Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28085

equine piroplasmosis, Venezuelan

equine encephalomyelitis, or equine

infectious anemia has occurred on the

premises of origin or on adjoining

premises during the 60 days preceding

exportation; and

(5) That, except as provided in

§ 92.301(g):

(i) The horses have not been in any

country listed in § 92.301(c)(1) as

affected with CEM during the 12 months

immediately prior to their importation

into the United States;

(ii) The horses have not been on any

premises at any time during which time

such premises were found by an official

of the veterinary services of the national

government of the country where such

premises are located, to be affected with

CEM;

(iii) The horses have not been bred by

or bred to any horses from an affected

premises; and

(iv) The horses have had no other

contact with horses that have been

found to be affected with CEM or with

horses that were imported from

countries affected with CEM.

(b) If a horse is presented for

importation from a country where it has

been for less than 60 days, the horse

must be accompanied by a certificate

that meets the requirements of

paragraph (a) of this section that has

been issued by a salaried veterinary

officer of the national government of

each country in which the horse has

been during the 60 days immediately

preceding its shipment to the United

States. The dates during which the

horse was in each country during the 60

days immediately preceding its

exportation to the United States shall be

included as a part of the certification.

(c) Following the port-of-entry

inspection required by § 92.306 of this

part, and before a horse offered for

importation from any part of the world

is released from the port of entry, an

inspector may require the horse and its

accompanying equipment to be

disinfected as a precautionary measure

against the introduction of foot-andmouth disease or any other disease

dangerous to the livestock of the United

States.

§ 92.315 [Amended]

9. In § 92.315, in the undesignated

center heading ‘‘CANADA 18’’, footnote

18 and its reference in the center

heading would be redesignated as

footnote 16.

§ 92.319 [Amended]

10. In § 92.319, in the undesignated

center heading ‘‘COUNTRIES OF

CENTRAL AMERICA AND WEST

INDIES 19’’, footnote 19 and its reference

in the center heading would be

redesignated as footnote 17.

§ 92.321 [Amended]

11. In § 92.321, in the undesignated

center heading ‘‘MEXICO20’’, footnote

20 and its reference in the center

heading would be redesignated as

footnote 18.

§ 92.324 [Amended]

12. In § 92.324, in the second

sentence, footnote 21 and its reference

in the text would be redesignated as

footnote 19.

Done in Washington, DC, this 30th day of

May 1996.

Terry L. Medley,

Acting Administrator, Animal and Plant

Health Inspection Service.

[FR Doc. 96–13897 Filed 6–03–96; 8:45 am]

BILLING CODE 3410–34–P

NATIONAL CREDIT UNION

ADMINISTRATION

12 CFR Parts 704, 709, and 741

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: Proposed rule.

SUMMARY: NCUA is issuing proposed

revisions to the rules governing

corporate credit unions. As the credit

union industry has become more

complex and competitive, the demands

on corporate credit unions have become

greater. Corporate credit unions are

providing a greater variety of more

sophisticated services. The proposed

rule is intended to strengthen corporate

credit union capital and ensure that the

risk on corporate credit union balance

sheets is adequately managed and

controlled.

DATES: Comments must be received on

or before September 3, 1996.

ADDRESSES: Comments should be

directed to Becky Baker, Secretary of the

Board. Mail or hand-deliver comments

to: National Credit Union

Administration, 1775 Duke Street,

Alexandria, Virginia 22314–3428. Fax

comments to (703) 518–6319. Post

comments on NCUA’s electronic

bulletin board by dialing (703) 518–

6480. Please send comments by one

method only.

FOR FURTHER INFORMATION CONTACT:

Robert F. Schafer, Acting 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

Part 704 was amended in 1992 to

address a broad array of corporate credit

union matters. See 57 FR 22626 (May

28, 1992). The regulation has been in

effect for several years, during a time of

great change in the credit union

industry. NCUA has had an opportunity

to see how the regulation has worked

and to consider how it could be

improved. Section 704.12, governing

representation issues, was revised in

1994. See 59 FR 59357 (Nov. 17, 1994).

In April 1995, NCUA issued a proposed

regulation to revise most of the sections

of Part 704. See 60 FR 20438 (Apr. 26,

1995). Comments were due by June 26,

1995. On May 17, 1995, NCUA extended

the comment period an additional 60

days to August 25, 1995. See 60 FR

27240 (May 23, 1995). The

supplementary information section

noted that NCUA had been working

with an outside firm to provide riskprofile assessments of corporate credit

unions, using simulated modeling

techniques, and that the process had

proven to be more time-consuming than

envisioned.

In response to the comments received

and results of the modeling, NCUA

determined to issue this revised

proposed rule for another round of

public comment. In developing this

revised proposal, NCUA considered all

of the written comments, the results of

further modeling, and the input

provided by corporate credit union

representatives in a number of dialogue

meetings conducted by NCUA.

It should be noted that the

background section of the initial

proposed rule observed that NCUA

supervises all corporate credit unions

but that only those that are federally

chartered pay an operating fee to the

agency. Questions were raised as to

whether this put federally chartered

corporate credit unions at a competitive

disadvantage and whether all corporate

credit unions should pay for NCUA’s

corporate credit union supervision

program. NCUA asked for comment on

whether it would be appropriate to

assess all corporate credit unions an

examination fee or to abolish corporate

credit union fees altogether and require

natural person credit unions, since they

benefit from the existence of corporate

credit unions, to make up the difference.
28086 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

Most of those who commented on this

issue favored assessing all corporate

credit unions a fee, rather than having

natural person credit unions pay for

corporate credit union supervision.

Many noted that not all natural person

credit unions use their corporate credit

union. NCUA has determined not to

pursue the issue of funding corporate

credit union supervision expenses in

this proposed regulation. However,

given the impact that the proposed rule

could have on future supervision efforts,

this issue will be reviewed in the future.

B. Comments

NCUA received over 1300 comments

on the proposed regulation, the bulk of

which were from natural person credit

unions. Comments were also received

from the national credit union trade

associations and most of the corporate

credit unions and state credit union

leagues. Finally, comments were

received from other trade associations,

state credit union regulatory authorities,

credit union organizations and

consultants, a Member of Congress,

other entities that do business with

credit unions, and individuals.

The commenters generally opposed

the proposed regulation, particularly the

asset-liability management and capital

requirements. The proposed regulation

required that a corporate credit union

identically match all of its shares and

deposits, except for 25 percent of its

overnight funds, to corresponding

assets. The commenters stated that the

proposal represented an attempt to

eliminate risk from the system, whereas

the appropriate role of a corporate credit

union was to manage risk. They stated

that the proposal would make it

impossible for corporate credit unions

to provide competitive products to their

members and to generate sufficient

income to meet the proposed minimum

capital requirements. The proposed

regulation required that corporate credit

unions achieve primary capital levels of

4 percent of average daily assets by

January 1, 1998.

The commenters also contended that

the proposed rule would

disproportionately affect small natural

person credit unions, which rely more

heavily on corporate credit unions for

investments and other services. They

argued that because the corporate credit

unions would not be able to earn a

spread on their investment activities,

costs for services would increase and

yield on investments would decrease.

C. Dialogue Meetings

After considering the comments and

preliminary modeling results, NCUA

determined that some changes to the

proposed regulation might be

appropriate. To obtain input on those

changes, NCUA hosted a series of

meetings with representatives of

corporate credit unions, natural person

credit unions, and national credit union

trade associations. There was a

productive exchange of information and

views. This proposed rule incorporates

a number of the suggestions received

during the meetings.

D. Modeling

NCUA contracted with a mortgage

investment and interest rate risk

advisory firm (the firm) to estimate the

market value of portfolio equity and

interest rate sensitivity of the balance

sheets of seven corporate credit unions.

The modeling exercise was conducted

to provide NCUA with an independent

assessment of the relative market risk in

a broad cross-section of corporate credit

unions. The firm believes that market

value of portfolio equity (MVPE) is the

best measure of interest rate risk, as it

can be computed quickly, captures

interest and principal cash flows,

provides an analysis of embedded

option risk, and is more complete than

income simulations. In addition, MVPE

models are not driven by assumptions

regarding future behavior or reactions to

interest rate changes. The firm

concluded that requiring corporate

credit unions to use MVPE techniques

would introduce a necessary risk

analysis and reduction discipline. The

firm stated that when properly

implemented, MVPE techniques would

significantly reduce the likelihood of

another failure similar to that of Capital

Corporate Federal Credit Union, which

failed in early 1995. Interestingly, many

of the commenters to the initial

proposed rule recommended that NCUA

use MVPE to measure interest rate risk.

The firm noted that managing market

value correctly can reduce the volatility

of earnings and net worth. The effects of

good management decisions stand out

when earnings are not significantly

affected by unexpected changes in

interest rates. Market value is the best

measure of the firm’s value and is

usually the best benchmark to judge

management’s performance. Also,

MVPE, and its volatility, is usually the

best indication of risk to the insurer and

regulators.

The firm analyzed the corporate credit

unions’ base MVPE and the sensitivity

of MVPE for instantaneous and

sustained parallel shifts in interest rates

up and down 400 basis points in 100

basis point increments. It also provided

a 12-month net interest income

projection for the same interest rate

scenario.

Additional tests included stresses on

several market-related variables to

determine their effect on MVPE. These

included: (1) flattening and steepening

the reference yield curve with a pivot at

the three-year maturity; (2) increasing

market volatilities by 50 percent from

the reference levels; (3) stressing

prepayment speed projections for

mortgage-related securities 100 percent

faster for the down 300 basis point

scenario; (4) stressing prepayment speed

projections for mortgage-related

securities 50 percent slower for the up

300 basis point scenario; and (5)

increasing market spreads by 50 basis

points above projected spreads.

Project results concluded that large

changes in prepayment expectations,

widening spreads, and increases in

volatility levels would adversely affect

corporate credit union MVPEs. Changes

in the shape of the yield curve did not

have a significant adverse effect; this

was due, in large part, to the relatively

short asset duration of most corporate

credit union balance sheets.

The balance sheets of the corporate

credit unions studied were ‘‘long the

market,’’ that is MVPE increased when

interest rates declined and decreased

when interest rates rose. This is a result

of the effective duration of the corporate

credit unions’ assets being longer than

that of their liabilities. Some corporate

credit union assets were shown to be

negatively convex, that is, projected

gains to MVPE were smaller for interest

rate declines than losses for equivalent

interest rate increases. This negative

convexity is caused by the presence of

embedded options, found most

commonly in mortgage-related

securities and structured notes.

The firm determined that many

corporate credit unions would need to

upgrade their interest rate risk models to

account for the impact of embedded

options. It noted that the establishment

of a minimum MVPE ratio would be a

key aspect of any regulation attempting

to control interest rate risk using MVPE

techniques. According to the firm, the

minimum should provide a safe margin

above the exposures created by a

positive or negative 300 basis point rate

shift. This is necessary because, as the

tests indicated, MVPE can also be

affected by changes in the slope of the

Treasury curve, prepayment activity

that differs from that expected, changes

in market spread levels, and changes in

market volatilities.

E. Three-Tiered Approach

In developing this revised proposed

rule, NCUA acknowledged the diversity

within the corporate credit union

network and the breadth of functions
Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28087

that are provided. Accordingly, this

proposal provides the flexibility for

additional authorities for those

corporate credit unions with a more

developed infrastructure and codifies

the requirements to obtain those

authorities. Presently, such authorities

are granted by waiver.

The basic regulatory requirements and

authorities applicable to all corporate

credit unions are set forth in the main

text of Part 704. Thus, a corporate credit

union that does not seek expanded

authorities need read only the main text

and Appendix A, which contains model

disclosure forms that a corporate credit

union may choose to use for capital

accounts. A ‘‘basic’’ corporate credit

union need not read Appendices B and

C, which set forth additional authorities

available to corporate credit unions and

the requirements to obtain such

authorities. The incorporation of

expanded authorities allows for an

element of self-determination that was

not a component of the initial proposal.

This approach is intended to remove the

‘‘one-size-fits-all’’ constraint and permit

flexibility for a corporate credit union to

choose a path consistent with its

members’ needs. The board of a

corporate credit union may pursue, via

a self- assessment, the level at which it

wishes its institution to operate.

F. Effective Date and Transition

Section 704.18 of the initial proposal

stated that the rule would take effect on

January 1, 1996. Obviously, that date

has passed. Due to the complexity of

this rule, it is difficult to determine

when a final rule will be issued, and

thus to predict a reasonable effective

date. Accordingly, rather than stating an

effective date in this proposal, the final

rule will announce an effective date that

is approximately 1 year from the date

the final rule is issued.

The preamble to the initial proposal

stated that NCUA was considering

requiring compliance with the

investment section 30 days after

issuance of the final rule, which would

be prior to the effective date of the rest

of the regulation. This was to deter

corporate credit unions from ‘‘loading

up’’ on investments that would no

longer be permissible under the new

rule. The commenters generally objected

to this provision, and NCUA has

determined not to proceed with it. As

noted in proposed Section 704.6(g), a

corporate credit union’s authority to

hold an investment is governed by the

regulation in effect at the time of

purchase.

As discussed above, if this proposal is

made final, each corporate credit union

will have to determine the level at

which it wishes to operate. While a

corporate credit union may change its

level at a later date, it will have to make

an initial decision regarding what its

status will be when the final rule

becomes effective. So that NCUA can

effectively supervise the transition to

the new regulation, each corporate

credit union will be asked to inform

NCUA, within 90 days of the final rule’s

publication, of its decision.

A corporate credit union that plans to

operate with expanded authorities

should submit its application for such

authorities as soon as possible to ensure

approval and implementation prior to

the effective date. The application must

demonstrate that the corporate credit

union either has sufficient staffing and

infrastructure to support the authorities

or will make the necessary changes so

that it will have such staffing and

infrastructure. The application also

must set forth the expected costs of such

changes. Since there is no guarantee of

approval, a corporate credit union

normally will not implement these

changes until it receives preliminary

approval.

NCUA will work closely with a

corporate credit union in evaluating its

application. Once all issues are

resolved, NCUA will issue a preliminary

approval. If the issues cannot be

resolved, NCUA will notify the

corporate credit union. Once

preliminary approval has been received,

the corporate credit union must make

the planned changes. Once NCUA has

been notified that the corporate credit

union is ready to begin using the

expanded authorities, it will review the

corporate credit union’s operations. If

they are sufficient to support the

requested authorities, final approval

will be granted.

Recognizing that an institution may

not be at the required capital level or

within the required MVPE limitations

by the effective date of the regulation,

NCUA plans to work with the corporate

credit unions to develop realistic time

frames for compliance. NCUA also is

aware of the unique role of wholesale

corporate credit unions and will make

accommodations to allow such

institutions to comply with the

regulation.

G. 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,

NCUA proposed to amend the Scope

section so that it states both that the

regulation applies to all federally

insured corporate credit unions, and

that non federally insured corporate

credit unions must agree, by written

contract, to adhere to the regulation and

submit to NCUA examination as a

condition of receiving funds from

federally insured credit unions. Some

commenters objected to this latter

requirement, arguing that it meant that

NCUA was holding non federally

insured corporate credit unions to a

higher standard than other investment

alternatives available to natural person

credit unions.

