Alternative Capital, 9691-9702 [2017-01713]
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9691
Proposed Rules
Federal Register
Vol. 82, No. 25
Wednesday, February 8, 2017
This section of the FEDERAL REGISTER
contains notices to the public of the proposed
issuance of rules and regulations. The
purpose of these notices is to give interested
persons an opportunity to participate in the
rule making prior to the adoption of the final
rules.
NATIONAL CREDIT UNION
ADMINISTRATION
12 CFR Parts 701, 702, 703, 709, 741,
and 745
Alternative Capital
National Credit Union
Administration.
ACTION: Advance notice of proposed
rulemaking.
AGENCY:
The NCUA Board (Board) is
issuing this advanced notice of
proposed rulemaking (ANPR) to solicit
comments on alternative forms of
capital federally insured credit unions
could use in meeting capital standards
required by statute and regulation. For
purposes of this ANPR, alternative
capital includes two different categories:
Secondary capital and supplemental
capital. Secondary capital is currently
permissible under the Federal Credit
Union Act (Act) only for low-income
designated credit unions to issue and to
be counted toward both the net worth
ratio and the risk-based net worth
requirement of NCUA’s prompt
corrective action standards. The Board
is considering changes to the secondary
capital regulation for low-income
designated credit unions. There are no
other forms of alternative capital
currently authorized. However, the
Board is also considering whether or not
to authorize credit unions to issue
supplemental capital instruments that
would only count towards the riskbased net worth requirement.
DATES: Comments must be received on
or before May 9, 2017.
ADDRESSES: You may submit comments
by any one of the following methods
(Please send comments by one method
only):
• Federal eRulemaking Portal: http://
www.regulations.gov. Follow the
instructions for submitting comments.
• Email: Address to regcomments@
ncua.gov. Include ‘‘[Your name]—
Comments on Advance Notice of
Proposed Rulemaking for Supplemental
Capital’’ in the email subject line.
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SUMMARY:
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• Fax: (703) 518–6319. Use the
subject line described above for email.
• Mail: Address to Gerald Poliquin,
Secretary of the Board, National Credit
Union Administration, 1775 Duke
Street, Alexandria, Virginia 22314–
3428.
• Hand Delivery/Courier: Same as
mail address.
Public Inspection: You can view all
public comments on NCUA’s Web site
at http://www.ncua.gov/Legal/Regs/
Pages/PropRegs.aspx as submitted,
except for those we cannot post for
technical reasons. NCUA will not edit or
remove any identifying or contact
information from the public comments
submitted. You may inspect paper
copies of comments in NCUA’s law
library at 1775 Duke Street, Alexandria,
Virginia 22314, by appointment
weekdays between 9 a.m. and 3 p.m. To
make an appointment, call (703) 518–
6546 or send an email to OGCMail@
ncua.gov.
FOR FURTHER INFORMATION CONTACT:
Steve Farrar, Supervisory Financial
Analyst, at (703) 518–6360; or Justin
Anderson, Senior Staff Attorney, Office
of General Counsel, at (703) 518–6540.
You may also contact them at the
National Credit Union Administration,
1775 Duke Street, Alexandria, Virginia
22314.
SUPPLEMENTARY INFORMATION: At its
October 2016 meeting, the Board held a
public briefing on the topic of
alternative capital for credit unions.
This ANPR provides relevant
background information and seeks
comment on a broad range of
considerations with respect to
alternative capital for federally insured
credit unions. This ANPR addresses
topics including: (1) NCUA’s authority
to include alternative capital for prompt
corrective action purposes; (2) credit
unions’ authority to issue alternative
forms of capital; (3) prudential
standards regarding the extent to which
various forms of instruments would
qualify as capital for prompt corrective
action purposes and credit union
eligibility for the sale of alternative
capital; (4) the utility and suitability of
supplemental capital for credit unions;
(5) standards for investor protection,
including disclosure requirements and
investor eligibility criteria for the
purchase of alternative capital; (6)
implications of securities law for
supplemental and secondary capital; (7)
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potential implications for credit unions,
including the credit union tax
exemption; and (8) overall regulatory
changes the Board would need to make
to permit supplemental capital, improve
secondary capital standards, and
provide or modify related supporting
authorities. The Board has posed a
number of specific questions on these
and other topics, but invites comments
on any and all aspects of alternative
capital.
I. Background
II. Current Secondary Capital Standards
III. Current and Prospective Use of
Alternative Capital
IV. Supplemental Capital Legal Authority
and Potential Taxation Implications
V. Securities Law Applicability
VI. Other Investor Considerations
VII. Prudential Standards for Issuing and
Counting Alternative Capital for Prompt
Corrective Action
VIII. Supporting Regulatory Changes
I. Background
In 1998, Congress passed the Credit
Union Membership Access Act
(CUMAA) which amended the Act to
mandate a system of prompt corrective
action for federally insured natural
person credit unions (credit unions).1
The prompt corrective action system
incorporates capital standards for credit
unions. The Act indexes a credit union’s
prompt corrective action status to five
categories: Well capitalized, adequately
capitalized, undercapitalized,
significantly undercapitalized, and
critically undercapitalized.2 As a credit
union’s capital level falls, its
classification among the prompt
corrective action categories can decline
below well capitalized, thus exposing it
to an expanding range of mandatory and
discretionary supervisory actions
designed to remedy the problem and
minimize any loss to the National Credit
Union Share Insurance Fund (Share
Insurance Fund).3
The Act defines a credit union’s
capital level based on a net worth ratio
requirement for all credit unions and a
risk-based net worth requirement for
credit unions the Board defines as
1 The Credit Union Membership Access Act of
1998, HR 1151, Public Law 105–219, 112 Stat. 913
(1998).
2 12 U.S.C. 1790d(c); 12 CFR part 702; 65 FR 8560
(Feb. 18, 2000); see 702 subpart C for categories for
‘‘new’’ credit unions.
3 Id. at § 1790d(e), (f) and (g); 12 CFR 702 subpart
B.
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complex.4 The Act also provides the
NCUA Board with broad discretion to
design the risk-based net worth
requirement. However, the net worth
ratio is defined in the Act as a credit
union’s ratio of net worth to total assets.
The Act defines net worth as: 5
• The retained earnings balance of the
credit union, as determined under
generally accepted accounting
principles, together with any amounts
that were previously retained earnings
of any other credit union with which
the credit union is combined;
• Secondary capital of a low-income
designated credit union that is
uninsured and subordinate to all other
claims of the credit union, including the
claims of creditors, shareholders, and
the Share Insurance Fund; and 6
• Certain assistance provided under
section 208 of the Act pursuant to
NCUA regulations.7
As noted above, per the Act,
secondary capital is currently only
permissible for low-income designated
credit unions to issue and to be counted
toward the net worth ratio. NCUA also
counts secondary capital issued by lowincome designated credit unions as net
worth for the risk-based net worth ratio.
The Board notes that, NCUA cannot
change the Act’s definition of net
worth—only Congress can. However,
the Board has broad discretion in
designing the risk-based net worth
requirement. Thus, it is possible for the
Board to authorize a credit union that is
not low-income designated to issue
alternative capital instruments that
would count towards satisfying the riskbased net worth requirement—but not
the net worth ratio. (See the discussion
of legal authority in Section IV). For
purposes of this ANPR, the term
supplemental capital includes any form
of capital instruments credit unions that
4 In 2000, NCUA adopted part 702 of NCUA Rules
and Regulations to implement the Act’s system of
prompt corrective action.
5 Id. at § 1790d(o)(3); 12 CFR 702.2(g) and (k).
6 In 1996, the NCUA Board authorized lowincome designated credit unions, including state
chartered credit unions to the extent permitted by
state law, to count as capital uninsured secondary
capital. At the time, the Board recognized that it
was difficult for low-income designated credit
unions to accumulate capital only through retained
earnings. The Board, therefore, permitted lowincome designated credit unions to use the
borrowing authority in the Act to issue secondary
capital accounts. This authority would allow these
credit unions to build capital to support greater
lending and financial services to their members and
their communities, and to absorb losses to protect
them from failing. To ensure the safety and
soundness of secondary capital activity, the 1996
rule imposed various restrictions on its use and
structure. At this time, prompt corrective action and
the associated definition of net worth was not yet
part of the Act. 61 FR 50696 (Sept. 27, 1996).
7 12 U.S.C. 1790d(o)(2).
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are not designated as low-income might
be authorized to issue and count only
for inclusion in the risk-based net worth
requirement.
The risk-based net worth requirement
for federally insured credit unions is
based on a risk-based net worth ratio
calculation in Part 702 of NCUA’s Rules
and Regulations.8 Per the Board’s
October 2015 final rule, on January 1,
2019, the risk-based net worth
requirement will be updated to replace
the risk-based net worth ratio with a
new risk-based capital ratio.9
During the risk-based capital
rulemaking process, the Board asked for
stakeholder input on supplemental
capital. Specifically, in the January 2015
risk-based capital (RBC) proposal the
NCUA Board posed the following six
questions: 10
1. Should additional supplemental
forms of capital be included in the RBC
numerator and how would including
such capital protect the Share Insurance
Fund from losses?
2. If yes, to be included in the RBC
numerator, what specific criteria should
such additional forms of capital
reasonably be required to meet to be
consistent with Generally Accepted
Accounting Practices (GAAP) and the
Act, and why?
3. If certain forms of certificates of
indebtedness were included in the risk
based capital ratio numerator, what
specific criteria should such certificates
reasonably be required to meet to be
consistent with GAAP and the Act, and
why?
4. In addition to amending NCUA’s
RBC regulations, what additional
changes to NCUA’s regulations would
be required to count additional
supplemental forms of capital in
NCUA’s RBC ratio numerator?
5. For state-chartered credit unions,
what specific examples of supplemental
capital currently allowed under state
law do commenters believe should be
included in the RBC ratio numerator,
and why should they be included?
6. What investor suitability, consumer
protection, and disclosure requirements
should be put in place related to
additional forms of supplemental
capital?
In response to these questions, a
majority of the commenters who
addressed supplemental capital stated
that it was imperative that the Board
consider allowing credit unions access
to additional forms of capital. The
8 Unless otherwise noted, throughout this ANPR
references to prompt corrective action, risk-based
capital, and citations to Part 702 refer to Part 702
as revised by the Board at its October 2015 meeting.
9 80 FR 66626 (Oct. 29, 2015).
10 80 FR 4340, 4384 (Jan. 27, 2015).
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commenters suggested credit union
authority to issue supplemental capital
was particularly important as credit
unions are at a disadvantage in the
financial market because most lack
access to additional capital outside of
retained earnings. While none of the
commenters offered specific suggestions
on how to implement supplemental
capital, a few did suggest that the Board
should promulgate broad, nonprescriptive rules to allow credit unions
maximum flexibility in issuing
supplemental capital.
As the Board did not receive
comments with sufficient detail in
response to the RBC proposal, the Board
is again posing the six questions listed
above for commenters to consider and
address. Throughout this ANPR, the
Board will expand on these six
questions and ask more specific
questions about the structure, form,
regulations, and requirements related to
supplemental capital, as well as relevant
changes and improvements to secondary
capital. The Board encourages all
stakeholders to address in detail as
many of these questions as possible and
provide the Board with specific
comments and responses. The Board
intends these questions to be a starting
point for commenters to present their
thoughts, but invites comments on all
aspects of alternative capital
Throughout this ANPR the Board
discusses several complex topics and
uses terms to refer to specific forms of
capital. In addition to supplemental,
secondary, and alternative capital, the
Board will use the term ‘‘regulatory
capital’’ when referring to financial
instruments issued by credit unions or
banks, that include both equity and
debt, and other financial statement
account which meet the criteria
contained in regulations for inclusion in
the calculation of capital adequacy
measures.
II. Current Secondary Capital
Standards
The Act’s definition of net worth
states that secondary capital must be
‘‘uninsured and subordinate to all other
claims of the credit union, including the
claims of creditors, shareholders, and
the Share Insurance Fund.’’ 11 This
means that any secondary capital issued
by a low-income designated credit
union must be the most subordinated
item on the balance sheet (first loss
position after retained earnings) and any
losses to secondary capital must be prorated equally—that is without
preference or priority. The practical
effect is that low-income designated
11 12
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U.S.C. 1790d(o)(C)(ii).
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credit unions cannot include payment
priority structures within or between
secondary capital instruments to
enhance investors’ interests.
NCUA’s rules and regulations also
contain various provisions addressing
the prudent and appropriate issuance
and use of secondary capital by lowincome designated credit unions. These
provisions are as follows:
• Low-income designed credit
unions:
Æ May only accept secondary capital
accounts from non-natural person
members and non-natural person
nonmembers.
Æ Must submit and receive approval
by NCUA of a Secondary Capital Plan.
Æ Must execute a Disclosure and
Acknowledgement statement.
• A secondary capital account:
Æ Must be uninsured;
Æ Have a minimum maturity of five
years with a reduction in the
recognition of the net worth value of
accounts with less than five years of
remaining maturity;
Æ Must be subordinate to all other
claims, including those of shareholders,
creditors and the Share Insurance Fund;
Æ Must be available to cover
operating losses that exceed net
available reserves and to extent losses
are applied the accounts must not be
restored;
Æ Cannot be pledged by investors as
security on a loan;
Æ Are subject to restrictions of
dividends as provided in prompt
corrective action; and
Æ May only in certain circumstances
be redeemed early and only with prior
NCUA approval.12
The regulations allow NCUA to
prohibit a low-income designated credit
union classified as critically
undercapitalized from paying principal,
dividends, or interest on secondary
capital. This provision is to ensure
secondary capital is available to cover
losses while the low-income designated
credit union is operating as a going
concern. These payment restrictions are
consistent with limitations on principal
and interest payments imposed by the
federal banking regulators for
subordinated debt issued by banks.13
Further, due to the fact that secondary
capital is not a permanent form of
capital, NCUA’s regulations reduce the
portion of secondary capital that is
included in the net worth ratio as it
approaches maturity. Once the
remaining maturity is less than five
years, the regulations require lowincome designated credit unions to
discount how much a secondary capital
account contributes to the credit union’s
net worth value based on the following
schedule: 14
natural person credit unions, and leave
the provisions specific to federal credit
union issuance authority in Part 701.
III. Current and Prospective Use of
Alternative Capital
This section provides information on
Remaining maturity
community bank use of subordinated
debt and low-income designated credit
unions’ use of secondary capital. This
Four to less than five years ..
80 section also provides information on the
Three to less than four years
60 projected impact of risk-based capital
Two to less than three years
40 standards on complex credit unions to
One to less than two years ..
20 estimate the potential need for
Less than one year ...............
0
supplemental capital for risk-based net
worth requirement purposes. This
Since 2006, low-income credit unions
information provides a basis for
may request NCUA approval to redeem
estimating the potential for use of
the portion of secondary capital no
supplemental capital, the purpose of its
longer included in net worth if:
use, the potential purchasers, and the
• The credit union will have a postrelated costs. The Board is interested in
redemption net worth classification of at
receiving comments concerning
least adequately capitalized;
projections on the volume of
• The discounted secondary capital
supplemental capital that credit unions
has been on deposit at least two years;
would be likely to issue. The Board also
and
seeks specific comments on the
• The discounted secondary capital
structures of supplemental capital
will not be needed to cover losses prior
instruments that would be beneficial,
15
to the final maturity date.
why credit unions will issue
With respect to secondary capital, the
supplemental capital, and how it fits
Board specifically seeks comments on
into the credit union’s business model.
the following:
The Board is also interested in any
• Whether or not to permit a lowcomments about who will purchase
income designated credit union to sell
supplemental capital. Since the costs
secondary capital to non-institutional
associated with supplemental capital
investors (see Sections V and VI for
are significant to the issuing credit
more discussion on investor protection
union, the Board seeks comments on
and suitability issues), and whether this
how any regulations should address the
would be for members only or any
issue of the cost of the instrument and
party.
any items that may be helpful in
• Allowing for broader call options
reducing the cost while maintaining
for the low-income designated credit
adequate protection for investors and
union, other than just the portion no
the Share Insurance Fund.
longer counting as net worth and subject
to NCUA approval, if provided for in the A. Community Bank Use of
secondary capital contract.
Subordinated Debt
• Relaxation of pre-approval of
Community bank use of subordinated
issuing secondary capital if a lowdebt increased in 2016. As of June, 30,
income designated credit union meets
2016, the amount outstanding was $831
certain conditions such as being at least million compared to $479 million as of
adequately capitalized and having prior December 31, 2016.16 Despite the
experience issuing secondary capital.
increase, subordinated debt is only 0.34
• Inclusion of more flexibility to fund percent of total community bank capital.
dividend payments as an operating loss
The stated purpose of recent issuances
if provided for in the contract.
of subordinated debt by community
• Any other prudential restrictions on banks generally fall into three
secondary capital that should be
categories:
considered.
