82_FR_9716 82 FR 9691 - Alternative Capital

82 FR 9691 - Alternative Capital

NATIONAL CREDIT UNION ADMINISTRATION

Federal Register Volume 82, Issue 25 (February 8, 2017)

Page Range9691-9702
FR Document2017-01713

The NCUA Board (Board) is issuing this advanced notice of proposed rulemaking (ANPR) to solicit comments on alternative forms of capital federally insured credit unions could use in meeting capital standards required by statute and regulation. For purposes of this ANPR, alternative capital includes two different categories: Secondary capital and supplemental capital. Secondary capital is currently permissible under the Federal Credit Union Act (Act) only for low- income designated credit unions to issue and to be counted toward both the net worth ratio and the risk-based net worth requirement of NCUA's prompt corrective action standards. The Board is considering changes to the secondary capital regulation for low-income designated credit unions. There are no other forms of alternative capital currently authorized. However, the Board is also considering whether or not to authorize credit unions to issue supplemental capital instruments that would only count towards the risk-based net worth requirement.

Federal Register, Volume 82 Issue 25 (Wednesday, February 8, 2017)
[Federal Register Volume 82, Number 25 (Wednesday, February 8, 2017)]
[Proposed Rules]
[Pages 9691-9702]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2017-01713]


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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.

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Federal Register / Vol. 82, No. 25 / Wednesday, February 8, 2017 / 
Proposed Rules

[[Page 9691]]



NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 701, 702, 703, 709, 741, and 745


Alternative Capital

AGENCY: National Credit Union Administration.

ACTION: Advance notice of proposed rulemaking.

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SUMMARY: The NCUA Board (Board) is issuing this advanced notice of 
proposed rulemaking (ANPR) to solicit comments on alternative forms of 
capital federally insured credit unions could use in meeting capital 
standards required by statute and regulation. For purposes of this 
ANPR, alternative capital includes two different categories: Secondary 
capital and supplemental capital. Secondary capital is currently 
permissible under the Federal Credit Union Act (Act) only for low-
income designated credit unions to issue and to be counted toward both 
the net worth ratio and the risk-based net worth requirement of NCUA's 
prompt corrective action standards. The Board is considering changes to 
the secondary capital regulation for low-income designated credit 
unions. There are no other forms of alternative capital currently 
authorized. However, the Board is also considering whether or not to 
authorize credit unions to issue supplemental capital instruments that 
would only count towards the risk-based net worth requirement.

DATES: Comments must be received on or before May 9, 2017.

ADDRESSES: You may submit comments by any one of the following methods 
(Please send comments by one method only):
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Email: Address to [email protected]. Include ``[Your 
name]--Comments on Advance Notice of Proposed Rulemaking for 
Supplemental Capital'' in the email subject line.
     Fax: (703) 518-6319. Use the subject line described above 
for email.
     Mail: Address to Gerald Poliquin, Secretary of the Board, 
National Credit Union Administration, 1775 Duke Street, Alexandria, 
Virginia 22314-3428.
     Hand Delivery/Courier: Same as mail address.
    Public Inspection: You can view all public comments on NCUA's Web 
site at http://www.ncua.gov/Legal/Regs/Pages/PropRegs.aspx as 
submitted, except for those we cannot post for technical reasons. NCUA 
will not edit or remove any identifying or contact information from the 
public comments submitted. You may inspect paper copies of comments in 
NCUA's law library at 1775 Duke Street, Alexandria, Virginia 22314, by 
appointment weekdays between 9 a.m. and 3 p.m. To make an appointment, 
call (703) 518-6546 or send an email to [email protected].

FOR FURTHER INFORMATION CONTACT: Steve Farrar, Supervisory Financial 
Analyst, at (703) 518-6360; or Justin Anderson, Senior Staff Attorney, 
Office of General Counsel, at (703) 518-6540. You may also contact them 
at the National Credit Union Administration, 1775 Duke Street, 
Alexandria, Virginia 22314.

SUPPLEMENTARY INFORMATION: At its October 2016 meeting, the Board held 
a public briefing on the topic of alternative capital for credit 
unions. This ANPR provides relevant background information and seeks 
comment on a broad range of considerations with respect to alternative 
capital for federally insured credit unions. This ANPR addresses topics 
including: (1) NCUA's authority to include alternative capital for 
prompt corrective action purposes; (2) credit unions' authority to 
issue alternative forms of capital; (3) prudential standards regarding 
the extent to which various forms of instruments would qualify as 
capital for prompt corrective action purposes and credit union 
eligibility for the sale of alternative capital; (4) the utility and 
suitability of supplemental capital for credit unions; (5) standards 
for investor protection, including disclosure requirements and investor 
eligibility criteria for the purchase of alternative capital; (6) 
implications of securities law for supplemental and secondary capital; 
(7) potential implications for credit unions, including the credit 
union tax exemption; and (8) overall regulatory changes the Board would 
need to make to permit supplemental capital, improve secondary capital 
standards, and provide or modify related supporting authorities. The 
Board has posed a number of specific questions on these and other 
topics, but invites comments on any and all aspects of alternative 
capital.

