Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations 12929

NATIONAL CREDIT UNION

ADMINISTRATION

12 CFR Parts 704, 709, and 741

RIN 3133–AB67

Corporate Credit Unions; Involuntary

Liquidation of Federal Credit Unions

and Adjudication of Creditor Claims

Involving Federally Insured Credit

Unions in Liquidation; Requirements

for Insurance

AGENCY: National Credit Union

Administration (NCUA).

ACTION: Final rule.

SUMMARY: NCUA is issuing a final rule

governing corporate credit unions. The

rule strengthens capital requirements,

establishes parameters to ensure that the

risk on corporate credit union balance

sheets is adequately managed, provides

for corporate credit unions with more

developed systems and infrastructures

to take more planned and controlled

risk, and sets forth special rules for

wholesale corporate credit unions.

EFFECTIVE DATE: January 1, 1998.

ADDRESSES: National Credit Union

Administration, 1775 Duke Street,

Alexandria, Virginia 22314–3428.

FOR FURTHER INFORMATION CONTACT:

Robert F. Schafer, Director, Office of

Corporate Credit Unions, at the above

address or telephone (703) 518–6640; or

Edward Dupcak, Director, Office of

Investment Services, at the above

address or telephone (703) 518-6620.

SUPPLEMENTARY INFORMATION:

A. Background

In April 1995, NCUA issued a

proposed regulation to revise most of

Part 704. 60 FR 20438, Apr. 26, 1995. In

response to the comments received and

results of risk-profile assessments of

corporate credit unions using simulated

modeling techniques, NCUA

determined to issue a revised proposed

rule for another round of public

comment. 61 FR 28085, June 4, 1996.

The proposed rule provided for a 90-day

comment period, ending on September

3, 1996. On July 16, 1996, NCUA issued

a proposed rule addressing the special

circumstances of wholesale corporate

credit unions. 61 FR 38117, July 23,

1996. The comment period to this

proposal also ended on September 3,

1996. The comment period for both

proposals subsequently was extended to

October 18, 1996. 61 FR 41750, August

12, 1996. This final rule addresses both

proposals.

A total of 289 comments were

received on the proposals, 202 from

natural person credit unions, 36 from

corporate credit unions, 24 from state

banking trade associations; 10 from state

credit union leagues, 5 from state credit

union regulatory authorities, 4 from

national credit union trade associations,

4 from credit union organizations and

consultants, 3 from other entities that do

business with credit unions, and 1 from

another type of trade association. The

commenters complimented NCUA’s

efforts to strengthen the regulation and

stated that progress had been made from

the previous proposal but that changes

were still necessary.

A general comment was a request to

standardize the time frames for

corporate credit unions to take various

actions described throughout the

regulation. The proposed regulation

required corporate credit unions to take

action in some cases in business days

and in others in calendar days. There

also were five different numbers of days

for those actions. To make compliance

easier, all dates in the final regulation

have been changed to calendar days,

and the number of days for compliance

has been reduced to either 10 days,

when only notification is required, or 30

days, when more substantive action is

required.

A common thread in many of the

comments was the comparison of

corporate credit unions with natural

person credit unions, banks, savings and

loans, and other financial institutions.

Another was the suggestion that NCUA

take the same approach with corporate

credit unions as its sister federal

financial institution regulatory agencies

take with their respective institutions.

While these comparisons are

understandable, NCUA cautions that in

many cases, they are not appropriate.

Corporate credit unions differ from

natural person credit unions, banks,

savings institutions, and other financial

institutions that serve consumers. They

serve exclusively one class of customer:

credit unions. Corporate credit union

balance sheets, cash flows, and liquidity

demands differ significantly from those

of other financial institutions. In

general, the volume of large dollar

transactions present unique risks not

seen in consumer-oriented institutions.

As a result, while considering

comparisons with other institutions and

sister agencies, NCUA has been careful

to put those comparisons into proper

perspective and to regulate to the areas

of risk.

A number of commenters strongly

suggested that NCUA review the

corporate regulation on an annual basis.

While NCUA believes that a periodic

review is necessary, it believes that

circumstances and need should

determine the frequency. NCUA has

identified a number of issues, some of

which are identified in this

supplementary information section, that

warrant further study relatively soon

after the regulation is implemented.

Accordingly, the Office of Corporate

Credit Unions will present a report of

these and other issues within 18 months

of publication of the final rule.

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

proposed rule added language to the

Scope section stating 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. Although a few commenters

questioned the need for such a contract,

the language has been retained in the

final rule. Since the majority of natural

person credit unions are federally

insured, NCUA has a strong interest in

ensuring that corporate credit unions

which accept their funds remain safe

and sound institutions.

Proposed Section 704.1(b), which set

forth NCUA’s authority to waive a

requirement of Part 704, is retained in

this final rule. NCUA may use this

authority to respond to innovation at

corporate credit unions and in the

marketplace. NCUA envisions the

approval of pilot programs involving

new investments or activities. Such

programs would be approved on a

limited basis so that NCUA could assess

their impact on corporate credit unions.

Language has been added to clarify

that a state chartered corporate credit

union’s request for expanded authority

must be approved by the state

supervisory authority before being

submitted to NCUA.

Section 704.2—Definitions

The proposed rule added a number of

new definitions, revised others, and

deleted some. A few commenters took

exception to specific proposed

definitions. Their comments and

NCUA’s responses are discussed below.

In response to a comment, the

definitions of the following terms have

been changed from the language that

was proposed. The definition of

‘‘adjusted trading’’ has been amended to

include transactions not ‘‘used to defer
12930 Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations

a loss.’’ The definition of collateralized

mortgage obligation has been changed

so that the collateral may consist simply

of ‘‘mortgages,’’ rather than ‘‘whole loan

mortgages.’’ The word ‘‘may’’ has been

added to the definition of

‘‘commitment’’ so that the list of items

included in the term is not absolute.

Although the definition of ‘‘expected

maturity’’ was proposed to be deleted, it

has been retained. A commenter noted

that the term is used in the definitions

of ‘‘long-term investment’’ and ‘‘shortterm investment.’’ The definition of

‘‘federal funds’’ has been broadened to

include transactions with domestic

branches of foreign banks, various

government-sponsored enterprises, and

other non depository entities. The

definition of ‘‘securities lending’’ has

been expanded to more precisely

describe the activity. The definition of

‘‘wholesale corporate credit union’’ has

been changed in light of the addition of

Section 701.19 to the regulation.

The proposed definition that elicited

the most comments was that for ‘‘market

value of portfolio equity (MVPE).’’ The

proposed definition treated membership

capital as a liability, rather than as part

of MVPE. A number of commenters

urged that it be included in MVPE.

Before addressing that issue, it must be

noted that NCUA has determined to

replace the term MVPE in the rule with

that of net economic value (NEV). The

calculation itself has not been altered,

merely renamed. The adoption of the

term ‘‘net economic value’’ in place of

‘‘market value of portfolio equity’’ is

preferred because of the potential

confusion that results from the integral

terms ‘‘market’’ and ‘‘portfolio.’’ The

calculation of estimated fair value, for

both assets and liabilities, is not only

obtained from market sources. The term

‘‘portfolio’’ is more typically used to

describe investment or loan assets in

contrast to an entire balance sheet.

While MVPE is a commonly used term

in the profession of asset and liability

management, many practitioners and

other financial regulators have recently

opted for new terminology. NEV better

connotes the concept of intrinsic or fair

value of the whole balance sheet than

does MVPE.

The suggestion that ‘‘capital is

capital,’’ whatever its form, is the basis

for the argument that corporate credit

unions should be permitted to include

secondary capital in the base for all risktaking activities. The calculation of NEV

serves as the base for credit and interest

rate risk limits as well as other activity

restrictions, and many commenters

suggested that corporate credit unions

should have as much risk-taking

potential as possible. NCUA disagrees

that membership capital should be

included in the definition of NEV.

The function of membership capital is

to serve as a secondary resource for the

absorption of risk when reserves and

undivided earnings have been

exhausted. The holder of membership

capital has the option to sell the shares

back to the corporate credit union three

years after notification of intent to

withdraw. This option makes the

membership capital considerably less

permanent than ‘‘core’’ capital, since it

is not controlled by the corporate credit

union and is potentially short-lived.

NCUA regards this form of capital to be

distinctly different and less reliable than

internally generated capital or paid-in

capital with far longer or no maturity.

Permitting corporates to place this form

of secondary capital directly at risk

substantially, and inappropriately,

increases the risk of a crisis in

membership confidence when losses do

occur.

NCUA views the balance between

core capital and risk-taking as essential

if the corporate credit union network is

to maintain and enhance its ability to

withstand financial crises, whether

limited to one institution or systemic in

nature. This final rule is designed to

strengthen core capital so that the

corporate credit union network can

better withstand financial stress without

placing an inappropriate reliance upon

its membership resources. Corporate

credit unions should gradually reduce

their reliance on secondary capital as

core capital accumulates over time.

To bolster the accumulation of core

capital, the proposed rule authorized

the issuance of paid-in capital, defined

as funds obtained from credit union and

non credit union sources, having no

maturity, and being callable only at the

option of the corporate credit union and

only if the corporate credit union meets

its minimum level of required capital

after the funds are called. Paid-in capital

is included in the definition of NEV,

thus giving corporate credit unions the

option of raising permanent capital from

their membership. Only a few

commenters addressed paid-in capital.

To make clear that paid-in capital is

subordinate to membership capital, the

definition has been modified and

expanded in this final rule. The

requirement that the funds have no

maturity has been deleted.

The final rule distinguishes between

‘‘member paid-in capital’’ and ‘‘non

member paid-in capital.’’ The former is

held by the corporate credit union’s

members, has a minimum 20-year

maturity, and may not be a condition of

membership, services, or prices.

Member paid-in capital may be retired

prior to the stated maturity only when

the corporate credit union elects to

‘‘call’’ the shares. Non member paid-in

capital is sold to the outside

marketplace and must be approved by

NCUA. Most of the features of non

member paid-in capital remain

unspecified in the regulation so that

issuance can be tailored to reflect

prevailing market demands. The

marketplace is the most efficient

distribution mechanism for capital, as

the market immediately determines the

value and liquidity of an issue based on

an issuer’s performance and the

perceived risk of the issue.

NCUA believes that paid-in capital

should not be issued unless the

corporate credit union can convince the

market or its members that it will use

the new capital to create new value. The

members, like the marketplace, need to

risk-adjust the expected return on paidin capital and expect a fair return. A

capital offering that serves to increase

risk without increasing value is in no

one’s interest.

The proposed separate definitions for

‘‘reserves’’ and ‘‘undivided earnings’’

have been unified in the final rule as

‘‘reserves and undivided earnings.’’ The

following proposed definitions have

been deleted because the term is no

longer used in the regulation or is so

self-evident as not to require a

definition: ‘‘business day,’’

‘‘commitment,’’ ‘‘forward rate

agreement,’’ ‘‘futures contract,’’ ‘‘gains

trading,’’ ‘‘material,’’ ‘‘maturity date,’’

‘‘mortgage-backed security,’’ ‘‘option

contract,’’ ‘‘primary dealer,’’ ‘‘private

placement,’’ ‘‘reverse repurchase

transaction,’’ ‘‘secured loan,’’ ‘‘swap

agreement,’’ tri-party contract,’’ ‘‘United

States Government or its agencies,’’ and

‘‘United States Government sponsored

corporations and enterprises.’’

A few definitions that were not

proposed have been added to the final

rule, generally to accommodate the

granting of certain additional

investment authorities. Corporate credit

unions may engage in the forward

settlement of transactions beyond

regular way settlement, under certain

conditions, and definitions of ‘‘forward

settlement’’ and ‘‘regular way

settlement’’ have been provided.

Corporate credit unions with additional

authorities have been authorized to

engage in dollar roll transactions and

when-issued trading, and definitions of

those activities have been provided.

Section 704.3—Corporate Credit Union

Capital

The proposal required that a corporate

credit union without expanded

authorities have a capital, or leverage,
Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations 12931

ratio of 4 percent. Most of the

comments, with the notable exception

of those submitted by banking

associations, were supportive of the

minimum leverage ratio of 4 percent. It

is important to discuss the

dissimilarities between corporate credit

unions and banks to understand why

the level of required capital should be

different. Banks primarily use capital to

support exposures to credit risk in the

form of commercial and consumer

loans. Corporate credit unions primarily

use capital to support exposures to

liquidity and interest rate risk

associated with investment in money

market instruments and fixed income

securities.

Corporate credit unions presently

provide a contingent liquidity resource

for members at the same time they offer

correspondent financial services. An

overwhelming portion of a corporate

credit union’s business consists of

providing banker’s bank services and

issuing shares and share certificates as

investment alternatives for members’

excess funds. Corporate credit unions

are not, in practice, primary-lending

institutions.

Capital adequacy is the central tenet

of the proposed regulation. The type

and amount of risk assumed were fully

considered when capital ratios and

corresponding risk limitations were

developed. Since corporate credit union

assets are predominantly high-grade

investment securities, not loans, the

regulation did not adopt a base leverage

ratio target in excess of 4 percent.

Additionally, the rule has a number of

triggers to measure the adequacy of

capital in a corporate credit union.

These triggers are related to market risk

exposures as measured by NEV. Risk

measures are required on a regular basis,

not only for the contemporary market

environment, but for stressed conditions

as well. Similar to the other federal

financial institution regulators, NCUA is

requiring the development of risk

management infrastructures which

better measure and control risk.

The scope of these new requirements

will vary by institution but will be

commensurate with the amount of risk

assumed and the degree of depth and

sophistication employed to control

these risks. This approach will facilitate

a more appropriate control of risk and

thereby establish a better early warning

detection system when capital adequacy

begins to deteriorate. Thus, the 4

percent minimum capital ratio is

appropriate based upon the type of

assets held and the rigorous riskassessment requirements of the rule.

Using risk-weighted assets to produce

a risk-based capital calculation has been

debated throughout the Part 704

revision process. Proponents have

argued that the calculation captures a

meaningful measure of credit risk

exposure which helps members and the

public ascertain credit-risk trends in

corporate credit union balance sheets.

Corporate credit unions have high riskweighted capital-to-asset ratios relative

to other financial institutions, making

the ratio a favorable measure for

comparative purposes.