• Facilitate mergers and acquisitions;
• Reorganization of the regulation to
• Redemption of preferred stock held
improve clarity by moving to part 702
by the U.S. Treasury Department due to
(Prompt Corrective Action) all matters
increasing costs; and
related to how the instrument must be
• Fund organic growth.17
structured to qualify for capital
While the interest rate paid on
treatment. This would move these
community bank subordinated debt can
conditions to the section of NCUA rules vary significantly, generally the interest
and regulations applicable to all insured
Net worth
value of
original
balance
(percent)
16 FDIC
12 12
CFR 701.34.
13 12 CFR 5.47(d)(3)(ii)(B)(3).
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Quarterly, Volume 10, Number 2, page 18.
on review of a sample of SEC Form D
filed by issuers.
14 Id.
at § 701.34(c).
15 Id. at § 701.34(d).
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rate is from 300 to 400 basis points over
ten year treasury note rates.18
Additionally community banks report
expenses associated with sales
commissions, ranging from 1.25 percent
to 3 percent, and fees along with legal
and operational costs.19 Most buyers of
bank subordinated debt are reported to
be pension funds, mutual funds, other
banks, and high net worth investors.20
B. Low-Income Designated Credit Union
Use of Secondary Capital
As of June 30, 2016, there were 2,426
low-income designated credit unions.
Only 73 low-income designated credit
unions (about 3 percent) report total
outstanding secondary capital of $181
million.21 Since December 31, 2011, the
number of low-income designated credit
unions has increased by 117 percent,
from 1,119 to 2,426. However, the
number of low-income designated credit
unions with outstanding secondary
capital has ranged from 72 to 79 during
this period.
The $181 million in outstanding
secondary capital equates to 13 percent
of the total net worth of the low-income
designated credit unions that issued it—
with an average balance of about $2.5
million. However, outstanding
secondary capital is concentrated in
four low-income designated credit
unions, which hold 74 percent of the
total secondary capital outstanding.
When excluding these four low-income
designated credit unions, the average
amount of secondary capital is under
$700,000 per low-income designated
credit union. The interest rate paid by
the four largest holders of the
outstanding secondary capital ranges
from 0.14 percent to 3.5 percent.
Secondary capital does, however,
significantly benefit a low-income
designated credit union’s net worth
ratio. The secondary capital adds an
average of nearly 300 basis points to the
net worth ratio, which brings the
average from just below 7 percent to
near 10 percent. Out of the 73 lowincome designated credit unions with
secondary capital, 66 have a net worth
ratio greater than the well capitalized 7
percent level. Without the secondary
capital, 25 of the 66 would have a net
worth ratio less than 7 percent.22
The Board notes that low-income
designated credit unions that have
issued secondary capital have a higher
failure rate than other low-income
designated credit unions. The average
annual failure rate for low-income
designated credit unions with secondary
capital was 2.9 percent from 2000–2013,
compared to 0.8 percent for low-income
designated credit unions without
secondary capital during the same
period.23 In a few failures of low-income
designated credit unions, the assets in
the credit union grew rapidly around
the time the secondary capital was
issued, which in turn led to higher
losses to the Share Insurance Fund.
NCUA has noted a pattern of poor
practices in some low-income
designated credit unions with secondary
capital that could account for the higher
failure rate, including: 24
• Poor due diligence, inaccurate cost
benefit analysis and weak strategic
planning in connection with
establishing and expanding member
service programs funded by secondary
capital.
• Concentrations of secondary capital
to support unproven or poorly
performing programs.
• Failure to realistically assess and
timely curtail programs not meeting
expectations.
• Use of secondary capital solely to
delay prompt corrective action.
• Insufficient liquidity to repay
secondary capital at maturity.
C. Potential for Credit Unions’ Use of
Supplemental Capital
The potential use of supplemental
capital is difficult to predict due to the
probable changes in market factors such
as interest rates, demographics, and
competition. Since supplemental capital
would only increase a credit union’s
risk-based capital ratio, the most likely
users would be those credit unions with
net worth ratios above the well
capitalized level but with a risk-based
capital below or near the minimum
needed to be well capitalized.
The following table contains an
estimate of the number of credit unions
likely to issue supplemental capital and
the potential amount of supplemental
capital that might be issued. Using Call
Report data as of December 31, 2015,
applied to FICUs with more than $100
million in assets,25 results in the
following:
Number of credit unions that do not have a low-income designation with a net worth ratio greater than 8% and an estimated
risk-based capital ratio less than 13.5%.
Net worth of the 140 credit unions that do not have a low-income designation with a net worth ratio greater than 8% and an
estimated risk-based capital ratio less than 13.5%.
Maximum amount of subordinated debt that could be issued with a limit set at 50% of net worth 26 ............................................
Amount of supplemental capital needed by the 140 to achieve a 13.5% risk-based capital ratio ..................................................
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The Board is interested in
commenter’s thoughts on whether credit
unions that are not designated as lowincome use of supplemental capital
could affect the availability of secondary
capital for low-income designated credit
unions. If so, are there any measures the
Board could take to protect against this?
IV. Supplemental Capital Legal
Authority and Potential Taxation
Implications
18 Based on review of a sample of capital market
announcements and publications of completed
offerings.
19 Based on review of a sample of SEC Form D
filed by issuers.
20 Based on review of a sample of capital market
announcements, publication of completed offerings,
and SEC Form D.
21 NCUA Call Report data.
22 Secondary capital is estimated to add an
average of 414 basis points to the risk-based capital
ratio that will go into effect on January 1, 2019.
23 See. Secondary Capital Best Practices Guide
available at https://www.ncua.gov/services/Pages/
small-credit-union-learning-center/Documents/
secondary-capital-guide.pdf.
24 Id.
25 The new risk-based net worth requirements
will only apply to credit unions with assets of $100
million or more.
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A. Risk-Based Net Worth Requirement
In addition to the Act’s requirements
related to the net worth ratio, the Act
requires the Board to design ‘‘a riskbased net worth requirement for credit
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140.
$9.2 billion.
$4.5 billion.
$1.0 billion.
unions defined as complex.’’ 27 The riskbased net worth requirement for credit
unions meeting the definition of
‘‘complex’’ was first applied on the
basis of data in the Call Report as of
March 31, 2001.28 Since its inception,
the risk-based net worth requirement
has included secondary capital issued
26 The Board would contemplate some limit on
how much supplemental capital will count for riskbased capital requirements to ensure it remains a
supplemental but not the primary source of capital.
For illustration purposes the estimate uses a 50%
limit so that it would not become the primary form
of capital held by these credit unions.
27 12 U.S.C. 1790d(d)(1).
28 65 FR 44950 (July 20, 2000).
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by low-income designated credit
unions.
While the Act defined the term ‘‘net
worth,’’ it did not define the risk-based
net worth requirement, nor how to
calculate any corresponding risk-based
ratio. In contrast to the narrow
definition of net worth, the lack of a
statutory prescription for the risk-based
net worth requirement gives the Board
the latitude to include within that
requirement items that would not meet
the statutory definition of ‘‘net worth’’
but otherwise serve as capital in
protecting the Share Insurance Fund
from losses when a credit union fails.
Given the statutory objective of prompt
corrective action ‘‘to resolve the
problems of insured credit unions at the
least possible long-term loss’’ to the
Share Insurance Fund, the Board
believes it should explore expanded
options for credit unions to build capital
beyond retained earnings.
For a credit union defined as complex
to be classified well capitalized, the Act
requires the credit union to have a net
worth ratio of 7 percent or greater (6
percent for adequately capitalized) and
to meet the applicable risk-based net
worth requirement. Starting in January
2019, the risk-based net worth
requirement will require the risk-based
capital ratio to be 10 percent or greater
to be well capitalized (8 percent for
adequately capitalized). The Act
classifies a credit union as
undercapitalized if it is unable to
achieve the applicable risk-based net
worth requirement, even if it has a high
net worth ratio, thus subjecting the
credit union to the corresponding
prompt corrective action supervisory
consequences.29
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B. Authority To Issue Supplemental
Capital
The authority for low-income
designated credit unions to issue
secondary capital is established in the
Act. Conversely, there is no express
authority for credit unions not
designated as low-income to issue
alternative forms of capital. However,
the Act does provide federal credit
unions with relatively broad authority
to borrow from any source in
accordance with such rules and
regulations as may be prescribed by the
Board.30 The Board has reviewed all
applicable sections of the Act to
determine the ability of federal credit
unions to issue various types of
financial instruments that could serve as
29 12
30 12
U.S.C. 1790d(c)(1)(C)(ii).
U.S.C. 1757(9).
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alternative capital.31 Other than as a
form of debt, there is no other explicit
authority in the Act for federal credit
unions to issue an instrument that is
uninsured and could be structured as
loss absorbing capital. As a result, the
Board believes only the borrowing
authority is available for federal credit
unions to issue supplemental capital.32
This means that federal credit unions
could only issue supplemental capital
as subordinated debt. However, the
Board invites commenters to identify
any other provisions of the Act they
believe could provide alternative
authority for federal credit unions to
issue supplemental capital instruments
other than as subordinated debt.
C. Supplemental Capital Relationship to
Secondary Capital
Supplemental capital and secondary
capital are similar in that, for federal
credit unions, both are uninsured
accounts issued as borrowings and
subject to applicable statutory
borrowing limits. Secondary capital,
however, is included in the statutory
definition of net worth and counts
towards both the net worth ratio and the
risk-based net worth requirement.
Supplemental capital is not included
the statutory definition of net worth and
can only be considered for inclusion in
the computation of the risk-based net
worth requirement.
Supplemental capital would have to
be subordinate to the Share Insurance
Fund and uninsured shareholders in the
payout priorities. However, since
secondary capital, per the Act, must be
subordinate to all other claims,
supplemental capital would be senior to
secondary capital in the payout
priorities. Credit unions issuing
supplemental capital could be provided
flexibility to include payment priority
structures within or between
supplemental capital instruments to
enhance investors’ interests.
D. Need for Comprehensive Borrowing
Rule for Federal Credit Unions
The Board is considering expanding
the borrowing rule to clarify this
authority for federal credit unions. As
noted above, the Act states that federal
31 Authority to issue capital instruments for
FISCUs is determined under applicable state law.
32 In December 2010, the Board issued Letter to
Federal Credit Unions 10–FCU–03: Sales of
Nondeposit Investments, which stated that federal
credit unions are not authorized under the Act to
sell nondeposit investments directly to their
members. After further consideration, the Board
believes federal credit unions have the authority to
issue supplemental capital instruments under the
borrowing authority in the Act, even though these
instruments may be considered securities for
purposes of state and federal securities laws.
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credit unions may ‘‘borrow, in
accordance with such rules and
regulations as may be prescribed by the
Board, from any source.’’ Currently,
NCUA’s regulations only contain a rule
addressing when federal credit unions
borrow from natural persons. Given that
the wording of the Act could suggest a
federal credit union’s borrowing
authority is contingent on rules and
regulations prescribed by the Board, it
may appear to investors that federal
credit unions are restricted to only
borrowing from natural persons. While
the Board disagrees with this reading of
the Act, the Board is concerned that
some supplemental capital investors
may question a federal credit union’s
authority to issue supplemental capital
instruments to anyone other than
natural persons. Clarity and certainty
about a federal credit union’s borrowing
authority may be important to the sale
of supplemental capital—by expanding
the potential investor base and reducing
unnecessary transaction complications.
With respect to this topic, the Board is
interested in commenter’s views on
whether the Board should promulgate a
more comprehensive borrowing rule as
part of any authorization of
supplemental capital, and what the rule
should address.
E. Authority for Federally Insured State
Chartered Credit Unions To Issue
Supplemental Capital
The authority under which a federally
insured state chartered credit union
could issue alternative capital
instruments is distinct from whether
and to what extent NCUA, as insurer,
would recognize it as regulatory capital
for prompt corrective action purposes. A
federally insured state chartered credit
union’s authority to issue supplemental
capital would be derived from
applicable state law and regulation
regarding its ability to issue liability and
equity instruments. Such state laws may
be narrower or broader than those for
federal credit unions. Recognition as
regulatory capital will depend on the
characteristics of the instrument and its
availability to protect the Share
Insurance Fund—which would be based
on uniform criteria that apply to all
federally insured credit unions. (see
section VI for more discussion)
For federal credit unions, the Act
limits the aggregate amount of borrowed
funds to 50 percent of paid-in and
unimpaired capital and surplus.33 Per
33 Section 700.2 of NCUA Rules and Regulations
defines Paid-in and unimpaired capital and surplus
as shares plus post-closing, undivided earnings.
This does not include regular reserves or special
reserves required by law, regulation or special
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§ 741.2, NCUA’s rules and regulations
limit borrowing by federally insured
state chartered credit unions to 50
percent of paid-in and unimpaired
capital and surplus. The regulation does
provide the ability for state credit
unions to obtain a waiver up to the
amount of borrowing allowed under
state law.34 The Board is not aware of
any federally insured state chartered
credit unions that have requested a
waiver to the borrowing limit in the past
decade. While authority to issue
alternative capital instruments for
federally insured state chartered credit
union is determined under state law, it
is possible that some states will only
allow their credit unions to issue
alternative capital instruments under
applicable borrowing authority. As
NCUA’s borrowing limit for federally
insured state chartered credit union is
not statutory, the Board can entertain
removing this limit and requests
comment on this option.
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F. Potential Taxation Implications
The Board recognizes that
supplemental capital could have an
impact on the credit union tax
exemption. The Act specifically
exempts federal credit unions from
taxation by the United States or by any
State or local taxing authority, except
real and personal property taxes.35 With
respect to federal credit unions, the
Board is aware that part of the basis for
the credit union tax exemption was that
Congress recognized most credit unions
could not access the capital markets to
raise capital.36 If all credit unions, not
just low-income designated credit
unions, have the ability to access the
capital markets to meet capital
standards, it could call into question
one of the bases for the credit union tax
exemption. The Board invites comments
on this topic and would like to hear
from stakeholders on the possible
impact a supplemental capital rule may
have on the federal credit union tax
exemption.
Unlike federal credit unions, the Act
does not exempt federally insured state
chartered credit unions from taxation.
agreement between the credit union and its
regulator or share insurer. 12 CFR 700.2.
34 12 CFR 741.2.
35 12 U.S.C. 1768.
36 It is noteworthy that, in 1951, thrift institutions
lost their tax exemption. The Senate report to the
Revenue Act of 1951 stated that mutual savings
banks and savings and loan associations were losing
their tax exemption because they had evolved into
commercial bank competitors. In addition, thrifts
had evolved from mutual organizations to ones that
operated in a similar manner to banks. Finally, the
exemption had given thrifts a competitive
advantage over taxable commercial banks and life
insurance companies.
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Federally insured state chartered credit
unions are exempt from federal income
tax under § 501(c)(14)(A) of the Internal
Revenue Code. Section 501(c)(14)(A) of
the Internal Revenue Code provides for
exemption from federal income taxes for
state credit unions without capital stock
organized and operated for mutual
purposes without profit. At this time,
there does not appear to be an
established definition of ‘‘capital stock’’
used by the IRS. It is possible federally
insured state chartered credit unions in
some states will have broad authority to
issue supplemental capital instruments
that have the characteristics of capital
stock, and by doing so could subject
themselves to taxation. The Board
therefore requests comment on whether
NCUA should limit the types of
instruments issued by federally insured
state chartered credit unions to those
that would clearly not meet the
definition of capital stock. Other options
the Board could consider, include
requiring a federally insured state
chartered credit unions to provide a
formal opinion from the IRS that the
supplemental capital instrument it is
issuing will not be classified as capital
stock or requiring the credit union to
provide projections in advance of
issuing the supplemental capital
demonstrating that it can afford to be
taxed and the benefits of the
supplemental capital outweigh the cost
of any taxes it might become subject to.
G. Mutual Ownership Structure of
Credit Unions
The Board also invites comments on
the potential effect supplemental capital
may have on the mutual ownership
structure and governance of credit
unions. The Board invites comments on
how it should structure any potential
rule to avoid issues impacting the
mutuality of credit unions, and the
members’ rights to govern the affairs of
the institution. Specifically, the Board
invites comments on restrictions it
might impose on characteristics of
supplemental capital to avoid these
issues, such as: Non-voting and limits
on covenants in the investment
agreement that may give investors levels
of control over the credit union.
V. Securities Law Applicability
The Board believes that both
secondary and supplemental capital
would be considered securities for
purposes of state and federal securities
laws. The Board invites comment on
this topic and its relationship to credit
unions issuing securities as
supplemental capital.
Being subject to securities laws can
impose requirements on the issuer to
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register with the Securities Exchange
Commission (SEC), issue SEC mandated
disclosures, and comply with the SEC’s
broad anti-fraud rules. The Board,
however, is aware that there are two
exemptions that would likely be
available to credit unions:
• Section 3(a)(5) of the Securities Act,
which is available to certain types of
financial institutions, including credit
unions, for the issuance of any type of
security to any type of investor; 37 and
• Rule 506 under Regulation D under
the Securities Act, which is available to
any entity offering any type of security,
provided that purchasers of the
securities are ‘‘accredited investors’’
(although sales to a limited number of
investors who are not accredited are
also possible under certain
circumstances).38
While these exemptions are likely to
relieve credit unions of the
requirements to register with the SEC
and issue SEC mandated disclosures,
there are a number of other issues that
credit unions must consider and comply
with before issuing any instrument that
would be considered a security. The
Board briefly addresses each of these
issues below.