These credit unions may be held to a

higher standard because they are

differently situated than other natural

person credit union investment

alternatives. The failure of a corporate

credit union, even one not federally

insured, would affect the credit union

system more dramatically than the

failure of a bank or broker-dealer. First,

the public would not necessarily

distinguish between a federally and non

federally insured corporate credit union:

all would be tarnished. Second, it is

likely that a far greater number of

federally insured natural person credit

unions would be affected by the failure

of a corporate credit union than would

be affected by the failure of a bank or

broker-dealer. For these reasons, and

because of NCUA’s responsibility to

protect the National Credit Union Share

Insurance Fund (NCUSIF), NCUA has

determined to retain in the revised

proposed rule the requirement 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.

As in the first proposed rule, Section

704.1(b), which sets forth NCUA’s

authority to waive a requirement of Part

704, is retained in this revised proposal.

NCUA again emphasizes that corporate

credit unions are expected to comply

with the rule and that waivers will not

be granted as a matter of course.

Section 704.2—Definitions

As noted in the initial proposed rule,

Part 704 currently incorporates by

reference Part 703, which governs

federal credit union investments, except

where inconsistent with Part 704. To

eliminate the confusion regarding the

applicability of certain provisions of

Part 703 to corporate credit unions,

NCUA determined in the initial

proposed rule to make the investment

section in Part 704 stand on its own.
28088 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

Among other tasks, this necessitated

importing a number of definitions from

Part 703 into Part 704. No commenters

objected to this idea, and it is continued

in this revised proposal.

The definitions that have been

repeated, either identically or with

minor changes, from current Part 703

are: ‘‘adjusted trading,’’ ‘‘collateralized

mortgage obligation,’’ ‘‘federal funds

transaction,’’ ‘‘futures contract,’’

‘‘immediate family member,’’ ‘‘market

price,’’ ‘‘maturity date,’’ ‘‘real estate

mortgage investment conduit,’’

‘‘repurchase transaction,’’ ‘‘residual

interest,’’ ‘‘reverse repurchase

transaction,’’ ‘‘Section 107(8)

institution,’’ ‘‘senior management

employee,’’ ‘‘settlement date,’’ ‘‘short

sale,’’ ‘‘stripped mortgage-backed

security,’’ and ‘‘trade date.’’

Since the issuance of the initial

proposed rule, NCUA has issued a

proposed revision to Part 703. 50 FR

61219 (Nov. 29, 1995). Proposed Part

703 contains a number of new

definitions, some of which have been

included in this revised proposed Part

704. These are: ‘‘business day,’’

‘‘commercial mortgage related security,’’

‘‘fair value,’’ ‘‘industry-recognized

information provider,’’ ‘‘mortgage

related security,’’ ‘‘mortgage servicing,’’

‘‘pair-off transaction,’’ ‘‘prepayment

model,’’ ‘‘securities lending

transaction,’’ and ‘‘small business

related security.’’

The initial proposed rule also

introduced a number of new definitions,

several of which have been included in

this revised proposal. These are:

‘‘embedded option,’’ ‘‘forward rate

agreement,’’ ‘‘long-term investment,’’

‘‘market value of portfolio equity,’’

‘‘matched’’ (‘‘identically matched’’ in

initial proposal), ‘‘official,’’ ‘‘option

contract,’’ ‘‘penalty for early

withdrawal,’’ ‘‘primary dealer,’’ ‘‘shortterm investment,’’ ‘‘swap agreement,’’

and ‘‘wholesale corporate credit union.’’

The initial proposal rule deleted a

number of definitions because the terms

were not used in the proposed

regulation, or because the meaning was

so self-evident as to not require

definition. No commenters objected to

this idea and it is continued in this

revised proposal. The definitions that

are proposed to be deleted are: ‘‘average

life,’’ ‘‘capital of a broker/dealer,’’

‘‘claims,’’ ‘‘corporate reserves,’’ non

credit union member,’’ ‘‘original

maturity,’’ ‘‘other reserves,’’ ‘‘risk-based

capital,’’ ‘‘secondary capital,’’

‘‘speculative activities,’’ ‘‘term

subordinated debt,’’ and ‘‘United States

depository institutions.’’

Finally, this revised proposal has

introduced definitions for the following

terms: ‘‘capital ratio,’’ ‘‘correspondent

services,’’ ‘‘credit enhancement,’’ ‘‘daily

average net assets,’’ ‘‘dealer bid

indication,’’ ‘‘gains trading,’’

‘‘membership capital,’’ ‘‘mortgagebacked security,’’ ‘‘moving daily average

net assets,’’ ‘‘NCUA,’’ ‘‘non secured

investment,’’ ‘‘paid-in capital,’’ ‘‘private

placement,’’ ‘‘reserves,’’ ‘‘reserve ratio,’’

‘‘secured loan,’’ ‘‘tri-party contract,’’ and

‘‘weighted average life.’’ NCUA believes

that the definitions are self-explanatory,

but will clarify any that are confusing in

the preamble to the final rule.

Section 704.3—Corporate Credit Union

Capital

Section 704.11 of the current

regulation establishes specific levels of

capital that corporate credit unions

must maintain, based on risk-weighted

assets. Primary capital, which consists

of reserves and undivided earnings,

must be at least 4 percent of riskweighted assets, and total capital, which

consists of primary capital and

membership capital share deposits,

must be at least 8 percent of riskweighted assets. In response to public

expressions of concern regarding the

relatively low levels of primary capital

in corporate credit unions, Section

704.12 of the initial proposed rule

established a new capital requirement

based on the ratio of primary capital to

average daily assets. The goal was for

corporate credit unions to reach the

minimum ratio of 4 percent of primary

capital to average daily assets by

January 1, 1998. The initial proposed

rule also required that all corporate

credit unions maintain a minimum ratio

of 10 percent of capital to risk-weighted

assets.

The proposed definition of primary

capital included, in addition to reserves

and undivided earnings, certain other

reserve accounts and a new type of

member-contributed capital, called a

permanent capital share account

(PCSA). Up to 50 percent of primary

capital could consist of PCSAs, the most

significant feature of which was that

they could be redeemed only with the

written concurrence of NCUA. In

general, the commenters opposed this

requirement. Corporate credit union

commenters stated that they would be

unable to sell such shares, and natural

person credit unions stated that they

would not purchase them.

With respect to the proposed capital

requirements, the commenters stated

that if PCSAs were to be retained, all

such shares should be counted toward

primary capital. In addition, the

commenters objected to the new

membership capital shares, called

secondary capital share accounts, not

being included in primary capital. They

argued that such shares were at risk and

should be counted. The commenters

also argued that the asset and liability

provisions were so stringent that it

would be impossible to meet the 4

percent requirement in the time frame

provided. Many commenters also

objected to using two ratios to measure

the adequacy of corporate credit union

capital.

NCUA is proposing to move away

from the concept of risk-based capital.

Because corporate credit union assets

tend to have relatively low credit risk,

most corporate credit unions have high

risk-based capital ratios, even if they

have low levels of leverage capital to

protect against interest rate or market

risks. This revised proposal focuses on

the capital that is available to protect

against those risks. Comments are

specifically requested on whether

NCUA should require the calculation of

the capital to risk-weighted assets ratio.

In responding to this issue, commenters

should bear in mind that NCUA would

likely require that the ratio be calculated

using the same risk weights and risk

categories required by the other federal

financial institution regulators.

Proposed Section 704.3(b) requires

that a corporate credit union without

expanded authorities have a capital

ratio of 4 percent. Capital is defined as

the sum of a corporate credit union’s

reserves and undivided earnings, paidin capital, and membership capital.

Membership capital accounts are similar

to the current membership capital share

deposits, except that they must have at

least a three-year notice provision,

rather than a one-year provision. Paidin capital consists of funds obtained

from credit union and non credit union

sources. Paid-in capital has no maturity

and is 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.

The capital (or ‘‘leverage’’) ratio is

calculated by dividing a corporate credit

union’s capital by its moving daily

average net assets. Including

membership capital in the definition of

capital means that most corporate credit

unions are already at 4 percent. NCUA

believes that 4 percent is appropriate,

because it is the amount estimated to

meet corporate credit union needs and

is comparable to the levels established

by the other financial institution

regulators.

The role of membership capital

relative to a corporate credit union’s

internally generated reserves and

undivided earnings has been cause for

extensive debate. NCUA regards
Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28089

membership capital as a vital

component of the corporate network’s

total capital structure. It is used in

calculating the minimum leverage ratio

(also included in total capital

requirement for expanded authorities),

the limit on loans to members, the limit

on loans to CUSOs, and the limit on

fixed assets. However, for purposes of

market and credit risk exposure, this

proposal sets the MVPE and

concentration limits as a percentage of

the sum of reserves and undivided

earnings and paid-in capital. Indirectly,

the member-contributed capital is in

line to absorb losses, but the revised

proposal seeks to restrict the incidence

of losses to a corporate credit union’s

own equity.

The ability of a member to withdraw

its capital contribution has been

preserved in this revised proposal. The

fact that a member may cancel its

ownership stake, irrespective of any

ability on the part of the corporate credit

union to replace it, adds an

extraordinary dimension to the

capitalization of corporate credit

unions. Some have argued that a

mechanism needs to exist which

permits a member to voluntarily provide

a more permanent form of capital to its

corporate credit union. Thus, the

revised proposal permits a member to

purchase paid-in capital. This

establishes the alternative for a member

to make a perpetual capital investment

which the corporate credit union can

use, along with its reserves and

undivided earnings, for direct risktaking purposes.

As members of a unique, private, and

cooperative financial system, corporate

credit unions will benefit from building

appropriate internal capital reserves

and, in turn, diminish the prospect of

placing member funds directly at risk.

Over time, the buildup of internal

reserves will increase a corporate credit

union’s capacity to provide greater

products and services to members while

it decreases the risk to members that

they will lose their capital stake due to

market or credit risk exposures or other

business losses incurred by their

corporate credit union.

Proposed Part 703, noted above, limits

a natural person credit union’s purchase

of capital shares in corporate credit

unions to one percent of the investing

credit union’s assets. Commenters with

opinions on this issue should direct

them at proposed Part 703.

Since NCUA believes that the stability

of the corporate system will be

strengthened if each corporate credit

union’s reserves and undivided earnings

plus paid-in capital ultimately equals 4

percent of net assets, proposed Section

704.3(c) establishes mandatory reserve

transfers when the amount is below 4

percent. Although NCUA expects that a

4 percent capital ratio will be

appropriate for most corporate credit

unions without expanded authorities, a

higher level may be necessary in the

rare situation when, for example, a

corporate credit union refuses to

recognize a loss, or a loss not

anticipated by the regulation occurs. A

lower level may be appropriate in the

event of a natural disaster or when, for

example, a merger results in the

continuing corporate credit union’s

reserves falling below 4 percent, and a

workout plan has been approved. To

accommodate increasing or decreasing

the capital requirement, proposed

Section 704.3(d) provides that NCUA

may require a different minimum

capital ratio for an individual corporate

credit union based on its circumstances.

Before imposing a different capital

requirement, NCUA will provide notice

to the corporate credit union and allow

it to respond.

In rare circumstances, conditions may

exist in a corporate credit union when

additional reserves may be needed but

are not available immediately. In those

cases, NCUA may require a corporate

credit union to increase the regularly

scheduled reserve transfers with

supplemental transfers which will

ultimately raise the reserves to the

required level. As an example, NCUA

may require that a corporate credit

union transfer 12 basis points each

period, rather than the 10 basis points

required by the regulations. This action

may be taken in conjunction with a

reserve transfer, or in lieu of the reserve

transfer.

As noted earlier, NCUA and corporate

credit union representatives have

discussed this revised proposal during

its development. As the 4 percent

capital ratio requirement has been

debated, some corporate credit union

representatives have asked about the

consequences of going below 4 percent,

because, for example, the corporate

credit union has accepted a large

volume of shares. NCUA is committed

to corporate credit unions maintaining

capital at the required minimum, but

realizes that there may be situations

where a corporate credit union

temporarily drops below that level. To

accommodate sudden spikes in share

growth, the capital ratio is calculated by

dividing capital by the moving daily

average net assets for the previous 12

months.

Proposed section 704.3(e) requires

management of a corporate credit union

to notify the board of directors, the

supervisory committee, and NCUA

within 10 business days when capital

falls below the minimum required. The

10 business days refers to the time

period after the books are closed at

month end. It is important to notify the

board and supervisory committee so

that they can act promptly, including

the calling of a special meeting, if

necessary, to ensure compliance within

the month.

If a corporate credit union is not in

compliance by month end, proposed

Section 704.3(f) requires that it submit

a plan to restore and maintain its capital

ratio at the minimum required level. For

example, if a corporate credit union

closes its books on March 31, and the

capital ratio is 3.9 percent, it must

notify the board of directors, the

supervisory committee, and NCUA by

April 10. If, on April 30, the capital ratio

is at or above 4 percent, no further

action is necessary. If, however, the

ratio is at 3.95 percent, a plan must be

submitted to NCUA by May 15.

Even if a corporate credit union

comes into compliance by the end of the

month, a plan is required if the

corporate credit union drops below the

required minimum two more times

within 12 months from the first

violation. Violating the required

minimum three times in one year

indicates a systemic problem that must

be addressed. Failure to develop an

adequate plan, fully supported by

projections and estimates, increases the

chances that NCUA will issue a capital

directive, a procedure that is provided

for in proposed Section 704.3(g).

A capital directive may 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. Unless a corporate credit

union’s capital level is severely under

the required minimum, it is intended

that capital directive will be issued only

after verbal and written communication

between NCUA and the corporate credit

union has failed to result in an

acceptable capital restoration plan or a

plan has not been followed.

Since a capital directive will be

issued only as a last resort, NCUA

expects full and immediate compliance

with any such directive. NCUA will

view failure to comply with a capital

directive as a serious issue.

It should be noted that the proposed

regulation provides for consultation

with the state regulator where a statechartered corporate credit union is

involved. NCUA will support state

requirements for higher capital levels or

shorter time frames for compliance.

Section 704.3(a) requires that a

corporate credit union develop capital
28090 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

goals, objectives, and strategies. A

corporate credit union should develop

various scenarios to accommodate slow,

medium, and rapid asset growth. It also

should consider setting goals higher

than regulatory minimums in order to

avoid non compliance due to

unexpected growth. Preplanning for

capital growth is needed if a corporate

credit union anticipates applying for

expanded authorities.

Section 704.4—Board Responsibilities

Currently, several different sections of

Part 704 set out policy and operational

requirements for corporate credit union

boards of directors. For example,

Section 704.3 requires boards to adopt

and review strategic plans and to

prepare business plans for certain

material expenditures. Sections 704.4

through 704.7 require corporate credit

unions to develop certain policies and

goals in the areas of asset and liability

management, capital, investments, and

lending, but the board is accountable for

the ratification of and adherence to such

policies and goals. The initial proposed

rule did not substantially change this

approach, maintaining the requirement

for board development of strategic and

business plans in Section 704.3 and the

requirement for credit union

development of capital goals, objectives,

and strategies in Section 704.6. Section

704.4, however, did combine the

requirements for credit union

development of investment and asset

and liability management policies.