I. Background
II. Current Secondary Capital Standards
III. Current and Prospective Use of Alternative Capital
IV. Supplemental Capital Legal Authority and Potential Taxation 
Implications
V. Securities Law Applicability
VI. Other Investor Considerations
VII. Prudential Standards for Issuing and Counting Alternative 
Capital for Prompt Corrective Action
VIII. Supporting Regulatory Changes

I. Background

    In 1998, Congress passed the Credit Union Membership Access Act 
(CUMAA) which amended the Act to mandate a system of prompt corrective 
action for federally insured natural person credit unions (credit 
unions).\1\ The prompt corrective action system incorporates capital 
standards for credit unions. The Act indexes a credit union's prompt 
corrective action status to five categories: Well capitalized, 
adequately capitalized, undercapitalized, significantly 
undercapitalized, and critically undercapitalized.\2\ As a credit 
union's capital level falls, its classification among the prompt 
corrective action categories can decline below well capitalized, thus 
exposing it to an expanding range of mandatory and discretionary 
supervisory actions designed to remedy the problem and minimize any 
loss to the National Credit Union Share Insurance Fund (Share Insurance 
Fund).\3\
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    \1\ The Credit Union Membership Access Act of 1998, HR 1151, 
Public Law 105-219, 112 Stat. 913 (1998).
    \2\ 12 U.S.C. 1790d(c); 12 CFR part 702; 65 FR 8560 (Feb. 18, 
2000); see 702 subpart C for categories for ``new'' credit unions.
    \3\ Id. at Sec.  1790d(e), (f) and (g); 12 CFR 702 subpart B.
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    The Act defines a credit union's capital level based on a net worth 
ratio requirement for all credit unions and a risk-based net worth 
requirement for credit unions the Board defines as

[[Page 9692]]