A. Federal Securities Requirements
Regardless of any exemption from
registration and disclosure, credit
unions issuing alternative capital must
still comply with the SEC’s broad antifraud regulations.39 The Securities
Exchange Act of 1934’s (Exchange Act)
general anti-fraud prohibitions are
embodied in § 10(b), which generally
prohibits the use of manipulative or
deceptive devices or contrivances that
violate SEC rules in connection with the
purchase or sale of securities. Most of
the litigation brought with respect to the
rules promulgated under § 10(b) has
been brought under the general antifraud provision, Rule 10b–5, which
provides as follows:
It shall be unlawful for any person,
directly or indirectly, by the use of any
means or instrumentality of interstate
commerce, or of the mails or of any
facility of any national securities
exchange,
(a) To employ any device, scheme, or
artifice to defraud,
37 17
CFR 240.3a5.
at § 230.506.
39 See, e.g., Regulation D, Rule 501(a): ‘‘Users of
Regulation D (§§ 230.500 et seq.) should note the
following:
(a) Regulation D relates to transactions exempted
from the registration requirements of section 5 of
the Securities Act of 1933 (the Act) (15 U.S.C. 77a
et seq., as amended). Such transactions are not
exempt from the anti-fraud, civil liability, or other
provisions of the federal securities laws.’’
38 Id.
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(b) To make any untrue statement of
a material fact or to omit to state a
material fact necessary in order to make
the statements made, in the light of the
circumstances under which they were
made, not misleading, or
(c) To engage in any act, practice, or
course of business which operates or
would operate as a fraud or deceit upon
any person, in connection with the
purchase or sale of any security.40
The primary intent of Rule 10b–5 and,
more broadly, the anti-fraud provisions
of the Securities Act of 1933 (Securities
Act) and Exchange Act, is to prevent
fraud, deceit, and incorrect or
misleading statements or omissions in
the offering, purchase and sale of
securities. Given that intent, clear and
complete disclosure is the critical factor
in ensuring the anti-fraud provisions of
the Securities Act and Exchange Act are
not breached in any offering by credit
unions, regardless of whether the
offering is registered with the SEC under
the Securities Act or exempt from
registration.
In the absence of SEC-mandated
disclosure delivery requirements, the
practical concern for credit unions
relying on either the Section 3(a)(5) or
Regulation D, Rule 506 exemption is
determining what type and amount of
disclosure is appropriate to meet the
anti-fraud standards. The Board is aware
that the amount of disclosure varies
depending on multiple factors,
including:
• The nature of the potential
investors (focusing on their level of
sophistication);
• The nature of the security being
offered (focusing on the complexity of
the instrument);
• The nature of the business of the
issuer and the industry in which the
issuer operates (focusing on the
complexity of the business or industry);
and
• Market practices (focusing on the
types of disclosure commonly provided
by peer companies).
In addition, the Board is aware that
for any disclosure to meet the standards
of Rule 10b–5, the disclosure must not
contain any untrue statement of a
material fact and must not omit to state
a material fact, the absence of which
renders any disclosure being made
misleading. Further, the disclosure must
be clear, accurate and verifiable, and
should cover topics that are typically
important to investors in making an
investment decision, including:
• Material risks relating to the issuer
and the industry in which the issuer
operates;
40 17
CFR 240.10b–5.
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• Material risks relating to the
security being offered;
• The issuer’s planned uses for the
proceeds of the offering;
• Regulatory matters impacting the
issuer and its operations;
• Tax issues associated with the
security being offered; and
• How the securities are being offered
and sold, including any conditions to be
met in order to complete the offering.
The Board is also aware that the
Office of Comptroller of the Currency
(OCC) promulgated regulations that
require supervised banks issuing
securities to register directly with the
OCC and issue OCC mandated
disclosures. The OCC mandated
disclosures are very similar to those
required by the SEC.41 The Board is
considering requiring similar
registration and disclosures for credit
unions issuing alternative capital. The
Board is concerned that without
mandated disclosures, credit unions
may be at greater risk for anti-fraud
suits, which, if successful, would impair
not only the credit union but also the
Share Insurance Fund’s ability to use
secondary or supplemental capital to
cover losses. Further, the Board also
believes it is important that investors in
credit union alternative capital
instruments have similar protections to
those provided investors in SEC and
OCC covered entities. The Board is
interested in comments on the following
questions in particular:
• Should the Board require credit
unions issuing alternative capital to
register with NCUA?
• How could NCUA protect the Share
Insurance Fund against potential antifraud claims that could impair the
alternative capital’s ability to cover
losses?
• Should the Board mandate
disclosures all credit unions issuing
alternative capital must provide to
investors? If the Board should mandate
disclosures, should it base them on the
SEC’s, the OCC’s, or create a unique set
of disclosures for credit unions? If the
Board creates a unique set of
disclosures, what should it include in
those disclosures? Should the level of
disclosures vary based on the level of
the investor (institutional, accredited,
natural person)?
• Should the Board require credit
unions to develop policies and
procedures to ensure ongoing
compliance with anti-fraud
requirements before it begins issuing
alternative capital?
The Board is also aware that there
may be potential broker-dealer
41 12
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registration issues related to secondary
and supplemental capital. Specifically,
marketing activities by a credit union
and its employees could require the
credit union to register as a brokerdealer. While there are exemptions
available to credit unions and their
employees, the Board notes that these
exemptions are complex and require a
thorough evaluation of a credit union’s
practices and the activities of its
employees. If a credit union or its
employees fail to qualify for an
exemption, the credit union or
employee could be required to register
as a broker-dealer or face penalties for
failure to comply with applicable rules.
The Board has previously stated that
federal credit unions are not permitted
to register as broker-dealers.42 The
Board invites comments on how it
should ensure a credit union has
determined if it or its employees are
required to register.
In addition, it is unlikely that credit
unions and their employees would be
subject to investment adviser
registration requirements. The Board
notes that certain marketing activities
and relationships with other credit
unions could raise investment adviser
requirements. The Board, therefore,
invites comments on this issue and if
NCUA should require credit unions to
have policies and procedures to ensure
their activities do not trigger investment
adviser registration requirements.
B. State Securities Requirements
First, certain provisions of the
Securities Act and SEC rules have
preempted state securities laws with
respect to most covered securities.
However, states may require issuers to
register with the state and/or pay state
registration fees. Further, states may
also pursue fraud-based claims. The
Board invites comment on how it
should ensure that any credit union
issuing alternative capital has
considered and complied with all
applicable state laws.
C. Director and Officer Liability
Coverage
The Board also notes that issuing
securities can affect a credit union’s
director and officer liability coverage. A
lack of coverage could not only impair
the credit union, but also threaten the
Share Insurance Fund in the event there
are losses that the credit union is
ultimately responsible for. Before
engaging in supplemental or secondary
capital activities, therefore, credit
unions will need to evaluate coverage to
42 NCUA Letter to FCUs 10–FCU–03, Sale of
Nondeposit Investments, December 2010.
CFR part 16.
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ensure these activities are covered
under their policy. The Board requests
comments on if it should mandate that
credit unions certify that they have
evaluated their policies and have
sufficient coverage before beginning
secondary or supplemental capital
activities.
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D. Contractual Matters and
Communications
A credit union will need to address
contractual provisions between the
credit union and its investors. Often
these provisions will include requiring
ongoing communications with
investors, reporting of compliance with
the contractual covenants, and sharing
of information with current and
prospective investors. Credit unions
will have to develop policies and
procedures to comply with these
covenants and provisions and ensure
that they are not providing non-public
information to investors that is not
generally available to all investors.
Failure to comply with the investment
contracts or to properly monitor
communications and sharing of
information could subject the credit
union to liability, which could
negatively impact the Share Insurance
Fund. As such, the Board requests
comment on if it should mandate
comprehensive policies addressing
compliance with investment contracts,
communications, and information
sharing. The Board invites commenters
to provide suggestions on the specific
details that should be in the policy and
if sufficient policies should be a
prerequisite to engaging in
supplemental or secondary capital
activities.
VI. Other Investor Considerations
Section 701.34(b) of NCUA’s
regulations limits eligible investors in
secondary capital to institutional
investors, referenced as non-natural
persons.43 This limitation is not
required by the Act. This limitation
prevents the sale of secondary capital to
consumers who could lack the ability to
understand the risks associated with
secondary capital, especially when there
is opportunity for confusion given that
the low-income designated credit union
is federally insured. Also, low-income
designated credit unions can sell
secondary capital to nonmembers.
When the secondary capital regulations
were written in 1996 the purchasers of
secondary capital were presumed to be
foundations and other philanthropicminded institutional investors.44
43 12
44 61
CFR 701.34(b).
FR 378 (Feb. 2, 1996).
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From an investor protection
standpoint, the issue of limiting the sale
of secondary capital and supplemental
capital largely focuses on providing
adequate protections to the purchasers
through the issuance of initial
disclosures, transparency standards
with respect to reporting of information
about the operations and performance of
the credit union, and whether the
purchaser has the necessary
sophistication relative to the complexity
and risk of the instrument. As discussed
in more detail in the Section V,
Securities Law Applicability, of this
ANPR, the OCC requires banks issuing
subordinated debt to comply with the
securities offering disclosure rules in its
regulations.45 The OCC’s regulations
establish registration statement and
prospectus requirements for the offer
and sale of securities issued, subject to
exemptions and disclosure requirements
based on the sophistication of the
investor. As banks are not restricted in
who they can sell securities to, these
rules, in part, help provide a level of
investor protection, particularly for less
sophisticated, non-institutional
investors.
The issue of permissible investors is
also related to anti-fraud considerations.
As noted above, the level of disclosures
necessary to comply with anti-fraud
rules varies, in part, on the level of
sophistication of the investors. In
practice, selling to non-sophisticated
investors would likely involve a much
higher initial and ongoing disclosure
and communications burden for credit
unions.
Thus, the Board requests comment on
whether the sale of secondary and
supplemental capital should be limited
to only institutional investors, include
accredited investor, or allow for anyone
to purchase. If the Board were to allow
credit unions to sell alternative capital
to non-accredited investors, should
there be limits on the amount individual
investors can purchase? Also, should
there be conditions on how the sale to
non-accredited investors must be
handled to minimize potential
confusion about its lack of federal
insurance?
Whether credit unions that are not
low-income designated should be able
sell supplemental capital instruments to
nonmembers with equity like
characteristics is a matter relevant to
considerations about the mutual model
of credit unions. The Board requests
comments on the extent to which credit
unions should be allowed to sell
alternative capital with equity like
characteristics to nonmembers, and if
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so, what controls are necessary to
preserve the mutual ownership
structure and democratic governance of
credit unions. The Board invites
comments on how it should structure
any potential rule to avoid issues
impacting the mutuality of credit
unions, and the members’ rights to
govern the affairs of the institution.
VII. Prudential Standards for Issuing
and Counting Alternative Capital for
Prompt Corrective Action
For a financial instrument to be
considered regulatory capital for prompt
corrective action purposes, NCUA must
consider the instrument’s degree of
permanence, capacity to absorb losses as
a going concern, the flexibility of
principal and interest payments, and
intended use of the proceeds. These
characteristics are consistent with the
Basel Tier 2 capital criteria.46 These
same criteria are also contained in the
regulatory capital quality distinctions
for the U.S. banking system.47
Provisions related to these
characteristics are intended to ensure
the funds will be available to protect the
Share Insurance Fund and do not create
incentives for credit unions to engage in
unsafe or unsound practices.
The function of supplemental capital
is to protect the credit union and the
Share Insurance Fund in the event of
loss. Supplemental capital, therefore,
must be able to absorb losses ahead of
the Share Insurance Fund while not
conferring control of the credit union to
the investor. The instruments must be
uninsured and cannot be guaranteed or
secured by the credit union or its assets.
These features ensure supplemental
capital fulfils its ultimate purpose and
does not result in unintended
encumbrances to the credit union or the
Share Insurance Fund.
The degree of permanence is
important because the instrument must
create sufficient stability in the credit
union’s capital base to be available to
cover losses over a long time period.
This is the reason for the minimum five
year maturity contained in the Basel
accords, the U.S. banking capital
regulations, and for secondary capital
46 Basel III was published in December 2010 and
revised in June 2011. The text is available at http://
www.bis.org/publ/bcbs189.htm. The BCBS is a
committee of banking supervisory authorities,
which was established by the central bank
governors of the G–10 countries in 1975. More
information regarding the BCBS and its
membership is available at http://www.bis.org/bcbs/
about.htm. Documents issued by the BCBS are
available through the Bank for International
Settlements Web site at http://www.bis.org. See
paragraph number 58 for criteria for inclusion in
Tier 2 Capital.
47 12 U.S.C. 324.20.
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for low-income designated credit
unions. With respect to secondary
capital, a low-income designated credit
unions is allowed to have a call option
for the portion no longer qualifying as
net worth so that they may retire the
instrument if it is no longer needed or
market conditions allow them to reprice
the capital at a lower rate. However,
supervisory approval is needed before
any call is exercised because it
represents a potentially material change
to the risk to the Share Insurance Fund.
The alternative capital must be able to
absorb losses while the institution is
still a going concern, and not just in the
case of liquidation. The existing
regulatory language regarding secondary
capital requires that it is available to
‘‘cover operating losses.’’ 48 The term
‘‘operating losses’’ has been interpreted
to not include the payment of dividends
on shares.49 However, a credit union’s
inability to fund a dividend rate that is
consistent with prevailing rates can
create liquidity and reputation risk.
Therefore, credit unions may need the
flexibility to issue alternative capital
instruments that are available to absorb
all losses in excess of retained earnings,
including the payment of dividends on
shares.50 The Board is seeking comment
on the exclusion of dividend expenses
as an operating expense and seeks
comment on how to resolve the
complexity that can result from
excluding dividend expense from losses
applied to secondary capital but not
from losses applied to supplemental
capital.
Further, the payment of interest on
the instruments must be capable of
being cancelled on a permanent,
noncumulative basis without
constituting a default. The interest
provisions must also not contain any
feature which would provide incentive
for the credit union to exercise a call
option, such as a large increase in the
interest rate. The flexibility of payments
ensures investors cannot obviate any
risk exposure to their principal through
problematic dividend and interest
provisions. These criteria are consistent
with the criteria for inclusion in Tier 2
capital used by the other banking
regulators 51 and are contained in Basel
III.52
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48 12
CFR 701.34(b)(7).
CFR 701.34.
50 If the Board authorizes supplemental capital, it
could be possible for low income designated credit
unions to concurrently offer both supplemental and
secondary capital instruments. The differing
treatment of payments on dividends could make the
administration of losses applied to alternative
capital complex and potentially confusing.
51 12 CFR 5.47.
52 Basel III was published in December 2010 and
revised in June 2011. The text is available at http://
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Because of these characteristics, most
alternative capital instruments can have
relatively low liquidity for the
purchaser and there is no guarantee of
a secondary market. These
characteristics also impact the interest
rate the credit union must pay for
alternative capital. The Board seeks
comment on how to maintain protection
of the Share Insurance Fund while
minimizing the impact the criteria
would have on the cost and
marketability of the alternative capital
instruments.
A. Approval To Issue and Notice
The Board is considering including an
application and notice requirement in
any supplemental capital regulations it
may issue.53 The Board notes that
requiring a credit union to obtain
approval to issue alternative capital and
provide a notice of issuance can
contribute to ensuring alternative
capital instruments are issued in
accordance with applicable regulations,
part of a sound management plan, and
are structured to properly protect the
Share Insurance Fund.54
The Board notes that currently NCUA
requires a low-income designated credit
union to submit a ‘‘Secondary Capital
Plan’’ prior to the acceptance of
secondary capital that includes: 55
• The maximum aggregate amount of
secondary capital the low-income
designated credit union plans to accept;
• The purpose for which the
secondary capital will be used and how
it will be repaid;
• Demonstration that the uses of the
secondary capital conform to the lowincome designated credit union’s
strategic plan, business plan, and
budget; and
• Supporting pro forma financial
statements covering a minimum of two
years.
The account agreement associated
with any alternative capital needs to
conform to the standards that ensure it
protects the Share Insurance Fund and
provide the credit union with flexibility
in conducting its daily affairs. The
secondary capital regulation currently
requires that the low-income designated
credit union retain the original account
agreement and the ‘‘Disclosure and
Acknowledgment’’ for the term of the
www.bis.org/publ/bcbs189.htm. See paragraph 58
for criteria for inclusion in Tier 2 Capital.
53 Secondary capital provisions already require
low income designated credit unions to obtain prior
NCUA approval.
54 See. 12 CFR 5.47(f) and (h) for the OCC’s
requirements for prior approval for issuance of
subordinated debt and for the notice procedure for
inclusion as tier 2 capital.
55 12 CFR 701.34(b)(1).
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agreement.56 The regulation does not
specifically require a low-income
designated credit union to submit to
NCUA either a draft account agreement
with the application or the executed
agreement.
