[Federal Register Volume 60, Number 80 (Wednesday, April 26, 1995)]
[Proposed Rules]
[Pages 20438-20458]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-10149]
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NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Parts 704 and 741
Corporate Credit Unions; Requirements for Insurance
AGENCY: National Credit Union Administration (NCUA).
ACTION: Proposed rule.
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SUMMARY: The proposed rule would strengthen the capital of corporate
credit unions, reduce the risk of their investments, and improve asset-
liability management. It would return corporate credit unions to their
primary functions of serving as liquidity centers and service providers
and would protect the safety and soundness of the corporate credit
union system.
DATES: Comments must be postmarked or posted on NCUA's electronic
bulletin board by June 26, 1995.
ADDRESSES: Mail comments to Becky Baker, Secretary of the Board,
National Credit Union Administration, 1775 Duke Street, Alexandria, VA
22314-3428. Send comments to Ms. Baker via the bulletin board by
dialing 703-518-6480.
FOR FURTHER INFORMATION CONTACT: H. Allen Carver, Director, Office of
Corporate Credit Unions (703) 518-6640, at the above address.
SUPPLEMENTARY INFORMATION:
A. Background
The corporate credit union system consists of 44 corporate credit
unions serving the nation's 13,000 natural person credit unions, and
U.S. Central Credit Union serving the corporate credit unions.
Corporate credit unions provide liquidity, investment, and payment
services to credit unions. Over the years, natural person and corporate
credit unions have gradually evolved into quite different types of
institutions. In 1977, NCUA first issued Part 704, which dealt
specifically with corporate credit unions. However, it was not until
1992 that the agency broadened Part 704 to address a broad array of
corporate credit union matters. See 57 FR 22626 (May 28, 1992). The
regulation has been in effect for several years, during a time of great
change in the credit union industry. The Agency has had an opportunity
to see how the regulation has worked and to consider how it could be
improved. Last year, the Board amended Section 704.12, governing
representation issues. See 59 FR 59357 (Nov. 17, 1994). After
consulting closely with the corporate credit union industry, credit
union trade associations, and outside experts, the Board is now
proposing to amend most of the remaining sections of Part 704 and to
add several new sections.
Before analyzing the specific proposed changes, the Board wishes to
draw the attention of interested parties to a gross inequity in the
corporate credit union system. NCUA oversight and supervision of
corporate credit unions has grown in complexity in the past few years,
resulting in additional costs for NCUA's corporate credit union
program. Although NCUA examines all of the corporate credit unions,
only federally chartered corporates currently pay an operating fee to
NCUA. Federally insured corporate credit unions maintain a deposit of
one percent of insured shares with the NCUSIF, but corporates have
minimal insured shares, and the income generated is not significant. Of
course, non federally insured corporate credit unions neither pay
operating fees to NCUA nor maintain deposits with the NCUSIF.
The Board is concerned that the additional monetary burden on
federal credit unions puts them at a competitive disadvantage and is
considering ways to level the playing field. One option is to assess
all corporate credit unions an annual examination fee, to be based on
the expenses associated with the NCUA corporate program. Alternatively,
the Board could abolish the operating fee for federal corporate credit
unions, [[Page 20439]] requiring natural person credit unions to make
up the difference. Since corporate credit unions benefit natural person
credit unions, it may be appropriate to ask the latter to pay for the
whole system. The Board requests comment on these options.
B. Section-by-Section Analysis
Section 704.1--Scope
Part 704 applies directly to all federally insured corporate credit
unions. It applies to non federally insured corporate credit unions,
via Part 703 of the Rules and Regulations, if such credit unions accept
shares from federally chartered credit unions. To clarify the
application of Part 704, the Board is proposing to amend the Scope
section so that it states both that the regulation applies to all
federally insured corporate credit unions, and that non federally
insured corporate credit unions must agree, by written contract, to
adhere to the regulation and submit to NCUA examination as a condition
of receiving funds from federally insured credit unions.
The Board considered deleting from the proposed rule Section
704.1(b), which sets forth its authority to waive a requirement of Part
704. In the few years that the provision has been in effect, NCUA has
been deluged with requests for waivers. The Board is concerned that
corporate credit unions may have received the impression that
compliance with the rule is optional and that waivers are granted as a
matter of course. The Board wishes to emphasize that corporate credit
unions are expected to comply with the rule. The Board has determined
to retain Section 704.1(b) in the proposed rule, however, to make clear
its authority, in extraordinary circumstances, to waive provisions of
the regulation.
The Board proposes to add a sentence to Section 704.1(b) regarding
state- chartered credit unions. Where a state law provision is also
contained in Part 704, and a state-chartered corporate wishes to
request a waiver of that provision, the corporate must obtain state
approval of the waiver before requesting a waiver from NCUA.
Section 704.2--Definitions
Capital
The Board is proposing to revise the definition of capital. The
revised definition encompasses primary capital and secondary capital
share accounts upon which notice has not been given. These terms are
defined later in this Section. The current definition includes each of
the balance sheet accounts that comprise primary capital. As these
accounts are also listed in the definition of primary capital, it is
not necessary to list them under capital.
Commitment -
The Board is proposing to delete the phrase ``or lease financing
receivables'' from the definition of ``commitments,'' as corporate
credit unions generally do not enter into lease financing arrangements.
Corporate Service Organization (CSO)
Currently, corporate credit unions can invest in and loan to credit
union service organizations (CUSOs) as defined in Section 701.27 of the
NCUA Rules and Regulations. Section 701.27 was written with natural
person credit unions in mind and contains a broad list of permissible
activities, many of which the Board believes are inappropriate for
corporate CUSOs. Accordingly, the Board is proposing to create a new
term and establish new rules for such organizations. They would be
called ``corporate service organizations (CSOs)'' and would be limited
to serving only the corporate credit unions that have invested in or
loaned to the CSO and/or the members of such corporate credit unions.
Thus, a CSO wholly owned by ABC Corporate Credit Union could serve only
ABC and its member credit unions. If the CSO received a loan from DEF
Corporate Credit Union, it could serve ABC and its member credit unions
and DEF and its member credit unions. The Board believes that this
restriction would preserve the integrity of field of membership
requirements.
The Board is also proposing that a CSO's services be limited to
data and item processing, wire transfers, record retention and storage,
securities brokerage services, investment advisory services, and trust
services. The Board is concerned that some corporate CUSOs currently
are performing services that have nothing to do with the daily
activities of corporate credit unions, such as shared branching
services and home banking.
The Board is also proposing to require that a CSO be chartered as a
corporation under state law.
Embedded Options
Embedded options are a common feature in many investment
securities. Mortgage backed securities, federal agency structured
notes, and many other corporate obligations have features such as
maturity calls, principal prepayments, periodic and lifetime interest
rate caps, and conversion factors, over which the investor has no
control. The fact that these options can be exercised by the issuer (or
mortgage holder) and not the investor raises concerns for the Board.
These features entail substantial risks for investors that do not
properly understand and evaluate how these options impact the
performance of the investment. The function of a matched book strategy
is to immunize the effects that changing interest rates will have on
the economic value of assets and liabilities. If the characteristics of
an asset are not replicated in the corresponding source of funds, the
integrity of the match is compromised. This is especially true for
assets which have conditional cash flows that are linked to the level
of interest rates and other market factors.
One example of an investment with conditional cash flows is
mortgage backed securities. Mortgage backed securities are impacted by
the behavior of the underlying mortgage holders whose loans make up the
securities. If they elect to pay off or refinance their mortgages, the
securities will likewise pay down. The investor has no control over
this action. Prepayment risk has a substantial impact on the market
value and liquidity of an instrument and the uncertainty of the cash
flow behavior makes these securities especially difficult to match.
Many investors were caught by surprise during the rate upswing in
1994 because the market values of their securities were adversely
impacted far more than they had anticipated. The embedded options such
as prepayment extension and caps on floating rate instruments caused a
serious threat to the liquidity and solvency of many credit unions. The
risk associated with such securities cannot be ignored and it must be
factored into the matching strategies of corporate credit unions. This
is imperative because corporate credit unions must ensure that the
viability of the income, liquidity and net market value of the matched
book balance sheet is not jeopardized.
Identically Matched
The Board recognizes that it is not possible for corporate credit
unions to perfectly match all shares and certificates to identical
assets because there sometimes exists an immaterial difference in
dollar amount, the accrual methods, or the precise maturity date. To be
substantiated as immaterial, such minute differences cannot have the
effect of causing any significant exposure to changing spread
performance or the net market value of the match. The integrity of the
matched book depends upon how substantially close the match is with
regard to such factors as the dollar amounts, rate reset
[[Page 20440]] features, final maturities, and embedded options.
Long-Term Investment; Short-Term Investment
Section 704.6 of the current regulation frequently uses the phrases
``long-term (initial maturity over 1 year) investments'' and ``short-
term (initial maturity of 1 year or less) investments.'' In the
interests of simplifying the regulation, the proposed rule would simply
define, for the purpose of investment ratings, a ``long-term
investment'' as one having an initial or expected maturity greater than
one year and a ``short-term investment'' as one having an initial or
expected maturity of one year or less.'' These definitions apply only
to investment ratings in Section 704.5, which sets forth corporate
credit union investment authority in the proposed rule. ``Long-term''
and ``short-term'' have different meanings in the context of asset-
liability management.
Market Value of Portfolio Equity (MVPE)
MVPE is designed to calculate the risk that changing interest rates
will have on a corporate credit union's capital. The traditional
practice of measuring interest rate risk sensitivity was the static Gap
model. With the introduction in recent years of more dynamic income
simulation models, a more sophisticated and precise calculation of
income (and capital) at risk is possible. The evolution of asset/
liability management techniques has led to a greater understanding of
how changing interest rates impact not only earnings but capital as
well.
The Board recognizes that, like any estimation, the validity of the
MVPE is dependent upon the quality of assumptions and integrity of the
data going into the calculation. If the MVPE is intended to capture
true mark-to-market risk of capital, the discount rates in the net
present value calculations must reflect any credit, liquidity, or
option premiums that are inherent in a specific asset or liability.
The development of simulation models that calculate changes in net
worth for given changes in interest rates has changed the way many risk
managers regard interest rate sensitivity. The MVPE calculation is
significant because it is a measure that captures risk over a more long
term horizon than net interest income (NII), and as such, it serves as
a better early warning detection system. Where net interest income
calculations typically focus on income over the next 12-24 months, MVPE
captures the long-term economic risk that is inherent in the balance
sheet. It is possible for an institution's current earnings to hold
steady over the near term as the mark-to-market of the balance sheet is
rapidly deteriorating. If a risk manager only focuses on earnings, the
risk of capital depletion may go unnoticed.
MVPE is intended to show how the economic values of both sides of
the balance sheet will change in relation to one another as interest
rates change. One need only look at the toll of the 1994 bear market to
understand the ramifications of ignoring the risk of capital depletion.
The Board is therefore compelled to ensure that all liquidity providers
be cognizant of the risk exposures they take with regard to their
capital and liquidity positions.
Many institutions have borrowed short-term funds to buy long-term
assets. The inducement is typically a steep yield curve that provides
an instant spread opportunity and quick income. The contribution of
retained earnings to capital is a favorable objective but the risk of
mismatched assets and liabilities can easily produce a situation where
the market takes all the benefits away faster than the income was
produced. The ability to withstand a liquidity crisis rests on core
solvency. Maintaining core solvency, on a mark-to-market basis, in all
probable interest rate environments is imperative, and MVPE is a method
by which oversight authorities can police the capital at risk.
An institution that has negative capital on a mark-to-market basis
cannot meet the demands or obligations of a liquidity crisis, and it is
for this reason that the Board desires to expand the risk measurement
techniques employed by corporate credit unions so as to detect
unacceptable exposures of risk at the earliest opportunity and mandate
an appropriate course of corrective action whenever necessary.
The MVPE calculation serves to inform risk takers of what the
stakes are before the adverse market changes occur. By employing a
``what if'' scenario approach, risk managers can observe the changes in
MVPE to determine the cost of entertaining certain risk exposures. It
is a dynamic approach that allows the oversight authorities to know how
much is at stake and to respond before problems arise.
Net Interest Income
The standard measure of risk in income simulation calculations is
the variability of net interest income, from ``most likely''
expectations, for given changes in interest rates. The relationship
between interest bearing assets and liabilities is subject to adverse
change when market rates rise and fall. The ability to capture the
variability of returns that results from changing rates is widely
regarded as a fundamental tool for managing interest rate risk.
The policy makers at corporate credit unions need to place
limitations upon the amount of income that is subject to interest rate
risk. Net interest income simulation is useful for understanding what
variables will impact earnings and it allows the user to subject the
balance sheet to severe rate stress tests and balance sheet composition
changes.
``What if'' analysis is essential for anticipating the damage that
will result if rates move contrary to the corporate credit union's
forecast. Since credit unions cannot predict interest rates, the risk
of positioning the balance sheet for a specific purpose must be
measured in a variety of interest rate scenarios. A net interest income
simulation provides a better means for forecasting the potential risk
to income posed by changing rates. Like MVPE, it helps senior
management and the board of directors to determine if the levels of
potential risk are acceptable.
Overnight
The integrity of the corporate credit union system rests on its
ability to repay member funds, other than PCSAs and SCSAs, upon demand
and without delay. A large portion of the funds in the system is in
overnight accounts, and the bulk of those funds should remain
immediately available to meet all contingent member needs. Since
overnight transactions might span several days when a weekend or
holiday is involved, the term ``overnight'' is recognized to mean from
one business day to the next.
Penalty for Early Withdrawal
Market-based penalties on shares, deposits and liabilities are
important because they protect corporate credit unions from the
replacement risk that results when an early withdrawal by a member
credit union can only be replaced by a higher cost alternative. This
risk is tantamount to selling an investment security on the secondary
market. Corporate credit unions are financial intermediaries that
should not absorb the risk caused by members seeking an early
redemption.
Member credit unions will have an economic incentive to request
early redemption when reinvestment prospects exceed early withdrawal
penalties. Unless the penalties are assessed on a contemporaneous mark-
to-market basis, the corporate will have [[Page 20441]] to absorb the
difference between the penalty and the replacement cost. While members
may not behave in a perfect economic fashion (calculating the break-
even point), the risk exposure is still significant. The incorporation
of mark-to-market penalties is consistent with the principle of running
a matched book.