Opponents have argued that the riskbased capital calculation is too arbitrary

in assigning credit risk weights and that

the absence of consideration for interest

rate risk makes the numbers misleading.

The most recent proposal for changes to

the interagency risk-based capital

standards adjusts some credit risk

weights and adds a new calculation for

interest rate risk by adding weights for

the duration of each asset. The

calculation appears to be complex and

potentially unwieldy while providing

limited regulatory value where

corporate credit unions are concerned.

NCUA advocates meaningful

measures for credit and interest rate risk

exposure expressed in relation to

capital. Concentration limits, for

example, have been converted from a

function of net assets to one of core

capital. While the risk-weighted asset

approach is not utilized, conservative

credit risk limitations are explicitly

defined in the regulation and additional

credit risk measurement and reporting

requirements have been developed in

the new credit risk management section,

Section 704.6.

NCUA does not discourage corporate

credit unions that desire to calculate the

risk-weighted capital-to-assets ratio

from doing so but would suggest that

they adopt the same standard used by

other financial institutions and

understand that the calculation is not a

regulatory requirement.

The proposed regulation provided

authority for NCUA to impose a higher

or lower minimum capital requirement

on a case-by-case basis, with prior

notice to the corporate credit union.

Some commenters supported this

authority, while others expressed

concern that the regulation did not

specify all of the circumstances in

which it could be exercised. They

suggested that it could be abused by

NCUA.

The proposed rule illustrated four

situations which might cause NCUA to

require reserve levels other than those

specified in the regulation. The first two

were examples of circumstances that

could require a higher level, while the

last two were examples that could

warrant a lower one. While NCUA

would like to be able to clearly define

every situation in which such actions

could be taken, changes in market

conditions and the corporate credit

union environment make that

impossible. Leaving the regulation open

provides NCUA more flexibility in

addressing unusual or non recurring

events, including those which may

result in a reduction in reserve levels.

It should be noted that NCUA already

has the authority, under Section 116(b)

of the Federal Credit Union Act, to

adjust reserve requirements for federal

corporate credit unions. This regulation

will ensure that such authority is

available for state-chartered corporate

credit unions, in the rare event that it is

needed.

To address concerns about NCUA

abuse, the rule was amended so that

NCUA may take action when significant

risk exposure exists only when it is

unsupported by adequate capital or risk

management processes.

The proposed regulation also

provided authority for NCUA to issue a

capital directive when a corporate credit

union fell below its minimum capital

requirement and failed to submit or

follow an adequate capital restoration

plan. The directive could order a

corporate credit union to achieve

adequate capitalization by taking one or

more of a number of actions, such as

reducing dividends and limiting

deposits. Some commenters objected to

this authority, arguing that it would give

NCUA management control over a

corporate credit union. NCUA disputes

that directing a corporate credit union to

take certain specific actions to return to

a safe and sound level of capital

constitutes taking ‘‘control’’ of the

institution. In addition, the authority in

question is one held by the other federal

financial institution regulators and, as

with the authority to impose an

individual minimum capital

requirement, would be exercised only

rarely. Accordingly, it has been retained

in the final rule.

A number of commenters expressed

concern that the NCUA Board would

delegate its capital directive authority to

NCUA staff. Several comments

specifically objected to delegating this

authority to examiners. Some

commenters requested that the NCUA

Board specifically state in the rule that

this and other authorities could never be

delegated to staff.

These comments reflect a lack of

understanding of Board practice

regarding administrative actions. While

the Board has delegated some

administrative actions to regional and

office directors, none of the authorities
12932 Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations

can be redelegated to other staff

members, including examiners.

Additionally, none of the actions

delegated are final.

Delegated actions have been limited

to preliminary actions, such as notices

of charges and temporary cease and

desist orders, which must go to the

Board for final action.

The Board does not intend to delegate

its authority to take administrative

actions to examiners and never intended

that any action proposed in Part 704 be

delegated to examiners. However, this

Board is unwilling to put into the

regulation a restriction that would limit

a future Board from taking an action it

believed to be necessary.

Proposed Section 704.3 provided that

when taking action in the case of a statechartered corporate credit union, NCUA

provide notice to the state supervisory

authority. NCUA agrees with comments

that notice should be provided when

any action is contemplated, not just one

relating to capital. To simplify the

regulation, a general provision for

consultation has been added to Section

704.17, governing state-chartered

corporate credit unions, and individual

provisions to that effect have been

deleted. It should be noted that,

contrary to the suggestion of one

commenter, consultation does not mean

that the state authority must give its

approval before NCUA may act. In order

to protect the share insurance fund,

NCUA must have the authority to take

action whenever safety and soundness

demands it.

Section 704.4—Board Responsibilities

Proposed Section 704.4 required the

board of directors of a corporate credit

union to approve comprehensive

written plans and policies and to

oversee senior management to ensure

these plans and policies are carried out.

To emphasize the board’s ultimate

responsibility for the actions it

delegates, the proposed rule stated,

‘‘The board of directors must know and

understand the activities, policies, and

procedures of the corporate credit

union.’’ While this was not intended to

turn directors into operating managers,

a large number of commenters

expressed concern about this

requirement. To mitigate this concern,

this sentence has been deleted from the

final rule. NCUA is confident that board

members will provided appropriate

oversight if they recognize and meet

their common law fiduciary

responsibilities.

Some commenters objected to the

proposed rule’s requirement that a

corporate credit union have in place, for

all line support and audit areas, back-up

personnel with adequate cross-training.

To lessen the burden, the final rule

allows for back-up resources rather than

personnel, which means that corporate

credit unions could temporarily support

their operations with staff from other

corporate credit unions or consulting

firms.

Two commenters noted that the

proposed requirement that a corporate

credit union follow generally accepted

accounting principles (GAAP) conflicts

with the classification of credit union

shares as equity. Since there may be

other departures from GAAP in the

future, the final rule requires that

corporate credit unions follow GAAP,

except where law or regulation has

provided for a departure from GAAP.

Currently, the shares classification is

the only departure.

Finally, a number of commenters

questioned the proposed rule’s

requirement that a corporate credit

union retain external consultants to

review the adequacy of resources

supporting major risk areas. To address

these concerns, the final rule requires

the retention of such consultants only as

appropriate.

Section 704.5—Investments

The proposed rule inadvertently

failed to require that a corporate credit

union establish an investment policy.

This requirement has been added to the

final rule. The policy must be consistent

with the corporate credit union’s other

risk management policies and must

address, at a minimum, appropriate

criteria for evaluating standard

investments and risk analysis

requirements for any new investment

type or transaction considered for a

corporate credit union’s portfolio and/or

sale to a member.

Certain commenters asked for

clarification of the ‘‘risk analysis

requirements.’’

This provision addresses the

evolutionary nature of instruments in

the financial marketplace. It is expected

that new money market and fixed

income securities will be created. Some

of these securities may be legally

permissible but may be distinctly

different from the universe of

instruments previously available. It is

not possible to anticipate what

additional analytical parameters, if any,

must be employed before a product

comes to market. Therefore, NCUA

believes that policies must clearly

indicate that the potential risks of new

products, not unlike new services, must

be carefully evaluated.

Many corporate credit unions

engineer new certificate offerings that

are structured to mirror specific

investment assets. Such structured

certificates effectively transfer the risk

of the asset through to the holder of the

certificate (the member).

Corporate credit unions need to

ensure that the risk characteristics that

are inherent, and perhaps unique, in a

new investment type be sufficiently

identified and rigorously analyzed

before being purchased for its portfolio

or marketed and sold to its members.

A corporate credit union should not

dictate what a member buys, but it

should understand a new product’s

implications and be able to explain

them to a member.

The proposed rule authorized

investments in corporate credit unions

and corporate credit union service

organizations (CUSOs). One commenter

asked that investments in wholesale

corporate credit unions and CUSOs be

specifically authorized. This is not

necessary, as wholesale corporate credit

unions are a subset of corporate credit

unions and are included when the latter

term is used.

The proposed rule established an

NCUA-modified High Risk Security Test

(HRST) for REMIC/CMO securities. The

commenters on the test generally

expressed two views. The first was to

urge adoption of the standard Federal

Financial Institutions Examination

Council (FFIEC) parameters for the

HRST so that the test would be

consistent with those used by other

depository institutions. The second was

to drop the use of the HRST altogether

based upon the assertion that proper

NEV calculations would capture the risk

of the underlying cash-flows and their

corresponding price sensitivities

anyway. These comments were about

evenly divided. One commenter

suggested that the proposed NCUAmodified tests be retained while another

expressed that HRST tests should only

be required if a corporate’s NEV ratio

fell below 1 percent.

NCUA is persuaded that the

requirement to produce net interest

income and NEV measures, set forth in

Section 704.8, should be sufficient to

evaluate the individual risk

characteristics of all financial

instruments, including CMOs/REMICs.

Because all instruments will have to be

individually modeled for plus and

minus 300 basis point shifts, the HRST

is effectively part of the risk

measurement process already.

When appropriately modeling CMO/

REMIC cash-flows in conjunction with

the calculation of net interest income

and NEV sensitivity, the HRST is

redundant. The test is useful indication,

however, of potential price volatility

and liquidity risk. Bonds which pass the
Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations 12933

FFIEC test are regarded to have a

substantially greater universe of

potential buyers. Given the liquidity

priority of corporate credit unions, it

makes sense to subject bonds to a

periodic analysis of factors which will

drive the market’s bias towards such

securities. By utilizing the test

employed by other depository

institutions, corporate credit unions

gain useful insight into the contingent

liquidity potential of individual CMO/

REMIC securities.

Several commenters urged that the

requirement to run a monthly HRST be

changed to quarterly. NCUA agrees that

if the net interest income and NEV tests

are appropriately prepared in

accordance with the rule, the HRST

requirement is less significant and that

quarterly testing will be adequate.

Some commenters suggested that the

rule allow for the use of fewer

prepayment models where the proposal

called for at least three models. The

reason that the rule required three or

more models was to avoid the risk of

‘‘cherry picking’’ one favorable

prepayment model to cause a CMO/

REMIC to pass whenever possible. With

the advent of simulation modeling

requirements for net interest income

and NEV, NCUA accepts that a more

sophisticated corporate credit union

will have the capacity to appropriately

analyze the risk of a CMO/REMIC

security with fewer than three

prepayment models. Thus, the

requirement that the board approve at

least three prepayment models for

CMOs/REMICs was removed from the

Part I and Part II authorities but retained

at the base level.

The proposed rule established

identical standards for repurchase and

securities lending transactions. One

commenter noted that these are

distinguishable economic and legal

transactions and urged that they be

separated in the regulation. NCUA

agrees and effected that separation. The

proposed rule required that collateral

securities be legal for corporate credit

unions, except that CMO/REMIC

securities that passed the FFIEC HRST

were permissible provided that the term

of the transaction did not exceed 95

days. A number of commenters asked

that the 95-day limit be dropped. The

whole exception is unnecessary, now,

with the substitution of the FFIEC HRST

for the NCUA-modified test.

The proposed rule authorized

investment in a registered investment

company, provided that the portfolio of

such investment company was

restricted by its investment policy,

changeable only if authorized by

shareholder vote, solely to investments

that were permissible for the corporate

credit union making the investment. In

response to comments, the shareholder

vote restriction has been deleted.

As proposed, the final rule provided

a grandfather clause, allowing corporate

credit unions to continue to hold

investments that were permissible when

purchased but have become

impermissible because of regulatory

changes. One commenter stated that this

was inconsistent with proposed Section

704.10, governing divestiture. That

section requires divestiture of or a

written plan to keep an investment that

fails a requirement of Part 704. It should

be understood that the grandfather

provision supersedes the divestiture

provision.

Section 704.6—Credit Risk Management

Most corporate and natural person

credit unions recommended only minor

revisions to the credit risk management

section. Some, however, objected to the

requirement of any credit due diligence,

given that minimum credit ratings were

limited to the top of the investmentgrade range. Credit ratings obtained

from nationally recognized statistical

rating organizations are a significant

tool for investors to evaluate credit risk

associated with a specific security,

issuer, guarantor, or provider of credit.

They are no substitute for due diligence,

however, and should be regarded as

only one part of the credit risk

management process.

Significant exposures to credit risk

require extensive and continuous credit

analysis by professionally trained staff.

Managing a large credit exposure

requires considerable personnel and

financial resources, which many

corporate credit unions do not possess.

Expanded authority provisions allow for

a broader spectrum of credit risk, and

increased credit due diligence by

corporate credit unions that obtain such

authorities is key. Conversely, the

amount of credit analysis conducted by

institutions that operate at the base level

and maintain very limited exposure to

credit risk is not expected to be

significant.

Credit risk exposure can be limited by

restriction of counterparty, dollar

amount, and/or maturity. Those

corporate credit unions that remain at

the base level and do not assume

significant exposures should be able to

achieve an adequate degree of credit risk

management by employing a

combination of these techniques. If a

corporate credit union expands its

tolerance for credit risk, it must increase

its due diligence accordingly. That may

mean hiring adequately trained staff

and/or increasing the frequency and

depth of review.

Several commenters suggested that

specific concentration limits on

repurchase agreements be removed from

the regulation and left up to a corporate

credit union’s board of directors. The

regulation allows corporate credit

unions with expanded authorities to

develop their own credit limits for these

transactions based upon the additional

depth and scope of their credit risk

management. The base level was

designed to accommodate institutions

with restricted capacity to handle credit

risk. The concentration limits are

commensurate with the very limited

due diligence expected to support low

credit risk strategies.

One commenter requested that NCUA

clearly state that it supported corporate

credit unions using outside providers

for investment and credit due diligence.

The implication is that a CUSO or other

third party provider could become the

primary arbiter of the appropriateness

and selection of investment assets. The

desire of corporate credit unions to

create cost-effective approaches to risk

management is understandable, but

outsourcing risk-management

evaluations diminishes the control,

independence, and accountability of

risk making decisions.

While discretionary judgments can be

outsourced, the board and

management’s accountability for

investment decisions cannot be

delegated, and the issue of credit risk

becomes particularly complicated. For

example, how would a CUSO, serving

multiple institutions, determine how to

equitably alert all clients to a declining

credit which requires disposition? The

sale of distressed financial instruments

often accelerates market value declines

(not inappropriately) leaving other

investors with unsold positions at an

increasing disadvantage. In other words,

which client gets out first? In the event

of material credit-related losses, who

bears responsibility for the justification

of the exposure and what recourse

would affected clients have with a

CUSO?