For all forms of alternative capital, the
Board seeks comments on the utility of
a prior approval process and a postissuance notification process. The Board
can also consider under what conditions
prior approval would not be necessary,
such as credit unions that are well
capitalized with a successful history of
issuing alternative capital. When prior
approval would be necessary, however,
the Board requests comments on what
should be required in an application for
authority to issue alternative capital,
and how long the credit union would
have to issue the alternative capital after
approval. In addition, the Board request
comment on the evaluation criteria
NCUA should use to approve or deny
the application, including whether or
not certain credit unions that are
already in danger of failing should be
precluded from issuing alternative
capital as a form of investor protection.
Also, the Board seeks comment on the
manner of and what should be included
in any post-issuance notice credit
unions would file with NCUA.
B. Subordination
Secondary capital must be
subordinate to all other claims per the
Act.57 Thus, supplemental capital must
have a payout priority senior to
secondary capital but still subordinate
to the Share Insurance Fund. The
requirement that alternative capital
instruments are subordinate to the Share
Insurance Fund, uninsured
shareholders, and general creditors is
consistent with the Basel criteria for
Tier 2 capital.58
Unlike secondary capital,
supplemental capital is not subject to
provisions in the Act that limit
flexibility in structuring payment
priorities within and between
supplemental capital instruments. For
example, a credit union could issue a
supplemental capital instrument with
56 Id.
at § 701.34(b)(11).
U.S.C. 1790d(o)(2)(C)(ii).
58 Basel III was published in December 2010 and
revised in June 2011. The text is available at http://
www.bis.org/publ/bcbs189.htm. The BCBS is a
committee of banking supervisory authorities,
which was established by the central bank
governors of the G–10 countries in 1975. More
information regarding the BCBS and its
membership is available at http://www.bis.org/bcbs/
about.htm. Documents issued by the BCBS are
available through the Bank for International
Settlements Web site at http://www.bis.org. See
paragraph number 58 for criteria for inclusion in
Tier 2 Capital.
57 12
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two tranches, a high-yield-high-risk
supporting tranche and a loweryielding-lower risk tranche. Credit
unions could also issue supplemental
capital instruments that have first infirst out, or last in-first out contractual
payment priorities. This flexibility
could help credit unions attract
investors of different risk tolerances and
profiles. The Board seeks comment on
whether authorizing supplemental
capital regulations should contain any
restrictions on payment priority options,
and if so, what should they be.
C. Limit on Amount of Supplemental
Capital That Counts as Regulatory
Capital
While supplemental capital can
protect the Share Insurance Fund and
uninsured shares from losses, reliance
on alternative capital as the primary
source of capital is generally unsafe and
unsound. Even with a high level of
permanent capital, such as retained
earnings and common stock, heavy
reliance on alternative capital can result
in wide fluctuations in capital measures
due to the timing of its maturity and
negative impact on earnings due to the
associated costs.
U.S. bank capital regulations require
banks to hold minimum levels of
common equity tier 1 capital, total tier
1 capital, and total tier 1 and tier 2
capital to total risk assets that ensures
that permanent capital is generally the
primary source of regulatory capital.59
An FDIC-supervised institution must
maintain the following minimum
capital ratios: 60
• A common equity tier 1 capital ratio
of 4.5 percent;
• A tier 1 capital ratio of 6 percent;
• A total capital ratio of 8 percent;
and
• A leverage ratio of 4 percent.61
Additionally to be classified as well
capitalized a bank must have:
59 12
CFR 324.10(a).
standardized capital ratio calculations are
defined in 12 CFR 3.10(b). The Common Equity Tier
1 Capital Ratio is the ratio of Common Equity Tier
1 Capital to standardized total risk-weighted assets.
The Tier 1 Capital Ratio is the ratio of Tier 1 Capital
to standardized total risk-weighted assets. The Total
Capital Ratio is the ratio of total capital (Tier 1
Capital plus Tier 2 Capital) to standardized total
risk-weighted assets. The Leverage Ratio is
generally Tier 1 Capital to total consolidated assets.
The components of regulatory capital are defined in
12 CFR 3.20. Common Equity Tier 1 Capital is
generally common stock, retained earnings, and
accumulated other comprehensive income.
Additional Tier 1 Capital primarily includes
noncumulative perpetual preferred stock. Tier 2
Capital generally includes limited allowance for
loan and lease losses, certain subordinated debt and
preferred stock, and qualifying capital minority
interests.
61 Id. at § 324.10(a).
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• A total risk-based capital ratio of
10.0 percent or greater;
• A Tier 1 risk-based capital ratio of
8.0 percent or greater;
• A common equity tier 1 capital ratio
of 6.5 percent or greater; and
• A leverage ratio of 5.0 percent or
greater.62
As a result, banks are inherently
limited in how much Tier 2 forms of
capital will be included in meeting their
regulatory capital standards. Most forms
of alternative capital likely available to
credit unions will be in the form of
subordinated debt—which does not
meet the standards to qualify as Tier 1
capital.
Neither the Act nor NCUA regulations
limit the amount of secondary capital
that can make up a low income
designated credit union’s net worth.
Given their unique needs and mission,
low-income designated credit unions
can primarily rely on secondary capital
to meet prompt corrective action
requirements, provided their use of the
proceeds and overall ongoing
management of their secondary capital
is otherwise safe and sound. However,
the Board believes any regulation for
supplemental capital needs to contain
some method of preventing
supplemental capital, a lower quality of
capital, from becoming the primary
component of regulatory capital for
credit unions. The Board seeks
comments on how capital regulations
could be designed to limit the amount
of supplemental capital included in
regulatory capital calculations.
Consistent with Basel, U.S. bank
capital standards,63 and secondary
capital regulations, the portion of
supplemental capital that would be
considered as regulatory capital and
included in the calculation of the riskbased net worth requirement would be
subject to reductions during the last five
years of the life of the instrument.
Consistent with secondary capital, at the
beginning of the each of last five years
of the life of the supplemental capital,
the amount that is eligible to be
included in the risk-based net worth
requirement would be reduced by 20
percent of the original amount of the
instrument (less any redemptions that
may have occurred). The Board seeks
comments on this concept and how to
reflect the increasingly limited utility as
loss absorbing capital for supplemental
capital approaching maturity.
The Board also notes that changing
conditions and circumstances may
warrant early repayment of alternative
capital, in part or in whole. The
decision on early repayment must reside
with the issuing credit union and not
the holder of the instrument, to ensure
the permanence of the instrument and
prevent undue influence by investors.
Currently the secondary capital
regulations only allow for early
redemption of the amount of secondary
capital that is not recognized as net
worth, with approval by NCUA.64
Regulatory controls over early
repayment are necessary to protect the
Share Insurance Fund and uninsured
shares. Regulatory controls over early
repayment are also consistent with the
Basel framework for subordinated debt
and the other banking agencies’
regulations, which provide control over
the early repayment of subordinated
debt by:
• Requiring all banks to obtain prior
approval to prepay or call subordinated
debt included in tier 2 capital.65
• Prohibiting the holder of
subordinated debt from having a
contractual right to accelerate principal
or interest payments in the instrument,
except in the event of a receivership,
insolvency, liquidation, or other similar
proceeding.66
• Prohibiting the exercise of a call
option in the first five years following
issuance, except in certain very limited
circumstances.
Enabling regulations for supplemental
capital will need to address the issue of
prepayment and call provisions for
supplemental capital. The options
regarding the abilities of a credit union
to prepay supplemental capital could
include minimum capital measures after
repayment, current and expected future
performance measures and notice
criteria of varying degrees. The Board
invites comments on the topic of
prepayment and call provisions for
alternative capital and how it should
structure any related requirements.
Allowing credit unions greater
flexibility to eliminate the cost of
alternative capital or reprice the
instrument under better terms could
provide benefits to the credit union.
Any alternative to the redemption
process would be contingent on the
credit union no longer relying on the
alternative capital to achieve an
appropriate level of capital.
D. Reciprocal Holdings
Regulations for alternative capital
need to address reciprocal holdings.
Reciprocal holdings exist when two or
more credit unions hold each other’s
alternative capital. Reciprocal holdings
64 12
CFR 701.34(d).
at § 5.47(d)(1)(vii).
66 Id. at § 5.47(d)(2).
62 Id.
at § 324.403(b)(1).
63 12 CFR 324.20(d)(iv).
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of alternative capital, without some
form of adjustment, would artificially
inflate the level of capital in the credit
union system, create loss transmission
channels between credit unions, and
could be subject to abuse.
The Board notes a national bank or
federal savings association must deduct
investments in the capital of other
financial institutions it holds
reciprocally, where such reciprocal
cross holdings result from a formal or
informal arrangement to swap,
exchange, or otherwise intent to hold
each other’s capital instruments, by
applying the corresponding deduction
approach.67 The Board requests
comment on how NCUA should address
this concern.
jstallworth on DSK7TPTVN1PROD with PROPOSALS
E. Merger
Per the current regulation, in the
event of merger of a low-income
designated credit union (other than
merger into another low-income
designated credit union) the secondary
capital accounts will be closed and paid
out to the investor to the extent they are
not needed to cover losses at the time
of merger or dissolution. The OCC
prohibits a covenant or provision in
subordinated debt instruments that
requires the prior approval of a
purchaser or holder of the subordinated
debt note in the case of a voluntary
merger where the resulting institution
assumes the due and punctual
performance of all conditions of the
subordinated debt note and where the
agreement is not in default of the
various other covenants.68
In order to avoid any perceptions of
an alternative capital holder having
ownership rights, any restrictions on
merger or other change of control must
not interfere with the credit union’s
ability to exercise its business
judgement and management of the
credit union in a manner that avoids
unsafe and unsound practices. The
Board seeks comment on the issue of
merging credit unions and how
alternative capital should be treated
post-merger.
F. Other Restrictions
Supplemental capital must not
contain contractual terms that would
limit or impede the authority of NCUA
or a State Supervisory Authority to
undertake supervisory action, as
necessary, to protect the issuing credit
union’s members or the Share Insurance
Fund. Any such contractual terms
would impose unsafe and unsound
limits on the credit union’s and
67 12
68 12
CFR 3.22(c)(3).
CFR 5.47(d)(2)(iv).
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15:10 Feb 07, 2017
regulators’ ability to manage the
institution and address problems.
Affirmative covenants within the
supplemental capital note or agreement
must not restrict operations or
potentially require a credit union to
violate a law or regulation. Negative
covenants should not unreasonably
impair the credit union’s flexibility in
conducting its operations or interfere
with management. Without these
restrictions, contractual terms could
undermine the purpose of supplemental
capital and provide holders of these
obligations with unintended rights and
control over the credit union’s
operations. Any representation or
warranties contained in the agreements
that would require acceleration and
repayment of the subordinated debt note
because of a technical violation that
does not reflect underlying credit issues
could be contrary to safety and
soundness. The Board seeks comments
on the issue of contractual restrictions
for alternative capital instruments.
VIII. Supporting Regulatory Changes
A. 701.32—Payment on Shares by
Public Unit Nonmembers
Due to the potential use of alternative
capital as a funding source similar to
public units and nonmembers, the
NCUA Board is seeking comment on
§ 701.32 of NCUA’s regulations as it
prescribes limits placed on these
accounts.
Section 1757(6) of the FCU Act grants
federal credit unions the power ‘‘to
receive from its members, from other
credit unions, from an officer,
employee, or agent of those nonmember
units of Federal, Indian tribal, State, or
local governments and political
subdivisions thereof enumerated in
section 1787 of this title and in the
manner so prescribed, from the Central
Liquidity Facility, and from
nonmembers in the case of credit unions
serving predominately low-income
members (as defined by the Board)
payments, representing equity, on—(A)
shares which may be issued at varying
dividend rates; (B) share certificates
which may be issued at varying
dividend rates and maturities; and (C)
share draft accounts authorized under
section 1785(f) of this title; subject to
such terms, rates, and conditions as may
be established by the board of directors,
within limitations prescribed by the
Board.’’ 69
Currently the regulation limits total
public unit and nonmember shares to 20
percent of the total shares of the federal
credit union or $3 million, whichever is
69 12
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9701
greater.70 Federal credit unions seeking
to exceed the limit must:
• Adopt a specific written plan
concerning the intended use of these
shares and provide it to the Regional
Director before accepting the funds; and
• Submit a written request to the
Regional Director for a new maximum
level of public unit and nonmember
shares.71
Under § 741.204, federally insured
state chartered credit unions must
adhere to the requirements of § 701.32
regarding public unit and nonmember
accounts.72 This regulation also
addresses a federally insured state
chartered credit union obtaining a lowincome designation, as provided under
state law, in order to accept nonmember
accounts other than from public units or
other credit unions.73 Additionally this
section addressed the ability of a
federally insured state chartered credit
union to receive and redeem secondary
capital consistent with § 701.34 and
consistent with applicable state law and
regulation.74
Because the limitations the NCUA
board may prescribe to these accounts is
not statutory, the NCUA Board is
interested in comments on revisions to
this regulation which would reduce the
regulatory burden of the waiver process
but still provide for adequate protection
of the Share Insurance Fund.
B. 701.34—Designation of Low-Income
Status; Acceptance of Secondary
Capital Accounts by LICUs
Section 701.34 of NCUA’s Rules and
Regulations sets out the requirements
and process for a credit union to receive
a low-income designation, the criteria
for accepting secondary capital and the
inclusion of secondary capital as
regulatory capital. NCUA is seeking
comment on whether the criteria and
process for obtaining the low income
designation, the criteria for issuing
secondary capital, and the criteria for
inclusion of secondary capital as
regulatory capital should be in separate
regulations.
Section 701.34 could be solely
focused on the process to receive a lowincome designation. A new section of
701 could be used to address:
• The authority and requirements of
secondary capital;
• Grandfathering treatment of existing
secondary capital in the event of
regulatory changes;
70 12
CFR 701.32(b)(1).
at § 701.32(b)(2).
72 Id. at § 741.204(a).
73 Id. at § 741.204(b).
74 Id. at § 741.204(c) and (d).
71 Id.
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• Requirement to comply with all
applicable federal and state laws in the
issuance of secondary capital;
• Requirements for written contract
agreements covering the terms and
conditions of the secondary capital;
• Requirements for disclosures and
acknowledgement;
• Investor suitability; and
• Prohibitions.
The items specific to secondary
capital’s and supplemental capital’s
inclusion in regulatory capital and
related capital adequacy issues could be
consolidated into Section 702—Capital
Adequacy, including:
• Standards for alternative capital
instruments to be counted as regulatory
capital;
• Any limits on the amount of
alternative capital counted as regulatory
capital;
• The role of supplemental capital in
approval of a net worth restoration plan;
• Provisions for discounting
regulatory capital treatments such as
violations of applicable laws or
regulation, including any deficiency
cure alternatives; and
• Risk weight for an investment in
supplemental capital.
C. Payout Priorities
To conform the regulatory payout
priorities for supplemental capital, the
payout priorities for an involuntary
liquidation will need to be revised.75
Supplemental capital would be listed in
the payout priority after uninsured
shareholders and the Share Insurance
Fund.
jstallworth on DSK7TPTVN1PROD with PROPOSALS
D. Other Regulations
The Board seeks comments on any
other related changes to existing
regulations, such as:
• Modifying the definition of insured
shares in 741.4(b) to exclude any equity
shares allowed under state law, if they
are in fact uninsured;
• Modifying 741.9 to provide for the
existence of uninsured accounts issued
under state law by FISCUs; and
• Any cohering changes to part 745 as
necessary.
By the National Credit Union
Administration Board on January 19, 2017.
Gerard Poliquin,
Secretary of the Board.
[FR Doc. 2017–01713 Filed 2–7–17; 8:45 am]
BILLING CODE P
75 12
CFR 709.5.
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DEPARTMENT OF ENERGY
Federal Energy Regulatory
Commission
18 CFR Part 40
[Docket No. RM16–20–000]
Remedial Action Schemes Reliability
Standard
Federal Energy Regulatory
Commission.
ACTION: Notice of proposed rulemaking.
AGENCY:
The Federal Energy
Regulatory Commission proposes to
approve Reliability Standard PRC–012–
2 (Remedial Action Schemes) submitted
by the North American Electric
Reliability Corporation. The purpose of
proposed Reliability Standard PRC–
012–2 is to ensure that remedial action
schemes do not introduce unintentional
or unacceptable reliability risks to the
bulk electric system.
DATES: Comments are due April 10,
2017
SUMMARY:
Comments, identified by
docket number, may be filed in the
following ways:
• Electronic Filing through http://
www.ferc.gov. Documents created
electronically using word processing
software should be filed in native
applications or print-to-PDF format and
not in a scanned format.
• Mail/Hand Delivery: Those unable
to file electronically may mail or handdeliver comments to: Federal Energy
Regulatory Commission, Secretary of the
Commission, 888 First Street, NE.,
Washington, DC 20426.
Instructions: For detailed instructions
on submitting comments and additional
information on the rulemaking process,
see the Comment Procedures Section of
this document.
FOR FURTHER INFORMATION CONTACT:
Syed Ahmad (Technical Information),
Office of Electric Reliability, Division
of Reliability Standards and Security,
888 First Street NE., Washington, DC
20426, Telephone: (202) 502–8718,
Syed.Ahmad@ferc.gov.