No significant comments were

received in this area, but to emphasize

the fact that the board sets the agenda

and is ultimately responsible for the

corporate credit union, Section 704.4 of

this revised proposal requires a board to

approve comprehensive written plans

and policies. The board should oversee

senior management to ensure that policy

limits are consistent with the existing

and forecast levels of capital and that all

activities are conducted in a safe and

sound manner and are consistent with

the board’s overall risk management

philosophy. The board should also

understand the role financial

instruments play in the corporate credit

union’s business strategies and the

mechanisms used to manage risks. The

board must provide for adequate staffing

and technological/financial resources to

support the corporate credit union’s

activities. When a corporate credit

union plans to enter a new market, the

board evaluation should reflect the cost

of establishing appropriate controls,

procedures, and attracting professional

staff with necessary expertise.

The emphasis upon board

responsibilities is not intended to turn

directors into operating managers. A

board needs to delegate the

development of goals, policies, and

procedures to operating management.

However, the board retains the ultimate

responsibility for ensuring that such

delegations are reasonably fulfilled. A

board’s active commitment to this can

significantly improve its awareness and

control of potential risks.

Section 704.5—Investments

Currently, Section 704.6 requires a

corporate credit union to develop

written investment policies and sets out

a list of authorized investments and

divestiture requirements. In the initial

proposed rule, the policies provision

was moved to Section 704.4, and the

remaining provisions were revised and

recodified at Section 704.5. Section

704.5 of the proposed rule also included

the relevant provisions of Part 703,

governing natural person federal credit

union investments, rather than simply

incorporating them by reference. No

comments were received on this matter,

and the split between Parts 703 and 704

has been maintained in this revised

proposal.

Section 704.6 of the initial proposed

rule restricted the aggregate of a

corporate credit union’s investment in

any one institution, issuer, or trust to 25

percent of primary capital. It instituted

minimum asset size and rating

requirements for investments in

depository institutions. It also tightened

the standards for CMOs.

A number of commenters stated that

the 25 percent of primary capital

limitation was too low, arguing that it

would concentrate corporate credit

union investments in the hands of fewer

issuers and create more credit risk in the

industry. They also suggested that U.S.

Government and Agency securities

should be exempt from the restriction.

NCUA agrees that the 25 percent of

primary capital concentration limit was

too low and has also determined that

concentration concerns should properly

focus on credit risk. Therefore, new

concentration limits are set forth in

proposed Section 704.6, which governs

credit risk management.

The weakness in the current CMO

tests became evident during the bear

market of 1994. While the fixed-rate

CMO test proved reasonably adequate in

preventing the purchase of many high

risk fixed-rate CMOs, the floating-rate

test proved inadequate. Many floatingrate CMOs were structured to enable

them to pass the test even though they

contained significant market risk

resulting from option and basis risk.

This revised proposal expands the

fixed rate CMO test to include limits on

extension/contraction of weighted

average life (WAL) and on price

volatility. These are similar to the

second two tests of the Federal

Financial Institutions Examination

Council (FFIEC) test for CMOs. Unlike

the current rule, the proposal allows for

bonds to extend from the initial

expected WAL provision of five years to

seven years. The price volatility test sets

the maximum market value decline at

15 percent of the base case value. This

means that the volatility of a CMO

should not exceed the comparable price

volatility of approximately a five year

zero coupon bond.

This proposal expands the floating

rate CMO test to include three new tests.

There is an initial expected WAL limit,

an extension/contraction WAL limit,

and a price volatility limit. These tests

were proposed in response to the

volatile price history of floating rate

CMOs and the inability of the FFIEC test

to adequately capture cap and basis risk.

The view that floating rate securities are

immune from general market risks has

been rudely dispelled over the past

several years, and NCUA believes there

is a need to subject such securities to

rigorous prepurchase selection tests.

During the dialogue sessions with

corporate credit unions, several

participants argued have that a

comprehensive MVPE analysis which

captures option and basis risk

eliminates the need for a special CMO

test. The fact that total risk is addressed

in MVPE, and subsequently limited as a

percentage of reserves and undivided

earnings plus paid-in capital, may make

the CMO tests redundant and needlessly

restrictive. Commenters are specifically

requested to address this issue.

To control possible ‘‘cherry picking’’

involving the testing of CMOs (selecting

a prepayment model that will allow a

particular CMO to pass the tests), this

revised proposal requires a corporate

credit union board to approve at least

three prepayment models, or a median

estimate, that will be used in the tests.

The models must be used for all

subsequent tests.

Section 704.5(c) of this revised

proposal establishes consistent,

minimum standards for repurchase and

securities lending transactions. These

transactions create room for spread

trade opportunities with minimal MVPE

and credit risk. Proposed Section

704.5(c)(4) requires that collateral

securities be legal for corporate credit

unions, except that CMO/REMIC

securities that pass the FFIEC HRST are

permissible provided that the term of

the transaction does not exceed 95 days.

The 95-day limit will permit standard 3-

month trades with such collateral.
Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28091

Section 704.5(k) of the initial

proposed rule carried over the provision

from Part 703 authorizing investment in

a mutual fund if the investments and

investment transactions of the fund are

legal for the purchasing credit union.

Proposed Section 704.5(d) broadens this

authority by permitting investment in

an investment company that is

registered with the Securities and

Exchange Commission under the

Investment Company Act of 1940, with

the same restriction regarding the

permissibility of the underlying

investments and investment

transactions. A mutual fund is the most

common type of registered investment

company, but credit unions have been

authorized by opinion letter to invest in

other types, such as money market

mutual funds and unit investment

trusts. The regulatory language has been

changed to clarify that these other types

of registered investment companies are

permissible investments for corporate

credit unions. A corporate credit union

can determine if the investments and

investment transactions of an

investment company are permissible by

reviewing the fund’s prospectus and

statement of additional information.

Oral or other written representations

regarding the fund’s activities are not

sufficient. The language also clarifies

that investments such as asset-backed

securities (ABS), which are specifically

authorized for corporate credit unions

but are not registered investment

companies, are permissible regardless of

the underlying instruments that make

up the security.

Proposed Section 704.5(e) sets forth

investment activities that are prohibited

for corporate credit unions that are not

operating with expanded authorities.

Several prohibitions are carried over

from Part 703. Proposed Section

704.5(e)(1) prohibits a corporate credit

union from purchasing and selling offbalance-sheet financial derivatives.

While derivatives can be important risk

management tools, NCUA believes that

they are appropriate only for corporate

credit unions that have sophisticated

risk management systems in place.

Proposed Section 704.5(e)(3) prohibits a

corporate credit union from purchasing

commercial mortgage related securities

and small business related securities

because the market for these securities

is undeveloped and the potential timing

of cash flows from the securities is not

widely disseminated.

Section 704.6—Credit Risk Management

Except for the concept of risk-based

assets, the current regulation addresses

credit risk only briefly. Section 704.6(a)

requires that a corporate credit union’s

investment policies address, among

other things, risk diversification and

approved investment credit limits and

credit ratings. Section 704.6(b)

authorizes the purchase of certain

investments only if they have specific

minimum credit ratings.

The initial proposed rule did not

significantly change this approach.

Section 704.4 required a corporate

credit union to develop policies

regarding acceptable credit risk, to

identify the credit risk associated with

an asset prior to purchase, and to

monitor such risks while an asset was

held. Section 704.5 established

minimum credit ratings for certain

investments and required corporate

credit unions to prepare quarterly

evaluations of lines of exposure to

foreign banks. Some commenters took

exception to some of the required

ratings and to the mandatory quarterly

evaluations. In addition, there was a

suggestion that credit risk be discussed

more comprehensively.

This revised proposed rule addresses

credit risk in a separate section and

requires that the board of a corporate

credit union adopt a written credit

policy that reflects objectives and limits

consistent with its risk management

philosophy. Proposed Section 704.6 was

developed in response to concerns that

some corporate credit unions consider

that credit risk management only

requires the use of credit ratings. This

section requires a corporate credit union

to establish a credit risk management

policy, sets concentration limits and

minimum credit ratings for certain

investments, and establishes specific

reporting and documentation

procedures.

In-depth credit risk management

requires considerable human and

financial resources. Many corporate

credit unions may not wish to commit

the resources necessary to assume

significant credit risk exposure.

Therefore, the proposed rule establishes

conservative credit ratings and

concentration requirements. It also

permits an expansion of these basic

credit authorities provided that credit

risk management resources increase

accordingly. For corporate credit unions

that restrict their credit activities, a

minimum due diligence process is

required. However, if a corporate credit

union increases its credit exposure, the

requirements will increase accordingly.

Proposed Section 704.6(a) requires

that a corporate credit union’s credit

risk management policy address how it

will ensure that it has exercised due

diligence in analyzing credit risk. The

due diligence requirement will not be

met solely by subscribing to a rating

agency’s credit research. To the extent

that a corporate credit union assumes

material credit risk exposures, the

internal analysis must provide the basis

for acceptable credit lines. The analysis

should contain a rationale for the

approved risk exposure. A corporate

credit union choosing to accept greater

risk exposure must have resident credit

expertise commensurate with the level

of risk assumed.

To ensure reduced risks to member

credit unions, the proposal requires a

corporate credit union to establish

maximum credit limits based on its

reserves, undivided earnings, and paidin capital. NCUA believes that

establishing limits based upon net assets

provides a poor basis to support risk

since the size of a corporate credit

union’s balance sheet does not

meaningfully correlate to its capacity to

absorb risk.

The proposal also requires that a

corporate credit union establish limits

on concentrations of credit risk that may

occur, by, for example, sector (e.g.,

automobile industry related

receivables), industry (e.g., banks), or

region (e.g., geographical concentrations

of loans in private mortgage-backed

securities). The policies must address

the fact that diversification by issuer

does not mitigate all pertinent credit

risk factors. Absent the appropriate risk

considerations, NCUA is concerned that

the corporate credit union system’s

assets could become overly

concentrated in one type of credit and

be prone to a systemic credit crisis. The

remedy is not to avoid credit risk but

rather to analyze and manage it.

The credit risk management section

establishes specific concentration limits

for certain types of securities and money

market transactions. These limits are

higher than those set forth in the initial

proposal. NCUA was persuaded that the

more conservative limits could have the

unintended consequence of forcing

corporate credit unions to purchase

securities from issuers with greater

credit risk. A credit instrument which

possesses structural components which

reduce the risk of default is preferred to

a credit instrument that is based upon

the credit quality of the issuer.

Therefore, the concentration limits

make a distinction between securities

which have an element of credit

enhancement and non secured direct

obligations. The latter have no collateral

or securitization enhancements to

absorb losses resulting from default.

Proposed Section 704.6(c)(1) provides

that the aggregate investments in any

single mortgage-backed security (MBS)

or asset-backed security (ABS) or trust

are limited to 200 percent of the sum of
28092 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

the corporate credit union’s reserves

and undivided earnings and paid-in

capital. MBS and ABS are instruments

with substantial credit enhanced

structures. The underlying instruments

provide protection from a credit risk

perspective. The limit on MBS and ABS

was set higher than the limit on

unsecured transactions because of the

relative lower credit risk associated with

these secured investments. This limit

allows for an appropriate level of

activity absent the substantial credit

review process that is requisite for

proportionately greater credit risk

exposures.

Repurchase agreements provide

opportunities for most corporate credit

unions to obtain spread income while

limiting MVPE exposure. Repurchase

agreements and securities lending

typically have a high degree of

protection against default. Since these

transactions are fully collateralized and

valued on a daily basis, they have

minimal credit risk exposure. The

concentration limits set forth in

proposed Section 704.6(c)(2) reflect the

objective to maintain credit risk

management requirements

commensurate with exposures. It

provides that a corporate credit union’s

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.

This limit does not apply to investments

in a wholesale corporate credit union.

The concentration limit restricts the

volume of repurchase transactions with

one counterparty and will require a

corporate credit union to develop an

adequate number of relationships to

support the level of current and

projected repurchase activity.

Proposed Section 704.6(c)(3) limits

non secured transactions to 100 percent

of the sum of a corporate credit union’s

reserves and undivided earnings and

paid-in capital. To the extent that a

corporate credit union cannot conduct

an in-depth analysis of credit

counterparties, this limit restrict

exposures to an appropriate maximum.

It is understood that preferences for risk

taking (i.e., credit versus market risk)

may change over time. The expanded

authorities address the capacity for a

corporate credit union to assume greater

levels of credit exposure if and when it

chooses. NCUA is concerned about

excessive exposures in non secured

credit instruments that are not

supported by the requisite due

diligence.

Proposed Section 704.6(d) addresses

credit ratings. It cannot be emphasized

too strongly that a high rating is not a

substitute for due diligence. Debt

structures and counterparty

creditworthiness must still be evaluated,

and the approval of credit lines and

limits must contain rationale which

reasonably justifies the willingness of

the corporate credit union to place its

capital at risk. The proposed rule

requires that downgraded instruments

be reviewed by the corporate credit

union. The corporate credit union must

ensure that any decision to hold a

downgraded instrument can be justified.

The provision does provide flexibility to

avoid automatic divestiture. The

specific conditions for instruments with

rating which fall below the regulatory

minimum is addressed in proposed

Section 704.10. Although the initial

proposed rule contained entity ratings,

these have not been included in this

revised proposal due to the variability of

standards on the part of the rating

agencies.

In establishing a minimum rating for

asset-backed securities, NCUA

considered the additional legal and

financial structure risks resident in such

securities. The complexity of these

factors is typically greater for lower

rated bonds. Taking these other risk

factors into consideration, it was

decided that that ABS would be limited

to AAA, despite the fact that the relative

credit risk was not necessarily different

from other similarly rated securities.

Proposed Section 704.6(b) exempts

from the credit requirements of Section

704.6 securities issued by the United

States government, its agencies, and

enterprises. Although governmentsponsored enterprises, such as Fannie

Mae and Freddie Mac, have been

exempted, they do possess some credit

risk. A corporate credit union should

not fail to consider that any material

credit risk needs to be evaluated

commensurate with the exposure taken.

These entities should not be considered

exempt from due diligence.

Section 704.7—Lending

Under Section 704.7 of the current

rule, loans to one credit union member

are limited to the corporate credit

union’s capital or 10 percent of its

shares and capital, whichever is greater.

The aggregate amount of loans to non

credit union members is limited to 15

percent of the corporate credit union’s

capital. The aggregate amount of loans

to credit union non members is limited

to 25 percent of the corporate credit

union’s shares and capital, with the

loans to one credit union non member

being limited to capital or 10 percent of

shares and capital, whichever is greater.

Out of concern that the existing

limitation was too permissive and posed

a potential threat to corporate credit

unions and the NCUSIF, Section 704.8

of the initial proposed regulation

limited loans to one member credit

union to the corporate credit union’s

primary capital. Corporate credit unions

were prohibited from lending to

members that were not credit unions,

except for loans to CUSOs and overdraft

protection for clearing accounts, and

were also prohibited from lending to

non members.

A number of commenters argued that

the limitation on loans to one member

credit union was too low. They argued

that there should be a separate

limitation for secured and unsecured

loans, due to the differing magnitude of

potential risk. NCUA agrees, noting that

the majority of corporate credit union

lending to member credit unions is done

on a secured basis. NCUA also notes

that a limit based solely on capital,

which includes membership capital,

may be unfair to some corporate credit

unions, which may choose not to issue

membership capital. Therefore, Section

704.7(c) of this revised proposal limits

unsecured loans to 50 percent of capital

or 75 percent of the sum of the reserves

and undivided earnings and paid-in

capital, whichever is greater, and limits

secured loans to 100 percent of capital

or 200 percent of the sum of reserves

and undivided earnings and paid-in

capital, whichever is greater. NCUA

believes that the unsecured limit

represents a balance between safety and

soundness concerns and the mission of

corporate credit unions to make loans.