Aside from accountability issues,

NCUA fears that a CUSO serving

numerous corporate credit unions with

credit risk research would significantly

increase the potential for a crisis in the

credit union system. The incidence of

systemic crises is not uncommon for

U.S. depository institutions.

Occurrences are infrequent but typically

severe, such as investments in Penn

Square, where numerous corporate

credit unions were simultaneously

affected to a significant degree.
12934 Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations

Another commenter urged that NCUA

remove the specific reporting and

documentation requirements. NCUA

developed this language to convey the

minimum expectations for this

important element of credit risk

management. While modifications were

made to this section to make it slightly

more generalized, the need for some

specificity was too critical to dismiss

altogether.

Several commenters sought

clarification on the credit risk

management policy provision

addressing concentrations of credit risk.

The examples of concentration

characteristics included in the

regulation are ‘‘industry type, sector

type, and geographic.’’ Commenters

were concerned that NCUA would

expect that all credit instruments be

evaluated on the basis of a set list of

concentration characteristics regardless

of whether all of the characteristics

applied to an individual instrument.

Examples were provided to indicate

that there are a number of relevant

concentration risks that can arise in the

process of managing credit risk. Not all

concentration types apply to all credit

instruments. For example, a corporate

credit union may need to consider

whether a particular industry is

disproportionately represented in its

overall portfolio. To capture aggregate

exposure, a corporate will need to

summarize such concentration by

reviewing across all transaction types.

Section 704.7—Lending

The proposed rule established limits

on secured and unsecured loans to one

member. A secured loan was defined to

mean one in which the corporate credit

union had perfected a security interest

in the collateral. In response to

comments, the requirement that the

security interest be perfected has been

deleted from the final rule. Further,

exclusions have been added for loans

secured by shares and marketable

securities and for member reverse

repurchase transactions.

The proposed rule required that a

loan to a non credit union member be

made in conformance with the member

business loan rule. In response to

comments, an exception has been

provided for loans fully guaranteed by

a credit union or credit unions. A few

commenters suggested that corporate

credit unions be permitted to participate

with natural person credit unions in

making loans to natural person

members. In the past, NCUA was

concerned that such activity could

jeopardize a corporate credit union’s

banker’s bank exemption from the

Federal Reserve Board’s Regulation D

reserve requirements.

While NCUA believes that this area

should be researched thoroughly, for

several reasons, it will take no action

now. First, the research necessary to

analyze the potential impact of such

loans would unnecessarily delay this

final rule. In light of the few credit

unions indicating interest, NCUA

believes it more beneficial to finalize the

rule and take the issue up at a later date.

Second, if corporate credit unions were

to participate in such loans, additional

reserves would be necessary to cover the

risk of default by natural persons. The

public should have an opportunity to

comment on such reserves before

corporate credit unions are required to

comply with them.

The NCUA Board has asked the Office

of Corporate Credit Unions to study the

issue and be prepared to make a

recommendation when it provides its

interim report to the Board 18 months

after publication of this final rule.

Section 704.8—Asset and Liability

Management

The proposed rule required a written

asset and liability management (ALM)

policy which addressed, among other

things, the modeling of indexes that

serve as references in financial

instrument coupon formulas. Several

commenters raised questions about this

requirement. Many adjustable rate

securities are available in the

marketplace which have interest rate

formulas linked to a number of

reference rates, foreign currencies, and/

or commodities. Corporate credit unions

tend to buy variable rate securities

which are linked to U.S. money market

rates such as U.S. LIBOR or Fed Funds.

Still others have purchased securities

linked to constant maturity Treasuries

(CMT), the Prime rate, or the 11th

District Cost of Funds (COFI). It is

important for an institution to evaluate

the basis risk in such instruments to

ensure that it has adequately measured

the interest rate risk associated with the

respective repricing behavior (vis-a ́-vis

its cost of funds). The weaker the

correlation between an index and the

cost of funds, the greater the need to

estimate the future behavior of the

index.

The proposed rule required a

corporate credit union to evaluate the

risk in its balance sheet by measuring

the impact of interest rate changes on its

NEV and NEV ratio. A corporate credit

union was required to limit its risk

exposure to levels that did not result in

an NEV ratio below 1 percent or a

decline in NEV of more than 18 percent.

The limit for corporate credit unions

with Part I expanded authorities was 35

percent and for those with Part II

authorities was 50 percent. Frequency of

testing was a function of the NEV ratio.

If NEV was 2 percent or above, testing

had to be done quarterly. If it fell below

2 percent, monthly testing was required.

The proposed rule also required

corporate credit unions with significant

holdings of instruments with embedded

options to perform additional testing

beyond the 300 basis point parallel shift

of the yield curve. The base test may not

be sufficient to evaluate the potential

risk to the balance sheet, particularly for

those portfolios comprised of complex

securities. Changes in the shape of the

yield curve, shifts in the credit and

liquidity risk premium reflected in

spread changes, factors affecting

prepayment speeds, and changes in

volatility, will all have an impact. While

the rule did not establish the testing

frequency or the parameters to be used

to evaluate the impact of these factors,

it did require that the tests reflect these

components of risk.

NCUA sought specific data from

corporate credit unions to support the

claim that a floor other than 1 percent

was appropriate. It sought similar

analytical support for challenges to the

18, 35, and 50 percent variation limits.

Most corporate credit union

commenters pointed out that the

minimum NEV ratio poses a major

restriction on balance sheet growth even

if such growth adds no incremental risk

to the balance sheet. Commenters

overwhelmingly supported keeping the

minimum ratio at 1 percent of the fair

value of assets, and some suggested

removal of a minimum NEV ratio

altogether. The vast majority of

comments submitted were without

supporting data. It is intuitive, however,

that substantial growth in corporate

credit union assets would exacerbate the

risk of penetrating a floor of 2 percent

or higher, since average core capital

levels are presently between 2 percent

and 3 percent of assets.

The use of a minimum NEV ratio is

intended to establish a floor for primary

capital which prevents a corporate

credit union’s core leverage ratio from

falling dangerously low. It provides an

estimate of the internal capacity of an

institution to handle its risk exposures

in the future and thus alerts the

corporate credit union and NCUA to

potential capital shortfalls.

Corporate credit unions have not

historically had a growth inhibitor in

the form of minimum capital ratios, and

thus, the NEV ratio introduces a new

element for management to control.

While the NEV ratio does not indicate

the nature or degree of risk that is
Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations 12935

inherent in a balance sheet, it does

indicate the degree of leverage. Capital

is the reserve of funds available to

manage all the risks of the institution,

including those which are not part of

the risks associated with changes in

interest rates.

Measuring risk is an imprecise

business because of the multitude of

assumptions that are required to

evaluate potential outcomes. NCUA

believes that an NEV ratio below 1

percent would be imprudent because

little room would remain for errors in

measurement or for the potential

confluence of business risks. An NEV

ratio of 1 percent will provide a

reasonable early-warning detection

mechanism for capital inadequacy. The

present levels of capital would not

permit a substantially higher floor at

this time without a risk of forced

shrinkage in corporate credit union

balance sheets.

Consistent with the base level

thresholds established in the credit risk

management section, an 18 percent NEV

volatility limit is adopted to set a

conservative market risk limit for

corporate credit unions that do not

possess the financial, system, or

personnel resources to support a

significant market-risk earnings strategy.

The 18 percent limit allows corporate

credit unions at the base authority level

to entertain a modest mismatch between

liabilities and assets (overnight and/or

term) and capital investments inside of

seven years.

NEV is an imperfect measure in the

sense that it portrays the risk inherent

in the balance sheet as one number. It

is a present value of the asset cash-flows

less a present value of the liability cashflows plus/minus the time value of any

embedded options. NEV does not

indicate when the risk will occur but it

does indicate the aggregate amount of

potential risk. Used in conjunction with

income simulation (a short-term view of

risk), NEV provides a good method for

simultaneously managing the earnings

and net worth of an institution.

It is expected that corporate credit

unions will have some degree of

mismatch in the normal course of

business because member demands for

amount and maturity on the liability

side of the balance sheet do not

perfectly correlate to available market

instruments on the asset side. The NEV

calculations will capture the aggregate

market risk and permit corporate credit

unions, no matter how their respective

mismatches are structured, to convey

risk in a relatively simple and consistent

manner.

An NEV volatility limit of 18 percent

was criticized by many commenters as

being too low and ‘‘essentially a

matched book.’’ Any NEV variance can

be achieved with a total matched book

in place since the duration of the asset

purchased with capital (not matched)

will determine the net risk. If capital is

invested in short duration instruments,

the NEV volatility will be

correspondingly low. If capital is

invested in long duration instruments,

the volatility will be higher. There is no

precise level of NEV that equates to a

‘‘matched book.’’ The 18 percent NEV

limit is the same as a net risk position

with a price sensitivity equal to that of

seven year zero-coupon Treasury bond.

This is not an insignificant amount of

market risk. It is a corporate credit

union’s choice whether it takes that risk

in an overnight account or whether it

spreads it out among various books of

business (overnight, term, capital, etc.).

Some institutions may choose to run

matched books and take all the risk with

their capital. Regardless, the maximum

decline will be limited to 18 percent of

base case NEV.

One aspect of using NEV which must

be noted is the effect of negative

convexity. Two corporate credit unions

may have an equivalent net risk

exposure at a given point in time, but

the respective exposures will change

very differently with subsequent

changes in market factors, depending on

the composition of assets. One may

choose to take the bulk of its mismatch

in the overnight account using

optionless money market instruments

and invest its capital in a mediummaturity debenture. The other may

incur a mismatch by buying low

duration floating rate securities which

possess a considerable amount of option

and basis risk.

In the first example, the sensitivity of

NEV is fairly constant and the risk

profile may be altered relatively quickly

with the passage of time (by letting short

maturities roll into overnight). In the

latter example, the option and basis risk

may not emerge until the interest rate

environment has changed. Because

securities with call, prepayment, and

cap options can extend dramatically, it

is possible for such a portfolio to go

from a sensitivity of 18 percent to an

exposure many times that amount in a

short time as the institution calibrates

its rate shocks to a new plus and minus

3 percent range.

Several corporate commenters

suggested that an interim operating level

be considered for moderate capacity

corporates, consisting of an NEV

volatility limit of 25 percent, with no

additional investment or credit

authorities. They argued that the cost of

building a risk management

infrastructure was essentially a barrier

to entry for expanded authorities, and

they viewed the higher NEV limit as a

mechanism for funding the incremental

costs of getting there. To compensate for

the incrementally greater risk, the

commenters suggested that qualifying

corporate credit unions conduct the rate

shock tests monthly, as opposed to

quarterly, and that they also conduct the

additional tests, beyond the 300 basis

point parallel shift of the yield curve,

regardless of their holdings of

instruments with embedded options.

NCUA agrees that select corporate

credit unions are capable of operating

between the base and Part I limits, and

has created a ‘‘base-plus’’ level. With

NCUA approval, an institution can

operate with an NEV volatility of 25

percent provided that it performs

additional tests and has additional

management and infrastructure. NCUA

will assess the institution to verify that

the incremental qualifications are

resident. For example, more than one

senior manager will be expected to have

strong knowledge of investments and

ALM. In addition to risk measurement,

the ability for the institution to

withstand the departure of a key staff

member and the ability to achieve

adequate separation between risk takers

and risk monitors will be important.

Corporate credit unions qualifying for

a 25 percent NEV variance will be

expected to conduct risk modeling with

greater vigilance than those operating

with an 18 percent variance, and such

institutions must establish

commensurate policies, procedures, and

internal controls. NCUA will expect

corporate credit unions that qualify for

a 25 percent NEV limit to demonstrate

a greater ability and inclination to

aggressively respond to adverse market

developments than base authority

institutions. Operating with an NEV

volatility of 25 percent may increase

current earnings, but it also raises the

probability of experiencing future

losses.

For corporate credit unions that want

to run bigger mismatches, the Part I

expanded authorities doubles the

amount of permitted market risk from

the base, allowing an NEV decline of 35

percent. This degree of mismatch has

the aggregate risk sensitivity of a 15 year

zero-coupon Treasury bond. Part II

expanded authorities allows an NEV

decline of 50 percent, equating to an

aggregate risk sensitivity of a 24 year

zero-coupon bond. The following table

shows the risk sensitivities of zerocoupon bonds of various durations.
12936 Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations

PRICE SENSITIVITY OF ZERO-COUPON

TREASURY BONDS

[Prices as of 01/08/97]

Investment

(years)

Price

sensitivity

+2% shock

(percent)

Price

sensitivity

+3% shock

(percent)

7 .............. ¥13 ¥18

10 .............. ¥18 ¥25

15 .............. ¥26 ¥36

24 .............. ¥38 ¥51

Source: Bloomberg; S <Govt>, TRA(O).

NCUA has allowed sophisticated and

well-developed corporate credit unions

to take much greater market risk than

that permitted for institutions with base

authorities. If a corporate credit union

wishes to make market timing a

substantial portion of its earnings

strategy, the expanded authority levels

provide ample room for managing

sizable mismatches between assets and

liabilities. But, at the base level, the rule

must have prudent limitations on

market risk that reflect the more limited

capacity of many smaller and/or more

conservative institutions which cannot

afford or do not desire to commit the

financial and personnel resources to

build the appropriate risk-taking

infrastructure that is required to support

higher NEV volatility.

The base level is intended to establish

a conservative territory where even the

smallest and most thinly developed

corporate credit union can continue to

provide standard products and services

without being subject to imprudent risks

or burdened with excessive

infrastructure costs. In order for the

regulation to encompass the full

spectrum of corporate credit unions, it

must provide both a minimum safety

and soundness barrier as well as a

mechanism for expanding opportunities

(commensurate with an increasing

capacity to manage risk). The rule is

structured to create distinctive operating

classifications in response to the widely

diverse corporate credit union network.

A number of commenters noted that

NCUA was adopting specific limits on

interest rate risk where other federal

financial institution regulators have

elected to handle it through supervision.

NCUA acknowledges this difference but

disagrees with the notion that its

approach is inconsistent or

inappropriate.

