82 FR 30774 - Corporate Credit Unions

NATIONAL CREDIT UNION ADMINISTRATION

Federal Register Volume 82, Issue 126 (July 3, 2017)

The NCUA Board (Board) proposes to amend its regulations governing corporate credit unions (corporates) and the scope of their activities. Specifically, the proposed amendments revise provisions on retained earnings and Tier 1 capital.

[Federal Register Volume 82, Number 126 (Monday, July 3, 2017)]
[Proposed Rules]
[Pages 30774-30776]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2017-13642]


========================================================================
Proposed Rules
                                                Federal Register
________________________________________________________________________

This section of the FEDERAL REGISTER contains notices to the public of 
the proposed issuance of rules and regulations. The purpose of these 
notices is to give interested persons an opportunity to participate in 
the rule making prior to the adoption of the final rules.

========================================================================


Federal Register / Vol. 82, No. 126 / Monday, July 3, 2017 / Proposed 
Rules

[[Page 30774]]



NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Part 704

RIN 3133-AE75


Corporate Credit Unions

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed rule.

-----------------------------------------------------------------------

SUMMARY: The NCUA Board (Board) proposes to amend its regulations 
governing corporate credit unions (corporates) and the scope of their 
activities. Specifically, the proposed amendments revise provisions on 
retained earnings and Tier 1 capital.

DATES: Comments must be received on or before September 1, 2017.

ADDRESSES: You may submit comments by any of the following methods, but 
please send comments by one method only:
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     NCUA Web site: http://www.ncua.gov/RegulationsOpinions 
Laws/proposed_regs/proposed_regs.html. Follow the instructions for 
submitting comments.
     Email: Address to [email protected]. Include ``[Your 
name]--Comments on Proposed Rule--Corporate Credit Unions'' in the 
email subject line.
     Fax: (703) 518-6319. Use the subject line described above 
for email.
     Mail: Address to Gerard Poliquin, Secretary of the Board, 
National Credit Union Administration, 1775 Duke Street, Alexandria, 
Virginia 22314-3428.
     Hand Delivery/Courier: Same as mail address.

FOR FURTHER INFORMATION CONTACT: Yvonne Applonie, Director of 
Supervision, Office of National Examinations and Supervision, at the 
above address or telephone (703) 518-6595; or Marvin Shaw, Staff 
Attorney, Office of General Counsel, at the above address or telephone 
(703) 518-6553.

SUPPLEMENTARY INFORMATION:

I. Background

    The financial crisis of 2007-2009 took a heavy toll on the 
corporate credit union system. The crisis, largely mortgage related, 
greatly affected the investment portfolios of many corporates causing 
widespread liquidity problems, instability in the system, and failures. 
During this time period, NCUA took extraordinary short and mid-term 
measures to stabilize the corporate system. Among other things, it: (1) 
Made capital injections; (2) approved the Temporary Corporate Credit 
Union Share Guarantee Program, which guaranteed uninsured shares at 
participating corporates; (3) engaged the services of an independent, 
highly qualified third party to conduct a comprehensive analysis of 
expected non-recoverable credit losses for distressed securities held 
by corporates; (4) conserved five corporates; \1\ and (5) created the 
NCUA Guaranteed Note Program.\2\
---------------------------------------------------------------------------

    \1\ The five were U.S. Central, Western Corporate, Members 
United Corporate, Southwest Corporate, and Constitution Corporate.
    \2\ As part of the corporate system resolution, NCUA created the 
NCUA Guaranteed Note Program to provide long-term funding for 
distressed investment securities (Legacy Assets) from the five 
failed corporate credit unions. Legacy Assets consisted of over 
2,000 investment securities, secured by approximately 1.6 million 
residential mortgages, as well as commercial mortgages and other 
securitized assets.
---------------------------------------------------------------------------

    To provide longer term structural enhancements to the corporate 
system, the Board comprehensively revised part 704, the regulations 
governing corporates and their activities, in 2010.\3\ The 2010 rule's 
primary purpose was to establish a regulatory framework that provides a 
foundation for a healthy corporate system that: (1) Delivers important 
services to the corporates' natural person credit union members, such 
as payment systems and liquidity; and (2) builds and attracts 
sufficient capital.\4\ The 2010 rule also helped to prevent the 
recurrence of the kind of financial losses that led to the failure of 
the referenced five corporates and weakened the financial condition of 
several others.
---------------------------------------------------------------------------

    \3\ 12 CFR part 704; 75 FR 64786 (Oct. 20, 2010).
    \4\ 75 FR 64787, 64787 (Oct. 20, 2010).
---------------------------------------------------------------------------