complex.\4\ The Act also provides the NCUA Board with broad discretion 
to design the risk-based net worth requirement. However, the net worth 
ratio is defined in the Act as a credit union's ratio of net worth to 
total assets. The Act defines net worth as: \5\
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    \4\ In 2000, NCUA adopted part 702 of NCUA Rules and Regulations 
to implement the Act's system of prompt corrective action.
    \5\ Id. at Sec.  1790d(o)(3); 12 CFR 702.2(g) and (k).
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     The retained earnings balance of the credit union, as 
determined under generally accepted accounting principles, together 
with any amounts that were previously retained earnings of any other 
credit union with which the credit union is combined;
     Secondary capital of a low-income designated credit union 
that is uninsured and subordinate to all other claims of the credit 
union, including the claims of creditors, shareholders, and the Share 
Insurance Fund; and \6\
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    \6\ In 1996, the NCUA Board authorized low-income designated 
credit unions, including state chartered credit unions to the extent 
permitted by state law, to count as capital uninsured secondary 
capital. At the time, the Board recognized that it was difficult for 
low-income designated credit unions to accumulate capital only 
through retained earnings. The Board, therefore, permitted low-
income designated credit unions to use the borrowing authority in 
the Act to issue secondary capital accounts. This authority would 
allow these credit unions to build capital to support greater 
lending and financial services to their members and their 
communities, and to absorb losses to protect them from failing. To 
ensure the safety and soundness of secondary capital activity, the 
1996 rule imposed various restrictions on its use and structure. At 
this time, prompt corrective action and the associated definition of 
net worth was not yet part of the Act. 61 FR 50696 (Sept. 27, 1996).
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     Certain assistance provided under section 208 of the Act 
pursuant to NCUA regulations.\7\
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    \7\ 12 U.S.C. 1790d(o)(2).
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    As noted above, per the Act, secondary capital is currently only 
permissible for low-income designated credit unions to issue and to be 
counted toward the net worth ratio. NCUA also counts secondary capital 
issued by low-income designated credit unions as net worth for the 
risk-based net worth ratio.
    The Board notes that, NCUA cannot change the Act's definition of 
net worth--only Congress can. However, the Board has broad discretion 
in designing the risk-based net worth requirement. Thus, it is possible 
for the Board to authorize a credit union that is not low-income 
designated to issue alternative capital instruments that would count 
towards satisfying the risk-based net worth requirement--but not the 
net worth ratio. (See the discussion of legal authority in Section IV). 
For purposes of this ANPR, the term supplemental capital includes any 
form of capital instruments credit unions that are not designated as 
low-income might be authorized to issue and count only for inclusion in 
the risk-based net worth requirement.
    The risk-based net worth requirement for federally insured credit 
unions is based on a risk-based net worth ratio calculation in Part 702 
of NCUA's Rules and Regulations.\8\ Per the Board's October 2015 final 
rule, on January 1, 2019, the risk-based net worth requirement will be 
updated to replace the risk-based net worth ratio with a new risk-based 
capital ratio.\9\
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    \8\ Unless otherwise noted, throughout this ANPR references to 
prompt corrective action, risk-based capital, and citations to Part 
702 refer to Part 702 as revised by the Board at its October 2015 
meeting.
    \9\ 80 FR 66626 (Oct. 29, 2015).
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    During the risk-based capital rulemaking process, the Board asked 
for stakeholder input on supplemental capital. Specifically, in the 
January 2015 risk-based capital (RBC) proposal the NCUA Board posed the 
following six questions: \10\
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    \10\ 80 FR 4340, 4384 (Jan. 27, 2015).
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    1. Should additional supplemental forms of capital be included in 
the RBC numerator and how would including such capital protect the 
Share Insurance Fund from losses?
    2. If yes, to be included in the RBC numerator, what specific 
criteria should such additional forms of capital reasonably be required 
to meet to be consistent with Generally Accepted Accounting Practices 
(GAAP) and the Act, and why?
    3. If certain forms of certificates of indebtedness were included 
in the risk based capital ratio numerator, what specific criteria 
should such certificates reasonably be required to meet to be 
consistent with GAAP and the Act, and why?
    4. In addition to amending NCUA's RBC regulations, what additional 
changes to NCUA's regulations would be required to count additional 
supplemental forms of capital in NCUA's RBC ratio numerator?
    5. For state-chartered credit unions, what specific examples of 
supplemental capital currently allowed under state law do commenters 
believe should be included in the RBC ratio numerator, and why should 
they be included?
    6. What investor suitability, consumer protection, and disclosure 
requirements should be put in place related to additional forms of 
supplemental capital?
    In response to these questions, a majority of the commenters who 
addressed supplemental capital stated that it was imperative that the 
Board consider allowing credit unions access to additional forms of 
capital. The commenters suggested credit union authority to issue 
supplemental capital was particularly important as credit unions are at 
a disadvantage in the financial market because most lack access to 
additional capital outside of retained earnings. While none of the 
commenters offered specific suggestions on how to implement 
supplemental capital, a few did suggest that the Board should 
promulgate broad, non-prescriptive rules to allow credit unions maximum 
flexibility in issuing supplemental capital.
    As the Board did not receive comments with sufficient detail in 
response to the RBC proposal, the Board is again posing the six 
questions listed above for commenters to consider and address. 
Throughout this ANPR, the Board will expand on these six questions and 
ask more specific questions about the structure, form, regulations, and 
requirements related to supplemental capital, as well as relevant 
changes and improvements to secondary capital. The Board encourages all 
stakeholders to address in detail as many of these questions as 
possible and provide the Board with specific comments and responses. 
The Board intends these questions to be a starting point for commenters 
to present their thoughts, but invites comments on all aspects of 
alternative capital
    Throughout this ANPR the Board discusses several complex topics and 
uses terms to refer to specific forms of capital. In addition to 
supplemental, secondary, and alternative capital, the Board will use 
the term ``regulatory capital'' when referring to financial instruments 
issued by credit unions or banks, that include both equity and debt, 
and other financial statement account which meet the criteria contained 
in regulations for inclusion in the calculation of capital adequacy 
measures.

II. Current Secondary Capital Standards

    The Act's definition of net worth states that secondary capital 
must be ``uninsured and subordinate to all other claims of the credit 
union, including the claims of creditors, shareholders, and the Share 
Insurance Fund.'' \11\ This means that any secondary capital issued by 
a low-income designated credit union must be the most subordinated item 
on the balance sheet (first loss position after retained earnings) and 
any losses to secondary capital must be pro-rated equally--that is 
without preference or priority. The practical effect is that low-income 
designated