Permanent Capital Share Account (PCSA)
The Board recognizes that it may be difficult for some corporate
credit unions to reach the capital levels required under proposed
Section 704.12 in the timeframes provided. The reports of the General
Accounting Office and the Corporate Credit Union Study Committee both
propose the use of a form of nonredeemable membership shares to assist,
in the short-term, corporate credit unions to attain minimum capital
goals. Accordingly, the Board is proposing to create a type of
membership share that would be at risk, would not be redeemable without
written concurrence of NCUA, and would pay non cumulative dividends.
Because of these elements of permanency, up to 50 percent of primary
capital could consist of PCSAs. The Board requests comment on the
criteria NCUA should use to determine when PCSAs may be redeemed.
PCSAs would be limited to credit unions within the corporate credit
union's field of membership, would not be subject to insurance by the
NCUSIF or other deposit insurer, and could not be used to collateralize
borrowings. PCSAs would be available to absorb losses in the event of a
deficit in the corporate credit union's other primary capital accounts.
In the event of liquidation of a corporate credit union, PCSAs would be
payable only after satisfaction of all liabilities.
A corporate credit union would be required to adequately disclose
the terms and conditions of PCSAs to each subscriber. A standard form
for such disclosure is provided in the regulation.
Primary Capital
Currently, primary capital is defined as all corporate statutory
and regular reserves and undivided earnings. The Board is proposing to
amend the definition to have primary capital consist of statutory
reserves, undivided earnings, other reserves (excluding the allowance
for loan losses and accumulated gains/losses on available-for-sale
securities), net income/loss, and permanent capital share accounts
(PCSAs). No more than 50 percent of primary capital would be permitted
to be comprised of PCSAs. The proposed regulation would provide for
several benchmarks that are tied to the level of the corporate credit
union's primary capital.
Rated
Section 704.6 of the current regulation frequently requires that a
security be rated at a certain level ``by an SEC-recognized rating
agency,'' which is defined in Sec. 704.2. In the interests of
simplifying the regulation, the proposed rule would simply define
``rated'' to mean ``rated by an SEC-recognized rating agency,'' which
would then be defined.
Secondary Capital Share Account (SCSA)
The current regulation introduced the concept of membership capital
share deposits (MCSDs), which are subject to certain restrictions in
order to qualify as secondary capital. The Board is proposing to retain
this concept in a new form called secondary capital share accounts
(SCSAs). As with PCSAs, SCSAs would be limited to credit unions within
the corporate credit union's field of membership, would not be subject
to insurance by the NCUSIF or other deposit insurer, could not be used
to collateralize borrowings, and in the event of liquidation of a
corporate credit union, would be payable only after satisfaction of all
liabilities.
In order for an SCSA to count as capital, it would have to have a
minimum notice of withdrawal of two years. The Board weighed several
options in establishing the notice period. The Board believes that the
one year notice that currently exists for MCSDs is too short. If a
corporate credit union experienced problems, all of its secondary
capital could be depleted in 12 months. This is often not enough time
to resolve problems, and a total depletion of secondary capital could
threaten a corporate credit union's continued viability. The Board
believes that a two year notice period would serve to preserve capital,
yet allow maneuverability on the part of member credit unions.
Individual corporates would be free to set longer notice periods if
they wished.
The Board also proposes that SCSAs be available to absorb losses in
the event of a deficit in the corporate credit union's primary capital.
SCSAs could be used not only if a corporate credit union were
liquidated, but also to cover any losses in a continuing corporate
credit union that has depleted its level of primary capital.
The Board is concerned that all the requirements and conditions of
SCSAs are adequately disclosed to each member credit union. Therefore,
specific disclosure at the time of the opening of an SCSA, and annual
disclosure thereafter, is provided in the regulation, along with
standard forms that may be used by the corporate credit unions.
The Board notes that SCSAs are the only permitted form of secondary
capital in the proposed rule. Currently, secondary capital consists of
MCSDs and term subordinated debt. A review of the corporate credit
unions determined that none had in fact used term subordinated debt as
a way to build secondary capital. In light of this, and the Board's
belief that it is more appropriate to build capital through a corporate
credit union's members, the proposed rule would not include term
subordinated debt in secondary capital and would delete any reference
to it in the regulation. Since SCSAs would be the only component of
secondary capital, the proposed rule would simply refer to SCSAs
instead of secondary capital.
Undivided Earnings
The Board is proposing to revise the definition of ``undivided
earnings'' to remove the term ``corporate reserves,'' as that term is
not used in the proposed rule.
United States Government or its Agencies; United States Government-
Sponsored Corporations and Enterprises
The Board is proposing to delete the reference to Appendix C from
these definitions and to delete current Appendix C. Rather than having
a fixed list of agencies and enterprises, which may become erroneous as
entities are created, dissolved, or changed, the Board wishes to simply
present the definition of government agencies and enterprises and place
the responsibility of determining an entity's status on the corporate
credit union. [[Page 20442]]
Adjusted Trading; Bailment for Hire Contract; Cash Forward Agreement;
Collateralized Mortgage Obligation; Facility; Federal Funds
Transaction; Forward Rate Agreement; Futures Contract; Immediate Family
Member; Market Price; Maturity Date; Official; Option Contract; Primary
Dealer; Real Estate Mortgage Investment Conduit; Repurchase
Transaction; Residual Interest; Reverse Repurchase Transaction; Section
107(8) Institution; Senior Management Employee; Settlement Date; Short
Sale; Standby Commitment; Stripped Mortgage Backed Security; Swap
Agreement; Trade Date; Zero Coupon Bond
Currently, Part 704 incorporates by reference Part 703, which
governs federal credit union investments, except where inconsistent
with Part 704. To eliminate the confusion that has arisen over the
applicability of certain provisions of Part 703, and because Part 703
may be amended in the future, the Board is proposing to move the
relevant portions of Part 703 into Part 704. Most of these definitions
are from Part 703; some have been altered slightly. A few other
investment-related definitions have been added.
Capital of a Broker/Dealer; Claims; Corporate Reserves; Credit Union
Service Organization; Membership Capital Share Deposit; Non Credit
Union Member; Original Maturity; Other Reserves; Risk-Based Capital;
Secondary Capital; Speculative Activities; Term Subordinated Debt
The Board is proposing to eliminate all of these definitions,
primarily because the terms are not used in the proposed regulation.
The term ``claims'' is used in the appendices, but the definition,
``loans or other debt obligations,'' is deemed to be self-evident.
Section 704.3--Planning: Strategic and Business Plans
The Board is proposing to revise Sec. 704.3 to specify that the
board of directors of a corporate credit union must adopt written
strategic and business plans. The Board is concerned that the directors
of corporate credit unions might develop concepts for such plans
through discussion and brainstorming sessions, but not place them in
formal written format. The lack of written documentation would result
in the inability of the directors to monitor their success in achieving
their goals. Additionally, wording was added to require that the annual
review of the plans be documented and provided to the corporate credit
union's auditor and supervisory committee and to NCUA. -
Section 704.4--Asset/Liability Management
Matched book requirement. The evolution of ``managed'' book
strategies in the corporate credit union network has become a huge
concern to the Board. The assumption of interest rate risk by some
corporates has been demonstrably short-sighted as evidenced by the
wide-spread exposure to rising interest rates taken by many corporates
in recent years.
In some dramatic instances, portfolios were merely matched by
repricing characteristics, and not always effectively at that, which
subjected some corporate credit unions to potentially extreme
depletions of capital. The mismatches that result when short duration
liabilities are matched against longer duration investment assets
cannot be managed if the ability to sell troubled assets is forfeited
by a ``hold-to-maturity'' philosophy. Thus, the managed book approach
has, in many cases, resulted in an unmanaged wager against changing
interest rates.
The fact that most securities in corporate portfolios that can be
adversely impacted by rising rates are classified as ``hold-to-
maturity'' largely contradicts the notion that the risks associated
with these managed portfolios can be managed when and if the wrong
combination of circumstances prevails.
The Board is concerned about the potential problems that result
when corporate credit unions that ``manage'' sources and uses of funds
assume unreasonable levels of risk exposure with the overnight portion
of member funds. The growth and complexity of the floating rate
securities market has inspired many corporate credit unions to employ a
``managed'' risk approach in which maturity and average life are
disregarded in favor of matching sources and uses of funds by interest
rate reset characteristics.
This has led some corporate credit unions to assume substantial
duration mismatches when they ``match'' their overnight funds against
corresponding floating rate assets which have embedded options, long
weighted average lives, or coupons linked to inappropriate indices.
When such assets have interest rate dependent features that affect
their market values, the liquidity and solvency of the credit union can
be adversely affected. The Board believes that such risk exposures
should be identified, measured, and limited to a reasonable level of
primary capital. When such risks cannot be immunized in the matching
process, they are unacceptable.
The Board is aware that a floating rate security can have a very
short duration if it is tied to a sensitive market index, reprices
frequently, has little or no embedded option risk, and has a relatively
short final maturity. The Board also recognizes that a portion of
overnight shares at a corporate credit union represents a core amount
of funds that is essentially permanent in nature. Such core funds are
required to cover clearings and other daily activities. It is not
inappropriate for a corporate credit union to mismatch a conservative
portion of overnight funds into longer maturity assets provided that
the assets are convertible to cash without suffering a material loss.
The Board is proposing that a corporate credit union be permitted
to mismatch 25 percent of funds in the overnight book. The parameters
set forth on the assets permitted in this 25 percent portion are
established to prevent any material adverse market value effect upon
the liquidation potential of these assets if and when the need arises.
The ability to mismatch a conservative portion of the overnight account
allows corporate credit unions to augment their earnings potential in
addition to the investment of capital.
The Board does not believe that any interest rate risk should be
taken with term certificates. Any source of funds, with the exception
of capital, that has a maturity of greater than one business day must
be identically matched to an asset that has the same maturity and
repricing characteristics. The danger of entertaining duration
mismatches with member certificates is regarded to be completely
inconsistent with the charge of a liquidity facility. This activity is
not regarded to be a legitimate means of generating retained earnings
because of the risk and complexity associated with managing a
mismatched portfolio.
Portfolio pricing. It is essential for corporate credit unions to
evaluate the risk inherent in their balance sheets on a regular basis.
A frequent pricing of the investment portfolio is an important
component of risk assessment since it provides critical information
about changes in the liquidation value of the balance sheet.
Whether assets are classified as available-for-sale or hold-to-
maturity, they need to be reviewed in the context of fair market value.
The management of a corporate credit union should know at all times
where the relative market value of its balance sheet stands in order to
ensure that the core solvency of the institution is not remotely
threatened by any adverse change in market rates. [[Page 20443]]
Maximum unrealized loss on available-for-sale assets. The Board is
proposing that the aggregate loss in the accumulated unrealized gains/
losses on available-for-sale assets, net of any unrealized gains or
losses on the corresponding source of funds, be limited to a
conservative percentage of the corporate's primary capital. Consistent
with the provision that all investment securities be priced to market
on a monthly basis, the need to closely monitor the impact of changing
market rates on the available-for-sale portfolio is imperative.
The Board is also proposing that sufficient early withdrawal
penalties be in place to guarantee protection from replacement risk.
This would allow corporates to capture the economic benefit of the
liabilities that are matched against available-for-sale assets;
accordingly, it is appropriate to factor in the corresponding
liabilities when setting a maximum limit upon the aggregate loss in the
accumulated unrealized gain/loss on ``available-for-sale'' assets.
Rate shock analysis. The use of scenario analysis to measure
potential risk is not a new concept to many corporate credit unions.
This discipline is already resident in a number of corporates. The
purpose of using a rate shock calculation is to view interest rate risk
from a severe but plausible perspective. The senior management and
board of directors of a corporate should always be cognizant of
potential interest rate risk exposures before they arise.
It is clear that a perfectly matched book does not have the same
volatility that a ``managed'' mismatched book has. Depending upon how
the overnight and capital accounts are structured, they could
potentially create some exposure to changing rates. Such exposures need
to be identified, measured, related to primary capital, and reported to
all oversight authorities on a regular basis.
Rate shock analysis is a standard form of risk assessment that is
used in many industry applications. The FFIEC High Risk Stress Test for
CMOs, total return analysis, and income simulation models all feature
this approach. It is a useful and conservative practice that enhances
the risk management process.
Risk analysis, supervision and compliance. The Board is
particularly concerned that corporate credit unions have a
comprehensive risk management process in place to identify all
applicable risk exposures before and after an investment is made. The
process should ensure that such risk exposures are measured on a
regular basis and in relation to all limitations that are in place to
govern such risks.
The risk management process is a discipline that requires a large
measure of vigilance on the part of management. The impact of changing
market and credit conditions may be swift and severe. The risk
management process must be a proactive and defensive mechanism for
preserving the earnings and capital of the credit union. The more in-
depth the risk analysis and the greater the frequency of review, the
more accountable the board of directors can be in policing the risks
that are undertaken.
The board of directors of a corporate credit union is responsible
for the actions and risk exposures that the institution undertakes. In
order to effectively understand and ultimately supervise risk, the
board must receive a complete distillation of risk activities on a
timely basis. That information must summarize the actions taken and the
consequences, as stated in terms of capital at risk, that will result
when applicable risk factors change.
The board of directors cannot supervise and direct the actions of
the credit union at the line level. However, the board is obligated to
demand that management provide all of the information necessary for
board members to make fully informed decisions. Thus the reporting
element of the risk management process is no less important in the
scheme of managing risk. The board must have clear, concise summaries
of risk activities and exposures in order to carry out its oversight
responsibilities.
The Board regards risk analysis, supervision, and compliance as an
essential process for all credit unions. Risk management procedures
vary considerably among corporate credit unions and are a major
concern. The need to standardize the discipline of the risk management
process is obvious. The incorporation of a consistent framework will
bolster the integrity and viability of the corporate credit union
system.
Contingency funding. The role of all corporate credit unions as
liquidity custodians has drawn attention to a major deficiency in the
system. The disregard for contingent funding plans has been a
particularly troublesome issue. Contingency funding plans guarantee the
role of a corporate as an inviolable provider of liquidity, regardless
of the circumstances. The fact that liquidity is most scarce when it is
most required underscores the danger of not planning for unexpected
needs.
The borrowing capacity of corporate credit unions is not an
unlimited resource. Many corporate credit unions have suggested that
liquidity will be easily obtainable through repurchase agreements and
lines of credit. The reality is that many factors can impinge upon the
ability of a corporate to borrow the amount of funds for the amount of
time that is required.
