); and
In order to recognize an agreement as a qualifying master
netting agreement for purposes of this part, a credit union must
conduct sufficient legal review, at origination and in response to any
changes in applicable law, to conclude with a well-founded basis (and
maintain sufficient written documentation of that legal review) that:
[cir] The agreement meets the requirements of paragraph (2) of this
definition; and
[cir] In the event of a legal challenge (including one resulting
from default or from conservatorship, receivership, insolvency,
liquidation, or similar proceeding), the relevant court and
administrative authorities would find the agreement to be legal, valid,
binding, and enforceable under the law of relevant jurisdictions.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Recourse. The second Proposal defined the term ``recourse'' as a
credit union's retention, in form or in substance, of any credit risk
directly or indirectly associated with an asset it has transferred that
exceeds a pro-rata share of that credit union's claim on the asset and
disclosed in accordance with GAAP. The definition provided further that
if a credit union has no claim on an asset it has transferred, then the
retention of any credit risk is recourse. The definition also provided
that a recourse obligation typically arises when a credit union
transfers assets in a sale and retains an explicit obligation to
repurchase assets or to absorb losses due to a default on the payment
of principal or interest or any other deficiency in the performance of
the underlying obligor or some other party. Finally, the definition
provided that recourse may also exist implicitly if the credit union
provides credit enhancement beyond any contractual obligation to
support assets it has transferred.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Residential mortgage-backed security. The Second Proposal defined
the term ``residential mortgage-backed security'' as a mortgage-backed
security backed by loans secured by a first-lien on residential
property.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Residential property. The Second Proposal defined the term
``residential property'' as a house, condominium unit, cooperative
unit, manufactured home, or the construction thereof, and unimproved
land zoned for one-to-four family residential use. The definition
provided further that the term residential property excludes boats and
motor homes, even if used as a primary residence, and timeshare
property.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Restructured. The Second Proposal defined the term
``restructured,'' with respect to any loan, as a restructuring of the
loan in which a credit union, for economic or legal reasons related to
a
[[Page 66653]]
borrower's financial difficulties, grants a concession to the borrower
that it would not otherwise consider. The definition provided further
that the term restructured excludes loans modified or restructured
solely pursuant to the U.S. Treasury's Home Affordable Mortgage
Program.
Public Comments on the Second Proposal
At least one commenter argued that the definition of the term
``restructured,'' as it applied to loans, and the accompanying footnote
in the preamble to the Second Proposal were troublesome.\87\ The
commenter believed that the footnote accompanying the preamble
discussion on the definition of ``restructured'' suggested that a loan
that was restructured was what FASB calls a TDR. The commenter was
confused further by the following statement in the preamble: ``A loan
extended or renewed at a stated interest rate equal to the current
market interest rate for new debt with similar risk is not a
restructured loan.'' \88\ According to the commenter, however, such a
loan would be treated as a restructured loan for accounting purposes by
FASB and under the TDR guidance. To avoid confusion, the commenter
recommended that the Board amend the definition of ``restructured'' to
be consistent with the standards and guidance set by FASB.
---------------------------------------------------------------------------
\87\ See 80 FR 4339, 4369 (Jan. 27, 2015) (Footnote 119,
referred to by the commenter, relates to Financial Accounting
Standards Board ASC 310-40, ``Troubled Debt Restructuring by
Creditors.'').
\88\ Id. at 4369.
---------------------------------------------------------------------------
Discussion
The proposed definition of ``restructured'' was based on the
classification of restructured loans for the purpose of assigning
appropriate risk weights. The proposed definition is consistent with
the definition used under the Other Banking Agencies' risk-based
capital rules and is not dependent upon nor contradictory to related
accounting pronouncements. Additional guidance will be provided to
credit unions in the future regarding risk-weighting restructured loans
through supervisory guidance and in the instructions on the Call
Report. Accordingly, the Board has decided to retain the proposed
definition of ``restructured'' in this final rule without change.
Revenue obligation. The Second Proposal defined the term ``revenue
obligation'' as a bond or similar obligation that is an obligation of a
public sector entity, but which the public sector entity is committed
to repay with revenues from the specific project financed rather than
general tax funds. Generally, such bonds or debts are paid with
revenues from the specific project financed rather than the general
credit and taxing power of the issuing jurisdiction.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Risk-based capital ratio. The Second Proposal defined the term
``risk-based capital ratio'' as the percentage, rounded to two decimal
places, of the risk-based capital ratio numerator to risk weighted
assets, as calculated in accordance with Sec. 702.104(a).
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Risk-weighted assets. The Second Proposal defined the term ``risk-
weighted assets'' as the total risk-weighted assets as calculated in
accordance with Sec. 702.104(c).
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Secured consumer loan. The Second Proposal defined the term
``secured consumer loan'' as a consumer loan associated with collateral
or other item of value to protect against loss where the creditor has a
perfected security interest in the collateral or other item of value.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Senior executive officer. The Second Proposal defined the term
``senior executive officer'' as a senior executive officer as defined
by 12 CFR 701.14(b)(2).
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Separate account insurance. The Second Proposal defined the term
``separate account insurance'' as an account into which a
policyholder's cash surrender value is supported by assets segregated
from the general assets of the carrier.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Shares. The Second Proposal defined the term ``shares'' as
deposits, shares, share certificates, share drafts, or any other
depository account authorized by federal or state law.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Share-secured loan. The Second Proposal defined the term ``share-
secured loan'' as a loan fully secured by shares on deposit at the
credit union making the loan, and does not include the imposition of a
statutory lien under 12 CFR 701.39.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule with the following
conforming changes. This final rule amends the definition of share-
secured loans to be consistent with the new zero percent risk weight
assigned to share-secured loans, where the shares securing the loan are
on hold with the credit union, which is discussed in more detail below.
Accordingly, this final rule defines the term ``share-secured loan'' as
a loan fully secured by shares, and does not include the imposition of
a statutory lien under Sec. 701.39 of this chapter.
STRIPS. The Second Proposal defined the term ``STRIPS'' as separate
traded registered interest and principal security.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Structured product. The Second Proposal defined the term
``structured product'' as an investment that is linked, via return or
loss allocation, to another investment or reference pool.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Subordinated. The Second Proposal defined the term ``subordinated''
to mean, with respect to an investment, that the investment has a
junior claim on the underlying collateral or assets to other
investments in the same issuance. The definition provided further that
the term subordinated does not apply to securities that are junior only
to money market fund eligible securities in the same issuance.
Public Comments on the Second Proposal
At least one commenter recommended the Board more clearly define
the term ``subordinated'' with respect to a ``tranche.'' As discussed
in the part of the preamble associated with Sec. 702.104(c)(2),
commenters also expressed some confusion regarding NCUA's use of the
term ``non-subordinated'' in the Second Proposal. Additionally,
commenters expressed their desire to have the risk-weight assigned to a
non-subordinated tranche
[[Page 66654]]
be based on the underlying collateral in the tranche.
Discussion
The Second Proposal defined the terms ``subordinated'' and
``tranche.'' These definitions, when read together, make it clear that
a subordinated tranche is an investment that has a junior claim to
other securities within the same transaction.
The Board agrees, however, that clarifying the definition of
``subordinated'' to clarify the meaning of the term non-subordinated in
Sec. 702.2 will help clarify the meaning of the term for credit unions
and other interested parties, and clarify that under this final rule
all tranches of investments, regardless of standing, can be risk-
weighted using the gross-up approach. As discussed in more detail
below, commenters suggested that credit unions be given the option of
using the gross-up approach to risk-weight non-subordinated tranches of
investments. A non-subordinated instrument is the most senior tranche
in a security with a senior/subordinated structure. The Board has
decided to further clarify the definition of ``subordinated'' for
credit unions using the gross-up approach for both subordinated and
non-subordinated investment tranches. This change will benefit credit
unions purchasing non-subordinated tranches of securities
collateralized with lower credit risk assets.
Accordingly, this final rule defines the term ``subordinated'' as
meaning, with respect to an investment, that the investment has a
junior claim on the underlying collateral or assets to other
investments in the same issuance. The definition also provides that an
investment that does not have a junior claim to other investments in
the same issuance on the underlying collateral or assets is non-
subordinated. Finally, the definition provides that a security that is
junior only to money-market-eligible securities in the same issuance is
also non-subordinated.
Supervisory merger or combination. The Second Proposal defined the
term ``supervisory merger or combination'' as a transaction that
involved the following:
An assisted merger or purchase and assumption where funds
from the NCUSIF are provided to the continuing credit union;
A merger or purchase and assumption classified by NCUA as
an ``emergency merger'' where the acquired credit union is either
insolvent or ``in danger of insolvency'' as defined under appendix B to
part 701 of this chapter; or
A merger or purchase and assumption that included NCUA's
or the appropriate state official's identification and selection of the
continuing credit union.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Swap dealer. The Second Proposal defined the term ``swap dealer''
as having the same meaning as defined by the Commodity Futures Trading
Commission in 17 CFR 1.3(ggg).
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Total assets. The Second Proposal retained the definition of
``total assets'' in current Sec. 702.2, but would have restructured
the definition and provided additional clarifying language. The
proposal amended the definition to provide that ``total assets'' means
a credit union's total assets as measured \89\ by either:
---------------------------------------------------------------------------
\89\ For each quarter, a credit union must elect one of the
measures of total assets listed in paragraph (2) of this definition
to apply for all purposes under this part except Sec. Sec. 702.103
through 702.106 (risk-based capital requirement).
---------------------------------------------------------------------------
Average quarterly balance. The credit union's total assets
measured by the average of quarter-end balances of the current and
three preceding calendar quarters;
Average monthly balance. The credit union's total assets
measured by the average of month-end balances over the three calendar
months of the applicable calendar quarter;
Average daily balance. The credit union's total assets
measured by the average daily balance over the applicable calendar
quarter; or
Quarter-end balance. The credit union's total assets
measured by the quarter-end balance of the applicable calendar quarter
as reported on the credit union's Call Report.
Public Comments on the Second Proposal
One commenter suggested that the proposed definition of ``total
assets'' would create inconsistency as to how risk-based capital
results are reported and would hinder comparability among credit
unions. The commenter recommended that the Board amend the definition
to require that total assets be measured by the average of quarter-end
balances of the current and three preceding calendar quarters.
Discussion
With the exception of a few non-substantive amendments, the
proposed definition of ``total assets'' is the same as the definition
in current Sec. 702.2. In fact, the revision suggested by the
commenter above would reduce the number of options available to a
credit union in determining which total assets to apply in calculating
its net worth ratio. Such a narrowing of the definition is not
appropriate. Accordingly, the Board has decided to retain the proposed
revisions to the definition in this final rule without change.
Tranche. The Second Proposal defined the term ``tranche'' as one of
a number of related securities offered as part of the same transaction.
The definition provided further that the term tranche includes a
structured product if it has a loss allocation based off of an
investment or reference pool.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
Unfunded commitment. Neither the current rule nor the Second
Proposal define the term ``unfunded commitment.''
Public Comments on the Second Proposal
At least one commenter recommended that the Board define the term
``unfunded commitment'' in the final rule because the commenter
believed the proposed definition was unclear as to whether a credit
union real estate loan pipeline or outstanding auto loan convenience
check would be classified as an unfunded commitment.
Discussion
The proposal provides in Sec. 702.2 that ``off-balance sheet
exposure'' means, for unfunded commitments, the remaining unfunded
portion of the contractual agreement. The definition of off-balance-
sheet exposure defines unfunded commitment, so adding an additional
separate definition for unfunded commitment would be redundant.
Additional guidance, however, will be included in future supervisory
guidance and in the instructions on the Call Report. Accordingly, the
Board has decided not to define the term ``unfunded commitment'' in
this final rule.
Unsecured consumer loan. The Second Proposal defined the term
``unsecured consumer loan'' as a consumer loan not secured by
collateral.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule without change.
U.S. Government agency. The Second Proposal defined the term ``U.S.
Government agency'' as an
[[Page 66655]]
instrumentality of the U.S. Government whose obligations are fully and
explicitly guaranteed as to the timely payment of principal and
interest by the full faith and credit of the U.S. Government.
The Board received no comments on this definition and has decided
to retain the proposed definition in this final rule with only minor
clarifying amendments. In particular, the Board clarified in the
definition that NCUA is a U.S. Government agency, to confirm that
NCUA's obligations receive a zero percent risk weight. Accordingly, the
final rule defines ``U.S. Government agency'' as an instrumentality of
the U.S. Government whose obligations are fully and explicitly
guaranteed as to the timely payment of principal and interest by the
full faith and credit of the U.S. Government. The definition provides
further that the term ``U.S. Government agency'' includes NCUA.
Weighted-average life of investments. Under the Second Proposal,
the definition of ``weighted-average life of investments'' and the
provisions in current Sec. 702.105 of NCUA's regulation would have
been removed completely.
Other than the comments supporting the removal of IRR from NCUA's
risk-based capital requirement, the Board received no comments
regarding the removal of this definition and has decided to retain the
proposed amendment in this final rule without change.
A. Subpart A--Prompt Corrective Action
The Second Proposal would have established a new subpart A titled
``Prompt Corrective Action.'' New subpart A would have contained the
sections of part 702 relating to capital measures, supervisory PCA
actions, requirements for net worth restoration plans, and reserve
requirements for all credit unions not defined as ``new'' pursuant to
section 216(b)(2) of the FCUA.\90\ The Board received no comments on
these revisions and has decided to retain the proposed amendments in
this final rule.
---------------------------------------------------------------------------
\90\ 12 U.S.C. 1790d(b)(2).
---------------------------------------------------------------------------
Section 702.101 Capital Measures, Capital Adequacy, Effective Date of
Classification, and Notice to NCUA
The Second Proposal retained the requirements of Sec. 702.101
leaving it largely unchanged from current Sec. 702.101, with a few
notable exceptions that are discussed in more detail below. The title
of proposed Sec. 702.101 would have been changed to ``Capital
Measures, capital adequacy, effective date of classification, and
notice to NCUA'' to better reflect the three major topics that would
have been covered in the section. In addition, proposed Sec. 702.101
would have amended current Sec. 702.101 to include a new capital
adequacy provision that was based on a similar provision in FDIC's
capital regulations.\91\ The new capital adequacy provision was added
as proposed Sec. 702.101(b). Paragraphs (b) and (c) of current Sec.
702.101 would have been renumbered as paragraphs (d) and (e). The new
capital adequacy provision would not have affected credit unions' PCA
capital category, but could have supported the assessment of capital
adequacy in the supervisory process (assigning CAMEL and risk ratings).
---------------------------------------------------------------------------
\91\ 12 CFR 324.10.
---------------------------------------------------------------------------
Public Comments on the Second Proposal
A substantial number of commenters objected to the proposed
addition of capital adequacy provisions to Sec. 702.101. Many
commenters stated that they were concerned about the subjective nature
of the capital adequacy provision. Commenters contended that if a
credit union meets the net worth and risk-based capital requirements,
NCUA should not have the ability to require the credit union to hold
additional capital. Other commenters argued that the proposed capital
adequacy provisions could be problematic because they would grant
examiners considerable latitude to determine whether a credit union
needs more capital even if it is well capitalized according to standard
net worth and risk-based capital ratio requirements. Commenters argued
that credit unions and the NCUSIF have functioned well without these
provisions and NCUA has not provided sufficient justification to
support their imposition now. Still other commenters noted that credit
unions already provide for capital adequacy through budgeting, ALM
planning, liquidity, interest rate risk, and risk management, and
speculated that the proposed capital adequacy provision would subject
credit unions' capital plans to be judged in an arbitrary and
subjective manner by hundreds of different NCUA examiners. The
commenters argued that such an approach would provide examiners with
too much authority to change the ``playing field,'' especially when
there is no independent entity to which a credit union can appeal. At
least one commenter suggested that the Board already has this authority
so adding to the existing authority would be unnecessary and redundant.
One commenter, however, acknowledged that codifying the additional
capital adequacy requirements in Sec. 702.101(b) was reasonable. But
the commenter suggested that the standards surrounding the provision's
use should be made clear because NCUA already examines credit unions to
determine whether they have sufficient net worth relative to risk, and
whether credit unions have adequate policies, practices, and procedures
regarding net worth and capital accounts.\92\ The commenter noted
further, the proposed rule indicates that it ``may provide specific
metrics for necessary reductions in risk levels, increases in capital
levels beyond those otherwise required under part 702, and some
combination of risk reduction and increased capital.'' \93\ The
commenter recommended that the Board clarify how it envisions Sec.
702.101(b) augmenting NCUA's current supervisory process and any
enforcement authority the agency holds in conjunction with that
process. Another commenter suggested that credit unions with lower risk
profiles and/or higher capital levels should be subjected to less
rigorous examinations of risk management. The commenter also suggested
that credit unions with higher risk levels against a given set of
reasonable thresholds, or those with lower capital levels, should have
their examination of risk elevated to the risk management specialists
within NCUA. The commenter suggested that removing field examiners with
little specific knowledge from the examination findings and
recommendation process would provide a more consistent exam, and
recommended that NCUA produce a set of known, published and reasonable
filters to define outlier credit unions, including a cross-risk look at
risks due to concentration, low capital or earnings levels, interest
rate exposure, credit quality, etc.
---------------------------------------------------------------------------
\92\ See LTCU 00-CU-08 (Nov. 2000); see also NCUA Examiner's
Guide, Ch. 16. available at https://www.ncua.gov/Legal/GuidesEtc/ExaminerGuide/chapter16.pdf.
\93\ 80 FR 4340, 4359 (Jan. 27, 2015).
---------------------------------------------------------------------------
At least one commenter questioned the Board's legal authority to
adopt a provision that would require individual credit unions to hold
capital above that required under the other provisions of the
regulation. The commenter acknowledged that the FCUA establishes a
risk-based net worth requirement for complex credit unions, but
suggested it does not grant NCUA the authority to impose individualized
capital requirements on a credit union-by-credit union basis. Another
[[Page 66656]]
commenter suggested if Congress had intended the capital thresholds
required under PCA to be minimum requirements, it would have described
the classification as minimally capitalized. The commenter maintained
that each credit union's long-term desired capital ratio will depend on
the credit union's own assessment of the risks it faces, and its
tolerance for risk. The commenter recommended the Board delete the
capital adequacy provisions, because credit unions' capital plans
should not be the subject of examination and supervision, and the goals
a credit union establishes for its own capital sufficiency should not
become targets or standards for review in an examination.
One commenter requested clarification on how NCUA would coordinate
the requirements of this new provision with state regulators for
capital planning purposes.
Discussion
The Board has carefully considered the comments above, and
disagrees with commenters who suggested that the capital adequacy
provisions are unnecessary. As stated in the preamble to the Second
Proposal, capital helps to ensure that individual credit unions can
continue to serve as credit intermediaries even during times of stress,
thereby promoting the safety and soundness of the overall U.S.
financial system. As a prudential matter, NCUA has a long-established
policy that federally insured credit unions should hold capital
commensurate with the level and nature of the risks to which they are
exposed. In some cases, this may entail holding capital above the
minimum requirements, depending on the nature of the credit union's
activities and risk profile.
Proposed Sec. 702.101(b) was based on a similar provision in the
Other Banking Agencies' rules \94\ and is within the Board's legal
authority under the FCUA. The FCUA grants NCUA broad authority to take
action to ensure the safety and soundness of credit unions and the
NCUSIF and to carry out the powers granted to the Board.\95\ Requiring
credit unions to maintain capital adequacy is part of ensuring safety
and soundness, and is not a new concept.\96\ NCUA's long-standing
practice has been to monitor and enforce capital adequacy through the
supervisory process. Proposed Sec. 702.101(b) would, with the
exception of the written capital adequacy plan discussed in more detail
below, merely codify the existing statutory requirement. The proposed
new capital adequacy provision would not affect credit unions' PCA
capital category, but would support the assessment of capital adequacy
in the supervisory process (assigning CAMEL and risk ratings).
---------------------------------------------------------------------------
\94\ See, e.g., 12 CFR 324.10(d)(1) & (2).
\95\ 12 U.S.C. 1786; and 1789.
\96\ See, e.g. 78 FR 55340, 55362 (Sept. 10, 2013).
---------------------------------------------------------------------------
Section 206 of the FCUA provides the Board with broad authority to
intervene and require credit unions to take actions to correct unsafe
or unsound practices, including requiring individual credit unions to
hold capital above that required under NCUA's PCA regulation.\97\ And
section 209 of the FCUA specifically authorizes the Board to prescribe
such rules and regulations as it may deem necessary or appropriate to
carry out the provisions of subchapter II of the FCUA, which includes
section 206. Accordingly, NCUA clearly has the legal authority to
include proposed Sec. 702.101(b) in this final rule.
---------------------------------------------------------------------------
\97\ 12 U.S.C. 1786.
---------------------------------------------------------------------------
Accordingly, the Board has decided to retain the proposed capital
adequacy provisions in this final rule without change.
101(b) Capital Adequacy
For the reasons discussed above, the new capital adequacy
provisions are added as Sec. 702.101(b) of this final rule, and
paragraphs (b) and (c) of current Sec. 702.101 are designated as
paragraphs (d) and (e) of Sec. 702.101 of this final rule.
101(b)(1)
The Second Proposal would have revised Sec. 702.101(b)(1) to
provide: Notwithstanding the minimum requirements in this part, a
credit union defined as complex must maintain capital commensurate with
the level and nature of all risks to which the institution is exposed.
For the reasons discussed above, the Board has decided to retain
the proposed capital adequacy provision in proposed Sec. 702.101(b)(1)
in this final rule without change.
101(b)(2)
Proposed Sec. 702.101(b)(2) provided: A credit union defined as
``complex'' must have a process for assessing its overall capital
adequacy in relation to its risk profile and a comprehensive written
strategy for maintaining an appropriate level of capital.
Public Comments on the Second Proposal
A significant number of commenters specifically objected to the
proposed new provision added as Sec. 702.101(b)(2) that would require
complex credit unions to have a comprehensive written strategy for
maintaining an appropriate level of capital. One commenter pointed out
that, while the Board has taken steps to closely align this proposal
with banking agency requirements in other areas, it has chosen to
deviate from that standard to add a written reporting requirement for
credit unions under this provision.\98\ The commenter suggested that
given that the specific requirements of the proposed capital adequacy
plan are not delineated in this proposed rule, but will be subsequently
outlined in supervisory guidance, commenters are unable to determine
the extent of the burden this requirement might entail. The commenter
noted that all credit unions with assets of $50 million or more are
already required to have a written policy on interest rate risk
management and a program to implement it effectively,\99\ as well as a
written liquidity policy and contingency funding plan.\100\ In
addition, the commenter noted that the largest credit unions are
already required by regulation to maintain a written capital policy and
capital plan that is approved annually by NCUA.\101\ The commenter
recommended the Board explain why it felt compelled to add a written
requirement to this provision for credit unions, and make every effort
to streamline it and other similar requirements to minimize the
associated regulatory burden.
---------------------------------------------------------------------------
\98\ There is no mandated written element to the corresponding
FDIC provision. 12 CFR 324.1(d); 12 CFR 324.100(d).
\99\ 12 CFR 741.3.
\100\ 12 CFR 741.12.
\101\ 12 CFR 702.501 through 702.506.
---------------------------------------------------------------------------
One commenter recommended that if the Board adopts a written
capital strategy requirement for all complex credit unions, it utilize
that written strategy to ensure that credit unions are addressing any
heightened risks from loan concentrations. The commenter suggested such
an approach should obviate the need for elevated risk weights in
connection with real estate and commercial loans by allowing NCUA to
address concentration risk in a more targeted way. The commenter
suggested further that such an approach would satisfy recommendations
from NCUA's Office of Inspector General (OIG) and GAO that NCUA
consider concentration risk as it pertains to capital adequacy, without
creating a competitive disadvantage for all complex credit unions in
relation to their banking counterparts. The commenter also recommended
that the Board incorporate any written capital strategy required within
the credit
[[Page 66657]]
union's strategic plan, or another existing report in order to minimize
duplication of effort across various reporting requirements. In
addition, the commenter suggested that an exemption from the
requirement be provided to institutions that are already subject to
capital planning and stress testing requirements, as the analysis
contemplated by this part would already be addressed by those existing
requirements. Other commenters contended that the written capital plan
requirement is not necessary for the vast majority of complex credit
unions based on their management, risk profiles, and current levels of
capital. And if NCUA examiners have concerns regarding the credit
unions they supervise, those commenters argued, those situations should
be addressed on an individual basis and not through rulemaking that
would apply universal requirements to all complex credit unions,
regardless of how well managed they may be.
At least one commenter stated that while NCUA should be able to
access the adequacy of a credit union's capital adequacy plan,
safeguards should be put in place to prevent over-zealous examiners
from implementing individualized minimum capital requirements during
the exam process. Another commenter suggested that the concept of a
written strategy was not bad, but that the final rule should provide
additional clarity about what exactly would be required under the
provision. Yet another commenter asked: What are the components of the
``comprehensive written strategy'' contemplated under this provision?
What are the possible consequences of an examiner determining that a
credit union's comprehensive written strategy does not meet the
requirements? The commenter requested that the Board provide more
description in this area and elaborate on its expectations of credit
unions.
Discussion
The Board disagrees with commenters who suggested the requirement
that complex credit unions maintain a written capital strategy be
removed from the final rule. The supervisory evaluation of a complex
credit union's capital adequacy, including the requirement to maintain
a written capital strategy, is focused on the credit union's own
process and strategy for assessing and maintaining its overall capital
adequacy in relation to its risk profile. The supervisory evaluation
may include various factors--such as whether the credit union is
engaged in merger activity, entering into new activities, introducing
new products, operating in a challenging economic environment, engaged
in nontraditional activities, or exposed to other risks like interest
rate risk or operational risks. The assessment evaluates the
comprehensiveness and effectiveness of the capital planning in light of
its activities. An effective capital planning process involves an
assessment of the risk to which a credit union is exposed and its
process for managing and mitigating those risks, an evaluation of
capital relative to those risks, and consideration of the potential
impact on earnings and capital from current and prospective economic
conditions. Under the proposal, the evaluation of an individual credit
union's risk management strategy and process will be commensurate with
the credit union's size, sophistication, and risk profile--which is
similar to the current supervisory process for credit unions.
For credit unions subject to Capital Planning and Stress Testing
under subpart E of part 702 of NCUA's regulations, compliance with
Sec. 702.504 will result in compliance with Sec. 702.101(b). Thus,
those credit unions subject to the stress testing regulation will not
be expected to write redundant capital plans to fulfill the
requirements of this final rule.
For other complex credit unions that will be expected to write
capital plans, supervisory guidance will be issued to help those credit
unions evaluate their compliance with Sec. 702.101(b). The supervisory
guidance will also be designed to provide consistency in the
examination process.
Accordingly, the Board has decided to retain the proposed capital
adequacy provision in proposed Sec. 702.101(b)(1) in this final rule
without change.
Section 702.102 Capital Classifications
Under the Second Proposal, the title of Sec. 702.102 would have
been changed from ``statutory net worth categories'' to ``capital
classifications.'' The section would have continued to list the five
statutory capital categories that are provided in Sec. 216(c) of the
FCUA.\102\
---------------------------------------------------------------------------
\102\ 12 U.S.C. 1790d(c).
---------------------------------------------------------------------------
The Board received no comments on these revisions and has decided
to retain the proposed amendments in this final rule without change.
102(a) Capital Categories
The Second Proposal would have revised current Sec. 702.102(a) to
include new minimum risk-based capital ratio levels for complex credit
unions. Consistent with section 216(c)(1)(A) through (E) of the FCUA,
the minimum net worth ratio levels listed in proposed Sec. Sec.
702.102(a)(1) through (5) would have continued to match the ratio
levels listed in the statute for each capital category, and would have
included both the net worth ratio and the proposed risk-based capital
ratio as elements of the capital categories for ``well capitalized,''
``adequately capitalized,'' and ``undercapitalized'' credit unions. The
new minimum risk-based capital ratio levels included components that
required higher capital ratio levels to reflect increased risk due to
concentration risk and credit risk.
The Original Proposal also introduced a new, scaled approach to
assigning minimum risk-based capital ratio levels to the capital
classifications for well capitalized, adequately capitalized, and
undercapitalized credit unions. This scaled approach recognized the
relationship between higher risk-based capital ratios and the
creditworthiness of credit unions.
Public Comments on the Second Proposal
The Board received numerous general comments concerning the capital
categories. Most of those commenters simply stated that they opposed
the proposed two-tiered risk-based capital requirement, believed that
the Board generally lacked the legal authority to impose the risk-based
capital requirement as proposed, or both. Others specifically suggested
that the language in section 216(d) of the FCUA prohibits NCUA from
adopting different risk-based capital ratio threshold levels for well
capitalized and adequately capitalized credit unions. At least one
commenter suggested that section 216(d)(2) expressly ties NCUA's
statutory authority to its assessment of whether the 6 percent net
worth ratio threshold provides ``adequate protection'' because the term
``adequately capitalized'' used in the section refers to the
``adequately capitalized'' net worth category defined in section
216(c)(1)(B)(i) of the FCUA. The commenter suggested further that the
FCUA limits NCUA, in developing the risk-based net worth requirement,
to considering only ``whether the 6 percent requirement provides
adequate protection'' against the risks faced by credit unions because
section 216(d)(2) speaks only to whether an institution is ``adequately
capitalized,'' not ``well capitalized.'' Accordingly, the commenter
concludes that NCUA lacks the authority to implement a separate risk-
based net worth threshold level for the ``well capitalized'' net worth
category. The commenter argued further that the legislative history of
the FCUA suggests that section 216(d) bars NCUA
[[Page 66658]]
from implementing a separate RBC ratio for ``well capitalized'' credit
unions because an earlier version of CUMAA passed by the House of
Representatives provided in relevant part:
[NCUA is authorized to] establish reasonable net worth
requirements, including risk-based net worth requirements in the
case of complex credit unions, for various categories of credit
unions and prescribe the manner in which net worth is calculated
(for purposes of such requirements) with regard to various types of
investments, including investments in corporate credit unions,
taking into account the unique nature and role of credit
unions.\103\
---------------------------------------------------------------------------
\103\ H.R. Rep. 105-472, 1998 WL 141880, at *9 (1998).
The language quoted above was never included in the Senate version
of the CUMAA legislation, which was ultimately enacted, nor was it ever
included in the FCUA. The commenter suggested that this legislative
change demonstrates Congress' express consideration and rejection of
NCUA's proposed approach of adopting separate RBC thresholds for ``well
capitalized'' and ``adequately capitalized'' credit unions.
Another commenter suggested that any credit union, with a 7 percent
or higher net worth ratio, that fails to exceed its required risk-based
capital ratio level be given consideration in any prompt corrective
action required under the risk-based capital regulation. In such a
case, the commenter recommended the Board limit the remedy to a capital
restoration plan that allows the credit union a reasonable and
appropriate period of time to improve its risk-based capital ratio--
even as they maintain their statutory net worth ratio above 7 percent.
Discussion
NCUA has the authority to impose the proposed risk-based capital
requirement on complex credit unions. For the reasons discussed in both
the Second Proposal and above in the legal authority part of this
preamble, requiring credit unions to meet different minimum risk-based
capital ratio levels to be adequately and well capitalized is
consistent with the plain language of section 216 of the FCUA, is
``comparable'' to the Other Banking Agencies' PCA regulations, and
takes into account the cooperative character of credit unions.
Moreover, the Agency is not persuaded by the language quoted above from
a prior House bill,\104\ which Congress ultimately choose not to
include in CUMAA. Contrary to the commenter's suggestion, Congress'
choice of language in section 216(d) instead of the language in a prior
House version of CUMAA does not demonstrate that Congress expressly
considered and rejected NCUA's proposed approach of adopting separate
RBC thresholds for well capitalized and adequately capitalized credit
unions.
---------------------------------------------------------------------------
\104\ H.R. Rep. 105-472, 1998 WL 141880, at *9 (1998).
---------------------------------------------------------------------------
Furthermore, requiring complex credit unions to meet a higher risk-
based capital ratio threshold to be classified as well capitalized
allows for a graduated scale, which can measure either a decline or
improvement in a credit union's risk-based capital level in relation to
the minimum capital requirements. Such a system provides for earlier
identification and resolution of credit unions experiencing gradual
declines in the level of capital held on a risk-based measure. Under
the current rule, a credit union failing the risk-based net worth
requirement is immediately subject to the mandatory supervision action
for undercapitalized credit unions and may not have been fully aware of
their declining capital buffer. The use of a two-tiered risk-based
capital measure also allows stakeholders and creditors, such as
uninured shareholders, to reasonably compare financial institution
capital measures to the minimum regulatory requirements on a risk-based
level.
The Agency also questions the legality of the suggestion to amend
the final rule to require only a capital restoration plan in cases
where a credit union fails to meet or exceed the minimum risk-based
capital requirement, but meets or exceeds the 7 percent net worth ratio
requirement. Such an approach was not proposed and appears to conflict
with the mandatory restrictions on undercapitalized credit unions under
section 216(g) of the FCUA.
Accordingly, the Board has decided to retain the proposed capital
categories in this final rule without change.
102(a)(1) Well Capitalized
Proposed Sec. 702.102(a)(1) required a credit union to maintain a
net worth ratio of 7 percent or greater and, if it were a complex
credit union, a risk-based capital ratio of 10 percent or greater to be
classified as well capitalized. The higher proposed risk-based capital
requirement for the well capitalized classification was designed to
boost the resiliency of complex credit unions throughout financial
cycles and align them with the standards used by the Other Banking
Agencies.\105\
---------------------------------------------------------------------------
\105\ See, e.g., 12 CFR 324.10; 324.11; and 324.403.
---------------------------------------------------------------------------
Public Comments on the Second Proposal
A substantial number of commenters speculated that the proposed
risk-based capital ratio level for well capitalized credit unions would
place credit unions at a competitive disadvantage to banks unless all
credit unions are given the ability to meet the 10 percent requirement
with supplemental (Tier 2) capital, as banks are allowed to do under
their rules. The commenters recommended the Board either delay the
final release of the risk-based capital rule until it has developed a
supplemental capital rule or eliminate the 10 percent risk-based
capital ratio requirement and establish a single-tier requirement of 8
percent that aligns with the banking industry's Tier 1 capital
requirement.
A few commenters suggested that, in removing the effect of the
capital conservation buffer from the Original Proposal, the Board
should have lowered the risk-based capital ratio requirement to 8
percent, not the 10 percent in the Second Proposal. After examining the
makeup of capital at credit unions and banks, the commenter suggested
that Tier 1 capital is most similar because both credit union and bank
Tier 1 capital is comprised of either equity or retained earnings, and
both bank and credit union Tier 1 capital represent the strongest form
of capital on a financial institution's balance sheet. Under NCUA's
Second Proposal, credit unions could count their ALLL towards their
risk-based capital requirement, which is similar to banks; however,
banks have the added benefit of counting supplemental capital as Tier 2
capital. Since NCUA has not yet authorized all credit unions to use
secondary capital as part of their capital base for risk-based capital
purposes, the commenter claimed the most logical point of comparability
between banks and credit unions is Tier 1 capital. The commenter
recommended that the Board set the risk-based capital ratio level at 8
percent, which aligns with the banking industry's Tier 1 risk-based
capital ratio level for well capitalized banks, to ensure that credit
unions' and banks' risk-based capital requirements are comparable. The
commenter recommended further that such an approach would eliminate the
capital benefit from the ALLL to ensure comparability to the banks'
Tier 1 risk-based capital ratio requirement.
One bank trade association commenter, however, suggested that the
Board adopt the same Basel III model that was adopted by prudential
banking regulators. The commenter argued the
[[Page 66659]]
NCUA's proposed model would not be the same because under the Second
Proposal, credit unions were not subjected to a capital conservation
buffer, which banks are. The commenter suggested that, because of this
difference, the proposed risk-based capital ratio level required for a
credit union to be classified as well capitalized was 50 basis points
lower than the analogous requirement applicable to banks under the
Other Banking Agencies' regulations. The commenter suggested further
that credit unions, with their ability to avoid the payment of U.S.
income taxes and retain all their earnings, should not be subject to
lower capital requirements than banks while managing the same risk
profile as community banks that are subject to taxation.
Other commenters simply stated they believed the proposal did not
sufficiently justify assigning a risk-based capital ratio requirement
for well capitalized credit unions that is 3 percent higher than the
statutory 7 percent net worth ratio level required for a credit union
to be classified as well capitalized.
One commenter speculated that the proposed risk-based capital ratio
of 10 percent would limit the ability of credit unions to allocate
resources as they see fit, directly impacting what credit unions can do
for their members because credit unions need flexibility to be
successful. The commenter pointed out that credit union management is
held accountable by fiduciary responsibility of the Board of Directors,
while some are overseen by both Certified Public Accountants' opinion
audits and ongoing NCUA examination, and are therefore in the best
position to determine the appropriate balance to best serve the needs
of their members.
Discussion
There are sound policy reasons for setting a higher risk-based
capital ratio threshold for the well capitalized category than the one
for the adequately capitalized category. Under the current rule, a
credit union's capital classification could rapidly decline directly
from well capitalized to undercapitalized if it fails to meet the
required risk-based net worth ratio level.\106\ Moreover, credit unions
classified as well capitalized are generally considered financially
sound, afforded greater latitude under some other regulatory
provisions,\107\ and, with the exception of a small earnings retention
requirement, are not subject to mandatory or discretionary supervisory
actions. In contrast, credit unions that fall to the undercapitalized
category are financially weak and are subject to various mandatory and
discretionary supervisory actions intended to resolve the capital
deficiency and limit risk taking until capital levels are restored to
prudent levels. The lack of graduated thresholds in the current rule's
construct for the risk-based net worth requirement does not effectively
provide for early reflection through a credit union's net worth
category, as suggested in the GAO and OIG reports. Under the current
rule, a change in the credit union's risk profile, capital levels, or
both, that results in a decline in the credit union's risk-based net
worth ratio, does not affect its net worth category until it results in
the credit union falling to the point where the situation mandates that
harsh supervisory actions be taken.
---------------------------------------------------------------------------
\106\ Per the FCUA, ``undercapitalized'' is the lowest PCA
category in which a failure to meet the risk-based net worth
requirement can result.
\107\ See 12 CFR 745.9-2; and 12 CFR 723.7.
---------------------------------------------------------------------------
The Board reasons that the more effective approach and better
policy option is to adopt a higher threshold for the well capitalized
category than for the adequately capitalized category to provide a more
graduated framework where a credit union does not necessarily drop
directly from well capitalized to undercapitalized. In fact, this
policy objective is reflected in how Congress, in section 216(c) of the
FCUA, and the Other Banking Agencies, in their risk-based capital
regulations, designed the graduated PCA capital categories.
For a given risk asset, the amount of capital required to be held
for that risk asset is calculated by multiplying the dollar amount of
the risk asset times the risk weight times the desired capital level.
To illustrate, where the threshold for well capitalized is 10 percent,
a credit union that has one dollar in a risk asset assigned a 50
percent risk weight would need to hold capital of five cents ($1
multiplied by 50 percent multiplied by 10 percent). The point of this
illustration is that the risk weights are interdependent with the
thresholds set for the regulatory capital categories. The risk weights
included in the Second Proposal were based predominantly on those used
by the Other Banking Agencies, as suggested by credit unions and other
interested parties who submitted comment letters in response to the
Original Proposal. For the total capital-to-risk assets ratio, the
Other Banking Agencies establish a threshold of 10 percent to be well
capitalized.\108\
---------------------------------------------------------------------------
\108\ The Other Banking Agencies' Total Risk-Based Capital ratio
is the most analogous standard for credit unions given the proposed
broadening of the definition of capital to include accounts that
would not be included in the definition of Tier 1 capital, such as
the allowance for loan and lease losses and secondary capital for
low-income designated credit unions.
---------------------------------------------------------------------------
For NCUA's risk-based capital requirement to be comparable, it
should also be equivalent in rigor to the Other Banking Agencies' risk-
based capital requirement.\109\ The rigor of a regulatory capital
standard is primarily a function of how much capital an institution is
required to hold for a given type of asset. Thus, if NCUA chose any
threshold below 10 percent for the minimum required level of regulatory
capital, it would either result in systematically lower incentives for
credit unions to accumulate capital or the risk weights would need to
be adjusted commensurately to offset the effect of the lower threshold.
For example, if a uniform threshold for both well and adequately
capitalized were maintained and set at only 8 percent, as some
commenters suggested, there would be a decline in the overall rigor of
the risk-based capital ratio. While NCUA's proposed risk weights for
various assets could be increased by 20 percent to offset this effect,
adjusting the risk weights in this manner would create more difficulty
in comparing asset types and risk weights across financial
institutions, and lead to misunderstanding.
---------------------------------------------------------------------------
\109\ See S. Rep. No. 193, 105th Cong., 2d Sess. Sec. 301
(1998) (`` `Comparable' here means parallel in substance though not
necessarily identical in detail) and equivalent in rigor.'').
---------------------------------------------------------------------------
Conversely, the uniform threshold level for the well capitalized
and adequately capitalized categories could be maintained, but raised
to maintain the rigor of the risk-based capital standard and avoid
adjusting the risk weights. This approach would set a higher point at
which credit unions would fall to undercapitalized (such as any risk-
based capital ratio under 10 percent), and therefore be subject to
mandatory and discretionary supervisory actions. The Board concluded
this approach would not be optimal, as the supervisory consequences for
credit unions with risk-based capital ratios between eight percent and
10 percent would be worse than for institutions operating under the
Other Banking Agencies' rules.
Maintaining the rigor of the risk-based net worth requirement is
also important for another key policy objective of the Board: Ensuring
the risk-based net worth requirement is relevant and meaningful. A
relevant and meaningful risk-based net worth requirement will result in
capital levels better correlated
[[Page 66660]]
to risk, and better inform credit union decision making.\110\ To be
relevant and meaningful, the risk-based net worth requirement must
result in minimum regulatory capital levels on par with the net worth
ratio for credit unions with elevated risk, and be the governing ratio
(require more capital than the net worth ratio) for credit unions with
extraordinarily high risk profiles. If the highest threshold for the
risk-based capital ratio were set as low as 8 percent for well
capitalized credit unions, as some commenters suggested, the risk-based
net worth requirement would govern very few, if any, credit unions. If
the highest risk-based capital ratio threshold were set at 8 percent,
NCUA estimates at most seven credit unions would have the proposed
risk-based capital ratio be the governing requirement, with only one
credit union currently holding insufficient capital to meet the
requirement.
---------------------------------------------------------------------------
\110\ The benefits of a capital system better correlated to risk
are discussed in the Summary of the Final Rule part of this
preamble.
---------------------------------------------------------------------------
Further, capital is a lagging indicator because it is founded
primarily on accounting standards, which by their nature are largely
based on past performance. The net worth ratio is even more so a
lagging indicator because it applies capital--a lagging measure in
itself--to total assets. Thus, the net worth ratio does not distinguish
among risky assets or changes in a balance sheet's composition. A risk-
based capital ratio is more prospective by accounting for asset
allocation choices and driving capital requirements before losses occur
and capital levels decline. The more relevant the risk-based net worth
requirement is, the more likely that credit unions will build capital
sufficient to prevent precipitous declines in their PCA capital
classifications that could result in greater regulatory oversight and
even failure.
To be relevant and meaningful, the risk-based net worth requirement
also needs to encourage credit unions to build and maintain capital as
they increase risk to be able to absorb any corresponding unexpected
losses. A graduated, or tiered, system of capital category thresholds
that distinguishes between the well capitalized and adequately
capitalized categories will incentivize credit unions to hold sound
levels of capital without invoking supervisory action before necessary.
While there is no requirement for a credit union to be well
capitalized, and there are no supervisory interventions required for a
credit union with an adequately capitalized classification, there are
some regulatory privileges and other benefits for a credit union that
is well capitalized. Chief among those benefits is the accumulation of
sufficient capital to weather financial and economic stress. During the
2007-2009 financial crisis, some credit unions experienced large losses
in a compressed timeframe, resulting in a rapid deterioration of net
worth. Some credit unions that historically had been classified as well
capitalized were quickly downgraded to undercapitalized. As noted in
the Second Proposal, credit unions that failed at a loss to the NCUSIF
on average were very well capitalized, based on their net worth ratios,
24 months prior to failure (average net worth ratio of 12.1 percent).
Over the last 10 years, more than 80 percent of all credit union
failures involved institutions that were well capitalized in the 24
months immediately preceding their failure. Unlike the net worth ratio,
which is indifferent to the composition of assets, a well-designed
risk-based net worth requirement should reflect material shifts in the
risk profile of assets.
A risk-based capital framework that encourages and promotes capital
accumulation benefits not only those credit unions that achieve the
well-capitalized classification, but the entire credit union system.
Thus, the Board remains committed to implementing the risk-based
requirement under a graduated (multi-tiered) capital category
framework.
The Board agrees with the commenters who suggested that a 10
percent risk-based capital ratio threshold would simplify the
comparison with the Other Banking Agencies' rules by removing the
effect of the capital conservation buffer. The 10 percent threshold for
well capitalized credit unions, along with the 8 percent threshold for
adequately capitalized credit unions, would also be consistent with the
total risk-based capital ratio requirements contained in the Other
Banking Agencies' capital rules.
Capital ratio thresholds are largely a function of risk weights. As
discussed in other parts of this final rule, the Board is now more
closely aligning NCUA's risk weights with those assigned by the Other
Banking Agencies. Therefore, for consistency, the Board reasons that
NCUA's risk-based capital ratio threshold levels should likewise align
with those of the Other Banking Agencies as closely as possible.
The Board plans to address additional forms of supplemental capital
in a separate proposed rule, with the intent to finalize a new
supplemental capital rule before the effective date of this risk-based
capital final rule. Therefore there is no need to delay release of this
final rule. The Board notes the second risk-based capital proposal
invited general comment on supplemental capital much in the way an
advanced notice of proposed rulemaking would do. A notice of proposed
rulemaking on supplemental capital with specific criteria and
requirements is necessary under the Administrative Procedure Act before
the Board could issue a final rule. Issuing a new, more specific and
detailed proposed rule on supplemental capital will give interested
parties full opportunity to comment on it.
Accordingly, the Board has decided to retain proposed Sec.
702.102(a)(1) in this final rule without change.
102(a)(2) Adequately Capitalized
Under the Second Proposal, Sec. 702.102(a)(2) required a credit
union to maintain a net worth ratio of 6 percent or greater and, if it
were a complex credit union, a risk-based capital ratio of 8 percent or
greater to be classified as adequately capitalized. This risk-based
capital ratio level is comparable to the 8 percent total risk-based
capital ratio level required by the Other Banking Agencies for a bank
to be adequately capitalized.
Other than the comments discussed above and in other parts of this
preamble, the Board received no comments on the proposed adequately
capitalized risk-based capital ratio level. Therefore, the Board has
decided to retain proposed Sec. 702.102(a)(2) in this final rule
without change.
102(a)(3) Undercapitalized
Under the Second Proposal, Sec. 702.102(a)(3) would have
classified a credit union as undercapitalized if: (1) The credit union
has a net worth ratio of 4 percent or more but less than 6 percent; or
(2) the credit union, if complex, has a risk-based capital ratio of
less than 8 percent.
Other than the comments discussed above and other parts of this
preamble, the Board received no comments on the proposed
undercapitalized risk-based capital ratio requirement. Therefore, the
Board has decided to retain proposed Sec. 702.102(a)(3) without
change.
102(a)(4) Significantly Undercapitalized
Under the Original Proposal, proposed Sec. 702.102(a)(4) would
have classified a credit union as significantly undercapitalized if:
The credit union has a net worth ratio of 2 percent or
more but less than 4 percent; or
[[Page 66661]]
The credit union has a net worth ratio of 4 percent or
more but less than 5 percent, and either--
o Fails to submit an acceptable net worth restoration plan within
the time prescribed in Sec. 702.111;
o Materially fails to implement a net worth restoration plan
approved by the Board; or
o Receives notice that a submitted net worth restoration plan has
not been approved.
The Board received no comments on the revisions to this paragraph
and has decided to retain the proposed amendments in this final rule
without change.
102(a)(5) Critically Undercapitalized
Under the Second Proposal, Sec. 702.102(a)(5) classified a credit
union as critically undercapitalized if it had a net worth ratio of
less than 2 percent. The Second Proposal would have also made some
minor technical amendments to the language in current Sec.
702.102(a)(5), but would not have changed the criteria for being
classified as critically undercapitalized under part 702.
The Board received no comments on the revisions to this paragraph
and has decided to retain the proposed amendments in this final rule
without change.
102(b) Reclassification Based on Supervisory Criteria Other Than Net
Worth
The Second Proposal would have retained current Sec. 702.102(b),
with only a few amendments to update terminology and make minor edits
for clarity. No substantive changes were intended.
The Board received no comments on the revisions to this paragraph
and has decided to retain the proposed amendments in this final rule
without change.
102(c) Non-Delegation
Proposed Sec. 702.102(c) would have been unchanged from current
Sec. 702.102(c).
The Board received no comments on this paragraph and has decided to
retain the paragraph in this final rule without change.
102(d) Consultation With State Officials
Proposed Sec. 702.102(d) would have retained current Sec.
702.102(d) with only non-substantive amendments for consistency with
other sections of NCUA's regulations. No substantive changes were
intended.
The Board received no comments on this paragraph and has decided to
retain the proposed amendments in this final rule without change.
Section 702.103 Applicability of the Risk-Based Capital Ratio Measure
The Second Proposal would have changed the title of current Sec.
702.103 from ``Applicability of risk-based net worth requirement'' to
``Applicability of risk-based capital ratio measure.'' Proposed Sec.
702.103 would have provided that, for purposes of Sec. 702.102, a
credit union is defined as ``complex'' and the risk-based capital ratio
measure is applicable only if the credit union's quarter-end total
assets exceed $100 million, as reflected in its most recent Call
Report.
Public Comments on the Second Proposal
The Board received a large number of comments on proposed Sec.
702.103. Several commenters argued that the FCUA requires the Board to
define ``complex'' credit unions based on the ``portfolios of assets
and liabilities of credit unions,'' and that the proposed use of an
asset size threshold to define ``complex'' credit unions would not
comply with the statutory requirement.