    The 2010 rule curtailed several of the practices that led to the 
referenced corporate failures. Specifically, it established investment 
concentration limits, limited asset maturities, and prohibited 
investments in subordinated and private label mortgage-backed 
securities. Most relevant to this proposal, the 2010 rule also 
implemented a prompt corrective action (PCA) regime stipulating capital 
adequacy for corporates. Largely based on the Basel I requirements, the 
capital requirements of the 2010 rule emphasized the importance of 
corporates holding tangible and durable capital.
    It has been nearly seven years since the Board issued the 2010 
rule. In that time, NCUA's efforts have had the intended effect of 
stabilizing the corporate system and improving the corporates' ability 
to function and provide needed services to natural person credit 
unions. Additionally, the overall economy has improved greatly, thereby 
improving the economic landscape in which corporates operate. Further, 
the large concentration of troubled assets within the corporate system 
has been reduced through portfolio repositioning or NCUA intervention. 
The corporate system has significantly contracted and consolidated, 
with assets declining from approximately $81.7 billion prior to the 
2010 rule to approximately $24.9 billion today. In that same time 
period, the number of corporates has declined from 26 to 11. Given all 
of these positive developments, the Board believes conditions are such 
that it is now safe and appropriate to revisit the capital standards of 
the 2010 rule. As discussed in more detail below, the proposed 
amendments to the corporate rule primarily affect the calculation of 
capital after corporates consolidate and set a retained earnings ratio 
target in meeting PCA standards.

II. Proposed Amendments

Corporate Consolidations and Capital

    In 2015, the Board made further refinements to part 704. 
Specifically, the Board amended the definition of ``Tier 1 capital'' to 
include as a component of that term, the retained earnings acquired 
through a merger. Given that retained earnings acquired through a 
merger are currently not recorded on the continuing corporate's 
financial statements, the amount must be recorded outside of the 
financial statements. This approach does not follow Generally Accepted 
Accounting

[[Page 30775]]

Principles (GAAP), thus inhibiting transparency of capital adequacy. 
The Board believes a corporate will be more transparent presenting its 
capital adequacy by adopting conventions more closely aligned with its 
published financial statements. Accordingly, with respect to the 
definition of ``retained earnings,'' the Board proposes to incorporate 
``GAAP equity acquired in a merger'' as a component of retained 
earnings. This amendment to the definition of ``retained earnings'' 
will, in turn, affect the definition of ``Tier 1 capital,'' which 
includes retained earnings as one of the components of Tier 1 capital.
    More specifically, the current definition of ``retained earnings'' 
includes undivided earnings, regular reserve, reserve for 
contingencies, supplemental reserves, reserve for losses, and other 
appropriations from undivided earnings as designated by management or 
NCUA. Including ``GAAP equity acquired in a merger'' to that list gives 
recognition to standard accounting conventions for purposes of 
consolidating records between merged entities. As a practical matter, 
the Board has treated equity acquired in a merger as retained earnings, 
but did so in the context of defining contributed capital's ability to 
cover losses. The Board believes that expressly including such equity 
acquired in a merger as retained earnings and referencing GAAP will 
clarify that this capital is available to cover losses, enhance 
transparency, and reduce ambiguity.
    Further, the Board proposes to delete the phrase ``the retained 
earnings of any acquired credit union, or an integrated set of 
activities and assets, calculated at the point of acquisition, if the 
acquisition is a mutual combination'' from the current definition of 
``Tier 1 capital.'' This provision becomes redundant as a result of the 
expanded definition of retained earnings which will include GAAP equity 
acquired in a merger.

Retained Earnings Ratio

    In addition to the Board's proposed amendments to the definitions 
of ``retained earnings'' and ``Tier 1 capital'' as discussed above, the 
Board also proposes to add a definition of ``retained earnings ratio'' 
to part 704.
    The 2010 rule's PCA provisions require corporates to meet a 
leverage ratio.\5\ The leverage ratio primarily consists of retained 
earnings and perpetual contributed capital (PCC).\6\ Capital included 
in the leverage ratio incorporated the provisions of Tier 1 capital as 
defined by the bank regulatory agencies, with a notable exception. The 
Board recognizes that while corporates had been permitted to secure 
contributed capital from any source, history has shown that nearly all 
contributed capital has been invested by federally insured natural 
person credit unions. As such, depletions of corporate capital can lead 
to corresponding investment impairments and capital erosion at the 
natural person credit unions. This can lead to greater exposure of loss 
to the National Credit Union Share Insurance Fund. The 2010 rule 
encouraged corporates to build sufficient retained earnings to absorb 
losses without causing a corresponding loss to another party, such as a 
natural person credit union that purchased contributed capital from 
that corporate (i.e., perpetual and non-perpetual capital as defined in 
the rule).
---------------------------------------------------------------------------