Corporate credit unions must evaluate all viable resources of
liquidity on a regular basis and understand how changes in market
factors will impact those resources over time. For example, it may be
unreasonable to assume that borrowing capacity is not hindered by
severe economic circumstances. The corporate must know that it can
provide liquidity in normal or catastrophic situations. The board of
directors needs to be assured that the plan to meet liquidity needs is
realistic and up-to-date.
Modeling. The Board wishes to quantify more precisely how the
proposed changes to Part 704 will affect corporate credit union
earnings and capital accumulation. To this end, NCUA will conduct
analytical assessments of these changes through simulation modeling
techniques using a sampling of corporate credit union balance sheets.
Interested parties who believe the proposed changes, if implemented,
would adversely affect corporate credit unions' ability to serve their
members are requested to submit the results of similar assessments to
support their positions.
Section 704.5--Investments
The Board is proposing to modify and move the policies section of
current Sec. 704.6 to proposed Sec. 704.4. The remaining sections of
current Sec. 704.6 would be revised and recodified at proposed
Sec. 704.5. The Board is also proposing to include the relevant
provisions of Part 703, governing federal credit union investments, in
proposed Part 704, rather than simply incorporating them by reference,
as is done currently. Sections 703.4 and 703.5, with some
modifications, would be included in Sec. 704.5, and Sec. 703.2, which
provides definitions, would be included in proposed Sec. 704.2.
Proposed Sec. 704.5(a) would replace current Sec. 704.6(b)(2)(i),
except that the reference to investments authorized by Part 703 would
be deleted. This paragraph would also explain the operation of the
divestiture provisions set forth in the remainder of the section.
Finally, this paragraph would address investments that must be
classified as available-for-sale and the limit on investments in any
one issuer. While the current rule bases all investment limitations on
a percentage of assets, the [[Page 20444]] proposed rule would base
those limitations on a percentage of primary capital. This would
encourage the building of primary capital.
The Board has determined that a corporate credit union should not
be permitted to invest in any non federally insured state banks, trust
companies, and mutual savings banks, so current Sec. 704.6(b)(2)(ii) is
not included in proposed Sec. 704.5.
Proposed Sec. 704.5(b) would replace current Sec. 704.6(b)(i),
except that it would refer to CSOs rather than CUSOs. In addition, the
limit on investments in CSOs would move to new Sec. 704.7, which would
address a number of issues relating to CSOs.
Proposed Sec. 704.5(c) would authorize corporate credit unions to
invest in U.S. Central Corporate Credit Union.
Proposed Sec. 704.5(d) would establish limits on investments in
domestic banks for the first time. Proposed Sec. 704.5(e) would replace
current Sec. 704.6(b)(2)(iii), except that it would add an entity
rating requirement for foreign banks and establish limits on
investments in foreign banks in any one country and in all foreign
banks.
Proposed Sec. 704.5 (f) and (g) would replace current
Sec. 704.6(b)(2) (iv) and (v) respectively. Proposed Sec. 704.5(h)
would replace current Sec. 704.6(b)(2)(vi), except that it would revise
the stress test and would require corporate credit unions test their
CMOs/REMICs on a monthly basis. Corporate credit unions would have to
test floating as well as fixed rate CMOs.
Proposed Sec. 704.5 (i)-(k) would set forth the relevant authorized
activities listed in Sec. 703.4, and proposed Sec. 704.5(l) would set
forth most of the prohibitions listed in Sec. 703.5. The Board is
proposing additionally to prohibit corporate credit unions from buying
or selling swap agreements, option contracts, and forward rate
agreements, and making deposits in non federally insured state banks,
trust companies, and mutual savings banks. While federal natural person
credit unions may purchase stripped mortgage backed securities and CMO/
REMIC residuals to reduce interest rate risk, the Board is proposing to
prohibit corporate credit unions from purchasing such securities for
any purpose. The Board is also proposing to lower the maturity date on
permissible zero coupon securities from 10 years Pto 5.
Finally, the Board notes that Sec. 107(15)(B) of the Federal Credit
Union Act authorizes federal credit unions to invest in mortgage
related securities as defined in Sec. 3(a)(41) of the Securities
Exchange Act of 1934, 15 U.S.C. 78c(a)(41). Until recently, that
definition required that a security be backed by promissory notes
secured by a first lien on real estate, upon which is located ``a
dwelling or mixed residential and commercial structure.'' Because of
this, a mortgage related security did not include a security backed by
purely commercial mortgages. The Riegle Community Development and
Regulatory Improvement Act of 1994, enacted on September 23, 1994,
amended the Exchange Act to provide that the underlying notes of a
mortgage related security may be directly secured by a first lien on
real estate upon which is located one or more commercial structures.
Thus, federal credit unions were granted the statutory authority to
invest in commercial mortgage related securities.
Under Sec. 107(15), however, this authority is ``subject to such
regulations as the Board may prescribe.'' It is the Board's view that
federal credit unions may not purchase commercial mortgage related
securities until explicitly permitted to do so by regulation. The Board
has not yet issued a regulation permitting federal natural person
credit unions to purchase such securities but will consider the matter
in its upcoming review of Part 703. The Board will also consider at
that time whether commercial mortgage related securities are
appropriate for corporate credit unions. In the meantime, to eliminate
potential confusion, the proposed rule explicitly prohibits corporate
credit unions from purchasing such securities.
Section 704.6--Capital Goals, Objectives, and Strategies
The proposed rule would substitute ``CSO'' for ``CUSO'' and would
require a cost/benefit analysis and impact study when an activity might
have a material effect on a corporate credit union. When an impact
study must be conducted, the proposed rule would require that it be on
a corporate's earnings, in addition to its capital position.
Section 704.7--Corporate Service Organizations (CSOs)
As noted in the definitions section, the Board is proposing to
revise the CUSO concept for corporate credit unions. Currently, Part
704 incorporates much of Sec. 701.27 by reference. Because of the
proposed change in terminology, and the determination that some of the
provisions of Sec. 701.27 are not applicable to corporate credit union
service organizations, proposed Sec. 704.7 contains all of the
necessary regulations governing CSOs. Therefore, the proposed rule does
not reference Sec. 701.27.
Proposed Sec. 704.7(a) would incorporate most of the definitions in
current Sec. 701.27(c). Proposed Sec. 704.7(b) would limit a
corporate's aggregate investments in and loans to member and non member
CSOs to 15 percent of capital at the time the investment or loan is
made. The current rule allows a corporate to invest 15 percent of
capital in and loan 15 percent of capital to CUSOs. The Board has
determined that it is inappropriate to allow corporate credit unions to
risk 30 percent of capital in such organizations. The Board has added
``member or non member'' to the limitation to clarify that loans to and
investments in all CSOs are governed by the Sec. 704.7, regardless of
whether the CSO is a member of the corporate credit union or not.
Proposed Sec. 704.7(b) would incorporate some of the limitations of
Sec. 701.27 (b) and (d). Proposed Sec. 704.7(c) would incorporate the
conflicts provisions of Sec. 701.27(d)(6). Proposed Sec. 704.7(d) would
replace the accounting and information access provisions of
Sec. 701.27(d)(7).
Finally, proposed Sec. 704.7(e) would require a corporate credit
union to take steps to bring its investments and loans in line with the
new regulation. Under the proposed rule, corporate credit unions would
not be authorized to invest in or loan to CUSOs. If a CUSO already
meets the CSO requirements, an investment in or loan to the CUSO
becomes an investment in or loan to a CSO, and there is no problem. If
a CUSO can meet the CSO requirements with some slight adjustments, as
for example, eliminating a service that a CSO may not perform, it is
expected that this be accomplished by the effective date of the
regulation. If there is no way that a CUSO can meet the CSO
requirements, a corporate credit union must divest itself of any
investments in the CUSO by the effective date of the regulation. Any
loan to such a CUSO must be terminated if permitted by contract. If not
permitted, a corporate credit union may retain the loan on its books
but may not renew or extend it.
Section 704.8--Lending
The Board is proposing to revise Sec. 704.7(b)(1), which would be
codified at Sec. 704.8(b)(1), to tighten the limitation on aggregate
loans to one member credit union. In the existing regulation, loans to
one borrower are limited to the corporate credit union's capital or 10
percent of the corporate credit union's shares and capital, whichever
is greater. Under the proposed regulation, the aggregate of loans to
one member credit union would be limited to the corporate credit
union's primary capital. The [[Page 20445]] Board believes that the
existing limitation is far too permissive and poses a potential threat
to the NCUSIF. In several of the larger corporate credit unions, the
current limitation could allow one member to borrow in excess of $1
billion. Limiting total loans to one borrower to the amount of a
corporate credit union's primary capital would greatly reduce the
exposure to the corporate credit union and the NCUSIF and, in addition,
would provide an incentive to the corporate credit union to increase
its level of primary capital.
The Board is proposing to eliminate Sec. 704.7(b)(2) and (3),
regarding loans to members that are not credit unions and to credit
unions that are not members. Proposed Sec. 704.8(b)(5) would explicitly
prohibit a corporate from making a loan to a non member or a natural
person member. Except for providing overdraft protection for a clearing
account, a corporate credit union would also be prohibited from making
a loan to a trade association member. Loans to CSO members would be
governed by proposed Sec. 704.7. The proposed rule would require any
loan to a trade association member to be fully collateralized.
Section 704.9--Borrowing
The Board is proposing to tighten the limitations on the amount a
corporate credit union may borrow. In the existing regulation, a
corporate credit union is permitted to borrow up to 10 times capital or
50 percent of shares (excluding shares created by the use of member
reverse repurchase agreements) and capital, whichever is greater. In
the proposed regulation, the wording is changed to indicate whichever
is less. The Board has determined that tying borrowing authority more
closely to the level of capital would encourage capital growth.
Additionally, unless extremely strong capital existed, the corporate
would not be permitted to borrow up to 50 percent of shares and
capital. The more well capitalized a corporate credit union, the higher
borrowing capacity it would have. The Board views this as an
enhancement to the safety and soundness of the corporate credit union
system.
This section is also revised in the proposed regulation to restrict
a corporate credit union to borrowing only to meet liquidity needs,
except for issuing a minimum amount of commercial paper to maintain a
market presence. As a liquidity center, a corporate credit union must
have the ability to borrow funds under certain circumstances to ensure
that liquidity remains available to meet member credit unions' needs.
However, the Board wishes to make it clear that corporate credit unions
should not be borrowing in order to fund investment transactions to
enhance net income. Therefore, the proposed regulation also requires
that the need for borrowing be documented, in writing, and that the
documentation be provided to the corporate credit union's auditor and
supervisory committee and to NCUA.
Finally, in acknowledging that there may exist extraordinary
circumstances under which a corporate credit union may need to borrow
in excess of the limitation set forth in this section, the regulation
allows a corporate credit union to submit a request to NCUA for
additional borrowing authority.
Section 704.10--Services
The Board is proposing to revise this section to eliminate the list
of services a corporate credit union may provide. Currently, corporate
credit unions may provide services involving investments, liquidity
management, payment systems, and correspondent services. The Board
believes that this authority has, on occasion, been interpreted too
broadly. Accordingly, the Board is proposing simply to say that
corporate credit unions may provide services to their member credit
unions, intending that to mean traditional loan, deposit and payment
services. A corporate credit union wishing to provide other types of
services should contact NCUA to determine whether such services are
permissible.
The Board is also proposing to clarify that a corporate credit
union may provide services only to its members. Historically, two
corporate credit unions might informally agree between themselves for
one to provide services to the members of the other. These types of
correspondent arrangements are permissible for natural person credit
unions, but only when the agreements are formalized in writing and
certain other requirements are met. The Board has determined that such
arrangements, even if formalized, are inappropriate for corporate
credit unions and is proposing to state that explicitly in the
regulation.
Corporate credit unions have also argued that they are authorized
to provide services to non member credit unions pursuant to Sec. 701.26
of the NCUA Rules and Regulations, which provides that a federal credit
union may enter into a contract with one or more credit unions or other
organizations ``for the purpose of sharing, utilizing, renting,
leasing, purchasing, selling, and/or joint ownership of fixed assets or
engaging in activities and/or services which relate to the daily
operations of credit unions.'' NCUA never intended this provision to
authorize corporate credit unions to provide services to non member
credit unions. Such an interpretation would make field of membership
limitations meaningless. The provision was intended to allow natural
person credit unions to jointly contract to obtain services from a non
credit union third party. In any event, the Board has the opportunity
now to clarify that Sec. 701.26 does not authorize corporate credit
unions to provide services to non member credit unions.
Finally, corporate credit unions have argued that they can accept
deposits from non member credit unions pursuant to Section 107(7)(G) of
the Federal Credit Union Act, 12 USC 1757(7)(G), which authorizes
federally chartered credit unions to invest in the shares or deposits
of any central credit union. The Board has determined that corporate
credit unions may only accept shares or deposits from members, pursuant
to its authority, under Section 120(a) of the Federal Credit Union Act,
12 USC 1766(a), to issue regulations governing corporate credit unions.
--
Section 704.11--Fixed Assets
The Board is proposing to revise Sec. 704.11(b)(1) to change the
limitation on the amount a corporate credit union may invest in fixed
assets without a waiver from NCUA. In the existing regulation, a
corporate credit union may invest up to 15 percent of capital in fixed
assets. In the proposed regulation, the limitation has been revised to
15 percent of primary capital. While all of the corporates are
presently in compliance with the proposed limitation, some may wish to
make large fixed asset investments in the future. The Board views the
proposed limit as a further incentive for corporate credit unions to
build stronger levels of primary capital.
Additionally, references to the Director, Office of Examination and
Insurance have been changed to NCUA in the proposed rule. These
references relate to the submission of waivers from the fixed asset
limitation. For the time being, waivers should be submitted to the
Director, Office of Corporate Credit Unions. Waivers may need to be
submitted elsewhere in the future, however, if NCUA offices are
restructured. Finally, the Board is proposing to eliminate the
provision regarding a corporate credit union proceeding with its
investment if it does not receive notification of the action taken on
its request within 45 days. This will ensure that NCUA has adequate
time to review any corporate credit union request to invest more than
15 [[Page 20446]] percent of primary capital in fixed assets.