A substantial number of commenters also stated that they opposed
the proposed definition of ``complex'' credit union because they
believed asset size should not be a primary qualifier of a credit
union's complexity.
At least one trade association commenter, however, acknowledged
that an asset threshold proxy, while less precise than individual
balance sheet analysis, would allow for a streamlined application of
the rule and would minimize opportunities for arbitrage. The commenter
suggested that if the definition of ``complex'' were tied to specific
activities, credit unions could be incentivized, on the margin, to
simply avoid those activities in order to avoid the risk-based capital
requirements. And such conduct could have unintended consequences and
create new unanticipated risks to capital adequacy. Similarly, at least
one credit union commenter stated that using an asset size threshold to
define complex credit unions would give credit unions a bright line
test and eliminate the difficulty of having to anticipate what products
and services should be classified as complex. Another credit union
commenter suggested that a rule that identified specific types of
lending activity that made an institution complex might mask undue
concentration risk.
A substantial number of commenters suggested that asset size, if
used in the final rule, should be raised to some amount above $100
million. Specific threshold amounts suggested by commenters ranged from
$250 million to $10 billion. Several commenters speculated that
refining the complexity analysis and raising the asset size threshold
would not considerably increase the risk to the Share Insurance Fund
because by the time the final rule is implemented in 2019, an even
greater percentage of system assets would be covered. Other commenters
maintained that the final rule should only apply to credit unions that
meet the same asset size threshold used by the Other Banking Agencies
to define small banks. One commenter suggested that the Board should
align the definitions of ``complex'' credit union across all of NCUA's
regulations so they are the same, and, at a minimum, the Board should
increase the threshold to $250 million to be consistent with the
definition in the derivatives regulation.
Some commenters contended that the proposed list of assets and
liabilities identified as complex were much too broad. One commenter
suggested that Congress limited the application of risk-based capital
to complex credit unions \111\ and directed NCUA to design the risk-
based capital standard to protect against material risks that may not
be adequately captured by the net worth ratio requirement \112\ because
Congress intended that credit unions be designated as ``complex'' based
on only their involvement in high-risk activities that the net worth
ratio requirement may not account for. The commenter noted further that
the list of complex assets and liabilities used by the Board to set the
asset size threshold at $100 million included several standard
activities that are already contemplated by the statutory net worth
ratio requirement. The commenter believed, for example, that real
estate loans, investments with maturities greater than five years, and
internet banking are staple activities of financial services
institutions in today's marketplace and should not be considered
complex; and that other activities only become complex when undertaken
in significant volumes--for example, a credit union that lends a member
$60,000 to purchase new equipment for his bakery is engaged in member
business lending, but that credit union should not be designated as
complex by virtue of that single loan. The commenter contended that the
size of the portfolio and its significance to the credit union's
overall business strategy drives complexity; so the commenter concluded
that member
[[Page 66662]]
business, indirect, interest-only, and participation loans should only
indicate complexity where the activity exceeds a certain percentage of
total assets, and borrowings should only denote complexity where they
constitute a significant element of the credit union's funding
strategy. Other commenters suggested that a credit union be defined as
``complex'' only if it engages in three or more of the following assets
or liabilities: Member business loans, participation loans, interest-
only loans, indirect loans, non-federally guaranteed student loans,
borrowings, and derivatives. Still other commenters suggested that the
definition of ``complex'' be based on the following activities:
Participation loans, interest-only loans, indirect loans, real estate
loans, non-agency mortgage backed securities, non-mortgage related
securities with embedded options, collateralized mortgage obligations/
real estate mortgage investment conduits, commercial mortgage-related
securities, and derivatives.
---------------------------------------------------------------------------
\111\ 12 U.S.C. 1790d(d)(1).
\112\ 12 U.S.C. 1790d(d)(2).
---------------------------------------------------------------------------
In addition, commenters argued that because they do not adequately
represent complexity, the Board should not use the following assets or
liabilities: Real estate loans, obligations fully guaranteed by the
U.S. Government, investments with maturities of greater than five
years, non-agency mortgage-backed securities, non-mortgage-related
securities with embedded options, collateralized mortgage obligations/
real estate mortgage investment conduits, commercial mortgage-related
securities, and internet banking. In addition, one commenter argued
that internet banking, a service that credit unions provide, is neither
an asset nor a liability so the FCUA bars NCUA from considering
internet banking when considering complexity.
One commenter recommended that the asset size threshold should be
set where all or most credit unions are engaged in four or more of the
activities the Board identifies as complex. The commenter claimed that
the FCUA, which requires NCUA to specify which credit unions are
``complex'' based on the portfolios of assets and liabilities of credit
unions,\113\ prohibits a credit union from being classified based on a
single complex activity.
---------------------------------------------------------------------------
\113\ 12 U.S.C. 1790(d)(1).
---------------------------------------------------------------------------
Another commenter suggested that using an asset size threshold
alone to define complexity was appropriate and that the presence of
more complex lending products should not necessarily define a complex
credit union because financial institutions in general become more
complex with size and by moving into more complex/sophisticated
financial transactions such as mortgage-backed securities, derivatives,
loan sales or purchases, mortgage pipelines and servicing assets. The
commenter suggested that these types of financial transactions are not
ordinary in smaller asset size institutions because they generally
require more scale and overhead of a larger institution to manage and
understand.
Other commenters recommended that the Board define complexity using
a credit union's product offerings, in a manner similar to that used in
the current rule. The commenters suggested that the most analogous
approach would be a ratio of risk-weighted assets to total assets
greater than 67 percent as measure by the proposal's risk weights. At
least one of those commenters, however, acknowledged that the 67
percent threshold might not be a meaningful measure of risk, but that
using different thresholds yielded similar results.
At least one commenter suggested that all federally insured credit
unions with assets of $500 million or less should be excluded from the
definition of ``complex,'' and that only those credit unions with $500
million or more in assets and that have an NCUA Complexity Index
(discussed in the Supplementary Information to the Original Proposal)
value of 17 or higher should be required to meet NCUA's risk-based
capital requirement. Similarly, another commenter suggested that all
federally insured credit unions with assets of $500 million or less
should be excluded from the definition of ``complex,'' and that only
those credit unions with $500 million or more in assets and that have
an NCUA Complexity Index value of 20 or higher should be required to
meet NCUA's risk-based capital requirement. Yet another commenter
suggested that all federally insured credit unions with assets of $1
billion or less should be excluded from the definition of ``complex,''
and that only those credit unions with assets above $1 billion and that
have an NCUA Complexity Index value of 20 or higher should be required
to meet NCUA's risk-based capital requirement.
Additional suggestions provided by commenters for defining credit
unions as ``complex'' included:
Defining ``complex'' with attributes such as deposit
account features, member services, loan and investment products, and
portfolio makeup.
Defining ``complex'' based on whether a credit union
engages in a combination of activities including, participation loans,
non-agency mortgage-backed securities, repurchase transactions, and
derivatives.
Defining ``complex'' as credit unions with over $100
million or more in assets and that provide member business loans and
invest in derivatives.
Defining ``complex'' as credit unions with $500 million or
more in assets and/or that are engaged in over 50 percent of all of the
categories, especially the investment section, noted in the preamble to
the Second Proposal.
Defining ``complex'' as credit unions with $500 million or
more in assets, and that invest in non-agency mortgage-backed
securities and non-mortgage related securities with embedded options.
As an alternative, one trade organization commenter suggested that
with credit unions exiting an extreme financial crisis where many of
these institutions failed due to lack of high-quality capital and
elevated risk profiles, the Board should be focusing its attention on
raising the minimum regulatory capital levels for all credit unions.
Other credit union commenters argued that the risk-based capital
requirements should apply to all credit unions because recent data on
credit union failures contradict claims that there is less risk in
credit unions with less than $100 million in assets. Granted, the
commenters suggested, in rural areas and in a few other special
circumstances, small credit unions play a crucial role, and in such
cases NCUA should offer waivers. A small credit union commenter
suggested that many credit unions with $100 million or less in assets
have the same, and often times more, risk on their balance sheets and
in their operations than credit unions with over $100 million in
assets. The commenter believed that smaller credit unions engage in
complex activities for the following reasons: (1) If they do not offer
products and services that the bigger credit unions do, their members
will leave and the credit unions will (eventually) be forced to merge
(not an outcome they wanted); (2) they need products that increase
their income and capital (e.g., business loans, participation loans,
and indirect lending); (3) they recognize they do not have the
expertise they should have but it is expensive and hard to attract
expertise based on their compensation structure. Another credit union
commenter claimed that smaller credit unions have failed at a higher
rate and have had a higher incidence of catastrophic failure due to a
lack of comprehensive internal management and process controls that can
lead to fraud. The commenter maintained that a
[[Page 66663]]
credit union charter is a privilege and not a right and that all credit
unions should be subject to the same risk-based capital requirements
and examination standards.
One commenter suggested that it is very likely that a small credit
union could pose a much larger risk to the NCUSIF than a larger credit
union, and that using asset size as a threshold for complexity suggests
that capital is not as critical for smaller institutions. The commenter
suggested further that ``complexity'' should be defined based on the
quality of the management of the risks undertaken by the institution,
which is ideally measured by the ``M'' in the CAMEL rating. The
commenter recommended that identifying the credit unions to which the
risk-based capital requirement applies is best done through the
supervision process so that those credit unions posing a higher risk to
the NCUSIF have higher standards and expectations by which to abide.
The commenter suggested that this solution would reduce the ``broad-
brush'' effect of the current proposal, applying more stringent
standards to those institutions that may benefit from regulatory risk
management and thus provide greater protection to the NCUSIF.
A significant number of commenters requested that the asset size
threshold, if used, be indexed so that it does not apply to smaller and
smaller credit unions through time due to inflation. And at least one
commenter suggested that any credit union that is identified as
``complex'' by NCUA should be able to present evidence to the agency as
to why it is not complex and thus, should not be subject to risk-based
capital requirements. The commenter suggested further that the process
for contesting an agency designation of ``complex'' should be detailed
in the final rule.
Discussion
The proposed use of an asset size threshold to define ``complex''
does comply with section 216 of the FCUA. As discussed in the Legal
Authority part of this preamble, section 216(d)(1) directs NCUA, in
determining which credit unions will be subject to the risk-based net
worth requirement, to base its definition of complex ``on the
portfolios of assets and liabilities of credit unions.'' \114\ The
statute does not require, as some commenters have argued, that the
Board adopt a definition of ``complex'' that takes into account the
portfolio of assets and liabilities of each credit union on an
individualized basis. Rather, section 216(d)(1) authorizes the Board to
develop a single definition of ``complex'' that takes into account the
portfolios of assets and liabilities of all credit unions. Consistent
with section 216(d)(1), the proposed definition of a ``complex'' credit
union included an asset size threshold that, as explained in more
detail below, was designed by taking into account the portfolios of
assets and liabilities of all credit unions.
---------------------------------------------------------------------------
\114\ 12 U.S.C. 1790d(d).
---------------------------------------------------------------------------
Under the current rule, credit unions are ``complex'' and subject
to the risk-based net worth requirement only if they have quarter-end
total assets over $50 million and they have a risk-based net worth
ratio over 6 percent. In effect, this means that all credit unions with
over $50 million in assets compute the risk-based net worth requirement
to determine if they meet the complex definition.
For reasons described more fully below, the Board maintains that
defining the term ``complex'' credit union using a single asset size
threshold of $100 million as a proxy for a credit union's complexity is
accurate, reduces the complexity of the rule, provides regulatory
relief for smaller institutions, and eliminates the potential
unintended consequences of having a checklist of activities that would
determine whether or not a credit union is subject to the risk-based
capital requirement.
Under the Second Proposal, the term ``complex'' was defined only
for purposes of the risk-based capital ratio measure. For the purpose
of defining a complex credit union, assets include tangible and
intangible items that are economic resources (products and services)
that are expected to produce economic benefit (income), and liabilities
are obligations (expenses) the credit union has to outside parties. The
Board recognizes there are products and services--which under GAAP are
reflected as the credit unions' portfolio of assets and liabilities
\115\--in which credit unions are engaged that are inherently complex
based on the nature of their risk and the expertise and operational
demands necessary to manage and administer such activities effectively.
Thus, credit unions offering such products and services have complex
portfolios of assets and liabilities for purposes of NCUA's risk-based
net worth requirement.
---------------------------------------------------------------------------
\115\ Products and services comprise a portfolio of assets and
liabilities through the accounts and fixed assets that must be
maintained to operate, the resources of staff and funds necessary to
operate the credit union, and the liabilities that may arise from
contractual obligations, among other things. Altogether, these
products and services are accounted for on the balance sheet through
the assets and liabilities according to GAAP.
---------------------------------------------------------------------------
Consistent with the Second Proposal, the following products and
services, if engaged in by a credit union, are accurate indicators of
complexity:
Member Business Loans
Participation Loans
Interest-Only Loans
Indirect Loans
Real Estate Loans
Non-Federally Guaranteed Student Loans
Investments with Maturities of Greater than Five Years (where
the investments are greater than one percent of total assets)
Non-Agency Mortgage-Backed Securities
Non-Mortgage-Related Securities With Embedded Options
Collateralized Mortgage Obligations/Real Estate Mortgage
Investment Conduits
Commercial Mortgage-Related Securities
Borrowings
Repurchase Transactions
Derivatives
Internet Banking
NCUA's review of Call Report data as of June 30, 2014 and March 31,
2015, showed that all credit unions with more than $100 million in
assets were engaged in offering at least one of the products and
services listed above; 99 percent engaged in two or more complex
activities, and 87 percent engaged in four or more. On the other hand,
less than two-thirds of credit unions below $100 million in assets were
involved in even a single complex activity, and only 15 percent had
four or more. Moreover, credit unions with total assets of less than
$100 million are only a small share (approximately 10 percent) of the
overall assets in the credit union system--which limits the exposure of
the Share Insurance Fund to these institutions. Accordingly, a $100
million asset size threshold is a clear demarcation above which complex
activities are always present, and where credit unions are almost
always engaged in multiple complex activities. Additionally, the
percentage of credit unions engaged in multiple activities using asset
size thresholds above $100 million does not produce a significant
demarcation between credit unions when compared to the differences
observed at the $100 million threshold.
Conversely, using a credit union's percentage of risk assets to
total assets as the factor for determining whether the credit union is
complex would require all credit unions to understand, monitor, and
apply a complex measure their risk asset to asset ratio each quarter.
This would be an additional and unnecessary burden for credit unions
below the $100 million asset size threshold.
[[Page 66664]]
As discussed earlier, $100 million in assets is an accurate proxy
for complexity based on credit unions' portfolios of assets and
liabilities. It is logical, clear, and easy to administer. Based on
December 31, 2014 Call Report data, this approach exempts approximately
76 percent of credit unions from the regulatory burden associated with
complying with the risk-based net worth requirement and capital
adequacy plan, while still covering 90 percent of the assets in the
credit union system. It is also consistent with the fact that the
majority of losses (68 percent as measured as a proportion of the total
dollar cost) \116\ to the NCUSIF spanning the last 12 years have come
from credit unions with assets greater than $100 million.\117\
---------------------------------------------------------------------------
\116\ Based on an analysis of loss and failure data collected by
NCUA.
\117\ NCUA performed backtesting analysis of Call Report and
failure data to determine whether this final regulation would have
resulted in earlier identification of emerging risks and possibly
reduced losses to the NCUSIF. The impact of the final rule on more
recent failures of credit unions with total assets over $100 million
was also evaluated. The testing revealed that maintaining a risk-
based capital ratio in excess of 10 percent would have triggered
eight out of nine such failing credit unions to hold additional
capital, which could have prevented failure or reduced losses to the
NCUSIF.
---------------------------------------------------------------------------
Accordingly, consistent with requirements of Sec. 216(d)(1) of the
FCUA, the final rule eliminates current Sec. 702.103(b) and defines
all credit unions with over $100 million in assets as ``complex.''
Section 702.104 Risk-Based Capital Ratio
Under the Second Proposal, the Board proposed changing the title of
current Sec. 702.104 from ``Risk portfolio defined'' to ``Risk-based
capital ratio.'' In addition, the Board proposed entirely replacing the
requirements for calculating the risk-based net worth requirement for
``complex'' credit unions under current Sec. 702.104 with a new risk-
based capital ratio measure.\118\ The proposed section would have
required all ``complex'' credit unions to calculate their risk-based
capital ratio as directed under the section. The proposed risk-based
capital ratio was designed to enhance sound capital management and help
ensure that credit unions maintain adequate levels of loss-absorbing
capital going forward, strengthening the stability of the credit union
system and ensuring credit unions serve as a source of credit in times
of stress.
---------------------------------------------------------------------------
\118\ 12 U.S.C. 1790d(d).
---------------------------------------------------------------------------
Public Comments on the Second Proposal
NCUA received many general comments on the proposed Sec. 702.104.
Many commenters simply stated that they opposed the new risk-based
capital ratio measure altogether, and preferred maintaining the current
risk-based net worth measure. Others objected to specific aspects of
the calculation, which are discussed in more detail below.
Discussion
As discussed above and in more detail below, the proposed changes
are necessary to provide a more comparable measure of capital across
all financial institutions and to better account for related elements
of the financial statement that are available to cover losses and
protect the NCUSIF. The proposed risk-based capital ratio employed the
method for computing the risk-based capital measures used by the Other
Federal Banking Agencies: A higher ratio reflects the existence of a
higher level of funds available to cover losses in relation to risk-
weighted assets. Because the risk weights in the final rule are
generally comparable to those used by banks, the risk-based capital
ratio will allow an interested party to compare risk-based capital
measures across institutions to obtain a relative measure of their
financial strength. Additionally, the current risk-based net worth
requirement assigns high risk weights to low-credit-risk assets to
account for interest rate risk--such as investments in Treasury
securities with maturities in excess of five years--which results in a
higher risk-based capital requirement for credit unions holding these
types of low-credit-risk investments. Thus, the Board concluded it is
no longer appropriate to retain NCUA's current risk-based net worth
measure.
Consistent with the Second Proposal, this final rule changes the
title of current Sec. 702.104 from ``Risk portfolio defined'' to
``Risk-based capital ratio.'' In addition, this final rule entirely
replaces the requirements for calculating the risk-based net worth
ratio for ``complex'' credit unions under current Sec. 702.104 with a
new risk-based capital ratio measure.\119\
---------------------------------------------------------------------------
\119\ 12 U.S.C. 1790d(d).
---------------------------------------------------------------------------
104(a) Calculation of Capital for the Risk-Based Capital Ratio
Under the Second Proposal, Sec. 702.104(a) provided that to
determine its risk-based capital ratio, a complex credit union must
calculate the percentage, rounded to two decimal places, of its risk-
based capital ratio numerator as described in Sec. 702.104(b) to its
total risk-weighted assets as described in Sec. 702.104(c). The
proposed method of calculating risk-based capital was generally
consistent with the methods used in other sectors of the financial
services industry.
Other than the comments discussed elsewhere in the preamble, the
Board received no comments on the proposed revisions to this paragraph
and has decided to retain the amendments in this final rule without
change.
104(b) Risk-Based Capital Ratio Numerator
Under the Second Proposal, Sec. 702.104(b) provided that the risk-
based capital ratio numerator is the sum of certain specific capital
elements listed in Sec. 702.104(b)(1), minus regulatory adjustments
listed in Sec. 702.104(b)(2).
Other than the comments discussed elsewhere in the preamble, the
Board received no comments on the proposed revisions to this paragraph
and has decided to retain the amendments in this final rule without
change.
104(b)(1) Capital Elements of the Risk-Based Capital Ratio Numerator
Under the Second Proposal, Sec. 702.104(b)(1) listed the capital
elements of the risk-based capital ratio numerator as follows:
Undivided earnings (including any regular reserve); appropriation for
non-conforming investments; other reserves; equity acquired in merger;
net income; ALLL; secondary capital accounts included in net worth (as
defined in Sec. 702.2); and section 208 assistance included in net
worth (as defined in Sec. 702.2). Consistent with the Second Proposal,
Sec. 702.104(b)(1) listed the elements of the risk-based capital ratio
numerator.
Public Comments on the Second Proposal
The Board received a significant number of comments suggesting
various amendments or additions to the capital elements included in the
Second Proposal, which are discussed in more detail below.
Discussion
The Board generally disagrees with the comments concerning capital
elements and has, for the reasons discussed in more detail below,
decided to retain the language in proposed Sec. 702.104(b)(1) in this
final rule. The Board proposed Sec. 702.104(b)(1) to provide for a
more comparable measure of capital across all financial institutions
and better account for
[[Page 66665]]
related elements of the financial statement that are available (or not)
to cover losses and protect the NCUSIF. As explained above, the FCUA
gives NCUA broad discretion in designing the risk-based net worth
requirement. Accordingly, this final rule incorporates the proposed
broadened definition of capital for purposes of calculating the new
risk-based capital ratio.
Undivided Earnings
The Second Proposal included undivided earnings in the risk-based
capital ratio numerator. The Board received no comments on the
inclusion of this capital element in the risk-based capital ratio
numerator. Accordingly, the Board has decided to retain this aspect of
the Second Proposal in this final rule without change.
Appropriation for Nonconforming Investments
The Second Proposal included the appropriation for nonconforming
investments in the risk-based capital ratio numerator. The Board
received no comments on the inclusion of this capital element in the
risk-based capital ratio numerator. Accordingly, the Board has decided
to retain this aspect of the Second Proposal in this final rule without
change.
Other Reserves
The Original Proposal included other reserves in the risk-based
capital ratio numerator. The Board received no comments on the
inclusion of this capital element in the risk-based capital ratio
numerator. Accordingly, the Board has decided to retain this aspect of
the Second Proposal in this final rule without change.
Equity Acquired in Merger
Under the Second Proposal, the risk-based capital ratio numerator
included the equity acquired in merger component of the balance sheet.
This equity item was used in place of the total adjusted retained
earnings acquired through business combinations amount that credit
unions currently report on the PCA net worth calculation worksheet in
the Call Report. Equity acquired in merger is the GAAP equity recorded
in a business combination and can vary from the amount of total
adjusted retained earnings acquired through business combinations,
which is not a GAAP accounting item. The use of equity acquired in a
merger, as measured using GAAP, more accurately reflects the overall
value of the business combination transaction.
The Board received no comments on the inclusion of this capital
element in the risk-based capital ratio numerator. Accordingly, the
Board has decided to retain this aspect of the Second Proposal in this
final rule without change.
Net Income
The Second Proposal included net income in the risk-based capital
ratio numerator. The Board received no comments on the inclusion of
this capital element in the risk-based capital ratio numerator.
Accordingly, the Board has decided to retain this aspect of the Second
Proposal in this final rule without change.
ALLL
The Second Proposal included the total amount of the ALLL,
maintained in accordance with GAAP, in the risk-based capital ratio
numerator. Credit unions already expense through the income statement
the expected credit losses on the loan portfolio. In times of financial
stress, while risk may be increasing (such as rising non-current
loans), an uncapped inclusion of the ALLL in the risk-based capital
ratio numerator would allow a properly funded ALLL to somewhat offset
the impact of the financial stressors on the risk-based capital ratio.
Public Comments on the Second Proposal
The vast majority of commenters who mentioned the treatment of ALLL
stated that they agreed with its proposed treatment in the Second
Proposal. A few commenters, however, did argue that the ALLL should be
limited to 1.25 percent of risk assets in determining the risk-based
capital ratio numerator. These commenters suggested that if the loan
loss reserves are established for identified losses, then they do not
possess the essential characteristic of capital--the ability to absorb
unidentified losses--and should not be included in the capital base.
The commenters suggested further that because it is not always possible
to clearly distinguish between identified and unidentified losses, the
Other Banking Agencies capped the amount of ALLL being counted as
capital at 1.25 percent of risk assets. These commenters argued further
that limiting ALLL to 1.25 percent of risk assets would not create a
disincentive for complex credit unions to fully fund the ALLL above the
1.25 percent ceiling because complex credit unions are bound by
generally accepted accounting principles to fully fund their ALLL, so
not doing so would constitute an unsafe and unsound practice. Finally,
these commenters argued that removing the 1.25 percent cap on ALLL
would overstate the amount of capital that complex credit unions have
available to absorb unexpected losses, and would make the comparison
between bank and credit union risk-based capital ratios more difficult.
Discussion
The Board disagrees with the commenters who suggested that the ALL
should be limited to 1.25 percent of risk assets. All of the ALLL,
maintained in accordance with GAAP, should be included in the risk-
based capital ratio numerator because credit unions will have already
expensed, through the income statement, the expected credit losses on
the loan portfolio. In times of financial stress, while risk may be
increasing (such as rising non-current loans), an uncapped inclusion of
the ALLL in the risk-based capital ratio numerator will allow a
properly funded ALLL to somewhat offset the impact of the financial
stressors on the risk-based capital ratio. Further, NCUA's supervision
process can address any concerns with inclusion of the ALLL, such as
ensuring proper funding. Accordingly, the Board has decided to retain
this aspect of the Second Proposal in this final rule without change.
Secondary Capital Accounts
The Second Proposal included secondary capital accounts included in
net worth (as defined in Sec. 702.2) in the risk-based capital ratio
numerator.
While there was overwhelming support for allowing credit unions to
count secondary capital accounts in the risk-based capital ratio
numerator (including support for access for additional forms of
supplemental capital), the Board received no comments opposing its
inclusion. Accordingly, the Board has decided to retain this aspect of
the Second Proposal in this final rule without change.
The Board plans to address comments supporting additional forms of
supplemental capital in a separate proposed rule, with the intent to
finalize a new supplemental capital rule before the effective date of
this risk-based capital final rule.
Section 208 Assistance
The Second Proposal included section 208 assistance that is
included in net worth (as defined in Sec. 702.2) in the risk-based
capital ratio numerator.
The Board received no comments on the inclusion of this capital
element in the risk-based capital ratio numerator. Accordingly, the
Board has decided to retain this aspect of the Second Proposal in this
final rule without change.
[[Page 66666]]
Call Report Equity Items Not Included in the Risk-Based Capital Ratio
Numerator
Under the Second Proposal, the risk-based capital ratio numerator
did not include the following Call Report equity items: Accumulated
unrealized gains (losses) on available for sale securities; accumulated
unrealized losses for other than temporary impairment (OTTI) on debt
securities; accumulated unrealized net gains (losses) on cash flow
hedges; and other comprehensive income. In designing the proposed rule,
the Board recognized that the items listed above reflected a credit
union's actual loss absorption capacity at a specific point in time,
but included gains or losses that may or may not be realized. The Board
also recognized that including these items in the risk-based ratio
numerator could lead to volatility in the risk-based capital ratio
measure, difficulty in capital planning and asset-management, and other
unintended consequences.\120\
---------------------------------------------------------------------------
\120\ The Other Banking Agencies' regulatory capital rules allow
institutions to make an opt-out election for similar accounts. See,
e.g., 12 CFR 324.22; and 78 FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------
The Board received no comments on the exclusion of these elements
in the risk-based capital ratio numerator. Accordingly, the Board has
decided to retain this aspect of the Second Proposal in this final rule
without change.
Other Supplemental Forms of Capital
Under the Second Proposal, supplemental forms of capital, other
than those discussed above, were not included in the risk-based capital
ratio numerator. The Board, however, did specifically request comment
on specific detailed questions regarding whether revisions should be
made to NCUA's regulations through a separate rulemaking to allow
additional supplemental forms of capital to be included in the risk-
based capital ratio.
Public Comments on the Second Proposal
A majority of the commenters who mentioned supplemental capital
stated that it was imperative the Board consider allowing credit unions
ready access to additional supplemental forms of capital. Commenters
suggested it was particularly important as risk-based capital goes into
effect, as credit unions are at a disadvantage in the financial market
because of lack of access to additional capital outside of retained
earnings. Commenters suggested that if supplemental capital were to
count toward regulatory capital, it would benefit the credit union by
allowing it to expand products and services without diluting its
regulatory capital, and it would protect the NCUSIF by incentivizing
credit unions to attract private capital that could absorb losses
before causing a loss to the Insurance Fund.
Some commenters suggested further that the Board include (as a
placeholder in this final rule) supplemental forms of capital, as
defined by the Board and approved by NCUA or the appropriate state
supervisory authority, in the risk-based capital numerator. Those
commenters suggested the specific criteria could then be developed
between finalizing the rule and its effective date in 2019.
Other commenters acknowledged that because Congress did not speak
directly to the calculation of risk-based capital, the Board need not
be limited by section 216(0)(2) of the FCUA in defining what elements,
including supplemental capital, constitute the ratio. Several
commenters, however, suggested that not allowing all credit unions to
use additional supplemental forms of capital to meet their risk-based
capital requirements would create a more stringent capital requirement
for credit unions, which would place credit unions at a competitive
disadvantage to banks. One commenter argued the Board failed to meet
the requirement to establish a capital framework that is comparable to
the Other Banking Agencies because credit unions will be disadvantaged
to banks.
Other commenters recommended that the Board delay the publication
of the final risk-based capital rule so that it can coincide with the
publication of a final supplemental capital rule.
Discussion
Consistent with the Second Proposal, this final rule would not
include additional supplemental forms of capital in the risk-based
capital ratio numerator at this time.
The authorization of additional supplemental forms of capital for
federal credit unions, and the inclusion of such forms of capital and
the various forms of capital authorized for federally insured state-
chartered credit unions in the risk-based capital ratio numerator, is
beyond the scope of this rulemaking. Delaying the issuance of this
final rule until a separate supplemental capital proposal could be
issued and then finalized, as several commenters suggested, would only
reduce the amount of time credit unions have to prepare to comply with
this final rule.
The Board, however, appreciates the comments requesting access to
additional supplemental forms of capital for credit unions. Board
Chairman Debbie Matz has formed a working group at NCUA to consult with
stakeholders and develop a separate proposed rule regarding
supplemental forms of capital that could be included in the numerator
of the risk-based capital ratio. The working group has reviewed the
comments received on this issue, studied the alternative forms of
capital used internationally and within the cooperative system, and
obtained additional insight from industry practitioners who were highly
interested or experienced with alternative forms of capital.
In the near future, the working group plans to present its
recommendations to the Board for revisions that could be made to NCUA's
regulations through a separate rulemaking to allow additional
supplemental forms of capital to be included in the risk-based capital
ratio. The Board's intent is to finalize a new supplemental capital
rule before the effective date of this risk-based capital final rule.
The Board also continues to support amending the FCUA to provide
all credit unions access to additional supplemental forms of capital
that, subject to certain reasonable restrictions and consumer
protections, could be counted toward a credit union's net worth ratio
requirement and its risk-based capital requirement.
104(b)(2) Risk-Based Capital Ratio Numerator Deductions
Under the Second Proposal, Sec. 702.104(b)(2) would have provided
that the elements deducted from the sum of the capital elements of the
risk-based capital ratio numerator are: (1) The NCUSIF Capitalization
Deposit; (2) goodwill; (3) other intangible assets; and (4) identified
losses not reflected in the risk-based capital ratio numerator.
The Board received a significant number of comments, which are
outlined in detail below, regarding the capital elements that would
have been deducted from the risk-based capital ratio numerator.
However, for the reasons explained in more detail below, the Board has
decided to retain most of these aspects of the Second Proposal in this
final rule without change.
NCUSIF capitalization deposit. Under the Second Proposal, the
NCUSIF capitalization deposit was subtracted from both the numerator
and denominator of the risk-based capital ratio.\121\ This treatment of
the risk-based capital ratio would not have altered the
[[Page 66667]]
NCUSIF capitalization deposit's accounting treatment for credit unions.
---------------------------------------------------------------------------
\121\ See U.S. Govt. Accountability Office, Available
Information Indicates No Compelling Need for Secondary Capital, GAO-
04-849 (2004), available at https://www.gao.gov/assets/250/243642.pdf.
---------------------------------------------------------------------------
Public Comments on the Second Proposal
The Board received many comments expressing concerns about the
Second Proposal's treatment of the NCUSIF capitalization deposit. A
minority of commenters suggested that they agreed with the proposed
treatment of the NCUSIF deposit. A majority of commenters who mentioned
the NCUSIF deposit, however, noted that credit unions treat their
NCUSIF capitalization deposit as an asset on their books. Those
commenters suggested that while banks expense their deposit insurance
and can never reclaim it, a credit union's deposit will be returned if
it decides to liquidate, convert to another charter, or convert to
private insurance. The commenters recommended that the Board
acknowledge the difference in treatment of insurance deposits between
the two systems and assign a capital value to the NCUSIF capitalization
deposit for credit unions. Another commenter suggested that, compared
to banks, credit unions on average have 1 percent less capital than the
net worth ratio suggests because credit unions carry the NCUSIF
capitalization deposit as an asset: Pre-paid NCUSIF premiums, which the
commenter argued should be amortized. The commenter speculated that if
credit unions amortized their NCUSIF premium at eight basis points per
year, it would have about the same effect as stabilization premiums and
credit unions would, over 12 years, write off the deposit. The
commenter suggested further that the deposit adds to the risk in
economic downturns because it poses the danger of increased pressure on
earnings and capital during a financial crisis. Another commenter
argued that GAAP recognizes the NCUSIF capitalization deposit as an
asset so it does not make sense to treat the deposit as an intangible
asset given that it is easily measured and can be returned or refunded.
Finally, some commenters recommended that the NCUSIF capitalization
deposit be treated as a credit union asset with a risk weighting of 100
percent or lower.
Discussion
As stated in the Second Proposal, the 1997 U.S. Treasury Report on
Credit Unions supports NCUA's position of excluding the NCUSIF
capitalization deposit from the risk-based capital ratio calculation.
The Treasury report concluded that the NCUSIF capitalization deposit is
double counted because it is an asset on credit union balance sheets
and equity in the NCUSIF.\122\ The Treasury noted that, in lieu of
expensing the NCUSIF capitalization deposit, holding additional capital
is necessary to offset the risk of loss from required credit union
replenishment. According to comments within the 1997 Treasury report,
Congress established a higher statutory leverage ratio for credit
unions in part to offset the risk of loss from required credit union
replenishment.\123\
---------------------------------------------------------------------------
\122\ U.S. Dep't of Treasury, Credit Unions 58 (1997) (``The one
percent deposit does present a double-counting problem. And it would
be feasible for credit unions to expense the deposit now, when they
are healthy and have strong earnings. However, expensing the deposit
would add nothing to the Share Insurance Fund's reserves, and [. .
.] better ways of protecting the Fund are available. Accordingly, we
do not recommend changing the accounting treatment of the 1 percent
deposit.'').
\123\ Id. at 4-5 & 55-59.
---------------------------------------------------------------------------
The NCUSIF capitalization deposit deduction needs to be addressed
in the risk-based capital ratio, not just the leverage ratio, to
correct for the double-counting concern in those credit unions where
the risk-based capital ratio is the governing requirement.
The NCUSIF capitalization deposit is not available for a credit
union to cover losses from risk exposures on its own individual balance
sheet in the event of insolvency.\124\ The purpose of the NCUSIF
capitalization deposit is to cover losses in the credit union system.
The Board is required to assess premiums necessary to restore and
maintain the NCUSIF equity ratio at 1.2 percent. Premiums were
necessary from 2009 through 2011 as a result of losses. A series of
NCUA Letters to Credit Unions issued during 2009 discuss the necessary
write-down of the 1 percent NCUSIF capitalization deposit and required
NCUSIF premium expenses needed to restore the NCUSIF equity ratio.\125\
---------------------------------------------------------------------------
\124\ 12 U.S.C. 1782(c)(1)(B)(iii).
\125\ NCUA, Premium Assessments, Letter to Credit Unions 09-CU-
20 (Oct. 2009); NCUA, Corporate Stabilization Fund Implementation,
Letter to Credit Unions 09-CU-14 (June 2009); NCUA, Corporate Credit
Union System Strategy, Letter to Credit Unions 09-CU-02 (Jan. 2009).
---------------------------------------------------------------------------
The NCUSIF capitalization deposit is refundable in the event of
voluntary credit union charter cancellation or conversion. However,
this aspect does not change the unavailability of the NCUSIF
capitalization deposit to cover individual losses while the credit
union is an active going concern, or its at-risk stature in the event
of major losses to the NCUSIF. NCUA refunds the NCUSIF capitalization
deposit only in the event a solvent credit union voluntarily
liquidates, or converts to a bank charter or private insurance.
Consistent with its exclusion from the risk-based capital ratio
numerator, the NCUSIF capitalization deposit was also deducted from the
denominator under proposed Sec. 702.104(c)(1), which properly adjusted
the risk-based capital ratio calculation and reduced the impact of the
adjustment.
Neither the Second Proposal nor this final rule adjusts for the
NCUSIF capitalization deposit twice or puts credit unions at a
disadvantage in relation to banks because banks have expensed premiums
to build the Deposit Insurance Fund.
The Board does not agree with commenters who suggested that the
NCUSIF capitalization deposit should be treated as an investment
similar to Federal Home Loan Bank (FHLB) stock. The NCUSIF
capitalization deposit and FHLB stock have several fundamental
differences. The deposit in the NCUSIF results in double counting of
capital within the credit union system. Investments in FHLB stock do
not. A financial institution does not need to change its charter for a
FHLB stock redemption as a credit union must do for a NCUSIF
capitalization deposit refund. Further, unlike FHLB stock, the NCUSIF
capitalization deposit is not an income-producing asset. The deposit
has not paid a dividend since 2006. And it cannot pay another dividend
while the Corporate Stabilization Fund loan from the Treasury is still
outstanding.
The Board is not requiring credit unions to expense the NCUSIF
capitalization deposit, and does not believe the risk-based capital
treatment will lead to a change in how this asset is accounted under
GAAP. The Board agrees with the U.S. Treasury position as stated in its
1997 Report on Credit Unions. Treasury stated that expensing the NCUSIF
capitalization deposit would not strengthen the NCUSIF. The financial
structure of the NCUSIF is reasonable and works well for credit unions.
The assignment of an appropriate risk weight for the NCUSIF
capitalization deposit, based on its credit risk, has the potential to
create additional criticisms, as a low risk weight may not capture the
true nature of the account and a high risk weight could produce
unnecessary concern about risk of the deposit. The NCUSIF
capitalization deposit is treated similarly to other intangible assets,
(e.g. goodwill and core deposits intangible assets), as they are not
available assets upon liquidation.
Accordingly, for all the reasons discussed above, the Board has
decided to retain this aspect of the Second Proposal in this final rule
without change.
[[Page 66668]]
Goodwill and Other Intangible Assets
Under the Second Proposal, goodwill and other intangible assets
were deducted from both the risk-based capital ratio numerator and
denominator in order to achieve a risk-based capital ratio numerator
reflecting equity available to cover losses in the event of
liquidation. Goodwill and other intangible assets contain a high level
of uncertainty regarding a credit union's ability to realize value from
these assets, especially under adverse financial conditions.
The Board, however, recognized that requiring the exclusion of
goodwill and other intangibles associated with supervisory mergers and
combinations of credit unions that occurred prior to this proposal
could directly reduce a credit union's risk-based capital ratio.
Accordingly, the Board also proposed allowing credit unions to include
certain goodwill and other intangibles in the risk-based capital ratio
numerator. In particular, the Second Proposal would have excluded from
the definition of goodwill, which must be deducted from the risk-based
capital ratio numerator, any goodwill or other intangible assets
acquired by a credit union in a supervisory merger or consolidation
that occurred before the publication of this rule in final form.
The Second Proposal would not have changed the financial reporting
requirements for credit unions, which requires they use GAAP to
determine how certain intangibles are valued over time. Under the
proposal, credit unions would have still been required to account for
goodwill in accordance with GAAP, and the amount of excluded goodwill
and other intangible assets would have been based on the outstanding
balance of the goodwill directly related to supervisory mergers.
The Board proposed allowing the excluded goodwill and other
intangible assets to be counted until December 31, 2024, to allow
affected credit unions to adjust to this change as they continue to
value goodwill and other intangibles in accordance with GAAP. The
proposed exclusions would have applied only to goodwill and other
intangible assets acquired through supervisory mergers or
consolidations and would not have been available for goodwill and other
intangible assets acquired from mergers or consolidations that did not
meet this definition. This change would have provided affected credit
unions time to revise their business practices to ensure goodwill and
other intangible assets directly related to supervisory mergers would
not adversely impact their risk-based capital ratio.
Public Comments on the Second Proposal
At least one commenter stated that they agreed with the proposed
treatment of goodwill and other intangible assets. A significant number
of commenters, however, suggested that the Board include all goodwill
and other intangible assets in the risk-based capital ratio numerator
so long as these intangible assets meet GAAP requirements (subjected to
annual goodwill impairment testing). Commenters reasoned that the
exclusion of non-supervisory goodwill from the numerator would
discourage some well managed and well capitalized credit unions from
participating in mergers, and many mergers serve to benefit the members
of both the surviving and non-surviving credit union. Similarly,
commenters reasoned that mergers can also have a favorable influence on
safety and soundness--producing institutions that in combination have
stronger financials and are able to weather more extreme economic
swings.
At least one commenter suggested that, as an alternative to
including all goodwill and intangible assets in the risk-based capital
ratio numerator, the Board might limit the retention of non-supervisory
goodwill and other intangible assets in the numerator of the risk-based
capital ratio for those credit unions that are well capitalized on the
basis of the net worth ratio. The commenter suggested further that, at
a minimum, non-supervisory goodwill that meets annual impairment
testing should be retained in the numerator over a 10-year phase-out
period, and all previous supervisory goodwill should be grandfathered
without time limit, subject to regular impairment testing. The
commenter suggested three reasons for taking such an approach: First,
those credit unions that engaged in such transactions almost certainly
reduced insurance losses to the Share Insurance Fund, and should not be
penalized after the fact. Second, they did so with an understanding of
current rules at that time. Many of these transactions would likely not
have occurred had the proposed treatment of goodwill been known; so no
longer counting this goodwill at some point in the future would be
changing the rules midstream. Third, the amount of previous supervisory
goodwill is a known, fixed, and relatively small quantity. Only 20
credit unions with more than $100 million in assets have goodwill
amounting to more than 5 percent of net worth, and the average goodwill
to net worth ratio at these credit unions is 12.8 percent. Supervisory
goodwill likely represents no more than three quarters of that goodwill
(approximately 10 percent of net worth). Considering future growth, the
commenter suggested that supervisory goodwill will decline in
proportion to net worth and assets going forward, and grandfathering it
would protect those credit unions that in the past reduced NCUSIF
resolution costs from a cliff reduction in their RBC ratios in the
future.
Other commenters suggested that excluding goodwill from the risk-
based capital ratio numerator would harm credit unions by: (1)
Penalizing credit unions who have recently gone through a merger, and
(2) dis-incentivizing merger activity, which could prevent healthy
industry consolidation and the combining of unhealthy credit unions
with stronger ones in the future. Some commenters suggested that if a
well-situated credit union relies on goodwill as a component of a
merger, and is no longer able to justify such as a business decision
because of a lack of allowance for goodwill, NCUA is then forced to
step in, which would negatively impact the NCUSIF and could require the
payment of additional premiums by all credit unions. Use of goodwill
allows a well-situated credit union to absorb a struggling credit union
without negatively impacting the NCUSIF, which the commenter suggested
should be incentivized. Thus, the commenter recommended that goodwill
arising from both previous and future mergers should continue to be
counted without a time limitation, so long as it meets GAAP
requirements.
Several commenters suggested that the rule grandfather credit
unions that have included goodwill on their books, and not impose the
10-year limit, since it has been used by the credit union in the past
and was sanctioned by NCUA. Another commenter suggested that if mergers
were part of a strategic plan accomplished before the risk-based
capital rule is finalized, then any goodwill acquired through those
mergers should be grandfathered.
Some commenters contended that goodwill acquired through a
supervisory merger should not be treated differently than goodwill
acquired through a strategic merger. Goodwill acquired through both
types of mergers have value according to GAAP. One commenter argued
that separating goodwill and other intangibles derived through a merger
of healthy credit unions versus those assisted by a regulator does not
make sense for the following reasons: (1) Some mergers that involve
troubled credit unions may have had informal assistance from state or
federal regulators, but may not meet the
[[Page 66669]]
definition outlined in the proposal as supervisory-assisted. This will
create inconsistency in the application of the rule. (2) The treatment
is inconsistent and provides potentially more risk to the NCUSIF as the
risk-based capital ratio may not reflect the actual risk of future
impairment of those assets. (3) The proposal favors troubled credit
union mergers while discouraging healthy credit union consolidation due
to the negative impact on the risk-based capital ratio. (4) Using a 10-
year life for supervisory-assisted transactions provides only temporary
relief for those credit unions impacted and it overstates the risk-
based capital ratios until the phase-out period is over.
One commenter argued that the proposed treatment of goodwill would
place credit unions that acquired failing or insolvent credit unions
(under supervisory/emergency merger conditions)--including those where
NCUA, the NCUSIF, and the credit union industry realized benefits from
the acquisition activities--at a competitive disadvantage. The
commenter suggested that the proposed 10-year deferral of goodwill is
an equitable solution for those credit unions that acquired failed
credit unions and received some level of funded assistance from the
NCUSIF, as the amount of goodwill carried on their books would
typically be less than goodwill carried by those credit unions that did
not receive assistance. The commenter explained that this is due to the
fact that the funded amount of assistance from the NCUSIF upon receipt
by the continuing credit union is recorded as a reduction to the
goodwill determined at the time the failed credit union was acquired.
The commenter argued that other credit unions, however, that acquired
failed credit unions relying on the current risk-based net worth
regulations, but did not receive funded assistance from the NCUSIF
would be penalized under the proposed 10-year deferral of goodwill. The
commenter speculated that these credit unions would be forced to forgo
many opportunities in lieu of having to meet changed regulator risk-
based capital targets, while their competitors (for the next 10 years)
would have the opportunity to focus on survival, service, product
innovation, community reinvestment and growth. Accordingly, the
commenter recommended the Board grant a one-time permanent exemption of
goodwill to credit unions that made significant, capital-impacting
decisions under the current risk-based net worth regulations.
Discussion
There is a high level of uncertainty regarding the ability of
credit unions to realize the value of goodwill and other intangibles,
particularly in times of adverse conditions. Thus, the proposed
approach to other intangibles generally mirrors the treatment by the
Other Banking Agencies.\126\
---------------------------------------------------------------------------
\126\ See, e.g., 12 CFR 324.22.
---------------------------------------------------------------------------
However, as discussed in the definitions part of this rule above,
the longer implementation period included in this final rule will serve
to mitigate some of the commenters' concerns regarding existing
goodwill and other intangibles because it provides affected credit
unions more than 13 years to write down the goodwill or otherwise
adjust their balance sheet.
While the final rule includes a provision to address goodwill and
other intangibles acquired through supervisory mergers and
consolidations that were completed 60 days following this rule's
publication, the final rule retains the requirement that all other
goodwill and other intangibles be excluded from the risk-based capital
ratio numerator as they are not available to cover losses.
Consistent with the comments, the Board recognizes that only 15
credit unions report total goodwill and intangible assets of more than
1 percent of assets, and notes that the valuation under GAAP of these
existing assets will be immaterial by the end of the extended sunset
date.
In future combinations, a credit union will need to consider the
impacts a combination will have on both its net worth ratio and its
risk-based capital ratio. For mergers involving financial assistance
from the NCUSIF, this means a credit union with higher capital may be
able to outbid a competing credit union. A credit union will need to
consider the impact on its capital when determining the components of a
merger proposal, which may result in higher costs to the NCUSIF.
However, stronger capital and a risk-based capital measure that is less
lagging should reduce the number and cost of failures, resulting in a
net positive benefit to the NCUSIF and the industry.
Accordingly, for all the reasons discussed above, the Board has
decided to retain this aspect of the Second Proposal in this final rule
without change.
Identified Losses Not Reflected in the Risk-Based Capital Ratio
Numerator
The Second Proposal allowed for identified losses, not reflected as
adjustments in the risk-based capital ratio numerator, to be deducted.
The inclusion of identified losses allowed for the calculation of an
accurate risk-based capital ratio.
The Board received no comments on this aspect of the proposal.
Accordingly, the Board has decided to retain this aspect of the Second
Proposal in this final rule without change.
104(c) Risk-Weighted Assets
In developing the proposed risk weights included in the Second
Proposal, the Board reviewed the Basel accords and the U.S. and various
international banking systems' existing risk weights.\127\ The Board
considered the comments contained in Material Loss Reviews (MLRs)
prepared by NCUA's OIG and comments by GAO in their respective reviews
of the financial services industry's implementation of PCA.\128\ The
Second Proposal was designed to address credit risk and concentration
risk in a manner comparable to the Other Banking Agencies' capital
regulations.\129\ As a result, the Second Proposal would have
substantially changed how the risk weights for nearly all credit union
assets are assigned. For example, instead of assigning an investment a
risk weight based on its weighted average life, the Second Proposal
assigned risk weights to investments based primarily on the credit
quality of the underlying collateral or repayment ability of the
issuer. These and other adjustments were intended to address, where
possible depending on the particular requirements of section 216 of the
FCUA, inconsistencies between the risk weights assigned to assets under
the Other Banking Agencies' capital regulations and NCUA's current PCA
regulations.
---------------------------------------------------------------------------
\127\ The Basel Committee on Banking Supervision (BCBS)
published Basel III in December 2010 and revised it in June 2011,
available at https://www.bis.org/publ/bcbs189.htm.
\128\ Section 988 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act obligates NCUA's OIG to conduct MLRs of
credit unions that incurred a loss of $25 million or more to the
NCUSIF. In addition, section 988 requires NCUA's OIG to review all
losses under the $25 million threshold to assess whether an in-depth
review is warranted due to unusual circumstances. The MLRs are
available at https://www.ncua.gov/about/Leadership/CO/OIG/Pages/MaterialLossReviews.aspx; see also GAO/GGD-98-153 (July 1998); GAO-
07-253 (Feb. 2007), GAO-11-612 (June 2011), GAO-12-247 (Jan. 2012),
and GAO-13-71 (Jan. 2013).
\129\ See, e.g., 12 CFR 324.32.
---------------------------------------------------------------------------
Public Comments on the Second Proposal
The Board received many general comments regarding the proposed
risk
[[Page 66670]]
weights. At least one commenter suggested the proposal significantly
improved the various risk weightings and that most of the proposed risk
weightings seemed appropriate. Most commenters who mentioned the risk
weights also acknowledged that the Board had made significant
improvements to the risk-weight categories from the original risk-based
capital proposal, and many of the adjustments and more detailed asset
categories included in the Second Proposal were significant
improvements.