The secured lending limit allows for

adequate diversification of the loan

portfolio with limited risk associated

with any one borrower.

NCUA emphasizes that the term

‘‘secured loan’’ is defined to mean a

loan in which the lender has perfected

a security interest in the collateral. The

rules for perfecting a security interest

are governed by state law. For example,

if collateral consists of loans, and state

law requires possession of loan

documents to perfect a security interest

in a loan, then the corporate credit

union must take possession of the

documents. If this is not feasible, then

the loan must be included in the

corporate credit union’s unsecured loan

limit. To assess the impact of the

unsecured vs. secured loan limits,

NCUA seeks comments on restrictions

imposed by state law on individual

corporate credit unions’ lending

activities.

NCUA was convinced by comments

that the corporate credit unions should

have the ability to make loans to non

credit union members. Section 704.7(d)

of the revised proposal allows corporate
Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28093

credit unions to make loans to members

other than credit unions as long as the

loans are in compliance with Section

701.21(h) of the NCUA Rules and

Regulations, which governs member

business loans. Additionally, the

aggregate of loans to members other

than credit unions cannot exceed 15

percent of the corporate credit union’s

capital plus pledged shares.

NCUA also was convinced that

corporate credit unions should have the

authority to make loans to non member

credit unions in order to accommodate

credit unions with branches in other

states. Proposed Section 704.7(e)

authorizes a corporate credit union to

make an overdraft loan related to

correspondent services to a non member

credit union. Although such a loan

generally will have a maturity of only

one business day, NCUA will not take

exception if, in the regular course of

business, an overdraft loan occasionally

has a maturity of two or three days.

Section 704.8—Asset and Liability

Management

Section 704.4 of the current regulation

requires a corporate credit union to

develop and implement comprehensive

written funds management policies and

to prepare monthly reports showing the

degree of mismatch between the sources

and uses of funds. In addition, 704.6

requires a corporate credit union to

develop written investment policies

which address funds management

strategies, among other things.

In response to the assumption of

significant interest rate risk by many

corporate credit unions, Section 704.4 of

the initial proposed rule required that

corporate credit unions identically

match almost all shares and deposits to

corresponding assets. In addition,

corporate credit unions were required to

calculate the fair value of all investment

securities monthly, limit aggregate

losses on available-for-sale assets to 15

percent of primary capital, limit

investment in instruments with

embedded options to capital, and

impose early withdrawal penalties to

guarantee protection from replacement

risk. Most respondents to the original

proposal pointed out that this

combination was too restrictive to

permit both a realistic management of

asset and liability positions and an

adequate provision of basic financial

products and services.

To ensure that corporate credit unions

were cognizant of potential interest rate

risk exposures before they arose,

proposed Section 704.4 required the

performance of monthly ‘‘shock test’’

calculations to show the impact on net

interest income and MVPE of interest

rate changes. The supplementary

information section of the proposed

regulation indicated that NCUA would

conduct analytical assessments of the

proposed rule through simulation

modeling techniques.

The linchpin of the asset and liability

management section of this revised

proposed rule is the use of MVPE.

MVPE shocks provide a critical insight

into potential risks to earnings and

capital. Most financial institutions are

comfortable viewing risk in terms of

variability of income. MVPE adds the

dimension of capital-at-risk to the

assessment of risk exposure. Simulation

models that produce estimates for both

net interest income and MVPE provide

a more comprehensive risk assessment.

NCUA is primarily focused upon the

preservation of capital. MVPE

simulations provide a long-term,

dynamic, and forward-looking

projection of the market risk impact

upon capital. Coupled with net interest

income sensitivity analysis, MVPE

provides a mechanism to view earnings

on a capital-at-risk basis. In most cases,

the management of MVPE will rely

upon the management of asset price

volatility.

NCUA realizes that the level of MVPE

that a corporate credit union targets is

not static. As a corporate credit union

assumes a greater mismatch between

liabilities and assets, MVPE variability

will rise. Corporate credit unions will

need to make constant adjustments to

the level of MVPE exposure based upon

their market biases and preferences. It is

assumed that a corporate credit union

uncomfortable with positioning its

balance sheet based upon assumptions

about future market factors will

minimize MVPE variability by matching

a majority of assets and liabilities. The

management of higher MVPE variability

requires considerable human, financial,

and system resources. The proposed

regulation recognizes that some

corporate credit unions will have

sufficient infrastructure to permit them

to incur more interest rate risk.

This proposal requires that a

corporate credit union maintain a

certain level of MVPE and that it not

decline too drastically in response to

interest rate shocks. However, effective

risk management begins and ends with

the board of directors. The board should

consider that the regulatory limitations

in this rule are outer boundaries. It is

anticipated that boards will set policies

within these boundaries, recognizing

that shock tests can only approximate

real world events are based upon a

number of subjective inputs. Estimated

results frequently vary from actual

results, and corporate credit unions will

need to develop procedures to ensure

regulatory and board policy limits are

not exceeded.

The board also is required to establish

policy limits on the maximum decline

in net income in both percentage and

dollar terms. While NCUA does not

address specific limits for net interest

income or net income in the asset and

liability management section, it

recognizes that corporate credit unions

must evaluate risk both from a

liquidation and a going concern

perspective. The board should receive

reports which reflect the impact on both

the net interest margin and the non

interest components of income.

A corporate credit union also must

model indexes so that it can establish a

relevant correlation between its cost of

funds and the reference indexes to

which asset coupon formulas are linked.

The risk that an index will change

independently of the factors which

affect liabilities creates basis risk. The

MVPE calculation misses a significant

risk when indexes (market and non

market) are not modeled appropriately.

This is particularly important for non

market indexes, such as COFI, where

correlations to funding behavior may be

weak or changes may be difficult to

project.

Proposed Section 704.8(e) requires a

corporate credit union to evaluate the

risk in its balance sheet by measuring

the impact of interest rate changes on its

MVPE and MVPE ratio. A corporate

credit union must limit its risk exposure

to levels that do not result in an MVPE

ratio below 1 percent or a decline in

MVPE of more than 18 percent.

Frequency of testing is a function of the

MVPE ratio. If MVPE is 2 percent or

above, testing must be done quarterly. If

it falls below 2 percent, monthly testing

is required.

The MVPE floor provision of 1

percent is included in the regulation to

reflect, in part, the potential that a

forecast of the effect of interest rates on

a corporate credit union’s balance sheet

will only approximate actual market

effects of interest rates. This floor

(remaining reserves and undivided

earnings plus paid-in capital) must also

absorb other risks which could affect the

corporate’s balance sheet such as

operational, credit, legal, liquidity,

settlement and systemic risk.

There has been considerable debate

on the appropriate level of this floor. A

floor as low as 1 percent provides a

reduced cushion to absorb differences

between forecast results and actual

market conditions, the impact of interest

rate risk not fully reflected by a 300

basis point parallel shock, and the other

risks identified above. This increases
28094 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

the potential that credit unions could

lose membership capital during

significant market disruptions.

Therefore, a low floor may require

NCUA to act more quickly and

forcefully to protect both natural person

credit union membership capital and

the NCUSIF.

NCUA seeks specific data from

corporate credit unions to support the

claim that a floor other than 1 percent

is appropriate. It seeks similar analytical

support for challenges to the 18, 35, and

50 percent variation limits.

If all liabilities are matched with

corresponding assets, investing all

reserves and undivided earnings and

paid-in capital in a 6-year zero coupon

bond is about the same as an MVPE

variance of 18 percent. This is a

moderate but acceptable risk limit for

corporate credit unions with limited

risk management infrastructure. The

firm’s modeling results showed that

corporate credit unions with matched

assets and liabilities had MVPE

variances of less than 5 percent when

their balance sheets were subjected to

plus and minus 300 basis point parallel

shocks. Therefore, corporate credit

unions that choose to remain with the

base case authorities will have room to

manage a mismatch of assets and

liabilities while remaining within

prudent limits.

The assumption of higher MVPE

variability is possible through expanded

authorities, but it is expected that a

corporate credit union with that

authority will aggressively alter its

balance sheet in response to shifting

market trends. Again, the MVPE

variability limit should not be viewed as

a static operating level for market

exposure. Managing money via

significantly mismatching assets and

liabilities carries a host of attendant

risks which must be constantly

evaluated. A corporate credit union

cannot run a mismatched portfolio with

a ‘‘buy and hold’’ strategy. Instead, it

must actively manage its balance sheet

in response to changing market factors.

NCUA believes that the basic shock

test set forth in this revised proposal

will reflect most interest rate risk,

although it may fail to capture some of

the risk associated with other market

conditions. One of the primary concerns

with the MVPE calculations is the

estimate of convexity risk resulting from

embedded options. Most of the

excessive MVPE variability experienced

within the corporate network in recent

years is the result of an excess of

options written (e.g., prepayment

options on amortizing securities and

periodic and lifetime caps on variable

rate bonds) versus options purchased

(usually none). These options typically

represent the most dynamic component

of the MVPE variability.

Therefore, under the proposed rule, a

corporate credit union with instruments

which possess unmatched embedded

options in excess of 200 percent of the

sum of its reserves and undivided

earnings and paid-in capital must

conduct additional tests. NCUA

recognizes that this is a naive hurdle

since the book amount of an instrument

with an option does not represent the

actual amount of option risk. The

development of a specific measure of

option risk was not pursued because of

the unwieldy nature of compliance.

This level was chosen as an

approximate threshold when aggregate

unmatched option exposure could have

a material effect upon MVPE. A number

of tests, in addition to the standard rate

shocks, are required when this hurdle is

exceeded. For example, a corporate

credit union must evaluate the effect on

MVPE of non parallel shifts in the yield

curve. Simulation tests done in

conjunction with this proposal found

that non linear shifts did not have a

significant incremental effect on the test

results. However, the pivot point was

selected at the three year note. A

corporate credit union would need to

conduct a test which pivots around a

point on the curve that reflects its

balance sheet structure.

In addition, adjustments to

prepayment speeds are necessary

because the historical evidence

indicates that prepayment projections

have varied substantially from actual

prepayment behavior. The adjustment to

prepayment speeds in the firm’s

simulated model exercise yielded

significantly different MVPE results.

The supply and demand factors

which can dominate various investment

sectors are reflected in the spread at

which such investments trade relative to

Treasuries. If a model maintains a static

spread assumption in all tests it may not

reflect a crucial form of market risk.

Credit spreads can be driven by

numerous factors, and a corporate credit

union should be prepared to address the

impact of such spreads.

A major potential component of

option value is the measure of volatility.

A corporate credit union must be able

to measure the impact of how changes

in volatility affect MVPE if it has a

material exposure to option risk.

Proposed Section 704.8(f) sets forth

procedures for violations of the

regulatory MVPE limits. This proposed

rule does not require the use of

particular risk models, allowing

corporate credit unions to use their

own. NCUA regards the timely

disclosure of violations as essential for

this approach to remain valid. It is

crucial that NCUA, the corporate credit

union board, and the supervisory

committee, be informed as soon as

possible of any violation that is not

corrected within 5 days. NCUA will

work with the corporate credit union to

assist it in returning to compliance.

Proposed Section 704.8(g) sets forth

procedures for violations of board asset

and liability policy. Again, NCUA must

be informed, but after notification is

provided to the board.

Section 704.9—Liquidity Management

The current rule does not address

liquidity explicitly, although the

requirements in Sections 704.4 and

704.6 regarding the development of

funds management policies clearly

include a concern for liquidity. Further,

Section 704.8 provides that a corporate

credit union may borrow up to 10 times

capital or 50 percent of shares,

whichever is greater. The initial

proposed rule also did not contain a

separate section regarding liquidity, but

paragraph (j) of the asset and liability

section did require corporate credit

unions to develop contingency funding

plans that ranked all sources of liquidity

that were available to service immediate

outflows of member funds. Proposed

Section 704.9 authorized a corporate

credit union to borrow up to 10 times

capital or 50 percent of shares,

whichever was less, and stated that

borrowing could only be done for

liquidity needs.

No significant comments were

received on proposed Section 704.4(j),

but a number of commenters objected to

the proposed limitation on borrowed

funds. In addition, many commenters

questioned the restriction on borrowing

only for liquidity purposes. In Section

704.9 of this revised proposal, NCUA

has determined to leave the borrowing

limit at the current level, that is 10

times capital or 50 percent of shares,

whichever is greater. Further, the

restriction on borrowing only for

liquidity needs has been removed.

However, this revised proposal requires

that a corporate credit union take a

number of actions to ensure that it can

fulfill one of its primary functions, that

of being a liquidity provider. A

corporate credit union must evaluate the

potential liquidity needs of its members

in a variety of economic scenarios,

continuously monitor sources of

internal and external liquidity, ensure

that it has sufficient investment

securities classified as available-for-sale

to meet liquidity needs, and develop a

contingency funding plan.
Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28095

Section 704.10—Divestiture

Currently, Section 704.6(d) provides

that a corporate credit union in

possession of an investment that does

meet regulatory requirements must

either sell the investment within 10

days or request NCUA permission to

hold it. Section 704.5(a) of the initial

proposed rule required divestiture

within 10 days of any downgraded

asset, and 704.5(h)(4) required the same

of any CMO that failed the average life

test or the price sensitivity test.

Many commenters objected to the

general divestiture requirement, stating

that it could result in one corporate

credit union being required to sell a

security at the same time that it was a

legal investment for another corporate

credit union. The commenters also

objected to the absolute nature of both

requirements and the fact that corporate

credit unions were given only 10 days

to sell the downgraded or failed

securities. They stated that automatic

divestiture within a short time frame

could magnify losses if a corporate

credit union were forced to sell in an

adverse market.

With respect to instruments that have

been downgraded but are still

permissible under the regulations,

proposed Section 704.6 now requires

only that a corporate credit union

review the investment and be able to

justify any decision to hold. With

respect to instruments that have failed

a requirement of Part 704, proposed

Section 704.10 requires that the board

and NCUA be informed within 20

business days. If the investment

continues to fail, the corporate credit

union must provide NCUA with a plan

within 25 business days that provides

the characteristics and risks of the

investment, how it fits into the

corporate credit union’s asset and

liability management strategy, the

impact of holding or selling, and the

likelihood that the investment will

again meet the requirements of Part 704.

Although the proposed rule provides for

NCUA to require submission of the plan

in less than 25 days, it is anticipated

that this would be necessary only if

there were a serious safety and

soundness problem.

Section 704.11—Corporate Credit Union

Service Organizations (Corporate

CUSOs)

Currently, the authority of corporate

credit unions to invest in credit union

service organizations (CUSOs) is

contained in Section 704.6 and the

authority to lend to CUSOs is contained

in Section 704.7. In addition, rather

than setting forth specific CUSO

guidelines, Section 704.6 incorporates

by reference much of Section 701.27,

which governs natural person

investments in and loans to CUSOs.

NCUA determined, in the initial

proposed rule, to address corporate

credit union investments in and loans to

CUSOs in one section and to explicitly

include the applicable portions of

Section 701.27. This was done in

proposed Section 704.7.