Section 704.12--Corporate Credit Union Reserves
A number of sources (including Congress, the General Accounting
Office, and the Corporate Credit Union Study Committee) have expressed
concern over the relativity low levels of capital in corporate credit
unions. The proposed regulation provides for several very specific
changes to the corporate credit union reserve structure. The existing
regulation establishes specific levels of capital that corporate credit
unions must maintain, based on risk-weighted assets. Currently,
corporate credit unions must maintain a ratio of 4 percent of primary
capital to risk-weighted assets and a ratio of 8 percent of total
capital to risk-weighted assets.
Under proposed Sec. 704.12(a), corporate credit unions would have
to reach capital levels based on primary capital to average daily
assets. The Board is proposing the changes to the reserve requirements
in order to emphasize the need for stronger primary capital. The
regulation provides for incremental increases in the minimum ratio of
primary capital to average daily assets until the level of 4 percent is
achieved by January 1, 1998. (The increments are 2.5 percent by January
1, 1996 and 3 percent by January 1, 1997.) The regulation does allow
for a possible waiver from the requirements at the first two intervals.
However, the Board is committed to building primary capital in
corporate credit unions. Any waiver request from this requirement must
include very specific time frames, with supporting documentation, for
reaching the regulatory capital level.
Proposed Sec. 704.12(b) would require that all corporate credit
unions maintain a minimum of 10 percent capital to risk-weighted
assets. Under the existing regulation, corporate credit unions are
required to maintain a capital to risk-weighted assets ratio of 8
percent. Although the major focus will be on primary capital, the Board
sees a continued need to provide a measure of capital compared to risk-
weighted assets. Risk-weighting of assets does provide some delineation
of the risk in a corporate credit union's balance sheet. The amount of
capital available to cover the risks associated with the balance sheet
is valuable information to corporate credit union officials as well as
NCUA. Currently, all corporate credit unions with the exception of U.S.
Central have capital to risk-weighted assets in excess of 10 percent.
Proposed Sec. 704.12(i) would require that each corporate credit
union develop a written projection detailing its action plan to achieve
the primary capital requirements established in Sec. 704.12(a). As part
of the plan, a corporate credit union will need to make reserve
transfers at levels that will ensure compliance with the minimum
primary capital requirements. At a minimum, corporate credit unions
that have already met the minimum 4 percent primary capital
requirement, must make reserve transfers as set forth in
Sec. 704.12(j).
Section 704.12(j) establishes the required reserve transfers for
corporate credit unions. The proposed rule makes certain changes to
conform to the proposed definitions of primary capital and capital to
risk-weighted asset ratios. There are five reserve transfer categories.
All corporate credit unions would be required to maintain minimum
primary capital to average daily assets of 4 percent and capital to
risk-weighted assets of 10 percent. Therefore, Category 1 begins when
these ratios are at 4 percent and 10 percent respectively. Once the
primary capital ratio is greater than 6 percent, and the capital to
risk-weighted assets ratios is greater than 20 percent, reserve
transfers are no longer required. For the purposes of reserve
transfers, it is proposed that PCSAs be excluded from primary capital.
The Board is proposing to eliminate the term ``risk-based
capital.'' In the current regulation, risk-based capital includes
primary capital and secondary capital up to 100 percent of primary
capital. Risk-based capital is used in comparison to risk-weighted
assets to establish minimum risk-based capital ratios for reserving
purposes. In the proposed regulation, reserve transfers are based on
primary capital to average daily assets and capital to risk-weighted
assets. There would no longer be any specific category of risk-based
capital.
Section 704.13--Representation
As noted earlier, the Board amended the representation section of
Part 704 last year. In light of the proposed changes to the definition
of ``member,'' the Board is proposing to delete certain provisions that
were designed to ensure that corporate credit unions were controlled by
their member credit unions. These provisions would no longer be
necessary if only representatives of member credit unions are permitted
to vote and stand for election. The Board is also proposing to
specifically state that the provisions of Sec. 701.14 of the Rules and
Regulations, governing changes in officials and senior executive
officers in credit unions that are newly chartered or in troubled
condition. This provision always was intended to apply to corporate
credit unions, as it is not inconsistent with any provision in Part
704. However, the provision refers to NCUA Regional Directors, and in
light of the centralization of the corporate credit union program, its
application to corporate credit unions may have been unclear.
Accordingly, the Board is proposing to specifically include Sec. 701.14
in Part 704, changing the reference from ``Regional Director'' to
``NCUA.'' As with requests for waivers to the fixed asset limitation,
notices required under Sec. 701.14 should be filed, for the time being,
with the Director, Office of Corporate Credit Unions.
Section 704.14--Audit Requirements
In the existing regulation, this section deals only with the need
for an annual audit. The only change relating to the annual audit in
the proposed regulation is the addition of wording to clearly specify
that the annual opinion audit will include a letter of reportable
conditions.
The Board is proposing to add a new Sec. 704.14(b) to include a
requirement for an internal auditor function in corporate credit unions
with assets in excess of $100 million. The requirement would also apply
to corporates with assets under $100 million, if so ordered by NCUA.
The Board realizes that not all corporate credit unions can readily
afford to hire a full-time internal auditor. Based on the asset size
and complexity of the institution, the corporate could hire a part-time
internal auditor or contract with an outside firm to perform the
internal auditor function. The proposed regulation requires that the
internal auditor report directly to the chair of the corporate credit
union's supervisory committee. The regulation provides specific minimum
responsibilities that the internal auditor must perform. Finally, the
internal auditor's findings and reports must be documented and made
available for review to the outside auditor and NCUA.
Section 704.15--Contracts/Written Agreements
The Board is not proposing any changes to this provision.
Section 704.16--State-Chartered Corporate Credit Unions
The Board is proposing to add new Sec. 704.16(b) to put non
federally insured state-chartered corporate credit unions that receive
funds from federally insured credit unions on notice that they are
considered ``institution-affiliated parties'' within Section 206(r)
[[Page 20447]] of the Federal Credit Union Act and subject to all of
the enforcement provisions of the Act.
Section 704.17--Fidelity Bond Coverage
The Board is proposing only minor changes to this Section. Section
704.17(d) would be amended to clarify that the minimum bond coverage is
based on a corporate credit union's average daily assets as of the
preceding December 31. The Board notes that in current Sec. 704.17(f),
the deductibles are based on a corporate credit union's primary capital
to risk asset ratio. Since the proposed regulation eliminates this
ratio, another one must be used. The Board is proposing that it be the
primary capital ratio and specifically requests comments on this issue.
Section 704.18--Effective Date
The Board is proposing to make any final regulation on these
matters effective January 1, 1996. However, although not stated in the
proposed regulation itself, the Board is also considering requiring
compliance with Sec. 704.5, governing investments, 30 days after the
final rule is published in the Federal Register. Investments purchased
before that date would be governed by the regulation in effect at the
time of purchase. The Board is proposing to make the investment
provisions applicable before the remainder of the regulation to deter
corporate credit unions from ``loading up'' on investments that would
no longer be permissible after January 1, 1996. All investments,
regardless of when acquired, would be subject to the asset-liability
provisions of proposed Section 704.4. In order to accomplish this
objective, it may be necessary for the Board to issue a final rule in
two separate stages with different effective dates, or to issue one
rule with a 30 day effective date, but with a delayed compliance date
for all sections other than Secs. 704.2, Definitions, and 704.5,
Investments.
Appendix A--Summary of Risk Weights and Risk Categories for
Corporate Credit Unions
The major focus of the Board's proposed amendments to the risk
weight schedule is the risk weighting of certain mortgage-backed
securities. The current regulation weights CMOs based on their
response to the interest-rate sensitivity test, and the Board has
determined that this is inappropriate in a scheme designed to
address credit risk. In the proposed rule, mortgage-backed
securities, including pass throughs and certain CMOs (but not
stripped mortgage backed securities), that are issued or guaranteed
by a U.S. Government agency or U.S. Government-sponsored enterprise
are assigned to the risk weight category appropriate to the issuer
or guarantor. Generally, a privately-issued mortgage backed security
meeting certain criteria, as set forth in the proposed regulation,
is treated as essentially an indirect holding of the underlying
assets, and assigned to the same risk category as the underlying
assets. Privately-issued mortgage backed securities whose structures
do not qualify them to be regarded as indirect holdings of the
underlying assets are assigned to the 100 percent risk category.
While the risk category to which mortgage backed securities is
assigned will generally be based upon the issuer or guarantor or, in
the case of privately-issued mortgage backed securities, the assets
underlying the security, any class of a mortgage backed security
that can absorb more than its pro rata share of loss without the
whole issue being in default, is assigned to the 100 percent risk
category.
The specific changes being proposed are as follows. In Category
1, the Board is proposing to delete item (g), claims on or
unconditionally guaranteed by sovereign central governments of
``AAA'' rated countries. Its inclusion in the current rule was
inadvertent, as such investments are not permissible for corporate
credit unions.
In Category 2, 20 percent risk weight, the Board is proposing to
delete the material at the end of Category 2, addressing bank
ratings. Proposed Section 704.5 sets forth the minimum ratings for
deposits in banks. The Board is also proposing to delete items (j)
and (k), which are certain types of repurchase transactions. Such
transactions should be risk weighted according to the type of
collateral involved. Item (m), CMOs/REMICs that pass the interest
rate sensitivity test, would also be deleted from the regulation. As
noted above, the proposed rule risk weights CMOs based on the
issuer, guarantor, or assets underlying the security. Finally, the
Board is proposing to change the risk weighting of claims on foreign
banks from 20 percent to 50 percent.
In Category 3, 50 percent risk weight, the Board is proposing to
delete item (b), CMOs that pass the interest rate sensitivity test,
and replace it with privately-issued mortgage backed securities that
meet certain criteria relating to credit risk. Claims on foreign
banks would be added to this category.
In Category 4, 100 percent risk weight, the Board is proposing
to delete investments in CUSOs from item (a), as corporate credit
unions would not be permitted to hold such investments from the
effective date of this regulation. The proposed rule would add item
(b), loans to and investments in CSOs, and replace item (e),
membership capital share deposits, with permanent and secondary
capital share accounts. The Board is also proposing to delete item
(d), hold-in-custody repurchase agreements, as the risk weighting of
such agreements should be based on the underlying collateral. The
Board is proposing to delete item (f), stripped mortgage backed
securities and item (g), residual interests of CMOs/REMICs. Under
the proposed rule, these investments would not be permissible for
corporate credit unions. In this category, the Board is also
proposing to add an item for other claims on private obligors, to
make it clear that unless a claim on a private obligor is guaranteed
or insured by a U.S. Government agency or enterprise, is
collateralized by such a claim, or is secured or collateralized by
highly liquid and reliable collateral, it is risk-weighted at 100
percent.
Appendix C--Model Forms
As noted earlier, the Board is proposing to delete the current
Appendix C as unnecessary and potentially confusing. The proposed
rule contains a new Appendix C, which features model disclosure
forms for permanent and secondary capital share accounts. Corporate
credit unions that use these forms will be deemed to be in
compliance with the proposed disclosure requirements of Sec. 704.2.
Section 741.3--Other Requirements
The Board is proposing to amend Sec. 741.3 of the NCUA Rules and
Regulations, governing requirements for insured credit unions, to
prohibit federally insured credit unions from transacting business with
corporate credit unions that do not comply with Part 704 and are not
examined by NCUA.
Regulatory Procedures
Regulatory Flexibility Act
The NCUA Board certifies that the proposed rule, if made final,
will not have a significant economic impact on small credit unions
(those under $1 million in assets). The rule applies only to corporate
credit unions, all of which have assets well in excess of $1 million.
Accordingly, a Regulatory Flexibility Analysis is not required.
Paperwork Reduction Act
The proposed rule contains a requirement for the collection of
additional information and a maintenance of documentation by a
corporate credit union. The proposed rule requires that each corporate
credit union develop and implement certain policies and plans and
document compliance with such policies and plans. The proposed rule
also requires that certain information regarding asset-liability
management and investments be sent to NCUA or maintained in the records
of the corporate credit union.
The paperwork requirements will be submitted to the Office of
Management and Budget (OMB) for review under the Paperwork Reduction
Act. Written comments on the paperwork requirements should be forwarded
directly to the OMB Desk Officer indicated below at the following
address: OMB Reports Management Branch, New Executive Office Building,
Room 10202, Washington, DC 20530. Attn: Milo Sunderhauf. NCUA will
publish a notice in the Federal Register [[Page 20448]] once OMB action
is taken on the submitted request.
Executive Order 12612
Executive Order 12612 requires NCUA to consider the effect of its
actions on state interests. It states that: ``Federal action limiting
the policy-making discretion of the states should be taken only where
constitutional authority for the action is clear and certain, and the
national activity is necessitated by the presence of a problem of
national scope.'' The risk of loss to federally insured credit unions
and the NCUSIF caused by actions of corporate credit unions are
concerns of national scope. The proposed rule would help assure that
proper safeguards are in place to ensure the safety and soundness of
corporate credit unions.
The rule applies to all corporate credit unions that accept funds
from federally insured credit unions. The NCUA Board believes that the
protection of such credit unions, and ultimately the NCUSIF, warrants
application of the proposed rule to non federally insured corporate
credit unions. The NCUA Board, pursuant to Executive Order 12612, has
determined that this rule may have an occasional direct effect on the
states, on the relationship between the national government and the
states, or on the distribution of power and responsibilities among the
various levels of government. However, the potential risk to the NCUSIF
without these changes justifies them.
List of Subjects
12 CFR Part 704
Credit unions, Reporting and recordkeeping requirements.
12 CFR Part 741
Bank deposit insurance, Credit unions, Reporting and recordkeeping
requirements.
By the National Credit Union Administration Board on April 13,
1995.
Becky Baker,
Secretary of the Board.
For the reasons set forth in the preamble, NCUA proposes to amend
12 CFR chapter VII as follows:
1. Part 704 is revised to read as follows:
PART 704--CORPORATE CREDIT UNIONS
Sec.
704.1 Scope.
704.2 Definitions.
704.3 Planning; strategic and business plans.
704.4 Asset/liability management.
704.5 Investments.
704.6 Capital goals, objectives, and strategies.
704.7 Corporate Service Organizations (CSOs).
704.8 Lending.
704.9 Borrowing.
704.10 Services.
704.11 Fixed assets.
704.12 Corporate credit union reserves.
704.13 Representation.
704.14 Audit requirements.
704.15 Contracts/written agreements.
704.16 State-chartered corporate credit unions.
704.17 Fidelity bond coverage.
704.18 Effective date.
Appendix A to Part 704--Summary of Risk Weights and Risk Categories for
Corporate Credit Unions
Appendix B to Part 704--Off-Balance Sheet Credit Conversion Factors
Appendix C to Part 704--Model Forms
Authority: 12 U.S.C. 1762, 1766(a), 1781, and 1789.