[[Page 9693]]

credit unions cannot include payment priority structures within or 
between secondary capital instruments to enhance investors' interests.
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    \11\ 12 U.S.C. 1790d(o)(C)(ii).
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    NCUA's rules and regulations also contain various provisions 
addressing the prudent and appropriate issuance and use of secondary 
capital by low-income designated credit unions. These provisions are as 
follows:
     Low-income designed credit unions:
    [cir] May only accept secondary capital accounts from non-natural 
person members and non-natural person nonmembers.
    [cir] Must submit and receive approval by NCUA of a Secondary 
Capital Plan.
    [cir] Must execute a Disclosure and Acknowledgement statement.
     A secondary capital account:
    [cir] Must be uninsured;
    [cir] Have a minimum maturity of five years with a reduction in the 
recognition of the net worth value of accounts with less than five 
years of remaining maturity;
    [cir] Must be subordinate to all other claims, including those of 
shareholders, creditors and the Share Insurance Fund;
    [cir] Must be available to cover operating losses that exceed net 
available reserves and to extent losses are applied the accounts must 
not be restored;
    [cir] Cannot be pledged by investors as security on a loan;
    [cir] Are subject to restrictions of dividends as provided in 
prompt corrective action; and
    [cir] May only in certain circumstances be redeemed early and only 
with prior NCUA approval.\12\
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    \12\ 12 CFR 701.34.
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    The regulations allow NCUA to prohibit a low-income designated 
credit union classified as critically undercapitalized from paying 
principal, dividends, or interest on secondary capital. This provision 
is to ensure secondary capital is available to cover losses while the 
low-income designated credit union is operating as a going concern. 
These payment restrictions are consistent with limitations on principal 
and interest payments imposed by the federal banking regulators for 
subordinated debt issued by banks.\13\
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    \13\ 12 CFR 5.47(d)(3)(ii)(B)(3).
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    Further, due to the fact that secondary capital is not a permanent 
form of capital, NCUA's regulations reduce the portion of secondary 
capital that is included in the net worth ratio as it approaches 
maturity. Once the remaining maturity is less than five years, the 
regulations require low-income designated credit unions to discount how 
much a secondary capital account contributes to the credit union's net 
worth value based on the following schedule: \14\
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    \14\ Id. at Sec.  701.34(c).

------------------------------------------------------------------------
                                                             Net worth
                                                             value of
                   Remaining maturity                        original
                                                              balance
                                                             (percent)
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Four to less than five years............................              80
Three to less than four years...........................              60
Two to less than three years............................              40
One to less than two years..............................              20
Less than one year......................................               0
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    Since 2006, low-income credit unions may request NCUA approval to 
redeem the portion of secondary capital no longer included in net worth 
if:
     The credit union will have a post-redemption net worth 
classification of at least adequately capitalized;
     The discounted secondary capital has been on deposit at 
least two years; and
     The discounted secondary capital will not be needed to 
cover losses prior to the final maturity date.\15\
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    \15\ Id. at Sec.  701.34(d).
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    With respect to secondary capital, the Board specifically seeks 
comments on the following:
     Whether or not to permit a low-income designated credit 
union to sell secondary capital to non-institutional investors (see 
Sections V and VI for more discussion on investor protection and 
suitability issues), and whether this would be for members only or any 
party.
     Allowing for broader call options for the low-income 
designated credit union, other than just the portion no longer counting 
as net worth and subject to NCUA approval, if provided for in the 
secondary capital contract.
     Relaxation of pre-approval of issuing secondary capital if 
a low-income designated credit union meets certain conditions such as 
being at least adequately capitalized and having prior experience 
issuing secondary capital.
     Inclusion of more flexibility to fund dividend payments as 
an operating loss if provided for in the contract.
     Any other prudential restrictions on secondary capital 
that should be considered.
     Reorganization of the regulation to improve clarity by 
moving to part 702 (Prompt Corrective Action) all matters related to 
how the instrument must be structured to qualify for capital treatment. 
This would move these conditions to the section of NCUA rules and 
regulations applicable to all insured natural person credit unions, and 
leave the provisions specific to federal credit union issuance 
authority in Part 701.

III. Current and Prospective Use of Alternative Capital

    This section provides information on community bank use of 
subordinated debt and low-income designated credit unions' use of 
secondary capital. This section also provides information on the 
projected impact of risk-based capital standards on complex credit 
unions to estimate the potential need for supplemental capital for 
risk-based net worth requirement purposes. This information provides a 
basis for estimating the potential for use of supplemental capital, the 
purpose of its use, the potential purchasers, and the related costs. 
The Board is interested in receiving comments concerning projections on 
the volume of supplemental capital that credit unions would be likely 
to issue. The Board also seeks specific comments on the structures of 
supplemental capital instruments that would be beneficial, why credit 
unions will issue supplemental capital, and how it fits into the credit 
union's business model. The Board is also interested in any comments 
about who will purchase supplemental capital. Since the costs 
associated with supplemental capital are significant to the issuing 
credit union, the Board seeks comments on how any regulations should 
address the issue of the cost of the instrument and any items that may 
be helpful in reducing the cost while maintaining adequate protection 
for investors and the Share Insurance Fund.