A substantial number of the commenters, however, argued that the
proposed risk weights remained too high in key areas, given credit
unions' level of risk, and suggested they should be lower than what the
federal bank regulators require for assets such as mortgage loans,
member business loans, servicing and certain investments. These
commenters suggested that lower risk weightings for credit union assets
are appropriate given their different incentives to manage risk as
compared to banks, and lower loss history based on their comparison to
the banking industry.
A significant number of commenters complained that the proposed
risk-weighting scheme was overly complex. At least one commenter
suggested that credit unions have assets on their books at fair value;
the change to fair value is accounted for in either the profit and loss
statement or in other comprehensive income. The commenter recommended
that the Board clarify the application of the risk weight for these
assets when a component of their book value has already impacted
capital through earnings or other comprehensive income. Other
commenters recommended that the risk weights and concentration
percentages take into account the standard credit risk factors such as
loan-to-value ratio, credit score, origination channel, etc. One
commenter suggested that credit risk is a function of underwriting, the
economy, loan portfolio diversity, institutional structure, business
strategy, profitability demands, time horizons, performance-monitoring
capacity, funding stability and other factors. But, the commenter
argued, the proposal ignores these local, individual factors in favor
of a one-size-fits-all risk weighting.
Interest rate risk. The Board also received many comments regarding
the proposed removal of IRR from the risk-weight calculation. A
majority of the commenters who mentioned IRR stated that they agreed
with the proposed removal of interest rate risk from the rule.
Moreover, they suggested a separate IRR standard was not needed to
reasonably account for IRR at credit unions because NCUA's current
framework of policies and regulations sufficiently address the risk.
One credit union commenter did recommend, however, that NCUA expand the
data it gathers in the 5300 Call Reports and use that information to
facilitate both RBC compliance and interest rate risk management. The
commenter suggested Call Reports also be used to monitor investment
losses for credit unions that invest in complex securities, which would
show the direction a credit union is trending and provide regulators
with an objective basis for determining which credit unions need
capital buffers that exceed regulatory minimums.
Concentration risk. The Board received a substantial number of
comments regarding the Second Proposal's retention of concentration
risk measures in the risk weightings of certain categories of assets. A
majority of the commenters who mentioned it suggested that
concentration risk is best addressed through the examination process as
it is for banks, and thus, should be dropped from the risk weights in
the final rule. At least one commenter argued that the proposed
concentration threshold requirements violate the FCUA, which requires
the Board to ``prescribe a system of prompt corrective action'' that is
``comparable to section 1831o'' of the Federal Deposit Insurance Act.
One commenter noted that while NCUA did cite to specific credit
union failures that involved high concentrations of certain assets, the
Material Loss Reviews associated with those failures revealed that
fraud or board mismanagement played a pivotal, if not a determining,
role in the failure of the credit unions. Other commenters claimed
that, based on 2007 and 2014 data, there was no meaningful difference
in the performance of credit unions with higher or lower levels of
concentration in mortgages or home equity loans. The proposal would
require credit unions to hold more capital than banks at certain levels
of asset concentration, which commenters argued would not create a
``comparable'' capital framework and would put credit unions at a
competitive disadvantage. The commenters contended this is particularly
true for mortgages and home equity loans where the capital requirements
materially increase even at relatively lower levels of concentration
(35 percent and 20 percent of assets, respectively).
One commenter claimed the Board did not provided any evidence the
proposed concentration risk thresholds aligned with increased capital
at risk, and insisted that the historical loss data provided by NCUA
did not support establishing a higher capital standard for credit
unions than banks. The commenter argued that the data in the Second
Proposal showing the differences in asset concentrations between those
credit unions that failed and those that survived was insufficient. And
for real estate loans, the commenter claimed the data was inconclusive
because credit unions that failed had 58 percent of their assets in
real estate whereas those credit unions that survived had 49 percent.
While there was a higher concentration of real estate assets for those
that failed, the commenter suggested the difference of 9 percent was
not a firm basis on which to assert higher concentrations of real
estate loans were a significant contributing factor to the credit
union's failure such that it warrants higher capital levels for all
complex credit unions. Similarly, the commenter argued that the data
for commercial loans would not support a concentration risk threshold
of 50 percent, and alleged that the Board examined the current level of
real estate exposure across the industry and set the capital
requirements such that roughly the top 10 percent of the industry would
see their capital requirements increase. Further, the commenter argued
that the methodology was unsupported by the evidence, that there was no
empirical evidence to support that either (a) two standard deviations
is the right basis for determining this threshold, or (b) the resultant
risk thresholds correlated directly to higher degrees of risk such that
additional capital should be held by these institutions. The commenter
insisted that, based on the comparability requirement in the FCUA, the
Board should eliminate the concentration risk thresholds for these
asset classes and set the risk weights equal to those applied to the
banking industry (50 percent for mortgages and 100 percent for both
home equity loans and commercial loans).
Another commenter noted that the examples given by the Board in
support of adopting concentration risk elements did not acknowledge the
fact that mortgage and home equity line of credit (HELOC) underwriting
standards have tightened, and claimed that credit unions have generally
divested away from residential real estate, and that the proposal fails
to anticipate where the credit union asset mix will likely migrate in
the future. Based on this claim, the commenter speculated that
[[Page 66671]]
the proposed concentration limits may not prudently attain the desired
goal of portfolio invariance and may, in fact, threaten the long-term
viability of many credit unions. The commenter recommended that the
Board adopt one of the following alternative approaches: (1) Do away
with the concentration risk element altogether; (2) use current
demarcation points as a trigger for expanded reporting in the Call
Report, thereby allowing NCUA to assess if there is in fact additional
risk; or (3) increase the current threshold levels that call for
increased weighting--for example, by moving the mortgage threshold to
50 percent to match the commercial loan threshold, and increasing the
residential junior lien threshold from 20 percent to 25 percent.
One commenter argued that the proposed approach of including
concentration risk thresholds in the risk weights was fundamentally
flawed because it considered the relative size of the portfolio and not
the benefit of diversification. Another commenter speculated that
without more specific information to capture diversification within a
lending portfolio,\130\ the proposal would have limited value in
providing early warning of truly unsafe concentrations. Instead, the
commenter recommended NCUA address outlier credit unions through the
timely application of supervisory tools or, if necessary, by applying
the capital adequacy planning requirements of section 702.101(b) to
credit unions flagged as outliers. The commenter suggested that using
capital adequacy plans to address concentration risk would control for
asset concentrations that pose safety and soundness risk without
placing the wider credit union system at a competitive disadvantage to
banks. The commenter speculated further that, given the shifting
landscape of the financial services market and the credit union
industry, building risk parameters around the current shape of the
market may not align with future risks.
---------------------------------------------------------------------------
\130\ For example, diversification based on geography, industry,
credit profile, or product type.
---------------------------------------------------------------------------
Yet another commenter suggested that if concentration risk is
maintained in the final rule, the concentration threshold level for all
secured loan categories should be 50 percent, and only unsecured loans
should have a concentration threshold level below 50 percent.
Finally, one commenter argued that there is no need for the rule to
address concentration risk, claiming that concentration risk would
address itself since the dollar amount applied against the risk weight
increases as concentration increases.
Discussion
After carefully considering the comments received, the Board
generally agrees with commenters who suggested that IRR concerns can be
addressed through NCUA guidance, supervision, and other regulations.
NCUA's guidance, supervision, and other regulations are designed to
address how IRR is managed and reported in a manner that is appropriate
to the size, complexity, risk profile, and scope of each credit union's
operations. The Board has determined not to include IRR in the risk-
based net worth requirement \131\ given the other mechanisms available
to NCUA to address such risk. NCUA will continue to monitor credit
unions' exposure to IRR through the supervision process and plans to
provide additional supervisory guidance in the future.
---------------------------------------------------------------------------
\131\ See 12 U.S.C. 1790d(d)(2) (``The Board shall design the
risk-based net worth requirement to take account of any material
risks against with the net worth ratio required for an insured
credit union to be adequately capitalized may not provide adequate
protection.'').
---------------------------------------------------------------------------
The Board, however, disagrees with commenters who suggested further
reductions in the scope of the use of risk weights to address
concentration risk. Under the Second Proposal, the Board substantially
reduced the risk-based capital requirements related to concentration
risk by using one concentration threshold, set at a higher level, for
assets that NCUA determined are vulnerable to concentration risk. As
stated in the preamble to the Second Proposal, the concept of
addressing concentration risk with the assignment of risk weights is
consistent with the risk-based net worth requirement under current part
702. Higher risk weights are assigned to real estate loans and MBLs
held in higher concentrations under the current rule. Elimination or
additional reductions in the concentration risk dimension of the risk-
based net worth requirement would be inconsistent with concerns
regarding concentration risk raised by GAO and in MLRs conducted by
NCUA's OIG.\132\ The preamble also noted that the Basel Committee on
Banking Supervision has stated that ``risk concentrations are arguably
the single most important cause of major problems in banks.'' \133\
---------------------------------------------------------------------------
\132\ See U.S. Govt. Accountability Office, GAO-12-247, Earlier
Actions are Needed to Better Address Troubled Credit Unions (2012),
available at https://www.gao.gov/products/GAO-12-247; Office of
Inspector General, National Credit Union Administration, OIG-10-03,
Material Loss Review of Cal State 9 Credit Union (April 14, 2010),
available at https://www.ncua.gov/about/Leadership/CO/OIG/Documents/OIG201003MLRCalState9.pdf; Office of Inspector General, National
Credit Union Administration,OIG-11-07, Material Loss Review of
Beehive Credit Union (July 7, 2011), available at https://www.ncua.gov/about/Leadership/CO/OIG/Documents/OIG201107MLRBeehiveCU.pdf; Office of Inspector General, National
Credit Union Administration, OIG-10-15, Material Loss Review of
Ensign Federal Credit Union, (September 23, 2010), available at
https://www.ncua.gov/about/Leadership/CO/OIG/Documents/OIG201015MLREnsign.pdf.
\133\ Basel Committee on Banking Supervision, International
Convergence of Capital Measurement and Capital Standards: A Revised
Framework, Comprehensive Version 214 (June 2006) available at https://www.bis.org/publ/bcbs128.pdf.
---------------------------------------------------------------------------
It is not appropriate to rely solely on the supervisory process to
address concentration risk because the holding of additional capital
for concentration risk should occur prior to the development of the
concentration risk, and is difficult to achieve after a concern with
concentration risk is identified during the supervisory process.
The concentration risk thresholds were adjusted in the Second
Proposal to focus on material levels of concentration risk and for more
consistency with the current effective impact of the concentration risk
on capital requirements for commercial loans. As a result of the risk-
weight adjustments, very few credit unions would be subject to the
marginally higher risk weights due to concentration risk. Credit unions
subject to the concentration risk weights will not be placed at a
competitive disadvantage, because all banks are required to maintain
capital commensurate with the level and nature of all risks, including
concentration risk, to which they are exposed.\134\
---------------------------------------------------------------------------
\134\ See 12 CFR 324.10(d).
---------------------------------------------------------------------------
Regarding support for the risk weights themselves, given the
statutory requirement to maintain comparability with the Other Banking
Agencies' PCA requirements,\135\ NCUA relied primarily on the risk
weights assigned to various asset classes within the Basel Accords and
established by the Other Banking Agencies' risk-based capital
regulations to develop this proposal. The Board, however, did tailor
the proposed risk weights for assets unique to credit unions, where
contemporary and sustained performance differences existed (as shown in
Call Report data) to differentiate for certain asset classes between
banks and credit unions, or where a provision of the FCUA necessitated
doing so.
---------------------------------------------------------------------------
\135\ See 12 U.S.C. 1790d(b)(1)(A)(ii).
---------------------------------------------------------------------------
The Board generally agrees with commenters who suggested that
credit risk factors such as loan-to-value ratio (LTV), credit score,
origination and other individual factors are meaningful
[[Page 66672]]
and should be evaluated. However, reporting loan data on LTVs and
credit scores to NCUA would be administratively burdensome. For
example, establishing regulations on how the LTV would be measured
would be complex when considering such items as how to take into
account private mortgage insurance as the financial strength of
mortgage insurers varies, or the LTV of a restructured loan. NCUA also
lacks credit union industry data on loan performance based on LTV
ratios that could be used to establish a framework for LTV-based risk
weights. And risk weights based on LTVs for real estate loans would not
be comparable to the risk weight framework used by the other banking
agencies.
Accordingly, the Board has decided to maintain the proposed
approach to risk-weighting assets in this final rule.
104(c)(1) General
Under the Second Proposal, Sec. 702.104(c)(1) provided that risk-
weighted assets include risk-weighted on-balance sheet assets as
described in Sec. Sec. 702.104(c)(2) and (c)(3), plus the risk-
weighted off-balance sheet assets in Sec. 702.104(c)(4), plus the
risk-weighted derivatives in Sec. 702.104(c)(5), less the risk-based
capital ratio numerator deductions in Sec. 702.104(b)(2). The section
provided further that, if a particular asset, derivative contract, or
off balance sheet item has features or characteristics that suggest it
could potentially fit into more than one risk weight category, then a
credit union shall assign the asset, derivative contract, or off-
balance sheet item to the risk weight category that most accurately and
appropriately reflects its associated credit risk. The Board proposed
adding this language to account for the evolution of financial products
that could lead to such products meeting the definition of more than
one risk asset category.
The Board received no comments on the language in this paragraph of
the proposal. Accordingly, the Board has decided to retain the language
in this proposed paragraph in this final rule without change.
104(c)(2) Risk Weights for On-Balance Sheet Assets
Under the Second Proposal, Sec. 702.104(c)(2) defined the risk
categories and risk weights to be assigned to each defined on-balance
sheet asset. All on-balance sheet assets were assigned to one of 10
risk-weight categories.
The Board received a significant number of comments, which are
discussed in more detail below, on the proposed risk-weight categories
and the risk weights assigned to particular assets.
Cash and Investment Risk Weights
Under the Second Proposal, the Board proposed eliminating the
process of assigning risk weights for investments based on the weighted
average life of investments in favor of a credit-risk centered approach
for investments. The credit risk approach to assigning risk weights
under the Second Proposal was based on applying lower risk weights to
safer investment types and higher risk weights to riskier investment
types.\136\ The proposed investment risk weights are similar to the
risk weights assigned to investments under the Other Banking Agencies'
regulations,\137\ which are based on the credit-risk elements of the
issuer, the underlying collateral, and the payout position of the
particular type of investment. The proposed changes to the risk weights
assigned to investments are outlined in the following table:
---------------------------------------------------------------------------
\136\ When the Board evaluates the risk of an investment type,
it is based on criteria such as volatility, historical performance
of the investments, and standard market conventions.
\137\ See, e.g., 12 CFR 324.32.
Second Proposal: Risk Weights for Cash and Investments
------------------------------------------------------------------------
Proposed
Item (percent)
risk weight
------------------------------------------------------------------------
The balance of cash, currency and coin, 0
including vault, automatic teller machine, and teller
cash...................................................
The exposure amount of:
[cir] An obligation of the U.S. Government, its
central bank, or a U.S. Government agency that is
directly and unconditionally guaranteed, excluding
detached security coupons, ex-coupon securities,
and principal and interest only mortgage-backed
STRIPS.............................................
[cir] Federal Reserve Bank stock and Central
Liquidity Facility stock...........................
Insured balances due from FDIC-insured
depositories or federally insured credit unions........
The uninsured balances due from FDIC-insured 20
depositories, federally insured credit unions, and all
balances due from privately-insured credit unions......
The exposure amount of:
[cir] A non-subordinated obligation of the U.S.
Government, its central bank, or a U.S. Government
agency that is conditionally guaranteed, excluding
principal and interest only mortgage-backed STRIPS.
[cir] A non-subordinated obligation of a GSE other
than an equity exposure or preferred stock,
excluding principal and interest only GSE
obligation STRIPS..................................
[cir] Securities issued by PSEs in the United States
that represent general obligation securities.......
[cir] Investment funds whose portfolios are
permitted to hold only part 703 permissible
investments that qualify for the zero or 20 percent
risk categories....................................
[cir] Federal Home Loan stock.......................
Balances due from Federal Home Loan Banks......
The exposure amount of: 50
[cir] Securities issued by PSEs in the U.S. that
represent non-subordinated revenue obligation
securities.........................................
[cir] Other non-subordinated, non-U.S. Government
agency or non-GSE guaranteed, residential mortgage-
backed securities, excluding principal and interest
only STRIPS........................................
The exposure amount of: 100
[cir] Industrial development bonds..................
[cir] All stripped mortgage-backed securities
(interest only and principal only STRIPS)..........
[cir] Part 703 compliant investment funds, with the
option to use the look-through approaches..........
[cir] Corporate debentures and commercial paper.....
[cir] Nonperpetual capital at corporate credit
unions.............................................
[cir] General account permanent insurance...........
[cir] GSE equity exposure and preferred stock.......
[[Page 66673]]
All other assets listed on the statement of
financial condition not specifically assigned a
different risk weight..................................
The exposure amount of perpetual contributed 150
capital at corporate credit unions.....................
The exposure amount of equity investments in
CUSOs..................................................
The exposure amount of: 300
[cir] Publicly traded equity investment, other than
a CUSO investment..................................
[cir] Investment funds that are not in compliance
with part 703 of this Chapter, with the option to
use the look-through approaches....................
[cir] Separate account insurance, with the option to
use the look-through approaches....................
The exposure amount of non-publicly traded 400
equity investments, other than equity investments in
CUSOs..................................................
The exposure amount of any subordinated tranche \138\ 1,250
of any investment, with the option to use the gross-up
approach...............................................
------------------------------------------------------------------------
Public Comments on the Second Proposal
The Board received many general comments regarding the proposed
investment risk weights. At least one commenter maintained that the
proposal would unfairly penalize credit unions by using investment risk
weights to compensate for interest rate risk, which the commenter
argued would create a bias towards lending and against investments.
Other commenters, however, suggested that, in general, the revised risk
weights for investments were reasonable, including the zero risk
weighting for investments issued by the U.S. Government, including NCUA
and FDIC. Some commenters suggested the 20 percent weight for
government-sponsored enterprises (GSEs) seemed reasonable given that
they are quasi-government entities.
---------------------------------------------------------------------------
\138\ The 1,250 percent risk-weight amount is based on holding
capital dollar-for-dollar at the 8 percent adequately capitalized
level for the risk-based capital ratio (8 percent adequately
capitalized level *1,250 percent = 100 percent).
---------------------------------------------------------------------------
The Board also received other comments regarding the risk weights
assigned to the following particular investments:
Deposits in banks or credit unions. One commenter contended that
the proposed risk weightings for investments were mute on weights for
deposits in banks or credit unions. The commenter believed such
deposits should have some level of risk weighting, at least for any
uninsured amounts on deposit at banks and credit unions, because they
can be a part of a smaller credit union's investment portfolio.
Part 703 compliant investment funds. At least one commenter
objected to a default risk weight of 100 percent for part 703 compliant
investment funds, and 300 percent for non-part 703 compliant funds. The
commenter believed the 200 percent increase in a default risk weight
would be punitive and would create a disadvantage for state-chartered
credit unions. The commenter suggested there are several non-
conforming, state-authorized investments that are not based in equities
or other ``volatile and risky investments'' and that do not warrant a
300 percent risk weight. The commenter argued further that, by using
part 703 as a threshold, the Board was assigning a significantly lower
baseline assumption of risk on the basis of the regulator that approved
the investment, which would single out state-chartered institutions and
force them to undertake look-through calculations on their investments
when federal charters may be able to rely on the default risk weight.
The commenter recommended that the default thresholds be tied to the
underlying holdings and investment strategy of the fund.
At least one commenter recommended that investment funds that hold
only investments that qualify for a zero or 20 percent risk weight
should receive a 20 percent risk weight regardless of whether the
underlying investments are part 703 compliant.
One commenter complained that the proposed risk-weight categories
for non-loan investments were too general, lumping together assets with
widely varying risks, especially when considering risks beyond those
tied to interest rate fluctuations. The commenter suggested that
additional risk-weighting tools within categories were needed to
properly take account of issuer- and security-specific issues for both
debt and equity securities and non-part 703 compliant funds. The
commenter speculated further that the proposed approach would
discourage responsible employee benefit pre-funding by penalizing those
investments, and provide incentives for excessively aggressive equity
investing in pursuit of higher returns to offset the especially high
reserve requirements. The commenter recommended that the baseline risk
weights should be presumptive only, so that if a credit union can
present good reasons why a lower risk weight should be assigned to its
investments within a certain category, those lower weights should be
applied going forward. Another commenter suggested that, while the
proposed 100 percent risk weight assigned to all private issuer
corporate debt is not a punitive level, there ought to be some ability
for a credit union to demonstrate that the corporate debt it holds
qualifies for a lower weighting, closer to the 20 percent for state and
local debt, or the 50 percent for revenue bonds, which are limited for
repayment to the revenue generated by a specific facility and thus
often are in reality private issuer obligations. The commenter believed
that a flat 100 percent weighting for all corporate debt takes no
account of actual issuer-specific repayment risk, and could serve to
distort reasonable investment decisions by credit unions looking to
include such issues in their employee benefit pre-funding portfolios.
The commenter recommended some issue/issuer-specific risk assessment be
allowed to more rationally, precisely equal risk and risk weights.
Non-significant equity exposures. Several commenters suggested that
banks are permitted to apply a 100 percent risk weight to certain
equity exposures deemed non-significant. The commenters suggested
further that non-significant exposures mean an equity exposure that
does not exceed 10 percent of the bank's total capital. The commenters
recommended that NCUA adopt a similar treatment if the publicly traded
equities and equity allocation within an investment fund are less than
10 percent of a credit union's total capital; then a risk weight of 100
percent shall be applied to the equity exposure. The commenters
suggested this would reduce the complexity of the look-through approach
and simplify the overall risk-weighting process for non-significant
equity exposure.
[[Page 66674]]
Community development investments. Several commenters suggested
that OCC's risk-based capital regulation recognizes the importance of
community development investments and assigns a risk weight of 100
percent rather than the standard 300 percent factor. The commenters
suggested further that the public policy embraced by OCC with this
allowance is to encourage investments to support charitable goals and
purposes. Commenters recommended that NCUA embrace a similar policy and
assign a risk weight of 100 percent for any equity or corporate bond
exposure in a community development investment. The commenters
suggested that such treatment would support broader participation by
credit unions with community development investments and enhance the
goodwill and reputation of the credit union industry as it builds an
investment resource to support charitable contributions.
Employee benefit plan investments. Some commenters argued that the
300 percent risk weighting assigned to publicly traded equity
investments should be much lower so that credit unions are not unduly
limited in their investments for employee benefit funding. One
commenter recommended that the Board continue to apply standard risk
weights to benefit plan investments. The commenter contended that a
457(b) executive plan is un-funded and does not vest until the employee
retires or terminates employment, and the assets underlying such plans
generally must remain the property of the credit union until vested and
are subject to the claims of general creditors. The commenter
speculated further that, if the credit union is put into
conservatorship, the investments never transfer to the employee. So,
the commenter maintained, it is appropriate for the Board to risk
weight such investments as part of the overall balance. The commenter
expressed concern that it could be very difficult for NCUA to determine
with certainty whether, and to what extent, the credit union held a
risk of loss in connection with the investments because employee
benefit plans can be tailored to fit the needs of each individual
credit union and executive.
One commenter claimed risk weighting all publicly traded equities
at 300 percent would be punitive and unjustified by real-world
experience with a long list of blue-chip, dividend-paying, financially
secure stocks regularly included in credit union client Sec. 701.19
portfolios. The commenter suggested that, as with corporate debt, some
tools must be offered to allow a credit union to obtain relief from the
extremely high risk assessment for specific equity issues which are
more secure than consumer loans in default, to which the proposal
assigns a 150 percent risk weight. The commenter suggested further that
relevant factors which could support a lowering of the risk weighting
for specific equity investments include the issuer's debt rating,
market capitalization and financial condition, history of dividend
payments, and absence of financial defaults. The commenter speculated
that imposing a blanket 300 percent risk weight on all public equity
would create two negative, counterproductive incentives: First, it
would discourage any public equity investments, driving down expected
overall portfolio return and requiring investment of a larger amount of
credit union funds to achieve a needed annual return tied to projected
future benefit costs. Second, for those credit unions which do
nevertheless include an equity component in their Sec. 701.19
portfolios, there would be pressure to overcome the high reserve ratio
by investing in higher-return, higher-risk equities, instead of more
stable dividend-paying stocks. The commenter also maintained that the
300 percent risk weight assigned to pre-funded, non-part 703 compliant
mutual funds, while subject to reduction under various look-through
methods, was unjustifiably high in comparison to the other weights
assigned to performing and even non-performing loans.
Publicly traded equity investments. One commenter recommended that
all publicly traded equity investments be treated as either available
for sale or trading. The commenter suggested that these two methods of
accounting require the investment to be recorded at market value, which
should be easily determined since they are publicly traded. Thus, the
commenter argued, the 300 percent risk weight assigned under the Second
Proposal would be excessive, especially given the amount of class B
Visa shares held by a significant number of credit unions, and with the
employee benefit funding allowed by Sec. 701.19 of NCUA's regulations.
Non-agency ABS structured securities. One commenter suggested that
collateral utilized to secure investments included in the non-agency
ABS structured securities category could include automobile loans.
Because the Second Proposal requires a risk weighting of 75 percent for
all current secured consumer loans--and since the risk profile of the
underlying collateral does not differ between secured automobile loans
and non-agency ABS structured securities backed by secured auto loans--
the commenter recommended the risk weightings for both instruments be
set at 75 percent.
Subordinate tranche of any investment. At least one commenter
complained that the Second Proposal would assign a risk weighting of
1,250 percent, or require the use of the gross-up approach to determine
the overall weighting of this category of investment. The commenter
argued that the 1,250 percent risk weighting was punitive in nature and
could not be justified from a safety and soundness standpoint because
it may appear to represent more than 100 percent of the monies at risk
in any one investment.
At least one commenter also objected that, by not including the
``simplified supervisory formula approach'' \139\ in the Second
Proposal, the Board deprived credit unions of a measurement tool that
is allowed by the Other Banking Agencies and the Basel Committee on
Banking Supervision. The commenter argued that this could represent a
competitive disadvantage to credit unions who are evaluating certain
investments for inclusion in their strategies. Given the significance
of the weighting and the exclusion of the evaluation method, the
commenter recommended the 1,250 percent weighting should be eliminated
and the Simplified Supervisory Formula Approach be utilized to
determine the weighting of investment categories.
---------------------------------------------------------------------------
\139\ See, e.g., 12 CFR 324.43.
---------------------------------------------------------------------------
One commenter suggested that the Board assign the subordinate
tranche of any investments the same risk weight that applies to
commercial loans.
Corporate debt. Several commenters maintained that applying high
risk weights to investments in the corporate system would penalize
credit unions that invest within the industry. Commenters also
suggested that the risk weights assigned to corporate paid-in capital
should recognize how the stricter regulatory standards for corporate
credit unions adopted in 2010 not only mitigate risks to natural-person
credit unions, but also protect the NCUSIF from potential losses.
Accordingly, some commenters recommended that a lower risk weight of
125 percent be assigned to corporate paid-in capital under the final
rule.
One commenter suggested that it would be more reasonable to
generally structure risk weights for corporate debt into tiers similar
to that of municipal bonds because the proposed structure would make it
costly to diversify and gain yield because the risk weights assigned
would negate the added yield
[[Page 66675]]
of these bonds. The commenter insisted that, in order to preserve a
credit union's ability to diversify and avoid concentration risk in
agency or government bonds, more reasonable risk weights should be
assigned to different forms of corporate debt. The commenter suggested
one alternative option for structuring risk weights for corporate debt
would be to create a four-tiered risk classification that would include
investment grade and non-investment grade bonds. The commenter noted
that the current definition is silent on whether bonds can be non-
investment grade. The commenter suggested further that the investment
grades could be broken down into high, medium and low investment grade
plus non-investment grade for four tiers. According to the commenter,
the high grade would be equivalent to an AAA rating, the medium grade
would be equivalent to an A rating, the low grade would be equivalent
to a BBB rating, and the non-investment grade would be non-investment
grade. The commenter recommended these ratings be part of the credit
union's internal ratings system for bonds, which would allow for lower
risk weights for high-grade bonds at 50 percent, medium-grade bonds at
75 percent, and low-grade bonds at 100 percent.
Discussion
The Board disagrees with commenters who suggested that the proposal
would unfairly penalize credit unions by using investment risk weights
to compensate for IRR. The Board intentionally removed the weighted
average life calculation from the assignment of risk weights to remove
the IRR components from the Second Proposal. As stated above, the risk
weights assigned to investments were based on credit risk, consistent
with the risk weights assigned to investments by the Other Banking
Agencies.
The Board disagrees with the commenters who claimed the proposed
risk weights assigned to investments were mute on the weights for
deposits in banks and credit unions. The Second Proposal assigned a
risk weight of zero percent to insured balances from FDIC-insured
depositories or federally insured credit unions. Uninsured balances,
and all balances due from privately insured credit unions, were risk-
weighted at 20 percent. Deposits in a bank that are guaranteed by a
state received the same 20 percent risk weight as an investment in a
PSE.
The Board disagrees with the commenters who suggested that a 300
percent risk weight for non-part 703 compliant investment funds would
be punitive compared to the 100 percent risk weight for part 703
compliant investment funds. The Board chose to create standard risk
weights for investment funds to allow credit unions a simple
alternative to calculating the risk weights for such assets using the
look-through approaches. Part 703 compliant investment funds were
assigned a 100 percent risk weight under the Second Proposal unless
they qualified for a lower risk weight because they were limited to
holding lower risk-weighted assets. The Board determined that part 703
compliant investment funds should qualify for a maximum 100 percent
risk weight under Sec. 702.104(c)(2) because the underlying
investments permitted under part 703 of NCUA's regulations were almost
exclusively assigned a risk weight of 100 percent or less under the
proposal. Non-part 703 investment funds, on the other hand, are
potentially more risky, so assigning them a risk weight equivalent to
the risk weight assigned to publicly traded equity investments is
appropriate. Under the Second Proposal, credit unions were also given
the option to calculate the risk weight for any investment fund using
one of the look-through approaches, which allow a credit union to risk
weight such a fund based on its underlying assets.
The Board disagrees with commenters who claimed the proposed risk
weights were too general because they lumped together assets with
widely varying risk, and those who suggested including additional risk-
weight measures, such as taking into account the specific loan-to-value
ratio or FICO scores of the underlying assets. As with loans, the risk
weights assigned to investments were generally determined based on the
underlying collateral or type of loan, and the relative credit risk.
The Board chose not to apply separate risk weights to investments based
on additional risk-weighting tools due to the complexity involved and
the backward-looking nature of an analysis based on past performance.
Adding risk-weighting factors within investment type categories would
have been inconsistent with the approach taken by the Other Banking
Agencies.
The Board also disagrees with commenters who suggested that credit
unions should be able use lower risk weights if they are able to
demonstrate that an investment should qualify for a lower-risk weight.
Alternative and individualized risk weight mechanisms would be
difficult and costly to implement consistently, and would be
inconsistent with the Other Banking Agencies' regulations.
Several commenters recommended that the Board apply a 100 percent
risk weight to non-significant equity exposures, which would be similar
to the approach taken by the Other Banking Agencies. As discussed in
more detail below in the part of the preamble associated with Sec.
702.104(c)(3)(i), the Board generally agrees with commenters on this
point and has amended this final rule to assign a 100 percent risk
weight to non-significant equity exposures. This change is consistent
with the Board's objective of assigning risk weights to assets that are
similar to the Other Banking Agencies' regulations where the level of
risk exposure does not create safety and soundness concerns.
The Board disagrees with commenters who suggested that lower risk
weights should be applied to certain types of investments, such as
corporate bonds and publicly traded equities, which are generally not
available to federal credit unions, simply because they were purchased
for employee benefit plans. In particular, several commenters argued
that the 300 percent risk weight assigned to publicly traded equity
investments should be much lower so that credit unions are not limited
in their investments for employee benefits. The proposed risk weights
were intended to be applied based on risk, not on use. And, consistent
with commenters' suggestions on the Original Proposal, the Board
assigned risk weights in a manner similar to the Other Banking
Agencies' regulations unless the FCUA or a unique circumstance
warranted a different risk weight be adopted. The 300 percent risk
weight for non-part 703 compliant investment funds is appropriate when
they are used to fund employee benefits because there are few limits on
the investments in these types of funds. A credit union may, however,
use one of the look-through approaches if the underlying assets have a
risk weight of less than 300 percent. Accordingly, for these types of
assets, the proposed risk weight reasonably reflects the risks
associated with the types of assets available to fund employee benefit
plans.
The Board disagrees with the commenter who suggested that a 300
percent risk-weight was excessive for publicly traded equity
investments because they are treated as available for sale or trading
and recorded at market value. The value at which an equity is recorded
does not reflect the risk of loss and does not preclude an equity from
losing a substantial amount of its value in the future. The lack of a
maturity date, loss position, and unknown
[[Page 66676]]
dividends make an equity riskier than many other types of assets.
The Board generally agrees with the commenter who suggested that a
senior asset-backed security should have the same risk weight as a
similar loan. Such an approach is consistent with the Other Banking
Agencies' regulations and focuses on the risk of the underlying
collateral. By applying the gross-up approach to a non-subordinated
tranche of an investment, a credit union can risk weight a non-
subordinated tranche of an investment with the same risk weight as if
they had owned the loans directly. Accordingly, this final rule adds
non-subordinated tranches of any investments to the 100 risk-weight
category and gives credit unions the option to use the gross-up
approach.
The Board disagrees with commenters who suggested that the proposed
1,250 percent risk weight was punitive for subordinated tranches of
investments. Under the proposal, credit unions were given the option to
use the gross-up approach to lower the risk weight of a subordinated
tranche of an investment if it did not contain an excessively large
amount of leverage. The 1,250 percent risk weight is a reasonable risk
weight for subordinated tranches if the credit union is unable, or
unwilling to use the gross-up approach. The risk weight is appropriate
given the leveraged risk in subordinated tranches, and is consistent
with the Other Banking Agencies' regulations.\140\ As noted in the
Second Proposal, the simplified supervisory formula approach for
subordinated tranches permitted under the Other Banking Agencies'
capital regulations was not included in the Second Proposal because of
its complexity and limited applicability.
---------------------------------------------------------------------------
\140\ NCUA estimates a de minimis number of investments would be
subject to the 1,250 risk weight.
---------------------------------------------------------------------------
The Board also disagrees with commenters who suggested that
subordinated tranches of investments should receive the same risk
weight as commercial loans. Applying subordinated tranches of
investments the same risk weights as commercial loans would likely fail
to account for highly leveraged transactions, and would be inconsistent
with the Other Banking Agencies' regulations. The Board also notes
that, using the gross-up approach, low-risk subordinated tranches of
certain investments could receive risk weights equal to or less than
the risk weights assigned to commercial loans.
The Board disagrees with commenters who suggested that assigning
high risk weights to investments in the corporate credit union system
would penalize credit unions that invest within the industry. The
proposed risk weights assigned to nonperpetual capital and perpetual
contributed capital at corporate credit unions are 100 percent and 150
percent, respectively. The proposed risk weights were not intended to
be a penalty or disincentive for holding any particular assets. Rather,
the intent was to assign appropriate risk weights that adequately
account for the risk associated with each particular asset. The risk
weights for corporate capital investments did take into consideration
the stricter regulations commenters cited when seeking lower risk
weights. And as a result, this final rule assigns reasonable risk
weights to corporate-capital investments given the stricter regulatory
requirements applicable to corporate credit unions as compared to the
higher risk weights associated with non-publicly traded equity
investments under the Other Banking Agencies' regulations.
The Board disagrees with the commenter who suggested that the final
rule should assign different risk-weight tiers in corporate debt,
similar to municipal bonds. Under the Second Proposal, the risk weight
assigned to a corporate debt was consistent with the risk weight
assigned to an industrial development bond, which is a type of
municipal bond. An industrial development bond is a security issued
under the auspices of a state or other political subdivision for the
benefit of a private party or enterprise where that party or
enterprise, rather than the government entity, is obligated to pay the
principal and interest on the obligation. Typically the ultimate
obligation of repayment of the industrial development bond is on a
corporation. The 100 percent risk weight for corporate bonds is
consistent with the risk weights assigned to industrial development
bonds, a tier within municipal bonds, where the ultimate obligation of
repayment is a corporate entity. The proposed risk weight for corporate
debt is generally consistent with the Other Banking Agencies'
regulations. The Board decided not to apply tiers within investment
types due to the complexity and the inability to apply a standard and
objective approach.
Consistent with the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010, which required agencies to remove all
references to credit ratings, this final rule does not use credit
ratings to determine risk weights for part 702.\141\
---------------------------------------------------------------------------
\141\ Public Law 111-203, Title IX, Subtitle C, section 939A,
124 Stat. 1376, 1887 (July 21, 2010).
---------------------------------------------------------------------------
Commercial Loans
The Second Proposal assigned risk weights to commercial loans in a
manner generally consistent with the Other Banking Agencies' capital
regulations and the objectives of the Basel Committee on Banking
Supervision.\142\ The proposal set a single concentration threshold at
50 percent of total assets. Commercial loans that were less than the 50
percent threshold were assigned a 100 percent risk weight, and
commercial loans over the threshold were assigned a 150 percent risk
weight. Commercial loans that were not current were assigned a 150
percent risk weight.
---------------------------------------------------------------------------
\142\ This is comparable with the other Federal Banking
Regulatory Agencies' capital rules. See e.g., 12 CFR 324.32 (Assigns
a 100 percent risk-weight for commercial real estate (CRE) and
includes a 150 percent risk-weight for loans defined as high
volatility commercial real estate (HVCRE)); 78 FR 55339 (Sept. 10,
2013); and Basel Committee on Banking Supervision, International
Convergence of Capital Measurement and Capital Standards (June 2006)
(``In view of the experience in numerous countries that commercial
property lending has been a recurring cause of troubled assets in
the banking industry over the past few decades, Committee holds to
the view that mortgages on commercial real estate do not, in
principle, justify other than a 100 percent risk weight of the loans
secured.'') available at https://www.bis.org/publ/bcbs128.htm.
\143\ The effective capital rate represents the blended
percentage of capital necessary for a given level of commercial loan
concentration. The calculation uses 10 percent as the level of risk-
based capital to be well capitalized.
----------------------------------------------------------------------------------------------------------------
Commercial loan concentration (percent of total assets)
-------------------------------------------------------------------------------
15% 20% 50% 75% 100%
----------------------------------------------------------------------------------------------------------------
Effective Capital Rate: \143\
Current Rule................ 6.0 6.5 10.4 11.6 12.2
This Proposal............... 10.0 10.0 10.0 11.7 12.5
----------------------------------------------------------------------------------------------------------------
[[Page 66677]]
Public Comments on the Second Proposal
A substantial number of commenters recommended that the risk
weights for commercial loans be adjusted downward to levels no more
than those in place for banks. Those commenters claimed credit unions
do not have higher levels of risk associated with holding commercial
loans than banks do. Commenters acknowledged that lower risk weights
for higher concentrations of commercial loans would imply lower risk
weights for lower concentrations of these loans compared to bank risk
weights, but they insisted this disparity would be appropriate given
lower loss rates at credit unions. One commenter recommended assigning
a lower risk weight, of perhaps 50-75 percent, to secured commercial
loans. The commenter explained that in locations where there is a
market for certain types of commercial vehicles, a lower risk weight
makes more sense. Another commenter recommended the following risk
weights for commercial loans be assigned as an alternative: Credit card
and other unsecured loans that are less than 50 percent of assets
should be assigned a 100 percent risk weight, and such loans that are
over 50 percent of assets should be assigned a 150 percent risk weight;
new vehicle loans that are less than 50 percent of assets should be
assigned a 50 percent risk weight, and such loans that are greater than
50 percent of assets should be assigned a 75 percent risk weight; used
vehicle loans that are less than 50 percent of assets should be
assigned a 75 percent risk weight, and such loans that are greater than
50 percent of assets should be assigned a 112 percent risk weight;
first-lien residential real estate loans and lines of credit that are
less than 50 percent of assets should be assigned a 75 percent risk
weight, and such loans that are greater than 50 percent of assets
should be assigned a 112 percent risk weight; all other real estate
loans and lines of credit that are less than 50 percent of assets
should be assigned a 100 percent risk weight, and such loans that are
greater than 50 percent of assets should be assigned a 150 percent risk
weight.
At least one commenter speculated that the vast majority of credit
union member business loans have real estate as collateral, while
commercial bank loans are typically collateralized with receivables,
etc. The commenter noted that under the banking agencies' rules,
commercial loans made by banks are assigned a 100 percent risk weight.
The commenter argued, however, that NCUA's risk weight for member
business loans should be lowered from 100 percent to 75 percent to
account for the fact that credit union member business loans are safer
than commercial loans made by banks.
Some commenters complained that the proposal did not account for
the different types of commercial loans made by credit unions.
Commenters also speculated that credit unions chartered for the purpose
of making MBLs would be unfairly penalized under the proposal.
Discussion
The Board disagrees that concentration thresholds for commercial
loans should vary based on the business purpose or underlying
collateral. The Agency did not pursue the alternative commercial risk
weights suggested by commenters because such alternatives would be
extremely difficult to implement consistently across all credit unions.
Utilizing specific commercial loan type or collateral loss history is
not a reliable or consistent method for assigning risk weights in a
regulatory model. Nor is it consistent with the Basel framework or the
Other Banking Agencies' capital regulations. All commercial asset
classes experience performance fluctuations with variations in business
cycles. Some sectors that had historically experienced minimal losses
are now pre-disposed to heightened credit risk. Both NCUA and FDIC have
recently addressed these types of exposures in respective Letters to
Credit Unions and Financial Institution Letters.\144\
---------------------------------------------------------------------------
\144\ NCUA, Taxi Medallion Lending, Letter to Credit Unions 14-
CU-06 (April 2014); FDIC, Prudent Management of Agricultural Credits
Through Economic Cycles, Financial Institution Letter FIL-39-2014
(July 16, 2014).
---------------------------------------------------------------------------
Contemporary variances between bank and credit union losses on
commercial loans are not substantial enough to warrant assigning lower
risk weights to commercial loans held by credit unions. As stated in
the Second Proposal, and as further clarified below using data to match
the asset breakouts within the FDIC Quarterly Banking Profile, credit
unions' commercial loan loss experience is comparable to community
banks after adjusting for asset size. The recent loss experience for
credit unions and banks is very similar.
---------------------------------------------------------------------------
\145\ See Yearend FDIC Quarterly Banking Profiles 11 (2012,
2013, & 2014).
\146\ See NCUA Financial Performance Report using year end data
for credit unions with assets greater than $100 million.
3 Year Average Loss History
[2012, 2013, 2014]
----------------------------------------------------------------------------------------------------------------
Credit unions >$100M Banks $100M to Banks $1B to $10B
in assets $10B in assets in assets
----------------------------------------------------------------------------------------------------------------
Commercial & Industrial \145\..................... .................... 0.61 0.42
Member Business Loans \146\....................... 0.52
----------------------------------------------------------------------------------------------------------------
Further, credit unions' long-term historical MBL losses are
somewhat understated because NCUA's Call Report did not collect
separate MBL data until 1992. Thus, significant MBL losses experienced
in the late 1980s and early 1990s are not included in the long-term
historical credit union MBL loss data.\147\
---------------------------------------------------------------------------
\147\ NCUSIF losses from MBLs are a recurring historical trend.
The U.S. Treasury Report on Credit Union Member Business Lending
discusses 16 credit union failures from 1987 to 1991 that cost the
NCUSIF over $100 million. See Department of the Treasury, Credit
Union Member Business Lending (Washington, DC January 2001).
---------------------------------------------------------------------------
Residential Real Estate Loans
The Second Proposal assigned risk weights to residential real
estate loans that are generally consistent with those assigned by the
Other Banking Agencies.\148\ The proposal set the first- and junior-
lien residential real estate loan concentration thresholds at 35
percent and 20 percent of total assets respectively. Current first-lien
residential real estate loans that were less than 35 percent of assets
were assigned a 50 percent risk weight, and
[[Page 66678]]
those equal to or greater than 35 percent of assets were assigned a 75
percent risk weight. Current junior-lien residential real estate loans
that were less than 20 percent of assets were assigned a 100 percent
risk weight, and those equal to or greater than 20 percent of assets
were assigned a 150 percent risk weight.
---------------------------------------------------------------------------
\148\ See, e.g., 12 CFR 324.32(g).
Proposed Residential Real Estate Loan Concentration Thresholds and Risk Weights
----------------------------------------------------------------------------------------------------------------
50% 75% 100% 150%
----------------------------------------------------------------------------------------------------------------
First-Lien...................... Current <35% of Current >=35% of
Assets. Assets.
Junior-Lien..................... .................. .................. Current <20% of Current >=20% of
Assets. Assets.
----------------------------------------------------------------------------------------------------------------
In addition, under the Second Proposal, first- and junior-lien
residential real estate loans that are not current were assigned 100
percent and 150 percent risk weights, respectively.
Public Comments on the Second Proposal
A majority of the commenters who mentioned these loans recommended
that the concentration risk component be removed entirely from the risk
weights for first- and junior-lien residential real estate loans. One
commenter expressed concern that the high risk weights assigned to
certain first-lien residential real estate loans and certain junior-
lien residential real estate loans could negatively impact mortgage
lending in the communities served by credit unions. The commenter
argued that the proposal did not appear to address the underlying
attributes of the mortgages nor the degree in which they may be match
funded, which could thereby restrict lending and curtail profitability
and capital growth at well managed, risk-averse credit unions.
Accordingly, the commenter recommended that the Board reconsider and
revise the risk weights for mortgage loans held on balance sheet to be
more consistent with the requirements of the Other Federal Banking
Agencies. Similarly, a substantial number of credit union commenters
suggested that the risk weights for mortgage loans be adjusted downward
to levels no more than those in place for banks because they claimed
credit unions do not have higher levels of risk associated with holding
these assets. Another commenter argued that the risk weights assigned
to real estate loans were arbitrary because: (1) The vast majority of
MBLs are collateralized with real estate at a loan-to-value ratio of 75
percent or less; (2) the vast majority of home equity loans are first
mortgages with a loan-to-value ratio of 80 percent or less; and (3)
some increased risk is associated with junior lien mortgages, but it is
not extensive or widespread. Yet another commenter suggested that the
final rule assign risk weights to these assets by including a study of
loss history and the market where a credit union operates.
Several commenters recommended further that consideration be given
to incorporating loan-to-value ratios, credit scores, salability of the
loan to secondary mortgage market participants, and the size of loans
in the proposed risk weighting. One commenter suggested that both
junior- and first-lien residential real estate loans amortize over
time, lessening their credit risk profile, and in the case of junior
liens, over time they can become first liens, at which point the risk
weightings become too conservative. The commenter maintained that this
reduction in risk was not accounted for under the Second Proposal.
One commenter suggested that the Board consider lower risk
weightings for loans with private mortgage insurance or government
guarantees.
One commenter suggested that one-to-four-family non-owner occupied
real-estate-backed loans should be treated as a separate category and
not count toward the premium of 75 percent risk weight when real estate
loans comprise over 35 percent of assets. From a concentration risk
standpoint, commercial loans are already limited by a statutory cap
under the FCUA at 12.25 percent for the majority of credit unions.
Some commenters argued that the proposal would exacerbate the
burden and costs credit unions are already facing under the Dodd-Frank
Act regulations by requiring higher levels of capital for those credit
unions that hold first-lien residential real estate loans in excess of
35 percent of total assets. Those commenters speculated that the
increased capital cost based upon concentration risk will put credit
unions at a competitive disadvantage to other financial institutions
that do not have higher risk weightings for holding higher
concentrations of loans.
Similarly, some commenters argued that the proposal would
exacerbate the burden and costs credit unions are already facing under
the Dodd-Frank Act regulations by requiring higher levels of capital
for those credit unions that hold junior-lien residential real estate
loans in excess of 20 percent of total assets. Those commenters
maintained that the increased capital cost based upon concentration
risk puts credit unions at a competitive disadvantage to other
financial institutions that do not have higher risk weightings for
holding higher concentrations of loans.
Discussion
The Board has considered the comments received, but, as stated in
the proposal, the contemporary variances between bank and credit union
losses on real estate loans are not substantial enough to warrant
assigning lower risk weights. As stated in the Second Proposal and as
further clarified below using data to match the asset breakouts within
the FDIC Quarterly Banking Profile, credit unions' real estate loss
experience is comparable to community banks after adjusting for asset
size.
---------------------------------------------------------------------------
\149\ See yearend FDIC Quarterly Banking Profiles for 2012,
2013, and 2014, page 11 and NCUA Financial Performance Report (FPR)
using year end data for credit unions with assets greater than $100
million.
3 Year Average Loss History \149\
[2012, 2013, 2014]
----------------------------------------------------------------------------------------------------------------
Credit unions Banks $100M to Banks $1B to $10B
>$100M in assets $10B in assets in assets
----------------------------------------------------------------------------------------------------------------
All real estate loans................................ 0.33 0.36 0.38
[[Page 66679]]
Other 1-4 family residential loans................... ................... 0.30 0.37
First mortgage loans................................. 0.24 ................. .................
Home equity loans.................................... ................... 0.52 0.51
Other real estate loans.............................. 0.63 ................. .................
----------------------------------------------------------------------------------------------------------------
Higher capital requirements for concentrations of real estate loans
exist in the current rule, and completely eliminating them would be a
step backwards in matching risks with minimum risk-based capital
requirements. Credit unions with high real estate loan concentrations
are particularly susceptible to changes in the economy and housing
market.
NCUA currently reviews credit concentrations during examinations as
commenters recommended. As discussed in the summary section, however,
the FCUA requires that NCUA's risk-based capital requirement account
for material risks that the 6 percent net worth ratio may not provide
adequate protection, including credit and concentration risks.\150\
---------------------------------------------------------------------------
\150\ See 12 U.S.C. 1790d(d)(2).
