**7535-01-U**

**NATIONAL CREDIT UNION ADMINISTRATION**

# 

# 12 CFR Part 704 

### RIN 3133- AD58

### 

### Corporate Credit Unions 

**AGENCY:** National Credit Union Administration (NCUA).

**ACTION:** Advance notice of proposed rulemaking and request for
comment (ANPR).

**SUMMARY:** In the light of current economic circumstances affecting
the U.S. economy and, in particular, the financial sector, NCUA is
evaluating and reconsidering the role corporate credit unions currently
play in the credit union system, including corporates' membership
structure, size, and types of services they offer. NCUA is also
considering whether to amend its regulation governing corporate credit
unions to clarify or revise current provisions, including those related
to: capital; permissible investments; management of credit risk and
liquidity; and corporate governance. NCUA seeks comment on these issues
and any others commenters think NCUA should consider.

**DATES:** Comments must be received on or before \[INSERT DATE THAT IS
SIXTY DAYS FROM DATE OF PUBLICATION IN THE FEDERAL REGISTER\].

**ADDRESSES:** You may submit comments by any of the following methods
(**Please send comments by one method only**):

-   Federal eRulemaking Portal:
    [**http://www.regulations.gov**](http://www.regulations.gov/).
    Follow the instructions for submitting comments.

-   NCUA Web Site:
    [**http://www.ncua.gov/RegulationsOpinionsLaws/proposed_regs/proposed_regs.html**](http://www.ncua.gov/RegulationsOpinionsLaws/proposed_regs/proposed_regs.html).
    Follow the instructions for submitting comments.

-   E-mail: Address to **<regcomments@ncua.gov>.** Include "\[Your
    name\] --

> Comments on Advanced Notice of Proposed Rulemaking for Part 704" in
> the e-mail subject line.

-   Fax: (703) 518-6319. Use the subject line described above for
    e-mail.

-   Mail: Address to Mary Rupp, Secretary of the Board, National Credit
    Union Administration, 1775 Duke Street, Alexandria, Virginia
    22314-3428.

-   Hand Delivery/Courier: Same as mail address.

**Public inspection**: All public comments are available on the agency's
website at
[http://]{.underline}www.ncua.gov[/RegulationsOpinionsLaws/comments]{.underline}
as submitted, except as may not be possible for technical reasons.
Public comments will not be edited to remove any identifying or contact
information. Paper copies of comments may be inspected in NCUA's law
library at 1775 Duke Street, Alexandria, Virginia 22314, by appointment
weekdays between 9:00 a.m. and 3:00 p.m. To make an appointment, call
(703) 518-6540 or send an e-mail to
[OGC]{.underline}Mail@ncua.gov[.]{.underline}

**FOR FURTHER INFORMATION CONTACT:** Ross Kendall, Trial Attorney,
Office of General Counsel, at the above address or telephone: (703)
518-6540, or David Shetler, Senior Corporate Program Specialist, at the
above address or telephone (703) 518-6640.

**SUPPLEMENTARY INFORMATION:**

### A. Background. 

The Federal Credit Union Act (Act) authorizes natural person federal
credit unions (FCUs) to invest in shares or deposits of any central
credit union (corporate credit union). 12 U.S.C. 1757(7)(G). A corporate
credit union is an organization, chartered under the Act or under
applicable state law as a credit union that receives shares from and
provides loan and other services primarily to other credit unions. 12
CFR 704.2. Historically, corporate credit unions have fulfilled an
important role in the credit union industry and have provided credit
unions with payment and clearing services, including access to wire
transfer facilities and automated clearing house transactions. Corporate
credit unions have also provided investment services, enabling smaller
credit unions to achieve economies of scale and access to greater market
returns otherwise unavailable to them. Corporate credit unions have been
an important source of liquidity for credit unions through short and
medium term credit facilities, and have served as agents on behalf of
NCUA's Central Liquidity Facility (CLF) in connection with loans funded
by the CLF. Corporate credit unions have also provided other operational
services, such as coin and currency services and safekeeping of
investments.

There are currently twenty-eight corporate credit unions serving the
nation's approximately 7,900 credit unions. As with all credit unions,
corporate credit unions are organized as cooperatives, owned by their
members and responsive to their needs, enabling members to receive
access to necessary products and services at affordable rates. They
provide a level of expertise and market presence that would be
unavailable to most of their members if required to rely solely on their
own resources.