A. Community Bank Use of Subordinated Debt

    Community bank use of subordinated debt increased in 2016. As of 
June, 30, 2016, the amount outstanding was $831 million compared to 
$479 million as of December 31, 2016.\16\ Despite the increase, 
subordinated debt is only 0.34 percent of total community bank capital. 
The stated purpose of recent issuances of subordinated debt by 
community banks generally fall into three categories:
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    \16\ FDIC Quarterly, Volume 10, Number 2, page 18.
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     Facilitate mergers and acquisitions;
     Redemption of preferred stock held by the U.S. Treasury 
Department due to increasing costs; and
     Fund organic growth.\17\
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    \17\ Based on review of a sample of SEC Form D filed by issuers.
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    While the interest rate paid on community bank subordinated debt 
can vary significantly, generally the interest

[[Page 9694]]

rate is from 300 to 400 basis points over ten year treasury note 
rates.\18\ Additionally community banks report expenses associated with 
sales commissions, ranging from 1.25 percent to 3 percent, and fees 
along with legal and operational costs.\19\ Most buyers of bank 
subordinated debt are reported to be pension funds, mutual funds, other 
banks, and high net worth investors.\20\
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    \18\ Based on review of a sample of capital market announcements 
and publications of completed offerings.
    \19\ Based on review of a sample of SEC Form D filed by issuers.
    \20\ Based on review of a sample of capital market 
announcements, publication of completed offerings, and SEC Form D.
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B. Low-Income Designated Credit Union Use of Secondary Capital

    As of June 30, 2016, there were 2,426 low-income designated credit 
unions. Only 73 low-income designated credit unions (about 3 percent) 
report total outstanding secondary capital of $181 million.\21\ Since 
December 31, 2011, the number of low-income designated credit unions 
has increased by 117 percent, from 1,119 to 2,426. However, the number 
of low-income designated credit unions with outstanding secondary 
capital has ranged from 72 to 79 during this period.
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    \21\ NCUA Call Report data.
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    The $181 million in outstanding secondary capital equates to 13 
percent of the total net worth of the low-income designated credit 
unions that issued it--with an average balance of about $2.5 million. 
However, outstanding secondary capital is concentrated in four low-
income designated credit unions, which hold 74 percent of the total 
secondary capital outstanding. When excluding these four low-income 
designated credit unions, the average amount of secondary capital is 
under $700,000 per low-income designated credit union. The interest 
rate paid by the four largest holders of the outstanding secondary 
capital ranges from 0.14 percent to 3.5 percent.
    Secondary capital does, however, significantly benefit a low-income 
designated credit union's net worth ratio. The secondary capital adds 
an average of nearly 300 basis points to the net worth ratio, which 
brings the average from just below 7 percent to near 10 percent. Out of 
the 73 low-income designated credit unions with secondary capital, 66 
have a net worth ratio greater than the well capitalized 7 percent 
level. Without the secondary capital, 25 of the 66 would have a net 
worth ratio less than 7 percent.\22\
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    \22\ Secondary capital is estimated to add an average of 414 
basis points to the risk-based capital ratio that will go into 
effect on January 1, 2019.
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    The Board notes that low-income designated credit unions that have 
issued secondary capital have a higher failure rate than other low-
income designated credit unions. The average annual failure rate for 
low-income designated credit unions with secondary capital was 2.9 
percent from 2000-2013, compared to 0.8 percent for low-income 
designated credit unions without secondary capital during the same 
period.\23\ In a few failures of low-income designated credit unions, 
the assets in the credit union grew rapidly around the time the 
secondary capital was issued, which in turn led to higher losses to the 
Share Insurance Fund. NCUA has noted a pattern of poor practices in 
some low-income designated credit unions with secondary capital that 
could account for the higher failure rate, including: \24\
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    \23\ See. Secondary Capital Best Practices Guide available at 
https://www.ncua.gov/services/Pages/small-credit-union-learning-center/Documents/secondary-capital-guide.pdf.
    \24\ Id.
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     Poor due diligence, inaccurate cost benefit analysis and 
weak strategic planning in connection with establishing and expanding 
member service programs funded by secondary capital.
     Concentrations of secondary capital to support unproven or 
poorly performing programs.
     Failure to realistically assess and timely curtail 
programs not meeting expectations.
     Use of secondary capital solely to delay prompt corrective 
action.
     Insufficient liquidity to repay secondary capital at 
maturity.