---------------------------------------------------------------------------
Credit concentration risk can be a material risk under certain
circumstances. The Board generally agrees that CFPB's new ability-to-
repay regulations should improve credit quality. However, the extent to
which this will alter loss experience rates remains to be seen.
NCUA has also been advised by its OIG and GAO to address credit
concentration risk. NCUA's OIG completed several MLRs where failed
credit unions had large real estate loan concentrations. The NCUSIF
incurred losses of at least $25 million in each of these cases. The
credit unions reviewed held substantial residential real estate loan
concentrations in either first-lien mortgages, home equity lines of
credit, or both.\151\ In addition, in 2012, GAO recommended that NCUA
address the credit concentration risk concerns raised by the NCUA
OIG.\152\ The 2012 GAO report notes credit concentration risk
contributed to 27 of 85 credit union failures that occurred between
January 1, 2008, and June 30, 2011. The report also indicated that the
Board should revise NCUA's PCA regulation so that the minimum net worth
levels required under the rule emphasize credit concentration risk. So
eliminating the concentration dimension for risk weights entirely would
be inconsistent with the concerns raised by GAO and the MLRs conducted
by NCUA's OIG.
---------------------------------------------------------------------------
\151\ See NCUA, Material Loss Review of Cal State 9 Credit
Union, OIG-10-03 (April 14, 2010); NCUA, Material Loss Review OF
Beehive Credit Union, OIG-11-07 (July 7, 2011); and NCUA, Material
Loss Review OF Ensign Federal Credit Union, OIG-10-15 (September 23,
2010), available at https://www.ncua.gov/about/Leadership/CO/OIG/Pages/MaterialLossReviews.aspx.
\152\ See U.S. Govt. Accountability Office, Earlier Actions are
Needed to Better Address Troubled Credit Unions, GAO-12-247 (2012),
available at https://www.gao.gov/products/GAO-12-247.
---------------------------------------------------------------------------
The proposed risk weights would not slow residential real estate
loan origination, stifle homeownership, or limit credit unions' ability
to assist low-income members because the revised risk weights provide
credit unions with continued flexibility to assist members in a
sustainable manner while maintaining sufficient minimum capital.
The Board agrees with commenters that credit scores, loan
underwriting, portfolio seasoning, and portfolio performance are
appropriate measures to evaluate a specific credit union's residential
real estate lending program. However, broadly applicable regulatory
capital models are portfolio invariant. This means the capital charge
for a particular loan category is consistent among all credit union
portfolios based on the loan characteristics, rather than an individual
credit union's portfolio performance or characteristics. Taking into
account each credit union's individual characteristics would be too
complicated for many credit unions and unwieldy for NCUA to enforce
minimum capital requirements.\153\ Further, such an approach would not
be comparable to the risk weight framework used by the Other Banking
Agencies.
---------------------------------------------------------------------------
\153\ Basel Committee on Banking and Supervision, An Explanatory
Note on the Basel II IRB Risk Weight Functions (July 2005),
available at https://www.bis.org/bcbs/irbriskweight.htm (``The model
should be portfolio invariant, i.e. the capital required for any
given loan should only depend on the risk of that loan and must not
depend on the portfolio it is added to. This characteristic has been
deemed vital in order to make the new IRB framework applicable to a
wider range of countries and institutions.'').
---------------------------------------------------------------------------
NCUA will continue to take into account loan underwriting
practices, portfolio performance and loan seasoning as part of the
examination and supervision process. This method of review is
consistent with the Basel three-pillar framework: Minimum capital
requirements, supervisory review, and market discipline.\154\ Credit
unions should use criteria from their own internal risk models and loan
underwriting in developing their internal risk management systems.
---------------------------------------------------------------------------
\154\ Basel Committee on Banking Supervision, International
Convergence of Capital Measurement and Capital Standards (June
2006), available at https://www.bis.org/publ/bcbs128.htm (``The
Committee notes that, in their comments on the proposals, banks and
other interested parties have welcomed the concept and rationale of
the three pillars (minimum capital requirements, supervisory review,
and market discipline) approach on which the revised Framework is
based.'').
---------------------------------------------------------------------------
The Board likewise agrees LTV ratios are an informative measure to
assess risk. However, it is not a practical measure to assess minimum
capital requirements because of volatility in values and the
corresponding reporting burden for credit unions. There is no
historical data across institutions upon which to base varying risk
weights according to LTVs and other underwriting criteria (such as
credit scores). Examiners take LTVs into consideration during the
examination process. Supervisory experience has demonstrated LTV
verification requires on-site review and application of credit
analytics to validate the most current information. On-site review also
minimizes reporting requirements on credit unions.
Junior-lien residential real estate loans continue to warrant a
higher risk weight based on loss history. Call Report data indicate
credit unions over $100 million in asset size reported nearly three
times the rate of loan losses (0.63 percent) on other real estate loans
\155\ when compared to first mortgage real estate loans (0.24 percent)
during the past three years. The final base risk weight for junior-lien
residential real estate loans is comparable to the risk weight assigned
by the Other Banking Agencies.\156\
---------------------------------------------------------------------------
\155\ Junior-lien real estate loans are currently reported on
the Call Report as part of ``other real estate loans.''
\156\ See, e.g., 12 CFR 324.32(g)(2).
---------------------------------------------------------------------------
[[Page 66680]]
Current Consumer Loans
Consumer loans (unsecured credit card loans, lines of credit,
automobile loans, and leases) are generally highly desired credit union
assets and a key element of providing basic financial services.\157\
Under the Second Proposal, a current secured consumer loan received a
risk weight of 75 percent, and a current unsecured consumer loan was
assigned a 100 percent risk weight.
---------------------------------------------------------------------------
\157\ Per Call Report data for years ending December 31, 2012,
2013, and 2014, consumer loans were greater than 40 percent of loans
in credit unions with total assets greater than $100 million.
---------------------------------------------------------------------------
Public Comments on the Second Proposal
One commenter claimed the risk weightings assigned to secured and
unsecured consumer loans at credit unions would be more restrictive
than the comparable risk weightings applicable to community banks. To
remain competitive, the commenter recommended that the proposed risk
weights should be changed to be more in line with Basel III instead of
being more restrictive. Other commenters argued that based on the
historical performance of credit unions in managing consumer loan risk,
the Board should assign a 50 percent risk weight to secured consumer
loans and a 75 percent risk weight to unsecured consumer loans. These
commenters speculated that if the risk weights proposed for consumer
loans were adopted, some credit unions would have to reduce the
services they are currently able to provide to members.
Discussion
The Board disagrees with the commenter who claimed the proposed
risk weight assigned to consumer loans that are current is more
restrictive than the corresponding risk weight assigned to such loans
for community banks. The risk weight for secured consumer loans in the
Second Proposal and in this final rule is 75 percent, which is less
than the 100 percent risk weight assigned to such loans held at
community banks under the Other Banking Agencies' regulations. The risk
weight for unsecured consumer loans that are current is identical to
the corresponding risk weight for such loans held at community banks.
Comparisons of historical losses on consumer loans between credit
unions and banks is difficult due to differences in Call Report data,
but generally the difference in historical performance measured by loss
history is not significant. Accordingly, the Board has decided to
maintain the consumer loan risk weights contained in the Second
Proposal.
Non-Current Consumer Loans
The risk-based net worth measure in NCUA's current PCA regulation
does not assign a higher risk weight to non-current consumer loans.
Increasing levels of non-current loans, however, are an indicator of
increased risk. To reflect the impaired credit quality of past-due
loans, the Second Proposal required credit unions to assign a 150
percent risk weight to loans (other than real estate loans) that are 90
days or more past due, in nonaccrual status, or restructured.
Public Comments on the Second Proposal
One commenter suggested that consumer loans that are not current
(90 days past due), could be assigned a 100 percent risk weight,
instead of a 150 percent risk weight, given the historically low
default rate of these loan types, strong underwriting and possible
further protection by underlying collateral. At least one commenter
maintained that with ALLL calculations already in place to account for
higher charge offs, the proposed risk weight for non-current loans
would be unnecessarily high and would ultimately hurt credit union
members. Other commenters speculated that the proposed risk weights
would force credit unions to pull back lending to low-income
communities for fear of carrying delinquent (non-current) loans at
elevated risk weightings.
Discussion
The proposed risk weight of 150 percent is warranted because non-
current consumer loans have a higher probability of default when
compared to current consumer loans. Non-current consumer loans are more
likely to default because repayment is already impaired, making them
one step closer to default compared to current consumer loans. As
stated in the Second Proposal, the Board assigned a higher risk weight
on past-due exposures to ensure sufficient regulatory capital for the
increased probability of unexpected losses on these exposures, which
results in a risk-based capital measure that is more responsive to
changes in the credit performance of the loan portfolio. The higher
risk weight will capture the risk associated with the impaired credit
quality of these exposures. Moreover, the 150 percent risk weight is
consistent with the risk weights used under Basel III and the Other
Banking Agencies.\158\
---------------------------------------------------------------------------
\158\ See, e.g., 12 CFR 324.32(k).
---------------------------------------------------------------------------
The Board disagrees with commenters who speculated that the
proposed risk weights would limit credit unions' ability to assist low-
income members. The removal of the ALLL cap will reduce the impact of
non-current loans to the risk-based capital ratio.
Accordingly, this final rule retains the 150 percent risk weight
for consumer loans that are not current.
Loans to CUSOs, and CUSO Investments
Under the Second Proposal, investments in CUSOs were assigned a
risk weight of 150 percent and loans to CUSOs were assigned a risk
weight of 100 percent.
Public Comments on the Second Proposal
Commenters generally maintained that the proposed risk weight for
investments in CUSOs was too high. A majority of the commenters who
mentioned it suggested that the risk weight for CUSO investments was
too high and should be the same as for CUSO loans, or less. A
substantial number of commenters argued that given the unique position
of CUSOs as cooperative cost-saving structures in the credit union
system, the Board should use its statutorily granted discretion to draw
distinctions between CUSOs and private equity investments held by
banks. Commenters maintained that not only must CUSOs provide NCUA with
open access to their books and records, but CUSOs will be required to
register directly with NCUA and, if complex, report audited financial
statements and customer information.\159\ Commenters reasoned that this
heightened supervisory oversight compared to general investment
exposures, combined with the limits on credit union investment powers,
makes a 100 percent risk weight more appropriate. The commenters
suggested further that, given the limits on credit union investment
powers, the vast majority of credit unions with unconsolidated equity
investments in CUSOs would fall within the ``non-significant''
exception under the banking regulations for investments aggregating
less than 10 percent of total assets, and would receive a 100 percent
risk weight. Therefore, the commenters reasoned, adjusting the CUSO
investment weighting to 100 percent would better reflect the role of
CUSOs in the credit union industry while still aligning in practice
with treatment of similar exposures in banks.
---------------------------------------------------------------------------
\159\ 12 CFR part 712; and 12 CFR 741.222.
---------------------------------------------------------------------------
Other commenters stated that they supported the proposed treatment
of
[[Page 66681]]
consolidated CUSO investments and loans in which no separate risk
weighting would apply. One commenter suggested that, if GAAP is
followed for the valuation of CUSOs, the proper valuation of the asset
should allow for the lowering of the risk weight from the proposed 150
percent risk weight. Several commenters contended that the 150 percent
risk weight assigned to unconsolidated CUSO investments, which applies
to the accumulated and undistributed earnings of these CUSOs under
GAAP, is inappropriate because it would require credit unions to set
aside additional capital, beyond what they initially invested, to cover
retained earnings to support future growth of these CUSOs. These
commenters recommended that the Board reduce the risk weight to 100
percent, or, if not lowered, to risk weight only the initial investment
by the credit union and not the appreciation of that investment over
time.
One commenter argued that the risk weight assigned to
unconsolidated investments in CUSOs would be counter-productive. The
commenter claimed that the Board presented only anecdotal and
unsubstantiated references to what it considers ``substantial CUSO
losses'' over the last decade as justification for CUSO regulations and
assigning a 150 percent risk weight to CUSO investments. The commenter
contended that no detailed statistics have been provided to justify
these losses as substantial, and the commenter would challenge any such
claim because they were not able to substantiate any losses of a
significant nature through credit union investment in CUSOs over the
past 10 years. The commenter recommended the Board investigate the
industry benefits of CUSOs and the relatively immaterial level of CUSO
investment impact on the NCUSIF before finalizing the current proposed
risk weights for CUSO investments.
Other commenters suggested that assigning a 150 percent risk weight
to multi-credit union owned CUSOs, which are important collaborative
tools for credit unions, is not reflective of the actual systemic risk
CUSOs pose. The commenters explained that, overall, based on 2014 data,
federally insured credit unions in total have less than 22 basis points
of their assets invested in CUSOs, including fully consolidated CUSO
investments. Therefore, the commenters asserted, CUSO investments are
not a systemic risk to the NCUSIF.
One commenter pointed out that the proposal stated that the risks
associated with CUSOs are similar to the risks associated with third-
party vendors. However, the commenter could not find any references in
the proposal that would account for the risks posed by non-CUSO third-
party vendors. The commenter claimed that only CUSOs were singled out
for their supposed risk, and argued that was not adequate justification
for the risk weight assigned to CUSO investments.
Some commenters argued that the proposal cited FDIC's capital
regulation in saying that risk weights should be set based on the risk
of loss and not the size of exposure. Those commenters suggested,
however, that FDIC agrees that non-significant investment exposures in
unconsolidated equity of a privately held company should be risk
weighted at 100 percent. The commenters recommended the Board look
deeper into the FDIC definition of ``non-significant'' and how it
translates to unconsolidated CUSO investments. In the commenters'
opinion, the statutory and regulatory structure of CUSO investments
make such investments non-significant using the FDIC definition, and
thereby should be assigned only a 100 percent risk weight.
One commenter suggested that investments in CUSOs should carry a
100 percent risk weighting based on the following risk-mitigating
factors: (1) GAAP requires credit unions to evaluate the asset for
potential impairment; (2) the majority of CUSOs are limited liability
corporations (LLCs) and the credit union would be protected under the
LLC structure; and (3) the stated purpose of NCUA's CUSO rule is to
reduce risk exposure to credit unions. Another commenter suggested that
investments in and loans to CUSOs should be equally risk weighted. The
commenter recommended assigning a 75 percent risk weight due to the
expertise that is brought to the business strategy within the relevant
business model that they are operating within and to encourage the use
of the cooperative business model. Other commenters suggested that
CUSOs should be risk weighted based on type: Operational CUSOs should
receive a 50 percent risk weight, fee-generating CUSOs should receive a
zero percent risk weight, and start-up CUSOs should receive a 100
percent risk weight.
Several commenters suggested that instead of assuming that all
CUSOs are inherently risky, the proposal should be primarily concerned
with the riskiness of the services provided by a CUSO and how dependent
a credit union is on CUSO investments. One commenter suggested that in
order to minimize the impacts of the proposal, CUSOs would be required
to give excess earnings back to the credit unions to reduce their CUSO
exposure. This would result in reduced services for the credit union.
Discussion
The Board has carefully considered the comments received. As
discussed in more detail below in the part of this preamble associated
with Sec. 702.104(c)(3)(i), under this final rule a credit union's
investments in CUSOs will receive a 100 percent risk weight if the
credit union has non-significant equity exposures.\160\
---------------------------------------------------------------------------
\160\ A credit union has ``non-significant equity exposures'' if
the aggregate amount of its equity exposures does not exceed 10
percent of the sum of the credit union's capital elements of the
risk-based capital ratio numerator.
---------------------------------------------------------------------------
The Board relied on GAAP accounting standards to determine the
reporting basis upon which any CUSO equity investments and loans are
assigned risk weights. For CUSOs subject to consolidation under GAAP,
the amount of CUSO equity investments and loans are eliminated from the
consolidated financial statements because the loans and investments are
intercompany transactions. The related CUSO assets that are not
eliminated are added to the consolidated financial statement and
receive risk-based capital treatment as part of the credit union's
statement of financial condition. For CUSOs not subject to
consolidation, the recorded value of the credit union's equity
investment would be assigned a 100 percent risk weight if its equity
exposures are non-significant or a 150 percent risk weight if its
equity exposures are significant, and the balance of any outstanding
loan would be assigned a 100 percent risk weight.
NCUA recognizes the uniqueness of CUSOs and the support they
provide to many credit unions. However, an equity investment in a CUSO
is an unsecured, at-risk equity investment in a first loss position,
which is analogous to an investment in a non-publicly traded entity.
There is no price transparency and extremely limited marketability
associated with CUSO equity exposures. In addition, unlike the Other
Banking Agencies, NCUA has no enforcement authority over third-party
vendors, including CUSOs.
The Board recognizes there are statutory limits on how much a
federal credit union can loan to and invest in CUSOs. However, the
limitations are not as stringent for some state charters, and only
binding for federal credit unions at the time the loan or investment is
made. The position can grow in proportion to assets over time. In
setting capital standards (such as Basel and FDIC), the risk of loss--
not the size of the
[[Page 66682]]
exposure--is central to determining the risk weight. In addition, while
a CUSO must predominantly serve credit unions or their members (more
than 50 percent) to be a CUSO, it can be owned and controlled primarily
by persons and organizations other than credit unions. Therefore, it
may not only serve non-credit unions, it can be majority-controlled by
a party or parties with interests not necessarily aligned with the
credit union's interests.\161\
---------------------------------------------------------------------------
\161\ Further, not all CUSOs are closely held. They can have
wider ownership distributed among many credit unions, none of which
may have significant control. If a particular credit union has
significant control, it will likely have to consolidate under GAAP
and then there will be no risk weight associated with the loan or
investment for the controlling credit union since it will be netted
out on a consolidated basis.
---------------------------------------------------------------------------
The Second Proposal noted that the risk weight should be higher
than 100 percent given that an equity investment in a CUSO is in a
first loss position, is an unsecured equity investment in a non-
publicly traded entity, the significant history of losses to the NCUSIF
related to CUSOs, and the fact NCUA lacks vendor authority. Loans to
CUSOs, on the other hand, have a higher payout priority in the event of
bankruptcy of a CUSO and therefore warrant a lower risk weight of 100
percent, which corresponds to the base risk weight for commercial
loans. It may be possible, however, to make more meaningful risk
distinctions in the future between the risk various types of CUSOs pose
once NCUA's CUSO registry is in place and sufficient trend information
has been collected.
Under the Second Proposal, the risk weights were derived from a
review of FDIC's capital treatment of bank service organizations.
FDIC's rule looks across all equity exposures.\162\ If the total is
``non-significant'' (less than 10 percent of the institution's total
capital), the entire amount receives a risk weight of 100 percent.
Otherwise, all the exposures are matched against a complicated risk
weight framework that runs from a minimum of 250 percent to 600 percent
risk weight, with some subsidiary equity having to be deducted from
capital. Under the Other Banking Agencies' regulations, an equity
investment in a CUSO would be treated the same as an equity investment
in a non-publicly traded entity (with limited marketability and
valuation transparency), which would receive a 400 percent risk weight
unless the cumulative level of all equity exposures held by the
institution were non-significant.
---------------------------------------------------------------------------
\162\ See, e.g., 12 CFR 324.52.
---------------------------------------------------------------------------
The Board recognizes the complexity of FDIC's approach and believes
that a simplified lower-risk-weight approach is appropriate when the
entire amount of equity exposures within the credit union are not
significant.
Accordingly, this final rule retains the proposed 100 percent risk
weight assigned to loans to CUSOs, and retains the 150 percent risk
weight assigned to investments in CUSOs if the equity exposure is
significant. As discussed in more detail below, however, this final
rule reduces the risk weight assigned to investments in CUSOs to 100
percent for complex credit unions with non-significant equity
exposures.
Mortgage Servicing Assets (MSAs)
The Second Proposal would have assigned a 250 percent risk weight
to MSAs to address the complexity and volatility of these assets.
Public Comments on the Second Proposal
A significant number of commenters maintained that the 250 percent
risk-weight assigned to MSAs would reduce the ability of credit unions
to grant mortgage loans, engage in loan participations, and retain
servicing of their member loans, and that it would likely also prevent
credit unions from using mortgage servicing rights as a hedge against
future rate changes. Accordingly, they argued the proposed risk
weighting for MSAs, which would be the same as for banks, would be too
high and should be significantly lower. One commenter suggested that,
because much of the risk associated with holding MSAs relates to the
volatility of their market value with changes in interest rates, credit
unions that book MSAs at, or close to, their current market value are
at a greater risk of loss in a falling interest rate scenario. One
commenter suggested further that those institutions that book MSAs more
conservatively have a built-in book-to-market value cushion to absorb
normal downward fluctuations in market value and are in a better
position to recapture their investment over a shorter period of time.
The commenter stated that in a rising-rate environment, the value of
MSAs and the corresponding cushion grow and the risk declines.
Consequently, the commenter contended, a flat 250 percent in all
circumstances would be punitive for those credit unions that
conservatively book MSAs, particularly in a low-interest-rate or low-
refinance environment. The commenter maintained that it is important to
note that the operational risks associated with MSAs are not avoided by
holding originated mortgage loans in portfolio, yet the risk weights of
portfolio mortgage loans varies from 50 percent to 75 percent, despite
the fact that such assets are burdened with a multitude of other risks
not inherent in MSAs.
One commenter observed that for sound asset, liability, and
liquidity management purposes, some credit unions sell nearly all of
their mortgage loan production into the secondary market and retain a
sizable portion of the servicing rights for member service and risk
mitigation purposes, the latter in terms of the stability of earnings
from the aggregate of mortgage-related activities over time. The
commenter maintained that these credit unions' MSA-portfolio market
values are evaluated independently each quarter, with the market value
consistently representing more than the stated book values,
representing sizable off-balance sheet assets. The commenter
recommended that the risk weight for MSAs be based on a reasonable
formula related to the ratio of book value to market value and in any
case not exceed a 75 percent risk weight.
Several commenters argued that MSAs are salable and, consistent
with GAAP, they are evaluated for potential impairment. Accordingly,
they argued MSAs should be assigned a risk weight of 100 percent. One
commenter suggested that the risk weight for MSAs should be no more
than 150 percent. Another commenter suggested that MSAs should be
assigned the same risk weight that is assigned to mortgage loans held
in portfolio and that are under 35 percent of assets. At least one
commenter recommended that, if a 250 percent risk weight is adopted for
MSAs, a lower risk weight of 100 percent should be assigned to MSAs on
loans sold without recourse, but that are serviced by the credit union.
Other commenters suggested that if a credit union is following
GAAP, it must record mortgage servicing as an asset that then requires
a valuation be done every year, and if as an asset it does not meet the
actual valuation reflected it must be written down to the audited
value.
One commenter argued that weighting MSAs at 250 percent would
penalize those credit unions who lowered their interest rate risk on
their balance sheet by selling their longer-term, fixed-rate real
estate loans. Another commenter suggested that the 250 percent risk
weight would pressure credit unions to sell the servicing rights on
mortgages they originate, effectively forcing credit unions to end a
significant member relationship many credit unions have with their
members, in order to manage interest rate risk.
[[Page 66683]]
One commenter claimed that MSAs only have two significant risks
associated with them: (1) Prepayment penalties, and (2) operational/
reputational risk. Both risks, the commenter suggested, are relatively
easily mitigated because prepayment risk can be mitigated by
maintaining a viable origination pipeline, and operational/reputational
risk can be mitigated by maintaining a good system of internal
controls. Moreover, the commenter argued MSAs provide a significant,
reliable source of fee revenue for many credit unions, which is
generated from fees that are paid by investors, not by members.
Discussion
The 250 percent risk weight factors in the relatively greater risks
inherent in MSAs, and maintains comparability with the risk weight
assigned to these assets by the Other Banking Agencies.\163\ As noted
in the preamble to the Second Proposal, MSAs typically lose value when
interest rates fall and borrowers refinance or prepay their mortgage
loans, leading to earnings volatility and erosion of capital. MSA
valuations are highly sensitive to unexpected shifts in interest rates
and prepayment speeds. MSAs are also sensitive to the costs associated
with servicing. These risks contribute to the high level of uncertainty
regarding the ability of credit unions to realize value from these
assets, especially under adverse financial conditions, and support
assigning a 250 percent risk weight to MSAs.
---------------------------------------------------------------------------
\163\ See, e.g., 12 CFR 324.32(l)(4)(i).
---------------------------------------------------------------------------
While the Board agrees with commenters that MSAs may provide some
hedge against falling rates under certain circumstances, MSAs'
effectiveness as a hedge, relative to particular credit unions' balance
sheets, is subject to too many variables to conclude that MSAs warrant
a lower risk weight. More importantly, since IRR has been removed from
the risk weights of this proposal, the commenters' argument is no
longer directly applicable.
NCUA does not agree with commenters who speculated that the
proposed 250 percent risk weight assigned to this relatively small
asset class would significantly dis-incentivize credit unions from
granting loans, engaging in loan participations, and retaining
servicing of their member loans. NCUA notes that banks have been
subject to at least as stringent (if not more stringent) risk weights
for MSAs for some time and continue to sell loans and retain MSAs.
The January 1, 2019 effective date for this final rule provides
credit unions more than three years to adjust to these new requirements
and provides credit unions with a phase-in period comparable to that
given to banks following a similar change to the Other Banking
Agencies' capital regulations.\164\
---------------------------------------------------------------------------
\164\ See, e.g., 12 CFR 324.1(f).
---------------------------------------------------------------------------
Other On-Balance Sheet Assets
The Second Proposal assigned specific risk weights to additional
asset classes, which are discussed in more detail below. Under the
proposal, all assets listed on the statement of financial condition not
specifically assigned a risk weight under proposed Sec. 702.104 were
assigned a 100 percent risk weight.\165\
---------------------------------------------------------------------------
\165\ This is comparable to the Other Banking Agencies' capital
rules, which maintained the 100 percent risk weight for assets not
assigned to a risk weight category. See, e.g., 12 CFR 324.32; and 78
FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------
Public Comments on the Second Proposal
The Board received several comments regarding the proposed risk
weights for other on-balance sheet assets.
Some commenters opposed the Second Proposal's risk weighting of 20
percent for share-secured loan balances and member business
(commercial) loans secured by compensating balances. By contrast, the
commenters observed the comparable risk weight for community banks is
zero percent if the cash is on deposit in the bank, which is
appropriate given there is no risk. Thus, the commenters recommended
that loan balances secured by shares or compensating balances on
deposit at the originating credit union be reduced to a zero percent
weighting, and loan balances secured by compensating balances on
deposit at another financial institution be weighted at the proposed 20
percent.
One commenter agreed that the Board's efforts to align the risk-
based capital regulation more closely with the Other Banking Agencies'
regulations were appropriate. The commenter suggested that, absent a
compelling rationale for different treatment between the two systems,
regulators should strive to maintain equal treatment for equal risks in
all depository institutions. The commenter also recommended that
principal-only STRIPS be risk-weighted based on the underlying
guarantor or collateral.
Some commenters suggested that imposing risk-based capital
limitations on charitable donation accounts would contravene the appeal
for credit unions to put money into these investments to fund
charitable activities. Those commenters recommended that the Board
amend the final rule to do one of the following: (1) Exempt CDAs from
the risk-based capital regulation because the Board effectively
balanced safety and soundness with effectuating credit unions'
charitable intent when it passed the CDA regulation; (2) Assign a 100
percent risk weight to any equity or corporate bond exposure in a CDA
investment; (3) Apply a 100 percent risk weight to non-significant
equity exposures because banks are permitted to apply a 100 percent
risk weight to certain equity exposures deemed non-significant. Those
commenters suggested that such treatment would support broader
participation by credit unions with community development investments
and enhance the goodwill and reputation of the credit union industry as
it builds an investment resource to support charitable contributions.
One commenter maintained that the Second Proposal would require a
credit union to reduce its capital (in the numerator) by the amount of
the underfunded portion of the pension plan, but was silent on how to
reflect an overfunded pension asset. The commenter recommended that
NCUA provide specific guidance on the treatment of an overfunded
pension asset. Specifically, the commenter recommended the Board
eliminate the inconsistent treatment by removing the overfunded pension
asset from both the numerator and the denominator.
A state supervisory authority commenter requested clarification on
the risk weighting treatment of credit union deposits in the Bank of
North Dakota. The commenter noted that the Bank is state-owned, and its
deposits are neither federally nor privately insured, but are backed by
a guarantee from the State of North Dakota. The commenter acknowledged
it is a unique institution, and thus was unsure which risk weighting
would apply to the deposits. The commenter suggested the deposits are
low risk due to the guarantee by the state, and recommended it be
afforded a 20 percent or lower weighting.
At least one commenter recommend that the Board define auto and
credit card servicing assets and assign them risk weights consistent
with the risk weighting assigned to mortgage servicing assets.
One commenter contended that the ``full look-through'' approach
described under the Second Proposal failed to apply risk weights to
mutual fund investments in a consistent manner to the holding of the
same securities by
[[Page 66684]]
credit unions directly. The commenter explained that, for example, a
credit union that holds ``U.S. Treasuries and Government Securities''
would assign a risk weight of zero percent to such holdings. By
contrast, an investment fund, with similar U.S. Treasuries and
Government Securities, would have a risk weight of 20 percent assigned
to this asset. The commenter suggested this disparity in the treatment
of the same asset when held by two different entities unnecessarily
discriminates against a credit union's investments in mutual funds by
penalizing the credit union for making the same investment indirectly
that they could otherwise make directly. The commenter suggested
further that the added layer of risk that the Second Proposal assumed
will be present for indirect investments is not a factor with mutual
funds, because they provide daily redemption at net asset value and
generally provide sold share proceeds to the investor on the next
business day. The commenter recommended that the Board revise the rule
so that mutual fund risk weights are consistent with the risk weights
on the underlying instruments. The commenter also recommended that the
Board adopt a full look-through approach that is attuned to the
distinctions between underlying assets that would allow low-risk mutual
funds to carry risk ratios ranging between zero percent and 20 percent
based upon the actual risk ratio of their holdings.
One commenter suggested that the proposal was silent on how to risk
weight loans held for sale, and recommended the Board assign a risk
weight of 25 percent to loans held for sale.
At least one commenter suggested that, under the Second Proposal,
current non-federally insured student loans would be assigned a 100
percent risk weight, despite other potential sources of insurance. The
commenter asked whether there should be a distinction, at least for
insured private student loans, and whether insured private student
loans should be assigned a 50 percent risk weight and uninsured private
student loans at 100 percent. The commenter suggested that, at some
credit unions, private student loans are not only insured by an
independent insurance company, but reinsured with three separate
carriers. In such a situation, the commenter suggested that a 100
percent risk weighting seemed excessive.
Discussion
The Board generally agrees with the commenter who suggested that
principal-only mortgage-backed-security STRIPS should be risk weighted
based on the underlying collateral, which would more closely align
NCUA's regulations with the Other Banking Agencies' rules. Principal-
only mortgage-backed-security STRIPS are purchased at a discount to
par, and par is paid to the investor over the life of the bond. As with
other mortgage-backed securities, the timing of the repayment of par is
the primary risk when credit risk is not considered. Absent credit
risk, the investor receives par. This is not the case with interest-
only mortgage-backed-security STRIPS, where an investor can receive
less than the amount paid even without a credit event. Accordingly,
this final rule assigns non-subordinated principal-only mortgage-
backed-security STRIPS a risk weight based on the underlying
collateral.
The Board also agrees with commenters who suggested the risk weight
for certain accounts used for charitable purposes should be aligned
with the 100 percent risk weight assigned to community development
investments under the Other Banking Agencies' regulations. Charitable
donation accounts are limited to 5 percent of net worth, which limits
the risks of such accounts to the Share Insurance Fund. In addition,
charitable donation accounts are required to be transparent segregated
accounts, which enables NCUA to ensure that such accounts comply with
applicable laws through supervision. As explained above and in more
detail below, this final rule would permit credit unions to assign a
100 percent risk weight to CDAs.
The Board disagrees with the commenter who recommended removing
overfunded pension assets from both the numerator and denominator.
Under the Second Proposal, overfunded pension assets were not included
in the risk-based capital ratio numerator or denominator, primarily
because they are not disclosed on the financial statement as an asset,
so there is no need to remove them from the calculation. Overfunded
pension assets were excluded completely from the proposed risk-based
capital calculation, and their inclusion in the final rule would add
only needless complexity and could create volatility in the risk-based
capital ratio.
The Board disagrees with the commenter who suggested that any
investment fund holding assets that are assigned a zero percent risk
weight should receive a zero percent risk weight. As discussed in the
Second Proposal, assets assigned a zero percent risk weight that are
held in an investment fund are considered indirect obligations. The
risk weight assigned to an investment fund that holds zero percent
risk-weighted assets is 20 percent even though the underlying
investments consist of zero risk-weighted assets due to the
investment's structure as an investment fund. This is consistent with
the Other Banking Agencies' regulations.
The Board agrees with the commenter who suggested that the final
rule should clarify the timing of holding reports used for the full
look-through approach. As explained in more detail below, new appendix
A to part 702 now clarifies which holding report should be used for the
full look-through approach.
The Board has decided to reduce the risk weight in the final rule
for share-secured loans, where the shares securing the loan are on
deposit at the credit union, to zero percent since the risk of loss is
more a function of operational risk than credit risk. The Board
maintained the 20 percent risk weight for share-secured loans where the
collateral deposit is at another depository institution due to the
added credit risk of the depository institution. The resulting risk
weights for share-secured loans are more consistent with the Other
Banking Agencies' related risk weights.
Loan servicing assets associated with credit card loans or auto
loans are different than loan servicing assets associated with
mortgages because of the much shorter duration of the associated cash
flows. Since shorter-term assets are individually assigned a risk
weight, they default to the 100 percent risk weight assigned to all
other assets, which is a reasonable risk weight based on the general
credit quality associated with the underlying consumer loans. The 100
percent risk weight is appropriate for this class of assets because the
difference between the book balance of some particular fixed assets and
the value of the assets in the event of liquidation can be substantial.
For example, in an area that has experienced a decline in the value of
real estate, the book value of a fairly recently constructed credit
union headquarters could be well below the fair value. Differentiating
between the risks of types of assets not otherwise identified is not
currently possible due to lack of data, would add complexity to the
rule, and require even more Call Report data. The 100 percent risk
weight is appropriate when considering that most assets in this group
are predominately non-earning assets which can hinder a credit union's
ability to increase capital. Further, the proposed risk weights match
the risk weights in
[[Page 66685]]
the Other Banking Agencies' capital regulations.\166\
---------------------------------------------------------------------------
\166\ See, e.g., 12 CFR 324.32(l).
---------------------------------------------------------------------------
This final rule would include loans held for sale within the pool
of loans subject to assignment of risk weights by loan type to avoid
the added complexity of determining the age of the loans held for sale.
Loans held for sale carry identical risks to the originating credit
union as other loans held in the credit union's portfolio until
transfer to the purchaser is final. Until the originating credit union
transfers the loan to the purchaser, the originating credit union bears
the risk of the loan defaulting. If the loan defaults prior to the
finalization of the transfer, the originating credit union must account
for any loss from the defaulting loan, similar to other loans held on
the credit union's books. Accordingly, consistent with the Second
Proposal, this final rule assigns loans held for sale a risk weight
based on the loan's type.
Non-federally guaranteed student loans are appropriately classified
under current consumer loans due to the higher risks (default risk and
extension risk) associated with this product.
104(c)(2)(i) Category 1--Zero Percent Risk Weight
Proposed Sec. 702.104(c)(2)(i) provided that a credit union must
assign a zero percent risk weight to the following on-balance sheet
assets:
The balance of cash, currency and coin, including vault,
automatic teller machine, and teller cash.
The exposure amount of:
[cir] An obligation of the U.S. Government, its central bank, or a
U.S. Government agency that is directly and unconditionally guaranteed,
excluding detached security coupons, ex-coupon securities, and
principal and interest only mortgage-backed STRIPS.
[cir] Federal Reserve Bank stock and Central Liquidity Facility
stock.
Insured balances due from FDIC-insured depositories or
federally insured credit unions.
For the reasons explained above, the Board decided to remove the
proposed language excluding directly and unconditionally guaranteed
principal-only mortgage-backed-security STRIPS that were an obligation
of the U.S. Government, its central bank, or a U.S. Government agency.
The final rule also adds the word ``security'' after the word
``mortgage-backed'' for clarity and consistently.
In addition, the Board decided to lower the risk weight for share-
secured loans, where the shares securing the loan are on deposit with
the credit union, to zero percent. Assigning a zero percent risk weight
to share-secured loans under such circumstances is consistent with the
risk weight assigned to such loans under the Other Banking Agencies.
Accordingly, Sec. 702.104(c)(2)(i) of this final rule provides
that a credit union must assign a zero percent risk weight to the
following on-balance sheet assets:
The balance of
[cir] Cash, currency and coin, including vault, automatic teller
machine, and teller cash.
[cir] Share-secured loans, where the shares securing the loan are
on deposit with the credit union.
The exposure amount of:
[cir] An obligation of the U.S. Government, its central bank, or a
U.S. Government agency that is directly and unconditionally guaranteed,
excluding detached security coupons, ex-coupon securities, and
interest-only mortgage-backed-security STRIPS.
[cir] Federal Reserve Bank stock and Central Liquidity Facility
stock.
Insured balances due from FDIC-insured depositories or
federally insured credit unions.
104(c)(2)(ii) Category 2--20 Percent Risk Weight
Proposed Sec. 702.104(c)(2)(ii) provided that a credit union must
assign a 20 percent risk weight to the following on-balance sheet
assets:
The uninsured balances due from FDIC-insured depositories,
federally insured credit unions, and all balances due from privately
insured credit unions.
The exposure amount of:
[cir] A non-subordinated obligation of the U.S. Government, its
central bank, or a U.S. Government agency that is conditionally
guaranteed, excluding principal- and interest-only mortgage-backed
STRIPS.\167\
---------------------------------------------------------------------------
\167\ This would include the NCUA Guaranteed Notes (NGNs), which
are an obligation of the NCUA and are backed by the full faith and
credit of the United States.
---------------------------------------------------------------------------
[cir] A non-subordinated obligation of a GSE other than an equity
exposure or preferred stock, excluding principal and interest only GSE
obligation STRIPS.
[cir] Securities issued by public sector entities in the United
States that represent general obligation securities.
[cir] Investment funds whose portfolios are permitted to hold only
part 703 permissible investments that qualify for the zero or 20
percent risk categories.
[cir] Federal Home Loan Bank stock.
The balances due from Federal Home Loan Banks.
The balance of share-secured loans.
The portions of outstanding loans with a government
guarantee.
The portions of commercial loans secured with contractual
compensating balances.
For the reasons explained above, the Board has decided to remove
the proposed language excluding conditionally guaranteed principal-only
mortgage-backed-security STRIPS that were an obligation of the U.S.
Government, its central bank, or a U.S. Government agency. In addition,
the Board decided to add the word ``security'' after the word
``mortgage-backed'' for clarity and consistently. The Board also
decided to revise the language regarding investment funds to clarify
that the 20 percent risk weight includes only investment funds with
portfolios permitted to hold only investments that are authorized under
12 CFR 703.14(c).
Accordingly, Sec. 702.104(c)(2)(ii) of this final rule provides
that a credit union must assign a 20 percent risk weight to the
following on-balance sheet assets:
The uninsured balances due from FDIC-insured depositories,
federally insured credit unions, and all balances due from privately
insured credit unions.
The exposure amount of:
[cir] A non-subordinated obligation of the U.S. Government, its
central bank, or a U.S. Government agency that is conditionally
guaranteed, excluding interest-only mortgage-backed-security STRIPS.
[cir] A non-subordinated obligation of a GSE other than an equity
exposure or preferred stock, excluding interest only GSE mortgage-
backed-security STRIPS.
[cir] Securities issued by PSEs that represent general obligation
securities.
[cir] Part 703 compliant investment funds that are restricted to
holding only investments that qualify for a zero or 20 percent risk
weight under Sec. 702.104.
[cir] Federal Home Loan Bank stock.
The balances due from Federal Home Loan Banks.
The balance of share-secured loans, where the shares
securing the loan are on deposit with another depository institution.
The portions of outstanding loans with a government
guarantee.
The portions of commercial loans secured with contractual
compensating balances.
104(c)(2)(iii) Category 3--50 Percent Risk Weight
Proposed Sec. 702.104(c)(2)(iii) provided that a credit union must
assign a 50 percent risk weight to the following on-balance sheet
assets:
The outstanding balance (net of government guarantees),
including loans
[[Page 66686]]
held for sale, of current first-lien residential real estate loans less
than or equal to 35 percent of assets.
The exposure amount of:
[cir] Securities issued by PSEs in the U.S. that represent non-
subordinated revenue obligation securities.
[cir] Other non-subordinated, non-U.S. Government agency or non-GSE
guaranteed, residential mortgage-backed security, excluding principal-
and interest-only STRIPS.
For the reasons explained above, the Board has decided to remove
the proposed language excluding conditionally guaranteed principal-only
mortgage-backed-security STRIPS that were non-subordinated, non-U.S.
Government agency or non-GSE guaranteed residential mortgage-backed
securities. In addition, the Board decided to add the word ``mortgage-
backed-security'' before the word ``STRIPS'' for clarity and
consistently.
Accordingly, Sec. 702.104(c)(2)(iii) of this final rule provides
that a credit union must assign a 50 percent risk weight to the
following on-balance sheet assets:
The outstanding balance (net of government guarantees),
including loans held for sale, of current first-lien residential real
estate loans less than or equal to 35 percent of assets.
The exposure amount of:
[cir] Securities issued by PSEs in the U.S. that represent non-
subordinated revenue obligation securities.
[cir] Other non-subordinated, non-U.S. Government agency or non-GSE
guaranteed, residential mortgage-backed securities, excluding interest-
only mortgage-backed-security STRIPS.
104(c)(2)(iv) Category 4--75 Percent Risk Weight
Proposed Sec. 702.104(c)(2)(iv) provided that a credit union must
assign a 75 percent risk weight to the outstanding balance (net of
government guarantees), including loans held for sale, of the following
on-balance sheet assets:
Current first-lien residential real estate loans greater
than 35 percent of assets.
Current secured consumer loans.
For the reasons explained above, the Board has decided to retain
this proposed section in the final rule without change.
104(c)(2)(v) Category 5--100 Percent Risk Weight
Proposed Sec. 702.104(c)(2)(v) provided that a credit union must
assign a 100 percent risk weight to the following on-balance sheet
assets:
The outstanding balance (net of government guarantees),
including loans held for sale, of:
[cir] First-lien residential real estate loans that are not
current.
[cir] Current junior-lien residential real estate loans less than
or equal to 20 percent of assets.
[cir] Current unsecured consumer loans.
[cir] Current commercial loans, less contractual compensating
balances that comprise less than 50 percent of assets.
[cir] Loans to CUSOs.
The exposure amount of:
[cir] Industrial development bonds.
[cir] All stripped mortgage-backed securities (interest-only and
principal-only STRIPS).
[cir] Part 703 compliant investment funds, with the option to use
the look-through approaches in Sec. 702.104(c)(3)(ii) of this section.
[cir] Corporate debentures and commercial paper.
[cir] Nonperpetual capital at corporate credit unions.
[cir] General account permanent insurance.
[cir] GSE equity exposure or preferred stock.
All other assets listed on the statement of financial
condition not specifically assigned a different risk weight under this
subpart.
For the reasons explained above, the Board has decided to remove
the proposed language including principal-only mortgage-backed-security
STRIPS in the 100 percent risk-weight category. The Board has also
decided to include the exposure amount of non-subordinated tranches of
any investments in the 100 percent risk-weight category. Credit unions
also are given the option to use the gross-up approach as an
alternative to the 100 percent risk-weight.
Accordingly, Sec. 702.104(c)(2)(v) of this final rule provides
that a credit union must assign a 100 percent risk weight to the
following on-balance sheet assets:
The outstanding balance (net of government guarantees),
including loans held for sale, of:
[cir] First-lien residential real estate loans that are not
current.
[cir] Current junior-lien residential real estate loans less than
or equal to 20 percent of assets.
[cir] Current unsecured consumer loans.
[cir] Current commercial loans, less contractual compensating
balances that comprise less than 50 percent of assets.
[cir] Loans to CUSOs.
The exposure amount of:
[cir] Industrial development bonds.
[cir] Interest-only mortgage-backed-security STRIPS.
[cir] Part 703 compliant investment funds, with the option to use
the look-through approaches in Sec. 702.104(c)(3)(iii)(B) of this
section.
[cir] Corporate debentures and commercial paper.
[cir] Nonperpetual capital at corporate credit unions.\168\
---------------------------------------------------------------------------
\168\ Subject to non-significant equity exposure risk-weight
under Sec. 702.104(c)(3)(i).
---------------------------------------------------------------------------
[cir] General account permanent insurance.
[cir] GSE equity exposure or preferred stock.
[cir] Non-subordinated tranches of any investment, with the option
to use the gross-up approach in paragraph (c)(3)(iii)(A) of this
section.
All other assets listed on the statement of financial
condition not specifically assigned a different risk weight under this
subpart.
As discussed in more detail below, however, this final rule reduces
the risk weight assigned to CUSO investments, corporate perpetual
capital, and other equity investments to 100 percent for complex credit
unions with non-significant equity exposures.\169\
---------------------------------------------------------------------------
\169\ A credit union has ``non-significant equity exposures'' if
the aggregate amount of its equity exposures does not exceed 10
percent of the sum of the credit union's capital elements of the
risk-based capital ratio numerator.
---------------------------------------------------------------------------
104(c)(2)(vi) Category 6--150 Percent Risk Weight
Proposed Sec. 702.104(c)(2)(vi) provided that a credit union must
assign a 150 percent risk weight to the following on-balance sheet
assets:
The outstanding balance, net of government guarantees and
including loans held for sale, of:
[cir] Current junior-lien residential real estate loans that
comprise more than 20 percent of assets.
[cir] Junior-lien residential real estate loans that are not
current.
[cir] Consumer loans that are not current.
[cir] Current commercial loans (net of contractual compensating
balances), which comprise more than 50 percent of assets.
[cir] Commercial loans (net of contractual compensating balances),
which are not current.
The exposure amount of:
[cir] Perpetual contributed capital at corporate credit
unions.\170\
---------------------------------------------------------------------------
\170\ Subject to the lower 100 percent non-significant equity
exposure risk-weight under Sec. 702.104(c)(3)(i).
---------------------------------------------------------------------------
[cir] Equity investments in CUSOs.\171\
---------------------------------------------------------------------------
\171\ Subject to the lower 100 percent non-significant equity
exposure risk-weight under Sec. 702.104(c)(3)(i).
---------------------------------------------------------------------------
As discussed in more detail below, however, this final rule reduces
the risk weight assigned to CUSO investments, and corporate perpetual
capital, to 100 percent for complex credit unions with
[[Page 66687]]
non-significant equity exposures.\172\ For the reasons explained above,
the Board has decided to retain this proposed section in the final rule
without change.
---------------------------------------------------------------------------
\172\ A credit union has ``non-significant equity exposures'' if
the aggregate amount of its equity exposures does not exceed 10
percent of the sum of the credit union's capital elements of the
risk-based capital ratio numerator.
---------------------------------------------------------------------------
104(c)(2)(vii) Category 7--250 Percent Risk Weight
Proposed Sec. 702.104(c)(2)(vii) provided that a credit union must
assign a 250 percent risk weight to the carrying value of mortgage
servicing assets (MSAs) held on-balance sheet.
For the reasons explained above, the Board has decided to retain
this proposed section in the final rule without change.
104(c)(2)(viii) Category 8--300 Percent Risk Weight
Proposed Sec. 702.104(c)(2)(viii) provided that a credit union
must assign a 300 percent risk weight to the exposure amount of the
following on-balance sheet assets:
Publicly traded equity investments, other than a CUSO
investment.
Investment funds that are not in compliance with 12 CFR
part 703, with the option to use the look-through approaches in Sec.
702.104(c)(3)(ii) of this section.
Separate account insurance, with the option to use the
look-through approaches in Sec. 702.104(c)(3)(ii).
For the reasons explained above, the Board has decided to retain
this proposed section in the final rule with only minor conforming
changes.
Accordingly, Sec. 702.104(c)(2)(viii) of this final rule provides
that a credit union must assign a 300 percent risk weight to the
exposure amount of the following on-balance sheet assets:
Publicly traded equity investments, other than a CUSO
investment.\173\
---------------------------------------------------------------------------
\173\ Subject to the lower 100 percent non-significant equity
exposure risk-weight under Sec. 702.104(c)(3)(i).
---------------------------------------------------------------------------
Investment funds that do not meet the requirements under
12 CFR 703.14(c), with the option to use the look-through approaches in
Sec. 702.104(c)(3)(iii)(B).
Separate account insurance, with the option to use the
look-through approaches in Sec. 702.104(c)(3)(iii)(B).
104(c)(2)(ix) Category 9--400 Percent Risk Weight
Proposed Sec. 702.104(c)(2)(ix) provided that a credit union must
assign a 400 percent risk weight to the exposure amount of non-publicly
traded equity investments that are held on-balance sheet, other than
equity investments in CUSOs.
For the reasons discussed above, the Board has decided to retain
this proposed section in the final rule without change.\174\
---------------------------------------------------------------------------
\174\ Subject to lower 100 percent non-significant equity
exposure risk-weight under Sec. 702.104(c)(3)(i).
---------------------------------------------------------------------------
104(c)(2)(x) Category 10--1,250 Percent Risk Weight
Proposed Sec. 702.104(c)(2)(x) provided that a credit union must
assign a 1,250 percent risk weight to the exposure amount of any
subordinated tranche of any investment held on balance sheet, with the
option to use the gross-up approach in Sec. 702.104(c)(3)(i).\175\
---------------------------------------------------------------------------
\175\ Based on June 30, 2014, Call Report data, NCUA estimates
that 93.3 percent of all investments for credit unions with more
than $100 million in assets would receive a risk weight of 20
percent or less; and, 96.1 percent of all investments would receive
a risk weight of 100 percent or less.
---------------------------------------------------------------------------
For the reasons discussed above and in additional detail below, the
Board has decided to retain this proposed section in the final rule
with only minor conforming changes to the cross citations.