Alan Rukin (Legal Information), Office
of the General Counsel, Federal
Energy Regulatory Commission, 888
First Street NE., Washington, DC
20426, Telephone: (202) 502–8502,
Alan.Rukin@ferc.gov.
SUPPLEMENTARY INFORMATION:
1. Pursuant to section 215 of the
Federal Power Act (FPA), the
Commission proposes to approve
proposed Reliability Standard PRC–
012–2 (Remedial Action Schemes). The
North American Electric Reliability
ADDRESSES:
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Corporation (NERC), the Commissioncertified Electric Reliability
Organization (ERO), submitted proposed
Reliability Standard PRC–012–2 for
approval. The purpose of proposed
Reliability Standard PRC 012–2 is to
ensure that remedial action schemes
(RAS) do not introduce unintentional or
unacceptable reliability risks to the bulk
electric system. In addition, the
Commission proposes to approve the
associated violation risk factors and
violation severity levels,
implementation plan, and effective date
proposed by NERC. NERC also
submitted proposals to retire two
currently-effective Reliability Standards
and to withdraw three Reliability
Standards that are pending review
before the Commission. While
proposing to approve Reliability
Standard PRC–012–2, the Commission
seeks clarifying comments addressing
‘‘limited impact’’ RAS. Based on
comments and information received, the
Commission may issue directives as
appropriate.
I. Background
A. Section 215 and Mandatory
Reliability Standards
2. Section 215 of the FPA requires a
Commission-certified ERO to develop
mandatory and enforceable Reliability
Standards, subject to Commission
review and approval.1 Once approved,
the Reliability Standards may be
enforced by the ERO subject to
Commission oversight, or by the
Commission independently.2 In 2006,
the Commission certified NERC as the
ERO pursuant to section 215 of the
FPA.3
B. Order No. 693
3. On March 16, 2007, the
Commission issued Order No. 693,
approving 83 of the 107 Reliability
Standards filed by NERC, including
Reliability Standards PRC–015–1
(Remedial Action Scheme Data and
Documentation) and PRC–016–1
(Remedial Action Scheme
Misoperation).4 Reliability Standard
PRC–015–1 requires transmission
owners, generator owners, and
distribution providers to maintain a
1 16
U.S.C. 824o(c), (d) (2012).
824o(e).
3 North American Electric Reliability Corp., 116
FERC ¶ 61,062 (ERO Certification Order), order on
reh’g and compliance, 117 FERC ¶ 61,126 (2006),
order on compliance, 118 FERC ¶ 61,190, order on
reh’g, 119 FERC ¶ 61,046 (2007), aff’d sub nom.
Alcoa Inc. v. FERC, 564 F.3d 1342 (D.C. Cir. 2009).
4 Mandatory Reliability Standards for the BulkPower System, Order No. 693, FERC Stats. and Regs.
¶ 31,242, order on reh’g, Order No. 693–A, 120
FERC ¶ 61,053 (2007).
2 Id.
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Agencies
[Federal Register Volume 82, Number 25 (Wednesday, February 8, 2017)]
[Proposed Rules]
[Pages 9691-9702]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-01713]
========================================================================
Proposed Rules
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.
========================================================================
Federal Register / Vol. 82, No. 25 / Wednesday, February 8, 2017 /
Proposed Rules
[[Page 9691]]
NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Parts 701, 702, 703, 709, 741, and 745
Alternative Capital
AGENCY: National Credit Union Administration.
ACTION: Advance notice of proposed rulemaking.
-----------------------------------------------------------------------
SUMMARY: The NCUA Board (Board) is issuing this advanced notice of
proposed rulemaking (ANPR) to solicit comments on alternative forms of
capital federally insured credit unions could use in meeting capital
standards required by statute and regulation. For purposes of this
ANPR, alternative capital includes two different categories: Secondary
capital and supplemental capital. Secondary capital is currently
permissible under the Federal Credit Union Act (Act) only for low-
income designated credit unions to issue and to be counted toward both
the net worth ratio and the risk-based net worth requirement of NCUA's
prompt corrective action standards. The Board is considering changes to
the secondary capital regulation for low-income designated credit
unions. There are no other forms of alternative capital currently
authorized. However, the Board is also considering whether or not to
authorize credit unions to issue supplemental capital instruments that
would only count towards the risk-based net worth requirement.
DATES: Comments must be received on or before May 9, 2017.
ADDRESSES: You may submit comments by any one of the following methods
(Please send comments by one method only):
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Email: Address to regcomments@ncua.gov. Include ``[Your
name]--Comments on Advance Notice of Proposed Rulemaking for
Supplemental Capital'' in the email subject line.
Fax: (703) 518-6319. Use the subject line described above
for email.
Mail: Address to Gerald Poliquin, Secretary of the Board,
National Credit Union Administration, 1775 Duke Street, Alexandria,
Virginia 22314-3428.
Hand Delivery/Courier: Same as mail address.
Public Inspection: You can view all public comments on NCUA's Web
site at http://www.ncua.gov/Legal/Regs/Pages/PropRegs.aspx as
submitted, except for those we cannot post for technical reasons. NCUA
will not edit or remove any identifying or contact information from the
public comments submitted. You may inspect paper copies of comments in
NCUA's law library at 1775 Duke Street, Alexandria, Virginia 22314, by
appointment weekdays between 9 a.m. and 3 p.m. To make an appointment,
call (703) 518-6546 or send an email to OGCMail@ncua.gov.
FOR FURTHER INFORMATION CONTACT: Steve Farrar, Supervisory Financial
Analyst, at (703) 518-6360; or Justin Anderson, Senior Staff Attorney,
Office of General Counsel, at (703) 518-6540. You may also contact them
at the National Credit Union Administration, 1775 Duke Street,
Alexandria, Virginia 22314.
SUPPLEMENTARY INFORMATION: At its October 2016 meeting, the Board held
a public briefing on the topic of alternative capital for credit
unions. This ANPR provides relevant background information and seeks
comment on a broad range of considerations with respect to alternative
capital for federally insured credit unions. This ANPR addresses topics
including: (1) NCUA's authority to include alternative capital for
prompt corrective action purposes; (2) credit unions' authority to
issue alternative forms of capital; (3) prudential standards regarding
the extent to which various forms of instruments would qualify as
capital for prompt corrective action purposes and credit union
eligibility for the sale of alternative capital; (4) the utility and
suitability of supplemental capital for credit unions; (5) standards
for investor protection, including disclosure requirements and investor
eligibility criteria for the purchase of alternative capital; (6)
implications of securities law for supplemental and secondary capital;
(7) potential implications for credit unions, including the credit
union tax exemption; and (8) overall regulatory changes the Board would
need to make to permit supplemental capital, improve secondary capital
standards, and provide or modify related supporting authorities. The
Board has posed a number of specific questions on these and other
topics, but invites comments on any and all aspects of alternative
capital.
I. Background
II. Current Secondary Capital Standards
III. Current and Prospective Use of Alternative Capital
IV. Supplemental Capital Legal Authority and Potential Taxation
Implications
V. Securities Law Applicability
VI. Other Investor Considerations
VII. Prudential Standards for Issuing and Counting Alternative
Capital for Prompt Corrective Action
VIII. Supporting Regulatory Changes
I. Background
In 1998, Congress passed the Credit Union Membership Access Act
(CUMAA) which amended the Act to mandate a system of prompt corrective
action for federally insured natural person credit unions (credit
unions).\1\ The prompt corrective action system incorporates capital
standards for credit unions. The Act indexes a credit union's prompt
corrective action status to five categories: Well capitalized,
adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized.\2\ As a credit
union's capital level falls, its classification among the prompt
corrective action categories can decline below well capitalized, thus
exposing it to an expanding range of mandatory and discretionary
supervisory actions designed to remedy the problem and minimize any
loss to the National Credit Union Share Insurance Fund (Share Insurance
Fund).\3\
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\1\ The Credit Union Membership Access Act of 1998, HR 1151,
Public Law 105-219, 112 Stat. 913 (1998).
\2\ 12 U.S.C. 1790d(c); 12 CFR part 702; 65 FR 8560 (Feb. 18,
2000); see 702 subpart C for categories for ``new'' credit unions.
\3\ Id. at Sec. 1790d(e), (f) and (g); 12 CFR 702 subpart B.
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The Act defines a credit union's capital level based on a net worth
ratio requirement for all credit unions and a risk-based net worth
requirement for credit unions the Board defines as
[[Page 9692]]
complex.\4\ The Act also provides the NCUA Board with broad discretion
to design the risk-based net worth requirement. However, the net worth
ratio is defined in the Act as a credit union's ratio of net worth to
total assets. The Act defines net worth as: \5\
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\4\ In 2000, NCUA adopted part 702 of NCUA Rules and Regulations
to implement the Act's system of prompt corrective action.
\5\ Id. at Sec. 1790d(o)(3); 12 CFR 702.2(g) and (k).
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The retained earnings balance of the credit union, as
determined under generally accepted accounting principles, together
with any amounts that were previously retained earnings of any other
credit union with which the credit union is combined;
Secondary capital of a low-income designated credit union
that is uninsured and subordinate to all other claims of the credit
union, including the claims of creditors, shareholders, and the Share
Insurance Fund; and \6\
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\6\ In 1996, the NCUA Board authorized low-income designated
credit unions, including state chartered credit unions to the extent
permitted by state law, to count as capital uninsured secondary
capital. At the time, the Board recognized that it was difficult for
low-income designated credit unions to accumulate capital only
through retained earnings. The Board, therefore, permitted low-
income designated credit unions to use the borrowing authority in
the Act to issue secondary capital accounts. This authority would
allow these credit unions to build capital to support greater
lending and financial services to their members and their
communities, and to absorb losses to protect them from failing. To
ensure the safety and soundness of secondary capital activity, the
1996 rule imposed various restrictions on its use and structure. At
this time, prompt corrective action and the associated definition of
net worth was not yet part of the Act. 61 FR 50696 (Sept. 27, 1996).
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Certain assistance provided under section 208 of the Act
pursuant to NCUA regulations.\7\
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\7\ 12 U.S.C. 1790d(o)(2).
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As noted above, per the Act, secondary capital is currently only
permissible for low-income designated credit unions to issue and to be
counted toward the net worth ratio. NCUA also counts secondary capital
issued by low-income designated credit unions as net worth for the
risk-based net worth ratio.
The Board notes that, NCUA cannot change the Act's definition of
net worth--only Congress can. However, the Board has broad discretion
in designing the risk-based net worth requirement. Thus, it is possible
for the Board to authorize a credit union that is not low-income
designated to issue alternative capital instruments that would count
towards satisfying the risk-based net worth requirement--but not the
net worth ratio. (See the discussion of legal authority in Section IV).
For purposes of this ANPR, the term supplemental capital includes any
form of capital instruments credit unions that are not designated as
low-income might be authorized to issue and count only for inclusion in
the risk-based net worth requirement.
The risk-based net worth requirement for federally insured credit
unions is based on a risk-based net worth ratio calculation in Part 702
of NCUA's Rules and Regulations.\8\ Per the Board's October 2015 final
rule, on January 1, 2019, the risk-based net worth requirement will be
updated to replace the risk-based net worth ratio with a new risk-based
capital ratio.\9\
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\8\ Unless otherwise noted, throughout this ANPR references to
prompt corrective action, risk-based capital, and citations to Part
702 refer to Part 702 as revised by the Board at its October 2015
meeting.
\9\ 80 FR 66626 (Oct. 29, 2015).
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During the risk-based capital rulemaking process, the Board asked
for stakeholder input on supplemental capital. Specifically, in the
January 2015 risk-based capital (RBC) proposal the NCUA Board posed the
following six questions: \10\
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\10\ 80 FR 4340, 4384 (Jan. 27, 2015).
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1. Should additional supplemental forms of capital be included in
the RBC numerator and how would including such capital protect the
Share Insurance Fund from losses?
2. If yes, to be included in the RBC numerator, what specific
criteria should such additional forms of capital reasonably be required
to meet to be consistent with Generally Accepted Accounting Practices
(GAAP) and the Act, and why?
3. If certain forms of certificates of indebtedness were included
in the risk based capital ratio numerator, what specific criteria
should such certificates reasonably be required to meet to be
consistent with GAAP and the Act, and why?
4. In addition to amending NCUA's RBC regulations, what additional
changes to NCUA's regulations would be required to count additional
supplemental forms of capital in NCUA's RBC ratio numerator?
5. For state-chartered credit unions, what specific examples of
supplemental capital currently allowed under state law do commenters
believe should be included in the RBC ratio numerator, and why should
they be included?
6. What investor suitability, consumer protection, and disclosure
requirements should be put in place related to additional forms of
supplemental capital?
In response to these questions, a majority of the commenters who
addressed supplemental capital stated that it was imperative that the
Board consider allowing credit unions access to additional forms of
capital. The commenters suggested credit union authority to issue
supplemental capital was particularly important as credit unions are at
a disadvantage in the financial market because most lack access to
additional capital outside of retained earnings. While none of the
commenters offered specific suggestions on how to implement
supplemental capital, a few did suggest that the Board should
promulgate broad, non-prescriptive rules to allow credit unions maximum
flexibility in issuing supplemental capital.
As the Board did not receive comments with sufficient detail in
response to the RBC proposal, the Board is again posing the six
questions listed above for commenters to consider and address.
Throughout this ANPR, the Board will expand on these six questions and
ask more specific questions about the structure, form, regulations, and
requirements related to supplemental capital, as well as relevant
changes and improvements to secondary capital. The Board encourages all
stakeholders to address in detail as many of these questions as
possible and provide the Board with specific comments and responses.
The Board intends these questions to be a starting point for commenters
to present their thoughts, but invites comments on all aspects of
alternative capital
Throughout this ANPR the Board discusses several complex topics and
uses terms to refer to specific forms of capital. In addition to
supplemental, secondary, and alternative capital, the Board will use
the term ``regulatory capital'' when referring to financial instruments
issued by credit unions or banks, that include both equity and debt,
and other financial statement account which meet the criteria contained
in regulations for inclusion in the calculation of capital adequacy
measures.
II. Current Secondary Capital Standards
The Act's definition of net worth states that secondary capital
must be ``uninsured and subordinate to all other claims of the credit
union, including the claims of creditors, shareholders, and the Share
Insurance Fund.'' \11\ This means that any secondary capital issued by
a low-income designated credit union must be the most subordinated item
on the balance sheet (first loss position after retained earnings) and
any losses to secondary capital must be pro-rated equally--that is
without preference or priority. The practical effect is that low-income
designated
[[Page 9693]]
credit unions cannot include payment priority structures within or
between secondary capital instruments to enhance investors' interests.
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\11\ 12 U.S.C. 1790d(o)(C)(ii).
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NCUA's rules and regulations also contain various provisions
addressing the prudent and appropriate issuance and use of secondary
capital by low-income designated credit unions. These provisions are as
follows:
Low-income designed credit unions:
[cir] May only accept secondary capital accounts from non-natural
person members and non-natural person nonmembers.
[cir] Must submit and receive approval by NCUA of a Secondary
Capital Plan.
[cir] Must execute a Disclosure and Acknowledgement statement.
A secondary capital account:
[cir] Must be uninsured;
[cir] Have a minimum maturity of five years with a reduction in the
recognition of the net worth value of accounts with less than five
years of remaining maturity;
[cir] Must be subordinate to all other claims, including those of
shareholders, creditors and the Share Insurance Fund;
[cir] Must be available to cover operating losses that exceed net
available reserves and to extent losses are applied the accounts must
not be restored;
[cir] Cannot be pledged by investors as security on a loan;
[cir] Are subject to restrictions of dividends as provided in
prompt corrective action; and
[cir] May only in certain circumstances be redeemed early and only
with prior NCUA approval.\12\
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\12\ 12 CFR 701.34.
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The regulations allow NCUA to prohibit a low-income designated
credit union classified as critically undercapitalized from paying
principal, dividends, or interest on secondary capital. This provision
is to ensure secondary capital is available to cover losses while the
low-income designated credit union is operating as a going concern.
These payment restrictions are consistent with limitations on principal
and interest payments imposed by the federal banking regulators for
subordinated debt issued by banks.\13\
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\13\ 12 CFR 5.47(d)(3)(ii)(B)(3).
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Further, due to the fact that secondary capital is not a permanent
form of capital, NCUA's regulations reduce the portion of secondary
capital that is included in the net worth ratio as it approaches
maturity. Once the remaining maturity is less than five years, the
regulations require low-income designated credit unions to discount how
much a secondary capital account contributes to the credit union's net
worth value based on the following schedule: \14\
---------------------------------------------------------------------------
\14\ Id. at Sec. 701.34(c).
------------------------------------------------------------------------
Net worth
value of
Remaining maturity original
balance
(percent)
------------------------------------------------------------------------
Four to less than five years............................ 80
Three to less than four years........................... 60
Two to less than three years............................ 40
One to less than two years.............................. 20
Less than one year...................................... 0
------------------------------------------------------------------------
Since 2006, low-income credit unions may request NCUA approval to
redeem the portion of secondary capital no longer included in net worth
if:
The credit union will have a post-redemption net worth
classification of at least adequately capitalized;
The discounted secondary capital has been on deposit at
least two years; and
The discounted secondary capital will not be needed to
cover losses prior to the final maturity date.\15\
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\15\ Id. at Sec. 701.34(d).