**B. Current Economic Climate and Remedial Measures Taken.**

Over the last year, many corporate credit unions have experienced a
dramatic reduction in the value of their investment portfolios. These
reductions, coupled with, in some cases, the virtual freeze-up of the
market for trading in certain types of investment securities, have
undermined the stability of the corporate credit union system.
Simultaneously with the issuance of this Advance Notice of Proposed
Rulemaking, which is designed to identify issues that may have
contributed to the current state of affairs and to solicit comment and
ideas on how to address them as the industry moves ahead, the NCUA Board
has taken several actions with a more immediate, remedial impact,
designed to stabilize the industry and maintain confidence in the
corporate system. These actions include the following:

-   An infusion of \$1 billion in capital into U.S. Central Federal
    Credit Union, the corporate system's wholesale credit union, by the
    National Credit Union Share Insurance Fund (NCUSIF); and

-   A temporary NCUSIF guarantee of all member shares, for any corporate
    credit union that decides to participate in a voluntary guarantee
    program offered by NCUA.

The Board believes these extraordinary measures, which are mandated by
the exigent economic conditions affecting the country, will help
stabilize the corporate credit union system and enable credit unions
return to their primary mandate, which is to provide affordable
financial services to their members. The Board believes that identifying
and addressing the issues discussed in this ANPR will help continue to
assure stability and confidence in the corporate credit union system in
the future.

**C. Issues for Consideration.**

Notwithstanding the successful role that corporates have played in the
credit union sector, events of recent months have highlighted several
areas in which re-evaluation is appropriate and necessary. As set out
more fully below, these include some fundamental aspects concerning the
structure, role and services offered by corporate credit unions to the
credit union industry.

1\. **The Role of Corporates in the Credit Union System.**

Recent events have highlighted structural vulnerabilities in the
corporate credit union system. NCUA is considering whether comprehensive
changes to the structure of the corporate system are warranted. Possible
approaches the agency is considering include eliminating the second or
wholesale tier from the corporate system, modifying the level of
required capital, isolating payment services from the risks associated
with other lines of business, determining which product and service
offerings are appropriate for corporates, requiring a restructure of
corporate boards, and tightening or eliminating the expanded investment
authority that is currently available to corporates.

*[Payment system.]{.underline}* Some of the questions and issues arising
in this context, on which the Board is seeking comment, include matters
such as whether payment system services should be isolated from other
services to separate the risks. If so, what is the best structure for
isolating these services from other business risks? Specific comment is
solicited concerning whether, for example, it would be better to
establish a charter for corporate credit unions whereby a corporate's
authority is strictly limited to operating a payment system, with no
authority to engage in other services, such as term or structured
investments. Additionally, a separate charter may be available for
corporate credit unions that want to engage in providing investment
services. Another alternative would be for NCUA to establish distinct
capital requirements for payment systems risk and the risks of other
corporate services. NCUA could also require that a legal and operational
firewall be established between payment system services and other
services. In connection with this topic, comment is also sought on the
question of whether there is sufficient earnings potential in offering
payment systems to support a limited business model that is restricted
to payment systems services only.

*[Liquidity and liquidity management.]{.underline}* Historically, the
primary role of corporate credit unions has been to provide and ensure
liquidity. Corporate investments were made with an eye towards ensuring
funds would be available to meet members' short-term liquidity needs.
Recent events underscore the need to assure a corporate properly
considers its investment position relative to its cash flow needs. The
Board recognizes and understands that providing liquidity for the credit
union system is one of the principal purposes of the corporate credit
union network. One question for consideration and comment is whether
liquidity ought to be considered a core service of the corporate system,
and if so, what steps should be taken, and by whom, to preserve and
strengthen corporates' ability to offer that service? For example,
should NCUA consider limiting a corporate's ability to offer other
specific types of products and services in order to preserve and defend
the liquidity function? What specific types of products and services
should corporates be authorized to provide?

NCUA is considering additional cash flow measuring requirements to
assist corporates in achieving and maintaining proper liquidity
management. In this respect, comment is specifically solicited on the
question of whether NCUA should add aggregate cash flow duration
limitations to Part 704. If so, commenters are invited to describe how
this requirement should be structured, and also to identify how such
limitations would benefit liquidity management. Finally, comment is
solicited on the question of what cash flow duration limits would be
appropriate for corporate credit unions, particularly in an evolving
interest rate market with previously unseen credit risk spreads.

*[Field of Membership Issues.]{.underline}* NCUA also seeks comment on
whether and how to restructure the corporate credit union system. For
example, despite its intention of fostering competition, NCUA's decision
to allow corporates to have national fields of membership (FOMs) may
have resulted in significant, and unforeseen, risk taking. For example,
corporates have competed with each other to offer higher rates, and have
done so through the accretion of credit and marketability risks. To
address this development, should the agency return to defined FOMs, for
example, state or regional FOMs?