Corporate credit unions comprise a

relatively small private financial

network which serves a finite universe

of members. The credit union system

cannot afford the failure of a corporate

credit union, whereas the failure of an

individual bank or thrift is less

consequential to the survival of all other

banks and thrifts. Because of these

differences, NCUA believes that explicit

measures of risk tolerances are

appropriate.

In addition, many corporate credit

unions are making a transition from a

traditional strategy where little interest

rate risk was taken (achieved through

maturity and rate-reset matching of

assets and liabilities) to a strategy which

assumes a variety of intentional market

risk mismatches, including maturity,

option, and basis risk. Explicit risk

measures are essential in such an

environment.

One corporate credit union

commenter, joined by a number of its

member credit unions, claimed that the

rule encourages corporate credit unions

to take credit risk as opposed to interest

rate risk. This sentiment is troubling.

The proposed rule is intended to

promote and reinforce the discipline of

comprehensive risk management,

regardless of the risk type assumed.

If a corporate credit union intends to

entertain significant exposures to

market, credit, and/or liquidity risk in

order to generate its spread income, the

obligation to professionally control

those risks is substantial. The expanded

authority concept is predicated on the

idea that professional risk taking must

be supported by a state-of-the-art risk

management infrastructure.

Section 704.9—Liquidity Management

Relatively few comments were

received on this section of the proposed

rule. However, in response to those

comments, the rule has been amended

so that a corporate credit union need

only monitor its liquidity sources

regularly, rather than continuously, and

need not necessarily test its external

lines to ensure that contingent sources

of liquidity remain available. However,

a corporate credit union must be able to

demonstrate, whether through testing,

written confirmation, or other means,

that such sources remain available.

Section 704.10—Divestiture

Few comments were received on this

section of the proposed rule, and except

for changes to time frames to

standardize them with others in the

regulation and the addition of the

supervisory committee to the list of

entities which must receive a failed

investment report, no changes have

been made in the final rule.

Section 704.11—Corporate Credit Union

Service Organizations (Corporate

CUSOs)

The proposed rule defined a corporate

CUSO as an entity that: (1) Has received

a loan from and/or is at least partly

owned by a corporate credit union; (2)

primarily serves credit unions; (3)

restricts its services to those related to

the daily activities of credit unions; and

(4) is chartered as a corporation under

state law. A number of commenters

pointed out that defining an entity that

has received a loan from a corporate

credit union as a corporate CUSO would

severely restrict the ability of corporate

credit unions to lend to natural person

CUSOs. This was not intended, and that

portion of the definition has been

deleted.

Some commenters expressed concern

that the restriction of services to those

related to the daily activities of credit

unions might unduly limit the activities

of corporate CUSOs, since a legitimate

activity might not occur every day. It

was not the intent of the proposed rule

to require that an activity occur every

day; however, to allay concerns, the

final rule requires that services be

related to the normal course of business

of credit unions.

In response to comments, the rule has

been amended to permit corporate

CUSOs to be structured as limited

liability companies or limited

partnerships, as well as corporations.

NCUA agrees that these forms are

appropriate for corporate CUSOs. Also

in response to comments, the conflict of

interest provision has been amended to

permit a corporate credit union to share

employees with a corporate CUSO.

NCUA was persuaded that there is a

legitimate business purpose for such an

arrangement. However, such

arrangements will be scrutinized to

ensure there is no insider self-dealing.

Further, the rule still prohibits corporate

credit union directors and committee

members from receiving compensation

from a corporate CUSO.

Section 704.12—Services

Few comments were received on this

section, and it is unchanged in the final

rule. This section was intended to

protect the integrity of federal corporate

credit union fields of membership.

However, should NCUA authorize

national fields of membership for

federal corporate credit unions, there

may be a determination to eliminate this

section at a future date.

Section 704.13—Fixed Assets

As proposed, the final rule permits a

corporate credit union to invest in fixed

assets where the aggregate of all such

investments does not exceed 15 percent

of the corporate credit union’s capital.

In response to one comment, NCUA

wishes to clarify that the 15 percent

refers to book value. As proposed, the

final rule provides for a corporate credit
Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations 12937

union to request a waiver of the

limitation from NCUA. The proposed

rule eliminated the current provision

that allows a corporate credit union to

proceed with its investment if it does

not receive notification of the action

taken on its request within 45 days.

Three commenters objected to NCUA

not having a deadline to respond, and

the 45 day timeframe has been

reinstated.

Section 704.14—Representation

The first proposal to revise Part 704,

issued in 1995, amended the

representation section to provide that

only representatives of member credit

unions were permitted to vote and stand

for election. This involved changes to a

number of paragraphs. When the

proposed revision to Part 704 was

reissued in 1996, NCUA determined not

to go forward with the member-only

proposal and intended to reverse all of

the changes that had been made in that

regard. Inadvertently, some of the

changes were left in place. The final

rule corrects this error.

Section 704.15—Audit Requirements

In response to the few comments

received on this section, the language

has been clarified and made more

consistent with auditing terminology.

Section 704.16—Contracts/Written

Agreements

No changes were made to this

provision.

Section 704.17—State-Chartered

Corporate Credit Unions

As noted earlier, a paragraph has been

added which provides that NCUA will

consult with the state supervisory

authority before taking administrative

action against a state-chartered

corporate credit union.

Section 704.18—Fidelity Bond Coverage

In response to comments, the

calculation of minimum bond has been

clarified and a $5 million cap has been

added to each category in the maximum

deductible table.

Section 704.19—Wholesale Corporate

Credit Unions

The commenters generally supported

this section, and it has been retained as

proposed.

Appendix A—Model Forms

Some changes have been made to

Sample Form 2 in the final rule to

accommodate the changes to the

definition of paid-in capital.

Appendix B—Expanded Authorities and

Requirements

The proposed rule introduced a multitier approach to the regulation of

corporate credit unions. Proposed

Appendix B set forth incrementally

greater authorities for corporate credit

unions and the infrastructure and

capital requirements that were required

to be in place to obtain such authorities.

The commenters supported the multitier approach, and it has been retained

in the final rule. Based on the comments

received, several additional authorities

have been added to Parts I and II. So

that NCUA can effectively supervise the

transition to this final rule, each

corporate credit union is asked to

inform NCUA, by April 15, 1997, of its

initial decision regarding the level at

which it wishes to operate.

One commenter thought that all

investments should be grandfathered in

a case where a corporate has its

expanded authorities revoked. This

observation raises an important issue.

The final rule will shift the major focus

of risk evaluation from individual

financial instruments towards an

aggregate or ‘‘balance sheet’’ risk

assessment. While individual securities

and transactions might be grandfathered

from automatic divestiture, the

revocation of expanded authorities

would likely be precipitated by

concerns about the overall risk profile of

that institution. While individual

transactions will not necessarily be

singled out, a corporate credit union

must be prepared to employ asset

disposition to reduce excessive risk

when exposures warrant.

For example, a substantial weakness

in internal controls and/or major capital

inadequacy would necessitate a

reduction in risk. If expanded

authorities are regarded to be adding

risk to an already unacceptable

exposure, then NCUA would have to

consider a revocation of the authorities.

This could prompt NCUA to mandate a

risk reduction strategy that requires the

institution to adopt asset disposition in

order to achieve an appropriate and

timely risk reduction. Once revocation

occurs, any additional expandedauthority activities will cease and

NCUA will evaluate, based on the

unique circumstances, what corrective

actions are necessary. Thus, while the

rule does not predetermine the sale of

specific expanded-authority

transactions, forbearance from

divestiture will not be assured.

Proposed Appendix C set forth

guidelines for evaluating requests for

expanded authorities. In response to the

comments received, these guidelines

have been removed from the regulation

and put into a handbook format.

Consequently, Appendix C has been

deleted. The guidelines will be provided

to all corporate credit unions.

Part 709—Involuntary Liquidation and

Creditor Claims

No comments were received on this

section, and it has been retained in the

final rule.

Part 741—Requirements for Insurance

No comments were received on this

section, and it has been retained in the

final rule.

C. Regulatory Procedures

Regulatory Flexibility Act

NCUA 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 reporting requirements in Part

704 have been submitted to and

approved by the Office of Management

and Budget under OMB control number

3133–0129. Under the Paperwork

Reduction Act of 1995, no persons are

required to respond to a collection of

information unless it displays a valid

OMB control number. The control

number will be displayed in the table at

12 CFR Part 795.

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 policymaking 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 final rule will 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. NCUA 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. NCUA, pursuant to

Executive Order 12612, has determined
12938 Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations

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, Surety

bonds.

12 CFR Part 709

Claims, Credit unions, Liquidation.

12 CFR Part 741

Bank deposit insurance, Credit

unions, Reporting and recordkeeping

requirements.

By the National Credit Union

Administration Board on March 7, 1997.

Becky Baker,

Secretary of the Board.

For the reasons set out in the

preamble, NCUA amends 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 Corporate credit union capital.

704.4 Board responsibilities.

704.5 Investments.

704.6 Credit risk management.

704.7 Lending.

704.8 Asset and liability management.

704.9 Liquidity management.

704.10 Divestiture.

704.11 Corporate Credit Union Service

Organizations (Corporate CUSOs).

704.12 Services.

704.13 Fixed assets.

704.14 Representation.

704.15 Audit requirements.

704.16 Contracts/written agreements.

704.17 State-chartered corporate credit

unions.

704.18 Fidelity bond coverage.

704.19 Wholesale corporate credit unions.

Appendix A to Part 704—Model Forms

Appendix B to Part 704—Expanded

Authorities and Requirements

Authority: 12 U.S.C. 1762, 1766(a), 1781,

and 1789.

§ 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 chapter

VII) 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 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 and for

expansions of authority under

Appendix B of this part must be

approved by the state regulator before

being submitted to NCUA.

§ 704.2 Definitions.

Adjusted trading means any method

or transaction 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 security means a

security that is primarily serviced by the

cashflows of a discrete pool of

receivables or other financial assets,

either fixed or revolving, that by their

terms convert into cash within a finite

time period plus any rights or other

assets designed to assure the servicing

or timely distribution of proceeds to the

securityholders. This definition

excludes those securities referred to in

the financial markets as mortgagebacked securities (MBS), which

includes collateralized mortgage

obligations (CMOs) and real estate

mortgage investment conduits

(REMICs).

Capital means the sum of a corporate

credit union’s reserves and undivided

earnings, paid-in capital, and

membership capital.

Capital ratio means the corporate

credit union’s capital divided by its

moving daily average net assets.

Collateralized mortgage obligation

(CMO) means a multi-class bond issue

collateralized by mortgages or mortgagebacked securities.

Commercial mortgage related security

means a mortgage related security where

the mortgages are secured by real estate

upon which is located a commercial

structure.

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.

Correspondent services means

services provided by one financial

institution to another, and includes

check clearing, credit and investment

services, and any other banking

services.

Credit enhancement means collateral,

third-party guarantees, and other

features that are designed to provide

structural support and protection

against losses to investors in a particular

security.

Daily average net assets means the

average of net assets calculated for each

day during the period.

Dealer bid indication means a dealer’s

approximation of the bid price of a

security.

Dollar roll means the purchase or sale

of a mortgage backed security to a

counterparty with an agreement to resell

or repurchase a substantially identical

security at a future date and at a

specified price.

Embedded option means a

characteristic of certain assets and

liabilities which gives the issuer of the

instrument the ability to change the

features such as final maturity, rate,

principal amount and average life.

Options include, but are not limited to,

calls, caps, and prepayment options.

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.

Fair value of a financial instrument

means the amount at which an

instrument could be exchanged in a

current arms-length transaction between

willing parties, other than in a forced

liquidation sale. Market prices, if

available, are the best evidence of the

fair value of financial instruments. If

market prices are not available, the best

estimate of fair value may be based on

the quoted market price of a financial
Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations 12939

instrument with similar characteristics

or on valuation techniques (for example,

the present value of estimated future

cash flows using a discount rate

commensurate with the risks involved,

option pricing models, or matrix pricing

models).

Federal funds transaction means a

short-term or open-ended unsecured

transfer of immediately available funds

by one depository institution to another

depository institution or entity.

Foreign bank means an institution

which is organized under the laws of a

country other than the United States, is

engaged in the business of banking, and

is recognized as a bank by the banking

supervisory authority of the country in

which it is organized.

Forward settlement of a transaction

means settlement on a date other than

the trade date.

Immediate family member means a

spouse or other family member living in

the same household.

Industry recognized information

provider means an organization which

obtains compensation by providing

information to investors and receives no

compensation for the purchase or sale of

investments.

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.

Matched means, with respect to assets

and liabilities, that the factors which

affect cash flows of an asset are

replicated in a corresponding liability.

Member paid-in capital means paid-in

capital that: Is held by the corporate

credit union’s members; and has an

initial maturity of at least 20 years. A

corporate credit union may not

condition membership, services, or

prices for services on a credit union’s

ownership of paid-in capital. When a

paid-in capital instrument has a

remaining maturity of 5 years, the

amount of the instrument that may be

considered paid-in capital for the

purposes of this part is reduced by a

constant monthly amortization which

ensures the recognition of paid-in

capital is fully amortized when the

instrument has a remaining maturity of

3 years. The terms and conditions of any

member paid-in capital instrument must

be disclosed to the recorded owner of

such instrument at the time the

instrument is created and at least

annually thereafter.

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.

Membership capital means funds

contributed by members which are

available to cover losses that exceed

reserves and undivided earnings and

paid-in capital. In the event of

liquidation of the corporate credit

union, membership capital is payable

only after satisfaction of all liabilities of

the liquidation estate, including

uninsured share obligations to

shareholders and the National Credit

Union Share Insurance Fund (NCUSIF),

but excluding paid-in capital. The funds

have a minimum withdrawal notice of

three years, are not insured by the

NCUSIF or other share or deposit

insurers, and cannot be used to pledge

against borrowings. A member may sell

its membership capital to a credit union

in the corporate credit union’s field of

membership, subject to the corporate

credit union’s approval. The funds may

be in the form of a term certificate, or

may be in the form of an adjusted

balance account. An adjusted balance

account may be adjusted in relation to

a measure (e.g., one percent of a member

credit union’s assets) established and

disclosed by the corporate credit union

at the time the account is opened

without regard to any minimum

withdrawal notice period. Upon written

notice of intent to withdraw

membership capital, the balance of the

account will be frozen (no annual

adjustment) until the conclusion of the

notice period. The terms and conditions

of a membership capital account must

be disclosed to the recorded owner of

such account at the time the account is

opened and at least annually thereafter.