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With respect to secondary capital, the Board specifically seeks
comments on the following:
Whether or not to permit a low-income designated credit
union to sell secondary capital to non-institutional investors (see
Sections V and VI for more discussion on investor protection and
suitability issues), and whether this would be for members only or any
party.
Allowing for broader call options for the low-income
designated credit union, other than just the portion no longer counting
as net worth and subject to NCUA approval, if provided for in the
secondary capital contract.
Relaxation of pre-approval of issuing secondary capital if
a low-income designated credit union meets certain conditions such as
being at least adequately capitalized and having prior experience
issuing secondary capital.
Inclusion of more flexibility to fund dividend payments as
an operating loss if provided for in the contract.
Any other prudential restrictions on secondary capital
that should be considered.
Reorganization of the regulation to improve clarity by
moving to part 702 (Prompt Corrective Action) all matters related to
how the instrument must be structured to qualify for capital treatment.
This would move these conditions to the section of NCUA rules and
regulations applicable to all insured natural person credit unions, and
leave the provisions specific to federal credit union issuance
authority in Part 701.
III. Current and Prospective Use of Alternative Capital
This section provides information on community bank use of
subordinated debt and low-income designated credit unions' use of
secondary capital. This section also provides information on the
projected impact of risk-based capital standards on complex credit
unions to estimate the potential need for supplemental capital for
risk-based net worth requirement purposes. This information provides a
basis for estimating the potential for use of supplemental capital, the
purpose of its use, the potential purchasers, and the related costs.
The Board is interested in receiving comments concerning projections on
the volume of supplemental capital that credit unions would be likely
to issue. The Board also seeks specific comments on the structures of
supplemental capital instruments that would be beneficial, why credit
unions will issue supplemental capital, and how it fits into the credit
union's business model. The Board is also interested in any comments
about who will purchase supplemental capital. Since the costs
associated with supplemental capital are significant to the issuing
credit union, the Board seeks comments on how any regulations should
address the issue of the cost of the instrument and any items that may
be helpful in reducing the cost while maintaining adequate protection
for investors and the Share Insurance Fund.
A. Community Bank Use of Subordinated Debt
Community bank use of subordinated debt increased in 2016. As of
June, 30, 2016, the amount outstanding was $831 million compared to
$479 million as of December 31, 2016.\16\ Despite the increase,
subordinated debt is only 0.34 percent of total community bank capital.
The stated purpose of recent issuances of subordinated debt by
community banks generally fall into three categories:
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\16\ FDIC Quarterly, Volume 10, Number 2, page 18.
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Facilitate mergers and acquisitions;
Redemption of preferred stock held by the U.S. Treasury
Department due to increasing costs; and
Fund organic growth.\17\
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\17\ Based on review of a sample of SEC Form D filed by issuers.
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While the interest rate paid on community bank subordinated debt
can vary significantly, generally the interest
[[Page 9694]]
rate is from 300 to 400 basis points over ten year treasury note
rates.\18\ Additionally community banks report expenses associated with
sales commissions, ranging from 1.25 percent to 3 percent, and fees
along with legal and operational costs.\19\ Most buyers of bank
subordinated debt are reported to be pension funds, mutual funds, other
banks, and high net worth investors.\20\
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\18\ Based on review of a sample of capital market announcements
and publications of completed offerings.
\19\ Based on review of a sample of SEC Form D filed by issuers.
\20\ Based on review of a sample of capital market
announcements, publication of completed offerings, and SEC Form D.
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B. Low-Income Designated Credit Union Use of Secondary Capital
As of June 30, 2016, there were 2,426 low-income designated credit
unions. Only 73 low-income designated credit unions (about 3 percent)
report total outstanding secondary capital of $181 million.\21\ Since
December 31, 2011, the number of low-income designated credit unions
has increased by 117 percent, from 1,119 to 2,426. However, the number
of low-income designated credit unions with outstanding secondary
capital has ranged from 72 to 79 during this period.
---------------------------------------------------------------------------
\21\ NCUA Call Report data.
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The $181 million in outstanding secondary capital equates to 13
percent of the total net worth of the low-income designated credit
unions that issued it--with an average balance of about $2.5 million.
However, outstanding secondary capital is concentrated in four low-
income designated credit unions, which hold 74 percent of the total
secondary capital outstanding. When excluding these four low-income
designated credit unions, the average amount of secondary capital is
under $700,000 per low-income designated credit union. The interest
rate paid by the four largest holders of the outstanding secondary
capital ranges from 0.14 percent to 3.5 percent.
Secondary capital does, however, significantly benefit a low-income
designated credit union's net worth ratio. The secondary capital adds
an average of nearly 300 basis points to the net worth ratio, which
brings the average from just below 7 percent to near 10 percent. Out of
the 73 low-income designated credit unions with secondary capital, 66
have a net worth ratio greater than the well capitalized 7 percent
level. Without the secondary capital, 25 of the 66 would have a net
worth ratio less than 7 percent.\22\
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\22\ Secondary capital is estimated to add an average of 414
basis points to the risk-based capital ratio that will go into
effect on January 1, 2019.
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The Board notes that low-income designated credit unions that have
issued secondary capital have a higher failure rate than other low-
income designated credit unions. The average annual failure rate for
low-income designated credit unions with secondary capital was 2.9
percent from 2000-2013, compared to 0.8 percent for low-income
designated credit unions without secondary capital during the same
period.\23\ In a few failures of low-income designated credit unions,
the assets in the credit union grew rapidly around the time the
secondary capital was issued, which in turn led to higher losses to the
Share Insurance Fund. NCUA has noted a pattern of poor practices in
some low-income designated credit unions with secondary capital that
could account for the higher failure rate, including: \24\
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\23\ See. Secondary Capital Best Practices Guide available at
https://www.ncua.gov/services/Pages/small-credit-union-learning-center/Documents/secondary-capital-guide.pdf.
\24\ Id.
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Poor due diligence, inaccurate cost benefit analysis and
weak strategic planning in connection with establishing and expanding
member service programs funded by secondary capital.
Concentrations of secondary capital to support unproven or
poorly performing programs.
Failure to realistically assess and timely curtail
programs not meeting expectations.
Use of secondary capital solely to delay prompt corrective
action.
Insufficient liquidity to repay secondary capital at
maturity.
C. Potential for Credit Unions' Use of Supplemental Capital
The potential use of supplemental capital is difficult to predict
due to the probable changes in market factors such as interest rates,
demographics, and competition. Since supplemental capital would only
increase a credit union's risk-based capital ratio, the most likely
users would be those credit unions with net worth ratios above the well
capitalized level but with a risk-based capital below or near the
minimum needed to be well capitalized.
The following table contains an estimate of the number of credit
unions likely to issue supplemental capital and the potential amount of
supplemental capital that might be issued. Using Call Report data as of
December 31, 2015, applied to FICUs with more than $100 million in
assets,\25\ results in the following:
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\25\ The new risk-based net worth requirements will only apply
to credit unions with assets of $100 million or more.
------------------------------------------------------------------------
------------------------------------------------------------------------
Number of credit unions that do not have a 140.
low-income designation with a net worth
ratio greater than 8% and an estimated risk-
based capital ratio less than 13.5%.
Net worth of the 140 credit unions that do $9.2 billion.
not have a low-income designation with a net
worth ratio greater than 8% and an estimated
risk-based capital ratio less than 13.5%.
Maximum amount of subordinated debt that $4.5 billion.
could be issued with a limit set at 50% of
net worth \26\.
Amount of supplemental capital needed by the $1.0 billion.
140 to achieve a 13.5% risk-based capital
ratio.
------------------------------------------------------------------------
The Board is interested in commenter's thoughts on whether credit
unions that are not designated as low-income use of supplemental
capital could affect the availability of secondary capital for low-
income designated credit unions. If so, are there any measures the
Board could take to protect against this?
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\26\ The Board would contemplate some limit on how much
supplemental capital will count for risk-based capital requirements
to ensure it remains a supplemental but not the primary source of
capital. For illustration purposes the estimate uses a 50% limit so
that it would not become the primary form of capital held by these
credit unions.
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IV. Supplemental Capital Legal Authority and Potential Taxation
Implications
A. Risk-Based Net Worth Requirement
In addition to the Act's requirements related to the net worth
ratio, the Act requires the Board to design ``a risk-based net worth
requirement for credit unions defined as complex.'' \27\ 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
as of March 31, 2001.\28\ Since its inception, the risk-based net worth
requirement has included secondary capital issued
[[Page 9695]]
by low-income designated credit unions.
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\27\ 12 U.S.C. 1790d(d)(1).
\28\ 65 FR 44950 (July 20, 2000).
---------------------------------------------------------------------------
While the Act defined the term ``net worth,'' it did not define the
risk-based net worth requirement, nor how to calculate any
corresponding risk-based ratio. In contrast to the narrow definition of
net worth, the lack of a statutory prescription for the risk-based net
worth requirement gives the Board the latitude to include within that
requirement items that would not meet the statutory definition of ``net
worth'' but otherwise serve as capital in protecting the Share
Insurance Fund from losses when a credit union fails. Given the
statutory objective of prompt corrective action ``to resolve the
problems of insured credit unions at the least possible long-term
loss'' to the Share Insurance Fund, the Board believes it should
explore expanded options for credit unions to build capital beyond
retained earnings.
For a credit union defined as complex to be classified well
capitalized, the Act requires the credit union to have a net worth
ratio of 7 percent or greater (6 percent for adequately capitalized)
and to meet the applicable risk-based net worth requirement. Starting
in January 2019, the risk-based net worth requirement will require the
risk-based capital ratio to be 10 percent or greater to be well
capitalized (8 percent for adequately capitalized). The Act classifies
a credit union as undercapitalized if it is unable to achieve the
applicable risk-based net worth requirement, even if it has a high net
worth ratio, thus subjecting the credit union to the corresponding
prompt corrective action supervisory consequences.\29\
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\29\ 12 U.S.C. 1790d(c)(1)(C)(ii).
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B. Authority To Issue Supplemental Capital
The authority for low-income designated credit unions to issue
secondary capital is established in the Act. Conversely, there is no
express authority for credit unions not designated as low-income to
issue alternative forms of capital. However, the Act does provide
federal credit unions with relatively broad authority to borrow from
any source in accordance with such rules and regulations as may be
prescribed by the Board.\30\ The Board has reviewed all applicable
sections of the Act to determine the ability of federal credit unions
to issue various types of financial instruments that could serve as
alternative capital.\31\ Other than as a form of debt, there is no
other explicit authority in the Act for federal credit unions to issue
an instrument that is uninsured and could be structured as loss
absorbing capital. As a result, the Board believes only the borrowing
authority is available for federal credit unions to issue supplemental
capital.\32\ This means that federal credit unions could only issue
supplemental capital as subordinated debt. However, the Board invites
commenters to identify any other provisions of the Act they believe
could provide alternative authority for federal credit unions to issue
supplemental capital instruments other than as subordinated debt.
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\30\ 12 U.S.C. 1757(9).
\31\ Authority to issue capital instruments for FISCUs is
determined under applicable state law.
\32\ In December 2010, the Board issued Letter to Federal Credit
Unions 10-FCU-03: Sales of Nondeposit Investments, which stated that
federal credit unions are not authorized under the Act to sell
nondeposit investments directly to their members. After further
consideration, the Board believes federal credit unions have the
authority to issue supplemental capital instruments under the
borrowing authority in the Act, even though these instruments may be
considered securities for purposes of state and federal securities
laws.
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C. Supplemental Capital Relationship to Secondary Capital
Supplemental capital and secondary capital are similar in that, for
federal credit unions, both are uninsured accounts issued as borrowings
and subject to applicable statutory borrowing limits. Secondary
capital, however, is included in the statutory definition of net worth
and counts towards both the net worth ratio and the risk-based net
worth requirement. Supplemental capital is not included the statutory
definition of net worth and can only be considered for inclusion in the
computation of the risk-based net worth requirement.
Supplemental capital would have to be subordinate to the Share
Insurance Fund and uninsured shareholders in the payout priorities.
However, since secondary capital, per the Act, must be subordinate to
all other claims, supplemental capital would be senior to secondary
capital in the payout priorities. Credit unions issuing supplemental
capital could be provided flexibility to include payment priority
structures within or between supplemental capital instruments to
enhance investors' interests.
D. Need for Comprehensive Borrowing Rule for Federal Credit Unions
The Board is considering expanding the borrowing rule to clarify
this authority for federal credit unions. As noted above, the Act
states that federal credit unions may ``borrow, in accordance with such
rules and regulations as may be prescribed by the Board, from any
source.'' Currently, NCUA's regulations only contain a rule addressing
when federal credit unions borrow from natural persons. Given that the
wording of the Act could suggest a federal credit union's borrowing
authority is contingent on rules and regulations prescribed by the
Board, it may appear to investors that federal credit unions are
restricted to only borrowing from natural persons. While the Board
disagrees with this reading of the Act, the Board is concerned that
some supplemental capital investors may question a federal credit
union's authority to issue supplemental capital instruments to anyone
other than natural persons. Clarity and certainty about a federal
credit union's borrowing authority may be important to the sale of
supplemental capital--by expanding the potential investor base and
reducing unnecessary transaction complications. With respect to this
topic, the Board is interested in commenter's views on whether the
Board should promulgate a more comprehensive borrowing rule as part of
any authorization of supplemental capital, and what the rule should
address.
E. Authority for Federally Insured State Chartered Credit Unions To
Issue Supplemental Capital
The authority under which a federally insured state chartered
credit union could issue alternative capital instruments is distinct
from whether and to what extent NCUA, as insurer, would recognize it as
regulatory capital for prompt corrective action purposes. A federally
insured state chartered credit union's authority to issue supplemental
capital would be derived from applicable state law and regulation
regarding its ability to issue liability and equity instruments. Such
state laws may be narrower or broader than those for federal credit
unions. Recognition as regulatory capital will depend on the
characteristics of the instrument and its availability to protect the
Share Insurance Fund--which would be based on uniform criteria that
apply to all federally insured credit unions. (see section VI for more
discussion)
For federal credit unions, the Act limits the aggregate amount of
borrowed funds to 50 percent of paid-in and unimpaired capital and
surplus.\33\ Per
[[Page 9696]]
Sec. 741.2, NCUA's rules and regulations limit borrowing by federally
insured state chartered credit unions to 50 percent of paid-in and
unimpaired capital and surplus. The regulation does provide the ability
for state credit unions to obtain a waiver up to the amount of
borrowing allowed under state law.\34\ The Board is not aware of any
federally insured state chartered credit unions that have requested a
waiver to the borrowing limit in the past decade. While authority to
issue alternative capital instruments for federally insured state
chartered credit union is determined under state law, it is possible
that some states will only allow their credit unions to issue
alternative capital instruments under applicable borrowing authority.
As NCUA's borrowing limit for federally insured state chartered credit
union is not statutory, the Board can entertain removing this limit and
requests comment on this option.
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\33\ Section 700.2 of NCUA Rules and Regulations defines Paid-in
and unimpaired capital and surplus as shares plus post-closing,
undivided earnings. This does not include regular reserves or
special reserves required by law, regulation or special agreement
between the credit union and its regulator or share insurer. 12 CFR
700.2.
\34\ 12 CFR 741.2.
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F. Potential Taxation Implications
The Board recognizes that supplemental capital could have an impact
on the credit union tax exemption. The Act specifically exempts federal
credit unions from taxation by the United States or by any State or
local taxing authority, except real and personal property taxes.\35\
With respect to federal credit unions, the Board is aware that part of
the basis for the credit union tax exemption was that Congress
recognized most credit unions could not access the capital markets to
raise capital.\36\ If all credit unions, not just low-income designated
credit unions, have the ability to access the capital markets to meet
capital standards, it could call into question one of the bases for the
credit union tax exemption. The Board invites comments on this topic
and would like to hear from stakeholders on the possible impact a
supplemental capital rule may have on the federal credit union tax
exemption.
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\35\ 12 U.S.C. 1768.
\36\ It is noteworthy that, in 1951, thrift institutions lost
their tax exemption. The Senate report to the Revenue Act of 1951
stated that mutual savings banks and savings and loan associations
were losing their tax exemption because they had evolved into
commercial bank competitors. In addition, thrifts had evolved from
mutual organizations to ones that operated in a similar manner to
banks. Finally, the exemption had given thrifts a competitive
advantage over taxable commercial banks and life insurance
companies.