*[Expanded Investment Authority.]{.underline}* At present, Part 704
provides for an option by which corporates meeting certain criteria can
qualify for expanded investment authority. For example, a corporate
meeting the criteria set out under Part One of the expanded authority is
allowed to purchase investments with relatively lower credit ratings
than otherwise permissible under the rule. NCUA seeks comment, first, as
to whether the need for expanded authorities continues to exist. If so,
should NCUA modify the procedures and qualifications, such as higher
capital standards, by which corporates currently qualify for expanded
authorities? If so, what should the new standards be? Should NCUA reduce
the expanded authorities available? If so, which ones? Alternatively,
should any of the limits in existing expanded authorities be reduced or
increased? If so, which ones? Once granted, should NCUA require periodic
requalification for expanded authorities? If so, what should be the
timeframe?

*[Structure; two-tiered system.]{.underline}* Over time, the corporate
system has evolved into two tiers: a retail network of corporates that
provide products and services to natural person credit unions, and a
single, wholesale corporate that exclusively services the retail
corporates. NCUA solicits comment about whether the two-tier corporate
system in its current form meets the needs of credit unions.
Specifically, NCUA seeks input from commenters about whether there is a
continuing need for a wholesale corporate credit union. If so, what
should be its primary role? Should there be a differentiation in powers
and authorities between retail and wholesale corporates? In considering
these issues, commenters are specifically asked to consider whether the
current configuration results in the inappropriate transfer of risk from
the retail corporates to the wholesale corporate. Commenters should also
address whether, assuming the two-tiered system is retained, capital
requirements and risk measurement criteria (e.g., NEV volatility), as
well as the range of permissible investments, for the wholesale
corporate credit union should be different from those requirements that
apply to a retail corporate credit union.

**2. Corporate Capital.**

NCUA is considering revising various definitions and standards for
determining appropriate capital requirements for corporate credit
unions. For example, the agency could establish a new required capital
ratio consisting only of core capital excluding membership capital
accounts as a component of regulatory capital; the agency could also
determine to increase the required capital ratio to more than four
percent. The agency could also establish a new ratio based on
risk-weighted asset classifications, which could include some form of
membership capital. These changes would bring the corporate capital
requirements more into line with standards applied by other federal
financial regulators, such as the Comptroller of the Currency and the
Federal Deposit Insurance Corporation (recognizing, however, that there
are other accounting differences that apply with respect to the
calculation of regulatory capital for banks). Another issue under
consideration is whether to require a certain level of contributed
capital from any natural person credit union seeking either membership
or services from a corporate.

*[Core capital.]{.underline}* The Board is considering several issues
relating to the agency's approach to core capital (i.e., the traditional
"tier one capital" definition as used by the several federal financial
institution regulators). Under the current rule, core capital is defined
as retained earnings plus paid-in capital. 12 CFR 704.2. Comment is
invited concerning whether NCUA should establish a new capital ratio
that corporates must meet consisting only of core capital, and if so,
what would be the appropriate level to require. Commenters should offer
their view concerning what actions are necessary to enable corporates to
attain a sufficient core capital ratio as described above, as well as
their thought about what would be an appropriate time frame for
corporates to attain sufficient capital. The Board invites comment also
on the question of what is the appropriate method to measure core
capital given the significant fluctuation in corporate assets that
occur. Commenters are invited to offer their view on the correct degree
of emphasis that ought to be placed on generating core capital through
undivided earnings. Finally, NCUA Is considering whether to require that
a corporate limit its services only to members maintaining contributed
core capital with the corporate. Commenters are invited to react to that
idea, and to offer any other suggestions or comments relative to the
issue of core capital for corporates.

*[Membership capital.]{.underline}* The Board is also considering
several issues involving membership capital. 12 CFR 704.3(b). Issues
under consideration and for which comment is sought include whether NCUA
should continue to allow membership capital in its current
configuration, or should the agency eliminate or modify certain
features, such as the adjustment feature, so that membership capital
meets the traditionally accepted definition of tier two capital. Other
questions include whether to tie adjusted balance requirements, as set
out currently in §704.3(b)(8), only to assets, as well as whether to
impose limits on the frequency of adjustments. The agency is considering
whether to require that any attempted reduction in membership capital
based on downward adjustment automatically result in the account being
placed on notice, within the meaning of current §704.3(b)(3), so that
only a delayed payout after the three-year notice expires is
permissible. Comment is also sought on whether to require that any
withdrawal of membership capital be conditioned on the corporate's
ability to meet all applicable capital requirements following
withdrawal. Comment is invited on all these issues and on any revisions
NCUA should consider for the definition and operation of membership
capital.