Upon notification of intent to withdraw,

the amount of the account on notice that

can be considered membership capital

is reduced by a constant monthly

amortization which ensures the

recognition of membership capital is

fully amortized at the end of the notice

period. The full balance of a

membership capital account that has

been placed on notice, not just the

remaining non amortized portion, is

available to absorb losses in excess of

the sum of reserves and undivided

earnings and paid-in capital until the

funds are released by the corporate

credit union at the conclusion of the

notice period.

Mortgage related security means a

security as defined in Section 3(a)(41) of

the Securities Exchange Act of 1934 (15

U.S.C. 78c(a)(41)), i.e., a privatelyissued security backed by mortgages

secured by real estate upon which is

located a dwelling, mixed residential

and commercial structure, residential

manufactured home, or commercial

structure.

Mortgage servicing means performing

tasks to protect a mortgage investment,

including collecting the installment

accounts, monitoring and dealing with

delinquencies, and overseeing

foreclosures and payoffs.

Moving daily average net assets

means the average of daily average net

assets for the month being measured

and the previous 11 months.

NCUA means NCUA Board (Board),

unless the particular action has been

delegated by the Board.

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. For its own

account, a corporate credit union’s

payables under reverse repurchase

agreements and receivables under

repurchase agreements may be netted

out if the Generally Accepted

Accounting Principles (GAAP)

conditions for offsetting are met.

Net economic value (NEV) means the

fair value of assets minus the fair value

of liabilities. All fair value calculations

must include the value of forward

settlements and embedded options and

of off balance sheet financial

derivatives, such as futures, options,

interest rate swaps, and forward rate

agreements. Membership capital is

treated as a liability for purposes of this

calculation. The NEV ratio is calculated

by dividing NEV by the fair value of

assets.

Net interest income means the

difference between income earned on

interest bearing assets and interest paid

on interest bearing liabilities.

Non member paid-in capital means

paid-in capital that is approved by

NCUA, upon application by the

corporate credit union. In determining

whether or not to approve any paid-in

capital instrument, NCUA will consider

such features as maturity, capital

amortization schedule, participation,

voting, acceleration, redemption, or

other rights of the holder, if any. NCUA

will also consider the strategic purpose

and financial impact of the proposed

paid-in capital issuance and the

corporate credit union’s financial

condition and management capabilities.
12940 Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations

Non secured obligation means an

obligation backed solely by the

creditworthiness of the obligor.

Official means any director or

committee member.

Paid-in capital means accounts or

other interests of a corporate credit

union that: Are available to cover losses

that exceed reserves and undivided

earnings; are not insured by the NCUSIF

or other share or deposit insurers; and

are callable only at the option of the

corporate credit union and only if the

corporate credit union meets its

minimum level of required capital after

the funds are called. Paid-in capital

includes both member paid-in capital

and non member paid-in capital. In the

event of liquidation of the corporate

credit union, paid-in capital is payable

only after satisfaction of all liabilities of

the liquidation estate, including

uninsured share obligations to

shareholders, the NCUSIF, and

membership capital holders. Paid-in

capital shall not exceed reserves and

undivided earnings.

Pair-off transaction means a security

purchase transaction that is closed out

or sold at, or prior to, the settlement or

expiration date.

Prepayment model means an

empirical method which produces a

reasonable and supportable forecast of

mortgage prepayments in alternative

interest rate scenarios. Models are

typically available from securities

broker-dealers and industry-recognized

information providers. These models are

used in tests to forecast the weighted

average life, change in weighted average

life, and price sensitivity of CMOs/

REMICs and mortgage-backed securities.

Real estate mortgage investment

conduit (REMIC) means a nontaxable

entity formed for the sole purpose of

holding a fixed pool of mortgages

secured by an interest in real property

and issuing multiple classes of interests

in the underlying mortgages.

Regular way settlement means

delivery of a security from a seller to a

buyer within the specified number of

days established for that type of

security.

Repurchase transaction means a

transaction in which a corporate credit

union agrees to purchase a security from

a counterparty and to resell the same or

any identical security to that

counterparty at a later date.

Reserve ratio means the corporate

credit union’s reserves and undivided

earnings plus paid in capital divided by

its moving daily average net assets.

Reserves and undivided earnings

means all forms of retained earnings,

including regular or statutory reserves

and all valuation allowances established

to meet the full and fair disclosure

requirements of § 702.3 of this chapter.

Residual interest means the remainder

cash flows from a CMO or REMIC

transaction after payments due

bondholders and trust administrative

expenses have been satisfied.

Section 107(8) institution means an

institution described in Section 107(8)

of the Federal Credit Union Act (12

U.S.C. 1757(8)).

Securities lending means lending a

security to a counterparty, either

directly or through an agent, and

accepting collateral in return.

Senior management employee means

a 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 counterparty 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.

Small business related security means

a security as defined in Section 3(a)(53)

of the Securities Exchange Act of 1934

(15 U.S.C. 78c(a)(53)), i.e., a security,

rated in one of the four highest rating

categories by a nationally recognized

statistical rating organization, that

represents ownership of one or more

promissory notes or leases of personal

property which evidence the obligation

of a small business concern. It does not

mean a security issued or guaranteed by

the Small Business Administration.

Stripped mortgage-backed security

means a security that represents either

the principal or interest only portion of

the cash flows of an underlying pool of

mortgages.

Trade association means an

association of organizations or persons

formed to promote their common

interests. For the purposes of § 704.14,

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.

Weighted average life means the

weighted average time to principal

repayment of a security based upon the

proportional balances of the cash flows

that make up the security.

When-issued trading means the

buying and selling of securities in the

period between the announcement of an

offering and the issuance and payment

date of the securities.

Wholesale corporate credit union

means a corporate credit union which

primarily serves other corporate credit

unions.

§ 704.3 Corporate credit union capital.

(a) General. A corporate credit union

must develop and ensure

implementation of written short- and

long-term capital goals, objectives, and

strategies which provide for the

building of capital consistent with

regulatory requirements, the

maintenance of sufficient capital to

support the risk exposures that may

arise from current and projected

activities, and the periodic review and

reassessment of the capital position of

the corporate credit union.

(b) Capital ratio. A corporate credit

union will maintain a minimum capital

ratio of 4 percent, except as otherwise

provided in this part. A corporate credit

union must calculate its capital ratio at

least monthly.

(c) Reserve transfers. A corporate

credit union’s monthly reserve transfers

are based upon the level of its reserve

ratio. Where the reserve ratio is greater

than or equal to 4 percent, the reserve

transfer is optional. Where the reserve

ratio is greater than or equal to 3 percent

but less than 4 percent, the corporate

credit union must transfer .10 percent of

its moving daily average net assets.

Where the reserve ratio is less than 3

percent, the corporate credit union must

transfer .15 percent of its moving daily

average net assets. Reserve transfers

must be calculated on a monthly basis

and funded on at least a quarterly basis.

(d) Individual capital ratio, reserve

transfer requirement. (1) When

significant circumstances or events

warrant, NCUA may require a different

minimum capital ratio and/or reserve

transfer level for an individual corporate

credit union based on its circumstances.

Factors that might warrant a different

minimum capital ratio or reserve

transfer level include, but are not

limited to, for example:

(i) An expectation that the corporate

credit union has or anticipates losses

resulting in capital inadequacy;

(ii) Significant exposure exists,

unsupported by adequate capital or risk

management processes, due to credit,

liquidity, market, fiduciary, operational,

and similar types of risks;

(iii) A merger has been approved; or

(iv) An emergency exists because of a

natural disaster.

(2) When NCUA determines that a

different minimum capital ratio or

reserve transfer level is necessary or

appropriate for a particular corporate
Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations 12941

credit union, NCUA will notify the

corporate credit union in writing of the

proposed ratio or level and, if

applicable, the date by which the ratio

should be reached. NCUA also will

provide an explanation of why the

proposed ratio or level is considered

necessary or appropriate for the

corporate credit union.

(3)(i) The corporate credit union may

respond to any or all of the items in the

notice. The response must be in writing

and delivered to NCUA within 30

calendar days after the date on which

the corporate credit union received the

notice. NCUA may shorten the time

period when, in its opinion, the

condition of the corporate credit union

so requires, provided that the corporate

credit union is informed promptly of the

new time period, or with the consent of

the corporate credit union. In its

discretion, NCUA may extend the time

period for good cause.

(ii) Failure to respond within 30

calendar days or such other time period

as may be specified by NCUA shall

constitute a waiver of any objections to

any item in the notice. Failure to

address any item in a response shall

constitute a waiver of any objection to

that item.

(iii) After the close of the corporate

credit union’s response period, NCUA

will decide, based on a review of the

corporate credit union’s response and

other information concerning the

corporate credit union, whether a

different minimum capital ratio or

reserve transfer level should be

established for the corporate credit

union and, if so, the ratio or level and

the date the requirement will become

effective. The corporate credit union

will be notified of the decision in

writing. The notice will include an

explanation of the decision, except for

a decision not to establish a different

minimum capital ratio or reserve

transfer level for the corporate credit

union.

(e) Failure to maintain minimum

capital ratio requirement. When a

corporate credit union’s capital ratio

falls below the minimum required by

paragraphs (b) or (d) of this section, or

Appendix B of this part, as applicable,

operating management of the corporate

credit union must notify its board of

directors, supervisory committee, and

NCUA within 10 calendar days.

(f) Capital restoration plan. (1) A

corporate credit union must submit a

plan to restore and maintain its capital

ratio at the minimum requirement when

either of the following conditions exist:

(i) The capital ratio falls below the

minimum requirement and is not

restored to the minimum requirement

by the next month end; or

(ii) Regardless of whether the capital

ratio is restored by the next month end,

the capital ratio falls below the

minimum requirement for three months

in any 12-month period.

(2) The capital restoration plan must,

at a minimum, include the following:

(i) Reasons why the capital ratio fell

below the minimum requirement;

(ii) Descriptions of steps to be taken

to restore the capital ratio to the

minimum requirement within specific

time frames;

(iii) Actions to be taken to maintain

the capital ratio at the minimum

required level and increase it thereafter;

(iv) Balance sheet and income

projections, including assumptions, for

the current calendar year and one

additional calendar year; and

(v) Certification from the board of

directors that it will follow the proposed

plan if approved by NCUA.

(3) The capital restoration plan must

be submitted to NCUA within 30

calendar days of the occurrence. NCUA

will respond to the corporate credit

union regarding the adequacy of the

plan within 45 calendar days of its

receipt.

(g) Capital directive. (1) If a corporate

credit union fails to submit a capital

restoration plan; or the plan submitted

is not deemed adequate to either restore

capital or restore capital within a

reasonable time; or the credit union fails

to implement its approved capital

restoration plan, NCUA may issue a

capital directive.

(2) A capital directive may order a

corporate credit union to:

(i) Achieve adequate capitalization

within a specified time frame by taking

any action deemed necessary, including

but not limited to the following:

(A) Increase the amount of capital to

specific levels;

(B) Reduce dividends;

(C) Limit receipt of deposits to those

made to existing accounts;

(D) Cease or limit issuance of new

accounts or any or all classes of

accounts;

(E) Cease or limit lending or making

a particular type or category of loans;

(F) Cease or limit the purchase of

specified investments;

(G) Limit operational expenditures to

specified levels;

(H) Increase and maintain liquid

assets at specified levels; and

(I) Restrict or suspend expanded

authorities issued under Appendix B of

this part.

(ii) Adhere to a previously submitted

plan to achieve adequate capitalization.

(iii) Submit and adhere to a capital

plan acceptable to NCUA describing the

means and a time schedule by which

the corporate credit union shall achieve

adequate capitalization.

(iv) Meet with NCUA.

(v) Take a combination of these

actions.

(3) Prior to issuing a capital directive,

NCUA will notify a corporate credit

union in writing of its intention to issue

a capital directive.

(i) The notice will state:

(A) The reasons for the issuance of the

directive; and

(B) The proposed content of the

directive.

(ii) A corporate credit union must

respond in writing within 30 calendar

days of receipt of the notice stating that

it either concurs or disagrees with the

notice. If it disagrees with the notice, it

must state the reasons why the directive

should not be issued and/or propose

alternative contents for the directive.

The response should include all matters

that the corporate credit union wishes to

be considered. For good cause,

including the following conditions, the

response time may be shortened or

lengthened:

(A) When the condition of the

corporate requires, and the corporate

credit union is notified of the shortened

response period in the notice;

(B) With the consent of the corporate

credit union; or

(C) When the corporate credit union

already has advised NCUA that it

cannot or will not achieve adequate

capitalization.

(iii) Failure to respond within 30

calendar days, or another time period

specified in the notice, shall constitute

a waiver of any objections to the

proposed directive.

(4) After the closing date of the

corporate credit union’s response

period, or the receipt of the response, if

earlier, NCUA shall consider the

response and may seek additional

information or clarification. Based on

the information provided during the

response period, NCUA will determine

whether or not to issue a capital

directive and, if issued, the form it

should take.

(5) Upon issuance, a capital directive

and a statement of the reasons for its

issuance will be delivered to the

corporate credit union. A directive is

effective immediately upon receipt by

the corporate credit union, or upon such

later date as may be specified therein,

and shall remain effective and

enforceable until it is stayed, modified,

or terminated by NCUA.

(6) A capital directive may be issued

in addition to, or in lieu of, any other

action authorized by law in response to

a corporate credit union’s failure to
12942 Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations

achieve or maintain the applicable

minimum capital ratios.

(7) Upon a change in circumstances,

a corporate credit union may request

reconsideration of the terms of the

directive. Requests that are not based on

a significant change in circumstances or

are repetitive or frivolous will not be

considered. Pending a decision on

reconsideration, the directive shall

continue in full force and effect.

§ 704.4 Board responsibilities.

(a) General. A corporate credit union’s

board of directors must approve

comprehensive written strategic plans

and operating policies, review them

annually, and provide them upon

request to the auditors, supervisory

committee, and NCUA.

(b) Operating policies. A corporate

credit union’s operating policies must

be commensurate with the scope and

complexity of the corporate credit

union.