104(c)(3) Alternative Risk Weights for Certain On-Balance Sheet Assets
Proposed Sec. 702.104(c)(3) provided that instead of using the
risk weights assigned in Sec. 702.104(c)(2), a credit union may
determine the risk weight of investment funds and subordinated tranches
of any investment using the approaches which are discussed in more
detail below. These alternative approaches provide a credit union with
the ability to risk weight certain assets based on the underlying
exposure of the subordinated tranche or investment fund without
exposing the NCUSIF to additional risk.
Other than the comments already discussed above, the Board received
few comments on this section of the proposal and has decided to retain
the proposed gross-up approach and look-through approaches in this
final rule with only minor changes, which are discussed in more detail
below. In addition, this final rule restructures proposed Sec.
702.104(c)(3).
As explained in more detail below, this final rule restructures the
provisions in Sec. 702.104(c)(3) to renumber the gross-up and look-
through approaches and add in alternative risk-weighting methodologies
for non-significant equity exposures and certain types of charitable
donation accounts. These changes are in response to public comments
received on the Second Proposal and, as explained below, would only
lower the risk weights assigned to certain on-balance sheet assets
under certain circumstances.
104(c)(3)(i) Non-Significant Equity Exposures
Under the Other Banking Agencies' capital regulations, banks are
permitted to assign a 100 percent risk weight to equity exposures when
the aggregate amount of the exposures does not exceed 10 percent of the
bank's total capital. The Board did not include a similar approach in
the Second Proposal because it would have added significant complexity
to the rule. As previously discussed, however, a significant number of
commenters requested that NCUA's risk-based capital requirement include
an alternative risk-weighting methodology, similar to that provided
under the Other Banking Agencies' capital regulations, for non-
significant equity exposures at credit unions.
Applying a 100 percent risk weight to an equity exposure, provided
the exposure does not exceed 10 percent of the sum of the credit
union's capital elements of the risk-based capital ratio numerator,
will provide relief to certain credit unions holding limited amounts of
higher-risk equity assets on their books. Such an approach is generally
consistent with the Other Banking Agencies' regulations and will not
increase risk weights for any equity exposures held by credit unions.
Accordingly, this final rule adds the following provisions
assigning alternative risk weights to non-significant equity exposures.
104(c)(3)(i)(A) General
Section 702.104(c)(3)(i)(A) of this final rule provides that
notwithstanding the risk weights assigned in Sec. 702.104(c)(2), a
credit union must assign a 100 percent risk weight to non-significant
equity exposures.
104(c)(3)(i)(B) Determination of Non-Significant Equity Exposures
Section 702.104(c)(3)(i)(B) of this final rule provides that a
credit union has non-significant equity exposures if the aggregate
amount of its equity exposures does not exceed 10 percent of the sum of
the credit union's capital elements of the risk-based capital ratio
numerator (as defined under paragraph Sec. 702.104(b)(1)).
104(c)(3)(i)(C) Determination of the Aggregate Amount of Equity
Exposures
As discussed above, Sec. 702.104(c)(3)(i)(C) of this final rule
provides that when determining the aggregate amount of its equity
exposures, a credit union must include
[[Page 66688]]
the total amounts (as recorded on the statement of financial condition
in accordance with GAAP) of the following:
Equity investments in CUSOs,
Perpetual contributed capital at corporate credit unions,
Nonperpetual capital at corporate credit unions, and
Equity investments subject to a risk weight in excess of
100 percent.
The Board determined that the assets identified above encompass the
extent of funds invested in stock, equities, or debts associated with
an ownership interest and are normally in a loss position subordinate
to unsecured creditors. Non-perpetual capital at corporate credit
unions, despite receiving a 100 percent risk-weight, is included in the
calculation of equity exposure because its priority in liquidation is
subordinate to shareholders and the NCUSIF. Limiting the sum of these
higher credit risk accounts to 10 percent or less of the sum of a
credit union's capital elements of the risk-based capital ratio
numerator receiving a 100 percent risk weight ensures that the related
loss exposure does not present a significant risk to the credit union
or the NCUSIF.
104(c)(3)(ii) Charitable Donation Accounts
Under the Other Banking Agencies' capital regulations, banks are
permitted to apply a 100 percent risk weight to equity exposures that
qualify as community development investments. The Board did not include
a similar approach in the Second Proposal because credit unions do not
hold community development investments in the same manner banks do. As
previously discussed, however, a significant number of commenters
requested that NCUA's risk-based capital requirement include an
alternative risk-weighting methodology, similar to that provided under
the Other Banking Agencies' capital regulations, for charitable
donation accounts.
The Board believes charitable donation accounts held at credit
unions are similar enough in purpose to community development
investments held at banks to warrant a 100 percent risk weight. Under
this final rule, a credit union can choose whether to apply the 100
percent risk weight because the account may be entitled to a lower risk
weight based on the investments held in the account. As explained in
the definitions part of the preamble, the 100 percent risk weight would
apply only to accounts that meet the definition of a ``charitable
donation account'' and the criteria provided therein. These limits are
prudent and provide credit unions the option of applying the 100
percent risk weight, if they choose.
Accordingly, this final rule revises Sec. 702.104(c)(3)(ii) to
provide that notwithstanding the risk weights assigned in Sec.
702.104(c)(2), a credit union may assign a 100 percent risk weight to a
charitable donation account.
104(c)(3)(iii) Alternative Approaches
As discussed above, this final rule reorganizes Sec. 702.104(c)(3)
and moves proposed Sec. Sec. 702.104(c)(3)(i) and (ii) under Sec.
702.104(c)(3)(iii) with only non-substantive conforming changes.
Instead of citing to FDIC's regulations, this final rule incorporates
the text explaining how to apply the gross up approach \176\ and the
look through approaches \177\ into appendix A to part 702 of NCUA's
regulations. As discussed below, to incorporate the full text of
Sec. Sec. 324.43(e) and 324.53 into NCUA's regulations, the Board made
some minor conforming changes to the language and numbering used in the
section. Other than the changes discussed above, no substantive changes
are intended by these revisions.
---------------------------------------------------------------------------
\176\ 12 CFR 324.43(e).
\177\ 12 CFR 324.53.
---------------------------------------------------------------------------
Accordingly, Sec. 702.104(c)(3)(iii) of this final rule provides
that, notwithstanding the risk weights assigned in paragraph (c)(2) of
this section, a credit union may determine the risk weight of
investment funds, and non-subordinated or subordinated tranches of any
investment as provided below.
104(c)(3)(iii)(A) Gross-Up Approach
Proposed Sec. 702.104(c)(3)(i) provided that a credit union may
use the gross-up approach under 12 CFR 324.43(e) to determine the risk
weight of the carrying value of any subordinated tranche of any
investment. When calculating the risk weight for a subordinated tranche
of any investment using the proposed gross-up approach, a credit union
must have the following information:
The exposure amount of the subordinated tranche;
The current outstanding par value of the credit union's
subordinated tranche;
The current outstanding par value of the total amount of
the entire tranche where the credit union has exposure;
The current outstanding par value of the more senior
positions in the securitization that are supported by the subordinate
tranche the credit union owns; and
The weighted average risk weight applicable to the assets
underlying the securitization.
The following is an example of the application of the gross-up
approach: \178\
---------------------------------------------------------------------------
\178\ More simple terminology than the FDIC rule language is
used to make this example easier to follow.
---------------------------------------------------------------------------
A credit union owns $4 million (exposure amount and outstanding par
value) of a subordinated tranche of a private-label mortgage-backed
security backed by first-lien residential mortgages. The total
outstanding par value of the subordinated tranche that the credit union
owns part of is $10 million. The current outstanding par value for the
tranches that are senior to and supported by the credit union's tranche
is $90 million.
------------------------------------------------------------------------
Calculation Result
------------------------------------------------------------------------
A Current outstanding par $4,000,000/ 40%
value of the credit $10,000,000.
union's subordinated
tranche divided by the
current outstanding par
value of the entire
tranche where the
credit union has
exposure.
B Current outstanding par ................... $90,000,000
value of the senior
positions in the
securitization that are
supporting the tranche
the credit union owns.
C Pro-rata share of the 40% times $36,000,000
more senior positions $90,000,000.
outstanding in the
securitization that is
supported by the credit
union's subordinated
tranche: (A) multiplied
by (B).
D Current exposure amount ................... $4,000,000
for the credit union's
subordinated tranche.
E Enter the sum of (C) and $36,000,000 + $40,000,000
(D). $4,000,000.
F The higher of the 50% primary risk 50%
weighted average risk weight for 1st
weight applicable to lien residential
the assets underlying real estate loan.
the securitization or
20%.
[[Page 66689]]
G Risk-weighted asset $40,000,000 times $20,000,000
amount of the credit 50%.
union's purchased
subordinated tranche:
(E) multiplied by (F).
------------------------------------------------------------------------
In this example, under the gross-up approach, the credit union
would be required to risk weight the subordinated tranche at $20
million. Conversely, under the 1,250 percent risk weight approach, the
credit union would be required to risk weight the subordinated tranche
at $50 million (1,250 percent times $4 million). This example shows the
benefit to credit unions of the proposed inclusion of the gross-up
approach.
In the case of master trust \179\ type structures and structured
products,\180\ credits unions should calculate the pro-rata share of
the more senior positions using the prospectus and current servicing/
reference pool reports.
---------------------------------------------------------------------------
\179\ Master trust subordinated tranches do not support any
particular senior tranche in the trust. The subordinated tranche
supports an amount of senior tranches as defined in the prospectus
and the current servicing reports.
\180\ Structured products may allocate losses based on other
securities or a reference pool. The credit union should calculate
the pro-rata senior tranche based on the amount the subordinated
tranche would support if it were an actual tranched security.
---------------------------------------------------------------------------
The Board received few comments objecting to allowing credit unions
to use the gross-up approach, and has decided to retain the option of
using the gross-up approach in this final rule. The final rule,
however, incorporates the text of Sec. 324.43(e) into NCUA's
regulations instead of simply citing to FDIC's regulations. As
discussed above, this final rule also would permit credit unions to use
the gross-up approach to risk-weight a non-subordinated tranche of any
investment.
Accordingly, Sec. 702.104(c)(3)(iii)(A) of this final rule
provides that a credit union may use the gross-up approach under
appendix A of this part to determine the risk weight of the carrying
value of non-subordinated or subordinated tranches of any investment.
104(c)(3)(iii)(B) Look-Through Approaches
Proposed Sec. 702.104(c)(3)(ii) provided that a credit union may
use one of the look-through approaches under 12 CFR 324.53 to determine
the risk weight of the fair value of mutual funds that are not in
compliance with part 703 of this chapter, the recorded value of
separate account insurance, or part 703 compliant mutual funds. In
particular, for purposes of applying risk weights to investment funds,
the Board proposed giving credit unions the option of using the three
look-through approaches that FDIC allows its regulated institutions to
use under 12 CFR 324.53 of its regulations, instead of using the
standard risk weights of 20, 100 and 300 percent that would be assigned
under proposed Sec. 702.104(c)(2). The Board included these
alternative approaches to make NCUA's risk-based capital requirement
more comparable to the Other Banking Agencies' regulations and to grant
credit unions additional flexibility.
The first of the three full look-through approaches under 12 CFR
324.53 required a credit union to look at the underlying assets owned
by the investment fund and apply an appropriate risk weight. The other
two approaches under 12 CFR 324.53 required a credit union to use the
information provided in the investment fund's prospectus. The minimum
risk weight for any investment fund asset was 20 percent, regardless of
which approach was used.
Regardless of the look-through approach selected, the credit union
must include any derivative contract that is part of the investment
fund, unless the derivative contract is used for hedging rather than
speculative purposes and does not constitute a material portion of the
fund's exposure.\181\
---------------------------------------------------------------------------
\181\ At this time FCUs are not permitted to engage in
derivative contract activity for the purpose of speculation.
However, federally insured, state-chartered credit unions may be
permitted to use derivative contracts for speculative purposes under
applicable state law, and thus the Board is including this statement
to address those scenarios.
---------------------------------------------------------------------------
The following examples outline each of the three proposed look-
through approaches:
Full look-through approach. The full look-through approach allowed
credit unions to weight the underlying assets in the investment fund as
if they were owned separately, with a minimum risk weight of 20 percent
for all underlying assets. Credit unions were required to use the most
recently available holdings reports when utilizing the full look-
through approach.
[[Page 66690]]
An example of the application of the full look-through approach is
as follow:
---------------------------------------------------------------------------
\182\ Fund holdings (percent of fund) multiplied by the credit
union investment.
\183\ Minimum 20 percent risk weight for assets in an investment
fund, even if the individual risk weight is zero percent.
\184\ Use 1,250 percent risk weight or gross-up calculation.
\185\ The weighted average risk weight was calculated by
dividing the amount of risk assets ($5,600,000) by the credit union
exposure ($10,000,000).
Credit Union Investment: $10,000,000
----------------------------------------------------------------------------------------------------------------
Fund holding Credit union
Fund investment (% of fund) % exposure \182\ Risk weight % Dollar risk weight
----------------------------------------------------------------------------------------------------------------
US Treasury Notes................. 50 $5,000,000 20 \183\............. $1,000,000
FNMA PACs......................... 30 3,000,000 20................... 600,000
PSE Revenue Bonds................. 17.5 1,750,000 50................... 875,000
Subordinated MBS \184\............ 2.5 250,000 1,250................ 3,125,000
-----------------------------------------------------------------------------
Totals........................ .............. 10,000,000 56 \185\............. 5,600,000 (Amount of
(Weighted average Risk Assets)
Risk weight).
----------------------------------------------------------------------------------------------------------------
Using the above example, the investment fund would have a weighted
average risk weight of 56 percent, which would be lower than the 100
percent standard risk weight for part 703 compliant investment funds or
the standard 300 percent risk weight for investment funds not compliant
with part 703.
Simple modified look-through approach. The simple modified look-
through approach allowed credit unions to risk weight their holdings in
an investment fund by the highest risk weight of any asset permitted by
the investment fund's prospectus. Credit unions should use the most
recently available prospectus to determine investment permissibility
for an investment fund. An example of the application of the simple
modified look-through approach is as follows:
---------------------------------------------------------------------------
\186\ Minimum 20 percent risk weight for assets in an investment
fund, even if the individual risk weight is zero percent.
Credit Union Investment: $10,000,000
------------------------------------------------------------------------
Fund limits
Permissible investments (% of fund) Risk weight
------------------------------------------------------------------------
US Treasury Notes....................... 100 \186\ 20
Agency MBS (non IO or PO)............... 50 20
PSE GEO Bonds........................... 20 20
PSE Revenue Bonds....................... 20 50
Non-Government/Subordinated/IO/PO MBS... 30 50
Subordinated MBS........................ 10 \187\ 1,250
------------------------------------------------------------------------
Using the above example, the investment fund would have a risk
weight of 1,250 percent using the simple modified look-through approach
because the investment fund can hold 1,250 percent risk-weighted
subordinated MBS. In this case, the credit union would most likely use
a 100 percent standard risk weight for the part 703 compliant
investment fund or the standard 300 percent risk weight for investment
funds not in compliance with part 703.
---------------------------------------------------------------------------
\187\ Use 1,250 percent risk weight unless the prospectus limits
gross-up risk weight.
---------------------------------------------------------------------------
Alternative modified look-through approach. The alternative
modified look-through approach allowed credit unions to risk weight
their holdings in an investment fund by applying the risk weights to
the limits in the prospectus. In the case where the aggregate limits in
the prospectus exceed 100 percent, the credit union must assume the
fund will invest in the highest risk-weighted assets first. An example
of the application of the simple modified look-through approach is as
follows:
---------------------------------------------------------------------------
\188\ Minimum 20 percent risk weight for assets in an investment
fund, even if the individual risk weight is zero percent.
\189\ Use 1,250 percent risk weight unless the prospectus limits
gross-up risk weights.
\190\ The weighted average risk weight was calculated by
dividing the amount of risk assets ($15,800,000) by the credit union
exposure ($10,000,000).
Credit Union Investment: $10,000,000
----------------------------------------------------------------------------------------------------------------
Fund Limits
Permissible investments (% of fund) Risk weight % CU exposure Dollar risk weight
----------------------------------------------------------------------------------------------------------------
US Treasury Notes................. 100 20 \188\............. $0 .....................
Agency MBS (non IO or PO)......... 50 20................... 2,000,000 400,000
PSE GEO Bonds..................... 20 20................... 2,000,000 400,000
PSE Revenue Bonds................. 20 50................... 2,000,000 1,000,000
Non-Government/Subordinated/IO/PO 30 50................... 3,000,000 1,500,000
MBS.
Subordinated MBS.................. 10 1,250 \189\.......... 1,000,000 12,500,000
-----------------------------------------------------------------------------
Total......................... .............. 158 \190\ (weighted 10,000,000 15,800,000 (Amount of
average risk weight). Risk Assets)
----------------------------------------------------------------------------------------------------------------
[[Page 66691]]
Using the example above, the investment fund would have a weighted
average risk weight of 158 percent using the alternative modified look-
through approach. In this case, the credit union would most likely use
a 100 percent standard risk weight for part 703 compliant investment
funds or the alternative modified look-through approach for risk
weights for investment funds that are not compliant with part 703.
Public Comments on the Second Proposal
The Board received a few comments relating to the proposed use of
the look-through approaches. Most of these comments were addressed
above. At least one commenter, however, suggested that the Board
clarify that the timing of the most recent available holding reports
are to be used by credit unions applying the full look-through
approach.
Discussion
The Board received no comments objecting to allowing credit unions
to use the look-through approaches, and has decided to retain the
option of using the gross-up approach in this final rule. The final
rule incorporates the relevant text of Sec. 324.53 into NCUA's
regulations instead of simply citing to FDIC's regulations and makes
other minor conforming edits. In response to the comments received, the
Board has also added language in paragraph (b)(2)(ii) of appendix A
below to clarify which holding reports should be used when calculating
a risk-weight using the full-look-through approach. The methodology for
applying the look-through approaches is added to new appendix A to part
702, which is discussed in more detail below.
Accordingly, Sec. 702.104(c)(3)(iii)(B) provides that a credit
union may use one of the look-through approaches under appendix A part
702 to determine the risk weight of the exposure amount of any
investment funds, the holdings of separate account insurance, or both.
104(c)(4) Risk Weights for Off-Balance-Sheet Activities
Under the Second Proposal, Sec. 702.104(c)(4) provided that the
risk-weighted amounts for all off-balance-sheet items are determined by
multiplying the off-balance-sheet exposure amount by the appropriate
credit conversion factor and the assigned risk weight as follows:
For the outstanding balance of loans transferred to a
Federal Home Loan Bank under the MPF program, a 20 percent CCF and a 50
percent risk weight.
For other loans transferred with limited recourse, a 100
percent CCF applied to the off-balance-sheet exposure and:
[cir] For commercial loans, a 100 percent risk weight.
[cir] For first-lien residential real estate loans, a 50 percent
risk weight.
[cir] For junior-lien residential real estate loans, a 100 percent
risk weight.
[cir] For all secured consumer loans, a 75 percent risk weight.
[cir] For all unsecured consumer loans, a 100 percent risk weight.
For unfunded commitments:
[cir] For commercial loans, a 50 percent CCF with a 100 percent
risk weight.
[cir] For first-lien residential real estate loans, a 10 percent
CCF with a 50 percent risk weight.
[cir] For junior-lien residential real estate loans, a 10 percent
CCF with a 100 percent risk weight.
[cir] For all secured consumer loans, a 10 percent CCF with a 75
percent risk weight.
[cir] For all unsecured consumer loans, a 10 percent CCF with a 100
percent risk weight.
Public Comments on the Second Proposal
The Board received several comments regarding the proposed risk
weights assigned to off-balance-sheet items. At least one commenter
agreed with requiring capital for most off-balance-sheet activities.
But the commenter suggested that credit unions should not be required
to hold capital for off-balance-sheet exposures that are
unconditionally cancellable (without cause), especially if the exposure
is for less than one year. The commenter recommended that the Board
adopt a more bank-like off-balance-sheet risk-based capital regime for
such exposures. Another commenter stated that the proposal identifies
the use of a 10 percent credit conversion factor for all noncommercial
unused lines of credit, but noted that community banks utilize various
credit conversion factors ranging from zero percent to 50 percent
depending on whether the commitment is unconditionally cancellable
(zero percent), conditionally cancellable within one year (20 percent),
or conditionally cancellable beyond one year (50 percent). The
commenter suggested that the design and inclusion of cancellation
language in lending contracts is to mitigate the overall potential risk
associated with unfunded amounts, and the type and extent of the
specific language helps outline the extent and timeframe of the risk
associated within each lending contract. As such, the commenter
recommended that the credit conversion factors utilized by the
community banks be adopted by NCUA to help ensure that the inherent
risk embedded within specific cancellation language in lending
contracts be accurately identified and risk weighted.
At least one commenter recommended that the Board lower the credit
conversion factor for unfunded consumer loans. Other commenters
recommended unfunded, unconditionally cancellable commitments should be
risk weighted at zero percent.
Some commenters noted that under the proposal, the Board
differentiates between partial recourse loans executed under the
Federal Home Loan Banks' Mortgage Partnership Finance (MPF) Program and
all other partial recourse lending programs. Commenters suggested that,
although the MPF program loans enjoy a lower 20 percent credit
conversion factor (CCF) compared to the 100 percent CCF applied to
other partial recourse loans, credit unions that hold a contractual
exposure amount that is less than 20 percent of the outstanding loan
balance will have to hold more capital for MPF loans than for other
partial recourse arrangements. For example, a $100,000 loan sold with a
3 percent contractual exposure would have an off-balance-sheet value of
$3,000 if it were a normal recourse loan and $20,000 if it were an MPF
loan.\191\ Since MPF loans include a fixed contractual exposure amount,
the commenter suggested there does not appear to be a strong
justification for differentiating this loan program from other partial
recourse loan arrangements. Even though this adjusted calculation may
track historical losses in the MPF program more closely, commenters
suggested that the Board consider whether it is appropriate to
incorporate individualized risk weights for specific counterparties.
---------------------------------------------------------------------------
\191\ The MPF program takes the outstanding loan balance
multiplied by a 20 percent CCF (100,000 * .20 = 20,000), while other
partial recourse loans take the maximum contractual exposure
multiplied by a 100 percent CCF (3,000 * 1 = 3,000). Both loans
would be subject to a 50 percent risk-weight as a first-lien
residential real estate loan.
---------------------------------------------------------------------------
One commenter suggested that the proposed treatment of the MPF
Program does not address the complexity and risks associated with the
program, and would prevent credit unions from selling loans in the
secondary market that have no recourse at all and therefore pose no
risk to the credit union. Under the Second Proposal, the capital
requirement (after a credit
[[Page 66692]]
conversion factor) is derived from the total outstanding principal
balance of all loans sold under the MPF Program. The commenter
suggested it is important to note that the MPF Program is actually
composed of several different types of loan purchase programs, some of
which have a limited recourse component and some that do not. The
commenter suggested further that each loan sold under an MPF program
that includes a credit-risk sharing component undergoes an FHLB
calculation that assigns a specific dollar amount for credit
enhancement to that loan. And some loans with very low credit risk may
have no credit enhancement assigned, while other loans with
characteristics of higher credit risk are assigned a higher credit
enhancement. According to the commenter, the total of these credit
enhancement calculations, which is tracked by the FHLB and available
online, is the maximum amount of risk for which a credit union is
liable. The commenter suggested that in some cases, the results of the
calculation for a particular loan may determine whether that loan is
sold under the MPF Xtra Program (with no credit enhancement) or under a
different MPF program that includes some form of credit enhancement.
The commenter contended that, by lumping all MPF loans into one
calculation, the proposal would significantly alter an institution's
analysis of how to price and sell individual loans without any benefit
to the institution or to NCUA in managing risk. As an alternative, the
commenter suggested the credit conversion and risk weight be applied to
the total credit enhancement under the MPF program for which a credit
union is liable, instead of to the loan balances.
Discussion
The small credit conversion factor for unused consumer lines of
credit provides for the potential swift shift in credit risk that can
occur when consumers access the lines. The other alternative credit
conversion factors that include a determination of the term of the
outstanding guarantee add additional complexity to the assignment of
credit conversion factors and could result in a less consistent
application of assigned risk weights even with expanded supervisory
guidance.
The definition of the (MPF) Program will provide for assignments of
proper risk weights in transactions where credit unions receive fees
for managing the credit risk of the loans. Under the MPF Program,
credit unions retain recourse risk through a credit enhancement
obligation to the FHLB for credit losses on certain loans. For loans
sold to the FHLB that do not meet the definition of MPF loans, the risk
weight is based on the maximum contractual amount of the credit union's
exposure. In a loan sale transaction that creates no contractual
exposure, the risk-weight would be zero. Supervisory guidance and Call
Report instructions will be provided to ensure proper treatment of
loans transferred under the FHLB programs and all other loans
transferred with limited recourse.
The proposed risk weights for off-balance-sheet activities will be
retained, as they are clear and generally comparable to those assigned
under the Other Banking Agencies' regulations.
104(c)(5) Derivatives
Proposed Sec. 702.104(c)(5) would have provided that a complex
credit union must assign a risk-weighted amount to any derivative
contracts as determined under 12 CFR 702.105.
For the reasons discussed below, the Board has decided to retain
this proposed section in the final rule without change.
Current Sec. 702.105 Weighted-Average Life of Investments
As discussed above, proposed new Sec. 702.105 would have replaced
current Sec. 702.105 regarding weighted-average life of investments.
The definition of weighted-average life of investments and the term
``weighted-average life of investments'' would have been removed from
part 702 altogether.
The Board received no comments objecting to this change and has
decided to retain this change in the final rule.
Section 702.105 Derivatives Contract
Under the Second Proposal, Sec. 702.105 assigned risk weights to
derivatives in a manner generally consistent with the approach adopted
by FDIC in its interim final rule regarding regulatory capital.\192\
The NCUA Board proposed to focus only on interest-rate-related
derivatives in the rule and referred credit unions to FDIC's rules for
all non-interest-rate-related derivatives. The Board made this
distinction because federal credit unions are restricted to interest-
rate-related contracts under NCUA's final derivatives rule, which was
approved in January 2014. Federally insured state-chartered credit
unions, however, may have broader authorization to use non-interest-
rate contracts if approved by the respective state supervisory
authorities.
---------------------------------------------------------------------------
\192\ See 78 FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------
Public Comments on the Second Proposal
The Board received a few general comments on proposed Sec.
702.105. One commenter recommended that the Board, rather than just
cross-citing to FDIC's regulations, incorporate the FDIC risk weights
for non-interest-rate derivatives into NCUA regulations verbatim. The
commenter suggested that although the vast majority of credit unions
will probably not engage in this activity, its inclusion in NCUA's
regulations would ease the regulatory burden for credit unions and
examiners in finding and citing the appropriate authority. The
commenter cautioned, however, that the Board should not create its own
risk-weight system for non-interest-rate-related derivatives. The
commenter suggested that, given the complex nature of derivatives,
modifying the established regulatory framework could result in
unintended consequences for credit unions engaged in that activity. In
addition, state regulators have experience supervising derivative
activity in state-chartered banks within the FDIC framework, which will
help facilitate effective state supervision for credit unions with
minimum confusion.
Another commenter complained that the risk-weight calculations for
derivatives were too complicated. The commenter suggested that
derivatives, per GAAP, are fair valued daily, monthly, quarterly, and
yearly, and reflected as an asset or a liability, while their impact
runs through earnings or equity. Accordingly, the commenter recommended
the Board apply a simpler formula to assess risk-based capital for
derivatives, using a credit conversion factor to the notional amount
and then applying a risk-weighted factor. Another commenter suggested
that the Board simplify the calculation for derivatives based on the
percentage of potential future exposure.
Discussion
The Board has considered the comments suggesting the derivatives
calculations be simplified. But given the number of variables to be
considered for risk weighting--which include the type of derivative
(interest rate or other), the legal agreement governing the
transactions (qualified master netting agreement), the type of
collateral to be used to satisfy margin movements, the method the
credit union will use for collateral risk mitigation, and the
counterparty approach (dealer or exchange)--it is impractical to
simplify the calculation any further given the number of options that
need to be
[[Page 66693]]
considered. Therefore the Board has maintained the proposed approach in
this final rule.
Consistent with NCUA's recently finalized derivatives rule,\193\
the Board is now adopting an approach to assign risk weights to
derivatives that is generally consistent with the approach adopted by
FDIC in its recently issued interim final rule regarding regulatory
capital.\194\ Under FDIC's interim rule, derivatives transactions
covered under clearing arrangements are treated differently than non-
cleared transactions. The Board addresses clearing separately below.
---------------------------------------------------------------------------
\193\ See 78 FR 55339 (Sept. 10, 2013).
\194\ See 78 FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------
The final rule focuses only on interest-rate-related derivatives
and refers credit unions to FDIC's rules for all non-interest-rate-
related derivatives. The final rule makes this distinction because
federal credit unions are restricted to interest-rate-related contracts
under the final derivatives rule approved in January 2014; however,
federally insured, state-chartered credit unions may have broader
authorization to use non-interest-rate contracts if approved by the
respective state supervisory authorities. NCUA is not aware of any non-
interest-rate derivative contracts being used by federally insured,
state-chartered credit unions (per Call Report data).
OTC Derivatives Transaction Risk Weight
Under the Second Proposal, a credit union would have undertaken the
following process to determine the risk weight for OTC derivative
contracts. To determine the risk-weighted asset amount for a
derivatives contract a credit union must first determine its exposure
amount for the contract. The credit union must then recognize the
credit mitigation of financial collateral, if qualified, and apply to
that amount a risk weight based on the counterparty or recognized
collateral or exchange (Derivatives Clearing Organization or DCO). For
a single interest rate derivatives contract that is not subject to a
qualifying master netting agreement, the proposal required the exposure
amount to be the sum of (1) the credit union's current credit exposure
(CCE), which is the greater of fair value or zero, and (2) potential
future exposure, which is calculated by multiplying the notional
principal amount of the derivatives contract by the appropriate
conversion factor, in accordance with the table below. Non-interest-
rate derivative contract conversion factors can be referenced in 12 CFR
324.34 of the FDIC rule.
Proposed Conversion Factor Matrix for Interest Rate Derivatives
Contracts
------------------------------------------------------------------------
IRR hedge
Remaining maturity derivatives
------------------------------------------------------------------------
One year or less........................................ 0.00
Greater than one year and less than or equal to five 0.005
years..................................................
Greater than five years................................. 0.015
------------------------------------------------------------------------
For multiple interest rate derivatives contracts subject to a
qualifying master netting agreement, a credit union would calculate the
exposure amount by adding the net CCE and the adjusted sum of the PFE
amounts for all derivatives contracts subject to that qualifying master
netting agreement.
Under the proposal, the net CCE would have been the greater of zero
and the net sum of all positive and negative fair values of the
individual derivatives contracts subject to the qualifying master
netting agreement. The adjusted sum of the PFE amounts would have been
calculated as described in proposed Sec. 702.105(a)(2)(ii)(B).
Under the proposal, to recognize the netting benefit of multiple
derivatives contracts, the contracts would have to be subject to the
same qualifying master netting agreement. For example, a credit union
with multiple derivatives contracts with a single counterparty could
net the counterparty exposure if the transactions fall under the same
International Swaps and Derivatives Association, Inc. (ISDA) Master
Agreement and Schedule.
Under the proposal, if a derivatives contract were collateralized
by financial collateral, a credit union would first determine the
exposure amount of the derivatives contract as described in Sec. Sec.
702.105(a)(i) or (a)(ii). Next, to recognize the credit risk mitigation
benefits of the financial collateral, the credit union would use the
approach for collateralized transactions as described in Sec.
702.105(c) of the proposal, which is discussed in more detail below.
The Board received no comments objecting to this particular
approach and has decided to retain the proposed process to determine
the risk weight for OTC derivatives contracts in this final rule
without change.
Cleared Derivatives Risk Weight
Proposed Sec. 702.105 would have adopted an approach to assign
risk weights to derivatives that is generally consistent with the
approach adopted by the Other Banking Agencies.\195\ Under the Second
Proposal, a credit union was required to calculate a trade exposure
amount, determine the risk mitigation of any financial collateral, and
multiply that amount by the applicable risk weight. Such an approach
allowed credit unions to take into account the lower degree of risk
associated with cleared derivatives transactions and the benefit of
collateral associated with these transactions. In addition, the
proposed approach also accounted for the risk of loss associated with
collateral posted by a credit union.
---------------------------------------------------------------------------
\195\ See 78 FR 55339 (Sept. 10, 2013).
---------------------------------------------------------------------------
The Board received no comments objecting to this particular
approach and has decided to retain the proposed process to determine
the risk weight for cleared derivatives in this final rule without
change.
Trade Exposure Amount
Under the Second Proposal, the trade exposure amount would have
been equal to the amount of the derivative, calculated as if it were an
OTC transaction under subsection (b) of this section, added to the fair
value of the collateral posted by the credit union and held by a DCO,
clearing member or custodian. This calculation took into account the
exposure amount of the derivatives transaction and the exposure
associated with any collateral posted by the credit union. This is the
same approach employed by the Other Banking Agencies.\196\
---------------------------------------------------------------------------
\196\ See, e.g., 12 CFR 324.35.
---------------------------------------------------------------------------
The Board received no comments objecting to this particular
approach and has decided to retain the proposed process to determine
the trade exposure amount in this final rule without change.
Cleared Transaction Risk Weights
Under the Second Proposal, after a credit union determines its
trade exposure amount, it would have been required to apply a risk
weight that is based on agreements preventing risk of loss of the
collateral posted by the counterparty to the transaction. The proposal
required credit unions to apply a 2 percent risk weight if the
collateral posted by a counterparty is subject to an agreement that
prevents any losses caused by the default, insolvency, liquidation, or
receivership of the clearing member or any of its clients. To qualify
for this risk weight, a credit union would have been required to
conduct a sufficient legal review and determine that the agreement to
prevent risk of loss is legal, valid, binding, and enforceable. If a
credit union did not
[[Page 66694]]
meet either or both of these requirements, the credit union would have
to apply a 4 percent risk weight to the transaction.
The differing risk weights for cleared transactions took into
account the risk that collateral will not be there because of a default
or other event, which further exposes the credit union to loss.
However, cleared transactions pose very low probability that collateral
will not be available in the event of a default, which is reflected in
the low overall risk weights. This is the same approach employed by the
Other Banking Agencies.\197\
---------------------------------------------------------------------------
\197\ See, e.g., 12 CFR 324.35.
---------------------------------------------------------------------------
The Board received no comments objecting to this particular
approach and has decided to retain the proposed process to determine
the risk weights for cleared transactions in this final rule without
change.
Collateralized Transactions
Under the Second Proposal, the Board proposed to permit a credit
union to recognize risk-mitigating effects of financial collateral in
OTC transactions. The collateralized portion of the exposure would
receive the risk weight applicable to the collateral. In all cases, (1)
the collateral must be subject to a collateral agreement (for example,
an ISDA Credit Support Annex) for at least the life of the exposure;
(2) the credit union must revalue the collateral at least every three
months; and (3) the collateral and the exposure must be denominated in
U.S. dollars.
Generally, the risk weight assigned to the collateralized portion
of the exposure would be no less than 20 percent. However, the
collateralized portion of an exposure may be assigned a risk weight of
less than 20 percent for the following exposures. Derivatives contracts
that are marked to fair value on a daily basis and subject to a daily
margin maintenance agreement could receive (1) a zero percent risk
weight to the extent that contracts are collateralized by cash on
deposit, or (2) a 10 percent risk weight to the extent that the
contracts are collateralized by an exposure that qualifies for a zero
percent risk weight under Sec. 702.104(c)(2)(i) of this proposed rule.
In addition, a credit union could assign a zero percent risk weight to
the collateralized portion of an exposure where the financial
collateral is cash on deposit. It also could do so if the financial
collateral is an exposure that qualifies for a zero percent risk weight
under Sec. 702.104(c)(2)(i) of this proposed rule, and the credit
union has discounted the fair value of the collateral by 20 percent.
The credit union would be required to use the same approach for similar
exposures or transactions.
The Board received no comments objecting to this particular
approach and, consistent with the proposal, has decided to permit a
credit union to recognize risk-mitigating effects of financial
collateral in OTC transactions in this final rule without change.
Risk Management Guidance for Recognizing Collateral
Under the Second Proposal, before a credit union could recognize
collateral for credit risk mitigation purposes, it should: (1) Conduct
sufficient legal review to ensure, at the inception of the
collateralized transaction and on an ongoing basis, that all
documentation used in the transaction is binding on all parties and
legally enforceable in all relevant jurisdictions; (2) consider the
correlation between risk of the underlying direct exposure and
collateral in the transaction; and (3) fully take into account the time
and cost needed to realize the liquidation proceeds and the potential
for a decline in collateral value over this time period.
A credit union should also ensure that the legal mechanism under
which the collateral is pledged or transferred ensures that the credit
union has the right to liquidate or take legal possession of the
collateral in a timely manner in the event of the default, insolvency,
or bankruptcy (or other defined credit event) of the counterparty and,
where applicable, the custodian holding the collateral.
Finally, a credit union should ensure that it (1) has taken all
steps necessary to fulfill any legal requirements to secure its
interest in the collateral so that it has, and maintains, an
enforceable security interest; (2) has set up clear and robust
procedures to ensure satisfaction of any legal conditions required for
declaring the borrower's default and prompt liquidation of the
collateral in the event of default; (3) has established procedures and
practices for conservatively estimating, on a regular ongoing basis,
the fair value of the collateral, taking into account factors that
could affect that value (for example, the liquidity of the market for
the collateral and deterioration of the collateral); and (4) has in
place systems for promptly requesting and receiving additional
collateral for transactions with terms requiring maintenance of
collateral values at specified thresholds.
When collateral other than cash is used to satisfy a margin
requirement, then a haircut is applied to incorporate the credit risk
associated with collateral, such as securities. The Board proposed
including this concept in the rule so that credit unions could
accurately recognize the risk mitigation benefit of collateral. This is
the same approach taken by the Other Banking Agencies.
The Board received no comments objecting to this particular
approach and has decided to retain the proposed approach to risk
management for recognizing collateral in this final rule without
change.
The table below illustrates an example of the calculations for
Risk-Weighted Asset Amounts for both OTC and clearing derivatives
agreements. For this example, both the OTC and clearing are considered
to be multiple contracts under a Qualified Master Netting Agreement.
Credit unions can use this as a guide in confirming the calculations
involved to produce a risk-weighted asset for derivatives. (See the
number references below for each line number of the table example.)
1. The Agreement Type indicates the transaction legal agreement
between the credit union and the counterparty.
2. The examples provide, but are not limited to the basis
calculations required for various collateral and agreement
approaches.
3. Variation Margin (amount as basis for margin calls which are
satisfied with collateral) collateral used for these examples.
4. The Risk Weight of Collateral is applied when utilizing the
Simple Approach in the recognition of credit risk of collateralized
derivative contracts.
5. To recognize the risk-mitigating effects of financial
collateral, a credit union may use the ``Simple Approach'' or the
``Collateral Haircut Approach''.
6. The Collateral Haircut is determined by using Table 2 to
Sec. 702.105 in the rule text: ``Standard Supervisor Market Price
Volatility Haircuts.''
7. Counterparty risk weights are determined in Sec. 702.104 for
OTC and Sec. 702.105 for clearing.
Lines 8 through 16 are calculations based on the approach and
types of agreement, collateral, fair values and notional amounts of
the credit union derivatives transactions.
[[Page 66695]]
[GRAPHIC] [TIFF OMITTED] TR29OC15.002
Federally Insured, State-Chartered Credit Unions' Derivative
Transactions
Under the Second Proposal, the Board included language that would
require federally insured, state-chartered credit unions (FISCUs) to
calculate risk weights in accordance with FDIC's rules for derivatives
transactions that are not permissible under NCUA's derivatives rule. As
noted above, one commenter requested that NCUA incorporate all of
FDIC's language into the final RBC rule. FDIC's rules for derivatives
are very detailed and lengthy. Incorporating these rules into this
final rule would add unnecessary complexity. Further, as the options
available to FISCUs are based on state laws, it would be a very time-
consuming and expensive process to monitor FDIC's rules to make future
conforming changes in NCUA's risk-based capital regulations. For these
reasons, the Board is retaining the cross-reference and is not
incorporating the text of FDIC's derivatives regulations into this
final rule.
Current Section 702.106 Standard Calculation of Risk-Based Net Worth
Requirement
The Second Proposal would eliminate current Sec. 702.106 regarding
the standard RBNW requirement. The current rule is structured so that
credit unions have a standard measure and optional alternatives for
measuring a credit union's RBNW. The Second Proposal, on the other
hand, contained only a single measurement for calculating a credit
union's risk-based capital ratio. Accordingly, current Sec. 702.106
will no longer be necessary.
The Board received no comments on this particular revision and has
decided to eliminate current Sec. 702.106 from this final rule as
proposed.
Current Section 702.107 Alternative Component for Standard Calculation
The Second Proposal would eliminate current Sec. 702.107 regarding
the use of alternative risk weight measures. The Board observed that
the current alternative risk weight measures add unnecessary complexity
to the rule. The current alternative risk weights focus almost
exclusively on IRR, which has resulted in some credit unions with
higher risk operations reducing their regulatory minimum capital
requirement to a level inconsistent with the risk of the credit union's
business model. The proposed risk weights would provide for lower risk-
based capital requirements for those credit unions making good quality
loans, investing prudently, and avoiding excessive concentrations of
assets.
The Board received no comments on this particular revision and has
decided to eliminate current Sec. 702.107 from this final rule as
proposed.
Current Section 702.108 Risk Mitigation Credit
The Second Proposal would eliminate current Sec. 702.108 regarding
the risk mitigation credit. The risk mitigation credit provides a
system for reducing a credit union's risk-based capital requirement if
it can demonstrate
[[Page 66696]]
significant mitigation of credit risk or IRR. Credit unions have rarely
taken advantage of risk mitigation credits; only one credit union has
ever received a risk mitigation credit.
The Board received no comments on this particular revision and has
decided to eliminate current Sec. 702.107 from this final rule as
proposed.
Section 702.106 Prompt Corrective Action for Adequately Capitalized
Credit Unions
The Second Proposal renumbered current Sec. 702.201 as proposed
Sec. 702.106, and would have made only minor conforming amendments to
the text of the section. Consistent with the proposed elimination of
the regular reserve requirement in current Sec. 702.401(b), proposed
Sec. 702.106(a) would also remove the requirement that adequately
capitalized credit unions transfer the earnings retention amount from
undivided earnings to their regular reserve account.
The Board received no comments on this section and has decided to
adopt the proposed amendments in this final rule without change.
Section 702.107 Prompt Corrective Action for Undercapitalized Credit
Unions
The Second Proposal renumbered current Sec. 702.202 as proposed
Sec. 702.107, and made only minor conforming amendments to the text of
the section. Consistent with the proposed elimination of the regular
reserve requirement in current Sec. 702.401(b), proposed Sec.
702.107(a)(1) would also remove the requirement that undercapitalized
credit unions transfer the earnings retention amount from undivided
earnings to their regular reserve account.
The Board received no comments on this section and has decided to
adopt the proposed amendments in this final rule without change.
Section 702.108 Prompt Corrective Action for Significantly
Undercapitalized Credit Unions
The Second Proposal renumbered current Sec. 702.203 as proposed
Sec. 702.108, and made only minor conforming amendments to the text of
the section. Consistent with the proposed elimination of the regular
reserve requirement in current Sec. 702.401(b), proposed Sec.
702.108(a)(1) would also remove the requirement that significantly
undercapitalized credit unions transfer the earnings retention amount
from undivided earnings to their regular reserve account.
Public Comments on the Second Proposal
One state agency commenter noted that under the proposal, credit
unions classified as significantly undercapitalized or worse would be
required to restrict member business loans. The commenter acknowledged
that it may be prudent to limit member business lending in some such
cases, but felt there could be instances in which rational loan workout
agreements require additional loans be granted to protect the cash flow
or collateral position on loans already granted. The commenter
suggested that forcing a restriction without some element of discretion
on the part of the state examiner or federal examiner and corresponding
state regulatory official and NCUA regional office may have the
unintended consequence of artificially creating a liquidity problem for
a borrower, and potentially jeopardizing the collection of existing
credits. The commenter recommended that the decision to limit any type
of lending be done on a case-by-case basis rather than a sweeping
decision to be applied to all regardless of the circumstances.
Discussion
The Board is bound by statute because section 216(g)(2) of the FCUA
provides in relevant part:
[A]n insured credit union that is undercapitalized may not make any
increase in the total amount of member business loans (as defined in
section 107A(c) of this title) outstanding at that credit union at
any one time, until such time as the credit union becomes adequately
capitalized.
The statutory language does not preclude a credit union from
entering into loan workout agreements provided the total amount of
member business loans outstanding, including unused commitments, does
not increase. Accordingly, the Board has retained the language in
proposed Sec. 702.108 in this final rule without change.
Section 702.109 Prompt Corrective Action for Critically
Undercapitalized Credit Unions
The Second Proposal renumbered current Sec. 702.204 as proposed
Sec. 702.109, and made only minor conforming amendments to the text of
the section. Consistent with the proposed elimination of the regular
reserve requirement in current Sec. 702.401(b), proposed Sec.
702.109(a)(1) would also remove the requirement that critically
undercapitalized credit unions transfer the earnings retention amount
from undivided earnings to their regular reserve account.
The Board received no comments on this section and has decided to
adopt the proposed amendments in this final rule without change.
Section 702.110 Consultation With State Official on Proposed Prompt
Corrective Action
The Second Proposal renumbered current Sec. 702.205 as proposed
Sec. 702.110, and made only minor conforming amendments to the text of
the section.
Public Comments on the Second Proposal
One state supervisory authority commenter pointed out that, under
the proposal, authority to approve certain actions (such as net worth
restoration plans, earnings retention waivers, etc.) must come from the
NCUA Board, after consulting with the state regulator. The commenter
recommended, however, that the authority to approve actions may be
better placed with NCUA regional directors, after consulting with the
state regulator. The commenter suggested that most states have a long
and well established working relationship with regional offices, and
regional directors should be in a better position to evaluate the
reasonableness of this type of request.
Discussion
The Board appreciates the commenter's suggestion, but declines to
make the recommended change at this time. However, the Board may choose
delegate its authority to approve actions under this section to
regional directors without having to change NCUA's regulations.
Accordingly, the Board has decided to retain proposed Sec. 702.110 in
this final rule without change.
Section 702.111 Net Worth Restoration Plans (NWRPs)
The Second Proposal renumbered current Sec. 702.206 as proposed
Sec. 702.111, and made only minor conforming amendments to the text of
most of the subsections, with a few exceptions discussed in more detail
below.
The Board reviewed the comments received on this section, which are
discussed in more detail below, and has decided to adopt proposed Sec.
702.111 in this final rule without change.
111(c) Contents of NWRP
Under the Second Proposal, Sec. 702.111(c)(1)(i) provided that the
contents of an NWRP must specify a quarterly timetable of steps the
credit union will take to increase its net worth ratio and risk-based
capital ratio, if applicable, so that it becomes adequately capitalized
by the end of the
[[Page 66697]]
term of the NWRP, and will remain so for four consecutive calendar
quarters.
The Board received no comments on this section and has decided to
adopt the proposed amendments in this final rule without change.
111(g)(4) Submission of Multiple Unapproved NWRPs
Under the Second Proposal, Sec. 702.111(g)(4) provided that the
submission of more than two NWRPs that are not approved is considered
an unsafe and unsound condition and may subject the credit union to
administrative enforcement actions under section 206 of the FCUA.\198\
The proposed amendments were intended to clarify that submitting
multiple NWRPs that are rejected by NCUA, or the applicable state
official, because of the inability of the credit union to produce an
acceptable NWRP is an unsafe and unsound practice and may subject the
credit union to further actions as permitted under the FCUA.
---------------------------------------------------------------------------
\198\ 12 U.S.C. 1786; and 1790d.
---------------------------------------------------------------------------
Public Comments on the Second Proposal
At least one commenter claimed that a number of credit unions are
not aware of proposed new Sec. 702.111(g)(4) because NCUA led them to
believe that the rule only applied to complex credit unions. The
commenter suggested that NCUA has significant latitude to approve or
deny net worth restoration plans, even if a credit union submits a plan
that meets the stated requirements. The commenter opposed including the
new provision in the final rule, and recommended the Board include
safeguards to ensure that credit unions acting in good faith are able
to successfully submit NWRPs. Another commenter contended that the
Board presented no evidence that submitting multiple net worth
restoration plans represents an unsafe and unsound condition.
Discussion
The failure of a credit union to prepare an adequate net worth
restoration plan places the credit union in violation of the FCUA
requiring submission of an acceptable plan within the time allowed. The
submission and rejection of multiple plans results in delays in
resolving the problem of insured credit unions. Accordingly, to further
ensure compliance with the FCUA, the Board has decided to adopt
proposed Sec. 702.111(g)(4) in this final rule without change.
The Board clarifies, however, that non-complex credit unions will
not be expected to address risk-based capital in net worth restoration
plans.
111(j) Termination of NWRP
Under the Second Proposal, Sec. 702.111(j) provided that, for
purposes of part 702, an NWRP terminates once the credit union has been
classified as adequately capitalized or well capitalized for four
consecutive quarters. The proposed paragraph also provided, as an
example, that if a credit union with an active NWRP attains the
classification as adequately capitalized on December 31, 2015, this
would be quarter one and the fourth consecutive quarter would end
September 30, 2016. The proposed paragraph was intended to provide
clarification for credit unions on the timing of an NWRP's termination.
The Board received no comments on this section and has decided to
adopt the proposed amendments in this final rule without change.
Section 702.112 Reserves
The Second Proposal renumbered current Sec. 702.401 as proposed
Sec. 702.112. Consistent with the text of current Sec. 702.401(a),
the proposal also would require that each credit union establish and
maintain such reserves as may be required by the FCUA, by state law, by
regulation, or, in special cases, by the Board or appropriate state
official.
The Board received no comments on this section and has decided to
adopt the proposed amendments in this final rule without change.
Regular Reserve Account
As mentioned above, the proposed rule would eliminate current Sec.