*[Risk-based capital and contributed capital requirements.]{.underline}*
Comment is solicited with respect to the following issues pertaining to
risk-based capital and contributed capital requirements. Should NCUA
consider risk-based capital for corporates consistent with that
currently required of other federally regulated financial institutions?
What regulatory and statutory changes, if any, would be required to
effectuate such a change? Should a natural person credit union be
required to maintain a contributed capital account with its corporate as
a prerequisite to obtaining services from the corporate? Should
contributed capital be calculated as a function of share balances
maintained with the corporate? What about using asset size?

**3. Permissible Investments.**

NCUA is considering whether the corporate investment authorities should
be constrained or restricted. Presently, corporates have the authority
to purchase and hold investments that would not be permissible for
natural person FCU members under Part 703 (or, in some cases, outside of
what is authorized for a state chartered credit union). This increases a
corporate member's exposure to these risks commensurate with their level
of investment in the corporate. Questions on which comment is solicited
in this context include whether NCUA should limit corporate credit union
investment authorities to those allowed for natural person credit
unions. NCUA is also considering whether to prohibit certain categories
of, or specific, investments, for example: collateralized debt
obligations (CDOs), net interest margin securities (NIMs), and subprime
and Alt-A asset-backed securities. Comment is solicited on that issue,
as well as on whether NCUA should modify existing permissibility or
prohibitions for investments.

**4. Credit Risk Management.**

The reliability of credit ratings for investments has become more
questionable in light of events in the financial industry and the
current absence of regulatory oversight for rating organizations.
Consequently, NCUA is considering curbing the extent to which a
corporate may rely on credit ratings provided by Nationally Recognized
Statistical Rating Organizations (NRSROs). Comment is requested on
whether NCUA should require more than one rating for an investment, or
require that the lowest rating meet the minimum rating requirements of
Part 704. NCUA also solicits comment on whether to require additional
stress modeling tools in the regulation to enhance credit risk
management.

Several specific aspects of this issue are under consideration, for
which comment is solicited, including whether Part 704 should be revised
to lessen the reliance on NRSRO ratings. Commenters are invited to
identify any other changes they believe may be prudent to help assure
adequate management of credit risk. In this respect, commenters should
consider whether Part 704 should be revised to provide specific
concentration limits, including sector and obligor limits. If so, what
specific limits would be appropriate for corporate credit unions?
Comments are also solicited on the question of whether corporates should
be required to obtain independent evaluations of credit risk in their
investment portfolios. If so, what would be appropriate standards for
these contractors? Another issue under consideration is whether
corporates should be required to test sensitivities to credit spread
widening, and if so, what standards should apply to that effort.

**5. Asset Liability Management.**

In a previous version of its corporate rule, NCUA required corporate
credit unions to perform net interest income modeling and stress
testing. Because one of the problems leading to the current market
dislocation is a widening of credit spreads, the agency is considering
re-instating this requirement. Alternatively, the agency may consider
some form of mandatory modeling and testing of credit spread increases.
Comment is solicited on whether NCUA should require corporates to use
monitoring tools to identify these types of trends, including
specifically comments about tangible benefits, if any, that would flow
from these types of modeling requirements.

**6. Corporate Governance.**

The sophistication and far-reaching impact of corporate activities
requires a governing board with appropriate knowledge and expertise.
NCUA is considering minimum standards for directors that would require a
director possess an appropriate level of experience and independence.
The agency is also considering term limits, allowing compensation for
corporate directors, and requiring greater transparency for executive
compensation. Comment is sought on all these issues.

In addition, commenters are invited to respond to the question of
whether or not the current structure of retail and wholesale corporate
credit union boards is appropriate given the corporate business model.
Should NCUA establish more stringent minimum qualifications and training
requirements for individuals serving as corporate credit union
directors? If so, what should the minimum qualifications be? NCUA is
also considering whether to establish a category of "outside director,"
i.e., persons who are not officers of that corporate, officers of member
natural person credit unions, and/or individuals from entirely outside
the credit union industry. Commenters should offer their view on whether
that approach is wise, and, if so whether NCUA should require that
corporates select some minimum number of outside directors for their
boards. Should a wholesale corporate credit union be required to have
some directors from natural person credit unions? Comment is sought on
whether NCUA should impose term limits on corporate directors, and, if
so, what the maximum term should be. Comment is also sought on whether
corporate directors should be compensated, and, if so, whether such
compensation should be limited to outside directors only. Another issue
under consideration, for which reaction from commenters is sought, is
whether NCUA should allow members of corporate credit unions greater
access to salary and benefit information for senior management.

**Request for Comments.**

The NCUA Board invites comment on any of the issues discussed above
including specifically if NCUA's regulations should be amended to
address the issues discussed in this ANPR. NCUA also welcomes comment on
any other relevant issues pertaining to corporate credit unions that
have not been addressed in this ANPR.

By the National Credit Union Administration Board on January 28, 2009.

Mary F. Rupp

Secretary of the Board