NCUA also proposed to create a new

term for corporate CUSOs: corporate

service organizations (CSOs). A CSO

was limited to serving only the

corporate credit unions that had

invested in or loaned to the CSO and/

or the members of such corporate credit

unions. In addition, CSOs were

authorized to provide only a few of the

services authorized for natural person

CUSOs. Finally, the proposed rule

required that a CSO be chartered as a

corporation under state law.

In response to comments and because

‘‘CUSO’’ is a term used and understood

throughout the credit union industry,

NCUA has determined to retain use of

the term in the context of corporate

credit unions. To avoid confusion with

natural person CUSOs, however, this

revised proposal does adopt the term

‘‘corporate CUSO.’’ In addition, for ease

of reference, the definition of corporate

CUSO has been included in Section

704.11, rather than being placed in

Section 704.2.

The limitation on the types of entities

that could be served by a CSO was

designed to preserve the integrity of

field of membership requirements. The

thought was that if a corporate credit

union could provide services to any

natural person credit union through a

CUSO, field of membership limitations

would be less meaningful. Further,

NCUA did not wish to address the issue

of broadening corporate credit union

fields of membership in the proposed

regulation. The commenters, however,

argued forcefully that CSOs should be

able to provide services to non

members. They suggested that a CSO

should be permitted to develop

expertise in a specific service which

could benefit all natural person credit

unions. NCUA agrees and the proposed

rule allows corporate CUSOs to serve

natural person credit unions that are not

members of affiliated corporate credit

unions.

In proposing to limit the services that

could be provided by CSOs, NCUA was

attempting to relate those services to the

daily activities of corporate credit

unions, that is, serving credit unions

rather than natural persons. However,

the commenters argued that CSOs

should be able to participate in ventures

related to services for members of

natural person credit unions, such as

shared branching and home banking.

NCUA is persuaded that corporate

CUSOs can have a broader purpose.

Accordingly, this revised proposed rule

requires simply that a corporate CUSO

restrict its services to those related to

the daily activities of credit unions.

Section 701.27(d) of the NCUA

Regulations provides guidance in this

area.

Section 704.7 of the initial proposed

rule limited the aggregate of all

investments in and loans to member and

non member CSOs to 15 percent of a

corporate credit union’s capital. Some

commenters expressed concern that

CUSOs involved in secondary mortgage

market activities might need additional

funds at certain times. This revised

proposal allows a corporate credit union

to loan to CUSOs an additional 15

percent of capital, provided that the

loan is secured.

Section 704.7 of the initial proposal

also incorporated some of the

limitations and requirements of Section

701.27 (b) and (d). One of these was the

requirement that the credit union

‘‘ensure’’ that it will not be held liable

for the obligations of the CUSO. Some

commenters stated that it was

impossible to provide absolute

assurance on this score. In response,

Section 704.11(b) of this revised

proposal requires a corporate credit

union to 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. The

point of this requirement is to obtain

reasonable assurance that a corporate

CUSO is operated as a sufficiently

separate entity that a court would not

‘‘pierce the corporate veil,’’ conclude

that the CUSO and corporate credit

union were essentially the same

organization, and hold the corporate

credit union liable for the obligations of

the CUSO. Since there seems to be some

confusion on this issue, clarifying

language has been added.

Since initial proposed Sections

704.7(b) and (c) received little comment,

they have been retained in revised

proposed Sections 704.11(c) and (d).

Section 704.7(d) of the initial proposed

rule required a corporate credit union to

take steps to bring its investments and

loans in line with the new regulation.

Since CSOs were significantly more

restricted than were CUSOs, it was

possible that many investments in and

loans to CUSOs would not have been

authorized. This provision has not been

retained in the revised proposed rule, as
28096 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

corporate CUSOs will have much the

same authority as existing CUSOs, and

the majority of existing investments and

loans will continue to be authorized.

Finally, Section 704.11(e) of the revised

proposed rule clarifies that the sole

authority for a corporate credit union to

invest in or loan to a CUSOs is that

contained in Part 704.

Section 704.12—Services

Section 704.9 currently states that

corporate credit unions may provide

services involving investments,

liquidity management, payment

systems, and correspondent services.

NCUA believed that this authority had,

on occasion, been interpreted too

broadly and proposed revising this

section to eliminate the specific list of

services. The initial proposal simply

stated that corporate credit unions could

provide services to their member credit

unions, intending that to mean

traditional loan, deposit, and payment

services. The initial proposal also stated

that a corporate credit union could

provide services only to its members

and could not provide services to non

members through correspondent credit

union arrangements or the service

contract authority of Section 701.26 of

the NCUA Rules and Regulations.

Some commenters expressed

confusion regarding the prohibition

against correspondent credit union

arrangements. The intent was to

prohibit arrangements whereby two

corporate credit unions would agree for

one to provide services to the members

of another. NCUA has determined,

however, that a corporate credit union

may provide services to the members of

another corporate credit union,

provided that the second corporate

credit union consents and NCUA has

given its prior written approval. A

corporate credit union also may provide

correspondent services to non member,

natural person credit union branch

operating in the geographical area that

the corporate credit union serves.

Section 704.13—Fixed Assets

Currently, Section 704.11 limits a

corporate credit union’s investment in

fixed assets to 15 percent of capital. The

initial proposed rule changed the

limitation to 15 percent of primary

capital, in order to control future large

fixed asset investments. Some

commenters argued that the proposed

limitation was too restrictive, while

others stated that corporate credit

unions should not put a significant

portion of their funds into fixed assets.

NCUA has determined that corporate

credit unions may need to make greater

investments in fixed assets, in order to

better serve their member credit unions,

and has set the limit in this revised

proposed rule at 15 percent of capital.

In addition, the requirements relating to

the submission of waivers from the

limitation have been condensed. As in

the initial proposed rule, this revised

proposal eliminates the provision

regarding a corporate credit union

proceeding with its investment if it does

not receive notification of the action

taken on its request within 45 days. This

will ensure that NCUA has adequate

time to review requests to invest more

than 15 percent of capital in fixed

assets.

Section 704.14—Representation

As noted earlier, NCUA amended the

representation section of Part 704 in

1994. Those changes were made because

NCUA was concerned about both real

and apparent conflicts of interest. The

initial proposed rule recodified that

section as 704.13, and amended it

further by providing that only

representatives of member credit unions

were permitted to vote and stand for

election. It also incorporated by

reference the provisions of Section

701.14 of the Rules and Regulations,

governing changes in officials and

senior executive officers in credit

unions that are newly chartered or in

troubled condition.

Although few comments were

received on this section, NCUA has

received assurances that this issue will

be addressed by the corporate credit

unions themselves and, thus, has

determined not to go forward with the

proposal to allow only representatives

of member credit unions to vote and run

for office.

For the reasons stated in the preamble

to the initial proposed rule, this revised

proposal again incorporates the

provisions of Section 701.14.

Section 704.15—Audit Requirements

Currently, Section 704.13 only

addresses the requirements for annual

audits. The initial proposed rule

recodified the provision at Section

704.14 and added a requirement for an

internal auditor function for corporate

credit unions with assets over $100

million. The proposed rule did not

require the hiring of a full-time internal

auditor, and the supplementary

information section indicated that,

based on the asset size and complexity

of the institution, it would be

permissible to hire a part-time auditor

or contract with an outside firm to

perform the function. The proposed rule

did list specific responsibilities of the

internal auditor.

Section 704.15 of the revised

proposed rule segregates the audit

requirements by external and internal

functions. The external audit function

relates to the annual opinion audit.

Although the existing regulation

contains the phrase reportable

conditions letter, some commenters

were confused about the meaning of the

term. Accordingly, it has been deleted.

This revised proposal requires that all

correspondence provided to a corporate

credit union by the external auditor be

made available to NCUA.

A number of commenters stated that

$100 million was too low a threshold for

an internal auditor function

requirement. NCUA agrees and has set

a threshold of $400 million in this

proposal. In addition, rather than listing

specific responsibilities for the internal

auditor, the revised proposed rule

simply states that the auditor must meet

the guidelines of the Standards and

Professional Practices of Internal

Auditing, as established by the Institute

of Internal Auditors. This proposal also

requires that the internal auditor report

to the chair of the supervisory

committee, who may delegate

supervision of the internal auditor’s

daily activities to the chief executive

officer of the corporate credit union.

The authority to delegate was provided

in response to comments that the

supervisory committee normally is not

directly involved in the daily operation

of the corporate credit union,

Notwithstanding the statement in the

supplementary information section that

the proposed rule did not require the

hiring of a full-time internal auditor,

some commenters stated that the

corporate credit union did not have the

resources to hire such an auditor. Again,

this is not required. Some corporates

have the operational complexity to

warrant a full-time internal auditor on

staff. Other corporate credit unions may

choose to hire a part-time internal

auditor or contract with an outside firm

to perform the internal auditor function.

Section 704.16—Contracts/Written

Agreements

Neither the initial proposed rule nor

this revised proposal made changes to

this provision.

Section 704.17—State-Chartered

Corporate Credit Unions

The initial proposed rule added new

Section 704.16(b) to put non federally

insured state-chartered corporate credit

unions that receive funds from federally

insured credit unions on notice that

they were considered ‘‘institutionaffiliated parties’’ within Section 206(r)

of the Federal Credit Union Act and
Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28097

subject to all of the enforcement

provisions of the Act. There was no

significant objection to the proposal and

it has been retained in this revised

proposed rule.

Section 704.18—Fidelity Bond Coverage

The currently regulation specifically

lists the bond forms that NCUA has

approved for corporate credit unions.

NCUA has recently approved several

new forms for credit unions, CUMIS

Credit Union Bond 200, CUMIS Credit

Union Bond 300, and CUMIS Credit

Union Bond 400, all of which corporate

credit unions may use, although some

may not be appropriate for particular

institutions. Rather than adding these to

the proposal and then having to amend

the regulation as other forms are

approved in the future, this proposal

deletes all references to specific bond

forms. Instead of listing them in the

regulation, NCUA will notify corporate

credit unions of all approved forms as

new forms are approved.

In current Section 704.17, the

deductibles are based on a corporate

credit unions primary capital to risk

asset ratio. Since the initial proposed

rule eliminated this ratio, the primary

capital ratio was used in this section.

The initial proposal also clarified that

the minimum bond coverage would be

based on a corporate credit union’s

average daily assets as of the preceding

December 31. NCUA received few

comments on this section.

Since the primary capital ratio is

being eliminated in this revised

proposed rule proposed Section 704.19

uses the corporate credit union’s reserve

ratio. NCUA requests comments on the

effect of this change on a corporate

credit union’s deductible. In addition,

the proposed rule deletes current

Section 704.17(e), which allows a

corporate credit union to request

approval for reduced coverage. Under

Section 704.1, a corporate credit union

may request a waiver of any provision

of Part 704.

Appendix A—Model Forms

Appendix A of the current rule sets

forth a summary of risk weights and risk

categories used to calculate a corporate

credit union’s capital to risk-weighted

assets ratio. Since this revised proposed

rule eliminates the required calculation

of that ratio, the summary has been

deleted. Appendix A of this revised

proposal contains variations of the

model disclosure forms that were set

forth in Appendix C of the initial

proposal.

Appendix B—Expanded Authorities and

Requirements; Appendix C—Guidelines

for Evaluating Requests for Expanded

Authorities

Appendix B of the current rule sets

out off-balance-sheet conversion factors

that are used in calculating the capital

to risk-weighted assets ratio. Since the

ratio is not used in this proposal, the

factors have been deleted. Appendix C

currently contains a list of U.S.

Government obligations and agencies.

Rather than having a fixed list, which

may become outdated as entities are

created, dissolved, or changed, the

proposed rule contains definitions of

government agencies and enterprises

and places the responsibility for

determining an entity’s status on the

corporate credit union.

Appendix B of this revised proposal

sets forth incrementally greater

authorities for corporate credit unions

and the infrastructure and capital

requirements that must be in place to

obtain such authorities. NCUA

recognizes that each corporate credit

union has partly evolved in response to

unique competitive forces and member

needs. The mission of a corporate credit

union and its capacity to fulfill its

respective goals can vary considerably

from institution to institution.

Expanded authorities were established

to permit the corporate credit unions

that qualify to obtain a reasonable

expansion of market and credit risk

limits. This mechanism permits the

flexibility for self-determination and it

avoids the consequence of regulating

down to the least developed institutions

at the expense of the most developed.

The expanded authorities are a

natural extension of the existing waiver

process whereby a corporate can submit

a request to NCUA to obtain additional

powers or an exemption from some

provision of the rules and regulations.

None of the incremental powers

provided for in this proposal are beyond

the scope of existing waiver authorities.

Codifying these powers in the regulation

standardizes the process and provides

an established set of criteria for

approval.

Authorities are segregated into four

parts to allow for some measure of

selectivity by corporate credit unions

that may seek only limited expansions

of their basic operating powers. These

parts, and their respective guidelines for

approval, are based upon an increasing

scale of depth and complexity. Greater

expansions of authority are supported

by greater capacities to measure and

control the corresponding risks.

Proposed Appendix C sets forth

guidelines for evaluating requests for

expanded authorities. The guidelines

are based, in part, on a number of

subjective factors. Factors include the

areas of board, management and staff;

systems and operations; credit risk

management; liquidity risk

management; audit and compliance; and

legal.

The proposal requires that a corporate

credit union seeking to use the

expanded authorities set forth in Part 1

of Appendix B have a capital ratio of 5

percent and meet additional

infrastructure criteria set forth in

Appendix C. Additional capital is

required because of the greater

opportunity to take risk. Strengthened

management, staff, and systems are

required in order to safely manage that

risk. A corporate credit union seeking to

use the even more expanded authorities

set forth in Part 2 of Appendix B must

have a capital ratio of 6 percent and

meet even stronger infrastructure

criteria. Again greater risk requires

greater protection against loss and

greater ability to manage the risk.

The proposal requires that a corporate

credit union seeking to invest in foreign

obligations, as set forth in Part 3 of

Appendix B, have a capital ratio of 5

percent, meet the infrastructure criteria

required for corporate credit unions

seeking the expanded authorities under

Part 1 of Appendix B, and meet

additional infrastructure criteria relating

to automation of systems and staff

experience with foreign credit. A

corporate credit union seeking to use

financial derivatives, as set forth in Part

4 of Appendix B, also must have a

capital ratio of 5 percent and meet the

infrastructure required for corporate

credit unions seeking the expanded

authorities under Part 1 of Appendix B.

In addition, the corporate credit union

must apply to NCUA for the specific

derivatives authority sought and have

additional staff and systems in place to

adequately control the risks of such

instruments.

Part 709—Involuntary Liquidation and

Creditor Claims

Section 709.5(b) of the NCUA Rules

and Regulations establishes a payout

priority for claims against credit unions

that are in involuntary liquidation.

Currently, the seventh item is

membership capital share deposits of

corporate credit unions. Since the

proposed rule uses the term

‘‘membership capital,’’ the words ‘‘share

deposits’’ have been deleted. The

proposed rule also provides for an

eighth item, i.e., paid-in capital.
28098 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

Part 741—Requirements for Insurance

The initial proposed rule amended

Section 741.3 of the NCUA Rules and

Regulations, governing requirements for

insured credit unions, to prohibit

federally insured credit unions from

transacting business with corporate

credit unions that did not comply with

Part 704 and were not examined by

NCUA. There was no significant

objection to the proposal and it has been

retained in this revised proposed rule.