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Unlike federal credit unions, the Act does not exempt federally
insured state chartered credit unions from taxation. Federally insured
state chartered credit unions are exempt from federal income tax under
Sec. 501(c)(14)(A) of the Internal Revenue Code. Section 501(c)(14)(A)
of the Internal Revenue Code provides for exemption from federal income
taxes for state credit unions without capital stock organized and
operated for mutual purposes without profit. At this time, there does
not appear to be an established definition of ``capital stock'' used by
the IRS. It is possible federally insured state chartered credit unions
in some states will have broad authority to issue supplemental capital
instruments that have the characteristics of capital stock, and by
doing so could subject themselves to taxation. The Board therefore
requests comment on whether NCUA should limit the types of instruments
issued by federally insured state chartered credit unions to those that
would clearly not meet the definition of capital stock. Other options
the Board could consider, include requiring a federally insured state
chartered credit unions to provide a formal opinion from the IRS that
the supplemental capital instrument it is issuing will not be
classified as capital stock or requiring the credit union to provide
projections in advance of issuing the supplemental capital
demonstrating that it can afford to be taxed and the benefits of the
supplemental capital outweigh the cost of any taxes it might become
subject to.
G. Mutual Ownership Structure of Credit Unions
The Board also invites comments on the potential effect
supplemental capital may have on the mutual ownership structure and
governance of credit unions. The Board invites comments on how it
should structure any potential rule to avoid issues impacting the
mutuality of credit unions, and the members' rights to govern the
affairs of the institution. Specifically, the Board invites comments on
restrictions it might impose on characteristics of supplemental capital
to avoid these issues, such as: Non-voting and limits on covenants in
the investment agreement that may give investors levels of control over
the credit union.
V. Securities Law Applicability
The Board believes that both secondary and supplemental capital
would be considered securities for purposes of state and federal
securities laws. The Board invites comment on this topic and its
relationship to credit unions issuing securities as supplemental
capital.
Being subject to securities laws can impose requirements on the
issuer to register with the Securities Exchange Commission (SEC), issue
SEC mandated disclosures, and comply with the SEC's broad anti-fraud
rules. The Board, however, is aware that there are two exemptions that
would likely be available to credit unions:
Section 3(a)(5) of the Securities Act, which is available
to certain types of financial institutions, including credit unions,
for the issuance of any type of security to any type of investor; \37\
and
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\37\ 17 CFR 240.3a5.
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Rule 506 under Regulation D under the Securities Act,
which is available to any entity offering any type of security,
provided that purchasers of the securities are ``accredited investors''
(although sales to a limited number of investors who are not accredited
are also possible under certain circumstances).\38\
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\38\ Id. at Sec. 230.506.
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While these exemptions are likely to relieve credit unions of the
requirements to register with the SEC and issue SEC mandated
disclosures, there are a number of other issues that credit unions must
consider and comply with before issuing any instrument that would be
considered a security. The Board briefly addresses each of these issues
below.
A. Federal Securities Requirements
Regardless of any exemption from registration and disclosure,
credit unions issuing alternative capital must still comply with the
SEC's broad anti-fraud regulations.\39\ The Securities Exchange Act of
1934's (Exchange Act) general anti-fraud prohibitions are embodied in
Sec. 10(b), which generally prohibits the use of manipulative or
deceptive devices or contrivances that violate SEC rules in connection
with the purchase or sale of securities. Most of the litigation brought
with respect to the rules promulgated under Sec. 10(b) has been
brought under the general anti-fraud provision, Rule 10b-5, which
provides as follows:
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\39\ See, e.g., Regulation D, Rule 501(a): ``Users of Regulation
D (Sec. Sec. 230.500 et seq.) should note the following:
(a) Regulation D relates to transactions exempted from the
registration requirements of section 5 of the Securities Act of 1933
(the Act) (15 U.S.C. 77a et seq., as amended). Such transactions are
not exempt from the anti-fraud, civil liability, or other provisions
of the federal securities laws.''
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It shall be unlawful for any person, directly or indirectly, by the
use of any means or instrumentality of interstate commerce, or of the
mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
[[Page 9697]]
(b) To make any untrue statement of a material fact or to omit to
state a material fact necessary in order to make the statements made,
in the light of the circumstances under which they were made, not
misleading, or
(c) To engage in any act, practice, or course of business which
operates or would operate as a fraud or deceit upon any person, in
connection with the purchase or sale of any security.\40\
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\40\ 17 CFR 240.10b-5.
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The primary intent of Rule 10b-5 and, more broadly, the anti-fraud
provisions of the Securities Act of 1933 (Securities Act) and Exchange
Act, is to prevent fraud, deceit, and incorrect or misleading
statements or omissions in the offering, purchase and sale of
securities. Given that intent, clear and complete disclosure is the
critical factor in ensuring the anti-fraud provisions of the Securities
Act and Exchange Act are not breached in any offering by credit unions,
regardless of whether the offering is registered with the SEC under the
Securities Act or exempt from registration.
In the absence of SEC-mandated disclosure delivery requirements,
the practical concern for credit unions relying on either the Section
3(a)(5) or Regulation D, Rule 506 exemption is determining what type
and amount of disclosure is appropriate to meet the anti-fraud
standards. The Board is aware that the amount of disclosure varies
depending on multiple factors, including:
The nature of the potential investors (focusing on their
level of sophistication);
The nature of the security being offered (focusing on the
complexity of the instrument);
The nature of the business of the issuer and the industry
in which the issuer operates (focusing on the complexity of the
business or industry); and
Market practices (focusing on the types of disclosure
commonly provided by peer companies).
In addition, the Board is aware that for any disclosure to meet the
standards of Rule 10b-5, the disclosure must not contain any untrue
statement of a material fact and must not omit to state a material
fact, the absence of which renders any disclosure being made
misleading. Further, the disclosure must be clear, accurate and
verifiable, and should cover topics that are typically important to
investors in making an investment decision, including:
Material risks relating to the issuer and the industry in
which the issuer operates;
Material risks relating to the security being offered;
The issuer's planned uses for the proceeds of the
offering;
Regulatory matters impacting the issuer and its
operations;
Tax issues associated with the security being offered; and
How the securities are being offered and sold, including
any conditions to be met in order to complete the offering.
The Board is also aware that the Office of Comptroller of the
Currency (OCC) promulgated regulations that require supervised banks
issuing securities to register directly with the OCC and issue OCC
mandated disclosures. The OCC mandated disclosures are very similar to
those required by the SEC.\41\ The Board is considering requiring
similar registration and disclosures for credit unions issuing
alternative capital. The Board is concerned that without mandated
disclosures, credit unions may be at greater risk for anti-fraud suits,
which, if successful, would impair not only the credit union but also
the Share Insurance Fund's ability to use secondary or supplemental
capital to cover losses. Further, the Board also believes it is
important that investors in credit union alternative capital
instruments have similar protections to those provided investors in SEC
and OCC covered entities. The Board is interested in comments on the
following questions in particular:
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\41\ 12 CFR part 16.
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Should the Board require credit unions issuing alternative
capital to register with NCUA?
How could NCUA protect the Share Insurance Fund against
potential anti-fraud claims that could impair the alternative capital's
ability to cover losses?
Should the Board mandate disclosures all credit unions
issuing alternative capital must provide to investors? If the Board
should mandate disclosures, should it base them on the SEC's, the
OCC's, or create a unique set of disclosures for credit unions? If the
Board creates a unique set of disclosures, what should it include in
those disclosures? Should the level of disclosures vary based on the
level of the investor (institutional, accredited, natural person)?
Should the Board require credit unions to develop policies
and procedures to ensure ongoing compliance with anti-fraud
requirements before it begins issuing alternative capital?
The Board is also aware that there may be potential broker-dealer
registration issues related to secondary and supplemental capital.
Specifically, marketing activities by a credit union and its employees
could require the credit union to register as a broker-dealer. While
there are exemptions available to credit unions and their employees,
the Board notes that these exemptions are complex and require a
thorough evaluation of a credit union's practices and the activities of
its employees. If a credit union or its employees fail to qualify for
an exemption, the credit union or employee could be required to
register as a broker-dealer or face penalties for failure to comply
with applicable rules. The Board has previously stated that federal
credit unions are not permitted to register as broker-dealers.\42\ The
Board invites comments on how it should ensure a credit union has
determined if it or its employees are required to register.
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\42\ NCUA Letter to FCUs 10-FCU-03, Sale of Nondeposit
Investments, December 2010.
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In addition, it is unlikely that credit unions and their employees
would be subject to investment adviser registration requirements. The
Board notes that certain marketing activities and relationships with
other credit unions could raise investment adviser requirements. The
Board, therefore, invites comments on this issue and if NCUA should
require credit unions to have policies and procedures to ensure their
activities do not trigger investment adviser registration requirements.
B. State Securities Requirements
First, certain provisions of the Securities Act and SEC rules have
preempted state securities laws with respect to most covered
securities. However, states may require issuers to register with the
state and/or pay state registration fees. Further, states may also
pursue fraud-based claims. The Board invites comment on how it should
ensure that any credit union issuing alternative capital has considered
and complied with all applicable state laws.
C. Director and Officer Liability Coverage
The Board also notes that issuing securities can affect a credit
union's director and officer liability coverage. A lack of coverage
could not only impair the credit union, but also threaten the Share
Insurance Fund in the event there are losses that the credit union is
ultimately responsible for. Before engaging in supplemental or
secondary capital activities, therefore, credit unions will need to
evaluate coverage to
[[Page 9698]]
ensure these activities are covered under their policy. The Board
requests comments on if it should mandate that credit unions certify
that they have evaluated their policies and have sufficient coverage
before beginning secondary or supplemental capital activities.
D. Contractual Matters and Communications
A credit union will need to address contractual provisions between
the credit union and its investors. Often these provisions will include
requiring ongoing communications with investors, reporting of
compliance with the contractual covenants, and sharing of information
with current and prospective investors. Credit unions will have to
develop policies and procedures to comply with these covenants and
provisions and ensure that they are not providing non-public
information to investors that is not generally available to all
investors. Failure to comply with the investment contracts or to
properly monitor communications and sharing of information could
subject the credit union to liability, which could negatively impact
the Share Insurance Fund. As such, the Board requests comment on if it
should mandate comprehensive policies addressing compliance with
investment contracts, communications, and information sharing. The
Board invites commenters to provide suggestions on the specific details
that should be in the policy and if sufficient policies should be a
prerequisite to engaging in supplemental or secondary capital
activities.
VI. Other Investor Considerations
Section 701.34(b) of NCUA's regulations limits eligible investors
in secondary capital to institutional investors, referenced as non-
natural persons.\43\ This limitation is not required by the Act. This
limitation prevents the sale of secondary capital to consumers who
could lack the ability to understand the risks associated with
secondary capital, especially when there is opportunity for confusion
given that the low-income designated credit union is federally insured.
Also, low-income designated credit unions can sell secondary capital to
nonmembers. When the secondary capital regulations were written in 1996
the purchasers of secondary capital were presumed to be foundations and
other philanthropic-minded institutional investors.\44\
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\43\ 12 CFR 701.34(b).
\44\ 61 FR 378 (Feb. 2, 1996).
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From an investor protection standpoint, the issue of limiting the
sale of secondary capital and supplemental capital largely focuses on
providing adequate protections to the purchasers through the issuance
of initial disclosures, transparency standards with respect to
reporting of information about the operations and performance of the
credit union, and whether the purchaser has the necessary
sophistication relative to the complexity and risk of the instrument.
As discussed in more detail in the Section V, Securities Law
Applicability, of this ANPR, the OCC requires banks issuing
subordinated debt to comply with the securities offering disclosure
rules in its regulations.\45\ The OCC's regulations establish
registration statement and prospectus requirements for the offer and
sale of securities issued, subject to exemptions and disclosure
requirements based on the sophistication of the investor. As banks are
not restricted in who they can sell securities to, these rules, in
part, help provide a level of investor protection, particularly for
less sophisticated, non-institutional investors.
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\45\ 12 CFR 5.47(d)(3)(iii).
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The issue of permissible investors is also related to anti-fraud
considerations. As noted above, the level of disclosures necessary to
comply with anti-fraud rules varies, in part, on the level of
sophistication of the investors. In practice, selling to non-
sophisticated investors would likely involve a much higher initial and
ongoing disclosure and communications burden for credit unions.
Thus, the Board requests comment on whether the sale of secondary
and supplemental capital should be limited to only institutional
investors, include accredited investor, or allow for anyone to
purchase. If the Board were to allow credit unions to sell alternative
capital to non-accredited investors, should there be limits on the
amount individual investors can purchase? Also, should there be
conditions on how the sale to non-accredited investors must be handled
to minimize potential confusion about its lack of federal insurance?
Whether credit unions that are not low-income designated should be
able sell supplemental capital instruments to nonmembers with equity
like characteristics is a matter relevant to considerations about the
mutual model of credit unions. The Board requests comments on the
extent to which credit unions should be allowed to sell alternative
capital with equity like characteristics to nonmembers, and if so, what
controls are necessary to preserve the mutual ownership structure and
democratic governance of credit unions. The Board invites comments on
how it should structure any potential rule to avoid issues impacting
the mutuality of credit unions, and the members' rights to govern the
affairs of the institution.
VII. Prudential Standards for Issuing and Counting Alternative Capital
for Prompt Corrective Action
For a financial instrument to be considered regulatory capital for
prompt corrective action purposes, NCUA must consider the instrument's
degree of permanence, capacity to absorb losses as a going concern, the
flexibility of principal and interest payments, and intended use of the
proceeds. These characteristics are consistent with the Basel Tier 2
capital criteria.\46\ These same criteria are also contained in the
regulatory capital quality distinctions for the U.S. banking
system.\47\ Provisions related to these characteristics are intended to
ensure the funds will be available to protect the Share Insurance Fund
and do not create incentives for credit unions to engage in unsafe or
unsound practices.
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\46\ Basel III was published in December 2010 and revised in
June 2011. The text is available at http://www.bis.org/publ/bcbs189.htm. The BCBS is a committee of banking supervisory
authorities, which was established by the central bank governors of
the G-10 countries in 1975. More information regarding the BCBS and
its membership is available at http://www.bis.org/bcbs/about.htm.
Documents issued by the BCBS are available through the Bank for
International Settlements Web site at http://www.bis.org. See
paragraph number 58 for criteria for inclusion in Tier 2 Capital.
\47\ 12 U.S.C. 324.20.
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The function of supplemental capital is to protect the credit union
and the Share Insurance Fund in the event of loss. Supplemental
capital, therefore, must be able to absorb losses ahead of the Share
Insurance Fund while not conferring control of the credit union to the
investor. The instruments must be uninsured and cannot be guaranteed or
secured by the credit union or its assets. These features ensure
supplemental capital fulfils its ultimate purpose and does not result
in unintended encumbrances to the credit union or the Share Insurance
Fund.
The degree of permanence is important because the instrument must
create sufficient stability in the credit union's capital base to be
available to cover losses over a long time period. This is the reason
for the minimum five year maturity contained in the Basel accords, the
U.S. banking capital regulations, and for secondary capital
[[Page 9699]]
for low-income designated credit unions. With respect to secondary
capital, a low-income designated credit unions is allowed to have a
call option for the portion no longer qualifying as net worth so that
they may retire the instrument if it is no longer needed or market
conditions allow them to reprice the capital at a lower rate. However,
supervisory approval is needed before any call is exercised because it
represents a potentially material change to the risk to the Share
Insurance Fund.
The alternative capital must be able to absorb losses while the
institution is still a going concern, and not just in the case of
liquidation. The existing regulatory language regarding secondary
capital requires that it is available to ``cover operating losses.''
\48\ The term ``operating losses'' has been interpreted to not include
the payment of dividends on shares.\49\ However, a credit union's
inability to fund a dividend rate that is consistent with prevailing
rates can create liquidity and reputation risk. Therefore, credit
unions may need the flexibility to issue alternative capital
instruments that are available to absorb all losses in excess of
retained earnings, including the payment of dividends on shares.\50\
The Board is seeking comment on the exclusion of dividend expenses as
an operating expense and seeks comment on how to resolve the complexity
that can result from excluding dividend expense from losses applied to
secondary capital but not from losses applied to supplemental capital.
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\48\ 12 CFR 701.34(b)(7).
\49\ 12 CFR 701.34.
\50\ If the Board authorizes supplemental capital, it could be
possible for low income designated credit unions to concurrently
offer both supplemental and secondary capital instruments. The
differing treatment of payments on dividends could make the
administration of losses applied to alternative capital complex and
potentially confusing.
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Further, the payment of interest on the instruments must be capable
of being cancelled on a permanent, noncumulative basis without
constituting a default. The interest provisions must also not contain
any feature which would provide incentive for the credit union to
exercise a call option, such as a large increase in the interest rate.
The flexibility of payments ensures investors cannot obviate any risk
exposure to their principal through problematic dividend and interest
provisions. These criteria are consistent with the criteria for
inclusion in Tier 2 capital used by the other banking regulators \51\
and are contained in Basel III.\52\
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\51\ 12 CFR 5.47.
\52\ Basel III was published in December 2010 and revised in
June 2011. The text is available at http://www.bis.org/publ/bcbs189.htm. See paragraph 58 for criteria for inclusion in Tier 2
Capital.
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Because of these characteristics, most alternative capital
instruments can have relatively low liquidity for the purchaser and
there is no guarantee of a secondary market. These characteristics also
impact the interest rate the credit union must pay for alternative
capital. The Board seeks comment on how to maintain protection of the
Share Insurance Fund while minimizing the impact the criteria would
have on the cost and marketability of the alternative capital
instruments.