(c) Procedures. The board of directors

of a corporate credit union must ensure

that:

(1) Senior managers have an in-depth,

working knowledge of their direct areas

of responsibility and are capable of

identifying, hiring, and retaining

qualified staff;

(2) Qualified personnel are employed

or under contract for all line support

and audit areas, and designated back-up

personnel or resources with adequate

cross-training are in place;

(3) GAAP is followed, except where

law or regulation has provided for a

departure from GAAP;

(4) Accurate balance sheets, income

statements, and internal risk

assessments (e.g., risk management

measures of liquidity, market, and credit

risk associated with current activities)

are produced timely in accordance with

§§ 704.6, 704.8, and 704.9;

(5) Systems are audited periodically

in accordance with industry-established

standards;

(6) Financial performance is evaluated

to ensure that the objectives of the

corporate credit union and the

responsibilities of management are met;

and

(7) Planning addresses the retention of

external consultants, as appropriate, to

review the adequacy of technical,

human, and financial resources

dedicated to support major risk areas.

§ 704.5 Investments.

(a) Policies. A corporate credit union

must operate according to an investment

policy that is consistent with its other

risk management policies, including,

but not limited to, those related to credit

risk management, asset and liability

management, and liquidity

management. The policy must address,

at a minimum:

(1) Appropriate tests and criteria, if

any, for evaluating standard investments

and investment transactions prior to

purchase; and

(2) Risk analysis requirements for any

new investment type or transaction, not

previously owned or marketed by the

corporate credit union, considered for

purchase by the corporate credit union

and/or for sale to members.

(b) General. All investments must be

U.S. dollar-denominated and subject to

the credit policy restrictions set forth in

§ 704.6.

(c) Authorized activities. A corporate

credit union may invest in:

(1) Securities, deposits, and

obligations set forth in Sections 107(7),

107(8), and 107(15) of the Federal Credit

Union Act, 12 U.S.C. 1757(7), 1757(8),

and 1757(15), except as provided in this

section;

(2) Deposits in, the sale of federal

funds to, and debt obligations of

corporate credit unions, Section 107(8)

institutions, and state banks, trust

companies, and mutual savings banks

not domiciled in the state in which the

corporate credit union does business;

(3) Corporate CUSOs, as defined in

and subject to the limitations of

§ 704.11;

(4) Marketable debt obligations of

corporations chartered in the United

States. This authority does not apply to

debt obligations that are convertible into

the stock of the corporation;

(5) Asset-backed securities; and

(6) CMOs/REMICs that meet the

Federal Financial Institutions

Examination Council High Risk Security

Test (HRST) requirements.

(i) The HRST must be prepared

quarterly on all CMOs/REMICs,

documented and reviewed by an

appropriate committee, and retained

while the instrument is held in portfolio

and until completion of the next audit

and NCUA examination.

(ii) A corporate credit union’s board

of directors must approve at least three

prepayment models for CMOs/REMICs

unless a median estimate from an

industry-recognized information

provider is used. These approved

models must be used consistently for all

subsequent compliance tests. Any

changes in approved models should be

infrequent and documented with a

reasonable and supportable justification.

(iii) A corporate credit union must

obtain prepayment estimates, based

upon an instantaneous, permanent,

parallel shift in market rates of plus or

minus 100, 200, and 300 basis points, to

conduct the HRST.

(A) If a median prepayment estimate

is used, it must be obtained from an

industry-recognized information

provider. At purchase, the median

estimate must be based on at least 5

prepayment models. At retesting, the

median estimate must be based on at

least 2 prepayment models.

(B) If individual prepayment models

are used, estimates must be obtained

from all of the models identified in the

corporate credit union’s investment

policy. One of the individual

prepayment models may be the median

prepayment estimate from an industryrecognized information provider. All of

the models identified in the investment

policy must be used when purchasing

and retesting a CMO/REMIC. At

purchase, a CMO/REMIC must pass the

tests for each prepayment model used.

At retesting, the CMO/REMIC must pass

the tests for a majority of the

prepayment models used at the time of

purchase.

(d) Repurchase agreements. A

corporate credit union may enter into a

repurchase agreement provided that:

(1) The corporate credit union, or its

agent, nominee, or designee, receives

written confirmation of the transaction

and either takes physical possession or

control of the repurchase securities or is

recorded as owner of the repurchase

securities through the Federal Reserve

Book-Entry Securities Transfer System;

(2) The repurchase securities are legal

investments for that corporate credit

union;

(3) In the event of default, the

corporate credit union sells the

repurchase securities in a timely

manner, subject to a bankruptcy stay, to

satisfy the commitment of any net

principal and interest owed to it by the

counterparty;

(4) The corporate credit union

receives daily assessment of the market

value of the repurchase securities,

including a market quote or dealer bid

indication and any accrued interest, and

maintains adequate margin that reflects

a risk assessment of the repurchase

securities and the term of the

transaction;

(5) The corporate credit union has

entered into signed contracts with all

approved counterparties. Such contracts

must address any supplemental terms

and conditions necessary to meet the

specific requirements of this part. Third

party arrangements must be supported

by tri-party contracts in which the

repurchase securities are priced and

reported daily and the tri-party agent

ensures compliance; and

(6) The corporate credit union has

sufficient market relationships

established in advance to timely execute
Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations 12943

the disposition of the repurchase

securities.

(e) Securities Lending. A corporate

credit union may enter into a securities

lending transaction provided that:

(1) The corporate credit union, or its

agent, nominee, or designee, receives

written confirmation of the loan, obtains

a perfected first priority security interest

in the collateral, and either takes

physical possession or control of the

collateral or is recorded as owner of the

collateral through the Federal Reserve

Book-Entry Securities Transfer System;

(2) The collateral is a legal investment

for that corporate credit union;

(3) The corporate credit union,

directly or through its agent, receives

daily assessment of the market value of

collateral, including a market quote or

dealer bid indication and any accrued

interest, and maintains adequate margin

that reflects a risk assessment of the

collateral and terms of the loan; and

(4) The corporate credit union,

directly or through its agent, has

executed a written loan and security

agreement with the borrower, approved

any form of agreement attached thereto,

and obtained the right to approve any

material modification to such

agreement.

(f) Investment companies. A corporate

credit union may invest in an

investment company registered with the

Securities and Exchange Commission

under the Investment Company Act of

1940 (15 U.S.C. 80a), provided that the

portfolio of such investment company is

restricted by its investment policy solely

to investments and investment

transactions that are permissible for that

corporate credit union.

(g) Forward settlement of transactions

later than regular way. A corporate

credit union may enter into an

agreement to purchase or sell an

instrument, with settlement later than

regular way, provided that:

(1) Delivery and acceptance are

mandatory;

(2) The transaction is clearly

disclosed in the appropriate risk

reporting required under § 704.8(b);

(3) If the corporate credit union is the

purchaser, it has adequate cash flow

projections evidencing its ability to

purchase the instrument;

(4) If the corporate credit union is the

seller, it owns the instrument on the

trade date; and

(5) The transaction is settled on a cash

basis at the settlement date.

(h) Prohibitions. A corporate credit

union is prohibited from:

(1) Purchasing or selling off balance

sheet financial derivatives, such as

futures, options, interest rate swaps, or

forward rate agreements;

(2) Engaging in pair-off transactions,

when-issued trading, adjusted trading,

or short sales; and

(3) Purchasing stripped mortgagebacked securities, residual interests in

CMO/REMICs, mortgage servicing

rights, commercial mortgage related

securities, or small business related

securities.

(i) Conflicts of interest. A corporate

credit union’s officials, 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. Employee

compensation is exempt from this

prohibition. All transactions not

specifically prohibited by this paragraph

must be conducted at arm’s length and

in the interest of the corporate credit

union.

(j) Grandfathering. A corporate credit

union’s authority to hold an investment

is governed by the regulation in effect at

the time of purchase. However, all

grandfathered investments are subject to

the requirements of §§ 704.8 and 704.9.

§ 704.6 Credit risk management.

(a) Policies. A corporate credit union

must operate according to a credit risk

management policy that is

commensurate with the investment and

lending risks and activities it

undertakes. The policy must address, at

a minimum:

(1) The approval process associated

with credit limits;

(2) Due diligence analysis

requirements;

(3) Maximum credit limits with each

obligor and transaction counterparty, set

as a percentage of the sum of reserves

and undivided earnings and paid-in

capital. In addition to addressing loans,

deposits, and securities, limits with

transaction counterparties must address

aggregate exposures of all transactions,

including, but not necessarily limited

to, repurchase agreements, securities

lending, and forward settlement of

purchases or sales of investments; and

(4) Concentrations of credit risk (e.g.,

industry type, sector type, and

geographic).

(b) Exemption. The requirements of

this section do not apply to instruments

that are issued or fully guaranteed as to

principal and interest by the U.S.

government or its agencies or

enterprises or are fully insured

(including accumulated interest) by the

National Credit Union Administration

or Federal Deposit Insurance

Corporation.

(c) Concentration limits. (1) Aggregate

investments in mortgage-backed and

asset-backed securities are limited to

200 percent of the sum of reserves and

undivided earnings and paid-in capital

for any single security or trust.

(2) Except for investments in a

wholesale corporate credit union,

aggregate investments in repurchase and

securities lending agreements with any

one counterparty are limited to 400

percent of the sum of reserves and

undivided earnings and paid-in capital.

(3) Except for investments in a

wholesale corporate credit union, the

aggregate of all investments in non

secured obligations of any single

domestic issuer is limited to 100 percent

of the sum of reserves and undivided

earnings and paid-in capital.

(4) For purposes of measurement,

each new credit transaction must be

evaluated in terms of the corporate

credit union’s sum of reserves and

undivided earnings and paid-in capital

at the time of the transaction. A

subsequent reduction in the sum of

reserves and undivided earnings and

paid-in capital will require a suspension

of additional transactions until

maturities, sales or terminations bring

existing exposures within the

requirements of this part.

(d) Credit ratings. (1) All debt

instruments must have a credit rating

from at least one nationally recognized

statistical rating organization (NRSRO).

(2) The rating(s) must be monitored

for as long as the corporate owns an

instrument.

(3) At the time of purchase, assetbacked securities must be rated no

lower than AAA (or equivalent), other

long-term investments must be rated no

lower than AA (or equivalent), and

short-term investments must be rated no

lower than A–1 (or equivalent).

(4) Any rated instrument that is

downgraded by the NRSRO used to

meet the requirements of this part at the

time of purchase must be reviewed by

the board or an appropriate committee

within 30 calendar days of the

downgrade. Instruments that fall below

the minimum rating requirements of

this part are subject to the requirements

of § 704.10.

(e) Reporting and documentation. (1)

A written evaluation of each credit line

must be prepared at least annually and

formally approved by the board or an

appropriate committee. At least

monthly, the board or an appropriate

committee must receive a watch list of

existing and/or potential credit

problems and summary credit exposure

reports, which demonstrate compliance

with the corporate credit union’s risk

management policies.

(2) At a minimum, the corporate

credit union must maintain:
12944 Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations

(i) A justification for each approved

credit line;

(ii) Disclosure documents, if any, for

all instruments held in portfolio.

Documents for an instrument that has

been sold must be retained until

completion of the next NCUA

examination; and

(iii) The latest available financial

reports, industry analyses, internal and

external analyst evaluations, and rating

agency information sufficient to support

each approved credit line.

§ 704.7 Lending.

(a) Policies. A corporate credit union

must operate according to a lending

policy which addresses, at a minimum:

(1) Loan types and limits;

(2) Required documentation and

collateral; and

(3) Analysis and monitoring

standards.

(b) General. Each loan or line of credit

limit will be determined after analyzing

the financial and operational soundness

of the borrower and the ability of the

borrower to repay the loan.

(c) Loans to member credit unions. (1)

The maximum aggregate amount in

unsecured loans and irrevocable lines of

credit to any one member credit union,

excluding pass-through and guaranteed

loans from the CLF and the NCUSIF,

shall not exceed 50 percent of capital or

75 percent of the sum of reserves and

undivided earnings and paid-in capital,

whichever is greater.

(2) The maximum aggregate amount

in secured loans and irrevocable lines of

credit to any one member credit union,

excluding those secured by shares or

marketable securities and member

reverse repurchase transactions, shall

not exceed 100 percent of capital or 200

percent of the sum of reserves and

undivided earnings and paid-in capital,

whichever is greater.

(d) Loans to members that are not

credit unions. Any loan or irrevocable

line of credit made to a member, other

than a credit union or a corporate

CUSO, must be made in compliance

with § 701.21(h) of this chapter,

governing member business loans,

unless such loan or line of credit is fully

guaranteed by a credit union. The

aggregate amount of loans and

irrevocable lines of credit to members

other than credit unions and corporate

CUSOs shall not exceed 15 percent of

the corporate credit union’s capital plus

pledged shares.

(e) Loans to non member credit

unions. A loan to a credit union that is

not a member of the corporate credit

union, other than through a loan

participation with another corporate

credit union, is only permissible if the

loan is for an overdraft related to the

providing of correspondent services

pursuant to § 704.12. Generally, such a

loan will have a maturity of only one

business day.

(f) Loans to corporate CUSOs. A

corporate credit union may make loans

and issue lines of credit to corporate

CUSOs, subject to the limitations of

§ 704.11.

(g) 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.

(h) Prepayment penalties. If provided

for in the loan contract, a corporate

credit union is authorized to assess

prepayment penalties on loans.

§ 704.8 Asset and liability management.

(a) Policies. A corporate credit union

must operate according to a written

asset and liability management policy

which addresses, at a minimum:

(1) The purpose and objectives of the

corporate credit union’s asset and

liability activities;

(2) The tests that will be used to

evaluate instruments prior to purchase;

(3) The maximum allowable

percentage decline in net economic

value (NEV), compared to current NEV;

(4) The minimum allowable NEV

ratio;

(5) The maximum decline in net

income (before reserve transfers), in

percentage and dollar terms, compared

to current net income;

(6) Policy limits and specific test

parameters for the interest rate risk

simulation tests set forth in paragraph

(d) of this section; and

(7) The modeling of indexes that serve

as references in financial instrument

coupon formulas.