Sec. 704.1 Scope.
(a) This part establishes special rules for all federally insured
corporate credit unions. Non-federally insured corporate credit unions
must agree, by written contract, to both adhere to the requirements of
this part and submit to examinations, as determined by NCUA, as a
condition of receiving shares or deposits from federally insured credit
unions. This part grants certain additional authorities to federal
corporate credit unions. Except to the extent that they are
inconsistent with this part, other provisions of NCUA's Rules and
Regulations (12 CFR Parts 700-795) and the Federal Credit Union Act
apply to federally chartered corporate credit unions and federally
insured state-chartered corporate credit unions to the same extent that
they apply to other federally chartered and federally insured state-
chartered credit unions, respectively.
(b) The NCUA Board has the authority to issue orders which vary
from this Part. This authority is provided under Section 120(a) of the
Federal Credit Union Act, 12 U.S.C. 1766(a). Requests by state-
chartered corporate credit unions for waivers to this part must be
approved by the state regulator before being submitted to NCUA.
Sec. 704.2 Definitions.
Adjusted trading means any method or transaction used to defer a
loss whereby a corporate credit union sells a security to a vendor at a
price above its current market price and simultaneously purchases or
commits to purchase from the vendor another security at a price above
its current market price.
Asset-backed securities (ABS) means all securities supported by
installment loans or leases or by revolving lines of credit. This
definition excludes those securities referred to in the financial
markets as mortgage-backed securities (MBS) which includes
collateralized mortgage obligations (CMOs) and real estate mortgage
investment conduits (REMICs).
Average daily assets means the daily average of net assets
calculated on the basis of assets at the close of each day in the
period.
Average life means the weighted average time to principal repayment
with the amount of the principal paydowns (both scheduled and
unscheduled) as the weights.
Bailment for hire contract means a contract whereby a third party,
bank, or other financial institution, for a fee, agrees to exercise
ordinary care in protecting the securities held in safekeeping for its
customers.
Capital means the total of all primary capital and secondary
capital share accounts upon which notice of withdrawal has not been
given.
Cash forward agreement means an agreement to purchase or sell a
security with delivery and acceptance being mandatory and at a future
date in excess of thirty (30) days from the trade date.
Collateralized mortgage obligation (CMO) means a multi-class bond
issue collateralized by whole loan mortgages or mortgage-backed
securities (MBS).
Commitment means any unconditional arrangement that obligates a
corporate credit union to extend credit in the form of loans; to
purchase loans, securities or other assets; or to participate in loans
and leases. Commitments also include overdraft facilities, revolving
credit, home equity, and mortgage lines of credit, and similar
transactions. An obligation is conditional if the corporate credit
union is not automatically obligated to extend funds.
Corporate credit union means an organization that:
(1) Is chartered under Federal or state law as a credit union;
(2) Receives shares from and provides loan services to credit
unions;
(3) Is operated primarily for the purpose of serving other credit
unions;
(4) Is designated by NCUA as a corporate credit union;
(5) Limits natural person members to the minimum required by state
or federal law to charter and operate the credit union; and
(6) Does not condition the eligibility of any credit union to
become a member on that credit union's membership in any other
organization. [[Page 20449]]
Corporate service organization (CSO) means an entity that:
(1) Serves only corporate credit unions that have made investments
in or loans to the entity and/or the member credit unions of such
corporate credit unions;
(2) Limits the services it provides to data and item processing,
wire transfers, record retention and storage, securities brokerage
services, investment advisory services, and trust services; and
(3) Is chartered as a corporation under state law.
Credit equivalent amount means the face amount of each off-balance
sheet item multiplied by a credit conversion factor outlined in
Appendix B of this part.
Embedded options mean characteristics of certain assets and
liabilities which give the issuer of the instrument the ability to
change the features such as final maturity, rate, principal amount and
average life. These options include, but are not limited to, caps,
floors, and prepayment options. These options are found in most
mortgage-backed securities, structured notes, and some Network
instruments.
Expected maturity means the date on which all remaining principal
amounts of an instrument or bond are anticipated to be paid off on the
basis of projected payment assumptions.
Facility means the home office of a corporate credit union or any
suboffice thereof including, but not necessarily limited to, wire
service, telephonic station, or mechanical teller station.
Federal funds transaction means a short-term or open-ended transfer
of funds between U.S. depository institutions.
-Federally issued CMO/REMIC means a CMO or REMIC which is issued by
a U.S. Government agency or a U.S. Government-sponsored corporation or
enterprise.
-Foreign bank means an institution which is organized under the
laws of a country other than the United States, which is engaged in the
business of banking, and which is recognized as a bank by the banking
supervisory authority of the country in which it is organized.
--Forward rate agreement means an over-the-counter market
instrument that allows two parties to trade interest rates on a
notional principal amount for a specified time period in the future.-
--Futures contract means a contract for the future delivery of
commodities, including certain government securities, sold on
commodities exchanges.
-Identically matched means matched, to the extent possible, by
amount, repricing, behavior, and final maturity. Any embedded options,
such as calls, caps, and prepayments, must be replicated in the
corresponding source or use of funds.
-Immediate family member means a person related by blood, marriage,
or adoption.
-Long-term investment means, for the purpose of issue ratings, an
investment that has an initial maturity, or expected maturity, greater
than one year.
--Market price means the price at which a security can be bought or
sold.
-Market value of portfolio equity (MVPE) means the net market value
of all assets and liabilities, including their embedded options. This
reflects the liquidation value of the balance sheet.
-Material means an amount that exceeds 5 percent of the corporate
credit union's capital.
--Maturity date means the date on which a security matures, and
shall not mean the call date or the average life of the security.
-Member reverse repurchase transaction means an integrated
transaction in which a corporate credit union purchases a security from
one of its member credit unions under agreement by that member credit
union to repurchase the same security at a specified time in the
future. The corporate credit union then sells that same security, on
the same day, to a third party, under agreement to repurchase it on the
same date on which the corporate credit union is obligated to return
the security to its member credit union.
-Net assets means total assets less Central Liquidity Facility
(CLF) stock subscriptions, CLF loans guaranteed by the NCUSIF, U.S.
Central CLF certificates, and member reverse repurchase transactions.
-Net interest income means the difference between income earned on
interest bearing assets and interest paid on interest bearing
liabilities.
-Official means any director or committee member.
-Option contract means a right, but not an obligation, to buy or
sell a security at a specified price and settlement date in the future.
-Overnight means having a maturity or call date of one business
day.
-Penalty for early withdrawal of a share, deposit, or liability
means a fee which will, at a minimum, fully compensate a corporate
credit union for the difference between fair value and book value of
the asset that is divested (including any accumulated unrealized losses
since the asset was purchased), or the replacement cost of funds, to
meet the demand for early withdrawal.
-Permanent capital share account (PCSA). (1) PCSA means a share
account that:
-(i) Is restricted to credit unions within a corporate credit
union's field of membership;
-(ii) Is not subject to share insurance coverage by the NCUSIF or
other deposit insurer;
-(iii) Cannot be used by member credit unions to collateralize
borrowings;
-(iv) Is available to absorb losses in the event of a deficit in
other primary capital accounts in the corporate credit union;
-(v) In the event of liquidation of the corporate credit union, is
payable only after satisfaction of all liabilities of the liquidation
estate including uninsured obligations to shareholders and the NCUSIF;
-(vi) Is redeemable only with the written concurrence of NCUA; and
-(vii) Pays noncumulative dividends.
-(2) The terms and conditions of permanent capital share accounts
must be disclosed at the time an account is opened. The board of
directors of the member credit union must acknowledge those terms and
conditions by signing a disclosure form. A copy of the disclosure form
must be given to the member credit union, with the original retained by
the corporate credit union.
-Primary capital means statutory reserves, undivided earnings,
other reserves (excluding the allowance for loan losses and accumulated
unrealized gains/losses on available-for-sale securities), net income
(loss), and permanent capital share accounts (PCSAs). No more than 50
percent of primary capital may be comprised of PCSAs.
-Primary dealer means a bank or investment dealer authorized to buy
and sell government securities in direct dealings with the Federal
Reserve Bank of New York in its execution of Fed open market
operations.
-Privately issued CMO/REMIC means a CMO or REMIC that qualifies as
a permissible investment for a federal credit union pursuant to the
provisions of Section 107(15)(B) of the Federal Credit Union Act.
-Rated, in the context of investments under Sec. 704.5, means rated
by an SEC-recognized rating agency. An SEC-recognized rating agency is
any firm recognized by the Securities and Exchange Commission (SEC) as
qualified to assign risk ratings to various investment instruments
required to be registered with the SEC.
Real Estate Mortgage Investment Conduit (REMIC) means a nontaxable
entity formed for the sole purpose of holding a fixed pool of mortgages
[[Page 20450]] secured by an interest in real property and issuing
multiple classes of interests in the underlying mortgages.
--Repurchase transaction means a transaction in which a corporate
credit union agrees to purchase a security from a counterpart and to
resell the same or any identical security to that counterpart at a
later date.
--Residual interest means the remainder cash flows from a CMO or
REMIC transaction after payments due bondholders and trust
administrative expenses have been satisfied.
--Reverse repurchase transaction means a transaction whereby a
corporate credit union agrees to sell a security to a purchaser and to
repurchase the same or any identical security from that purchaser at a
future date and at a specified price.
-Risk-weighted assets means the sum of total balance sheet assets
and off-balance sheet credit equivalent amounts multiplied by their
appropriate risk weights.
-Secondary capital share account. (1) Secondary capital share
account means a share account that:
-(i) Is restricted to credit unions within a corporate credit
union's field of membership;
-(ii) Is not subject to share insurance coverage by the NCUSIF or
other deposit insurer;
-(iii) Is established, at a minimum, as a two year notice account;
-(iv) Cannot be used by member credit unions to collateralize
borrowings;
-(v) Is available to absorb losses in the event of a deficit in
primary capital in the corporate credit union; and
-(vi) In the event of liquidation of the corporate credit union, is
payable only after satisfaction of all liabilities of the liquidation
estate including uninsured obligations to shareholders and the NCUSIF.
-(2) Notwithstanding the notice requirement, in the case of a
member credit union's merger or liquidation, a corporate credit union
shall return the member's secondary capital shares, less any penalty
for early withdrawal, within 30 days of written notification from NCUA.
-(3) The terms and conditions of secondary capital share accounts
must be disclosed at the time an account is opened. The board of
directors of the member credit union must acknowledge those terms and
conditions by signing a disclosure form. A copy of the disclosure form
must be given to the member credit union, with the original retained by
the corporate credit union. A statement of the terms and conditions of
a secondary capital share account must be provided to member credit
unions annually. The annual disclosure statement must be signed by the
chairman of the board of the corporate credit union.
Section 107(8) institution means an institution described in
Section 107(8) of the Federal Credit Union Act (12 U.S.C. 1757(8)).
-Senior management employee means the corporate credit union's
chief executive officer, any assistant chief executive officer (e.g.,
any assistant president, any vice president or any assistant treasurer/
manager) and the chief financial officer (controller).
Settlement date means the date originally agreed to by a corporate
credit union and a counterpart for settlement of the purchase or sale
of a security.
--Short sale means the sale of a security not owned by the seller.
Short-term investment means, for the purpose of issue ratings, an
investment that has an initial maturity, or expected maturity, of one
year or less.
Standby commitment means a commitment to either buy or sell a
security, on or before a future date, at a predetermined price. The
seller of the commitment is the party receiving payment for assuming
the risk associated with committing either to purchase a security in
the future at a predetermined price, or to sell a security in the
future at a predetermined price. The seller of the commitment is
required to either accept delivery of a security (in the case of a
commitment to buy) or make delivery of a security (in the case of a
commitment to sell), in either case at the option of the buyer of the
commitment.
Stripped mortgage-backed security (SMBS) means a security that
represents either the principal or interest only portion of the cash
flows of an underlying pool of mortgages.
Swap agreement means a contract to exchange interest payments that
are based upon a specified dollar amount (the ``notional'') at
specified dates in the future.
Trade association means an association of organizations or persons
formed to promote their common interests. The term includes entities
owned or controlled directly or indirectly by such an association but
does not include credit unions.
Trade date means the date a corporate credit union originally
agrees, whether orally or in writing, to enter into the purchase or
sale of a security.
Undivided earnings means all forms of retained earnings, except:
(1) Regular or statutory reserves; and
(2) Valuation allowances established to meet the full and fair
disclosure requirements of Sec. 702.3 of this chapter.
United States depository institutions means offices or branches
(foreign and domestic) of federally insured banks and depository
institutions chartered and headquartered in the United States, Puerto
Rico, and U.S. territories and possessions. This includes banks, mutual
or stock savings banks, savings or building and loan associations,
cooperative banks, credit unions, international banking facilities of
domestic depository institutions, and U.S. chartered depository
institutions owned by entities outside of the United States.
United States Government or its agencies means the United States
Government or instrumentalities of the United States whose debt
obligations are fully and explicitly guaranteed as to the timely
payment of principal and interest by the full faith and credit of the
United States Government.
United States Government-sponsored corporations and enterprises
means agencies originally established or chartered to serve public
purposes specified by Congress, but whose obligations are not
explicitly guaranteed by the full faith and credit of the United States
Government.
Wholesale corporate credit union means a corporate credit union
that serves other corporate credit unions.
Zero coupon bond means a debt obligation that makes no periodic
interest payments but instead is sold at a discount from its face
value. The holder of a zero coupon bond realizes the rate of return
through the gradual appreciation of the security, which is redeemed at
face value on a specified maturity date.