In the interim, Section 741.3 has been

recodified, so this revised proposed rule

creates new Section 741.219, containing

the same language as set forth in the

initial proposal.

H. 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 collection of information

contained in this notice of proposed

rulemaking has been submitted to the

Office of Management and Budget for

review in accordance with the

Paperwork Reduction Act of 1980 (44

U.S.C. 3504(h)). Comments on the

collection of information should be

directed to Ms. Beauchesne, at the

National Credit Union Administration,

1775 Duke Street, Alexandria, Virginia

22314–3428; Fax No. (703) 518–6433; EMail Address: SUEB@NCUA.GOV

within 90 days from the date of this

publication in the Federal Register.

Comments should also be sent to the

OMB Desk Officer at the following

address: Mr. Milo Sunderhauf, OMB

Reports Management Branch, New

Executive Office Building, Room 10202,

Washington DC 20530.

The collection of information

requirements in this proposed

regulation are found in 12 CFR [704.2;

704.3(a); 704.4(a); 704.6(a); 704.7(a);

704.8(a); 704.3(e)–(g); 704.5(b)(i)–(v);

704.6(e); 704.8(e)–(g); 704.10; 704.15(b);

and Appendices A and B]. This

information is required by corporate

credit union management and staff in

making critical operational decisions on

an ongoing basis. Additionally, the

information will be utilized by NCUA

during the annual examination and the

ongoing supervision process. The

respondents and recordkeepers are

corporate credit unions. Respondents

and recordkeepers are not required to

respond to this collection of information

unless it displays a currently valid OMB

control number.

Respondents: Corporate credit unions.

Estimated number of respondents

and/or recordkeepers: 41.

Estimated average annual burden

hours per respondent/recordkeeper:

3,909 hours.

Estimated total annual reporting and

recordkeeping burden: 160,293 hours.

Estimated Total Annual Cost:

$4,018,630.

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 proposed rule

would help assure that proper

safeguards are in place to ensure the

safety and soundness of corporate credit

unions.

The rule applies to all corporate credit

unions that accept funds from federally

insured credit unions. 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

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.

I. List of Subjects

12 CFR Part 704

Credit unions, Reporting and

recordkeeping requirements.

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 May 22, 1996.

Becky Baker,

Secretary of the Board.

For the reasons set out in the

preamble, NCUA proposes to amend 12

CFR parts 704, 709, and 741 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.

Appendix A to Part 704—Model Forms

Appendix B to Part 704—Expanded

Authorities and Requirements

Appendix C to Part 704—Guidelines for

Evaluating Requests for Expanded

Authorities

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

and 1789.

PART 704—CORPORATE CREDIT

UNIONS

§ 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.
Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28099

(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 must be

approved by the state regulator before

being submitted to NCUA.

§ 704.2 Definitions.

Adjusted trading means any method

or transaction used to defer a loss

whereby a corporate credit union sells

a security to a vendor at a price above

its current market price and

simultaneously purchases or commits to

purchase from the vendor another

security at a price above its current

market price.

Asset-backed 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).

Business day means a day other than

a Saturday, Sunday, or federal holiday.

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 whole loan mortgages

or mortgage-backed 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.

Commitment means any

unconditional arrangement that

obligates a corporate credit union to

extend credit in the form of loans; to

purchase loans, securities or other

assets; or to participate in loans and

leases. Commitments also include

overdraft facilities, revolving credit,

home equity, and mortgage lines of

credit, and similar transactions. An

obligation is conditional if the corporate

credit union is not automatically

obligated to extend funds.

Corporate credit union means an

organization that:

(1) Is chartered under Federal or state

law as a credit union;

(2) Receives shares from and provides

loan services to credit unions;

(3) Is operated primarily for the

purpose of serving other credit unions;

(4) Is designated by NCUA as a

corporate credit union;

(5) Limits natural person members to

the minimum required by state or

federal law to charter and operate the

credit union; and

(6) Does not condition the eligibility

of any credit union to become a member

on that credit union’s membership in

any other organization.

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.

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,

caps, floors, and prepayment options.

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

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 transfer of

funds between U.S. depository

institutions.

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 rate agreement means an

over-the-counter contract between

counterparties where one party agrees to

pay the other a specified interest rate

payment on a reference notional amount

at a specified date in the future

(settlement date). The amount paid or

received at the settlement date of the

contract is based on the market value of

the contract. The market value depends

upon the notional amount, the contract

rate, and the prevailing market reference

rate at the time of settlement.

Futures contract means a contract for

the future delivery of commodities,

including certain money market

instruments and government securities,

sold on commodities exchanges.

Gains trading means the purchase of

a security as an investment portfolio

asset and the subsequent sale of that

same security at a profit after a shortterm holding period.

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.

Market value of portfolio equity

(MVPE) means the fair value of assets

minus the fair value of liabilities. All

fair value calculations must include the

value of embedded options.

Membership capital is treated as a

liability for purposes of this calculation.

The MVPE ratio is calculated by

dividing MVPE by the fair value of

assets.

Matched means, with respect to assets

and liabilities, that the factors which

affect cash flows of an asset are

replicated in a corresponding liability.

Material means an amount that

exceeds 5 percent of the corporate credit

union’s capital.

Maturity date means the date on

which a security matures, and shall not

mean the call date or the average life of

the security.

Member reverse repurchase

transaction means an integrated

transaction in which a corporate credit

union purchases a security from one of

its member credit unions under

agreement by that member credit union
28100 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

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).

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. Membership capital

may be sold to a member, 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 established and

disclosed by the corporate credit union

at the time the account is opened (e.g.,

one percent of a member credit union’s

assets). 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 backed security means a

security that represents either an

ownership claim in a pool of mortgages

or an obligation that is secured by such

a pool, where the cash flows are passed

through to the holders of the security.

Mortgage related security means a

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

the Securities Exchange Act of 1934,

i.e., a privately-issued 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 interest income means the

difference between income earned on

interest bearing assets and interest paid

on interest bearing liabilities.

Nonsecured investment means an

obligation backed solely by the

creditworthiness of the obligor.

Official means any director or

committee member.

Option contract means a right, but not

an obligation, to buy or sell a security

at a specified price and settlement date

in the future.

Paid-in capital means funds which

are obtained from credit union and non

credit union sources and are available to

cover losses that exceed reserves and

undivided earnings. Paid-in capital is

nonvoting and subordinate to

membership capital and the NCUSIF.

The funds have no maturity 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. The terms and

conditions of a paid-in capital account

held by a member or non member credit

union must be disclosed to the recorded

owner of such account at the time the

account is opened and at least annually

thereafter.

Pair-off transaction means a security

purchase transaction that is closed out

or sold at, or prior to, the settlement or

expiration date.

Penalty for early withdrawal of a

share, deposit, or liability means a fee

which will, at a minimum, fully

compensate a corporate credit union for

the difference between fair value and

book value of the asset that is divested

(including any accumulated losses since

the asset was purchased), or the

replacement cost of funds, to meet the

demand for early withdrawal.

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.

Primary dealer means a bank or

investment dealer authorized to buy and

sell government securities in direct

dealings with the Federal Reserve Bank

of New York in its execution of Fed

open market operations.

Private placement means the sale of

an entire issue to a small group of

investors. Except for investments with

tax shelter provisions, private

placement to 35 or fewer investors are

exempt from Securities and Exchange

Commission registration requirements.

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.

Repurchase transaction means a

transaction in which a corporate credit

union agrees to purchase a security from

a counterpart and to resell the same or

any identical security to that

counterpart at a later date.

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 mean all regular or statutory

reserves, including 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.

Reverse repurchase transaction means

a transaction whereby a corporate credit

union agrees to sell a security to a

purchaser and to repurchase the same or

any identical security from that
Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28101

purchaser at a future date and at a

specified price.

Section 107(8) institution means an

institution described in Section 107(8)

of the Federal Credit Union Act (12

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

Secured loan means a loan

collateralized by assets in which the

lender has perfected a security interest

under state law.

Securities lending transaction means

a transaction in which a federal credit

union agrees to lend a security to a

counterparty.

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 counterpart for settlement

of the purchase or sale of a security.

Short sale means the sale of a security

not owned by the seller.

Short-term investment means, for the

purpose of issue ratings, an investment

that has an initial maturity, or expected

maturity, of one year or less.

Small business related security means

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

of the Securities and Exchange Act of

1934, 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.

Swap agreement means a contract to

exchange payments that are based upon

a specified dollar amount at specified

dates in the future.

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.

Tri-party contract means a repurchase

agreement between two parties in which

a third party acts as a custodian for the

securities involved.

Undivided earnings means all forms

of retained earnings, except:

(1) Regular or statutory reserves; and

(2) Valuation allowances established

to meet the full and fair disclosure

requirements of § 702.3 of this chapter.

United States Government or its

agencies means the United States

Government or instrumentalities of the

United States, the debt obligations of

which are fully and explicitly

guaranteed as to the timely payment of

principal and interest by the full faith

and credit of the United States

Government.

United States Government-sponsored

corporations and enterprises means

agencies originally established or

chartered to serve public purposes

specified by Congress, the debt

obligations of which are not explicitly

guaranteed by the full faith and credit

of the United States Government.

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.

Wholesale corporate credit union

means a corporate credit union which

meets the requirements of Part II of

Appendix B of this part and 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 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

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. In the case of a

state-chartered corporate credit union,

NCUA also will provide notification and

explanation to the state supervisory

authority.

(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 10

business 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 10

business 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, and, in the case

of a state-chartered corporate credit
28102 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

union, in consultation with the state

supervisory authority, 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, as applicable, operating

management of the corporate credit

union must notify its board of directors,

supervisory committee, and NCUA

within 10 business 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, and in the case

of a state-chartered corporate credit

union, to the state supervisory

authority, within 30 business days of

the occurrence.

(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. In the case of a statechartered corporate credit union, NCUA

also will provide notice to the state

supervisory authority.

(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 10 business

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 its comments to be

considered, the state supervisory

authority must respond in writing

within the same 10 business days. For

good cause, the response time may be

shortened or lengthened, including the

following conditions:

(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 10

business 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

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. The board of

directors must know and understand the

activities, policies, and procedures of

the corporate credit union.

(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:
Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28103

(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 with adequate cross-training

are in place;

(3) GAAP is followed;

(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 industryestablished 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 necessary

retention of external consultants to

review the adequacy of technical,

human, and financial resources

dedicated to support major risk areas.

§ 704.5 Investments.

(a) All investments must be U.S.

dollar-denominated and subject to the

credit policy restrictions set forth in

§ 704.6.

(b) 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 and Section

107(8) institutions and deposits in 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, subject to these

additional limitations:

(i) Fixed rate CMOs/REMICs must

meet the following NCUA-modified

Federal Financial Institutions

Examination Council (FFIEC) High Risk

Security Test requirements:

(A) The weighted average life may not

exceed 5 years at the time of purchase;

(B) The weighted average life may not

extend by more than 2 years, nor

contract by more than 3 years for an

instantaneous, permanent, and parallel

shift in market rates of plus or minus

300 basis points;

(C) The extended weighted average

life may not, in any case, exceed 7 years;

and

(D) The investment’s price may not

decline by more than 15 percent for an

instantaneous, permanent, and parallel

shift in market rates of plus or minus

300 basis points;

(ii) Floating rate CMOs/REMICs must

meet the following NCUA-modified

FFIEC High Risk Security Test

requirements:

(A) The weighted average life of the

security may not exceed 7 years at the

time of purchase;

(B) The weighted average life may not

extend by more than 2 years, nor

contract by more than 3 years for an

instantaneous, permanent, and parallel

shift in market rates of plus or minus

300 basis points;

(C) The extended weighted average

life may not, in any case, exceed 9 years;

and

(D) The investment’s price may not

decline by more than 10 percent for an

instantaneous, permanent, and parallel

shift in market rates of plus or minus

300 basis points;

(iii) The NCUA-modified FFIEC High

Risk Security Tests must be prepared

monthly on all CMO/REMICs,

documented and reviewed by an

appropriate committee, and retained

until after completion of the next audit

and examination;

(iv) 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;

and

(v) 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 tests set forth in paragraph

(b)(6) of this section.

(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.

(c) A corporate credit union may enter

into a repurchase agreement or

securities lending transaction provided

that:

(1) The corporate credit union takes

physical possession of the security,

receives written confirmation of the

purchase and a safekeeping receipt from

a third party under a written custodial

contract, or is recorded as owner of the

security through the Federal Reserve

Book-Entry Securities Transfer System;

(2) Collateral securities are legal

investments for corporate credit unions,

except that a corporate credit union may

receive, as permissible collateral, CMO/

REMIC securities that pass the FFIEC

High Risk Security Test if the term of

the repurchase transaction does not

exceed 95 days from the date of

settlement;

(3) In the event of default, the

corporate credit union sells the

collateral in a timely manner, subject to

a bankruptcy stay, to satisfy the

commitment of any net principal and

interest owed to it by the counterpart;

(4) The corporate credit union

receives daily assessment of the market

value of collateral securities, including

a market quote or dealer bid indication

and any accrued interest, and maintains

adequate margin that reflects a risk

assessment of the collateral securities

and the term of the transaction;

(5) The corporate credit union has

entered into signed contracts with all

approved counterparts. 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 collateral

is priced and reported daily and the triparty agent ensures compliance; and

(6) The corporate credit union has

sufficient market relationships

established in advance to timely execute

the disposition of collateral securities.
28104 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

(d) 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 management company is

restricted by its investment policy,

changeable only if authorized by

shareholder vote, solely to investments

and investment transactions that are

permissible for that corporate credit

union.

(e) A corporate credit union is

prohibited from:

(1) Purchasing or selling financial

derivatives such as futures, options,

interest rate swap contracts, or forward

rate agreement;

(2) Engaging in pair-off transactions,

when issued trading, adjusted trading,

gains 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.

(f) 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.

(g) 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, which addresses, 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 counterpart, 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 counterparts 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.,

sector, industry, and regional

concentrations);

(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 counterpart 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.

(2) The rating(s) must be monitored

for as long as the corporate owns an

instrument.

(3) Any rated instrument that is

downgraded by the nationally

recognized statistical rating

organization(s) used to meet the

requirements of this part at the time of

purchase must be reviewed by an

appropriate committee within 20

business days of the downgrade.

Instruments that fall below the

minimum rating requirements of this

part are subject to the divestiture

requirements of 704.10.

(4) Investments in asset-backed

securities must be rated no lower than

AAA (or equivalent). All other

investments must be rated no lower

than A–1 (or equivalent) for short-term

investments and AA (or equivalent) for

long-term investments at the time of

purchase and at any subsequent time by

the nationally recognized statistical

rating organization(s) used to meet the

requirements of this part at the time of

purchase.

(e) Reporting and documentation.

(1) A written evaluation of each credit

line must be prepared at least annually

and formally approved by an

appropriate committee of the board. A

watch list of existing and/or potential

credit problems must be prepared at

least monthly and provided to an

appropriate committee of the board.

Summary credit exposure reports,

which demonstrate compliance with the

corporate’s risk management policies,

must be continuously maintained,

reviewed by appropriate staff, and

provided monthly to the board.

(2) At a minimum, the corporate must

maintain:

(i) A justification for each approved

credit line;

(ii) Prospectuses for all publicly

traded securities and offering

memoranda for private placements and

securities that are exempt from the

registration requirements of the

Securities Act of 1933 or the margin

requirements of the Securities Exchange

Act of 1934; and

(iii) The latest available financial

reports, industry analyses, internal and

external analyst evaluations, and rating

agency information for 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.