    \5\ The leverage ratio is currently defined as Tier 1 Capital 
divided by moving daily average net assets. The leverage ratio and 
capital definitions were revised as part of the 2010 rule, which 
contained a series of phased in definitions over a three-year 
period. Beginning October 21, 2011 and before October 21, 2013, the 
leverage ratio was defined as the ratio of total capital to moving 
daily average net assets. This ratio was called the ``interim'' 
leverage ratio. After October 21, 2013, the leverage ratio was 
redefined as the ratio of adjusted core capital to moving daily 
average net assets. This was called the permanent leverage ratio. In 
May 6, 2015 the NCUA Board approved changes to the regulation that 
sought to simplify and clarify the capital definitions in the 
regulations now that the major phase-in dates had passed. The 
definitions of core capital and adjusted core capital were combined 
into one definition called Tier 1 capital. The leverage ratio and 
other related capital ratio definitions were similarly amended to 
reflect the change to Tier 1 Capital.
    \6\ Perpetual Contributed Capital means accounts or other 
interests of a corporate credit union that are perpetual, non-
cumulative dividend accounts; are available to cover losses that 
exceed retained earnings, are not insured by the National Credit 
Union Share Insurance Fund or other share or deposit insurers; and 
cannot be pledged against borrowings. In the event the corporate is 
liquidated, any claims made by the holders of the perpetual 
contributed capital will be subordinate to all other claims 
(including National Credit Union Share Insurance Fund claims).
---------------------------------------------------------------------------

    The incentive to build retained earnings was created by limiting 
the amount of contributed capital permitted to be included in 
calculating the corporate's leverage ratio.\7\ The limitation on PCC 
was phased-in over a period of ten years recognizing the erosion of 
corporate capital during the financial crisis and reasonable 
expectations for future corporate profitability.\8\ Until October 2016, 
all PCC was included in the leverage ratio. Effective October 2016, 
part 704 requires corporates to deduct the amount of PCC exceeding 
retained earnings by 200 basis points. Effective October 2020, 
corporates must deduct the amount of PCC exceeding retained earnings.
---------------------------------------------------------------------------

    \7\ 12 CFR 704.2
    \8\ As financial intermediaries, the net margins for corporates 
have been low with a historical average net return on assets ratio 
of approximately 23 bps.
---------------------------------------------------------------------------

    The 2010 revisions to part 704 have resulted in the intended 
effect. Specifically, all corporates have accumulated sufficient 
retained earnings to meet or exceed the adequate capitalization 
threshold under PCA through the October 2016 phase-in adjustment.
    While the result has been positive, the Board recognizes that the 
language in the current rule is indirect and may disadvantage 
corporates working with third parties. The limitation on PCC for 
regulatory capital purposes does not recognize the full value of PCC 
that stands to absorb losses and protect counterparties. Further, the 
construct to reduce the inclusion of PCC as capital provides for 
inconsistent treatment compared to capital regulations governing other 
types of financial institutions, such as banks, and could promote 
confusion. Accordingly, the Board proposes to remove the requirement 
effective October 2020 to limit PCC counted as Tier 1 capital to the 
amount of retained earnings. Further, the Board proposes to permit a 
corporate to include in its Tier 1 capital all PCC that is sourced from 
an entity not covered by federal share insurance.
    However, recognizing that retained earnings is critical to the 
health of the corporate system and the share insurance fund, the Board 
proposes to add a provision to part 704 requiring all corporates to 
achieve an eventual retained earnings ratio of 250 basis points. To 
that end, the Board proposes to add a definition of ``retained earnings 
ratio'' to mean ``the corporate credit union's retained earnings 
divided by its moving daily average net assets.'' Upon attaining this 
benchmark, a corporate would be permitted to include all PCC, 
regardless of source, in its Tier 1 capital. The PCA thresholds will 
remain at their current limits. Until such time as a corporate achieves 
a 250 basis points retained earnings ratio, it must deduct the amount 
of PCC exceeding retained earnings by 200 basis points as an inducement 
to build retained earnings.
    The Board believes this proposal will promote clarity as to the 
minimum amount of retained earnings to be held by a corporate to 
account for potential losses. In setting this minimum standard, the 
Board balances it with the risk mitigating provisions of current part 
704 including investment concentration limits, NEV volatility limits, 
asset maturity limits, and investment prohibitions. As such, the Board 
is not contemplating amending other

[[Page 30776]]

corporate risk taking authorities in part 704.

Appendix B to Part 704--Expanded Authorities and Requirements

    Appendix B to part 704 enumerates the expanded authorities 
available to corporates and the procedures that a corporate must follow 
to be granted such authorities. The Part I expanded investment 
authority allows a corporate to take on additional risk in certain 
investment products. As part of this authority, a corporate's NEV 
ratios may decline to specified amounts when meeting certain leverage 
ratios.
    The Board proposes to add a ``retained earnings ratio'' requirement 
to the Part I expanded investment authorities. The Board believes that 
by doing so the retained earnings ratio requirement will limit the risk 
of the expanded investment portfolios. Specifically, the Board proposes 
to employ an indexed retained earnings requirement, which will 
correlate with the actual level of risk taking.