Sec. 704.3 Planning; strategic and business plans. -
(a) The board of directors of a corporate credit union shall adopt
a written strategic plan with appropriate objectives and goals. This
plan will be reviewed periodically during the year to determine that
the goals are being accomplished. At least annually, the strategic plan
will be reviewed and updated. These reviews will be documented in
writing and provided upon request to the auditor, supervisory
committee, and NCUA. -
(b) A written business plan will be prepared for any material
expenditure in fixed assets, new products and services, or investments
in a CSO and/or for any planned field of membership expansion. Such
plans shall be provided upon request to the auditor, supervisory
committee, and NCUA. [[Page 20451]]
Sec. 704.4- Asset/liability management. -
(a) Matching. All shares and deposits, exclusive of permanent
capital share accounts and secondary capital share accounts, whether
fixed or variable rate, must be identically matched to a corresponding
asset. An identical match means that any factor which impacts the cash
flows of an asset must be identically replicated in the corresponding
liability. The corporate's capital is exempt from the matching
requirement. The overnight shares of a corporate credit union are
subject to the matching requirement with the following exception: Up
to, but no more than, 25 percent of a corporate credit union's
overnight shares and deposits (based on the average daily overnight
balance for the preceding calendar year) can be matched against
variable rate securities with a final maturity of three years or less
provided that the following provisions are met: the security coupon
reprices at least monthly, the coupon formula is tied to an appropriate
market index (such as LIBOR, PRIME, Fed funds and Treasury Bills) not a
lagging indicator (such as COFI); the change in coupon formula is not
inverse to or a multiple of the change in the market index, and, if the
asset is a marketable security, is classified as ``available for
sale''.-
(b) Unmatched embedded option limitation. A corporate credit union
is limited to an aggregate amount of instruments that possess unmatched
embedded options of no more than capital. -
(c) Penalty for early withdrawal. All shares and deposits must
either be non redeemable or include a fair value penalty for early
withdrawal as defined in Sec. 704.2. -
(d) Portfolio pricing. The fair value of all investment securities,
regardless of classification, must be calculated and documented on a
monthly basis using reliable market price indicators. Such
documentation shall be provided upon request to the auditor,
supervisory committee, and NCUA. -
(e) Maximum unrealized loss on ``available-for-sale'' assets. The
aggregate loss in the accumulated unrealized gains/losses on
``available-for-sale'' assets, net of any unrealized gains/losses on
the corresponding source of funds, may not exceed 15 percent of primary
capital excluding accumulated unrealized gains/losses on available for
sale securities. Any violation of this limit must be addressed with a
corrective action that reduces the loss below the maximum allowed
within 10 days.
-(f) Rate shock analysis. A corporate credit union must perform a
monthly ``shock test'' calculation to show the impact upon its net
interest income and market value of portfolio equity (MVPE) for an
immediate and sustained tandem shift in interest rates of plus and
minus 300 basis points. The MVPE cannot change by more than plus or
minus 25 percent for a plus or minus 300 basis point rate shock. The
documentation for these calculations must include the balance sheet
categories, interest rates, and other assumptions used. This
information must be presented to a senior committee that includes board
membership and provided upon request to the auditor, supervisory
committee and NCUA.
-(g) Risk analysis. A corporate credit union must identify and list
all risks associated with an asset or source of funds prior to purchase
or issuance. Where applicable, the risk analysis must include, at a
minimum, liquidity, market, credit, legal, systems/operations,
sovereign, exchange, and management risks. The risk analysis shall be
maintained with other supporting documentation in a permanent record,
which shall be provided upon request to the auditor, supervisory
committee, and NCUA.
-(h) Risk supervision. A corporate credit union must identify,
measure, and document the risks associated with all assets. The measure
of risk exposure and a comparison of such exposure to board policy
limits must be reported in writing on a quarterly basis. Such reports
shall be provided upon request to the auditor, supervisory committee,
and NCUA.
-(i) Risk compliance. A corporate credit union must review all
investment assets on a monthly basis for compliance with NCUA Rules and
Regulations and board of director policies to determine whether any
such assets require divestiture. The results and analysis shall be
provided upon request to the auditor, supervisory committee, and NCUA.
-(j) Contingency funding. A corporate credit union must develop a
contingency funding plan that ranks, in order of priority, all sources
of liquidity, by category and amount, that are available to service an
immediate outflow of member funds. The plan must analyze the impact
that potential changes in fair value will have on the disposition of
assets in a variety of interest rate scenarios and be reviewed by a
committee of the board no less frequently than annually or as market
and business conditions dictate. The plan and annual review shall be
provided upon request to the auditor, supervisory committee, and NCUA.
-(k) Policies. Corporate credit unions must develop and implement
comprehensive written policies, which shall be reviewed annually and
provided upon request to the auditor, supervisory committee, and NCUA.
The policies must address, at a minimum, the following:
-(1) Diversification of assets by issuer, type and risk;
-(2) Approved issuers, instruments, and broker-dealers;
-(3) Liabilities, including pricing strategies, diversification and
penalties for early withdrawal;-
(4) Limits on the maximum permitted change in net interest income
as calculated for a plus and minus 300 basis point rate shock; -
(5) Acceptable credit risk; -
(6) Authorization of and limitations on persons/committees involved
with asset/liability management.
Sec. 704.5 Investments.
-(a) A corporate credit union may invest in those securities,
deposits, and obligations set forth in Sections 107(7), 107(8), and
107(15)(B) of the Federal Credit Union Act (12 U.S.C. 1757(7), 1757(8),
and 1757(15)(B)), except as provided in this section. Any asset that
has the potential to be divested must be classified as available-for-
sale. An asset downgraded by the same rating agency used when the
investment was purchased must be divested within 10 business days of
the downgrade. Other than investments in wholesale corporate credit
unions, CSOs, and repurchase transactions, the aggregate of a corporate
credit union's investments in any one institution, issuer, or trust is
limited to 25 percent of the corporate credit union's primary capital
at the time of purchase.
-(b) A corporate credit union may invest in CSOs, as defined in
Sec. 704.2 and subject to the limitations of Sec. 704.7.
-(c) A corporate credit union may invest in deposits in, the sale
of Federal Funds to, and debt obligations of wholesale corporate credit
unions.
-(d)(1) A corporate credit union may invest in deposits in, the
sale of Federal Funds to, and debt obligations of Section 107(8)
institutions subject to the following requirements:
-(i) The institution must have assets of at least US $5 billion and
an entity rating no lower than B (or equivalent);
-(ii) The investment must be rated no lower than A-1 (or
equivalent) for short-term investments and no lower than AA (or
equivalent) for long-term investments; and
-(iii) The investment must be denominated in United States dollars.
-
(2) A written evaluation of lines of exposure to all Section 107(8)
[[Page 20452]] institutions must be prepared quarterly by qualified
staff and approved by an appropriate committee of the board so that
changes in credit quality can be detected at the earliest opportunity.
This approval must be documented in the minutes of the committee and be
provided upon request to the auditor, supervisory committee, and NCUA.
-(e)(1) A corporate credit union may invest in deposits in, the
sale of Federal Funds to, and debt obligations of foreign banks,
subject to the following requirements: -
(i) The bank must have assets of at least US $20 billion and an
entity rating no lower than A/B (or equivalent); -
(ii) The investment must be rated no lower than A-1 (or equivalent)
for short-term investments and no lower than AA (or equivalent) for
long-term investments; -
(iii) The investment must be denominated in United States dollars;
-
(iv) The country in which the issuing bank is organized must be
rated AAA (or equivalent) for political and economic stability; -
(v) Aggregate investments in banks in any single foreign country
are limited to 50 percent of the corporate credit union's primary
capital at the time of purchase; and -
(vi) Aggregate investments in all foreign banks are limited to 300
percent of the corporate credit union's primary capital at the time of
purchase. -
(2) A written evaluation of lines of exposure to all foreign banks
must be prepared quarterly by qualified staff and approved by an
appropriate committee of the board so that changes in credit quality
can be detected at the earliest opportunity. This approval must be
documented in the minutes of the committee and be provided upon request
to the auditor, supervisory committee, and NCUA. -
(f) A corporate credit union may invest in marketable debt
obligations of corporations chartered in the United States, provided
that the obligations are rated not lower than A-1 (or equivalent) for
short-term investments and not lower than AA- (or equivalent) for long-
term investments. A marketable obligation is one that may be sold with
reasonable promptness at a price which corresponds reasonably to its
fair value. This authority does not apply to debt obligations that are
convertible into the stock of the corporation.
-(g) A corporate credit union may invest in asset-backed securities
subject to the following requirements:
-(1) Rated not lower than AAA (or equivalent); and
-(2) Having an average life at the time of purchase not to exceed 5
years.
-(h) A corporate credit union may invest in federally and privately
issued CMOs/REMICs, subject to the following limitations:
(1) All investments in fixed rate CMOs/REMICs must meet the
following NCUA-modified FFIEC High Risk Security Test requirements:
(i) The weighted average life of the security may not exceed 5
years at the time of purchase;
(ii) The weighted average life may not extend by more than 2 years
nor contract by more than 3 years for an instantaneous shift in market
rates of plus or minus 300 basis points;
(iii) The investment's price may not decline by more than 10
percent for an instantaneous shift in market rates of plus or minus 300
basis points.
(2) All investments in floating rate CMOs/REMICs must meet the
following NCUA-modified FFIEC High Risk Security Test requirements:
(i) The weighted average life of the security may not exceed 5
years at the time of purchase;
(ii) The weighted average life may not extend by more than 2 years
nor contract by more than 3 years for an instantaneous shift in market
rates of plus or minus 300 basis points;
(iii) The investment's price may not decline by more than 5 percent
for an instantaneous shift in market rates of plus or minus 300 basis
points.
(3) The prepayment assumption for the underlying mortgages shall be
based on an industry standard median prepayment estimate or the median
estimate of no fewer than five independent brokerage firms, at least
one of which must be a primary dealer. When estimates from specific
dealers are used, those dealers must be approved by an appropriate
committee and listed along with monthly test results. The same industry
standard or selection of dealers must be used for all CMO/REMIC
securities each time the tests are performed. In computing the average
life of a CMO/REMIC investment, it must be assumed that the anticipated
rate of prepayment remains constant over the remaining life of the
mortgage collateral.
(4) Any CMO/REMIC security that fails the average life standard or
the price sensitivity test shall be divested within 10 business days.
(5) Results of monthly CMO/REMIC tests must be documented and
reviewed by an appropriate committee and maintained in a permanent
record. Such results shall be provided upon request to the auditor,
supervisory committee, and NCUA.
(i) A corporate credit union may enter into a cash forward
agreement to purchase or sell a security, provided that:
(1) The period from the trade date to the settlement date does not
exceed one hundred and twenty (120) days;
(2) If the credit union is the purchaser, it has written cash flow
projections evidencing its ability to purchase the security;
(3) If the credit union is the seller, it owns the security on the
trade date; and
(4) The cash forward agreement is settled on a cash basis at the
settlement date.
(j)- A corporate credit union may enter into a repurchase or
reverse repurchase transaction provided that the collateral securities
are permissible investments for corporate credit unions and the
transaction is priced to reflect accrued interest, the risk of the
securities, and the term of the trade. A corporate credit union
purchasing a security in a repurchase transaction must take physical
possession of the security, receive written confirmation of the
purchase and a safekeeping receipt from a third party under a written
bailment for hire contract, or be recorded as the owner of the security
through the Federal Reserve Book-Entry System. A corporate credit union
obtaining funds from a reverse repurchase transaction may not invest
those funds for a term greater than the maturity date of the reverse
repurchase transaction. A repurchase transaction shall be considered to
have a credit exposure of 5 percent of the principal and accrued
interest outstanding on the transaction for the purpose of the
limitation on investments in a single institution, issuer, or trust set
forth in paragraph (a) of this section.
(k) A corporate credit union may invest in a mutual fund if the
investments and investment transactions of the fund are legally
permissible for corporate credit unions.
(l) A corporate credit union is prohibited from:
(1) Purchasing or selling a standby commitment, except as provided
in Sec. 701.21(i) of this Chapter;
(2) Buying or selling a futures contract, forward rate agreement,
swap agreement, or option contract;
(3) Engaging in adjusted trading;
(4) Engaging in a short sale;
(5) Purchasing a stripped mortgage-backed security or residual
interest in a CMO/REMIC;
(6) Purchasing a zero coupon security with a maturity date that is
more than 5 years from the settlement date for purchase of the
security, except for funds matched against primary capital;
[[Page 20453]]
(7) Making deposits in nonfederally insured state banks, trust
companies, and mutual savings banks; and
(8) Purchasing commercial mortgage-related securities.
(m) A corporate credit union's officials, senior management
employees, and immediate family members of such individuals, may not
receive pecuniary consideration in connection with the making of an
investment or deposit by the corporate credit union. The prohibition
contained in this subsection also applies to any employee not otherwise
covered if the employee is directly involved in investments or
deposits. All transactions not specifically prohibited by this
paragraph must be conducted at arm's length and in the interest of the
credit union.
Sec. 704.6 Capital goals, objectives and strategies.
(a) General. Corporate credit unions shall adopt formal, written
goals (both long-term and short-term), objectives and strategies,
including a budgetary process, for the building of capital.
(b) Impact study. Where a proposed new service or program, purchase
or lease of a fixed asset, or investment in or loan to a CSO may have a
material effect on a corporate credit union, the corporate credit union
shall perform a cost/benefit analysis of the activity and a study of
its impact on the earnings and capital position of the corporate credit
union.
(c) Monitoring. Management will establish monitoring standards and
procedures to periodically review and reassess the capital position of
the corporate credit union and will document these reviews.
Sec. 704.7 Corporate service organizations (CSOs).
(a) The aggregate of all investments in and loans to member and non
member CSOs shall not exceed 15 percent of a corporate credit union's
capital at the time the investment or loan is made. A corporate credit
union may not use this authority to acquire control, directly or
indirectly, of another financial institution, or to invest in shares,
stocks or obligation of another financial institution, insurance
company, trade association, liquidity facility, or similar
organization. A CSO must be operated as an entity separate from any
credit union. A corporate credit union investing in or lending to a CSO
must take those steps necessary to ensure that it will not be held
liable for the obligations of the CSO.
(b) An official or senior management employee of a corporate credit
union which has invested in or loaned to a CSO, and immediate family
members of such an individual, may not receive, either directly or
indirectly, any salary, commission, investment income, or other income
or compensation, from the CSO. This prohibition extends to any other
corporate credit union employee if such employee deals directly with
the CSO.
(c) Prior to making an investment in or loan to a CSO, a corporate
credit union must obtain a written agreement that the CSO will:
(1) Follow GAAP;
(2) Provide financial statements to the corporate credit union at
least quarterly;
(3) Obtain an annual CPA audit and provide a copy to the corporate
credit union; and
(4) Allow the auditor, supervisory committee, and NCUA complete
access to its books, records, and any other pertinent documentation.