702.401(b) regarding the regular reserve account from the earnings
retention process. The process and substance of requesting permission
for charges to the regular reserve would be eliminated upon the
effective date of a final rule. Upon the effective date of a final
rule, a federal credit union would close out the regular reserve
balance into undivided earnings. A state-chartered, federally insured
credit union may, however, still be required to maintain a regular
reserve account by its respective state supervisory authority.
The Board received no comments on the elimination of current Sec.
702.401(b) and has decided to adopt the proposed revision in this final
rule without change.
Section 702.113 Full and Fair Disclosure of Financial Condition
The Second Proposal renumbered current Sec. 702.402 as proposed
Sec. 702.113, and made only minor conforming amendments to the text of
the section with the exception of the changes to proposed Sec.
702.113(d) that are discussed in more detail below.
The Board received no comments on this section and has decided to
adopt the proposed amendments in this final rule without change.
113(d) Charges for Loan and Lease Losses
Consistent with the proposed elimination of the regular reserve
requirement which is discussed above, proposed Sec. 702.113(d) would
remove current Sec. 702.402(d)(4), which provides that the maintenance
of an ALLL shall not affect the requirement to transfer earnings to a
credit union's regular reserve when required under subparts B or C of
part 702.
In addition, the proposed rule would remove current Sec.
702.402(d)(4), which provides that adjustments to the valuation ALLL
will be recorded in the expense account ``Provision for Loan and Lease
Losses.'' This change is intended to clarify that the ALLL is to be
maintained in accordance with GAAP, as discussed above.
The Board received no comments on these proposed revisions and has
decided to adopt the proposed amendments in this final rule without
change.
(d)(1)
Proposed Sec. 702.113(d)(1) would amend current Sec.
702.401(d)(1) to provide that charges for loan and lease losses shall
be made timely and in accordance with GAAP. The italicized words ``and
lease'' and ``timely and'' would be added to the language in the
current rule to clarify that the requirement also applies to lease
losses and to require that credit unions make charges for loan and
lease losses in a timely manner. As with the section above, these
changes are intended to clarify that charges for potential lease losses
are to be recorded in accordance with GAAP through the same allowance
account as loan losses. In addition, timely recording is critical to
maintain full and fair disclosure as required under this section.
The Board received no comments on this section and has decided to
adopt the proposed amendments in this final rule without change.
(d)(2)
Proposed Sec. 702.113(d)(2) would amend current Sec.
702.401(d)(2) to eliminate the detailed requirement and simply provide
that the ALLL must be maintained in accordance with GAAP. This change
is intended to provide full
[[Page 66698]]
and fair disclosure to a credit union member, NCUA, or, at the
discretion of a credit union's board of directors, to creditors to
fairly inform them of the credit union's financial condition and
operations.
The Board received no comments on this section and has decided to
adopt the proposed amendments in this final rule without change.
(d)(3)
Proposed Sec. 702.113(d)(3) retained the language in current Sec.
702.401(d)(5) with no changes.
The Board received no comments on this section and has decided to
adopt the proposed amendments in this final rule without change.
Section 702.114 Payment of Dividends
The Second Proposal renumbered current Sec. 702.402 as proposed
Sec. 702.114 and made amendments to the text of paragraphs (a) and
(b).
The Board received no comments on this section and has decided to
adopt the proposed amendments in this final rule without change.
114(a) Restriction on Dividends
Current Sec. 702.402(a) permits credit unions with a depleted
undivided earnings balance to pay dividends out of the regular reserve
account without regulatory approval, as long as the credit union will
remain at least adequately capitalized. Under proposed Sec.
702.114(a), however, only credit unions that have substantial net
worth, but no undivided earnings, would be allowed to pay dividends
without regulatory approval. Because of the removal of the regular
reserve account, and to conform to GAAP, the proposal would amend the
language to clarify that dividends may be paid when there is sufficient
net worth. Net worth may incorporate accounts in addition to undivided
earnings. Accordingly, Sec. 702.114(a) of this proposal would provide
that dividends shall be available only from net worth, net of any
special reserves established under Sec. 702.112, if any.
The Board received no comments on this section and has decided to
adopt the proposed amendments in this final rule without change.
114(b) Payment of Dividends and Interest Refunds
The Second Proposal would eliminate the language in current Sec.
702.403(b) and replace it with a new provision. Proposed new Sec.
702.114(b) would provide that the board of directors must not pay a
dividend or interest refund that will cause the credit union's capital
classification to fall below adequately capitalized under subpart A of
part 702 unless the appropriate regional director and, if state-
chartered, the appropriate state official, have given prior written
approval (in an NWRP or otherwise). Proposed paragraph (b) would have
provided further that the request for written approval must include the
plan for eliminating any negative retained earnings balance.
The Board received no comments on this section and has decided to
adopt the proposed amendments in this final rule without change.
B. Subpart B--Alternative Prompt Corrective Action for New Credit
Unions
Consistent with the Second Proposal, this final rule adds new
subpart B, which contains most of the capital adequacy rules that apply
to ``new'' credit unions. The current net worth measures, net worth
classification, and text of the PCA requirements applicable to new
credit unions are renumbered. They remain mostly unchanged from the
current rule, except for minor conforming changes and the following
substantive amendments:
(1) Clarification of the language in current Sec. 702.301(b)
regarding the ability of credit unions to become ``new'' again due to a
decrease in asset size after having exceeded the $10 million threshold.
(2) Elimination of the regular reserve account requirement in
current Sec. 702.401(b) and all cross-references to the requirement.
(3) Addition of new Sec. 701.206(f)(3) clarifying that the
submission of more than two revised business plans would be considered
an unsafe and unsound condition.
(4) Amendment of the language of current Sec. 702.402 regarding
the full and fair disclosure of financial condition.
(5) Amendment of the requirements of current Sec. 702.403
regarding the payment of dividends.
Section 702.201 Scope
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, this final rule renumbers current
Sec. 702.301 as Sec. 702.201. The final rule also clarifies that a
credit union may not regain a designation of ``new'' after reporting
total assets in excess of $10 million.
Section 702.202 Net Worth Categories for New Credit Unions
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, this final rule renumbers current
Sec. 702.302 as Sec. 702.202, and makes only minor technical edits
and conforming amendments to the text of the section.
Section 702.203 Prompt Corrective Action for Adequately Capitalized New
Credit Unions
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, this final rule renumbers current
Sec. 702.303 as Sec. 702.203, and makes only minor conforming
amendments to the text of the section. Consistent with the proposed
elimination of the regular reserve requirement in current Sec.
702.401(b), this final rule also removes the requirement that
adequately capitalized credit unions transfer the earnings retention
amount from undivided earnings to their regular reserve account.
Section 702.204 Prompt Corrective Action for Moderately Capitalized,
Marginally Capitalized or Minimally Capitalized New Credit Unions
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, this final rule renumbers current
Sec. 702.304 as Sec. 702.204, and makes only minor conforming
amendments to the text of the section. Consistent with the proposed
elimination of the regular reserve requirement in current Sec.
702.401(b), this final rule removes the requirement that such credit
unions transfer the earnings retention amount from undivided earnings
to their regular reserve account.
Section 702.205 Prompt Corrective Action for Uncapitalized New Credit
Unions
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, this final rule renumbers current
Sec. 702.305 as proposed Sec. 702.205, and makes only minor
conforming amendments to the text of the section.
Section 702.206 Revised Business Plans (RBPs) for New Credit Unions
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, this final rule renumbers current
Sec. 702.306 as Sec. 702.206, makes mostly minor conforming
amendments to the text of the section, and adds new Sec.
702.206(g)(3). Consistent with the proposed elimination of the regular
reserve requirement in current Sec. 702.401(b), this final rule also
removes the requirement that new credit unions transfer the earnings
retention amount from undivided earnings to their regular reserve
account.
[[Page 66699]]
206(g)(3) Submission of Multiple Unapproved Revised Business Plans
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, Sec. 702.206(g)(3) of this final
rule provides that the submission of more than two RBPs that were not
approved is considered an unsafe and unsound condition and may subject
the credit union to administrative enforcement actions under section
206 of the FCUA.\199\ As explained in the preamble to the Second
Proposal, NCUA regional directors have expressed concerns that some
credit unions have in the past submitted multiple RBPs that could not
be approved due to non-compliance with the requirements of the current
rule, resulting in delayed implementation of actions to improve the
credit union's net worth. This amendment is intended clarify that
submitting multiple RBPs that are rejected by NCUA, or a state
official, because of the failure of the credit union to produce an
acceptable RBP is an unsafe and unsound practice and may subject the
credit union to further actions as permitted under the FCUA.
---------------------------------------------------------------------------
\199\ 12 U.S.C. 1786 and 1790d.
---------------------------------------------------------------------------
Section 702.207 Incentives for New Credit Unions
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, this final rule renumbers current
Sec. 702.307 as proposed Sec. 702.207, and makes only minor
conforming amendments to the text of the section.
Section 702.208 Reserves
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, this final rule adds new Sec.
702.208 regarding reserves for new credit unions. Also, consistent with
the text of the current reserve requirement in Sec. 702.401(a), this
final rule requires that each new credit union establish and maintain
such reserves as may be required by the FCUA, by state law, by
regulation, or in special cases, by the Board or appropriate state
official.
As explained under the part of the preamble associated with Sec.
702.112 above, this final rule eliminates the regular reserve account
under current Sec. 702.402(b) from the earnings retention requirement.
Additionally, the process and substance of requesting permission for
charges to the regular reserve will be eliminated upon the effective
date of this final rule. Upon the effective date of this final rule, a
federal credit union should close out its regular reserve balance into
undivided earnings. A federally insured state-chartered credit union,
however, may still maintain a regular reserve account if required under
state law or by its state supervisory authority.
Section 702.209 Full and Fair Disclosure of Financial Condition
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, this final rule renumbers current
Sec. 702.402 as Sec. 702.209 and makes only minor conforming
amendments to the text of this section with the exception of the
changes to paragraph (d) that are discussed in more detail below.
209(d) Charges for Loan and Lease Losses
The Board received no comments on this section. Accordingly,
consistent with the proposed elimination of the regular reserve
requirement, Sec. 702.209(d) of this final rule removes the language
in current Sec. 702.402(d)(4), which provides that the maintenance of
an ALLL shall not affect the requirement to transfer earnings to a
credit union's regular reserve when required under subparts B or C of
part 702. In addition, this final rule removes current Sec.
702.402(d)(3), which provides that adjustments to the valuation ALLL
will be recorded in the expense account ``Provision for Loan and Lease
Losses.'' As discussed in the part of the preamble associated with
Sec. 702.113, the changes to this section emphasize the need to record
the ALLL in accordance with GAAP.
(d)(1)
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, current Sec. 702.401(d)(1) is
renumbered as Sec. 702.209(d)(1) and amended to provide that charges
for loan and lease losses shall be made timely and in accordance with
GAAP. This final rule adds the italicized words ``and lease'' and
``timely and'' to the language in the current rule to clarify that the
requirement also applies to lease losses and to require that credit
unions make charges for loan and lease losses in a timely manner. As
with the section above, this section is changed to clarify that charges
for potential lease losses should be recorded in accordance with GAAP
through the same allowance account as loan losses. In addition, timely
recording is critical to maintain full and fair disclosure as required
under this section.
(d)(2)
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, current Sec. 702.401(d)(2) is
renumbered as Sec. 702.209(d)(2) and is amended to provide that the
ALLL must be maintained in accordance with GAAP. This change is
intended to provide full and fair disclosure to credit union members,
NCUA, or, at the discretion of a credit union's board of directors, to
creditors to fairly inform them of the credit union's financial
condition and operations.
(d)(3)
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, current Sec. 702.401(d)(5) is
renumbered as Sec. 702.209(d)(3) and retains the language with no
changes.
Section 702.210 Payment of Dividends
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, the language in current Sec.
702.403 is incorporated into new Sec. 702.210 of this final rule.
210(a) Restriction on Dividends
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, Sec. 702.210(a) provides that,
for new credit unions, dividends shall be available only from net
worth, net of any special reserves established under Sec. 702.208, if
any.
210(b) Payment of Dividends if Retained Earnings Depleted
The Board received no comments on this section. Accordingly,
consistent with the Second Proposal, Sec. 702.210 provides that the
board of directors must not pay a dividend or interest refund that will
cause the credit union's capital classification to fall below
adequately capitalized under subpart B of part 702 unless the
appropriate regional director and, if state-chartered, the appropriate
state official, has given prior written approval (in an RBP or
otherwise). Paragraph (b) provides further that the request for written
approval must include the plan for eliminating any negative retained
earnings balance.
C. Appendix A to Part 702--Alternative Risk Weights for Certain On-
Balance Sheet Assets
As discussed in the part of the preamble that discusses Sec.
702.104(c)(3) of this final rule, the Board is adding new appendix A to
part 702 of NCUA's regulations. As previously stated, this final rule
allows credit unions to
[[Page 66700]]
determine the risk weight of certain investment funds, and the risk
weight of a subordinated tranche of any investment instead of using the
risk weights assigned in Sec. 702.104(c)(2). This final rule
incorporates the relevant portions of Sec. Sec. 324.43(e) and 324.53
of FDIC's regulations, which were incorporated only by reference in the
Second Proposal, into new appendix A of part 702 of NCUA's regulations.
To incorporate the text of FDIC's regulations into NCUA's regulations,
the Board had to make some minor conforming changes to the proposed
language incorporated into appendix A. No substantive changes to the
proposed methodology for calculating the gross-up and look-through
approaches are intended.
Accordingly, Appendix A to part 702 of this final rule provides
that instead of using the risk weights assigned in Sec. 702.104(c)(2),
a credit union may determine the risk weight of certain investment
funds, and the risk weight of non-subordinated or subordinated tranches
of any investment as provided below.
(a) Gross Up-Approach
(a)(1) Applicability
Paragraph (a)(1) of appendix A provides that: Section
702.104(c)(3)(iii)(A) of part 702 provides that, a credit union may use
the gross-up approach in this appendix to determine the risk weight of
the carrying value of non-subordinated or subordinated tranches of any
investment.
(a)(2) Calculation
Paragraph (a)(2) of appendix A provides, to use the gross-up
approach, a credit union must calculate the following four inputs:
Pro rata share, which is the par value of the credit
union's exposure as a percent of the par value of the tranche in which
the securitization exposure resides;
Enhanced amount, which is the par value of tranches that
are more senior to the tranche in which the credit union's
securitization resides;
Exposure amount, which is the amortized cost for
investments classified as held-to-maturity and available-for-sale, and
the fair value for trading securities; and
Risk weight, which is the weighted-average risk weight of
underlying exposures of the securitization as calculated under this
appendix.
(a)(3) Credit Equivalent Amount
Paragraph (a)(3) of appendix A provides that the ``credit
equivalent amount'' of a securitization exposure under this part equals
the sum of:
The exposure amount of the credit union's exposure; and
The pro rata share multiplied by the enhanced amount, each
calculated in accordance with paragraph (a)(2) of appendix A to part
702.
(a)(4) Risk-Weighted Assets
Paragraph (a)(4) of appendix A provides, to calculate risk-weighted
assets for a securitization exposure under the gross-up approach, a
credit union must apply the risk weight required under paragraph (a)(2)
of appendix A to part 702 to the credit equivalent amount calculated in
paragraph (a)(3) of appendix A to part 702.
(a)(5) Securitization Exposure Defined
Paragraph (a)(5) of appendix A provides, for purposes of paragraph
(a) of appendix A to part 702, ``securitization exposure'' means:
A credit exposure that arises from a securitization; or
An exposure that directly or indirectly references a
securitization exposure described in first element of this definition.
(a)(6) Securitization Defined
Paragraph (a)(6) of appendix A provides, for purposes of paragraph
(a) of appendix A to part 702, ``securitization'' means a transaction
in which:
The credit risk associated with the underlying exposures
has been separated into at least two tranches reflecting different
levels of seniority;
Performance of the securitization exposures depends upon
the performance of the underlying exposures; and
All or substantially all of the underlying exposures are
financial exposures (such as loans, receivables, asset-backed
securities, mortgage-backed securities, or other debt securities).
(b) Look-Through Approaches
(b)(1) Applicability
Paragraph (b)(1) of appendix A provides: Section
702.104(c)(3)(iii)(B) provides that, a credit union may use one of the
look-through approaches in appendix A to part 702 to determine the risk
weight of the exposure amount of any investment fund, or the holding of
separate account insurance.
(b)(2) Full Look-Through Approach
(b)(2)(i) General
Paragraph (b)(2)(i) of appendix A provides, a credit union that is
able to calculate a risk-weighted asset amount for its proportional
ownership share of each exposure held by the investment fund may set
the risk-weighted asset amount of the credit union's exposure to the
fund equal to the product of:
The aggregate risk-weighted asset amounts of the exposures
held by the fund as if they were held directly by the credit union; and
The credit union's proportional ownership share of the
fund.
(b)(2)(ii) Holding Report
Paragraph (b)(2)(ii) of appendix A provides, to calculate the risk-
weighted amount under paragraph (b)(2)(i) of appendix A, a credit union
should:
Use the most recently issued investment fund holding
report; and
Use an investment fund holding report that reflects
holdings that are not older than six months from the quarter-end
effective date (as defined in Sec. 702.101(c)(1) of part 702).
(b)(3) Simple Modified Look-Through Approach
Paragraph (b)(3) of appendix A provides that under the simple
modified look-through approach, the risk-weighted asset amount for a
credit union's exposure to an investment fund equals the exposure
amount multiplied by the highest risk weight that applies to any
exposure the fund is permitted to hold under the prospectus,
partnership agreement, or similar agreement that defines the fund's
permissible investments (excluding derivative contracts that are used
for hedging rather than speculative purposes and that do not constitute
a material portion of the fund's exposures).
(b)(4) Alternative Modified Look-Through Approach
Paragraph (b)(4) of appendix A provides that under the alternative
modified look-through approach, a credit union may assign the credit
union's exposure amount to an investment fund on a pro rata basis to
different risk weight categories under subpart A of part 702 based on
the investment limits in the fund's prospectus, partnership agreement,
or similar contract that defines the fund's permissible investments.
The paragraph provides further that the risk-weighted asset amount for
the credit union's exposure to the investment fund equals the sum of
each portion of the exposure amount assigned to an exposure type
multiplied by the applicable risk weight under subpart A of this part.
The paragraph also notes that if the sum of the investment limits for
all exposure types within the fund exceeds 100
[[Page 66701]]
percent, the credit union must assume that the fund invests to the
maximum extent permitted under its investment limits in the exposure
type with the highest applicable risk weight under subpart A of this
part and continues to make investments in order of the exposure type
with the next highest applicable risk weight under subpart A of this
part until the maximum total investment level is reached. The paragraph
also provides that if more than one exposure type applies to an
exposure, the credit union must use the highest applicable risk weight.
Finally, the paragraph provides that a credit union may exclude
derivative contracts held by the fund that are used for hedging rather
than for speculative purposes and do not constitute a material portion
of the fund's exposures.
D. Other Conforming Changes to the Regulations
The Board received only one comment on this section. The commenter
expressed concern that the references to the risk weightings for member
business loans under Sec. 723.1(d) and (e) were confusing and should
be eliminated because of the proposed rule's use of the term
``commercial loan,'' instead of member business loans, in assigning
risk weights. The Board generally agrees with the commenter's concerns
and has revised Sec. 723.1(d) and (e) to remove the words referring to
the risk-weighting standards for member business loans. Accordingly,
consistent with the Second Proposal, this final rule makes minor
conforming amendments to Sec. Sec. 700.2, 701.21, 701.23, 701.34,
703.14, 713.6, 723.1, 723.7, 747.2001, 747.2002, and 747.2003.
V. Effective Date
How much time would credit unions have to implement these new
requirements?
In the preamble to the Second Proposal, the Board proposed an
effective date of January 1, 2019 to provide credit unions and NCUA a
lengthy implementation period to make the necessary adjustments, such
as systems, processes, and procedures, and to reduce the burden on
affected credit unions in meeting the new requirements.
Public Comments on the Second Proposal
The Board received many comments regarding the proposed effective
date of the final rule. Several commenters suggested that given the
significant operational implications for both credit unions and the
NCUA, a 2019 effective date is appropriate. Those commenters suggested
the proposed effective date would allow credit unions to adjust their
balance sheets and strategic plans to achieve a well-capitalized
standard under the rule without disrupting member products and
services. Commenters also noted that the proposed effective date aligns
with the implementation timeframe of the Other Banking Agencies and,
thus, would avoid creating a competitive disadvantage across competing
financial services entities.
A substantial number of other commenters, however, requested that
the effective date be delayed until 2021 to coincide with refunds the
commenters expect to receive from the Corporate Stabilization Fund. The
commenters suggested the refunds will be important to those credit
unions that will need to increase capital levels in order to comply
with the new regulation.
Other commenters argued that the proposed timeframe was
insufficient given the significance of the impact of the proposed
requirements and the length of time it would take credit unions to
adjust their business strategies, portfolios and capital to best
position themselves relative to the rule. Commenters complained the
task would be burdensome for credit unions given their limited options
for raising capital when compared to banks, which were afforded seven
years to fully implement BASEL III. Accordingly, those commenters
recommended various extended implementation periods ranging from five
years to seven years, or phase-in periods over a similar timeframe.
One commenter speculated that extending the implementation until
2019 would create a dual standard for credit unions near threshold
levels. The commenter asked: What measure should be the plan for the
coming 2-3 years? The commenter acknowledged that for some credit
unions, the change will result in better risk-based capital levels than
under the current rule. But the commenter argued that fixing the
current capital levels under rules being phased out could cause real
harm to memberships and credit union health.
Several commenters noted that the Financial Accounting Standards
Board (FASB) plans to replace the current credit impairment model with
a current expected credit loss model. Commenters suggested further that
any final rule issued by FASB will require NCUA and FASB harmonization
with respect to forecasting models utilized by credit unions to reduce
conflicts between examination guidance. Accordingly, commenters
recommended that the NCUA Board delay implementation of any final risk-
based capital rule until the final FASB rule has been fully implemented
by credit unions.
One commenter recommended that if IRR, access to additional
supplemental forms of capital, and risk-based share insurance premium
changes are likely in the near future, the Board should delay
finalization and implementation of the proposed rule until a
comprehensive analysis can be conducted to ensure an integrated,
aligned approach to risk-based capital. The commenter contended that
addressing interest rate risk, supplemental capital, risk-based share
insurance premiums and risk-based capital in silos will not create the
most efficient and effective solution.
Discussion
The proposed January 1, 2019 effective date provides credit unions
with more than three years to ramp up implementation, which should be
more than sufficient time to make the necessary adjustments to systems
and operations before the effective date of this final rule. In
addition, as noted above, the effective date generally coincides with
the full phase-in of FDIC's capital regulations. In response to
commenters who asked the Board to phase in the implementation, the
Board found that phasing in the new capital rules for credit unions
would add additional complexity with minimal benefit.
Further, it would be inappropriate to delay implementation due to
potential changes in accounting that may be forthcoming, and the
elimination of the cap on the amount of the ALLL will reduce the impact
of the announced change in maintaining the ALLL.
Accordingly, this final rule will become effective on January 1,
2019.
VI. Impact of This Final Rule
This final rule will apply to credit unions with $100 million or
greater in total assets. As of December 31, 2014, there were 1,489
credit unions (23.7 percent of all credit unions) with assets of $100
million or greater. As a result, approximately 76 percent of all credit
unions will be exempt from the risk-based capital requirement.\200\ A
net of 16 complex credit unions with total assets of $9.8 billion would
have a
[[Page 66702]]
lower capital classification as a result this rule with a capital
shortfall of approximately $67 million.\201\ Approximately 98.5 percent
of all complex credit unions will remain well capitalized.\202\ The
aggregate and average RBC ratios for complex credit unions are 17.9 and
19.2 percent respectively.\203\ As shown in the table below most
complex credit unions will have a risk-based capital ratio well in
excess of the 10 percent needed to be well capitalized.
---------------------------------------------------------------------------
\200\ The proposed risk-based capital requirements applied only
to credit unions with assets of $100 million or more, compared to
the Other Banking Agencies' rules that apply to banks of all sizes.
There were 1,872 FDIC-insured banks with assets less than $100
million as of December 2014.
\201\ In the second proposal using data as of December 31, 2013,
NCUA estimated less than 20 credit unions would experience a decline
in their capital classification with a capital shortfall of $53.6
million.
\202\ Of the 1,489 impacted credit unions, only 23, or 1.54
percent, would have less than the 10 percent risk-based capital
requirement to be well capitalized. Of these, seven have net worth
ratios less than 7 percent and therefore are already categorized as
less than well capitalized.
\203\ In the second proposal, based on December 2013 Call Report
data, NCUA estimated the aggregate average risk-based capital ratio
would be 18.2 percent with an average risk-based capital ratio of
19.3 percent.
Distribution of Net Worth Ratio and Final Risk-Based Capital Ratio
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than well Well capitalized Well capitalized Well capitalized Greater than well
Number of CUs capitalized to well +2% +2% to +3.5% +3.5% to +5% capitalized +5%
Net Worth Ratio <7% 7%-9% 9%-10.5% 10.5%-12% >12%
RBC Ratio <10% 10%-12% 12%-13.5% 13.5%-15% >15%
--------------------------------------------------------------------------------------------------------------------------------------------------------
Net Worth Ratio......................................... 14 297 449 334 395
Final RBC Ratio......................................... 23 107 140 194 1,025
--------------------------------------------------------------------------------------------------------------------------------------------------------
Public Comments on the Second Proposal
The Board received a substantial number of comments regarding
NCUA's estimates of the impacts of the Second Proposal. Most commenters
who mentioned the impacts of the proposal suggested the rule would have
negative impacts on the credit union industry. Numerous commenters
speculated that the proposal would unjustifiably slow credit union
growth in the future, and that the funds used to meet the newly
proposed requirements could otherwise be used to make loans to
consumers or small businesses, or be used in other productive ways.
Commenters also speculated that the requirements in the proposal would
restrict credit union lending to consumers by forcing credit unions to
maintain capital on their books rather than lending to their members.
At least one commenter recommended that the Board more thoughtfully
consider the actual market effect on the credit union industry and
produce more reasonably calibrated risk weights based on the
cooperative nature of credit unions. The commenter recommended that the
Board also reconsider the value of concentration escalators and provide
empirical data that reflect what actual additional risk is created
based on concentration of certain asset categories. Other commenters
claimed the higher capital levels that would be required under the
proposal would reduce the amount of support, both monetary and
operational, that larger credit unions have historically provided to
their smaller counterparts, which would put additional strain on the
finances and operations of many smaller credit unions.
One credit union trade association commenter speculated that under
the proposal, the number of credit unions downgraded would more than
double during a downturn in the business cycle. Under the commenter's
analysis, 45 credit unions would have been downgraded during the most
2007-2009 financial crisis if this proposal had been in place in 2009.
According to the commenter, of those 45 credit unions, 41 would be well
capitalized today. The commenter suggested that to have avoided a
downgrade, those credit unions would have had to increase their capital
by $145 million, or an average of $3.2 million per credit union. The
commenter stated that almost all of the credit unions that would have
been downgraded (95 percent) are well capitalized or adequately
capitalized today. The commenter claimed this empirically proves that
the proposal is unnecessary and unduly burdensome, as it would further
strain the credit union system during a financial downturn. The
commenter estimated that, in order to satisfy the proposal's well
capitalized threshold, credit unions would need to hold at least an
additional $729 million. The commenter estimated further that, to
satisfy the proposal's adequately capitalized threshold, credit unions
would need to hold at least an additional $260 million.
Another commenter argued that the Board's cost estimates failed to
include the one-time costs that would be incurred by the entire credit
union industry in system changes, additional reports, potential
additional segregation and segmentation of the balance sheet, etc. in
order to fill out the new Call Report forms. The commenter speculated
that such costs will far outweigh the costs that the Board has
identified in the proposal.
Yet another commenter maintained that, according to the proposal,
most complex credit unions are currently well capitalized under both
the net worth ratio and the proposed risk-based capital ratio. The
commenter calculated that as of September 30, 2014, complex credit
unions had an average net worth ratio of 10.7 percent and a risk-based
capital ratio of 19.3 percent, both well in excess of guidelines
identifying well capitalized status. The commenter suggested that only
19 complex credit unions would fall from well capitalized status under
the proposal. Thus, the commenter concluded that the costs associated
with the proposal seemed excessive given how extremely well capitalized
the credit union industry is today under current guidelines.
One credit union commenter suggested that for the risk-based
capital requirement to be effective, it would have to be more complex.
The commenter explained that this would mean requiring more information
on the Call Report and adding new categories of loans in the final
rule. Another credit union commenter supported making the risk-based
capital framework as complicated as it needs to be to more accurately
reflect the unique needs and structure of the credit union industry.
Several commenters noted that in March 2015, FASB announced
expectations to finalize the standard for timely financial reporting of
credit losses in the third quarter of 2015. Commenters recommended the
Board consider the possible effects of the FASB proposal in relation to
NCUA's risk-based capital regulations and remove any duplicative
regulatory burdens that may be created.
[[Page 66703]]
A significant number of commenters requested that the Board
minimize the burden on credit unions of expanding the Call Report.
Several commenters suggested the Board consider an approach where
credit unions would have the option of providing the additional,
detailed information required under the proposal. One commenter
suggested such an approach could be accomplished by including
additional optional data fields within the Call Report, similar to the
approach used by FDIC. The commenter suggested further that any changes
required of a credit union require the expenditure of resources, and in
a time when many credit unions are struggling to comply with existing
rules from NCUA and other regulators, the Board should consider any
alternatives that will reduce the burden of this rule on credit unions.
Another commenter contended that NCUA's current estimate of the public
burden of collecting information for the Call Report grossly
understates the actual amount of time required. The commenter suggested
that the variety of data needed to generate a quarterly Call Report
takes employees from some credit unions 66 hours (10 times NCUA's
current 6.6 hour estimate). The commenter recommended the Board
consider the time and resources dedicated to producing the additional
Call Report data required by the proposal and focus on minimizing that
burden and impact to credit unions. At least one commenter recommended
that any Call Report updates required by this rulemaking be made
available to credit unions at least six months before the effective
date of the final rule.
Discussion
The Board has considered the comments received and recognizes that
unduly high minimum regulatory capital requirements and unnecessary
burdens could lead to less-than-optimal outcomes. Thus, as discussed
throughout this preamble and in the Paperwork Reduction Act section to
follow, the Board has made appropriate efforts to target the impacts
and reduce the burdens of this final rule. This final rule only targets
outlier credit unions with insufficient capital relative to their risk.
The final rule meets Congress' express purpose of prompt corrective
action ``. . . to resolve the problems of insured credit unions at the
least possible long-term cost to the Fund,'' \204\ by establishing a
risk-based capital requirement which will reduce the likelihood that a
credit union will become undercapitalized and eventually fail at a cost
to the Fund.
---------------------------------------------------------------------------
\204\ 12 U.S.C. 1790d(a)(1).
---------------------------------------------------------------------------
The Board's elimination of the 1.25 percent of risk-assets cap on
the amount of ALLL in the risk-based capital ratio numerator will
reduce the impact of the risk-based capital ratio during economic
downturns when credit unions are more likely to be funding higher
levels of loan losses. Removal of the ALLL cap will also mitigate
concerns with FASB's proposed related changes to GAAP.\205\ A reduction
in capital ratios during economic downturns is a normal result for both
the risk-based capital ratio and the net worth ratio. The capital
adequacy requirement will enhance a credit union's ability to measure
and plan for economic downturns.
---------------------------------------------------------------------------
\205\ See Financial Standards Accounting Board, Proposed
Accounting Standards Update, Financial Instruments--Credit Losses,
Subtopic 825-15 (Dec. 20, 2012).
---------------------------------------------------------------------------
Sound capital levels are vital to the long-term health of all
financial institutions. Credit unions are already expected to
incorporate into their business models and strategic plans provisions
for maintaining prudent levels of capital. This final rule ensures
minimum regulatory capital levels for complex credit unions will be
more accurately correlated to risk. The final rule achieves a
reasonable balance between requiring credit unions posing an elevated
risk to hold more capital, while not overburdening lower-risk credit
unions.
As indicated in the table below, according to the impact measure
used in the Second Proposal, 72 complex credit unions would have had
higher capital requirements due to the risk-based capital ratio
requirement based on December 31, 2014 data.\206\
---------------------------------------------------------------------------
\206\ The method used in the Second Proposal was calculated by
taking 10 percent of estimated risk assets divided by total assets
with results exceeding 7.5 percent indicating the risk-based capital
requirement is the higher minimum-capital requirement.
\207\ This computation calculates the amount of capital required
by multiplying the estimated proposed risk weighted assets by 10
percent (the level to be well capitalized), and then dividing this
result by total assets. This provides a measure comparable to the
net worth ratio. Since the risk-based capital provisions provide for
a broader definition of capital included in the risk-based capital
ratio numerator, which on average benefits credit unions by
approximately 50 basis points, the appropriate comparison point for
the leverage equivalent is 7.5 percent, not the 7 percent level for
well capitalized for the net worth ratio.
Distribution of Risk-Based Leverage Equivalent Ratio \207\
--------------------------------------------------------------------------------------------------------------------------------------------------------
RBC ratio--leverage equivalent <6% 6-7.5% 7.5-8.5% 8.5-9.5% 9.5-11% >11% Average
--------------------------------------------------------------------------------------------------------------------------------------------------------
Number of CUs.................... 816 601 57 11 4 0 5.90%
--------------------------------------------------------------------------------------------------------------------------------------------------------
Using another more conservative measure developed based on
suggestions received from commenters, NCUA identified 308 credit
unions, or 20 percent of all complex credit unions, that are likely to
have a higher minimum capital requirement under the risk-based capital
ratio requirement being adopted under this final rule.\208\ While up to
20 percent of credit unions are likely to have the risk-based capital
ratio as the binding constraint, only 20 of those credit unions have an
estimated risk-based capital ratio below 10 percent.\209\
---------------------------------------------------------------------------
\208\ Calculated based on a positive result to the following
formula: ((risk-weighted assets times 10 percent) - allowance for
loan losses - equity acquired in merger - total adjusted retained
earnings acquired through business combinations + NCUA share
insurance capitalization deposit + goodwill + identifiable
intangible assets) - (total assets times 7 percent).
\209\ Also, given the new treatment of non-significant equity
exposures, which could not be estimated due to existing data
limitations, this impact may be further reduced.
---------------------------------------------------------------------------
NCUA's latest analysis concludes it is reasonable for the risk-
based capital ratio requirement to be the primary determiner of the
capital requirement for about 20 percent of complex credit unions
because these 308 credit unions have an average risk-weighted assets to
total assets ratio of 72 percent--which is significantly higher than
the 59 percent average ratio for all complex credit unions.
As noted earlier, concentration risk is a material risk addressed
in this final rule. Based on December 31, 2014 Call Report data, if
this final rule were effective today, NCUA estimates that the
additional capital required for concentration risk would have the
following impact:
[[Page 66704]]
------------------------------------------------------------------------
Number of credit Percentage of 1,489
unions with total credit unions with
Concentration threshold assets greater than total assets
$100 million as of greater than $100
12/31/2014 million
------------------------------------------------------------------------
First-Lien Residential Real 135 9.1
Estate (>35% of Total Assets)
Junior-Lien Residential Real 57 3.8
Estate (>20% of Total Assets)
Commercial Loans (using MBLs 12 0.8
as a proxy) \210\ (>50% of
Total Assets)................
------------------------------------------------------------------------
The Board considered the impact of the individual data items
necessary to compute the risk-based capital ratio. Many commenters'
requests for further stratification of risk weights were determined to
create a data burden in excess of the benefits. All revisions to the
Call Report will be subject to the publication and opportunity for
comment process in accordance with the requirements of the Paperwork
Reduction Act of 1994 to obtain a valid control number from the U.S.
Office of Management and Budget (OMB). Interested parties are invited
to submit written comments to each notice of information collection
that NCUA will submit to OMB for review.
---------------------------------------------------------------------------
\210\ Using MBL data as the current Call Report does not capture
``commercial loan'' data as defined in this final rule.
---------------------------------------------------------------------------
VII. Regulatory Procedures
Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) generally requires that, in
connection with a final rulemaking, an agency prepare and make
available a final regulatory flexibility analysis that describes the
impact of the final rule on small entities. A regulatory flexibility
analysis is not required, however, if the agency certifies that the
rule will not have a significant economic impact on a substantial
number of small entities (defined for purposes of the RFA to include
credit unions with assets less than $50 million \211\) and publishes
its certification and a short, explanatory statement in the Federal
Register together with the rule.
---------------------------------------------------------------------------
\211\ On September 24, 2015, the Board published Interpretative
Ruling and Policy Statement 15-1, which amends the definition of
small credit unions for purposes of the RFA to credit unions with
assets of less than $100 million. 80 FR 57512 (Sept. 24, 2015). This
change, however, does not take effect until November 23, 2015, which
is after the date this rule is scheduled to be voted on by the
Board.
---------------------------------------------------------------------------
Public Comments on the Second Proposal
A small credit union commenter suggested that while credit unions
with less than $100 million in assets are not subject to the
requirements of this proposal, there is great apprehension among small
credit unions that NCUA examiners will require them to meet the basic
requirements in the risk-based capital rule.
Several commenters contended that NCUA's current estimate of the
public burden of collecting information for the Call Report grossly
understates the actual amount of time required. At least one commenter
suggested that the variety of data needed to generate a quarterly Call
Report takes employees from some credit unions 66 hours (10 times
NCUA's estimate of 6.6 hours).
Discussion
The amendments this final rule makes to part 702 primarily affect
complex credit unions, which are those with $100 million or more in
assets. The revised risk-based capital requirement and capital adequacy
plan under this final rule do not apply to small credit unions.
NCUA recognizes that because many commenters suggested NCUA collect
more granular data for credit union Call Reports, small credit unions
with assets less than $50 million could be affected if they are asked
to assemble and report additional data. NCUA, however, will make every
reasonable effort to redesign the Call Report system so that all credit
unions with $100 million or less in assets are not unnecessarily
burdened by the data requirements that apply to complex credit unions.
NCUA plans to propose information collection changes to reflect the new
requirements of this final rule in the future, and publish the
regulatory reporting requirements separately--including the steps NCUA
has taken to minimize the impact of the reporting burden on small
credit unions--for comment.
In addition, this final rule makes a number of minor changes to
current part 702 of NCUA's regulations including:
Part 702--Reorganizing and renumbering part 702, including
sections of the part applicable to small credit unions.
Section 702.2--Making minor amendments to certain
definitions applicable to all credit unions under part 702.
Section 702.111(g)(4) & 702.206(g)(3)--Making minor
clarifications regarding the submission of multiple unapproved NWRPs or
RBPs.
Sections 702.112 & 702.208--Eliminating the regular
reserve account requirement for all credit unions.
Sections 702.113(d) & 702.209(d)--Making minor amendments
to the treatment of loan and lease losses.
Section 702.114 & 702.210--Making minor amendments to part
702 regarding the payments of dividends for all credit unions.
Section 702.201--Making minor revisions to the definition
of ``new credit union.''
NCUA believes the one time burden associated with the policy review
and revisions related to these amended provisions will be one hour for
small credit unions. Accordingly, the effects of this final rule on
small credit unions are minor.
Based on the above assessment, the Board certifies that this final
rule will not have a significant economic impact on a substantial
number of small credit unions.
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 increases an existing burden.\212\ For purposes of the PRA,
a paperwork burden may take the form of a reporting, disclosure or
recordkeeping requirement, each referred to as an information
collection. The changes made to part 702 by this final rule will impose
new information collection requirements.
---------------------------------------------------------------------------
\212\ 44 U.S.C. 3507(d); 5 CFR part 1320.
---------------------------------------------------------------------------
NCUA determined that the proposed changes to part 702 would have
costs associated with updating internal policies, and updating data
collection and reporting systems for preparing Call Reports. Based on
December 2013 Call Report data, NCUA in the Second Proposal estimated
that all 6,554 credit unions would have to amend their procedures and
systems for preparing Call Reports. NCUA proposed addressing the costs
and providing notice of the particular changes that would be made in
other collections, such as the NCUA Call Report and Profile as part of
its regular amendments separate from this proposed rule.
[[Page 66705]]
NCUA also estimated that approximately 21.5 percent, or 1,455
credit unions, would be defined as ``complex'' under the proposed rule
and would have additional data collection requirements related to the
new risk-based capital requirements.
NCUA's Total Estimated One-Time Costs of the Second Proposal:
One-time burden for policy review and revision, (20 hours times
5,099 credit unions (non-complex), or 40 hours times 1,455 credit
unions (complex)). The total one-time cost for non-complex credit
unions totals 101,980 hours or $3,252,142, an average of $638 per
credit union. The total one-time cost for complex credit unions totals
58,200 hours or $1,855,998, an average of $1,276 per credit union.
Public Comments on the Second Proposal
A significant number of commenters maintained that the proposal did
not incorporate the estimated burden for establishing a comprehensive
written strategy for maintaining an appropriate level of capital and
other changes to a complex credit union's operations other than data
collection. Commenters suggested the effects of the proposal would be a
greater burden for complex credit unions upon the implementation year
and for ongoing years. Commenters noted that NCUA's final rule on
Capital Planning and Stress Testing estimated 750 hours of paperwork
burden in the initial year and 250 hours in subsequent years, and
suggested it was unclear how the requirements of the Second Proposal
would differ from the final rule on Capital Planning and Stress Testing
in terms of burden. Using the cost estimate previously utilized by NCUA
for the final rule on Capital Planning and Stress Testing, one
commenter suggested a more reasonable estimate for this proposal would
be $23,926 per credit union or $34.8 million to the industry for the
initial year of the final RBC rule. The commenter also suggested there
would be an ongoing annual cost of $7,975 per credit union or $11.6
million to the industry, which, over a five-year period, would have a
cumulative cost to the industry of approximately $81.2 million.
In addition, several commenters contended that NCUA's current
estimate of the public burden of collecting information for the Call
Report grossly understates the actual amount of time required. At least
one commenter suggested that the variety of data needed to generate a
quarterly Call Report takes employees from some credit unions 66 hours
(10 times NCUA's estimate 6.6 hours).
Discussion
The final changes will result in some costs for complex credit
unions associated with updating internal policies, including a
comprehensive strategy for maintaining an appropriate level of capital,
the cost estimates for which are discussed in more detail below.
Further, there will be marginal costs associated with updating data
collection and reporting systems for the NCUA Call Reports. The changes
to the Call Reporting requirements, however, will be handled as part of
NCUA's regular Call Report updates separately from this proposed rule.
The information collection requirements for the Call Report are
approved by OMB under Control No. 3133-004.
In response to commenters who believe all complex credit unions
will need substantial time to establish and maintain a comprehensive
written capital strategy, NCUA field staff report that many well-
managed complex credit unions already have comprehensive strategies for
maintaining appropriate levels of capital. Further, commenters compared
the burden of the Capital Planning and Stress Testing hours; however,
for the vast majority of complex credit unions, the written capital
strategy will not necessarily approach the complexity and more rigorous
requirements associated with stress testing.
NCUA has updated its PRA analysis based on December 2014 Call
Report data. Again, NCUA will make every effort to redesign the Call
Report system so that small credit unions are not unnecessarily
burdened by the data requirements that apply to complex credit unions.
The final rule contains minor changes to Sec. Sec. 702.2,
702.111(g)(4), 702.206(g)(3), 702.112, 702.208, 702.113(d), 702.209(d),
702.114, 702.210, and 702.201 for which all credit union's should be
aware. The information collection requirements contained in
702.111(g)(4) and 702.206(g)(3) are generally related to information
collected under OMB Control No. 3133-0154.
NCUA estimates that 1,489 credit unions defined as ``complex'' will
have additional data collection requirements related to the new risk-
based capital requirements. This slight increase from 1,455 credit
unions in the Second Proposal occurred as some credit unions that had
assets of less than $100 million grew in size and now meet the
definition of ``complex.''
As a result, NCUA's Total Estimated One-Time Costs based on the
December 2014 Call Report data have changed slightly:
One-time burden for policy review and revision:
40 hours times 1,489 complex credit unions. The total one-
time cost for complex credit unions totals 59,560 hours or $1,898,174,
an average of $1,275 per credit union.
1 hour times 4,784 non-complex credit unions. The total
one-time cost for credit unions with $100 million or less in assets
totals 4,784 hours, for a total estimated cost of $152,562.
Executive Order 13132
Executive Order 13132 encourages independent regulatory agencies to
consider the impact of their actions on state and local interests.
NCUA, an independent regulatory agency as defined in 44 U.S.C. 3502(5),
voluntarily complies with the principles of the executive order to
adhere to fundamental federalism principles. This final rule will apply
to all federally insured natural-person credit unions, including
federally insured, state-chartered natural-person credit unions.
Accordingly, it may have, to some degree, a direct effect on the
states, on the relationship between the national government and the
states, or on the distribution of power and responsibilities among the
various levels of government. The Board believes this impact is minor,
and it is an unavoidable consequence of carrying out the statutory
mandate to adopt a system of PCA to apply to all federally insured,
natural-person credit unions. Throughout the rulemaking process, NCUA
has consulted with representatives of state regulators regarding the
impact of PCA on state-chartered credit unions. Comments and
suggestions of those state regulators are reflected in this final rule.
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).
List of Subjects
12 CFR Part 700
Credit unions.
12 CFR Part 701
Credit, Credit unions, Insurance, Reporting and recordkeeping
requirements.
[[Page 66706]]
12 CFR Part 702
Credit unions, Reporting and recordkeeping requirements.
12 CFR Part 703
Credit unions, Investments, Reporting and recordkeeping
requirements.
12 CFR Part 713
Bonds, Credit unions, Insurance.
12 CFR Part 723
Credit unions, Loan programs-business, Reporting and recordkeeping
requirements.
12 CFR Part 747
Administrative practice and procedure, Bank deposit insurance,
Claims, Credit unions, Crime, Equal access to justice, Investigations,
Lawyers, Penalties.
By the National Credit Union Administration Board on October 15,
2015.
Gerard Poliquin,
Secretary of the Board.
For the reasons discussed above, the Board proposes to amend 12 CFR
parts 700, 701, 702, 703, 713, 723, and 747 as follows:
PART 700--DEFINITIONS
0
1. The authority citation for part 700 continues to read as follows:
Authority: 12 U.S.C. 1752, 1757(6), 1766.
Sec. 700.2 [Amended]
0
2. Amend the definition of ``net worth'' in Sec. 700.2 by removing
``Sec. 702.2(f)'' and adding in its place ``Sec. 702.2''.
PART 701--ORGANIZATION AND OPERATION OF FEDERAL CREDIT UNIONS
0
3. The authority citation for part 701 continues to read as follows:
Authority: 12 U.S.C. 1752(5), 1755, 1756, 1757, 1758, 1759,
1761a, 1761b, 1766, 1767, 1782, 1784, 1786, 1787, 1789. Section
701.6 is also authorized by 15 U.S.C. 3717. Section 701.31 is also
authorized by 15 U.S.C. 1601 et seq.; 42 U.S.C. 1981 and 3601-3610.
Section 701.35 is also authorized by 42 U.S.C. 4311-4312.
Sec. 701.21 [Amended]
0
4. Amend Sec. 701.21(h)(4)(iv) by removing ``Sec. 702.2(f)'' and
adding in its place ``Sec. 702.2''.
Sec. 701.23 [Amended]
0
5. Amend Sec. 701.23(b)(2) by removing the words ``net worth'' and
adding in their place the word ``capital'', and removing the words
``or, if subject to a risk-based net worth (RBNW) requirement under
part 702 of this chapter, has remained `well capitalized' for the six
(6) immediately preceding quarters after applying the applicable RBNW
requirement''.
Sec. 701.34 [Amended]
0
6. Amend Sec. 701.34 as follows:
0
a. In paragraph (b)(12) remove the words ``Sec. Sec. 702.204(b)(11),
702.304(b) and 702.305(b)'' and add in their place the words ``part
702''.
0
b. In paragraph (d)(1)(i) remove the words ``net worth'' and add in
their place the word ``capital''.
0
c. In the appendix to Sec. 701.34, amend the paragraph beginning ``8.
Prompt Corrective Action'' by removing the words ``net worth
classifications (see 12 CFR 702.204(b)(11), 702.304(b) and 702.305(b),
as the case may be)'' and adding in their place the words ``capital
classifications (see 12 CFR part 702)''.
PART 702--CAPITAL ADEQUACY
0
7. The authority citation for part 702 continues to read as follows:
Authority: 12 U.S.C. 1766(a), 1790d.
0
8. Revise Sec. Sec. 702.101, 702.202, and subparts A and B to read as
follows:
Sec.
702.1 Authority, purpose, scope, and other supervisory authority.
702.2 Definitions.
Subpart A--Prompt Corrective Action
702.101 Capital measures, capital adequacy, effective date of
classification, and notice to NCUA.
702.102 Capital classification.
702.103 Applicability of the risk-based capital ratio measure.
702.104 Risk-based capital ratio.
702.105 Derivative contracts.
702.106 Prompt corrective action for adequately capitalized credit
unions.
702.107 Prompt corrective action for undercapitalized credit unions.
702.108 Prompt corrective action for significantly undercapitalized
credit unions.
702.109 Prompt corrective action for critically undercapialized
credit unions.
702.110 Consultation with state officials on proposed prompt
corrective action.
702.111 Net worth restoration plans (NWRP).
702.112 Reserves.
702.113 Full and fair disclosure of financial condition.
702.114 Payment of dividends.
Subpart B--Alternative Prompt Corrective Action for New Credit Unions
702.201 Scope and definition.
702.202 Net worth categories for new credit unions.
702.203 Prompt corrective action for adequately capitalized new
credit unions.
702.204 Prompt corrective action for moderately capitalized,
marginally capitalized, or minimally capitalized new credit unions.
702.205 Prompt corrective action for uncapitalized new credit
unions.
702.206 Revised business plans (RBP) for new credit unions.
702.207 Incentives for new credit unions.
702.208 Reserves
702.209 Full and fair disclosure of financial condition.
702.210 Payment of dividends.
Subpart A--Prompt Corrective Action
Sec. 702.1 Authority, purpose, scope, and other supervisory
authority.