A. Approval To Issue and Notice
The Board is considering including an application and notice
requirement in any supplemental capital regulations it may issue.\53\
The Board notes that requiring a credit union to obtain approval to
issue alternative capital and provide a notice of issuance can
contribute to ensuring alternative capital instruments are issued in
accordance with applicable regulations, part of a sound management
plan, and are structured to properly protect the Share Insurance
Fund.\54\
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\53\ Secondary capital provisions already require low income
designated credit unions to obtain prior NCUA approval.
\54\ See. 12 CFR 5.47(f) and (h) for the OCC's requirements for
prior approval for issuance of subordinated debt and for the notice
procedure for inclusion as tier 2 capital.
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The Board notes that currently NCUA requires a low-income
designated credit union to submit a ``Secondary Capital Plan'' prior to
the acceptance of secondary capital that includes: \55\
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\55\ 12 CFR 701.34(b)(1).
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The maximum aggregate amount of secondary capital the low-
income designated credit union plans to accept;
The purpose for which the secondary capital will be used
and how it will be repaid;
Demonstration that the uses of the secondary capital
conform to the low-income designated credit union's strategic plan,
business plan, and budget; and
Supporting pro forma financial statements covering a
minimum of two years.
The account agreement associated with any alternative capital needs
to conform to the standards that ensure it protects the Share Insurance
Fund and provide the credit union with flexibility in conducting its
daily affairs. The secondary capital regulation currently requires that
the low-income designated credit union retain the original account
agreement and the ``Disclosure and Acknowledgment'' for the term of the
agreement.\56\ The regulation does not specifically require a low-
income designated credit union to submit to NCUA either a draft account
agreement with the application or the executed agreement.
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\56\ Id. at Sec. 701.34(b)(11).
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For all forms of alternative capital, the Board seeks comments on
the utility of a prior approval process and a post-issuance
notification process. The Board can also consider under what conditions
prior approval would not be necessary, such as credit unions that are
well capitalized with a successful history of issuing alternative
capital. When prior approval would be necessary, however, the Board
requests comments on what should be required in an application for
authority to issue alternative capital, and how long the credit union
would have to issue the alternative capital after approval. In
addition, the Board request comment on the evaluation criteria NCUA
should use to approve or deny the application, including whether or not
certain credit unions that are already in danger of failing should be
precluded from issuing alternative capital as a form of investor
protection. Also, the Board seeks comment on the manner of and what
should be included in any post-issuance notice credit unions would file
with NCUA.
B. Subordination
Secondary capital must be subordinate to all other claims per the
Act.\57\ Thus, supplemental capital must have a payout priority senior
to secondary capital but still subordinate to the Share Insurance Fund.
The requirement that alternative capital instruments are subordinate to
the Share Insurance Fund, uninsured shareholders, and general creditors
is consistent with the Basel criteria for Tier 2 capital.\58\
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\57\ 12 U.S.C. 1790d(o)(2)(C)(ii).
\58\ Basel III was published in December 2010 and revised in
June 2011. The text is available at http://www.bis.org/publ/bcbs189.htm. The BCBS is a committee of banking supervisory
authorities, which was established by the central bank governors of
the G-10 countries in 1975. More information regarding the BCBS and
its membership is available at http://www.bis.org/bcbs/about.htm.
Documents issued by the BCBS are available through the Bank for
International Settlements Web site at http://www.bis.org. See
paragraph number 58 for criteria for inclusion in Tier 2 Capital.
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Unlike secondary capital, supplemental capital is not subject to
provisions in the Act that limit flexibility in structuring payment
priorities within and between supplemental capital instruments. For
example, a credit union could issue a supplemental capital instrument
with
[[Page 9700]]
two tranches, a high-yield-high-risk supporting tranche and a lower-
yielding-lower risk tranche. Credit unions could also issue
supplemental capital instruments that have first in-first out, or last
in-first out contractual payment priorities. This flexibility could
help credit unions attract investors of different risk tolerances and
profiles. The Board seeks comment on whether authorizing supplemental
capital regulations should contain any restrictions on payment priority
options, and if so, what should they be.
C. Limit on Amount of Supplemental Capital That Counts as Regulatory
Capital
While supplemental capital can protect the Share Insurance Fund and
uninsured shares from losses, reliance on alternative capital as the
primary source of capital is generally unsafe and unsound. Even with a
high level of permanent capital, such as retained earnings and common
stock, heavy reliance on alternative capital can result in wide
fluctuations in capital measures due to the timing of its maturity and
negative impact on earnings due to the associated costs.
U.S. bank capital regulations require banks to hold minimum levels
of common equity tier 1 capital, total tier 1 capital, and total tier 1
and tier 2 capital to total risk assets that ensures that permanent
capital is generally the primary source of regulatory capital.\59\ An
FDIC-supervised institution must maintain the following minimum capital
ratios: \60\
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\59\ 12 CFR 324.10(a).
\60\ The standardized capital ratio calculations are defined in
12 CFR 3.10(b). The Common Equity Tier 1 Capital Ratio is the ratio
of Common Equity Tier 1 Capital to standardized total risk-weighted
assets. The Tier 1 Capital Ratio is the ratio of Tier 1 Capital to
standardized total risk-weighted assets. The Total Capital Ratio is
the ratio of total capital (Tier 1 Capital plus Tier 2 Capital) to
standardized total risk-weighted assets. The Leverage Ratio is
generally Tier 1 Capital to total consolidated assets. The
components of regulatory capital are defined in 12 CFR 3.20. Common
Equity Tier 1 Capital is generally common stock, retained earnings,
and accumulated other comprehensive income. Additional Tier 1
Capital primarily includes noncumulative perpetual preferred stock.
Tier 2 Capital generally includes limited allowance for loan and
lease losses, certain subordinated debt and preferred stock, and
qualifying capital minority interests.
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A common equity tier 1 capital ratio of 4.5 percent;
A tier 1 capital ratio of 6 percent;
A total capital ratio of 8 percent; and
A leverage ratio of 4 percent.\61\
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\61\ Id. at Sec. 324.10(a).
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Additionally to be classified as well capitalized a bank must have:
A total risk-based capital ratio of 10.0 percent or
greater;
A Tier 1 risk-based capital ratio of 8.0 percent or
greater;
A common equity tier 1 capital ratio of 6.5 percent or
greater; and
A leverage ratio of 5.0 percent or greater.\62\
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\62\ Id. at Sec. 324.403(b)(1).
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As a result, banks are inherently limited in how much Tier 2 forms
of capital will be included in meeting their regulatory capital
standards. Most forms of alternative capital likely available to credit
unions will be in the form of subordinated debt--which does not meet
the standards to qualify as Tier 1 capital.
Neither the Act nor NCUA regulations limit the amount of secondary
capital that can make up a low income designated credit union's net
worth. Given their unique needs and mission, low-income designated
credit unions can primarily rely on secondary capital to meet prompt
corrective action requirements, provided their use of the proceeds and
overall ongoing management of their secondary capital is otherwise safe
and sound. However, the Board believes any regulation for supplemental
capital needs to contain some method of preventing supplemental
capital, a lower quality of capital, from becoming the primary
component of regulatory capital for credit unions. The Board seeks
comments on how capital regulations could be designed to limit the
amount of supplemental capital included in regulatory capital
calculations.
Consistent with Basel, U.S. bank capital standards,\63\ and
secondary capital regulations, the portion of supplemental capital that
would be considered as regulatory capital and included in the
calculation of the risk-based net worth requirement would be subject to
reductions during the last five years of the life of the instrument.
Consistent with secondary capital, at the beginning of the each of last
five years of the life of the supplemental capital, the amount that is
eligible to be included in the risk-based net worth requirement would
be reduced by 20 percent of the original amount of the instrument (less
any redemptions that may have occurred). The Board seeks comments on
this concept and how to reflect the increasingly limited utility as
loss absorbing capital for supplemental capital approaching maturity.
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\63\ 12 CFR 324.20(d)(iv).
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The Board also notes that changing conditions and circumstances may
warrant early repayment of alternative capital, in part or in whole.
The decision on early repayment must reside with the issuing credit
union and not the holder of the instrument, to ensure the permanence of
the instrument and prevent undue influence by investors. Currently the
secondary capital regulations only allow for early redemption of the
amount of secondary capital that is not recognized as net worth, with
approval by NCUA.\64\
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\64\ 12 CFR 701.34(d).
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Regulatory controls over early repayment are necessary to protect
the Share Insurance Fund and uninsured shares. Regulatory controls over
early repayment are also consistent with the Basel framework for
subordinated debt and the other banking agencies' regulations, which
provide control over the early repayment of subordinated debt by:
Requiring all banks to obtain prior approval to prepay or
call subordinated debt included in tier 2 capital.\65\
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\65\ Id. at Sec. 5.47(d)(1)(vii).
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Prohibiting the holder of subordinated debt from having a
contractual right to accelerate principal or interest payments in the
instrument, except in the event of a receivership, insolvency,
liquidation, or other similar proceeding.\66\
---------------------------------------------------------------------------
\66\ Id. at Sec. 5.47(d)(2).
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Prohibiting the exercise of a call option in the first
five years following issuance, except in certain very limited
circumstances.
Enabling regulations for supplemental capital will need to address
the issue of prepayment and call provisions for supplemental capital.
The options regarding the abilities of a credit union to prepay
supplemental capital could include minimum capital measures after
repayment, current and expected future performance measures and notice
criteria of varying degrees. The Board invites comments on the topic of
prepayment and call provisions for alternative capital and how it
should structure any related requirements. Allowing credit unions
greater flexibility to eliminate the cost of alternative capital or
reprice the instrument under better terms could provide benefits to the
credit union. Any alternative to the redemption process would be
contingent on the credit union no longer relying on the alternative
capital to achieve an appropriate level of capital.
D. Reciprocal Holdings
Regulations for alternative capital need to address reciprocal
holdings. Reciprocal holdings exist when two or more credit unions hold
each other's alternative capital. Reciprocal holdings
[[Page 9701]]
of alternative capital, without some form of adjustment, would
artificially inflate the level of capital in the credit union system,
create loss transmission channels between credit unions, and could be
subject to abuse.
The Board notes a national bank or federal savings association must
deduct investments in the capital of other financial institutions it
holds reciprocally, where such reciprocal cross holdings result from a
formal or informal arrangement to swap, exchange, or otherwise intent
to hold each other's capital instruments, by applying the corresponding
deduction approach.\67\ The Board requests comment on how NCUA should
address this concern.
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\67\ 12 CFR 3.22(c)(3).
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E. Merger
Per the current regulation, in the event of merger of a low-income
designated credit union (other than merger into another low-income
designated credit union) the secondary capital accounts will be closed
and paid out to the investor to the extent they are not needed to cover
losses at the time of merger or dissolution. The OCC prohibits a
covenant or provision in subordinated debt instruments that requires
the prior approval of a purchaser or holder of the subordinated debt
note in the case of a voluntary merger where the resulting institution
assumes the due and punctual performance of all conditions of the
subordinated debt note and where the agreement is not in default of the
various other covenants.\68\
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\68\ 12 CFR 5.47(d)(2)(iv).
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In order to avoid any perceptions of an alternative capital holder
having ownership rights, any restrictions on merger or other change of
control must not interfere with the credit union's ability to exercise
its business judgement and management of the credit union in a manner
that avoids unsafe and unsound practices. The Board seeks comment on
the issue of merging credit unions and how alternative capital should
be treated post-merger.
F. Other Restrictions
Supplemental capital must not contain contractual terms that would
limit or impede the authority of NCUA or a State Supervisory Authority
to undertake supervisory action, as necessary, to protect the issuing
credit union's members or the Share Insurance Fund. Any such
contractual terms would impose unsafe and unsound limits on the credit
union's and regulators' ability to manage the institution and address
problems. Affirmative covenants within the supplemental capital note or
agreement must not restrict operations or potentially require a credit
union to violate a law or regulation. Negative covenants should not
unreasonably impair the credit union's flexibility in conducting its
operations or interfere with management. Without these restrictions,
contractual terms could undermine the purpose of supplemental capital
and provide holders of these obligations with unintended rights and
control over the credit union's operations. Any representation or
warranties contained in the agreements that would require acceleration
and repayment of the subordinated debt note because of a technical
violation that does not reflect underlying credit issues could be
contrary to safety and soundness. The Board seeks comments on the issue
of contractual restrictions for alternative capital instruments.
VIII. Supporting Regulatory Changes
A. 701.32--Payment on Shares by Public Unit Nonmembers
Due to the potential use of alternative capital as a funding source
similar to public units and nonmembers, the NCUA Board is seeking
comment on Sec. 701.32 of NCUA's regulations as it prescribes limits
placed on these accounts.
Section 1757(6) of the FCU Act grants federal credit unions the
power ``to receive from its members, from other credit unions, from an
officer, employee, or agent of those nonmember units of Federal, Indian
tribal, State, or local governments and political subdivisions thereof
enumerated in section 1787 of this title and in the manner so
prescribed, from the Central Liquidity Facility, and from nonmembers in
the case of credit unions serving predominately low-income members (as
defined by the Board) payments, representing equity, on--(A) shares
which may be issued at varying dividend rates; (B) share certificates
which may be issued at varying dividend rates and maturities; and (C)
share draft accounts authorized under section 1785(f) of this title;
subject to such terms, rates, and conditions as may be established by
the board of directors, within limitations prescribed by the Board.''
\69\
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\69\ 12 U.S.C. 1785(f).
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Currently the regulation limits total public unit and nonmember
shares to 20 percent of the total shares of the federal credit union or
$3 million, whichever is greater.\70\ Federal credit unions seeking to
exceed the limit must:
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\70\ 12 CFR 701.32(b)(1).
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Adopt a specific written plan concerning the intended use
of these shares and provide it to the Regional Director before
accepting the funds; and
Submit a written request to the Regional Director for a
new maximum level of public unit and nonmember shares.\71\
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\71\ Id. at Sec. 701.32(b)(2).
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Under Sec. 741.204, federally insured state chartered credit
unions must adhere to the requirements of Sec. 701.32 regarding public
unit and nonmember accounts.\72\ This regulation also addresses a
federally insured state chartered credit union obtaining a low-income
designation, as provided under state law, in order to accept nonmember
accounts other than from public units or other credit unions.\73\
Additionally this section addressed the ability of a federally insured
state chartered credit union to receive and redeem secondary capital
consistent with Sec. 701.34 and consistent with applicable state law
and regulation.\74\
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\72\ Id. at Sec. 741.204(a).
\73\ Id. at Sec. 741.204(b).
\74\ Id. at Sec. 741.204(c) and (d).
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Because the limitations the NCUA board may prescribe to these
accounts is not statutory, the NCUA Board is interested in comments on
revisions to this regulation which would reduce the regulatory burden
of the waiver process but still provide for adequate protection of the
Share Insurance Fund.
B. 701.34--Designation of Low-Income Status; Acceptance of Secondary
Capital Accounts by LICUs
Section 701.34 of NCUA's Rules and Regulations sets out the
requirements and process for a credit union to receive a low-income
designation, the criteria for accepting secondary capital and the
inclusion of secondary capital as regulatory capital. NCUA is seeking
comment on whether the criteria and process for obtaining the low
income designation, the criteria for issuing secondary capital, and the
criteria for inclusion of secondary capital as regulatory capital
should be in separate regulations.
Section 701.34 could be solely focused on the process to receive a
low-income designation. A new section of 701 could be used to address:
The authority and requirements of secondary capital;
Grandfathering treatment of existing secondary capital in
the event of regulatory changes;
[[Page 9702]]
Requirement to comply with all applicable federal and
state laws in the issuance of secondary capital;
Requirements for written contract agreements covering the
terms and conditions of the secondary capital;
Requirements for disclosures and acknowledgement;
Investor suitability; and
Prohibitions.
The items specific to secondary capital's and supplemental
capital's inclusion in regulatory capital and related capital adequacy
issues could be consolidated into Section 702--Capital Adequacy,
including:
Standards for alternative capital instruments to be
counted as regulatory capital;
Any limits on the amount of alternative capital counted as
regulatory capital;
The role of supplemental capital in approval of a net
worth restoration plan;
Provisions for discounting regulatory capital treatments
such as violations of applicable laws or regulation, including any
deficiency cure alternatives; and
Risk weight for an investment in supplemental capital.
C. Payout Priorities
To conform the regulatory payout priorities for supplemental
capital, the payout priorities for an involuntary liquidation will need
to be revised.\75\ Supplemental capital would be listed in the payout
priority after uninsured shareholders and the Share Insurance Fund.
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\75\ 12 CFR 709.5.
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D. Other Regulations
The Board seeks comments on any other related changes to existing
regulations, such as:
Modifying the definition of insured shares in 741.4(b) to
exclude any equity shares allowed under state law, if they are in fact
uninsured;
Modifying 741.9 to provide for the existence of uninsured
accounts issued under state law by FISCUs; and
Any cohering changes to part 745 as necessary.
By the National Credit Union Administration Board on January 19,
2017.
Gerard Poliquin,
Secretary of the Board.
[FR Doc. 2017-01713 Filed 2-7-17; 8:45 am]
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