III. Regulatory Procedures

1. Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
of any significant economic impact a regulation may have on a 
substantial number of small entities (primarily those under $100 
million in assets).\9\ This proposed rule only affects corporates, all 
of which have more than $100 million in assets. Accordingly, NCUA 
certifies the rule will not have a significant economic impact on a 
substantial number of small credit unions.
---------------------------------------------------------------------------

    \9\ 5 U.S.C. 603(a).
---------------------------------------------------------------------------

2. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (PRA) applies to rulemakings in 
which an agency by rule creates a new paperwork burden or increases an 
existing burden.\10\ For purposes of the PRA, a paperwork burden may 
take the form of a reporting or recordkeeping requirement, both 
referred to as information collections. The proposed rule does not 
contain information collection requirements that require approval by 
OMB under the Paperwork Reduction Act (44 U.S.C. 3501).
---------------------------------------------------------------------------

    \10\ 44 U.S.C. 3507(d); 5 CFR part 1320.
---------------------------------------------------------------------------

3. Executive Order 13132

    Executive Order 13132 encourages independent regulatory agencies to 
consider the impact of their actions on state and local interests. 
NCUA, an independent regulatory agency as defined in 44 U.S.C. 3502(5), 
voluntarily complies with the executive order to adhere to fundamental 
federalism principles. The proposed rule does not have substantial 
direct effects 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. NCUA has, 
therefore, determined that this proposal does not constitute a policy 
that has federalism implications for purposes of the executive order.

4. Assessment of Federal Regulations and Policies on Families

    NCUA has determined that this proposed rule will not affect family 
well-being within the meaning of Sec.  654 of the Treasury and General 
Government Appropriations Act, 1999, Public Law 105-277, 112 Stat. 2681 
(1998).

List of Subjects in 12 CFR Part 704

    Credit unions, Corporate credit unions, Reporting and recordkeeping 
requirements.

    By the National Credit Union Administration Board on June 23, 
2017.
Gerard Poliquin,
Secretary of the Board.

    For the reasons discussed above, the National Credit Union 
Administration Board proposes to amend 12 CFR part 704 as follows:

PART 704--CORPORATE CREDIT UNIONS

0
1. The authority citation for Part 704 continues to read as follows:

    Authority:  12 U.S.C. 1766(a), 1781, 1789.

0
2. Amend Sec.  704.2 by:
0
a. Revising the definition of ``Retained earnings'';
0
b. Adding a definition of ``Retained Earnings Ratio''; and
0
c. Revising the definition of ``Tier 1 capital'' to read as follows:


Sec.  704.2  Definitions

* * * * *
    Retained earnings means undivided earnings, regular reserve, 
reserve for contingencies, supplemental reserves, reserve for losses, 
GAAP equity acquired in a merger, and other appropriations from 
undivided earnings as designated by management or NCUA.
    Retained earnings ratio means the corporate credit union's retained 
earnings divided by its moving daily average net assets.
* * * * *
    Tier 1 capital means the sum of items (1) through (2) of this 
definition from which items (3) through (6) are deducted:
    (1) Retained earnings;
    (2) Perpetual contributed capital;
    (3) Deduct the amount of the corporate credit union's intangible 
assets that exceed one half percent of its moving daily average net 
assets (however, NCUA may direct the corporate credit union to add back 
some of these assets on NCUA's own initiative, or NCUA's approval of 
petition from the applicable state regulator or application from the 
corporate credit union);
    (4) Deduct investments, both equity and debt, in unconsolidated 
CUSOs;
    (5) Deduct an amount equal to any PCC or NCA that the corporate 
credit union maintains at another corporate credit union;
    (6) Deduct any amount of PCC received from federally insured credit 
unions that causes PCC minus retained earnings, all divided by moving 
daily average net assets, to exceed two percent when a corporate credit 
union's retained earnings ratio is less than two and a half percent.
* * * * *
0
3. Amend by revising paragraphs (b)(2) and (b)(3) of Part I of Appendix 
B to Part 704 to read as follows:

Appendix B to Part 704--Expanded Authorities and Requirements

* * * * *
    (b)(1) * * *
    (2) 28 percent if the corporate credit union has a seven percent 
minimum leverage ratio and a two and a half percent retained 
earnings ratio, and is specifically approved by NCUA; or
    (3) 35 percent if the corporate credit union has an eight 
percent minimum leverage ratio and a three percent retained earnings 
ratio and is specifically approved by NCUA.
* * * * *
[FR Doc. 2017-13642 Filed 6-30-17; 8:45 am]
BILLING CODE 7535-01-P