(b) Asset and liability management

committee (ALCO). A corporate credit

union’s ALCO must have at least one

member who is also a member of the

board of directors. The ALCO must

review asset and liability management

reports on at least a monthly basis.

These reports must address compliance

with Federal Credit Union Act, NCUA

Rules and Regulations (12 CFR chapter

VII), and all related risk management

policies.

(c) Penalty for early withdrawals. A

corporate credit union that permits early

certificate/share withdrawals must

assess market-based penalties sufficient

to cover the estimated replacement cost

of the certificate/share redeemed.

(d) Interest rate sensitivity analysis.

(1) A corporate credit union must:

(i) Evaluate the risk in its balance

sheet by measuring, at least quarterly,

the impact of an instantaneous,

permanent, and parallel shock in the

Treasury yield curve of plus and minus

100, 200, and 300 basis points on its

NEV, NEV ratio, and net interest

income. If the base case NEV ratio falls

below 2 percent at the last testing date,

these tests must be calculated at least

monthly until the base case NEV ratio

again exceeds 2 percent;

(ii) Limit its risk exposure to levels

that do not result in an NEV ratio below

1 percent; and

(iii) Limit its risk exposures to levels

that do not result in a decline in NEV

of more than 18 percent, except as

provided in paragraph (e) of this

section.

(2) A corporate credit union that owns

an aggregate amount of instruments

which possess unmatched embedded

options in a book value amount which

exceeds 200 percent of the sum of its

reserves and undivided earnings and

paid-in capital must conduct

periodically, as appropriate, additional

tests that address market factors which

potentially can impact the value of the

instruments and that reflect the policy

limits addressed in paragraph (a) of this

section. These factors should include,

but not be limited to, the following:

(i) Changes in the shape of the

Treasury yield curve;

(ii) Adjustments to prepayment

projections used for amortizing

securities to consider the impact of

significantly faster/slower prepayment

speeds;

(iii) Adjustments to the market spread

assumptions for non Treasury

instruments to consider the impact of

widening spreads; and

(iv) Adjustments to volatility

assumptions to consider the impact that

changing volatilities have on embedded

option values.

(e) Base-plus. (1) In performing the

rate stress tests set forth in paragraph

(d)(1)(i) of this section, the NEV of a

corporate credit union which has met

the requirements of this paragraph (e)

may decline as much as 25 percent.

(2) The corporate credit union must

meet additional management and

infrastructure requirements and receive

NCUA’s written approval. The

additional requirements are set forth in

the NCUA publication Guidelines for

Submission of Requests for Expanded

Authority. The procedures for

processing base-plus authority are the

same as those set forth in Appendix B
Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations 12945

of this part for requesting expanded

authorities.

(3) The corporate credit union must

evaluate monthly the changes in NEV,

NEV ratio, and net interest income for

the tests set forth in paragraph (d)(1)(i)

of this section.

(4) Regardless of the amount of

instruments which possess unmatched

embedded options, the corporate credit

union must conduct periodically, as

appropriate, the tests set forth in

paragraph (d)(2) of this section.

(f) Regulatory violations. If a corporate

credit union’s base case NEV or NEV

ratio or the NEV or NEV ratio resulting

from the tests indicated in paragraph

(d)(1)(i) of this section decline below the

limits established by this part and are

not brought into compliance within 10

calendar days, operating management of

the corporate credit union must

immediately report the information to

the board of directors, supervisory

committee, and NCUA. If any of these

measures remain below the limits

established by this part within 30

calendar days of the violation, the

corporate credit union must submit a

detailed, written action plan to NCUA

that sets forth the time needed and

means by which it intends to correct the

violation. If NCUA determines that the

plan is unacceptable, the corporate

credit union must immediately

restructure the balance sheet to bring

the exposures back within compliance

or adhere to an alternative course of

action determined by NCUA.

(g) Policy violations. If a corporate

credit union’s NEV or NEV ratio for any

required test(s) exceed the limits

established by the board, it must

determine how it will bring the

exposures within policy limits. The

disclosure to the board of the limit

violation must occur no later than its

next regularly scheduled board meeting.

§ 704.9 Liquidity management.

(a) General. In the management of

liquidity, a corporate credit union must:

(1) Evaluate the potential liquidity

needs of its membership in a variety of

economic scenarios;

(2) Regularly monitor sources of

internal and external liquidity;

(3) Demonstrate that the accounting

classification of investment securities is

consistent with its ability to meet

potential liquidity demands; and

(4) Develop a contingency funding

plan that addresses alternative funding

strategies in successively deteriorating

liquidity scenarios. The plan must:

(i) List all sources of liquidity, by

category and amount, that are available

to service an immediate outflow of

funds in various liquidity scenarios;

(ii) Analyze the impact that potential

changes in fair value will have on the

disposition of assets in a variety of

interest rate scenarios; and

(iii) Be reviewed by the board or an

appropriate committee no less

frequently than annually or as market or

business conditions dictate.

(b) 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 greater. CLF

borrowings and borrowed funds created

by the use of member reverse

repurchase agreements are excluded

from this limit. The corporate credit

union must demonstrate that sufficient

contingent sources of liquidity remain

available.

§ 704.10 Divestiture.

(a) Any corporate credit union in

possession of an investment that fails to

meet a requirement of this part must,

within 30 calendar days of the failure,

report the failed investment to its board

of directors, supervisory committee, and

NCUA. If the corporate credit union

does not sell the failed investment, and

the investment continues to fail to meet

a requirement of this part, the corporate

credit union must, within 30 calendar

days of the failure, provide to NCUA a

written action plan that addresses:

(1) The investment’s characteristics

and risks;

(2) The process to obtain and

adequately evaluate the investment’s

market pricing, cash flows, and risk;

(3) How the investment fits into the

credit union’s asset and liability

management strategy;

(4) The impact that either holding or

selling the investment will have on the

corporate credit union’s earnings,

liquidity, and capital in different

interest rate environments; and

(5) The likelihood that the investment

may again pass the requirements of this

part.

(b) NCUA may require, for safety and

soundness reasons, a shorter time

period for plan development than that

set forth in paragraph (a) of this section.

(c) If the plan described in paragraph

(a) of this section is not approved by

NCUA, the credit union must adhere to

NCUA’s directed course of action.

§ 704.11 Corporate Credit Union Service

Organizations (Corporate CUSOs).

(a) A corporate CUSO is an entity that:

(1) Is at least partly owned by a

corporate credit union;

(2) Primarily serves credit unions;

(3) Restricts its services to those

related to the normal course of business

of credit unions; and

(4) Is structured as a corporation,

limited liability company, or limited

partnership under state law.

(b) The aggregate of all investments in

and loans to member and non member

corporate CUSOs shall not exceed 15

percent of a corporate credit union’s

capital. However, a corporate credit

union may loan to member and non

member corporate CUSOs an additional

15 percent of capital if collateralized by

assets in which the corporate credit

union has perfected a security interest

under state law. 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 obligations of

another financial institution, insurance

company, trade association, liquidity

facility, or similar organization. A

corporate CUSO must be operated as an

entity separate from any credit union. A

corporate credit union investing in or

lending to a corporate CUSO must

obtain a written legal opinion that the

corporate CUSO is organized and

operated in such a manner that the

corporate credit union will not

reasonably be held liable for the

obligations of the corporate CUSO. This

opinion must address factors that have

led courts to ‘‘pierce the corporate veil,’’

such as inadequate capitalization, lack

of separate corporate identity, common

boards of directors and employees,

control of one entity over another, and

lack of separate books and records.

(c) An official of a corporate credit

union which has invested in or loaned

to a corporate CUSO may not receive,

either directly or indirectly, any salary,

commission, investment income, or

other income, compensation, or

consideration from the corporate CUSO.

This prohibition also extends to

immediate family members of officials.

(d) Prior to making an investment in

or loan to a corporate CUSO, a corporate

credit union must obtain a written

agreement that the corporate CUSO will:

(1) Follow GAAP;

(2) Provide financial statements to the

corporate credit union at least quarterly;

(3) Obtain an annual CPA opinion

audit and provide a copy to the

corporate credit union; and

(4) Allow the auditor, board of

directors, and NCUA complete access to

its books, records, and any other

pertinent documentation.

(e) Corporate credit union authority to

invest in or loan to a CUSO is limited

to that provided in this section. A

corporate credit union is not authorized

to invest in or loan to a CUSO under

§ 701.27 of this chapter.
12946 Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations

§ 704.12 Services.

Except for correspondent services to a

non member, natural person credit

union branch office operating in the

geographic area defined in the corporate

credit union’s charter, 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 agreements with other

corporate credit unions or pursuant to

§ 701.26 of this chapter, except with the

written permission of NCUA.

§ 704.13 Fixed assets.

(a) A corporate credit union’s

ownership in fixed assets shall be

limited as described in § 701.36 of this

chapter, except that in lieu of

§ 701.36(c)(1) through (4) of this

chapter, paragraph (b) of this section

applies.

(b) A corporate credit union may

invest in fixed assets where the

aggregate of all such investments does

not exceed 15 percent of the corporate

credit union’s capital. A corporate credit

union desiring to exceed the limitation

shall submit a written request to NCUA.

Requests shall be supplemented by such

statements and reports as NCUA may

require. If the corporate credit union

does not receive notification of the

action taken on its request within 45

calendar days of the date all required

information has been received, it may

proceed with its proposed investment in

fixed assets.

§ 704.14 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) At least a majority of directors,

including the chair of the board, must

serve on the board as representatives of

member credit unions;

(2) The chair of the board may not

serve simultaneously as an officer,

director, or employee of a credit union

trade association;

(3) 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);

(4) 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; and

(5) In the case of a corporate credit

union whose membership is composed

of more than 25 percent non credit

unions, the majority of directors serving

as representatives of member credit

unions, including the chair, must be

elected only by member credit unions.

(b) Representatives of organizational

members. (1) An organizational member

of a corporate credit union is a member

that is not a natural person. An

organizational member 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. No

individual may serve as the

representative of more than one

organizational member 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 § 701.14 of this

chapter apply to corporate credit

unions, except that where ‘‘Regional

Director’’ is used, read ‘‘NCUA Board.’’

§ 704.15 Audit requirements.

(a) External audit. The corporate

credit union supervisory committee

shall cause an annual opinion audit of

the financial statements to be made. The

audit must be performed in accordance

with generally accepted auditing

standards and the audited financial

statements must be prepared consistent

with GAAP, except where law or

regulation has provided for a departure

from GAAP. The supervisory committee

shall submit the audit report to the

board of directors. A copy of the audit

report, and copies of all

communications that are provided to

the corporate credit union by the

external auditor, shall be submitted to

NCUA within 30 calendar days after

receipt by the board of directors. If

requested by NCUA, the external

auditor’s workpapers shall be made

available, at the auditor’s office or

elsewhere, for NCUA’s review. The

corporate credit union shall submit a

summary of the audit report to the

membership at the next annual meeting.

(b) Internal audit. A corporate credit

union with average daily assets in

excess of $400 million for the preceding

calendar year, or as ordered by NCUA,

must employ or contract, on a full- or

part-time basis, the services of an

internal auditor. The internal auditor’s

responsibilities will, at a minimum,

comply with the Standards and

Professional Practices of Internal

Auditing, as established by the Institute
Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations 12947

of Internal Auditors. The internal

auditor will report directly to the chair

of the corporate credit union’s

supervisory committee, who may

delegate supervision of the internal

auditor’s daily activities to the chief

executive officer of the corporate credit

union. The internal auditor’s reports,

findings, and recommendations will be

in writing and presented to the

supervisory committee no less than

quarterly, and will be provided upon

request to the external auditor and

NCUA.

§ 704.16 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.

§ 704.17 State-chartered corporate credit

unions.

(a) This part does not expand the

powers and authorities of any statechartered 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

NCUSIF, 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).

(c) NCUA will notify, consult with,

and provide explanation to the

appropriate state supervisory authority

before taking administrative action

against a state-chartered corporate credit

union.

§ 704.18 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 NCUA.

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 NCUA,

requiring written notification by surety

to NCUA:

(1) When the bond of a credit union

is terminated in its entirety;

(2) When bond coverage is

terminated, by issuance of a written

notice, on an employee, director, officer,

supervisory or credit committee

member; or

(3) When a deductible is increased

above permissible limits. Said

notification shall be sent to NCUA and

shall include a brief statement of cause

for termination or increase.

(d) Minimum coverage amounts. (1)

The minimum amount of bond coverage

will be computed based on the

corporate credit union’s daily average

net assets for the preceding calendar

year. The following table lists the

minimum requirements:

Daily average net assets

Minimum

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

$10.0–$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 minimums in the table in

paragraph (d)(1) of this section.

(e) Deductibles. (1) The maximum

amount of deductibles allowed are

based on the corporate credit union’s

reserve ratio. The following table sets

out the maximum deductibles, except

that in each category the maximum

deductible shall be $5 million:

Reserve ratio Maximum deductible

Less than 1.0 percent ................... 7.5 percent of the sum of reserves and undivided earnings and paid-in capital.

1.0–1.74 percent ........................... 10.0 percent of the sum of reserves and undivided earnings and paid-in capital

1.75–2.24 percent ......................... 12.0 percent of the sum of reserves and undivided earnings and paid-in capital.

Greater than 2.25 percent ............. 15.0 percent of the sum of reserves and undivided earnings and paid-in 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 NCUA at least 30 calendar days prior

to the effective date of the deductibles.

(f) Additional coverage. NCUA may

require additional coverage for any

corporate credit union when, in the

opinion of NCUA, current coverage is

insufficient. The board of directors of

the corporate credit union must obtain

additional coverage within 30 calendar

days after the date of written notice

from NCUA.

§ 704.19 Wholesale corporate credit

unions.

(a) General. Wholesale corporate

credit unions are subject to the

preceding requirements of this part,

except as set forth in this section.

(b) Capital. (1) A wholesale corporate

credit union will maintain a minimum

capital ratio of 5 percent.

(2) A wholesale corporate credit

union shall make reserve transfers at the

lower of .10 percent of its moving daily

average net assets or the amount that

would be required under § 704.3(c).

(i) Required transfers are to be made

from earnings in either the prior

calendar month or prior twelve-month

period. Transfers made during the prior

twelve-month period must be greater

than or equal to the aggregate amount of

required reserve transfers for each of the

months in that twelve-month period.