(a) Authority. Subparts A and B of this part and subpart L of part
747 of this chapter are issued by the National Credit Union
Administration (NCUA) pursuant to sections 120 and 216 of the Federal
Credit Union Act (FCUA), 12 U.S.C. 1776 and 1790d (section 1790d), as
revised by section 301 of the Credit Union Membership Access Act,
Public Law 105-219, 112 Stat. 913 (1998).
(b) Purpose. The express purpose of prompt corrective action under
section 1790d is to resolve the problems of federally insured credit
unions at the least possible long-term loss to the National Credit
Union Share Insurance Fund. Subparts A and B of this part carry out the
purpose of prompt corrective action by establishing a framework of
minimum capital requirements, and mandatory and discretionary
supervisory actions applicable according to a credit union's capital
classification, designed primarily to restore and improve the capital
adequacy of federally insured credit unions.
(c) Scope. Subparts A and B of this part implement the provisions
of section 1790d as they apply to federally insured credit unions,
whether federally- or state-chartered; to such credit unions defined as
``new'' pursuant to section 1790d(b)(2); and to such credit unions
defined as ``complex'' pursuant to section 1790d(d). Certain of these
provisions also apply to officers and directors of federally insured
credit unions. Subpart C applies capital planning and stress testing to
credit unions with $10 billion or more in total assets. This part does
not apply to corporate credit unions. Unless otherwise provided,
procedures for issuing, reviewing and enforcing orders and directives
issued under this part are set forth in subpart L of part 747 of this
chapter.
(d) Other supervisory authority. Neither section 1790d nor this
part in any way limits the authority of the NCUA Board or appropriate
state official under any other provision of law to take additional
supervisory actions to
[[Page 66707]]
address unsafe or unsound practices or conditions, or violations of
applicable law or regulations. Action taken under this part may be
taken independently of, in conjunction with, or in addition to any
other enforcement action available to the NCUA Board or appropriate
state official, including issuance of cease and desist orders, orders
of prohibition, suspension and removal, or assessment of civil money
penalties, or any other actions authorized by law.
Sec. 702.2 Definitions.
Unless otherwise provided in this part, the terms used in this part
have the same meanings as set forth in FCUA sections 101 and 216, 12
U.S.C. 1752, 1790d. The following definitions apply to this part:
Allowances for loan and lease losses (ALLL) means valuation
allowances that have been established through a charge against earnings
to cover estimated credit losses on loans, lease financing receivables
or other extensions of credit as determined in accordance with GAAP.
Amortized cost means the purchase price of a security adjusted for
amortizations of premium or accretion of discount if the security was
purchased at other than par or face value.
Appropriate state official means the state commission, board or
other supervisory authority that chartered the affected credit union.
Call Report means the Call Report required to be filed by all
credit unions under Sec. 741.6(a)(2) of this chapter.
Carrying value means the value of the asset or liability on the
statement of financial condition of the credit union, determined in
accordance with GAAP.
Central counterparty (CCP) means a counterparty (for example, a
clearing house) that facilitates trades between counterparties in one
or more financial markets by either guaranteeing trades or novating
contracts.
Charitable donation account means an account that satisfies all of
the conditions in Sec. 721.3(b)(2)(i), (b)(2)(ii), and (b)(2)(v) of
this chapter.
Commercial loan means any loan, line of credit, or letter of credit
(including any unfunded commitments) for commercial, industrial, and
professional purposes, but not for investment or personal expenditure
purposes. Commercial loan excludes loans to CUSOs, first- or junior-
lien residential real estate loans, and consumer loans.
Commitment means any legally binding arrangement that obligates the
credit union to extend credit, purchase or sell assets, enter into a
borrowing agreement, or enter into a financial transaction.
Consumer loan means a loan for household, family, or other personal
expenditures, including any loans that, at origination, are wholly or
substantially secured by vehicles generally manufactured for personal,
family, or household use regardless of the purpose of the loan.
Consumer loan excludes commercial loans, loans to CUSOs, first- and
junior-lien residential real estate loans, and loans for the purchase
of one or more vehicles to be part of a fleet of vehicles.
Contractual compensating balance means the funds a commercial loan
borrower must maintain on deposit at the lender credit union as
security for the loan in accordance with the loan agreement, subject to
a proper account hold and on deposit as of the measurement date.
Credit conversion factor (CCF) means the percentage used to assign
a credit exposure equivalent amount for selected off-balance sheet
accounts.
Credit union means a federally insured, natural person credit
union, whether federally- or state-chartered.
Current means, with respect to any loan, that the loan is less than
90 days past due, not placed on non-accrual status, and not
restructured.
CUSO means a credit union service organization as defined in part
712 and 741 of this chapter.
Custodian means a financial institution that has legal custody of
collateral as part of a qualifying master netting agreement, clearing
agreement, or other financial agreement.
Depository institution means a financial institution that engages
in the business of providing financial services; that is recognized as
a bank or a credit union by the supervisory or monetary authorities of
the country of its incorporation and the country of its principal
banking operations; that receives deposits to a substantial extent in
the regular course of business; and that has the power to accept demand
deposits. Depository institution includes all federally insured offices
of commercial banks, mutual and stock savings banks, savings or
building and loan associations (stock and mutual), cooperative banks,
credit unions and international banking facilities of domestic
depository institutions, and all privately insured state chartered
credit unions.
Derivatives Clearing Organization (DCO) means the same as defined
by the Commodity Futures Trading Commission in 17 CFR 1.3(d).
Derivative contract means a financial contract whose value is
derived from the values of one or more underlying assets, reference
rates, or indices of asset values or reference rates. Derivative
contracts include interest rate derivative contracts, exchange rate
derivative contracts, equity derivative contracts, commodity derivative
contracts, and credit derivative contracts. Derivative contracts also
include unsettled securities, commodities, and foreign exchange
transactions with a contractual settlement or delivery lag that is
longer than the lesser of the market standard for the particular
instrument or five business days.
Equity investment means investments in equity securities and any
other ownership interests, including, for example, investments in
partnerships and limited liability companies.
Equity investment in CUSOs means the unimpaired value of the credit
union's equity investments in a CUSO as recorded on the statement of
financial condition in accordance with GAAP.
Exchange means a central financial clearing market where end users
can enter into derivative transactions.
Excluded goodwill means the outstanding balance, maintained in
accordance with GAAP, of any goodwill originating from a supervisory
merger or combination that was completed on or before December 28,
2015. This term and definition expire on January 1, 2029.
Excluded other intangible assets means the outstanding balance,
maintained in accordance with GAAP, of any other intangible assets such
as core deposit intangible, member relationship intangible, or trade
name intangible originating from a supervisory merger or combination
that was completed on or before December 28, 2015. This term and
definition expire on January 1, 2029.
Exposure amount means:
(1) The amortized cost for investments classified as held-to-
maturity and available-for-sale, and the fair value for trading
securities.
(2) The outstanding balance for Federal Reserve Bank Stock, Central
Liquidity Facility Stock, Federal Home Loan Bank Stock, nonperpetual
capital and perpetual contributed capital at corporate credit unions,
and equity investments in CUSOs.
(3) The carrying value for non-CUSO equity investments, and
investment funds.
(4) The carrying value for the credit union's holdings of general
account permanent insurance, and separate account insurance.
(5) The amount calculated under Sec. 702.105 of this part for
derivative contracts.
[[Page 66708]]
Fair value has the same meaning as provided in GAAP.
Financial collateral means collateral approved by both the credit
union and the counterparty as part of the collateral agreement in
recognition of credit risk mitigation for derivative contracts.
First-lien residential real estate loan means a loan or line of
credit primarily secured by a first-lien on a one-to-four family
residential property where:
(1) The credit union made a reasonable and good faith determination
at or before consummation of the loan that the member will have a
reasonable ability to repay the loan according to its terms; and
(2) In transactions where the credit union holds the first-lien and
junior lien(s), and no other party holds an intervening lien, for
purposes of this part the combined balance will be treated as a single
first-lien residential real estate loan.
GAAP means generally accepted accounting principles in the United
States as set forth in the Financial Accounting Standards Board's
(FASB) Accounting Standards Codification (ASC).
General account permanent insurance means an account into which all
premiums, except those designated for separate accounts are deposited,
including premiums for life insurance and fixed annuities and the fixed
portfolio of variable annuities, whereby the general assets of the
insurance company support the policy.
General obligation means a bond or similar obligation that is
backed by the full faith and credit of a public sector entity.
Goodwill means an intangible asset, maintained in accordance with
GAAP, representing the future economic benefits arising from other
assets acquired in a business combination (e.g., merger) that are not
individually identified and separately recognized. Goodwill does not
include excluded goodwill.
Government guarantee means a guarantee provided by the U.S.
Government, FDIC, NCUA or other U.S. Government agency, or a public
sector entity.
Government-sponsored enterprise (GSE) means an entity established
or chartered by the U.S. Government to serve public purposes specified
by the U.S. Congress, but whose debt obligations are not explicitly
guaranteed by the full faith and credit of the U.S. Government.
Guarantee means a financial guarantee, letter of credit, insurance,
or similar financial instrument that allows one party to transfer the
credit risk of one or more specific exposures to another party.
Identified losses means those items that have been determined by an
evaluation made by NCUA, or in the case of a state chartered credit
union the appropriate state official, as measured on the date of
examination in accordance with GAAP, to be chargeable against income,
equity or valuation allowances such as the allowances for loan and
lease losses. Examples of identified losses would be assets classified
as losses, off-balance sheet items classified as losses, any provision
expenses that are necessary to replenish valuation allowances to an
adequate level, liabilities not shown on the books, estimated losses in
contingent liabilities, and differences in accounts that represent
shortages.
Industrial development bond means a security issued under the
auspices of a state or other political subdivision for the benefit of a
private party or enterprise where that party or enterprise, rather than
the government entity, is obligated to pay the principal and interest
on the obligation.
Intangible assets mean assets, maintained in accordance with GAAP,
other than financial assets, that lack physical substance.
Investment fund means an investment with a pool of underlying
investment assets. Investment fund includes an investment company that
is registered under section 8 of the Investment Company Act of 1940,
and collective investment funds or common trust investments that are
unregistered investment products that pool fiduciary client assets to
invest in a diversified pool of investments.
Junior-lien residential real estate loan means a loan or line of
credit secured by a subordinate lien on a one-to-four family
residential property.
Loan secured by real estate means a loan that, at origination, is
secured wholly or substantially by a lien(s) on real property for which
the lien(s) is central to the extension of the credit. A lien is
``central'' to the extension of credit if the borrowers would not have
been extended credit in the same amount or on terms as favorable
without the liens on real property. For a loan to be ``secured wholly
or substantially by a lien(s) on real property,'' the estimated value
of the real estate collateral at origination (after deducting any more
senior liens held by others) must be greater than 50 percent of the
principal amount of the loan at origination.
Loan to a CUSO means the outstanding balance of any loan from a
credit union to a CUSO as recorded on the statement of financial
condition in accordance with GAAP.
Loans transferred with limited recourse means the total principal
balance outstanding of loans transferred, including participations, for
which the transfer qualified for true sale accounting treatment under
GAAP, and for which the transferor credit union retained some limited
recourse (i.e., insufficient recourse to preclude true sale accounting
treatment). Loans transferred with limited recourse excludes transfers
that qualify for true sale accounting treatment but contain only
routine representation and warranty clauses that are standard for sales
on the secondary market, provided the credit union is in compliance
with all other related requirements, such as capital requirements.
Mortgage-backed security (MBS) means a security backed by first- or
junior-lien mortgages secured by real estate upon which is located a
dwelling, mixed residential and commercial structure, residential
manufactured home, or commercial structure.
Mortgage partnership finance program means a Federal Home Loan Bank
program through which loans are originated by a depository institution
that are purchased or funded by the Federal Home Loan Banks, where the
depository institution receives fees for managing the credit risk of
the loans. The credit risk must be shared between the depository
institution and the Federal Home Loan Banks.
Mortgage servicing assets mean those assets, maintained in
accordance with GAAP, resulting from contracts to service loans secured
by real estate (that have been securitized or owned by others) for
which the benefits of servicing are expected to more than adequately
compensate the servicer for performing the servicing.
NCUSIF means the National Credit Union Share Insurance Fund as
defined by 12 U.S.C. 1783.
Net worth means:
(1) The retained earnings balance of the credit union at quarter-
end as determined under GAAP, subject to paragraph (3) of this
definition.
(2) For a low income-designated credit union, net worth also
includes secondary capital accounts that are uninsured and subordinate
to all other claims, including claims of creditors, shareholders, and
the NCUSIF.
(3) For a credit union that acquires another credit union in a
mutual combination, net worth also includes the retained earnings of
the acquired credit union, or of an integrated set of activities and
assets, less any bargain purchase gain recognized in either case
[[Page 66709]]
to the extent the difference between the two is greater than zero. The
acquired retained earnings must be determined at the point of
acquisition under GAAP. A mutual combination, including a supervisory
combination, is a transaction in which a credit union acquires another
credit union or acquires an integrated set of activities and assets
that is capable of being conducted and managed as a credit union.
(4) The term ``net worth'' also includes loans to and accounts in
an insured credit union, established pursuant to section 208 of the Act
[12 U.S.C. 1788], provided such loans and accounts:
(i) Have a remaining maturity of more than 5 years;
(ii) Are subordinate to all other claims including those of
shareholders, creditors, and the NCUSIF;
(iii) Are not pledged as security on a loan to, or other obligation
of, any party;
(iv) Are not insured by the NCUSIF;
(v) Have non-cumulative dividends;
(vi) Are transferable; and
(vii) Are available to cover operating losses realized by the
insured credit union that exceed its available retained earnings.
Net worth ratio means the ratio of the net worth of the credit
union to the total assets of the credit union rounded to two decimal
places.
New credit union has the same meaning as in Sec. 702.201.
Nonperpetual capital has the same meaning as in Sec. 704.2 of this
chapter.
Off-balance sheet exposure means:
(1) For loans transferred under the Federal Home Loan Bank mortgage
partnership finance program, the outstanding loan balance as of the
reporting date, net of any related valuation allowance.
(2) For all other loans transferred with limited recourse or other
seller-provided credit enhancements and that qualify for true sales
accounting, the maximum contractual amount the credit union is exposed
to according to the agreement, net of any related valuation allowance.
(3) For unfunded commitments, the remaining unfunded portion of the
contractual agreement.
Off-balance sheet items means items such as commitments, contingent
items, guarantees, certain repo-style transactions, financial standby
letters of credit, and forward agreements that are not included on the
statement of financial condition, but are normally reported in the
financial statement footnotes.
On-balance sheet means a credit union's assets, liabilities, and
equity, as disclosed on the statement of financial condition at a
specific point in time.
Other intangible assets means intangible assets, other than
servicing assets and goodwill, maintained in accordance with GAAP.
Other intangible assets does not include excluded other intangible
assets.
Over-the-counter (OTC) interest rate derivative contract means a
derivative contract that is not cleared on an exchange.
Part 703 compliant investment fund means an investment fund that is
restricted to holding only investments that are permissible under Sec.
703.14(c) of this chapter.
Perpetual contributed capital has the same meaning as in Sec.
704.2 of this chapter.
Public sector entity (PSE) means a state, local authority, or other
governmental subdivision of the United States below the sovereign
level.
Qualifying master netting agreement means a written, legally
enforceable agreement, provided that:
(1) The agreement creates a single legal obligation for all
individual transactions covered by the agreement upon an event of
default, including upon an event of conservatorship, receivership,
insolvency, liquidation, or similar proceeding, of the counterparty;
(2) The agreement provides the credit union the right to
accelerate, terminate, and close out on a net basis all transactions
under the agreement and to liquidate or set off collateral promptly
upon an event of default, including upon an event of conservatorship,
receivership, insolvency, liquidation, or similar proceeding, of the
counterparty, provided that, in any such case, any exercise of rights
under the agreement will not be stayed or avoided under applicable law
in the relevant jurisdictions, other than in receivership,
conservatorship, resolution under the Federal Deposit Insurance Act,
Title II of the Dodd-Frank Wall Street Reform and Consumer Protection
Act, or under any similar insolvency law applicable to GSEs;
(3) The agreement does not contain a walkaway clause (that is, a
provision that permits a non-defaulting counterparty to make a lower
payment than it otherwise would make under the agreement, or no payment
at all, to a defaulter or the estate of a defaulter, even if the
defaulter or the estate is a net creditor under the agreement); and
(4) In order to recognize an agreement as a qualifying master
netting agreement for purposes of this part, a credit union must
conduct sufficient legal review, at origination and in response to any
changes in applicable law, to conclude with a well-founded basis (and
maintain sufficient written documentation of that legal review) that:
(i) The agreement meets the requirements of paragraph (2) of this
definition; and
(ii) In the event of a legal challenge (including one resulting
from default or from conservatorship, receivership, insolvency,
liquidation, or similar proceeding), the relevant court and
administrative authorities would find the agreement to be legal, valid,
binding, and enforceable under the law of relevant jurisdictions.
Recourse means a credit union's retention, in form or in substance,
of any credit risk directly or indirectly associated with an asset it
has transferred that exceeds a pro rata share of that credit union's
claim on the asset and disclosed in accordance with GAAP. If a credit
union has no claim on an asset it has transferred, then the retention
of any credit risk is recourse. A recourse obligation typically arises
when a credit union transfers assets in a sale and retains an explicit
obligation to repurchase assets or to absorb losses due to a default on
the payment of principal or interest or any other deficiency in the
performance of the underlying obligor or some other party. Recourse may
also exist implicitly if the credit union provides credit enhancement
beyond any contractual obligation to support assets it has transferred.
Residential mortgage-backed security means a mortgage-backed
security backed by loans secured by a first-lien on residential
property.
Residential property means a house, condominium unit, cooperative
unit, manufactured home, or the construction thereof, and unimproved
land zoned for one-to-four family residential use. Residential property
excludes boats or motor homes, even if used as a primary residence, or
timeshare property.
Restructured means, with respect to any loan, a restructuring of
the loan in which a credit union, for economic or legal reasons related
to a borrower's financial difficulties, grants a concession to the
borrower that it would not otherwise consider. Restructured excludes
loans modified or restructured solely pursuant to the U.S. Treasury's
Home Affordable Mortgage Program.
Revenue obligation means a bond or similar obligation that is an
obligation of a PSE, but which the PSE is committed to repay with
revenues from the specific project financed rather than general tax
funds.
Risk-based capital ratio means the percentage, rounded to two
decimal places, of the risk-based capital ratio numerator to risk-
weighted assets, as
[[Page 66710]]
calculated in accordance with Sec. 702.104(a).
Risk-weighted assets means the total risk-weighted assets as
calculated in accordance with Sec. 702.104(c).
Secured consumer loan means a consumer loan associated with
collateral or other item of value to protect against loss where the
creditor has a perfected security interest in the collateral or other
item of value.
Senior executive officer means a senior executive officer as
defined by Sec. 701.14(b)(2) of this chapter.
Separate account insurance means an account into which a
policyholder's cash surrender value is supported by assets segregated
from the general assets of the carrier.
Shares means deposits, shares, share certificates, share drafts, or
any other depository account authorized by federal or state law.
Share-secured loan means a loan fully secured by shares, and does
not include the imposition of a statutory lien under Sec. 701.39 of
this chapter.
STRIPS means a separately traded registered interest and principal
security.
Structured product means an investment that is linked, via return
or loss allocation, to another investment or reference pool.
Subordinated means, with respect to an investment, that the
investment has a junior claim on the underlying collateral or assets to
other investments in the same issuance. An investment that does not
have a junior claim to other investments in the same issuance on the
underlying collateral or assets is non-subordinated. A Security that is
junior only to money market eligible securities in the same issuance is
also non-subordinated.
Supervisory merger or combination means a transaction that involved
the following:
(1) An assisted merger or purchase and assumption where funds from
the NCUSIF were provided to the continuing credit union;
(2) A merger or purchase and assumption classified by NCUA as an
``emergency merger'' where the acquired credit union is either
insolvent or ``in danger of insolvency'' as defined under appendix B to
Part 701 of this chapter; or
(3) A merger or purchase and assumption that included NCUA's or the
appropriate state official's identification and selection of the
continuing credit union.
Swap dealer has the meaning as defined by the Commodity Futures
Trading Commission in 17 CFT 1.3(ggg).
Total assets means a credit union's total assets as measured \1\ by
either:
---------------------------------------------------------------------------
\1\ For each quarter, a credit union must elect one of the
measures of total assets listed in paragraph (2) of this definition
to apply for all purposes under this part except Sec. Sec. 702.103
through 702.106 (risk-based capital requirement).
---------------------------------------------------------------------------
(1) Average quarterly balance. The credit union's total assets
measured by the average of quarter-end balances of the current and
three preceding calendar quarters;
(2) Average monthly balance. The credit union's total assets
measured by the average of month-end balances over the three calendar
months of the applicable calendar quarter;
(3) Average daily balance. The credit union's total assets measured
by the average daily balance over the applicable calendar quarter; or
(4) Quarter-end balance. The credit union's total assets measured
by the quarter-end balance of the applicable calendar quarter as
reported on the credit union's Call Report.
Tranche means one of a number of related securities offered as part
of the same transaction. Tranche includes a structured product if it
has a loss allocation based off of an investment or reference pool.
Unsecured consumer loan means a consumer loan not secured by
collateral.
U.S. Government agency means an instrumentality of the U.S.
Government whose obligations are fully and explicitly guaranteed as to
the timely payment of principal and interest by the full faith and
credit of the U.S. Government. U.S. Government agency includes NCUA.
Subpart A--Prompt Corrective Action
Sec. 702.101 Capital measures, capital adequacy, effective date of
classification, and notice to NCUA.
(a) Capital measures. For purposes of this part, a credit union
must determine its capital classification at the end of each calendar
quarter using the following measures:
(1) The net worth ratio; and
(2) If determined to be applicable under Sec. 702.103, the risk-
based capital ratio.
(b) Capital adequacy. (1) Notwithstanding the minimum requirements
in this part, a credit union defined as complex must maintain capital
commensurate with the level and nature of all risks to which the
institution is exposed.
(2) A credit union defined as complex must have a process for
assessing its overall capital adequacy in relation to its risk profile
and a comprehensive written strategy for maintaining an appropriate
level of capital.
(c) Effective date of capital classification. For purposes of this
part, the effective date of a federally insured credit union's capital
classification shall be the most recent to occur of:
(1) Quarter-end effective date. The last day of the calendar month
following the end of the calendar quarter;
(2) Corrected capital classification. The date the credit union
received subsequent written notice from NCUA or, if state-chartered,
from the appropriate state official, of a decline in capital
classification due to correction of an error or misstatement in the
credit union's most recent Call Report; or
(3) Reclassification to lower category. The date the credit union
received written notice from NCUA or, if state-chartered, the
appropriate state official, of reclassification on safety and soundness
grounds as provided under Sec. Sec. 702.102(b) or 702. 202(d).
(d) Notice to NCUA by filing Call Report. (1) Other than by filing
a Call Report, a federally insured credit union need not notify the
NCUA Board of a change in its capital measures that places the credit
union in a lower capital category;
(2) Failure to timely file a Call Report as required under this
section in no way alters the effective date of a change in capital
classification under paragraph (b) of this section, or the affected
credit union's corresponding legal obligations under this part.
Sec. 702.102 Capital classification.
(a) Capital categories. Except for credit unions defined as ``new''
under subpart B of this part, a credit union shall be deemed to be
classified (Table 1 of this section)--
(1) Well capitalized if:
(i) Net worth ratio. The credit union has a net worth ratio of 7.0
percent or greater; and
(ii) Risk-based capital ratio. The credit union, if complex, has a
risk-based capital ratio of 10 percent or greater.
(2) Adequately capitalized if:
(i) Net worth ratio. The credit union has a net worth ratio of 6.0
percent or greater; and
(ii) Risk-based capital ratio. The credit union, if complex, has a
risk-based capital ratio of 8.0 percent or greater; and
(iii) Does not meet the definition of a well capitalized credit
union.
(3) Undercapitalized if:
(i) Net worth ratio. The credit union has a net worth ratio of 4.0
percent or more but less than 6.0 percent; or
(ii) Risk-based capital ratio. The credit union, if complex, has a
risk-based capital ratio of less than 8.0 percent.
[[Page 66711]]
(4) Significantly undercapitalized if:
(i) The credit union has a net worth ratio of 2.0 percent or more
but less than 4.0 percent; or
(ii) The credit union has a net worth ratio of 4.0 percent or more
but less than 5.0 percent, and either--
(A) Fails to submit an acceptable net worth restoration plan within
the time prescribed in Sec. 702.110;
(B) Materially fails to implement a net worth restoration plan
approved by the NCUA Board; or
(C) Receives notice that a submitted net worth restoration plan has
not been approved.
(5) Critically undercapitalized if it has a net worth ratio of less
than 2.0 percent.
Table 1 to Sec. 702.102--Capital Categories
----------------------------------------------------------------------------------------------------------------
Risk-based capital
A credit union's capital ratio also And subject to following
classification is . . . Net worth ratio applicable if condition(s) . . .
complex
----------------------------------------------------------------------------------------------------------------
Well Capitalized................. 7% or greater....... And 10.0% or greater .........................
Adequately Capitalized........... 6% or greater....... And 8% or greater....... And does not meet the
criteria to be
classified as well
capitalized.
Undercapitalized................. 4% to 5.99%......... Or Less than 8%........ .........................
Significantly Undercapitalized... 2% to 3.99%......... ...... N/A................. Or if ``undercapitalized
at <5% net worth and (a)
fails to timely submit,
(b) fails to materially
implement, or (c)
receives notice of the
rejection of a net worth
restoration plan.
Critically Undercapitalized...... Less than 2%........ ...... N/A .........................
----------------------------------------------------------------------------------------------------------------
(b) Reclassification based on supervisory criteria other than net
worth. The NCUA Board may reclassify a well capitalized credit union as
adequately capitalized and may require an adequately capitalized or
undercapitalized credit union to comply with certain mandatory or
discretionary supervisory actions as if it were classified in the next
lower capital category (each of such actions hereinafter referred to
generally as ``reclassification'') in the following circumstances:
(1) Unsafe or unsound condition. The NCUA Board has determined,
after providing the credit union with notice and opportunity for
hearing pursuant to Sec. 747.2003 of this chapter, that the credit
union is in an unsafe or unsound condition; or
(2) Unsafe or unsound practice. The NCUA Board has determined,
after providing the credit union with notice and opportunity for
hearing pursuant to Sec. 747.2003 of this chapter, that the credit
union has not corrected a material unsafe or unsound practice of which
it was, or should have been, aware.
(c) Non-delegation. The NCUA Board may not delegate its authority
to reclassify a credit union under paragraph (b) of this section.
(d) Consultation with state officials. The NCUA Board shall consult
and seek to work cooperatively with the appropriate state official
before reclassifying a federally insured state-chartered credit union
under paragraph (b) of this section, and shall promptly notify the
appropriate state official of its decision to reclassify.
Sec. 702.103 Applicability of the risk-based capital ratio measure.
For purposes of Sec. 702.102, a credit union is defined as
``complex'' and the risk-based capital ratio measure is applicable only
if the credit union's quarter-end total assets exceed one hundred
million dollars ($100,000,000), as reflected in its most recent Call
Report.
Sec. 702.104 Risk-based capital ratio.
A complex credit union must calculate its risk-based capital ratio
in accordance with this section.
(a) Calculation of the risk-based capital ratio. To determine its
risk-based capital ratio, a complex credit union must calculate the
percentage, rounded to two decimal places, of its risk-based capital
ratio numerator as described in paragraph (b) of this section, to its
total risk-weighted assets as described in paragraph (c) of this
section.
(b) Risk-based capital ratio numerator. The risk-based capital
ratio numerator is the sum of the specific capital elements in
paragraph (b)(1) of this section, minus the regulatory adjustments in
paragraph (b)(2) of this section.
(1) Capital elements of the risk-based capital ratio numerator. The
capital elements of the risk-based capital numerator are:
(i) Undivided earnings;
(ii) Appropriation for non-conforming investments;
(iii) Other reserves;
(iv) Equity acquired in merger;
(v) Net income
(vi) ALLL, maintained in accordance with GAAP;
(vii) Secondary capital accounts included in net worth (as defined
in Sec. 702.2); and
(viii) Section 208 assistance included in net worth (as defined in
Sec. 702.2).
(2) Risk-based capital ratio numerator deductions. The elements
deducted from the sum of the capital elements of the risk-based capital
ratio numerator are:
(i) NCUSIF Capitalization Deposit;
(ii) Goodwill;
(iii) Other intangible assets; and
(iv) Identified losses not reflected in the risk-based capital
ratio numerator.
(c) Risk-weighted assets. (1) General. Risk-weighted assets
includes risk- weighted on-balance sheet assets as described in
paragraphs (c)(2) and (3) of this section, plus the risk-weighted off-
balance sheet assets in paragraph (c)(4) of this section, plus the
risk-weighted derivatives in paragraph (c)(5) of this section, less the
risk-based capital ratio numerator deductions in paragraph (b)(2) of
this section. If a particular asset, derivative contract, or off
balance sheet item has features or characteristics that suggest it
could potentially fit into more than one risk weight category, then a
credit union shall assign the asset, derivative contract, or off
balance sheet item to the risk weight category that most accurately and
appropriately reflects its associated credit risk.
(2) Risk weights for on-balance sheet assets. The risk categories
and weights for assets of a complex credit union are as follows:
(i) Category 1--zero percent risk weight. A credit union must
assign a zero percent risk weight to:
(A) The balance of:
(1) Cash, currency and coin, including vault, automatic teller
machine, and teller cash.
(2) share-secured loans, where the shares securing the loan are on
deposit with the credit union.
[[Page 66712]]
(B) The exposure amount of:
(1) An obligation of the U.S. Government, its central bank, or a
U.S. Government agency that is directly and unconditionally guaranteed,
excluding detached security coupons, ex-coupon securities, and
interest-only mortgage-backed-security STRIPS.
(2) Federal Reserve Bank stock and Central Liquidity Facility
stock.
(C) Insured balances due from FDIC-insured depositories or
federally insured credit unions.
(ii) Category 2--20 percent risk weight. A credit union must assign
a 20 percent risk weight to:
(A) The uninsured balances due from FDIC-insured depositories,
federally insured credit unions, and all balances due from privately-
insured credit unions.
(B) The exposure amount of:
(1) A non-subordinated obligation of the U.S. Government, its
central bank, or a U.S. Government agency that is conditionally
guaranteed, excluding interest-only mortgage-backed-security STRIPS.
(2) A non-subordinated obligation of a GSE other than an equity
exposure or preferred stock, excluding interest-only GSE mortgage-
backed-security STRIPS.
(3) Securities issued by PSEs that represent general obligation
securities.
(4) Part 703 compliant investment funds that are restricted to
holding only investments that qualify for a zero or 20 percent risk-
weight under this section.
(5) Federal Home Loan Bank stock.
(C) The balances due from Federal Home Loan Banks.
(D) The balance of share-secured loans, where the shares securing
the loan are on deposit with another depository institution.
(E) The portions of outstanding loans with a government guarantee.
(F) The portions of commercial loans secured with contractual
compensating balances.
(iii) Category 3--50 percent risk weight. A credit union must
assign a 50 percent risk weight to:
(A) The outstanding balance (net of government guarantees),
including loans held for sale, of current first-lien residential real
estate loans less than or equal to 35 percent of assets.
(B) The exposure amount of:
(1) Securities issued by PSEs in the U.S. that represent non-
subordinated revenue obligation securities.
(2) Other non-subordinated, non-U.S. Government agency or non-GSE
guaranteed, residential mortgage-backed security, excluding interest-
only mortgage-backed security STRIPS.
(iv) Category 4--75 percent risk weight. A credit union must assign
a 75 percent risk weight to the outstanding balance (net of government
guarantees), including loans held for sale, of:
(A) Current first-lien residential real estate loans greater than
35 percent of assets.
(B) Current secured consumer loans.
(v) Category 5--100 percent risk weight. A credit union must assign
a 100 percent risk weight to:
(A) The outstanding balance (net of government guarantees),
including loans held for sale, of:
(1) First-lien residential real estate loans that are not current.
(2) Current junior-lien residential real estate loans less than or
equal to 20 percent of assets.
(3) Current unsecured consumer loans.
(4) Current commercial loans, less contractual compensating
balances that comprise less than 50 percent of assets.
(5) Loans to CUSOs.
(B) The exposure amount of:
(1) Industrial development bonds.
(2) Interest-only mortgage-backed security STRIPS.
(3) Part 703 compliant investment funds, with the option to use the
look-through approaches in paragraph (c)(3)(iii)(B) of this section.
(4) Corporate debentures and commercial paper.
(5) Nonperpetual capital at corporate credit unions.
(6) General account permanent insurance.
(7) GSE equity exposure or preferred stock.
(8) Non-subordinated tranches of any investment, with the option to
use the gross-up approach in paragraph (c)(3)(iii)(A) of this section.
(C) All other assets listed on the statement of financial condition
not specifically assigned a different risk weight under this subpart.
(vi) Category 6--150 percent risk weight. A credit union must
assign a 150 percent risk weight to:
(A) The outstanding balance, net of government guarantees and
including loans held for sale, of:
(1) Current junior-lien residential real estate loans that comprise
more than 20 percent of assets.
(2) Junior-lien residential real estate loans that are not current.
(3) Consumer loans that are not current.
(4) Current commercial loans (net of contractual compensating
balances), which comprise more than 50 percent of assets.
(5) Commercial loans (net of contractual compensating balances),
which are not current.
(B) The exposure amount of:
(1) Perpetual contributed capital at corporate credit unions.
(2) Equity investments in CUSOs.
(vii) Category 7--250 percent risk weight. A credit union must
assign a 250 percent risk weight to the carrying value of mortgage
servicing assets.
(viii) Category 8--300 percent risk weight. A credit union must
assign a 300 percent risk weight to the exposure amount of:
(A) Publicly traded equity investments, other than a CUSO
investment.
(B) Investment funds that do not meet the requirements under Sec.
703.14(c) of this chapter, with the option to use the look-through
approaches in paragraph (c)(3)(iii)(B) of this section.
(C) Separate account insurance, with the option to use the look-
through approaches in paragraph (c)(3)(iii)(B) of this section.
(ix) Category 9--400 percent risk weight. A credit union must
assign a 400 percent risk weight to the exposure amount of non-publicly
traded equity investments, other than equity investments in CUSOs.
(x) Category 10--1,250 percent risk weight. A credit union must
assign a 1,250 percent risk weight to the exposure amount of any
subordinated tranche of any investment, with the option to use the
gross-up approach in paragraph (c)(3)(iii)(A) of this section.
(3) Alternative risk weights for certain on-balance sheet assets--
(i) Non-significant equity exposures.-- (A) General. Notwithstanding
the risk weights assigned in paragraph (c)(2) of this section, a credit
union must assign a 100 percent risk weight to non-significant equity
exposures.
(B) Determination of non-significant equity exposures. A credit
union has non-significant equity exposures if the aggregate amount of
its equity exposures does not exceed 10 percent of the sum of the
credit union's capital elements of the risk-based capital ratio
numerator (as defined under paragraph (b)(1) of this section).
(C) Determination of the aggregate amount of equity exposures. When
determining the aggregate amount of its equity exposures, a credit
union must include the total amounts (as recorded on the statement of
financial condition in accordance with GAAP) of the following:
(1) Equity investments in CUSOs,
(2) Perpetual contributed capital at corporate credit unions,
(3) Nonperpetual capital at corporate credit unions, and
(4) Equity investments subject to a risk weight in excess of 100
percent.
(ii) Charitable donation accounts. Notwithstanding the risk weights
[[Page 66713]]
assigned in paragraph (c)(2) of this section, a credit union may assign
a 100 percent risk weight to a charitable donation account.
(iii) Alternative approaches. Notwithstanding the risk weights
assigned in paragraph (c)(2) of this section, a credit union may
determine the risk weight of investment funds, and non-subordinated or
subordinated tranches of any investment as follows:
(A) Gross-up approach. A credit union may use the gross-up approach
under appendix A of this part to determine the risk weight of the
carrying value of non-subordinated or subordinated tranches of any
investment.
(B) Look-through approaches. A credit union may use one of the
look-through approaches under appendix A of this part to determine the
risk weight of the exposure amount of any investment funds, the
holdings of separate account insurance, or both.
(4) Risk weights for off-balance sheet activities. The risk
weighted amounts for all off-balance sheet items are determined by
multiplying the off-balance sheet exposure amount by the appropriate
CCF and the assigned risk weight as follows:
(i) For the outstanding balance of loans transferred to a Federal
Home Loan Bank under the mortgage partnership finance program, a 20
percent CCF and a 50 percent risk weight.
(ii) For other loans transferred with limited recourse, a 100
percent CCF applied to the off-balance sheet exposure and:
(A) For commercial loans, a 100 percent risk weight.
(B) For first-lien residential real estate loans, a 50 percent risk
weight.
(C) For junior-lien residential real estate loans, a 100 percent
risk weight.
(D) For all secured consumer loans, a 75 percent risk weight.
(E) For all unsecured consumer loans, a 100 percent risk weight.
(iii) For unfunded commitments:
(A) For commercial loans, a 50 percent CCF with a 100 percent risk
weight.
(B) For first-lien residential real estate loans, a 10 percent CCF
with a 50 percent risk weight.
(C) For junior-lien residential real estate loans, a 10 percent CCF
with a 100 percent risk weight.
(D) For all secured consumer loans, a 10 percent CCF with a 75
percent risk weight.
(E) For all unsecured consumer loans, a 10 percent CCF with a 100
percent risk weight.
(5) Derivative contracts. A complex credit union must assign a
risk-weighted amount to any derivative contracts as determined under
Sec. 702.105.
Sec. 702.105 Derivative contracts.
(a) OTC interest rate derivative contracts--(1) Exposure amount--
(i) Single OTC interest rate derivative contract. Except as modified by
paragraph (a)(2) of this section, the exposure amount for a single OTC
interest rate derivative contract that is not subject to a qualifying
master netting agreement is equal to the sum of the credit union's
current credit exposure and potential future credit exposure (PFE) on
the OTC interest rate derivative contract.
(A) Current credit exposure. The current credit exposure for a
single OTC interest rate derivative contract is the greater of the fair
value of the OTC interest rate derivative contract or zero.
(B) PFE. (1) The PFE for a single OTC interest rate derivative
contract, including an OTC interest rate derivative contract with a
negative fair value, is calculated by multiplying the notional
principal amount of the OTC interest rate derivative contract by the
appropriate conversion factor in Table 1 of this section.
(2) A credit union must use an OTC interest rate derivative
contract's effective notional principal amount (that is, the apparent
or stated notional principal amount multiplied by any multiplier in the
OTC interest rate derivative contract) rather than the apparent or
stated notional principal amount in calculating PFE.
Table 1 to Sec. 702.105--Conversion Factor Matrix for Interest Rate
Derivative Contracts \2\
------------------------------------------------------------------------
Conversion
Remaining maturity factor
------------------------------------------------------------------------
One year or less........................................... 0.00
Greater than one year and less than or equal to five years. 0.005
Greater than five years.................................... 0.015
------------------------------------------------------------------------
(ii) Multiple OTC interest rate derivative contracts subject to a
qualifying master netting agreement. Except as modified by paragraph
(a)(2) of this section, the exposure amount for multiple OTC interest
rate derivative contracts subject to a qualifying master netting
agreement is equal to the sum of the net current credit exposure and
the adjusted sum of the PFE amounts for all OTC interest rate
derivative contracts subject to the qualifying master netting
agreement.
---------------------------------------------------------------------------
\2\ Non-interest rate derivative contracts are addressed in
paragraph (d) of this section.
---------------------------------------------------------------------------
(A) Net current credit exposure. The net current credit exposure is
the greater of the net sum of all positive and negative fair value of
the individual OTC interest rate derivative contracts subject to the
qualifying master netting agreement or zero.
(B) Adjusted sum of the PFE amounts (Anet). The adjusted sum of the
PFE amounts is calculated as Anet = (0.4 x Agross) + (0.6 x NGR x
Agross), where:
(1) Agross equals the gross PFE (that is, the sum of the PFE
amounts as determined under paragraph (a)(1)(i)(B) of this section for
each individual derivative contract subject to the qualifying master
netting agreement); and
(2) Net-to-gross Ratio (NGR) equals the ratio of the net current
credit exposure to the gross current credit exposure. In calculating
the NGR, the gross current credit exposure equals the sum of the
positive current credit exposures (as determined under paragraph
(a)(1)(i) of this section) of all individual derivative contracts
subject to the qualifying master netting agreement.
(2) Recognition of credit risk mitigation of collateralized OTC
derivative contracts. A credit union may recognize credit risk
mitigation benefits of financial collateral that secures an OTC
derivative contract or multiple OTC derivative contracts subject to a
qualifying master netting agreement (netting set) by following the
requirements of paragraph (c) of this section.
(b) Cleared transactions for interest rate derivatives. (1) General
requirements--A credit union must use the methodologies described in
paragraph (b) of this section to calculate risk-weighted assets for a
cleared transaction.
(2) Risk-weighted assets for cleared transactions. (i) To determine
the risk weighted asset amount for a cleared transaction, a credit
union must multiply the trade exposure amount for the cleared
transaction, calculated in accordance with paragraph (b)(3) of this
section, by the risk weight appropriate for the cleared transaction,
determined in accordance with paragraph (b)(4) of this section.
(ii) A credit union's total risk-weighted assets for cleared
transactions is the sum of the risk-weighted asset amounts for all its
cleared transactions.
(3) Trade exposure amount. For a cleared transaction the trade
exposure amount equals:
(i) The exposure amount for the derivative contract or netting set
of derivative contracts, calculated using the methodology used to
calculate
[[Page 66714]]
exposure amount for OTC interest rate derivative contracts under
paragraph (a) of this section; plus
(ii) The fair value of the collateral posted by the credit union
and held by the, clearing member, or custodian.
(4) Cleared transaction risk weights. A credit union must apply a
risk weight of:
(i) Two percent if the collateral posted by the credit union to the
DCO or clearing member is subject to an arrangement that prevents any
losses to the credit union due to the joint default or a concurrent
insolvency, liquidation, or receivership proceeding of the clearing
member and any other clearing member clients of the clearing member;
and the clearing member credit union has conducted sufficient legal
review to conclude with a well-founded basis (and maintains sufficient
written documentation of that legal review) that in the event of a
legal challenge (including one resulting from an event of default or
from liquidation, insolvency, or receivership proceedings) the relevant
court and administrative authorities would find the arrangements to be
legal, valid, binding and enforceable under the law of the relevant
jurisdictions; or
(ii) Four percent if the requirements of paragraph (b)(4)(i) are
not met.
(5) Recognition of credit risk mitigation of collateralized OTC
derivative contracts. A credit union may recognize the credit risk
mitigation benefits of financial collateral that secures a cleared
derivative contract by following the requirements of paragraph (c) of
this section.
(c) Recognition of credit risk mitigation of collateralized
interest rate derivative contracts. (1) A credit union may recognize
the credit risk mitigation benefits of financial collateral that
secures an OTC interest rate derivative contract or multiple interest
rate derivative contracts subject to a qualifying master netting
agreement (netting set) or clearing arrangement by using the simple
approach in paragraph (c)(3) of this section.
(2) As an alternative to the simple approach, a credit union may
recognize the credit risk mitigation benefits of financial collateral
that secures such a contract or netting set if the financial collateral
is marked-to-fair value on a daily basis and subject to a daily margin
maintenance requirement by applying a risk weight to the exposure as if
it were uncollateralized and adjusting the exposure amount calculated
under paragraph (a) or (b) of this section using the collateral
approach in paragraph (c)(3) of this section. The credit union must
substitute the exposure amount calculated under paragraphs (b) or (c)
of this section in the equation in paragraph (c)(3) of this section.
(3) Collateralized transactions--(i) General. A credit union may
use the approach in paragraph (c)(3)(ii) of this section to recognize
the risk-mitigating effects of financial collateral.
(ii) Simple collateralized derivatives approach. To qualify for the
simple approach, the financial collateral must meet the following
requirements:
(A) The collateral must be subject to a collateral agreement for at
least the life of the exposure;
(B) The collateral must be revalued at least every six months; and
(C) The collateral and the exposure must be denominated in the same
currency.
(iii) Risk weight substitution. (A) A credit union may apply a risk
weight to the portion of an exposure that is secured by the fair value
of financial collateral (that meets the requirements for the simple
collateralized approach of this section) based on the risk weight
assigned to the collateral as established under Sec. 702.104(c).
(B) A credit union must apply a risk weight to the unsecured
portion of the exposure based on the risk weight applicable to the
exposure under this subpart.
(iv) Exceptions to the 20 percent risk weight floor and other
requirements. Notwithstanding the simple collateralized derivatives
approach in paragraph (c)(3)(ii) of this section:
(A) A credit union may assign a zero percent risk weight to an
exposure to a derivatives contract that is marked-to-market on a daily
basis and subject to a daily margin maintenance requirement, to the
extent the contract is collateralized by cash on deposit.
(B) A credit union may assign a 10 percent risk weight to an
exposure to a derivatives contract that is marked-to-market daily and
subject to a daily margin maintenance requirement, to the extent that
the contract is collateralized by an exposure that qualifies for a zero
percent risk weight under Sec. 702.104(c)(2)(i).
(v) A credit union may assign a zero percent risk weight to the
collateralized portion of an exposure where:
(A) The financial collateral is cash on deposit; or
(B) The financial collateral is an exposure that qualifies for a
zero percent risk weight under Sec. 702.104(c)(2)(i), and the credit
union has discounted the fair value of the collateral by 20 percent.
(4) Collateral haircut approach. (i) A credit union may recognize
the credit risk mitigation benefits of financial collateral that
secures a collateralized derivative contract by using the standard
supervisory haircuts in paragraph (c)(3) of this section.
(ii) The collateral haircut approach applies to both OTC and
cleared interest rate derivatives contracts discussed in this section.
(iii) A credit union must determine the exposure amount for a
collateralized derivative contracts by setting the exposure amount
equal to the max {0,[(exposure amount - value of collateral) + (sum of
current fair value of collateral instruments * market price volatility
haircut of the collateral instruments)]{time} , where:
(A) The value of the exposure equals the exposure amount for OTC
interest rate derivative contracts (or netting set) calculated under
paragraphs (a)(1)(i) and (ii) of this section.
(B) The value of the exposure equals the exposure amount for
cleared interest rate derivative contracts (or netting set) calculated
under paragraph (b)(3) of this section.
(C) The value of the collateral is the sum of cash and all
instruments under the transaction (or netting set).
(D) The sum of current fair value of collateral instruments as of
the measurement date.
(E) A credit union must use the standard supervisory haircuts for
market price volatility in Table 2 to this section.
Table 2 to Sec. 702.105--Standard Supervisory Market Price Volatility
Haircuts
[Based on a 10 business-day holding period]
------------------------------------------------------------------------
Haircut (in percent)
assigned based on:
---------------------
Residual maturity Collateral risk
weight (in percent)
---------------------
Zero 20 or 50
------------------------------------------------------------------------
Less than or equal to 1 year...................... 0.5 1.0
Greater than 1 year and less than or equal to 5 2.0 3.0
years............................................
Greater than 5 years.............................. 4.0 6.0
---------------------
Cash collateral held.............................. Zero
Other exposure types.............................. 25.0
------------------------------------------------------------------------
(d) All other derivative contracts and transactions. Credit unions
must follow the requirements of the applicable provisions of 12 CFR
part 324, when assigning risk weights to exposure amounts for
derivatives contracts not addressed in paragraphs (a) or (b) of this
section.
[[Page 66715]]
Sec. 702.106 Prompt corrective action for adequately capitalized
credit unions.
(a) Earnings retention. Beginning on the effective date of
classification as adequately capitalized or lower, a federally insured
credit union must increase the dollar amount of its net worth quarterly
either in the current quarter, or on average over the current and three
preceding quarters, by an amount equivalent to at least 1/10th percent
(0.1%) of its total assets (or more by choice), until it is well
capitalized.
(b) Decrease in retention. Upon written application received no
later than 14 days before the quarter end, the NCUA Board, on a case-
by-case basis, may permit a credit union to increase the dollar amount
of its net worth by an amount that is less than the amount required
under paragraph (a) of this section, to the extent the NCUA Board
determines that such lesser amount:
(1) Is necessary to avoid a significant redemption of shares; and
(2) Would further the purpose of this part.
(c) Decrease by FISCU. The NCUA Board shall consult and seek to
work cooperatively with the appropriate state official before
permitting a federally insured state-chartered credit union to decrease
its earnings retention under paragraph (b) of this section.
(d) Periodic review. A decision under paragraph (b) of this section
to permit a credit union to decrease its earnings retention is subject
to quarterly review and revocation except when the credit union is
operating under an approved net worth restoration plan that provides
for decreasing its earnings retention as provided under paragraph (b)
of this section.
Sec. 702.107 Prompt corrective action for undercapitalized credit
unions.
(a) Mandatory supervisory actions by credit union. A credit union
which is undercapitalized must--
(1) Earnings retention. Increase net worth in accordance with Sec.
702.106;
(2) Submit net worth restoration plan. Submit a net worth
restoration plan pursuant to Sec. 702.111, provided however, that a
credit union in this category having a net worth ratio of less than
five percent (5%) which fails to timely submit such a plan, or which
materially fails to implement an approved plan, is classified
significantly undercapitalized pursuant to Sec. 702.102(a)(4)(i);
(3) Restrict increase in assets. Beginning the effective date of
classification as undercapitalized or lower, not permit the credit
union's assets to increase beyond its total assets for the preceding
quarter unless--
(i) Plan approved. The NCUA Board has approved a net worth
restoration plan which provides for an increase in total assets and--
(A) The assets of the credit union are increasing consistent with
the approved plan; and
(B) The credit union is implementing steps to increase the net
worth ratio consistent with the approved plan;
(ii) Plan not approved. The NCUA Board has not approved a net worth
restoration plan and total assets of the credit union are increasing
because of increases since quarter-end in balances of:
(A) Total accounts receivable and accrued income on loans and
investments; or
(B) Total cash and cash equivalents; or
(C) Total loans outstanding, not to exceed the sum of total assets
plus the quarter-end balance of unused commitments to lend and unused
lines of credit provided however that a credit union which increases a
balance as permitted under paragraphs (a)(3)(ii)(A), (B) or (C) of this
section cannot offer rates on shares in excess of prevailing rates on
shares in its relevant market area, and cannot open new branches;
(4) Restrict member business loans. Beginning the effective date of
classification as undercapitalized or lower, not increase the total
dollar amount of member business loans (defined as loans outstanding
and unused commitments to lend) as of the preceding quarter-end unless
it is granted an exception under 12 U.S.C. 1757a(b).