The maximum aggregate amount in

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, for unsecured

loans and irrevocable lines of credit, or

100 percent of capital or 200 percent of

the sum of reserves and undivided

earnings and paid-in capital, whichever
Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28105

is greater, for secured loans and

irrevocable lines of credit.

(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. 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 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 market value of

portfolio equity (MVPE), over specified

periods of time, compared to current

MVPE;

(4) The minimum allowable MVPE

ratio under any condition;

(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

(e) of this section;

(7) Concentration limits that reflect

the default, liquidity, and market risks

of investments;

(8) Policy limits which address

transaction types and amounts for all

off-balance sheet risk (e.g., lines of

credit or other contracts); and

(9) 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 the 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, 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) Risk analysis. A corporate credit

union must adopt appropriate tests and

criteria for evaluating each investment

prior to its purchase. Risk analysis of

the instrument type and industry sector

must be conducted for any new product

that is considered for purchase by the

corporate credit union and/or for sale to

members.

(e) 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 or minus

100, 200, and 300 basis points on its

MVPE and MVPE ratio. If the base case

MVPE ratio falls below 2 percent at the

last testing date, these tests must be

calculated no less frequently than

monthly until the base case MVPE ratio

again exceeds 2 percent; and

(ii) Limit its risk exposure to levels

that do not result in a MVPE ratio below

1 percent at any time either from a

calculation of a base case MVPE ratio or

as a result of the tests indicated in

paragraph (e)(1)(i) of this section.

(2) A corporate credit union must

limit its risk exposures to levels that do

not result in a decline in MVPE of more

than 18 percent at any time.

(3) 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 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.

(f) Regulatory violations. If a corporate

credit union’s base case MVPE or MVPE

ratio or the MVPE or MVPE ratio

resulting from the tests indicated in

paragraph (e)(1)(i) of this section decline

below the limits established by this part

and are not brought into compliance

within 5 business days, operating

management of the corporate credit

union must report the information to the

board of directors, supervisory

committee, and NCUA on the sixth

business day. If any of these measures

remain below the limits established by

this part by the 25th business day, 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 MVPE or MVPE 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.

A specific written disclosure detailing

the limit violation(s) and the intended

course of action must be sent to NCUA

within 25 business days after disclosure

to the board.

§ 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;
28106 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

(2) Continuously 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 an appropriate

committee of the board 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, through

periodic usage of external lines, that all

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 20 business days of the failure,

report the failed investment to its board

of directors 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, by the 25th business day after 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) 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.

(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 it is a secured

loan. 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 or senior management

employee of a corporate credit union

which has invested in or loaned to a

corporate CUSO, and immediate family

members of such an individual, may not

receive, either directly or indirectly, any

salary, commission, investment income,

or other income, compensation, or

consideration from the corporate CUSO.

This prohibition extends to any other

corporate credit union employee if such

employee deals directly with the

corporate CUSO.

(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 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.

§ 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), 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,

which will provide a written decision.

§ 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); and
Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28107

(4) For purposes of meeting the

requirements of paragraphs (a)(1) and

(a)(2) 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.

(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 member credit

unions. (1) A member credit union may

appoint one of its members or officials

as a representative to the corporate

credit union. The representative shall be

empowered to attend membership

meetings, to vote, and to stand for

election on behalf of the member. No

individual may serve as the

representative of more than one member

credit union in the same corporate

credit union.

(2) Any vacancy on the board of a

corporate credit union caused by a

representative being unable to complete

his or her term shall be filled by the

board of the corporate credit union

according to its bylaws governing the

filling of board vacancies.

(c) Recusal provision. (1) No director,

committee member, officer, or employee

of a corporate credit union shall in any

manner, directly or indirectly,

participate in the deliberation upon or

the determination of any question

affecting his or her pecuniary interest or

the pecuniary interest of any entity

(other than the corporate credit union)

in which he or she is interested, except

if the matter involves general policy

applicable to all members, such as

setting dividend or loan rates or fees for

services.

(2) An individual is ‘‘interested’’ in an

entity if he or she:

(i) Serves as a director, officer, or

employee of the entity;

(ii) Has a business, ownership, or

deposit relationship with the entity; or

(iii) Has a business, financial, or

familial relationship with an individual

whom he or she knows has a pecuniary

interest in the entity.

(3) In the event of the disqualification

of any directors, by operation of

paragraph (c)(1) of this section, the

remaining qualified directors present at

the meeting, if constituting a quorum

with the disqualified directors, may

exercise, by majority vote, all the

powers of the board with respect to the

matter under consideration. Where all of

the directors are disqualified, the matter

must be decided by the members of the

corporate credit union.

(4) In the event of the disqualification

of any committee member by operation

of paragraph (c)(1) of this section, the

remaining qualified committee

members, if constituting a quorum with

the disqualified committee members,

may exercise, by majority vote, all the

powers of the committee with respect to

the matter under consideration. Where

all of the committee members are

disqualified, the matter shall be decided

by the board of directors.

(d) Administration. (1) A corporate

credit union shall be under the direction

and control of its board of directors.

While the board may delegate the

performance of administrative duties,

the board is not relieved of its

responsibility for their performance.

The board may employ a chief executive

officer who shall have such authority

and such powers as delegated by the

board to conduct business from day to

day. Such chief executive officer must

answer solely to the board of the

corporate credit union, and may not be

an employee of a credit union trade

association.

(2) The provisions of § 701.14 of this

chapter apply to corporate credit

unions, except that where reference is

made to ‘‘Regional Director,’’ substitute

‘‘NCUA.’’

§ 704.15 Audit requirements.

(a) External audit. The corporate

credit union supervisory committee

shall cause an annual opinion audit to

be made by an independent, duly

licensed certified public accountant

(CPA) and 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 days after receipt by

the board of directors. The CPA’s audit

workpapers shall be provided upon

request to NCUA. A summary of the

audit report shall be submitted 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

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).

§ 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;
28108 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

(2) When bond coverage is

terminated, by issuance of a written

notice, on an employees, 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 as of December 31 of the

preceding 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 above minimums.

(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.

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 up to a maximum of $1 million.

(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 20 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 days after

the date of written notice from NCUA.

Appendix A—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 account 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

Account

(1) A paid-in capital account is not

subject to share insurance coverage by

the NCUSIF or other deposit insurer.

(2) The funds have no maturity 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.

(3) Paid-in capital is available to cover

losses that exceed reserves and

undivided earnings.

(4) Paid-in capital is nonvoting and

subordinate to membership capital 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

paid-in capital account.

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—Expanded Authorities

and Requirements

A corporate credit union may obtain

expanded authorities if it meets all of the

requirements of 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. 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 these

additional authorities after NCUA has

provided its written 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
Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28109

deficiencies. Further guidance on the

characteristics necessary to obtain additional

authorities is available in Appendix C.

Part I

(a) In order to participate in the authorities

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

a corporate credit union must:

(1) Have a minimum capital ratio of 5

percent.

(2) Meet the management, staff, systems,

compliance, legal, and risk assessment

requirements specified in Appendix C.

(3) Evaluate monthly the changes in MVPE

and the MVPE ratio for the tests set forth in

§ 704.8(e)(1)(i).

(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 short-term investments rated

no lower than A–1 (or equivalent) and longterm investments rated no lower than AA–

(or equivalent); at the time of purchase and

at any subsequent time by same nationally

recognized statistical rating organization(s)

used at the time of purchase.

(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; and

(5) Purchase principal only (PO) stripped

mortgage-backed securities to reduce interest

rate risk.

(d) In performing the rate stress tests set

forth in § 704.8(e)(1)(i), the MVPE 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

loans and irrevocable lines of credit to any

one member credit union, excluding passthrough and guaranteed loans from the CLF

and the NCUSIF, shall not exceed 100

percent of the corporate credit union’s capital

for unsecured loans and irrevocable lines of

credit. The board 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;

(2) Meet the management, staff, systems,

compliance, legal, and risk assessment

requirements specified in Appendix C.

(3) Evaluate monthly the changes in MVPE

and the MVPE ratio for the tests set forth in

§ 704.8(e)(1)(i).

(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

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 non secured

obligations of any single domestic issuer up

to 250 percent of the sum of reserves and

undivided earnings and paid-in capital;

(2) Purchase short-term investments rated

no lower than A–1 (or equivalent) and longterm investments rated no lower than A– (or

equivalent) at the time of purchase and at any

subsequent time by the nationally recognized

statistical rating organizations used at the

time of purchase.

(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; and

(5) Purchase principal only (PO) stripped

mortgage-backed securities to reduce interest

rate risk.

(d) In performing the rate stress tests set

forth in § 704.8(e)(1)(i), the MVPE 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 Part I of

this Appendix and the foreign investment

criteria set forth in Appendix C, may invest

in:

(1) Debt obligations of a foreign country;

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

and debt obligations of foreign banks or

obligations guaranteed by these banks;

(3) Non secured obligations of any single

foreign issuer, not exceeding 150 percent of

the sum of reserves and undivided earnings

and paid-in capital; and

(4) Non secured obligations in any single

foreign country, not exceeding 500 percent of

the sum of reserves and undivided earnings

and paid-in capital.

(b) All investments with sovereign entities

and foreign banks are subject to the following

requirements:

(1) Short-term investments must be rated

no lower than A–1 (or equivalent);

(2) Long-term investments must be rated no

lower than AA (or equivalent);

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

in which a corporate issuer is organized,

must be rated no lower than AA (or

equivalent) for political and economic

stability.

(4) For each approved foreign bank line,

the corporate credit union must identify the

specific banking centers and branches to

which it will lend funds.

Part IV

A corporate credit union which has met

the requirements of paragraph (a) of Part I of

this Appendix and the financial derivatives

criteria set forth in Appendix C, 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.

Appendix C—Guidelines for Evaluating

Requests for Expanded Authorities

This Appendix provides guidance for

corporate credit unions which seek expanded

authorities under Appendix B of part 704.

These guidelines represent the prudent

practices and acceptable qualifications which

must be evident in a corporate credit union

for NCUA to approve its request. There are

four distinct expanded authority alternatives

which are set forth Appendix B. Corporate

credit unions which are granted expanded

authorities must adhere at all times to the

requirements set forth in Appendix B and

Appendix C. NCUA will ensure that

corporate credit unions continue to meet the

necessary qualifications and remain in sound

financial condition through its regular, ongoing safety and soundness review. Provided

that the corporate credit union is in sound

financial condition, the primary areas which

are used to evaluate each request for

expanded authority are: board, senior

management, and staff; systems and

operations; credit risk management; liquidity

risk management; audit and compliance; and

legal matters.

Part I

(a) General. Requests for the expanded

authorities as outlined in Appendix B, Part

I, will be evaluated based on the criteria

outlined in paragraphs (b) through (g) of this

Appendix C, Part I.

(b) Board, senior management, and staff.

(1) The board has received adequate

training and is sufficiently knowledgeable to

make informed decisions regarding the risk

activities of the corporate credit union and to

properly evaluate the use of the expanded

authorities.

(2) Senior management has in-depth

experience in their direct areas of

responsibility and a working knowledge of

most key areas.

(3) The asset and liability committee

(ALCO) members are conversant in

investment activities and strategies and are
28110 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

capable of individually explaining, justifying,

and supporting the risk exposures of the

corporate credit union.

(4) Senior investment managers and asset

and liability managers have knowledge and

experience commensurate with the potential

expanded authorities of the corporate credit

union.

(5) Staff supporting the asset and liability

management functions have expert

knowledge in developing and applying the

assumptions, methodologies, and

interrelationships between the financial

factors driving the risk measurement results.

The staff has the ability to adjust the model

and customize applications consistent with

the additional test requirements of

§ 704.8(e)(3).

(6) Qualified designated back-ups are in

place and capable of assuming primary

responsibilities. Back-ups are adequately

trained to ensure that minimum disruption

would occur in the event of the loss

(temporary or permanent) of primary

personnel.

(7) Qualified, cross-trained personnel are

in place for all essential support positions.

(c) Systems/Operations. (1) Systems

support and operational capacity are

adequate to process, measure, monitor, and

report all financial transactions. This

includes the capacity to handle volume and

complexity with timely and accurate results.

Systems can provide sophisticated measures

of valuation for a variety of simulated market

scenarios. Systems can interface, and

automation ensures a strong measure of

control and standardization.

(2) The major financial-related areas,

which require a particular emphasis upon

support and control, are the accounting and

risk measurement systems. Specific areas of

infrastructure strength include, but are not

limited to, the following areas:

(i) Valuation of instruments and risk

measurement.

(A) Methodologies permit alternative

scenario analysis in addition to those

required in § 704.8(e)(3).

(B) Qualified staff are capable of

challenging and validating the analytical

applications and assumptions of the risk

measurement methodologies.

(C) Simulations can be produced in a

timely, accurate manner on at least a monthly

basis.

(D) Variance analysis is conducted each

month to evaluate and explain the reasons for

differences between projected and actual

results.

(E) The model(s) and supporting processes

are capable of meeting the needs of

management reporting for both compliance

and decision-making.

(F) The model(s) and supporting statistical

analyses used to measure risk are validated

prior to use and periodically thereafter.

(ii) Accounting for transactions.

(A) Accounting processes are independent

of the risk taking unit (investments).

(B) Accounting systems and processes are

commensurate with instruments that have

complex structures and/or embedded

options, including off-balance sheet

activities.

(C) Systems have a demonstrated ability to

produce timely, accurate financial statements

for internal and external purposes, in

conformance with GAAP.

(D) There is an on-line, dedicated, and

automated system capable of providing

timely, accurate reports independent of the

corporate credit union’s risk taking unit.

Reports are standardized and may be

customized for both financial and risk

reporting purposes. For example, systems

would include:

(1) Automated data transfer;

(2) On-demand report generation based on

current data;

(3) Ability to account for investments with

complex structures and/or embedded options

including off-balance sheet activities;

(4) Accounts for all investment

characteristics and cash flows;

(5) General ledger treatment—

amortization/accretion of discounts/

premiums can be produced for dynamic

cash-flow instruments and transactions;

(6) Security safeguards that ensure

protection and integrity of input and output

through a dedicated and controlled system

environment;

(7) Ability to handle expanded authorities

and changes in strategies and external market

factors; and

(8) Establishment and maintenance of

adequate back-up arrangements to minimize

the disruption of major services and to

address system problems timely.

(d) Credit risk management. The credit risk

management function is independent and

able to assess the inherent risk associated

with all concentrations, limits and proposed

transactions, including any additional

authorities provided in Appendix B. The

measuring and monitoring methodologies are

sufficient to meet the scope and complexity

of all credit related activities. (1)

Management/Staff. (i) Credit risk

management is independent from the risk

taking unit and is directed by a level of

senior management sufficient to ensure that

credit risk activities remain consistent with

board policies and objectives.

(ii) Analysts are qualified to identify and

assess the inherent credit risk in all

transactions that possess material credit

exposures. Analysts have knowledge and

experience in evaluating credit risk in the

money and capital markets.

(2) Policies and procedures. (i) Procedures

address the methodology for measuring and

monitoring credit risk and the means of

responding to a deterioration in credit.

(ii) There is a daily process of measuring

and reporting the credit exposures in

comparison to policy limits.