(ii) NCUA and, in the case of statechartered wholesale corporate credit

unions, the state supervisory authority,

must be notified within 30 calendar

days of the close of any calendar month

in which a wholesale corporate credit

union’s required reserve transfer

exceeds earnings for that month. The

notice must include the dollar amounts

of the required reserve transfer and

earnings for that month and for the prior

twelve-month period. The notice must

also provide an explanation of why the

current month’s required reserve
12948 Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations

transfer exceeded earnings for that

month.

(c) Asset and liability management.

(1) In conducting the interest rate

sensitivity analysis set forth in

§ 704.8(d)(1)(i), a wholesale corporate

credit union must limit its risk exposure

to levels that do not result, at any time,

in an NEV ratio below .75 percent or a

decline in NEV of more than 35 percent.

(2) A wholesale corporate credit

union must obtain, at its expense, an

annual third-party review of its asset

and liability management modeling

system.

Appendix A to Part 704—Model Forms

This appendix contains sample forms

intended for use by corporate credit unions

to aid in compliance with the membership

capital account and paid-in capital disclosure

requirements of § 704.2. Corporate credit

unions that use this form will be in

compliance with those requirements.

Sample Form 1

Terms and Conditions of Membership Capital

Account

(1) A membership capital account is not

subject to share insurance coverage by the

NCUSIF or other deposit insurer.

(2) A member credit union may withdraw

membership capital with three years’ notice.

(3) Membership capital cannot be used to

pledge borrowings.

(4) Membership capital is available to

cover losses that exceed reserves and

undivided earnings and paid-in capital.

(5) Where the corporate credit union is

liquidated, membership capital accounts are

payable only after satisfaction of all liabilities

of the liquidation estate including uninsured

obligations to shareholders and the NCUSIF.

If the form is used when an account is

opened, it must also contain the following

statement:

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

membership capital account.

The form must be signed by either all of the

directors of the member credit union or, if

authorized by board resolution, the chair and

secretary of the board of the credit union.

If the form is used for the annual notice

requirement, it must be signed by the chair

of the corporate credit union. The chair must

then sign a statement which certifies that the

form has been sent to member credit unions

with membership capital accounts. The

certification must be maintained in the

corporate credit union’s files and be available

for examiner review.

Sample Form 2

Terms and Conditions of Paid-In Capital

(1) Paid-in capital is not subject to share

insurance coverage by the NCUSIF or other

deposit insurer.

(2) The funds are callable only at the

option of the corporate credit union and only

if the corporate credit union meets its

minimum level of required capital after the

funds are called.

(3) Paid-in capital is available to cover

losses that exceed reserves and undivided

earnings.

(4) Paid-in capital is subordinate to

membership capital and the NCUSIF.

If the form is used when a paid-in capital

instrument is created, it must also contain

the following statement:

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

paid-in capital instrument.

The form must be signed by either all of the

directors of the credit union or, if authorized

by board resolution, the chair and secretary

of the board of the credit union.

If the form is used for the annual notice

requirement, it must be signed by the chair

of the corporate credit union. The chair must

then sign a statement which certifies that the

form has been sent to credit unions with

paid-in capital accounts. The certification

must be maintained in the corporate credit

union’s files and be available for examiner

review.

Appendix B to Part 704— Expanded

Authorities and Requirements

A corporate credit union may obtain

expanded authorities if it meets all of the

requirements of this part 704, fulfills

additional capital, management,

infrastructure, and asset and liability

requirements, and receives NCUA’s written

approval. The additional requirements and

authorities are set forth in this Appendix and

in the NCUA publication Guidelines for

Submission of Requests for Expanded

Authority. A corporate credit union which

seeks expanded authorities must submit to

NCUA a self-assessment plan which analyzes

and supports its request. A corporate credit

union may adopt expanded authorities when

NCUA has provided final approval. If NCUA

denies a request for expanded authorities, it

will advise the corporate of the reasons for

the denial and what it must do to resubmit

its request. NCUA may revoke these

expanded authorities at any time if an

analysis indicates a significant deficiency.

NCUA will notify the corporate credit union

in writing of the identified deficiency. A

corporate credit union may request, in

writing, reinstatement of the revoked

authorities by providing a self-assessment

plan which details how it has corrected these

deficiencies.

(a) In order to participate in the authorities

set forth in paragraphs (b) through (d) of this

Part I, a corporate credit union must:

(1) Have a minimum capital ratio of 5

percent;

(2) Evaluate monthly the changes in NEV,

NEV ratio, and net interest income for the

tests set forth in § 704.8(d)(1)(i); and

(3) Regardless of the amount of instruments

which possess unmatched embedded

options, conduct periodically, as appropriate,

the tests set forth in § 704.8(d)(2).

(b) A corporate credit union which has met

the requirements of paragraph (a) of this Part

I is not bound by the concentration limits on

investments set forth at § 704.6(c)(1) and (2).

Instead, the corporate credit union must

establish limits on such investments as a

percentage of the sum of reserves and

undivided earnings and paid-in capital that

take into account the relative amount of

credit risk exposure based upon, but not

limited to, the legal and financial structure of

the transaction, the collateral, all other types

of credit enhancement, and the term of the

transaction.

(c) A corporate credit union which has met

the requirements of paragraph (a) of this Part

I may:

(1) Except for investments in a wholesale

corporate credit union, invest in non secured

obligations of any single domestic issuer up

to 150 percent of the sum of reserves and

undivided earnings and paid-in capital;

(2) Purchase long-term investments rated

no lower than AA-(or equivalent);

(3) Purchase asset-backed securities rated

no lower than AA (or equivalent);

(4) Engage in short sales of permissible

investments to reduce interest rate risk;

(5) Purchase principal only (PO) stripped

mortgage-backed securities to reduce interest

rate risk;

(6) Purchase CMOs/REMICs using fewer

prepayment models than required in

§ 704.5(c)(6);

(7) Enter into a repurchase transaction

where the collateral securities are rated no

lower than A (or equivalent);

(8) Enter into a dollar roll transaction; and

(9) Engage in when-issued trading, when

accounted for on a trade date basis.

(d) In performing the rate stress tests set

forth in § 704.8(d)(1)(i), the NEV of a

corporate credit union which has met the

requirements of paragraph (a) of this Part I

may decline as much as 35 percent.

(e) The maximum aggregate amount in

unsecured loans and irrevocable lines of

credit to any one member credit union,

excluding pass-through and guaranteed loans

from the CLF and the NCUSIF, shall not

exceed 100 percent of the corporate credit

union’s capital. The board of directors will

establish the limit, as a percent of the

corporate credit union’s capital plus pledged

shares, for secured loans and irrevocable

lines of credit.

Part II

(a) In order to participate in the authorities

set forth in paragraphs (b)–(d) of this Part II,

a corporate credit union must:

(1) Have a minimum capital ratio of 6

percent; and

(2) Evaluate monthly the changes in NEV,

NEV ratio, and net interest income for the

tests set forth in § 704.8(d)(1)(i); and

(3) Regardless of the amount of instruments

which possess unmatched embedded

options, conduct periodically, as appropriate,

the tests set forth in § 704.8(d)(2).

(b) A corporate credit union which has met

the requirements of paragraph (a) of this Part

II is not bound by the concentration limits on

investments set forth at § 704.6(c) (1) and (2).

Instead, the corporate credit union must

establish limits on such investments as a

percentage of the sum of reserves and

undivided earnings and paid-in capital, that

take into account the relative amount of

credit risk exposure based upon, but not
Federal Register / Vol. 62, No. 53 / Wednesday, March 19, 1997 / Rules and Regulations 12949

limited to, the legal and financial structure of

the transaction, the collateral, all other types

of credit enhancement, and the term of the

transaction.

(c) A corporate credit union which has met

the requirements of paragraph (a) of this Part

II may:

(1) Except for investments in a wholesale

corporate credit union, invest in nonsecured

obligations of any single domestic issuer up

to 250 percent of the sum of reserves and

undivided earnings and paid-in capital;

(2) Purchase long-term investments rated

no lower than A¥ (or equivalent);

(3) Purchase asset-backed securities rated

no lower than AA (or equivalent);

(4) Engage in short sales of permissible

investments to reduce interest rate risk;

(5) Purchase principal only (PO) stripped

mortgage-backed securities to reduce interest

rate risk;

(6) Purchase CMOs/REMICs using fewer

prepayment models than required in

§ 704.5(c)(6);

(7) Enter into a dollar roll transaction; and

(8) Engage in when-issued trading, when

accounted for on a trade date basis.

(d) In performing the rate stress tests set

forth in § 704.8(d)(1)(i), the NEV of a

corporate credit union which has met the

requirements of paragraph (a) of this Part II

may decline as much as 50 percent.

(e) The maximum aggregate amount in

secured and unsecured loans and irrevocable

lines of credit to any one member credit

union, excluding pass-through and

guaranteed loans from the CLF and the

NCUSIF, shall be established by the board of

directors as a percentage of the corporate

credit union’s capital plus pledged shares.

Part III

(a) A corporate credit union which has met

the requirements of paragraph (a) of either

Part I or Part II of this Appendix may invest

in:

(1) Debt obligations of a foreign country;

and

(2) Deposits in, the sale of federal funds to,

and debt obligations of foreign banks or

obligations guaranteed by these banks.

(b) All foreign investments are subject to

the following requirements:

(i) Short-term investments must be rated no

lower than A–1 (or equivalent);

(ii) Long-term investments must be rated

no lower than AA (or equivalent);

(iii) A sovereign issuer, and/or the country

in which a bank issuer/guarantor is

organized, must be rated no lower than AA

(or equivalent) for political and economic

stability;

(iv) A bank issuer/guarantor must be rated

no lower than AA;

(v) For each approved foreign bank line,

the corporate credit union must identify the

specific banking centers and branches to

which it will lend funds;

(vi) Non secured obligations of any single

foreign issuer may not exceed 150 percent of

the sum of reserves and undivided earnings

and paid-in capital; and

(vii) Non secured obligations in any single

foreign country may not exceed 500 percent

of the sum of reserves and undivided

earnings and paid-in capital.

Part IV

A corporate credit union which has met

the requirements of paragraph (a) of either

Part I or Part II of this Appendix may engage

in derivatives transactions which are directly

related to its financial activities and which

have been specifically approved by NCUA. A

corporate credit union may use such

derivatives authority only for the purposes of

creating structured instruments and hedging

its own balance sheet and the balance sheets

of its members.

PART 709—INVOLUNTARY

LIQUIDATION OF FEDERAL CREDIT

UNIONS AND ADJUDICATION OF

CREDITOR CLAIMS INVOLVING

FEDERALLY INSURED CREDIT

UNIONS IN LIQUIDATION

2. The authority citation for part 709

continues to read as follows:

Authority: 12 U.S.C. 1766; Pub. L. 101–73,

103 Stat. 183, 530 (1989) (12 U.S.C. 1787 et

seq.).

3. Section 709.5 is amended by

revising paragraphs (b)(7) and (b)(8) and

adding paragraph (b)(9) to read as

follows:

§ 709.5 Payout priorities in involuntary

liquidation.

* * * * *

(b) * * *

(7) In a case involving liquidation of

a corporate credit union, membership

capital;

(8) In a case involving liquidation of

a low-income designated credit union,

any outstanding secondary capital

accounts issued pursuant to the

authority of §§ 701.34 or 741.204(c) of

this chapter; and

(9) In a case involving liquidation of

a corporate credit union, paid-in capital.

* * * * *

PART 741—REQUIREMENTS FOR

INSURANCE

4. The authority citation for part 741

continues to read as follows:

Authority: 12 U.S.C. 1757, 1766, and 1781–

1790. Section 741.4 is also authorized by 31

U.S.C. 3717.

5. Section 741.219 is added to read as

follows:

§ 741.219 Investment requirements.

Any credit union which is insured

pursuant to Title II of the Act must

adhere to the requirements stated in part

703 of this chapter concerning

transacting business with corporate

credit unions.

[FR Doc. 97–6417 Filed 3–18–97; 8:45 am]

BILLING CODE 7535–01–P

DEPARTMENT OF TRANSPORTATION

Federal Aviation Administration

14 CFR Part 39

[Docket No. 94–CE–34–AD; Amendment 39–

9967; AD 97–06–10]

RIN 2120–AA64

Airworthiness Directives; Raytheon

Aircraft Company (Formerly Beech

Aircraft Corporation) Model 76

Airplanes

AGENCY: Federal Aviation

Administration, DOT.

ACTION: Final rule.

SUMMARY: This amendment supersedes

Airworthiness Directive (AD) 91–14–14,

which currently requires repetitively

inspecting the main landing gear (MLG)

‘‘A’’ frame assemblies for cracks on

Raytheon Aircraft Company (Raytheon)

Model 76 airplanes (formerly referred to

as Beech Model 76 airplanes), and

replacing any assembly found cracked.

AD 91–14–14 resulted from reports of

fatigue cracks developing on the MLG

‘‘A’’ frame assemblies of the affected

airplanes. Raytheon has developed

improved design MLG ‘‘A’’ frame

assemblies, and the Federal Aviation

Administration (FAA) has determined

that Model 76 airplanes with an

improved design ‘‘A’’ frame assembly

installed on both the left and right MLG

should be exempt from AD 91–14–14.

This action retains the requirement of

repetitively inspecting the MLG ‘‘A’’

frame assemblies for cracks and

replacing any cracked ‘‘A’’ frame

assembly only for those Model 76

airplanes that do not have the improved

design parts installed. The actions

specified by this AD are intended to

prevent MLG failure because of a

cracked ‘‘A’’ frame assembly, which

could result in loss of control of the

airplane during landing operations.

DATES: Effective May 16, 1997.

The incorporation by reference of

certain publications listed in the

regulations is approved by the Director

of the Federal Register as of May 16,

1997.

ADDRESSES: Service information that

applies to this AD may be obtained from

the Raytheon Aircraft Company, P.O.

Box 85, Wichita, Kansas 67201–0085.

This information may also be examined

at the FAA, Central Region, Office of the

Assistant Chief Counsel, Attention:

Rules Docket No. 94–CE–34–AD, Room

1558, 601 E. 12th Street, Kansas City,

Missouri 64106; or at the Office of the

Federal Register, 800 North Capitol

Street, NW., suite 700, Washington, DC.