C. Potential for Credit Unions' Use of Supplemental Capital

    The potential use of supplemental capital is difficult to predict 
due to the probable changes in market factors such as interest rates, 
demographics, and competition. Since supplemental capital would only 
increase a credit union's risk-based capital ratio, the most likely 
users would be those credit unions with net worth ratios above the well 
capitalized level but with a risk-based capital below or near the 
minimum needed to be well capitalized.
    The following table contains an estimate of the number of credit 
unions likely to issue supplemental capital and the potential amount of 
supplemental capital that might be issued. Using Call Report data as of 
December 31, 2015, applied to FICUs with more than $100 million in 
assets,\25\ results in the following:
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    \25\ The new risk-based net worth requirements will only apply 
to credit unions with assets of $100 million or more.

------------------------------------------------------------------------
 
------------------------------------------------------------------------
Number of credit unions that do not have a     140.
 low-income designation with a net worth
 ratio greater than 8% and an estimated risk-
 based capital ratio less than 13.5%.
Net worth of the 140 credit unions that do     $9.2 billion.
 not have a low-income designation with a net
 worth ratio greater than 8% and an estimated
 risk-based capital ratio less than 13.5%.
Maximum amount of subordinated debt that       $4.5 billion.
 could be issued with a limit set at 50% of
 net worth \26\.
Amount of supplemental capital needed by the   $1.0 billion.
 140 to achieve a 13.5% risk-based capital
 ratio.
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    The Board is interested in commenter's thoughts on whether credit 
unions that are not designated as low-income use of supplemental 
capital could affect the availability of secondary capital for low-
income designated credit unions. If so, are there any measures the 
Board could take to protect against this?
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    \26\ The Board would contemplate some limit on how much 
supplemental capital will count for risk-based capital requirements 
to ensure it remains a supplemental but not the primary source of 
capital. For illustration purposes the estimate uses a 50% limit so 
that it would not become the primary form of capital held by these 
credit unions.
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IV. Supplemental Capital Legal Authority and Potential Taxation 
Implications

A. Risk-Based Net Worth Requirement

    In addition to the Act's requirements related to the net worth 
ratio, the Act requires the Board to design ``a risk-based net worth 
requirement for credit unions defined as complex.'' \27\ The risk-based 
net worth requirement for credit unions meeting the definition of 
``complex'' was first applied on the basis of data in the Call Report 
as of March 31, 2001.\28\ Since its inception, the risk-based net worth 
requirement has included secondary capital issued

[[Page 9695]]

by low-income designated credit unions.
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    \27\ 12 U.S.C. 1790d(d)(1).
    \28\ 65 FR 44950 (July 20, 2000).
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    While the Act defined the term ``net worth,'' it did not define the 
risk-based net worth requirement, nor how to calculate any 
corresponding risk-based ratio. In contrast to the narrow definition of 
net worth, the lack of a statutory prescription for the risk-based net 
worth requirement gives the Board the latitude to include within that 
requirement items that would not meet the statutory definition of ``net 
worth'' but otherwise serve as capital in protecting the Share 
Insurance Fund from losses when a credit union fails. Given the 
statutory objective of prompt corrective action ``to resolve the 
problems of insured credit unions at the least possible long-term 
loss'' to the Share Insurance Fund, the Board believes it should 
explore expanded options for credit unions to build capital beyond 
retained earnings.
    For a credit union defined as complex to be classified well 
capitalized, the Act requires the credit union to have a net worth 
ratio of 7 percent or greater (6 percent for adequately capitalized) 
and to meet the applicable risk-based net worth requirement. Starting 
in January 2019, the risk-based net worth requirement will require the 
risk-based capital ratio to be 10 percent or greater to be well 
capitalized (8 percent for adequately capitalized). The Act classifies 
a credit union as undercapitalized if it is unable to achieve the 
applicable risk-based net worth requirement, even if it has a high net 
worth ratio, thus subjecting the credit union to the corresponding 
prompt corrective action supervisory consequences.\29\
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    \29\ 12 U.S.C. 1790d(c)(1)(C)(ii).
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B. Authority To Issue Supplemental Capital

    The authority for low-income designated credit unions to issue 
secondary capital is established in the Act. Conversely, there is no 
express authority for credit unions not designated as low-income to 
issue alternative forms of capital. However, the Act does provide 
federal credit unions with relatively broad authority to borrow from 
any source in accordance with such rules and regulations as may be 
prescribed by the Board.\30\ The Board has reviewed all applicable 
sections of the Act to determine the ability of federal credit unions 
to issue various types of financial instruments that could serve as 
alternative capital.\31\ Other than as a form of debt, there is no 
other explicit authority in the Act for federal credit unions to issue 
an instrument that is uninsured and could be structured as loss 
absorbing capital. As a result, the Board believes only the borrowing 
authority is available for federal credit unions to issue supplemental 
capital.\32\ This means that federal credit unions could only issue 
supplemental capital as subordinated debt. However, the Board invites 
commenters to identify any other provisions of the Act they believe 
could provide alternative authority for federal credit unions to issue 
supplemental capital instruments other than as subordinated debt.
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    \30\ 12 U.S.C. 1757(9).
    \31\ Authority to issue capital instruments for FISCUs is 
determined under applicable state law.
    \32\ In December 2010, the Board issued Letter to Federal Credit 
Unions 10-FCU-03: Sales of Nondeposit Investments, which stated that 
federal credit unions are not authorized under the Act to sell 
nondeposit investments directly to their members. After further 
consideration, the Board believes federal credit unions have the 
authority to issue supplemental capital instruments under the 
borrowing authority in the Act, even though these instruments may be 
considered securities for purposes of state and federal securities 
laws.
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C. Supplemental Capital Relationship to Secondary Capital