(d) A corporate credit union with an investment in, or a loan to, a
credit union service organization (CUSO) as defined in Sec. 701.27 of
this chapter must, by January 1, 1996, divest of the investment,
terminate the loan if contractually possible, or ensure that the
organization meets the requirements of this section and Sec. 704.2. If
the loan cannot legally be terminated by January 1, 1996 it cannot be
renewed or extended upon its next renewal or extension date.-
Sec. 704.8 Lending.
(a) Policies. A corporate credit union shall develop, implement,
and adhere to written loan policies which address, at a minimum:
(1) Loan types and limits;
(2) Documentation for each loan and line of credit;
(3) Security;
(4) Analysis of financial and operational data;
(5) Monitoring standards; and
(6) Review and reassessment of the credit quality of the member
credit union.
(b) General. Each loan or line of credit limit will be determined
after analyzing the financial and operational soundness of the member
credit union and the ability of the member credit union to repay the
loan. Loans are limited as follows:
(1) Loans to member credit unions. The maximum aggregated amount in
loans and approved lines of credit to any one member credit union,
excluding pass-through and guaranteed loans from the CLF and the NCUSIF
and repurchase transactions, shall not exceed the corporate credit
union's primary capital.
(2) Loans to CSOs. A corporate credit union may make loans and
issue lines of credit to CSOs, as defined in Sec. 704.2 and subject to
the limitations of Sec. 704.7
(3) Participation loans with other corporate credit unions. A
corporate credit union is permitted to participate in a loan with
another corporate credit union and must retain an interest of at least
5 percent of the face amount of the loan. The participation agreement
may be executed at any time prior to, during, or after disbursement. A
participating corporate credit union must exercise the same due
diligence as if it were the originating corporate credit union.
(4) Prepayment penalties. If provided for in the loan contract, a
corporate credit union is authorized to assess prepayment penalties on
loans made to member credit unions.
(5) Prohibitions. A corporate credit union may not make loans,
issue lines of credit, or otherwise provide loan services to non
members or natural person members. Except for providing overdraft
protection for clearing accounts, a corporate credit union may not
provide loan services to member trade associations. A loan or line of
credit provided to a member trade association for the purpose of
overdraft protection must be fully collateralized by any security which
is permissible under Sec. 704.5.
Sec. 704.9 Borrowing.
A corporate credit union may borrow up to 10 times capital or 50
percent of shares (excluding shares created by the use of member
reverse repurchase agreements) and capital, whichever is less. Other
that the issuance of the minimum amount of commercial paper to maintain
a market presence, a corporate credit union may borrow only to meet
liquidity needs. The need must be documented in writing and provided
upon request to the auditor, supervisory committee, and NCUA. CLF
borrowings, as agent member for natural person credit unions, and
borrowed funds created by the use of repurchase agreements are excluded
from this limit. In the event of extreme liquidity demands from its
member credit unions, a corporate credit union may submit a request to
NCUA for additional borrowing authority.
Sec. 704.10 Services.
A corporate credit union may provide services only to its members,
subject to the limitations of this Part. A corporate credit union may
not provide services to non members through the correspondent credit
union authority or pursuant to Sec. 701.26 of this
chapter. [[Page 20454]]
Sec. 704.11 Fixed assets.
(a) General. A corporate credit union's ownership in fixed assets
shall be limited as described in Sec. 701.36 of this chapter, except
that in lieu of Sec. 701.36 (c)(1) through (4), paragraph (b) of this
section applies.
(b) Investment in fixed assets. (1) A corporate credit union may,
invest in fixed assets where the aggregate of all such investments does
not exceed 15 percent of primary capital.
(2) A corporate credit union shall submit requests to exceed the
limitation of paragraph (b)(1) of this section to NCUA. Requests shall
be supplemented by such statements and reports as NCUA may require. If
NCUA determines that the proposal will not adversely affect the
corporate credit union, it will respond in writing and an aggregate
dollar amount or percentage of primary capital will be approved for
investment in fixed assets.
Sec. 704.12 Corporate Credit Union Reserves.
(a) Minimum Primary Capital Ratio. The primary capital ratio is
computed by dividing primary capital by average daily assets for the
month. Each corporate credit union shall maintain a minimum primary
capital ratio as follows:
(1) By January 1, 1996, primary capital shall be at least 2.5
percent of average daily assets. If this level of primary capital is
not achieved, the corporate must submit a request for a waiver of this
requirement to NCUA. The waiver request must provide an acceptable plan
for meeting the requirement. This waiver request must be submitted to
NCUA no later than 90 days prior to the effective date of this
requirement.
(2) By January 1, 1997, primary capital shall be at least 3.0
percent of average daily assets. If this level of primary capital is
not achieved, the corporate must submit a request for a waiver of this
requirement to NCUA. The waiver request must provide an acceptable plan
for meeting the requirement. This waiver request must be submitted to
NCUA no later than 90 days prior to the effective date of this
requirement.
(3) By January 1, 1998, primary capital must be at least 4.0
percent of average daily assets. Thereafter, each corporate credit
union will be required to maintain a minimum primary capital to average
daily assets ratio of 4.0 percent. Any corporate credit union that does
not meet this provision will be considered to be inadequately
capitalized and must submit to NCUA a plan of action to achieve this
capital level within an acceptable period of time. This plan must be
submitted to NCUA within 30 calendar days of the month-end in which
minimum primary capital fell below 4.0 percent.
(b) Capital to risk-weighted assets ratio. The capital to risk-
weighted assets ratio is computed by dividing capital by total risk-
weighted assets at month end. Each corporate credit unions shall
maintain capital of at least 10.0 percent of risk-weighted assets. Any
corporate credit union that does not meet this provision will be
considered to be inadequately capitalized and must submit to NCUA a
plan of action to achieve this capital level within an acceptable
period of time. This plan must be submitted to NCUA within 30 calendar
days of the month-end in which capital fell below 10.0 percent of risk-
weighted assets.
(c) Failure to comply with minimum capital requirements. NCUA will
review each plan of action to achieve stated levels of capital as put
forth in paragraphs (a) and (b) of this section. NCUA will make a
determination as to the viability of the plan of action, and analyze
the impact of the capital level on the corporate credit union and its
member credit unions. If it is determined that a plan of action is not
viable, the corporate credit union's board of directors will be
required to merge or accept other corrective action as set forth by
NCUA.
(d) Procedures. Balance sheet assets and credit equivalent amounts
for off- balance sheet items are assigned to a risk-weight category.
The total dollar amount in each category shall be multiplied by the
risk-weight assigned to that category. The sum of the categories
comprises risk-weighted assets.
(e) Frequency. Each corporate credit union shall calculate and
document the ratio of primary capital to average daily assets and
capital to risk-weighted assets each month. Documentation of such
calculations shall be maintained and provided upon request to the
auditor, supervisory committee, and NCUA.
(f) Risk weights for balance sheet assets. Each balance sheet asset
shall be assigned a risk weight of 0 percent, 20 percent, 50 percent,
and 100 percent as indicated in Appendix A of this part.
(g) Other considerations. (1) An investment in the shares of a
mutual fund is assigned to the risk category appropriate to the highest
risk-weighted asset that the fund is permitted to hold.
(2) Accruals will be assigned the risk-weighting of the underlying
asset that they represent.
(h) Credit conversion factors for off-balance sheet Items. Off-
balance sheet items will be risk-weighted each month using credit
conversion factors as indicated in Appendix B of this part.
(i) Interim reserve accumulation. Corporate credit unions will be
required to accumulate sufficient amounts of primary capital to meet
the requirements of paragraph (a) of this section. Each corporate
credit union must prepare a written projection, including assumptions
utilized, which shows compliance with the minimum primary capital
requirements each year through the accumulation of net income and
reserve transfers, the issuance of PCSAs, and/or the shrinkage of the
corporate credit union's assets. The written projection must be
provided upon request to the auditor, supervisory committee, and NCUA.
In addition, each corporate credit union must meet the reserve transfer
requirements outlined in paragraph (j) of this section.
(j) Required reserve transfers. The amount that a corporate credit
union is required to transfer or set aside in reserves is based on both
the corporate credit union's primary capital and capital to risk-
weighted assets ratios. For the purposes of calculating required
reserve transfers, PCSAs shall be excluded from primary capital. Ranges
of capital ratios have been established. These capital ratio ranges are
then associated with 1 of 5 corresponding categories in determining the
required reserve transfer. To qualify for a lower reserve transfer
category, the capital ratio must fall in both the primary capital and
capital to risk-weighted assets ratio ranges of the applicable
category. The corporate credit union shall set aside an amount equal to
the appropriate required reserve transfer percentage multiplied by the
corporate credit union's average daily assets for the transfer period
multiplied by the number of days in the transfer period divided by 365.
(1) Category 1 requires a corporate reserve transfer percentage of
20 basis points of average daily assets when either the primary capital
ratio is greater than 4.0 percent and less than 4.75 percent or the
capital to risk-weighted assets ratio is greater than 10.0 percent and
less than 11.0 percent.
(2) Category 2 requires a corporate reserve transfer percentage of
15 basis points of average daily assets when either the primary capital
ratio is greater than 4.75 percent and less than 5.25 percent or the
capital to risk-weighted assets ratio is greater than 11.0 percent and
less than 14.0 percent.
(3) Category 3 requires a corporate reserve transfer percentage of
10 basis points of average daily assets when either the primary capital
ratio is greater [[Page 20455]] than 5.25 percent and less than 5.75
percent or the capital to risk-weighted assets ratio is greater than
14.0 percent and less than 17.0 percent.
(4) Category 4 requires a corporate reserve transfer percentage of
5 basis points of average daily assets when either the primary capital
ratio is greater than 5.75 percent and less than 6.0 percent or the
capital to risk-weighted assets ratio percentage is greater than 17.0
percent and less than 20.0 percent.
(5) Category 5 requires a corporate reserve transfer percentage of
0 basis points when the primary capital ratio is greater than 6.0
percent and the capital to risk-weighted assets ratio percentage is
greater than 20.0 percent.
(k) Full and fair disclosure. Corporate credit unions must provide
reserves necessary for full and fair disclosure as specified in
Sec. 702.3 of this chapter.
Sec. 704.13 Representation.
(a) Board representation. The board shall be determined as
stipulated in the standard corporate federal credit union bylaws
governing election procedures, provided that:
(1) The chair of the board may not serve simultaneously as an
officer, director, or employee of a credit union trade association;
(2) A majority of directors may not serve simultaneously as
officers, directors, or employees of the same credit union trade
association or its affiliates (not including chapters or other subunits
of a state trade association); and -
(3) For purposes of meeting the requirements of paragraphs (a)(2)
and (a)(3) of this section, an individual may not serve as a director
or chair of the board if that individual holds a subordinate employment
relationship to another employee who serves as an officer, director, or
employee of a credit union trade association.
(b) Representatives of member credit unions. (1) A member credit
union may appoint one of its members or officials as a representative
to the corporate credit union. The representative shall be empowered to
attend membership meetings, to vote, and to stand for election on
behalf of the member. Only a member credit union representative is
eligible to vote and to stand for election. No individual may serve as
the representative of more than one member credit union in the same
corporate credit union.
(2) Any vacancy on the board of a corporate credit union caused by
a representative being unable to complete his or her term shall be
filled by the board of the corporate credit union according to its
bylaws governing the filling of board vacancies.
(c) Recusal provision. (1) No director, committee member, officer,
or employee of a corporate credit union shall in any manner, directly
or indirectly, participate in the deliberation upon or the
determination of any question affecting his or her pecuniary interest
or the pecuniary interest of any entity (other than the corporate
credit union) in which he or she is interested, except if the matter
involves general policy applicable to all members, such as setting
dividend or loan rates or fees for services.
(2) An individual is ``interested'' in an entity if he or she:
(i) Serves as a director, officer, or employee of the entity;
(ii) Has a business, ownership, or deposit relationship with the
entity; or
(iii) Has a business, financial, or familial relationship with an
individual whom he or she knows has a pecuniary interest in the entity.
(3) In the event of the disqualification of any directors, by
operation of paragraph (c)(1) of this section, the remaining qualified
directors present at the meeting, if constituting a quorum with the
disqualified directors, may exercise, by majority vote, all the powers
of the board with respect to the matter under consideration. Where all
of the directors are disqualified, the matter must be decided by the
members of the corporate credit union.
(4) In the event of the disqualification of any committee member by
operation of paragraph (c)(1) of this section, the remaining qualified
committee members, if constituting a quorum with the disqualified
committee members, may exercise, by majority vote, all the powers of
the committee with respect to the matter under consideration. Where all
of the committee members are disqualified, the matter shall be decided
by the board of directors.
(d) Administration. (1) A corporate credit union shall be under the
direction and control of its board of directors. While the board may
delegate the performance of administrative duties, the board is not
relieved of its responsibility for their performance. The board may
employ a chief executive officer who shall have such authority and such
powers as delegated by the board to conduct business from day to day.
Such chief executive officer must answer solely to the board of the
corporate credit union, and may not be an employee of a credit union
trade association.
(2) The provisions of Sec. 701.14 of this chapter apply to
corporate credit unions, except that where reference is made to
``Regional Director,'' substitute ``NCUA.''
Sec. 704.14 Audit requirements.
(a) Annual audit. (1) The corporate credit union supervisory
committee shall cause an annual opinion audit, which shall include a
reportable conditions letter (i.e. management letter) to be made by an
independent, duly licensed certified public account (CPA) and shall
submit the audit report to the board of directors. A summary of the
audit report shall be submitted to the membership at the next annual
meeting.
(2) The CPA's audit workpapers shall be provided upon request to
NCUA.
(3) A copy of the audit report and reportable conditions letter
(i.e. management letter) shall be submitted to NCUA, within 30 days
after receipt by the board of directors.
(b) Internal auditor function. (1) A corporate credit union with
net assets in excess of $100 million as of the preceding December 31,
or as ordered by NCUA, will be required to employ or contract the
services of an internal auditor.
(2) The internal auditor will report directly to the chairperson of
the corporate credit union's supervisory committee.