(b) Second tier discretionary supervisory actions by NCUA. Subject
to the applicable procedures for issuing, reviewing and enforcing
directives set forth in subpart L of part 747 of this chapter, the NCUA
Board may, by directive, take one or more of the following actions with
respect to an undercapitalized credit union having a net worth ratio of
less than five percent (5%), or a director, officer or employee of such
a credit union, if it determines that those actions are necessary to
carry out the purpose of this part:
(1) Requiring prior approval for acquisitions, branching, new lines
of business. Prohibit a credit union from, directly or indirectly,
acquiring any interest in any business entity or financial institution,
establishing or acquiring any additional branch office, or engaging in
any new line of business, unless the NCUA Board has approved the credit
union's net worth restoration plan, the credit union is implementing
its plan, and the NCUA Board determines that the proposed action is
consistent with and will further the objectives of that plan;
(2) Restricting transactions with and ownership of a CUSO. Restrict
the credit union's transactions with a CUSO, or require the credit
union to reduce or divest its ownership interest in a CUSO;
(3) Restricting dividends paid. Restrict the dividend rates the
credit union pays on shares to the prevailing rates paid on comparable
accounts and maturities in the relevant market area, as determined by
the NCUA Board, except that dividend rates already declared on shares
acquired before imposing a restriction under this paragraph may not be
retroactively restricted;
(4) Prohibiting or reducing asset growth. Prohibit any growth in
the credit union's assets or in a category of assets, or require the
credit union to reduce its assets or a category of assets;
(5) Alter, reduce or terminate activity. Require the credit union
or its CUSO to alter, reduce, or terminate any activity which poses
excessive risk to the credit union;
(6) Prohibiting nonmember deposits. Prohibit the credit union from
accepting all or certain nonmember deposits;
(7) Dismissing director or senior executive officer. Require the
credit union to dismiss from office any director or senior executive
officer, provided however, that a dismissal under this clause shall not
be construed to be a formal administrative action for removal under 12
U.S.C. 1786(g);
(8) Employing qualified senior executive officer. Require the
credit union to employ qualified senior executive officers (who, if the
NCUA Board so specifies, shall be subject to its approval); and
(9) Other action to carry out prompt corrective action. Restrict or
require such other action by the credit union as the NCUA Board
determines will carry out the purpose of this part better than any of
the actions prescribed in paragraphs (b)(1) through (8) of this
section.
(c) First tier application of discretionary supervisory actions. An
undercapitalized credit union having a net worth ratio of five percent
(5%) or more, or which is classified undercapitalized by reason of
failing to maintain a risk-based capital ratio equal to or greater than
8 percent under Sec. 702.104, is subject to the discretionary
supervisory actions in paragraph (b) of this section if it fails to
comply with any mandatory supervisory action in paragraph (a) of this
section or fails to timely implement an approved net worth restoration
plan under Sec. 702.111,
[[Page 66716]]
including meeting its prescribed steps to increase its net worth ratio.
Sec. 702.108 Prompt corrective action for significantly
undercapitalized credit unions.
(a) Mandatory supervisory actions by credit union. A credit union
which is significantly undercapitalized must--
(1) Earnings retention. Increase net worth in accordance with Sec.
702.106;
(2) Submit net worth restoration plan. Submit a net worth
restoration plan pursuant to Sec. 702.111;
(3) Restrict increase in assets. Not permit the credit union's
total assets to increase except as provided in Sec. 702.107(a)(3); and
(4) Restrict member business loans. Not increase the total dollar
amount of member business loans (defined as loans outstanding and
unused commitments to lend) as provided in Sec. 702.107(a)(4).
(b) Discretionary supervisory actions by NCUA. Subject to the
applicable procedures for issuing, reviewing and enforcing directives
set forth in subpart L of part 747 of this chapter, the NCUA Board may,
by directive, take one or more of the following actions with respect to
any significantly undercapitalized credit union, or a director, officer
or employee of such credit union, if it determines that those actions
are necessary to carry out the purpose of this part:
(1) Requiring prior approval for acquisitions, branching, new lines
of business. Prohibit a credit union from, directly or indirectly,
acquiring any interest in any business entity or financial institution,
establishing or acquiring any additional branch office, or engaging in
any new line of business, except as provided in Sec. 702.107(b)(1);
(2) Restricting transactions with and ownership of CUSO. Restrict
the credit union's transactions with a CUSO, or require the credit
union to divest or reduce its ownership interest in a CUSO;
(3) Restricting dividends paid. Restrict the dividend rates that
the credit union pays on shares as provided in Sec. 702.107(b)(3);
(4) Prohibiting or reducing asset growth. Prohibit any growth in
the credit union's assets or in a category of assets, or require the
credit union to reduce assets or a category of assets;
(5) Alter, reduce or terminate activity. Require the credit union
or its CUSO(s) to alter, reduce, or terminate any activity which poses
excessive risk to the credit union;
(6) Prohibiting nonmember deposits. Prohibit the credit union from
accepting all or certain nonmember deposits;
(7) New election of directors. Order a new election of the credit
union's board of directors;
(8) Dismissing director or senior executive officer. Require the
credit union to dismiss from office any director or senior executive
officer, provided however, that a dismissal under this clause shall not
be construed to be a formal administrative action for removal under 12
U.S.C. 1786(g);
(9) Employing qualified senior executive officer. Require the
credit union to employ qualified senior executive officers (who, if the
NCUA Board so specifies, shall be subject to its approval);
(10) Restricting senior executive officers' compensation. Except
with the prior written approval of the NCUA Board, limit compensation
to any senior executive officer to that officer's average rate of
compensation (excluding bonuses and profit sharing) during the four (4)
calendar quarters preceding the effective date of classification of the
credit union as significantly undercapitalized, and prohibit payment of
a bonus or profit share to such officer;
(11) Other actions to carry out prompt corrective action. Restrict
or require such other action by the credit union as the NCUA Board
determines will carry out the purpose of this part better than any of
the actions prescribed in paragraphs (b)(1) through (10) of this
section; and
(12) Requiring merger. Require the credit union to merge with
another financial institution if one or more grounds exist for placing
the credit union into conservatorship pursuant to 12 U.S.C.
1786(h)(1)(F), or into liquidation pursuant to 12 U.S.C.
1787(a)(3)(A)(i).
(c) Discretionary conservatorship or liquidation if no prospect of
becoming adequately capitalized. Notwithstanding any other actions
required or permitted to be taken under this section, when a credit
union becomes significantly undercapitalized (including by
reclassification under Sec. 702.102(b)), the NCUA Board may place the
credit union into conservatorship pursuant to 12 U.S.C. 1786(h)(1)(F),
or into liquidation pursuant to 12 U.S.C. 1787(a)(3)(A)(i), provided
that the credit union has no reasonable prospect of becoming adequately
capitalized.
Sec. 702.109 Prompt corrective action for critically undercapitalized
credit unions.
(a) Mandatory supervisory actions by credit union. A credit union
which is critically undercapitalized must--
(1) Earnings retention. Increase net worth in accordance with Sec.
702.106;
(2) Submit net worth restoration plan. Submit a net worth
restoration plan pursuant to Sec. 702.111;
(3) Restrict increase in assets. Not permit the credit union's
total assets to increase except as provided in Sec. 702.107(a)(3); and
(4) Restrict member business loans. Not increase the total dollar
amount of member business loans (defined as loans outstanding and
unused commitments to lend) as provided in Sec. 702.107(a)(4).
(b) Discretionary supervisory actions by NCUA. Subject to the
applicable procedures for issuing, reviewing and enforcing directives
set forth in subpart L of part 747 of this chapter, the NCUA Board may,
by directive, take one or more of the following actions with respect to
any critically undercapitalized credit union, or a director, officer or
employee of such credit union, if it determines that those actions are
necessary to carry out the purpose of this part:
(1) Requiring prior approval for acquisitions, branching, new lines
of business. Prohibit a credit union from, directly or indirectly,
acquiring any interest in any business entity or financial institution,
establishing or acquiring any additional branch office, or engaging in
any new line of business, except as provided by Sec. 702.107(b)(1);
(2) Restricting transactions with and ownership of CUSO. Restrict
the credit union's transactions with a CUSO, or require the credit
union to divest or reduce its ownership interest in a CUSO;
(3) Restricting dividends paid. Restrict the dividend rates that
the credit union pays on shares as provided in Sec. 702.107(b)(3);
(4) Prohibiting or reducing asset growth. Prohibit any growth in
the credit union's assets or in a category of assets, or require the
credit union to reduce assets or a category of assets;
(5) Alter, reduce or terminate activity. Require the credit union
or its CUSO(s) to alter, reduce, or terminate any activity which poses
excessive risk to the credit union;
(6) Prohibiting nonmember deposits. Prohibit the credit union from
accepting all or certain nonmember deposits;
(7) New election of directors. Order a new election of the credit
union's board of directors;
(8) Dismissing director or senior executive officer. Require the
credit union to dismiss from office any director or senior executive
officer, provided however, that a dismissal under this clause shall not
be construed to be a formal administrative action for removal under 12
U.S.C. 1786(g);
[[Page 66717]]
(9) Employing qualified senior executive officer. Require the
credit union to employ qualified senior executive officers (who, if the
NCUA Board so specifies, shall be subject to its approval);
(10) Restricting senior executive officers' compensation. Reduce
or, with the prior written approval of the NCUA Board, limit
compensation to any senior executive officer to that officer's average
rate of compensation (excluding bonuses and profit sharing) during the
four (4) calendar quarters preceding the effective date of
classification of the credit union as critically undercapitalized, and
prohibit payment of a bonus or profit share to such officer;
(11) Restrictions on payments on uninsured secondary capital.
Beginning 60 days after the effective date of classification of a
credit union as critically undercapitalized, prohibit payments of
principal, dividends or interest on the credit union's uninsured
secondary capital accounts established after August 7, 2000, except
that unpaid dividends or interest shall continue to accrue under the
terms of the account to the extent permitted by law;
(12) Requiring prior approval. Require a critically
undercapitalized credit union to obtain the NCUA Board's prior written
approval before doing any of the following:
(i) Entering into any material transaction not within the scope of
an approved net worth restoration plan (or approved revised business
plan under subpart C of this part);
(ii) Extending credit for transactions deemed highly leveraged by
the NCUA Board or, if state-chartered, by the appropriate state
official;
(iii) Amending the credit union's charter or bylaws, except to the
extent necessary to comply with any law, regulation, or order;
(iv) Making any material change in accounting methods; and
(v) Paying dividends or interest on new share accounts at a rate
exceeding the prevailing rates of interest on insured deposits in its
relevant market area;
(13) Other action to carry out prompt corrective action. Restrict
or require such other action by the credit union as the NCUA Board
determines will carry out the purpose of this part better than any of
the actions prescribed in paragraphs (b)(1) through (12) of this
section; and
(14) Requiring merger. Require the credit union to merge with
another financial institution if one or more grounds exist for placing
the credit union into conservatorship pursuant to 12 U.S.C.
1786(h)(1)(F), or into liquidation pursuant to 12 U.S.C.
1787(a)(3)(A)(i).
(c) Mandatory conservatorship, liquidation or action in lieu
thereof --(1) Action within 90 days. Notwithstanding any other actions
required or permitted to be taken under this section (and regardless of
a credit union's prospect of becoming adequately capitalized), the NCUA
Board must, within 90 calendar days after the effective date of
classification of a credit union as critically undercapitalized--
(i) Conservatorship. Place the credit union into conservatorship
pursuant to 12 U.S.C. 1786(h)(1)(G); or
(ii) Liquidation. Liquidate the credit union pursuant to 12 U.S.C.
1787(a)(3)(A)(ii); or
(iii) Other corrective action. Take other corrective action, in
lieu of conservatorship or liquidation, to better achieve the purpose
of this part, provided that the NCUA Board documents why such action in
lieu of conservatorship or liquidation would do so, provided however,
that other corrective action may consist, in whole or in part, of
complying with the quarterly timetable of steps and meeting the
quarterly net worth targets prescribed in an approved net worth
restoration plan.
(2) Renewal of other corrective action. A determination by the NCUA
Board to take other corrective action in lieu of conservatorship or
liquidation under paragraph (c)(1)(iii) of this section shall expire
after an effective period ending no later than 180 calendar days after
the determination is made, and the credit union shall be immediately
placed into conservatorship or liquidation under paragraphs (c)(1)(i)
and (ii) of this section, unless the NCUA Board makes a new
determination under paragraph (c)(1)(iii) of this section before the
end of the effective period of the prior determination;
(3) Mandatory liquidation after 18 months --(i) Generally.
Notwithstanding paragraphs (c)(1) and (2) of this section, the NCUA
Board must place a credit union into liquidation if it remains
critically undercapitalized for a full calendar quarter, on a monthly
average basis, following a period of 18 months from the effective date
the credit union was first classified critically undercapitalized.
(ii) Exception. Notwithstanding paragraph (c)(3)(i) of this
section, the NCUA Board may continue to take other corrective action in
lieu of liquidation if it certifies that the credit union--
(A) Has been in substantial compliance with an approved net worth
restoration plan requiring consistent improvement in net worth since
the date the net worth restoration plan was approved;
(B) Has positive net income or has an upward trend in earnings that
the NCUA Board projects as sustainable; and
(C) Is viable and not expected to fail.
(iii) Review of exception. The NCUA Board shall, at least
quarterly, review the certification of an exception to liquidation
under paragraph (c)(3)(ii) of this section and shall either--
(A) Recertify the credit union if it continues to satisfy the
criteria of paragraph (c)(3)(ii) of this section; or
(B) Promptly place the credit union into liquidation, pursuant to
12 U.S.C. 1787(a)(3)(A)(ii), if it fails to satisfy the criteria of
paragraph (c)(3)(ii) of this section.
(4) Nondelegation. The NCUA Board may not delegate its authority
under paragraph (c) of this section, unless the credit union has less
than $5,000,000 in total assets. A credit union shall have a right of
direct appeal to the NCUA Board of any decision made by delegated
authority under this section within ten (10) calendar days of the date
of that decision.
(d) Mandatory liquidation of insolvent federal credit union. In
lieu of paragraph (c) of this section, a critically undercapitalized
federal credit union that has a net worth ratio of less than zero
percent (0%) may be placed into liquidation on grounds of insolvency
pursuant to 12 U.S.C. 1787(a)(1)(A).
Sec. 702.110 Consultation with state officials on proposed prompt
corrective action.
(a) Consultation on proposed conservatorship or liquidation. Before
placing a federally insured state-chartered credit union into
conservatorship (pursuant to 12 U.S.C. 1786(h)(1)(F) or (G)) or
liquidation (pursuant to 12 U.S.C. 1787(a)(3)) as permitted or required
under subparts A or B of this part to facilitate prompt corrective
action--
(1) The NCUA Board shall seek the views of the appropriate state
official (as defined in Sec. 702.2), and give him or her an
opportunity to take the proposed action;
(2) The NCUA Board shall, upon timely request of the appropriate
state official, promptly provide him or her with a written statement of
the reasons for the proposed conservatorship or liquidation, and
reasonable time to respond to that statement; and
(3) If the appropriate state official makes a timely written
response that disagrees with the proposed conservatorship or
liquidation and gives reasons for that disagreement, the
[[Page 66718]]
NCUA Board shall not place the credit union into conservatorship or
liquidation unless it first considers the views of the appropriate
state official and determines that--
(i) The NCUSIF faces a significant risk of loss if the credit union
is not placed into conservatorship or liquidation; and
(ii) Conservatorship or liquidation is necessary either to reduce
the risk of loss, or to reduce the expected loss, to the NCUSIF with
respect to the credit union.
(b) Nondelegation. The NCUA Board may not delegate any
determination under paragraph (a)(3) of this section.
(c) Consultation on proposed discretionary action. The NCUA Board
shall consult and seek to work cooperatively with the appropriate state
official before taking any discretionary supervisory action under
Sec. Sec. 702.107(b), 702.108(b), 702.109(b), 702.204(b) and
702.205(b) with respect to a federally insured state-chartered credit
union; shall provide prompt notice of its decision to the appropriate
state official; and shall allow the appropriate state official to take
the proposed action independently or jointly with NCUA.
Sec. 702.111 Net worth restoration plans (NWRP).
(a) Schedule for filing--(1) Generally. A credit union shall file a
written net worth restoration plan (NWRP) with the appropriate Regional
Director and, if state-chartered, the appropriate state official,
within 45 calendar days of the effective date of classification as
either undercapitalized, significantly undercapitalized or critically
undercapitalized, unless the NCUA Board notifies the credit union in
writing that its NWRP is to be filed within a different period.
(2) Exception. An otherwise adequately capitalized credit union
that is reclassified undercapitalized on safety and soundness grounds
under Sec. 702.102(b) is not required to submit a NWRP solely due to
the reclassification, unless the NCUA Board notifies the credit union
that it must submit an NWRP.
(3) Filing of additional plan. Notwithstanding paragraph (a)(1) of
this section, a credit union that has already submitted and is
operating under a NWRP approved under this section is not required to
submit an additional NWRP due to a change in net worth category
(including by reclassification under Sec. 702.102(b)), unless the NCUA
Board notifies the credit union that it must submit a new NWRP. A
credit union that is notified to submit a new or revised NWRP shall
file the NWRP in writing with the appropriate Regional Director within
30 calendar days of receiving such notice, unless the NCUA Board
notifies the credit union in writing that the NWRP is to be filed
within a different period.
(4) Failure to timely file plan. When a credit union fails to
timely file an NWRP pursuant to this paragraph, the NCUA Board shall
promptly notify the credit union that it has failed to file an NWRP and
that it has 15 calendar days from receipt of that notice within which
to file an NWRP.
(b) Assistance to small credit unions. Upon timely request by a
credit union having total assets of less than $10 million (regardless
how long it has been in operation), the NCUA Board shall provide
assistance in preparing an NWRP required to be filed under paragraph
(a) of this section.
(c) Contents of NWRP. An NWRP must--
(1) Specify--
(i) A quarterly timetable of steps the credit union will take to
increase its net worth ratio, and risk-based capital ratio if
applicable, so that it becomes adequately capitalized by the end of the
term of the NWRP, and to remain so for four (4) consecutive calendar
quarters;
(ii) The projected amount of net worth increases in each quarter of
the term of the NWRP as required under Sec. 702.106(a), or as
permitted under Sec. 702.106(b);
(iii) How the credit union will comply with the mandatory and any
discretionary supervisory actions imposed on it by the NCUA Board under
this subpart;
(iv) The types and levels of activities in which the credit union
will engage; and
(v) If reclassified to a lower category under Sec. 702.102(b), the
steps the credit union will take to correct the unsafe or unsound
practice(s) or condition(s);
(2) Include pro forma financial statements, including any off-
balance sheet items, covering a minimum of the next two years; and
(3) Contain such other information as the NCUA Board has required.
(d) Criteria for approval of NWRP. The NCUA Board shall not accept
a NWRP plan unless it--
(1) Complies with paragraph (c) of this section;
(2) Is based on realistic assumptions, and is likely to succeed in
restoring the credit union's net worth; and
(3) Would not unreasonably increase the credit union's exposure to
risk (including credit risk, interest-rate risk, and other types of
risk).
(e) Consideration of regulatory capital. To minimize possible long-
term losses to the NCUSIF while the credit union takes steps to become
adequately capitalized, the NCUA Board shall, in evaluating an NWRP
under this section, consider the type and amount of any form of
regulatory capital which may become established by NCUA regulation, or
authorized by state law and recognized by NCUA, which the credit union
holds, but which is not included in its net worth.
(f) Review of NWRP--(1) Notice of decision. Within 45 calendar days
after receiving an NWRP under this part, the NCUA Board shall notify
the credit union in writing whether the NWRP has been approved, and
shall provide reasons for its decision in the event of disapproval.
(2) Delayed decision. If no decision is made within the time
prescribed in paragraph (f)(1) of this section, the NWRP is deemed
approved.
(3) Consultation with state officials. In the case of an NWRP
submitted by a federally insured state-chartered credit union (whether
an original, new, additional, revised or amended NWRP), the NCUA Board
shall, when evaluating the NWRP, seek and consider the views of the
appropriate state official, and provide prompt notice of its decision
to the appropriate state official.
(g) NWRP not approved --(1) Submission of revised NWRP. If an NWRP
is rejected by the NCUA Board, the credit union shall submit a revised
NWRP within 30 calendar days of receiving notice of disapproval, unless
it is notified in writing by the NCUA Board that the revised NWRP is to
be filed within a different period.
(2) Notice of decision on revised NWRP. Within 30 calendar days
after receiving a revised NWRP under paragraph (g)(1) of this section,
the NCUA Board shall notify the credit union in writing whether the
revised NWRP is approved. The Board may extend the time within which
notice of its decision shall be provided.
(3) Disapproval of reclassified credit union's NWRP. A credit union
which has been classified significantly undercapitalized shall remain
so classified pending NCUA Board approval of a new or revised NWRP.
(4) Submission of multiple unapproved NWRPs. The submission of more
than two NWRPs that are not approved is considered an unsafe and
unsound condition and may subject the credit union to administrative
enforcement actions under section 206 of the FCUA, 12 U.S.C. 1786 and
1790d.
(h) Amendment of NWRP. A credit union that is operating under an
approved NWRP may, after prior written notice to, and approval by the
NCUA Board, amend its NWRP to reflect a
[[Page 66719]]
change in circumstance. Pending approval of an amended NWRP, the credit
union shall implement the NWRP as originally approved.
(i) Publication. An NWRP need not be published to be enforceable
because publication would be contrary to the public interest.
(j) Termination of NWRP. For purposes of this part, an NWRP
terminates once the credit union is classified as adequately
capitalized and remains so for four consecutive quarters. For example,
if a credit union with an active NWRP attains the classification as
adequately classified on December 31, 2015 this would be quarter one
and the fourth consecutive quarter would end September 30, 2016.
Sec. 702.112 Reserves.
Each credit union shall establish and maintain such reserves as may
be required by the FCUA, by state law, by regulation, or in special
cases by the NCUA Board or appropriate state official.
Sec. 702.113 Full and fair disclosure of financial condition.
(a) Full and fair disclosure defined. ``Full and fair disclosure''
is the level of disclosure which a prudent person would provide to a
member of a credit union, to NCUA, or, at the discretion of the board
of directors, to creditors to fairly inform them of the financial
condition and the results of operations of the credit union.
(b) Full and fair disclosure implemented. The financial statements
of a credit union shall provide for full and fair disclosure of all
assets, liabilities, and members' equity, including such valuation
(allowance) accounts as may be necessary to present fairly the
financial condition; and all income and expenses necessary to present
fairly the statement of income for the reporting period.
(c) Declaration of officials. The Statement of Financial Condition,
when presented to members, to creditors or to NCUA, shall contain a
dual declaration by the treasurer and the chief executive officer, or
in the latter's absence, by any other officer designated by the board
of directors of the reporting credit union to make such declaration,
that the report and related financial statements are true and correct
to the best of their knowledge and belief and present fairly the
financial condition and the statement of income for the period covered.
(d) Charges for loan and lease losses. Full and fair disclosure
demands that a credit union properly address charges for loan losses as
follows:
(1) Charges for loan and lease losses shall be made timely and in
accordance with GAAP;
(2) The ALLL must be maintained in accordance with GAAP; and
(3) At a minimum, adjustments to the ALLL shall be made prior to
the distribution or posting of any dividend to the accounts of members.
Sec. 702.114 Payment of dividends.
(a) Restriction on dividends. Dividends shall be available only
from net worth, net of any special reserves established under Sec.
702.112, if any.
(b) Payment of dividends and interest refunds. The board of
directors must not pay a dividend or interest refund that will cause
the credit union's capital classification to fall below adequately
capitalized under this subpart unless the appropriate Regional Director
and, if state-chartered, the appropriate state official, have given
prior written approval (in an NWRP or otherwise). The request for
written approval must include the plan for eliminating any negative
retained earnings balance.
Subpart B--Alternative Prompt Corrective Action for New Credit
Unions
Sec. 702.201 Scope and definition.
(a) Scope. This subpart B applies in lieu of subpart A of this part
exclusively to credit unions defined in paragraph (b) of this section
as ``new'' pursuant to section 216(b)(2) of the FCUA, 12 U.S.C.
1790d(b)(2).
(b) New credit union defined. A ``new'' credit union for purposes
of this subpart is a credit union that both has been in operation for
less than ten (10) years and has total assets of not more than $10
million. Once a credit union reports total assets of more than $10
million on a Call Report, the credit union is no longer new, even if
its assets subsequently decline below $10 million.
(c) Effect of spin-offs. A credit union formed as the result of a
``spin-off'' of a group from the field of membership of an existing
credit union is deemed to be in operation since the effective date of
the spin-off. A credit union whose total assets decline below $10
million because a group within its field of membership has been spun-
off is deemed ``new'' if it has been in operation less than 10 years.
(d) Actions to evade prompt corrective action. If the NCUA Board
determines that a credit union was formed, or was reduced in asset size
as a result of a spin-off, or was merged, primarily to qualify as
``new'' under this subpart, the credit union shall be deemed subject to
prompt corrective action under subpart A of this part.
Sec. 702.202 Net worth categories for new credit unions.
(a) Net worth measures. For purposes of this part, a new credit
union must determine its capital classification quarterly according to
its net worth ratio.
(b) Effective date of net worth classification of new credit union.
For purposes of subpart B of this part, the effective date of a new
credit union's classification within a capital category in paragraph
(c) of this section shall be determined as provided in Sec.
702.101(c); and written notice of a decline in net worth classification
in paragraph (c) of this section shall be given as required by Sec.
702.101(c).
(c) Net worth categories. A credit union defined as ``new'' under
this section shall be classified--
(1) Well capitalized if it has a net worth ratio of seven percent
(7%) or greater;
(2) Adequately capitalized if it has a net worth ratio of six
percent (6%) or more but less than seven percent (7%);
(3) Moderately capitalized if it has a net worth ratio of three and
one-half percent (3.5%) or more but less than six percent (6%);
(4) Marginally capitalized if it has a net worth ratio of two
percent (2%) or more but less than three and one-half percent (3.5%);
(5) Minimally capitalized if it has a net worth ratio of zero
percent (0%) or greater but less than two percent (2%); and
(6) Uncapitalized if it has a net worth ratio of less than zero
percent (0%).
Table 1 to Sec. 702.202--Capital Categories for New Credit Unions
------------------------------------------------------------------------
A new credit union's capital
classification is If it's net worth ratio is
------------------------------------------------------------------------
Well Capitalized.......................... 7% or above.
Adequately Capitalized.................... 6 to 7%.
Moderately Capitalized.................... 3.5% to 5.99%.
Marginally Capitalized.................... 2% to 3.49%.
Minimally Capitalized..................... 0% to 1.99%.
Uncapitalized............................. Less than 0%.
------------------------------------------------------------------------
(d) Reclassification based on supervisory criteria other than net
worth. Subject to Sec. 702.102(b), the NCUA Board may reclassify a
well capitalized, adequately capitalized or moderately capitalized new
credit union to the next lower capital category (each of such actions
is hereinafter referred to generally as ``reclassification'') in either
of the circumstances prescribed in Sec. 702.102(b).
(e) Consultation with state officials. The NCUA Board shall consult
and seek to work cooperatively with the appropriate state official
before
[[Page 66720]]
reclassifying a federally insured state-chartered credit union under
paragraph (d) of this section, and shall promptly notify the
appropriate state official of its decision to reclassify.
Sec. 702.203 Prompt corrective action for adequately capitalized new
credit unions.
Beginning on the effective date of classification, an adequately
capitalized new credit union must increase the dollar amount of its net
worth by the amount reflected in its approved initial or revised
business plan in accordance with Sec. 702.204(a)(2), or in the absence
of such a plan, in accordance with Sec. 702.106 until it is well
capitalized.
Sec. 702.204 Prompt corrective action for moderately capitalized,
marginally capitalized, or minimally capitalized new credit unions.
(a) Mandatory supervisory actions by new credit union. Beginning on
the date of classification as moderately capitalized, marginally
capitalized or minimally capitalized (including by reclassification
under Sec. 702.202(d)), a new credit union must--
(1) Earnings retention. Increase the dollar amount of its net worth
by the amount reflected in its approved initial or revised business
plan;
(2) Submit revised business plan. Submit a revised business plan
within the time provided by Sec. 702.206 if the credit union either:
(i) Has not increased its net worth ratio consistent with its then-
present approved business plan;
(ii) Has no then-present approved business plan; or
(iii) Has failed to comply with paragraph (a)(3) of this section;
and
(3) Restrict member business loans. Not increase the total dollar
amount of member business loans (defined as loans outstanding and
unused commitments to lend) as of the preceding quarter-end unless it
is granted an exception under 12 U.S.C. 1757a(b).
(b) Discretionary supervisory actions by NCUA. Subject to the
applicable procedures set forth in subpart L of part 747 of this
chapter for issuing, reviewing and enforcing directives, the NCUA Board
may, by directive, take one or more of the actions prescribed in Sec.
702.109(b) if the credit union's net worth ratio has not increased
consistent with its then-present business plan, or the credit union has
failed to undertake any mandatory supervisory action prescribed in
paragraph (a) of this section.
(c) Discretionary conservatorship or liquidation. Notwithstanding
any other actions required or permitted to be taken under this section,
the NCUA Board may place a new credit union which is moderately
capitalized, marginally capitalized or minimally capitalized (including
by reclassification under Sec. 702.202(d)) into conservatorship
pursuant to 12 U.S.C. 1786(h)(1)(F), or into liquidation pursuant to 12
U.S.C. 1787(a)(3)(A)(i), provided that the credit union has no
reasonable prospect of becoming adequately capitalized.
Sec. 702.205 Prompt corrective action for uncapitalized new credit
unions.
(a) Mandatory supervisory actions by new credit union. Beginning on
the effective date of classification as uncapitalized, a new credit
union must--
(1) Earnings retention. Increase the dollar amount of its net worth
by the amount reflected in the credit union's approved initial or
revised business plan;
(2) Submit revised business plan. Submit a revised business plan
within the time provided by Sec. 702.206, providing for alternative
means of funding the credit union's earnings deficit, if the credit
union either:
(i) Has not increased its net worth ratio consistent with its then-
present approved business plan;
(ii) Has no then-present approved business plan; or
(iii) Has failed to comply with paragraph (a)(3) of this section;
and
(3) Restrict member business loans. Not increase the total dollar
amount of member business loans as provided in Sec. 702.204(a)(3).
(b) Discretionary supervisory actions by NCUA. Subject to the
procedures set forth in subpart L of part 747 of this chapter for
issuing, reviewing and enforcing directives, the NCUA Board may, by
directive, take one or more of the actions prescribed in Sec.
702.109(b) if the credit union's net worth ratio has not increased
consistent with its then-present business plan, or the credit union has
failed to undertake any mandatory supervisory action prescribed in
paragraph (a) of this section.
(c) Mandatory liquidation or conservatorship. Notwithstanding any
other actions required or permitted to be taken under this section, the
NCUA Board--
(1) Plan not submitted. May place into liquidation pursuant to 12
U.S.C. 1787(a)(3)(A)(ii), or conservatorship pursuant to 12 U.S.C.
1786(h)(1)(F), an uncapitalized new credit union which fails to submit
a revised business plan within the time provided under paragraph (a)(2)
of this section; or
(2) Plan rejected, approved, implemented. Except as provided in
paragraph (c)(3) of this section, must place into liquidation pursuant
to 12 U.S.C. 1787(a)(3)(A)(ii), or conservatorship pursuant to 12
U.S.C. 1786(h)(1)(F), an uncapitalized new credit union that remains
uncapitalized one hundred twenty (120) calendar days after the later
of:
(i) The effective date of classification as uncapitalized; or
(ii) The last day of the calendar month following expiration of the
time period provided in the credit union's initial business plan
(approved at the time its charter was granted) to remain uncapitalized,
regardless whether a revised business plan was rejected, approved or
implemented.
(3) Exception. The NCUA Board may decline to place a new credit
union into liquidation or conservatorship as provided in paragraph
(c)(2) of this section if the credit union documents to the NCUA Board
why it is viable and has a reasonable prospect of becoming adequately
capitalized.
(d) Mandatory liquidation of uncapitalized federal credit union. In
lieu of paragraph (c) of this section, an uncapitalized federal credit
union may be placed into liquidation on grounds of insolvency pursuant
to 12 U.S.C. 1787(a)(1)(A).
Sec. 702.206 Revised business plans (RBP) for new credit unions.
(a) Schedule for filing--(1) Generally. Except as provided in
paragraph (a)(2) of this section, a new credit union classified
moderately capitalized or lower must file a written revised business
plan (RBP) with the appropriate Regional Director and, if state-
chartered, with the appropriate state official, within 30 calendar days
of either:
(i) The last of the calendar month following the end of the
calendar quarter that the credit union's net worth ratio has not
increased consistent with the-present approved business plan;
(ii) The effective date of classification as less than adequately
capitalized if the credit union has no then-present approved business
plan; or
(iii) The effective date of classification as less than adequately
capitalized if the credit union has increased the total amount of
member business loans in violation of Sec. 702.204(a)(3).
(2) Exception. The NCUA Board may notify the credit union in
writing that its RBP is to be filed within a different period or that
it is not necessary to file an RBP.
(3) Failure to timely file plan. When a new credit union fails to
file an RBP
[[Page 66721]]
as provided under paragraphs (a)(1) or (a)(2) of this section, the NCUA
Board shall promptly notify the credit union that it has failed to file
an RBP and that it has 15 calendar days from receipt of that notice
within which to do so.
(b) Contents of revised business plan. A new credit union's RBP
must, at a minimum--
(1) Address changes, since the new credit union's current business
plan was approved, in any of the business plan elements required for
charter approval under chapter 1, section IV.D. of appendix B to part
701 of this chapter, or for state-chartered credit unions under
applicable state law;
(2) Establish a timetable of quarterly targets for net worth during
each year in which the RBP is in effect so that the credit union
becomes adequately capitalized by the time it no longer qualifies as
``new'' per Sec. 702.201;
(3) Specify the projected amount of earnings of net worth increases
as provided under Sec. 702.204(a)(1) or 702.205(a)(1);
(4) Explain how the new credit union will comply with the mandatory
and discretionary supervisory actions imposed on it by the NCUA Board
under this subpart;
(5) Specify the types and levels of activities in which the new
credit union will engage;
(6) In the case of a new credit union reclassified to a lower
category under Sec. 702.202(d), specify the steps the credit union
will take to correct the unsafe or unsound condition or practice; and
(7) Include such other information as the NCUA Board may require.
(c) Criteria for approval. The NCUA Board shall not approve a new
credit union's RBP unless it--
(1) Addresses the items enumerated in paragraph (b) of this
section;
(2) Is based on realistic assumptions, and is likely to succeed in
building the credit union's net worth; and
(3) Would not unreasonably increase the credit union's exposure to
risk (including credit risk, interest-rate risk, and other types of
risk).
(d) Consideration of regulatory capital. To minimize possible long-
term losses to the NCUSIF while the credit union takes steps to become
adequately capitalized, the NCUA Board shall, in evaluating an RBP
under this section, consider the type and amount of any form of
regulatory capital which may become established by NCUA regulation, or
authorized by state law and recognized by NCUA, which the credit union
holds, but which is not included in its net worth.
(e) Review of revised business plan--(1) Notice of decision. Within
30 calendar days after receiving an RBP under this section, the NCUA
Board shall notify the credit union in writing whether its RBP is
approved, and shall provide reasons for its decision in the event of
disapproval. The NCUA Board may extend the time within which notice of
its decision shall be provided.
(2) Delayed decision. If no decision is made within the time
prescribed in paragraph (e)(1) of this section, the RBP is deemed
approved.
(3) Consultation with state officials. When evaluating an RBP
submitted by a federally insured state-chartered new credit union
(whether an original, new or additional RBP), the NCUA Board shall seek
and consider the views of the appropriate state official, and provide
prompt notice of its decision to the appropriate state official.
(f) Plan not approved--(1) Submission of new revised plan. If an
RBP is rejected by the NCUA Board, the new credit union shall submit a
new RBP within 30 calendar days of receiving notice of disapproval of
its initial RBP, unless it is notified in writing by the NCUA Board
that the new RBP is to be filed within a different period.
(2) Notice of decision on revised plan. Within 30 calendar days
after receiving an RBP under paragraph (f)(1) of this section, the NCUA
Board shall notify the credit union in writing whether the new RBP is
approved. The Board may extend the time within which notice of its
decision shall be provided.
(3) Submission of multiple unapproved RBPs. The submission of more
than two RBPs that are not approved is considered an unsafe and unsound
condition and may subject the credit union to administrative
enforcement action pursuant to section 206 of the FCUA, 12 U.S.C. 1786
and 1790d.
(g) Amendment of plan. A credit union that has filed an approved
RBP may, after prior written notice to and approval by the NCUA Board,
amend it to reflect a change in circumstance. Pending approval of an
amended RBP, the new credit union shall implement its existing RBP as
originally approved.
(h) Publication. An RBP need not be published to be enforceable
because publication would be contrary to the public interest.
Sec. 702.207 Incentives for new credit unions.
(a) Assistance in revising business plans. Upon timely request by a
credit union having total assets of less than $10 million (regardless
how long it has been in operation), the NCUA Board shall provide
assistance in preparing a revised business plan required to be filed
under Sec. 702.206.
(b) Assistance. Management training and other assistance to new
credit unions will be provided in accordance with policies approved by
the NCUA Board.
(c) Small credit union program. A new credit union is eligible to
join and receive comprehensive benefits and assistance under NCUA's
Small Credit Union Program.
Sec. 702.208 Reserves.
Each new credit union shall establish and maintain such reserves as
may be required by the FCUA, by state law, by regulation, or in special
cases by the NCUA Board or appropriate state official.
Sec. 702.209 Full and fair disclosure of financial condition.
(a) Full and fair disclosure defined. ``Full and fair disclosure''
is the level of disclosure which a prudent person would provide to a
member of a new credit union, to NCUA, or, at the discretion of the
board of directors, to creditors to fairly inform them of the financial
condition and the results of operations of the credit union.
(b) Full and fair disclosure implemented. The financial statements
of a new credit union shall provide for full and fair disclosure of all
assets, liabilities, and members' equity, including such valuation
(allowance) accounts as may be necessary to present fairly the
financial condition; and all income and expenses necessary to present
fairly the statement of income for the reporting period.
(c) Declaration of officials. The Statement of Financial Condition,
when presented to members, to creditors or to NCUA, shall contain a
dual declaration by the treasurer and the chief executive officer, or
in the latter's absence, by any other officer designated by the board
of directors of the reporting credit union to make such declaration,
that the report and related financial statements are true and correct
to the best of their knowledge and belief and present fairly the
financial condition and the statement of income for the period covered.
(d) Charges for loan and lease losses. Full and fair disclosure
demands that a new credit union properly address charges for loan
losses as follows:
(1) Charges for loan and lease losses shall be made timely in
accordance with generally accepted accounting principles (GAAP);
(2) The ALLL must be maintained in accordance with GAAP; and
(3) At a minimum, adjustments to the ALLL shall be made prior to
the distribution or posting of any dividend to the accounts of members.
[[Page 66722]]
Sec. 702.210 Payment of dividends.
(a) Restriction on dividends. Dividends shall be available only
from net worth, net of any special reserves established under Sec.
702.208, if any.
(b) Payment of dividends and interest refunds. The board of
directors may not pay a dividend or interest refund that will cause the
credit union's capital classification to fall below adequately
capitalized under subpart A of this part unless the appropriate
regional director and, if state-chartered, the appropriate state
official, have given prior written approval (in an RBP or otherwise).
The request for written approval must include the plan for eliminating
any negative retained earnings balance.
Subparts C and D--[Removed]
0
9. Remove subparts C and D.
Subpart E--[Redesignated as Subpart C]
0
10. Redesignate subpart E, consisting of Sec. Sec. 702.501-702.506, as
subpart C, consisting of Sec. Sec. 702.301-702.306.
Sec. 702.504 [Amended]
0
11. Amend newly redesignated Sec. 702.504(b)(4) by removing the
citation ``Sec. 702.506(c)'' and adding in its place ``Sec.
702.306(c)''.
Sec. 702.505 [Amended]
0
12. Amend newly redesignated Sec. 702.505(b)(4) by removing the
citation ``Sec. 702.504'' and adding in its place ``Sec. 702.304''.
0
13. Appendix A to part 702 is added to read as follows:
Appendix A to Part 702--Gross-Up Approach, and Look-Through Approaches
Instead of using the risk weights assigned in Sec.
702.104(c)(2) a credit union may determine the risk weight of
certain investment funds, and the risk weight of a non-subordinated
or subordinated tranche of any investment as follows:
(a) Gross-up approach--(1) Applicability. Section
702.104(c)(3)(iii)(A) of this part provides that, a credit union may
use the gross-up approach in this appendix to determine the risk
weight of the carrying value of non-subordinated or subordinated
tranches of any investment.
(2) Calculation. To use the gross-up approach, a credit union
must calculate the following four inputs:
(i) Pro rata share, which is the par value of the credit union's
exposure as a percent of the par value of the tranche in which the
securitization exposure resides;
(ii) Enhanced amount, which is the par value of tranches that
are more senior to the tranche in which the credit union's
securitization resides;
(iii) Exposure amount, which is the amortized cost for
investments classified as held-to-maturity and available-for-sale,
and the fair value for trading securities; and
(iv) Risk weight, which is the weighted-average risk weight of
underlying exposures of the securitization as calculated under this
appendix.
(3) Credit equivalent amount. The ``credit equivalent amount''
of a securitization exposure under this part equals the sum of:
(i) The exposure amount of the credit union's exposure; and
(ii) The pro rata share multiplied by the enhanced amount, each
calculated in accordance with paragraph (a)(2) of this appendix.
(4) Risk-weighted assets. To calculate risk-weighted assets for
a securitization exposure under the gross-up approach, a credit
union must apply the risk weight required under paragraph (a)(2) of
this appendix to the credit equivalent amount calculated in
paragraph (a)(3) of this appendix.
(5) Securitization exposure defined. For purposes of this this
paragraph (a), ``securitization exposure'' means:
(i) A credit exposure that arises from a securitization; or
(ii) An exposure that directly or indirectly references a
securitization exposure described in paragraph (a)(5)(i) of this
appendix.
(6) Securitization defined. For purposes of this paragraph (a),
``securitization'' means a transaction in which:
(i) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different
levels of seniority;
(ii) Performance of the securitization exposures depends upon
the performance of the underlying exposures; and
(iii) All or substantially all of the underlying exposures are
financial exposures (such as loans, receivables, asset-backed
securities, mortgage-backed securities, or other debt securities).
(b) Look-through approaches.--(1) Applicability. Section
702.104(c)(3)(iii)(B) provides that, a credit union may use one of
the look-through approaches in this appendix to determine the risk
weight of the exposure amount of any investment fund, or the holding
of separate account insurance.
(2) Full look-through approach. (i) General. A credit union that
is able to calculate a risk-weighted asset amount for its
proportional ownership share of each exposure held by the investment
fund may set the risk-weighted asset amount of the credit union's
exposure to the fund equal to the product of:
(A) The aggregate risk-weighted asset amounts of the exposures
held by the fund as if they were held directly by the credit union;
and
(B) The credit union's proportional ownership share of the fund.
(ii) Holding report. To calculate the risk-weighted amount under
paragraph (b)(2)(i) of this appendix, a credit union should:
(A) Use the most recently issued investment fund holding report;
and
(B) Use an investment fund holding report that reflects holding
that are not older than 6-months from the quarter-end effective date
(as defined in Sec. 702.101(c)(1).
(3) Simple modified look-through approach. Under the simple
modified look-through approach, the risk-weighted asset amount for a
credit union's exposure to an investment fund equals the exposure
amount multiplied by the highest risk weight that applies to any
exposure the fund is permitted to hold under the prospectus,
partnership agreement, or similar agreement that defines the fund's
permissible investments (excluding derivative contracts that are
used for hedging rather than speculative purposes and that do not
constitute a material portion of the fund's exposures).
(4) Alternative modified look-through approach. Under the
alternative modified look-through approach, a credit union may
assign the credit union's exposure amount to an investment fund on a
pro rata basis to different risk weight categories under subpart A
of this part based on the investment limits in the fund's
prospectus, partnership agreement, or similar contract that defines
the fund's permissible investments. The risk-weighted asset amount
for the credit union's exposure to the investment fund equals the
sum of each portion of the exposure amount assigned to an exposure
type multiplied by the applicable risk weight under subpart A of
this part. If the sum of the investment limits for all exposure
types within the fund exceeds 100 percent, the credit union must
assume that the fund invests to the maximum extent permitted under
its investment limits in the exposure type with the highest
applicable risk weight under subpart A of this part and continues to
make investments in order of the exposure type with the next highest
applicable risk weight under subpart A of this part until the
maximum total investment level is reached. If more than one exposure
type applies to an exposure, the credit union must use the highest
applicable risk weight. A credit union may exclude derivative
contracts held by the fund that are used for hedging rather than for
speculative purposes and do not constitute a material portion of the
fund's exposures.
PART 703--INVESTMENT AND DEPOSIT ACTIVITIES
0
14. The authority citation for part 703 continues to read as follows:
Authority: 12 U.S.C. 1757(7), 1757(8), 1757(15).
Sec. 703.14 [Amended]
0
15. Amend Sec. 703.14 as follows:
0
a. In paragraph (i) remove the words ``net worth classification'' and
add in their place the words ``capital classification'', and remove the
words ``or, if subject to a risk-based net worth (RBNW) requirement
under part 702 of this chapter, has remained `well capitalized' for the
six (6) immediately preceding quarters after applying the applicable
RBNW requirement,''.
0
b. In paragraph (j)(4) remove the words ``net worth classification''
and add in their place the words ``capital classification'', and remove
the words ``or, if subject to a risk-based net worth
[[Page 66723]]
(RBNW) requirement under part 702 of this chapter, has remained `well
capitalized' for the six (6) immediately preceding quarters after
applying the applicable RBNW requirement,''.
PART 713--FIDELITY BOND AND INSURANCE COVERAGE FOR FEDERAL CREDIT
UNIONS
0
16. The authority citation for part 713 continues to read as follows:
Authority: 12 U.S.C. 1761a, 1761b, 1766(a), 1766(h),
1789(a)(11).
0
17. Amend Sec. 713.6 as follows:
0
a. In paragraph (a)(1), revise the table; and
0
b. In paragraph (c) remove the words ``net worth'' each place they
appear and add in their place the word ``capital'', and remove the
words ``or, if subject to a risk-based net worth (RBNW) requirement
under part 702 of this chapter, has remained `well capitalized' for the
six (6) immediately preceding quarters after applying the applicable
RBNW requirement,''.
Sec. 713.6 What is the permissible deductible?
(a)(1) * * *
------------------------------------------------------------------------
Assets Maximum deductible
------------------------------------------------------------------------
$0 to $100,000............................ No deductible allowed.
$100,001 to $250,000...................... $1,000.
$250,000 to $1,000,000.................... $2,000.
Over $1,000,000........................... $2,000 plus 1/1000 of total
assets up to a maximum of
$200,000; for credit unions
that have received a
composite CAMEL rating of
``1'' or ``2'' for the last
two (2) full examinations
and maintained a capital
classification of ``well
capitalized'' under part
702 of this chapter for the
six (6) immediately
preceding quarters the
maximum deductible is
$1,000,000.
------------------------------------------------------------------------
* * * * *
PART 723--MEMBER BUSINESS LOANS
0
18. The authority citation for part 723 continues to read as follows:
Authority: 12 U.S.C. 1756, 1757, 1757A, 1766, 1785, 1789.
Sec. 723.1 [Amended]
0
19. Amend Sec. 723.1 as follows:
0
a. In paragraph (d) remove the words ``and the risk weighting standards
of part 702 of this chapter''; and
0
b. In paragraph (e) remove the words ``and the risk weighting standards
under part 702 of this chapter''.
Sec. 723.7 [Amended]
0
20. Amend Sec. 723.7(c)(1) by removing the words ``as defined by Sec.
702.102(a)(1)'' and adding in their place the words ``under part 702''.
PART 747--ADMINSTRATIVE ACTIONS, ADJUDICATIVE HEARINGS, RULES OF
PRACTICE AND PROCEDURE, AND INVESTIGATIONS
0
21. The authority citation for part 747 continues to read as follows:
Authority: 12 U.S.C. 1766, 1782, 1784, 1785, 1786, 1787, 1790a,
1790d; 42 U.S.C. 4012a; Pub. L. 101-410; Pub. L. 104-134; Pub. L.
109-351; 120 Stat. 1966.
Sec. 747.2001 [Amended]
0
22. Amend Sec. 747.2001(a) by removing the citation ``702.302(d)'' and
adding in its place the citation ``702.202(d)''.
Sec. 747.2002 [Amended]
0
23. Amend Sec. 747.2002(a) by removing the words ``Sec. Sec.
702.202(b), 702.203(b) and 702.204(b)'' and adding in their place the
words ``Sec. Sec. 702.107 (b), 702.108(b) or 702.109(b)'', and by
removing the words ``Sec. 702.304(b) or Sec. 702.305(b)'' and adding
in their place the words ``Sec. 702.204(b) or Sec. 702.205(b)''.
Sec. 747.2003 [Amended]
0
24. Amend Sec. 747.2003(a) by removing the citation ``702.302(d)'' and
adding in its place the citation ``702.202(d)''.
[FR Doc. 2015-26790 Filed 10-28-15; 8:45 am]
BILLING CODE 7535-01-P