    Supplemental capital and secondary capital are similar in that, for 
federal credit unions, both are uninsured accounts issued as borrowings 
and subject to applicable statutory borrowing limits. Secondary 
capital, however, is included in the statutory definition of net worth 
and counts towards both the net worth ratio and the risk-based net 
worth requirement. Supplemental capital is not included the statutory 
definition of net worth and can only be considered for inclusion in the 
computation of the risk-based net worth requirement.
    Supplemental capital would have to be subordinate to the Share 
Insurance Fund and uninsured shareholders in the payout priorities. 
However, since secondary capital, per the Act, must be subordinate to 
all other claims, supplemental capital would be senior to secondary 
capital in the payout priorities. Credit unions issuing supplemental 
capital could be provided flexibility to include payment priority 
structures within or between supplemental capital instruments to 
enhance investors' interests.

D. Need for Comprehensive Borrowing Rule for Federal Credit Unions

    The Board is considering expanding the borrowing rule to clarify 
this authority for federal credit unions. As noted above, the Act 
states that federal credit unions may ``borrow, in accordance with such 
rules and regulations as may be prescribed by the Board, from any 
source.'' Currently, NCUA's regulations only contain a rule addressing 
when federal credit unions borrow from natural persons. Given that the 
wording of the Act could suggest a federal credit union's borrowing 
authority is contingent on rules and regulations prescribed by the 
Board, it may appear to investors that federal credit unions are 
restricted to only borrowing from natural persons. While the Board 
disagrees with this reading of the Act, the Board is concerned that 
some supplemental capital investors may question a federal credit 
union's authority to issue supplemental capital instruments to anyone 
other than natural persons. Clarity and certainty about a federal 
credit union's borrowing authority may be important to the sale of 
supplemental capital--by expanding the potential investor base and 
reducing unnecessary transaction complications. With respect to this 
topic, the Board is interested in commenter's views on whether the 
Board should promulgate a more comprehensive borrowing rule as part of 
any authorization of supplemental capital, and what the rule should 
address.

E. Authority for Federally Insured State Chartered Credit Unions To 
Issue Supplemental Capital

    The authority under which a federally insured state chartered 
credit union could issue alternative capital instruments is distinct 
from whether and to what extent NCUA, as insurer, would recognize it as 
regulatory capital for prompt corrective action purposes. A federally 
insured state chartered credit union's authority to issue supplemental 
capital would be derived from applicable state law and regulation 
regarding its ability to issue liability and equity instruments. Such 
state laws may be narrower or broader than those for federal credit 
unions. Recognition as regulatory capital will depend on the 
characteristics of the instrument and its availability to protect the 
Share Insurance Fund--which would be based on uniform criteria that 
apply to all federally insured credit unions. (see section VI for more 
discussion)
    For federal credit unions, the Act limits the aggregate amount of 
borrowed funds to 50 percent of paid-in and unimpaired capital and 
surplus.\33\ Per

[[Page 9696]]

Sec.  741.2, NCUA's rules and regulations limit borrowing by federally 
insured state chartered credit unions to 50 percent of paid-in and 
unimpaired capital and surplus. The regulation does provide the ability 
for state credit unions to obtain a waiver up to the amount of 
borrowing allowed under state law.\34\ The Board is not aware of any 
federally insured state chartered credit unions that have requested a 
waiver to the borrowing limit in the past decade. While authority to 
issue alternative capital instruments for federally insured state 
chartered credit union is determined under state law, it is possible 
that some states will only allow their credit unions to issue 
alternative capital instruments under applicable borrowing authority. 
As NCUA's borrowing limit for federally insured state chartered credit 
union is not statutory, the Board can entertain removing this limit and 
requests comment on this option.
---------------------------------------------------------------------------