(3) The internal auditor's responsibilities will include, but are
not limited to, the review of ongoing compliance with statutory and
regulatory requirements, adherence to the corporate credit union's own
policies and procedures, testing of the accuracy and completeness of
recordkeeping and operation functions, ensuring adequate control
measures are in place, apprising the supervisory committee of all
findings, and providing appropriate recommendations to address concerns
and deficiencies relating to the condition or operations of the
corporate credit union.
(4) The internal auditor's reports, findings, and recommendations
will be in writing. Oral presentations by the internal auditor to the
supervisory committee will be documented in the supervisory committee
minutes. All documentation relating to the work of the internal auditor
will be provided upon request to the external auditor and NCUA.
Sec. 704.15 Contracts/written agreements.
Services, facilities, personnel, or equipment shared with any party
shall be supported by a written contract, with the duties and
responsibilities of each party specified and the allocation of service
fee/expenses fully supported and documented. [[Page 20456]]
Sec. 704.16 State-chartered corporate credit unions.
(a) This part does not expand the powers and authorities of any
state-chartered corporate credit union, beyond those powers and
authorities provided under the laws of the state in which it was
chartered. -
(b) A state-chartered corporate credit union that is not insured by
the National Credit Union Share Insurance Fund, but that receives funds
from federally insured credit unions, is considered an ``institution-
affiliated party'' within the meaning of Section 206(r) of the Federal
Credit Union Act, 12 U.S.C. 1786(r).
Sec. 704.17 Fidelity bond coverage.
(a) Scope. This section provides the fidelity bond requirements for
employees and officials in corporate credit unions.
(b) Review of coverage. The board of directors of each corporate
credit union shall, at least annually, carefully review the bond
coverage in force to determine its adequacy in relation to risk
exposure and to the minimum requirements in this section.
(c) Minimum coverage; Approved forms. Every corporate credit union
will maintain bond coverage with a company holding a certificate of
authority from the Secretary of the Treasury. All bond forms, and any
riders and endorsements which limit the coverage provided by approved
bond forms, must receive the prior written approval of the NCUA Board.
The Corporate Credit Union Discovery Bond (NCUA 100) and Standard Form
24 with Credit Union Bond Conversion Endorsement are approved for use
by corporate credit unions. Credit Union Blanket Bond Form 581 and Form
23--Extended Form, may also be utilized by corporate credit unions.
Fidelity bonds must provide coverage for the fraud and dishonesty of
all employees, directors, officers, and supervisory and credit
committee members. Notwithstanding the foregoing, all bonds must
include a provision, in a form approved by the NCUA Board, requiring
written notification by surety to the Board: When the bond of a credit
union is terminated in its entirety; or when bond coverage is
terminated, by issuance of a written notice, on an employees, director,
officer, supervisory or credit committee member. Said notification
shall be sent to the Secretary of the NCUA Board or designee and shall
include a brief statement of cause for termination.
(d) Minimum; coverage amounts. (1) The minimum amount of bond
coverage will be computed based on the corporate credit union's average
daily assets as of December 31 of the preceding year. The following
table lists the minimum requirements:
------------------------------------------------------------------------
Minimum
Net assets bond
(million)
------------------------------------------------------------------------
Less than $50 million--.................................... $1.0
$50--$99 million........................................... 2.0
$100--$499 million......................................... 4.0
$500--$999 million......................................... 6.0
$1.0--$1.999 billion....................................... 8.0
$2.0--$4.999 billion....................................... 10.0
$5.0--$9.999 billion....................................... 15.0
$10--$24.999 billion....................................... 20.0
$25.0 billion plus......................................... 25.0
------------------------------------------------------------------------
(2) It is the duty of the board of directors of each corporate
credit union to provide adequate protection to meet its unique
circumstances by obtaining, when necessary, bond coverage in excess of
the above minimums. -
(e) Reduced coverage; NCUA approval. Any proposal for reduced
coverage must be approved in writing by the NCUA Board at least 20 days
in advance of the proposed effective date of the reduction. -
(f) Deductibles. (1) The maximum amount of deductibles allowed are
based on the corporate credit union's primary capital ratio as defined
in Sec. 704.12(a). The following table sets out the maximum
deductibles:
------------------------------------------------------------------------
Primary capital ratio Maximum deductible
------------------------------------------------------------------------
Less than 4.0 percent.............. 7.5 percent of primary capital.
4.0--7.99 percent.................. 10.0 percent of primary capital.
8.0--11.99 percent................. 12.0 percent of primary capital.
Greater than 12.0 percent.......... 15.0 percent of primary capital. -
------------------------------------------------------------------------
(2) A deductible may be applied separately to one or more insuring
clauses in a blanket bond. Deductibles in excess of those showing in
this section must have the written approval of the NCUA Board at least
20 days prior to the effective date of the deductibles. -
(g) Additional coverage. The NCUA Board may require additional
coverage for any corporate credit union when, in the opinion of the
Board, current coverage is insufficient. The board of directors of the
corporate credit union must obtain additional coverage within 30 days
after the date of written notice from the NCUA Board.
Sec. 704.18 Effective date.
The regulations in this part are effective beginning January 1,
1996.
Appendix A to Part 704--Summary of Risk Weights and Risk Categories
for Corporate Credit Unions
Category 1: Zero Percent Risk Weight.
a. Coin and currency on hand or physically in transit.
b. Balances due from and claims on Federal Reserve Banks.
c. Claims on and portions of claims that are unconditionally
guaranteed by the U.S. Government or its agencies.
d. Claims collateralized by cash or eligible deposits.
e. CLF subscriptions, including U.S. Central CLF Participation
Certificates, and CLF Pass-Through Loans from the CLF through U.S.
Central to the corporate credit unions.
f. Asset Accounts related to Member Reverse Repurchase
Agreements without indemnity obligation.
g. Accrued Interest Receivable on the above.
Category 2: 20 Percent Risk Weight.
a. Items, other than coin and currency, in process of
collection.
b. Claims on or portions of claims guaranteed by U.S.
Government-sponsored corporations and enterprises.
c. Claims conditionally guaranteed by the U.S. Government or its
agencies or U.S. Government-sponsored corporations and enterprises.
d. Claims or portions of claims (including Repurchase
Agreements) collateralized by securities issued by the U.S.
Government or its agencies or U.S. Government-sponsored corporations
and enterprises.
e. General obligation claims on state and local governments
located in the United States.
-f. Claims on U.S. depository institutions (including Federal
Funds sold)
-g. Claims on a corporate credit union.
-h. Asset accounts related to Member Reverse Repurchase
Agreements with indemnity obligation.
-i. Asset-backed securities with remaining weighted average
lives of 3 years or less.
-j. Secured loans to credit unions.
-k. Accrued Interest Receivable on the above.
Category 3: 50 Percent Risk Weight.
-a. Asset-backed securities with remaining weighted average
lives greater than 3 years.
-b. Privately-issued mortgage-backed securities provided that:
(1) The security is structured so that it is treated as an indirect
holding of the underlying assets;\1\ (2) If the
[[Page 20457]] security is backed by a pool of conventional
mortgages, 1- to 4-family residential, or multifamily residential
properties, each underlying mortgage must have been made in
accordance with prudent underwriting standards, be performing in
accordance with its original terms, and not be 90 days or more past
due or carried in nonaccrual status; (3) If the security is backed
by privately-issued mortgage-backed securities, each underlying
security qualifies for the 50 percent risk category at the time the
pool is originated; and (4) if the security is backed by a pool of
multifamily residential mortgages, principal and interest payments
on the security are not 30 days or more past due.
\1\A private-issued mortgage-backed security may be treated as
an indirect holding of the underlying assets provided that: (1) The
underlying assets are held by an independent trustee and the trustee
has a first priority, perfected security interest in the underlying
assets on behalf of the holders of the security; (2) either the
holder of the security has an undivided pro rata ownership interest
in the underlying mortgage assets or the trust or single purpose
entity (or conduit) that issues the security has no liabilities
unrelated to the issued securities; (3) the security is structured
such that the cash flow from the underlying assets in all cases
fully meets the cash flow requirements of the security without undue
reliance on any reinvestment income; and (4) there is no material
reinvestment risk associated with any funds awaiting distribution to
the holders of the security. In addition, if the underlying assets
of a mortgage-backed security are composed of more than one type of
asset, for example, U.S. Government-sponsored agency securities and
privately-issued pass-through securities that qualify for the 50
percent risk category, the entire mortgage-backed security is
generally assigned to the category appropriate to the highest risk-
weighted asset underlying the issue. Thus, in this example, the
security would receive the 50 percent risk weight appropriate to the
privately-issued pass-through securities.
---------------------------------------------------------------------------
-c. Accrued Interest Receivable on the above.
-d. Claims on foreign banks (including Fed Funds sold).
Category 4: 100 Percent Risk Weight for All Other Assets
Including, but NOT LIMITED to:
-a. Loans to CUSOs outstanding as of January 1, 1996.
-b. Loans to and Investments in CSOs.
-c. Unsecured loans to credit unions.
-d. All fixed assets, including land, buildings, furniture,
fixtures, equipment, automobiles, and leasehold improvements.
-e. Permanent capital share account and secondary capital share
account investments in a corporate credit union.
-f. Any mortgage-backed securities that do not meet the criteria
for assignment to a lower risk weight (including any classes of
mortgage-backed securities that can absorb more than their pro rata
share of loss without the whole issue being in default).-
-g. Zero Coupon Securities.
-h. Claims on U.S. chartered corporations and bank holding
companies, including commercial paper and corporate bonds.
-i. Mutual Funds that do not qualify for a lower risk weighting.
-j. Prepaid Assets.
-k. Accounts Receivable and other receivables.
-l. NCUSIF Deposit
-m. Mortgage servicing rights.
-n. Intangible assets.
-o. All other claims on private obligors.
-p. Accrued Interest Receivable on the above.
Appendix B to Part 704--Off-Balance Sheet Credit Conversion Factors
Zero Percent Credit Conversion Factor:
-Unused portions of credit lines with original maturities of 6
months or less, or which are unconditionally cancelable.
50 Percent Credit Conversion Factor:
-a. Unused portions of credit lines with original maturities
exceeding 6 months.
-b. Commitments to participate in a loan or loan package.
100 Percent Credit Conversion Factor:
-a. Irrevocable standby letters of credit guaranteeing financial
performance (including VISA letters of credit issued by corporate
credit unions on behalf of their members, or standby letters of
credit backing Industrial Revenue Bonds).
-b. Forward Commitments to purchase an asset or perform under a
lease contract.
-c. Securities held in safekeeping loaned with indemnification.
Other off-balance sheet items will be addressed on a case-by-case
basis by NCUA.
Appendix C to Part 704--Model Forms
This appendix contains three sample forms intended for use by
corporate credit unions to aid in compliance with the permanent
capital share account and secondary capital share account disclosure
requirements of Sec. 704.2. Corporate credit unions that use these
forms will be in compliance with those requirements.
C-1 Sample disclosure for opening of secondary capital share
account.
Terms and Conditions of Secondary Capital Share Account
-(1) A secondary capital share account is not subject to share
insurance coverage by the NCUSIF or other deposit insurer.
-(2) A member credit union may withdraw shares from its
secondary capital share account only with two years' notice, except
where the member credit union is merging or liquidating. If a member
credit union merges, the corporate credit union will return the
member's secondary capital shares, less any penalty for early
withdrawal, within 30 days of written notification from NCUA.
-(3) Secondary capital share accounts cannot be used by member
credit unions to collateralize borrowings.
-(4) Secondary capital share accounts are available to absorb
losses in the event of a deficit in primary capital in the corporate
credit union.
-(5) Where the corporate credit union is liquidated, secondary
capital share accounts are payable only after satisfaction of all
liabilities of the liquidation estate including uninsured
obligations to shareholders and the NCUSIF.
I have read the above terms and conditions and I understand
them. I further agree to maintain in the credit union's files the
annual notice of terms and conditions of the secondary capital share
account.
Signatures of Directors and Date
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Name of member credit union:
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Address of member credit union:
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C-2 Sample annual notice of terms and conditions of secondary
capital share account.
Terms and Conditions of Secondary Capital Share Account
(1) A secondary capital share account is not subject to share
insurance coverage by the NCUSIF or other deposit insurer.
(2) A member credit union may withdraw shares from its secondary
capital share account only with two years' notice, except where the
member credit union is merging or liquidating. If a member credit
union merges, the corporate credit union will return the member's
secondary capital shares, less any penalty for early withdrawal,
within 30 days of written notification from NCUA.
-(3) Secondary capital shares cannot be used by member credit
unions to collateralize borrowings.
-(4) Secondary capital share accounts are available to absorb
losses in the event of a deficit in primary capital in the corporate
credit union.
-(5) Where the corporate credit union is liquidated, secondary
capital share accounts are payable only after satisfaction of all
liabilities of the liquidation estate including uninsured
obligations to shareholders and the NCUSIF. -----
Mailed to member - ----------------------------------------------------
Month/Year.
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Signature of the Chairman of the Board
C-3 Sample disclosure for opening of permanent capital share
account.
Terms and Conditions of Permanent Capital Share Account
-(1) A permanent capital share account is not subject to share
insurance coverage by the NCUSIF or other deposit insurer.
-(2) Permanent capital shares are not redeemable without the
written concurrence of NCUA.
-(3) Permanent capital share accounts cannot be used by member
credit unions to collateralize borrowings.
-(4) Permanent capital share accounts are available to absorb
losses in the event of a deficit in other primary capital accounts
in the corporate credit union.
-(5) Where the corporate credit union is liquidated, permanent
capital share accounts are payable only after satisfaction of all
liabilities of the liquidation estate including uninsured
obligations to shareholders and the NCUSIF.
-(6) Permanent capital share account dividends are
noncumulative.
I have read the above terms and conditions and I understand
them.
Signatures of Directors and Date
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Name of member credit union: --
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Address of member credit union: --
- ---- --------------------------------------------------------------
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PART 741--REQUIREMENTS FOR INSURANCE
-2. The authority citation for part 741 continues to read as
follows:
[[Page 20458]] Authority: 12 U.S.C. 1757, 1766, and 1781-1790.
Section 741.11 is also authorized by 31 U.S.C. 3717.
-3. Section 741.3 is amended by revising the heading and adding new
paragraph (c) to read as follows:
Sec. 741.3 Other requirements.
* * * * *
(c) Adhere to the requirements stated in Part 703 of this chapter
concerning transacting business with corporate credit unions.
[FR Doc. 95-10149 Filed 4-25-95; 8:45 am]
BILLING CODE 7535-01-P