(iii) Procedures provide the risk taking unit

with daily credit exposures and remaining

limit capacity.

(iv) Credit limits and transaction types are

approved by a credit risk committee to

ensure consistency with corporate credit

union objectives.

(v) Senior credit personnel have the direct

authority to reduce, suspend, or revoke a

credit limit.

(e) Liquidity risk management. (1) Effective

controls exist for liquidity exposures arising

from both market or product liquidity and

instrument cash flows.

(2) Daily liquidity management procedures

for investment activities are an integral part

of the day-to-day operations.

(3) Management reporting includes an ongoing daily liquidity assessment which is

updated to reflect current changes to

investment and funding positions.

(f) Audit and compliance. (1) The internal

audit and compliance area has staff, or has

engaged outside personnel, with expert

knowledge and experience adequate to

support the scope and complexity of all

activities associated with expanded

authorities.

(2) The scope of review addresses

appropriateness of risk as well as general

compliance issues.

(g) Legal issues. The corporate credit union

has inside legal counsel or has access to

outside counsel which can provide a

specialized review of all associated legal

matters.

Part II

(a) General. Requests for the expanded

authorities as outlined in Appendix B, Part

II, will be evaluated based on the criteria

outlined in paragraphs (b) through (f) of this

Appendix C, Part II.

(b) Senior management and staff. (1)

Senior management is demonstrably familiar

with key areas of the corporate credit union

and conversant in technical factors affecting

the institution’s risk.

(2) Senior management is substantially

represented by individuals who have

extensive related experience with a

depository institution, investment banker, or

broker/dealer.

(3) Investment and risk management staff

have substantial experience and have

received extensive training to support

expanded authorities.

(c) Systems and operations. (1) Qualified

staff are capable of modeling securities and

financial transactions to determine that

components are valued consistent with the

market. This means that the value of all

transactions, securities, and options can be

independently determined by corporate

credit union staff.

(2) Senior management receives a daily

position report detailing current activities,

mark-to-market valuations, balance sheet

positions, and other critical financial

information.

(d) Credit risk management. (1)

Management and staff. (i) Senior credit

analyst(s) has extensive experience (e.g.,

years of experience, held positions of

responsibility, and/or completed specialized

credit training in capital markets) with

particular emphasis on evaluating financial

institutions and debt securities.

(ii) Sufficient number of analysts are on

staff to ensure that all credits receive

appropriate, timely, and in-depth analysis.

(2) Policies and procedures. (i) The credit

risk management is a stand-alone unit.

(ii) There is a formal credit risk committee

which approves all credit limits.

(e) Audit and compliance. (1) There is an

independent, stand-alone risk compliance

unit managed by senior staff who are capable

of comprehending, evaluating, and

challenging all potential risk areas of the

corporate credit union.
Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules 28111

(2) A highly qualified senior management

executive is responsible for the unit.

(3) The unit is responsible for assuring the

board of directors that staff in all potential

risk areas are conducting their activities in

conformance with all board policies and

procedures.

(4) The unit is also responsible for assisting

management in developing and enhancing

the existing risk management processes to

improve the areas where potential

weaknesses or deficiencies are identified.

(5) The unit has specialized staff with

extensive knowledge of systems, policies,

and procedures used to govern all approved

activities and which understands the

inherent risk issues affecting those activities.

(f) Legal issues. The corporate credit union

maintains inside counsel or has established

relationships with outside legal firms which

specialize in evaluating relevant contracts

and transactions to ensure that the corporate

credit union’s legal and business interests are

represented for all expanded authorities.

Part III

(a) General. Requests for the expanded

authorities as outlined in Appendix B, Part

III, will be evaluated based on the criteria for

management, staff, systems, compliance,

legal, and risk assessment specified in Part I

of this Appendix C and the additional criteria

outlined in paragraphs (b) and (c) of this Part

III.

(b) Senior management and staff. (1)

Senior management has addressed the

unique potential risk impact of foreign

investments and has contingency policies

and procedures to address these factors.

(2) Staff includes qualified analysts with

knowledge and experience evaluating crossborder risk.

(3) Analysts are experienced in evaluating

sovereign and foreign institution credits and

conduct a timely, in-depth analysis for all

approved foreign limits.

(4) Analysts have training and/or

experience in evaluating the political,

economic and regulatory environment and

the unique financial and accounting

standards which affect the interpretation of

financial data used to evaluate foreign

counterparties.

(c) Systems and operations. (1) An

automated system is in place which monitors

all foreign investment exposures by entity

and country and is updated daily or as

exposures change; and

(2) Credit risk management procedures

address the unique political, legal, and

economic factors which potentially affect all

approved foreign counterparties.

Part IV

(a) General. Requests for the expanded

authorities as outlined in Appendix B, Part

IV, will be evaluated based on the criteria for

management, staff, systems, compliance,

legal, and risk assessment specified in Part I

of this Appendix C and the additional criteria

outlined in paragraphs (b) through (h) of this

Part IV.

(b) Request to NCUA for authority. The

request for derivative authority must include,

at a minimum, the following:

(1) A detailed description of the relevant

products, markets and business strategies

including examples of how each type of

proposed transaction will work;

(2) The methodology for measuring

exposures and the proposed limits on each

type of transaction, as well as an aggregate

limit based upon a percentage of capital at

risk;

(3) The costs associated with establishing

effective risk management systems and hiring

and retaining professionals with derivative

transaction experience;

(4) An analysis which justifies the

reasonableness of the proposed activities

relative to the corporate credit union’s

overall financial condition and capital level;

(5) An analysis of the risks that may arise

from the use of derivatives which includes,

at a minimum, market, credit, liquidity,

operations, and legal risks;

(6) The detailed procedures the corporate

credit union will use to effectively identify,

measure, monitor, report, and control risks;

(7) The relevant accounting guidelines to

be used;

(8) Internal control procedures detailing

the segregating of duties between the staff

that executes transactions and operational

personnel that monitor and report activity;

and

(9) The scope of the audit and internal risk

monitoring functions.

(c) Board, senior management, and staff.

(1) Board and senior management have

sufficient knowledge and experience to

understand, approve, and provide oversight

for all proposed derivative activities.

(2) Board members and responsible

management and staff have received

adequate training to familiarize them with all

relevant aspects of effective derivative use

and related control issues before assuming

risk exposures.

(3) Board and senior management

understand and agree that the risk

management process that will be used is

appropriate and that actual and potential risk

exposures will be clearly identified and fully

disclosed to the board on a regular basis.

(4) Senior management has retained

knowledgeable and experienced personnel in

derivative transactions for both the

management and operations functions.

(5) The manager directly responsible for

these activities has extensive related

experience with a depository institution,

investment banker, or broker/dealer.

(d) Systems and operations. (1) The board

has dedicated sufficient financial and

personnel resources to support operations

and systems development and maintenance.

The sophistication of the systems support

and operational capacity is commensurate

with the size and complexity of the

derivatives activity.

(2) Derivatives support systems provide

accurate and timely transactions processing

and allow for proper risk exposure

monitoring and interfacing with other

systems of the corporate credit union.

(3) The risk measurement system is capable

of quantifying the risk exposures resulting

from derivatives activities arising from

changes in relevant market factors.

(4) The market risk measurement system is

capable of producing prompt and accurate

assessments at least monthly.

(5) The risk management system addresses,

at a minimum, the following:

(i) Procedures that accurately identify and

quantify risk levels on a timely basis;

(ii) Limits and other controls on levels of

risk associated with counterparty credit,

concentrations and other relevant market

factors;

(iii) Limits on aggregate risk positions

which capture the inter-connected effect of

all positions;

(iv) Reports to senior management and the

board that accurately present the types and

amounts of risks assumed and demonstrate

compliance with approved policies and

limits; and

(v) Auditing procedures to ensure the

integrity of risk management systems and

confirm compliance with approved policies

and procedures.

(6) Appropriate resources are devoted to

operations sufficient to support the scope

and complexity of the activities.

(7) Effective senior management

supervision and Board oversight is in place

to ensure that all derivative activities are

conducted in a safe and sound manner.

(8) Comprehensive written policies and

procedures are approved by the board and

periodically reviewed thereafter as activity

levels or market and business conditions

warrant.

(9) Procedures support the proper control

over the recordation, settlement, and

monitoring of derivative transactions.

Internal controls assure that proper

processing procedures for all transactions

and reconciliation of front and back office

databases is done on a regular basis.

(10) Policies and procedures address risk

management (market, credit, liquidity, and

operations), legal issues, capital

requirements, and accounting standards. In

conjunction with the credit risk function, the

methods of valuation (e.g. bid side or midmarket) are appropriate and the sources and

methods of pricing are reasonable and

supportable.

(e) Credit risk management. (1) Policies

and procedures are in place to address, at a

minimum, significant counterparty

exposures, concentrations, credit exceptions,

risk ratings, and non performing contracts.

Management has established internal limits

which are prudent and consistent with the

corporate credit union’s financial condition

and management’s expertise.

(2) Timely, detailed reports, which are

consistent with the policy and procedure

requirements, are available for board and

senior management review. Reports

consolidate activities by counterparty and are

incorporated into aggregate credit exposure

reports for other non derivative exposures.

(3) Approved counterparts have credit

ratings no lower than operating parameters

authorized for the corporate credit union

under Part I of this Appendix B.

(4) Credit personnel are qualified to

identify and assess the inherent credit risk in

all proposed derivative transactions.

(5) Procedures ensure credit analysis of

counterparties is performed before

transactions are executed and there is

periodic assessment of credit throughout the

life of outstanding derivative transactions.
28112 Federal Register / Vol. 61, No. 108 / Tuesday, June 4, 1996 / Proposed Rules

(6) Credit procedures address the

availability and impact of credit exposure

reduction techniques (e.g., bilateral collateral

agreements and/or mutual margining

agreements).

(7) The corporate credit union can

calculate the current mark-to-market (current

exposure) as well as projected changes in

value (potential exposure) when assessing

credit exposure per transaction and

counterparty.

(8) Reports track the aggregate and net

exposures for each counterparty.

(9) Mark-to-market calculations are

obtained independently from qualified

sources as frequently as necessary.

(10) Policies and procedures address the

issue of settlement risk and establish prudent

settlement limits where applicable.

(f) Liquidity risk management. (1) Effective

controls exist for liquidity exposures arising

from both market or product liquidity and

instrument cash flows.

(2) Policies address the exposures to cash

flow gaps arising from derivative transactions

and establish appropriate limits on the size

and duration of such gaps (e.g., concentration

of swap payments, margin calls, or early

terminations).

(3) Liquidity management procedures for

derivatives are an integral part of the day-today operations and are also incorporated into

the overall liquidity stress test and

contingency funding plan requirements of

§ 704.8.

(4) Monitoring procedures are integrated

with the overall liquidity management

process for all corporate credit union

activities.

(g) Audit and compliance. (1) An

independent risk management unit is

responsible for measuring and reporting risk

exposures taken in derivatives.

(2) Audit coverage is adequate to ensure

timely identification of internal control

weaknesses or system deficiencies. Audit

coverage is provided by competent

professionals who are knowledgeable about

the risks inherent in derivative transactions

and have commensurate experience auditing

financial institutions which utilize the same

or similar types of derivatives. The scope of

the audit includes coverage of the

accounting, legal, operating, and risk

controls.

(3) All risk measurement applications and

models are reviewed and validated annually.

(4) Controls are in place to ensure

documentation is confirmed, maintained and

safeguarded. Any documentation exceptions

are monitored and reviewed by appropriate

senior management and legal counsel.

(h) Legal issues. (1) The corporate credit

union has in-house legal counsel or has

access to outside counsel which can

reasonably ensure that any derivatives

related contracts adequately represent the

legal and business interests of the corporate

credit union.

(2) The corporate credit union has access

to outside counsel which is expert in all

financial derivatives contracts and related

matters.

PART 709—INVOLUNTARY

LIQUIDATION AND CREDITOR CLAIMS

2. The authority citation for part 709

continues to read as follows:

Authority: 12 USC 1766; Pub. L. 101–73,

103 Stat. 183, 530 (1989) (12 USC 1787 et

seq.).

3. Section 709.5 is amended by

revising paragraphs (b)(6) and (b)(7);

removing the period and adding a

semicolon and the word ‘‘and’’ at the

end of paragraph (b)(8); and adding

paragraph (b)(9) to read as follows:

§ 709.5 Payout Priorities in Involuntary

Liquidation.

* * * * *

(b) * * *

(6) Shareholders to the extent of their

respective uninsured shares and the

National Credit Union Share Insurance

Fund, to the extent of its payment of

share insurance;

(7) In a case involving liquidation of

a corporate credit union, membership

capital; 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 USC 1757, 1766, and 1781–

1790. Section 741.11 is also authorized by 31

USC 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. 96–13518 Filed 6–3–96; 8:45 am]

BILLING CODE 7535–01–U

DEPARTMENT OF TRANSPORTATION

Federal Aviation Administration

14 CFR Part 39

[Docket No. 95–ANE–65]

RIN 2120–AA64

Airworthiness Directives; CFM

International CFM56–5/-5B/-5C Series

Turbofan Engines

AGENCY: Federal Aviation

Administration, DOT.

ACTION: Notice of proposed rulemaking

(NPRM).

SUMMARY: This document proposes the

adoption of a new airworthiness

directive (AD) that is applicable to CFM

International (CFMI) CFM56–5/–5B/–5C

series turbofan engines. This proposal

would require initial and repetitive

borescope inspections of the stage 1 disk

bore of certain high pressure compressor

rotor (HPCR) stage 1–2 spools for rubs

and scratches, and replacement, if found

rubbed or scratched, with a serviceable

part. This proposal would also require

removal and replacement of certain

stationary number 3 bearing aft air/oil

seals as terminating action to the

inspection program. This proposal is

prompted by a report of an engine found

with a rub on the forward corner of the

HPCR stage 1 disk bore due to contact

with the stationary number 3 bearing aft

air/oil seal. The actions specified by the

proposed AD are intended to prevent a

failure of the stage 1 disk of the HPCR

stage 1–2 spool, which could result in

an uncontained engine failure and

damage to the aircraft.

DATES: Comments must be received by

August 5, 1996.

ADDRESSES: Submit comments in

triplicate to the Federal Aviation

Administration (FAA), New England

Region, Office of the Assistant Chief

Counsel, Attention: Rules Docket No.

95– ANE–65, 12 New England Executive

Park, Burlington, MA 01803- 5299.

Comments may also be submitted to the

Rules Docket by using the following

Internet address:

‘‘epdodcomments@mail.hq.faa.gov’’.

Comments may be inspected at this

location between 8:00 a.m. and 4:30

p.m., Monday through Friday, except

Federal holidays.

The service information referenced in

the proposed rule may be obtained from

CFM International, Technical

Publications Department, One Neumann

Way, Cincinnati, OH 45215; telephone

(513) 552–2981, fax (513) 552–2816.

This information may be examined at

the FAA, New England Region, Office of

the Assistant Chief Counsel, 12 New

England Executive Park, Burlington,

MA.

FOR FURTHER INFORMATION CONTACT:

Robert J. Ganley, Aerospace Engineer,

Engine Certification Office, FAA, Engine

and Propeller Directorate, 12 New

England Executive Park, Burlington, MA

01803–5299; telephone (617) 238–7138,

fax (617) 238–7199.