    \33\ Section 700.2 of NCUA Rules and Regulations defines Paid-in 
and unimpaired capital and surplus as shares plus post-closing, 
undivided earnings. This does not include regular reserves or 
special reserves required by law, regulation or special agreement 
between the credit union and its regulator or share insurer. 12 CFR 
700.2.
    \34\ 12 CFR 741.2.
---------------------------------------------------------------------------

F. Potential Taxation Implications

    The Board recognizes that supplemental capital could have an impact 
on the credit union tax exemption. The Act specifically exempts federal 
credit unions from taxation by the United States or by any State or 
local taxing authority, except real and personal property taxes.\35\ 
With respect to federal credit unions, the Board is aware that part of 
the basis for the credit union tax exemption was that Congress 
recognized most credit unions could not access the capital markets to 
raise capital.\36\ If all credit unions, not just low-income designated 
credit unions, have the ability to access the capital markets to meet 
capital standards, it could call into question one of the bases for the 
credit union tax exemption. The Board invites comments on this topic 
and would like to hear from stakeholders on the possible impact a 
supplemental capital rule may have on the federal credit union tax 
exemption.
---------------------------------------------------------------------------

    \35\ 12 U.S.C. 1768.
    \36\ It is noteworthy that, in 1951, thrift institutions lost 
their tax exemption. The Senate report to the Revenue Act of 1951 
stated that mutual savings banks and savings and loan associations 
were losing their tax exemption because they had evolved into 
commercial bank competitors. In addition, thrifts had evolved from 
mutual organizations to ones that operated in a similar manner to 
banks. Finally, the exemption had given thrifts a competitive 
advantage over taxable commercial banks and life insurance 
companies.
---------------------------------------------------------------------------

    Unlike federal credit unions, the Act does not exempt federally 
insured state chartered credit unions from taxation. Federally insured 
state chartered credit unions are exempt from federal income tax under 
Sec.  501(c)(14)(A) of the Internal Revenue Code. Section 501(c)(14)(A) 
of the Internal Revenue Code provides for exemption from federal income 
taxes for state credit unions without capital stock organized and 
operated for mutual purposes without profit. At this time, there does 
not appear to be an established definition of ``capital stock'' used by 
the IRS. It is possible federally insured state chartered credit unions 
in some states will have broad authority to issue supplemental capital 
instruments that have the characteristics of capital stock, and by 
doing so could subject themselves to taxation. The Board therefore 
requests comment on whether NCUA should limit the types of instruments 
issued by federally insured state chartered credit unions to those that 
would clearly not meet the definition of capital stock. Other options 
the Board could consider, include requiring a federally insured state 
chartered credit unions to provide a formal opinion from the IRS that 
the supplemental capital instrument it is issuing will not be 
classified as capital stock or requiring the credit union to provide 
projections in advance of issuing the supplemental capital 
demonstrating that it can afford to be taxed and the benefits of the 
supplemental capital outweigh the cost of any taxes it might become 
subject to.

G. Mutual Ownership Structure of Credit Unions

    The Board also invites comments on the potential effect 
supplemental capital may have on the mutual ownership structure and 
governance of credit unions. The Board invites comments on how it 
should structure any potential rule to avoid issues impacting the 
mutuality of credit unions, and the members' rights to govern the 
affairs of the institution. Specifically, the Board invites comments on 
restrictions it might impose on characteristics of supplemental capital 
to avoid these issues, such as: Non-voting and limits on covenants in 
the investment agreement that may give investors levels of control over 
the credit union.

V. Securities Law Applicability

    The Board believes that both secondary and supplemental capital 
would be considered securities for purposes of state and federal 
securities laws. The Board invites comment on this topic and its 
relationship to credit unions issuing securities as supplemental 
capital.
    Being subject to securities laws can impose requirements on the 
issuer to register with the Securities Exchange Commission (SEC), issue 
SEC mandated disclosures, and comply with the SEC's broad anti-fraud 
rules. The Board, however, is aware that there are two exemptions that 
would likely be available to credit unions:
     Section 3(a)(5) of the Securities Act, which is available 
to certain types of financial institutions, including credit unions, 
for the issuance of any type of security to any type of investor; \37\ 
and
---------------------------------------------------------------------------

    \37\ 17 CFR 240.3a5.
---------------------------------------------------------------------------

     Rule 506 under Regulation D under the Securities Act, 
which is available to any entity offering any type of security, 
provided that purchasers of the securities are ``accredited investors'' 
(although sales to a limited number of investors who are not accredited 
are also possible under certain circumstances).\38\
---------------------------------------------------------------------------

    \38\ Id. at Sec.  230.506.
---------------------------------------------------------------------------

    While these exemptions are likely to relieve credit unions of the 
requirements to register with the SEC and issue SEC mandated 
disclosures, there are a number of other issues that credit unions must 
consider and comply with before issuing any instrument that would be 
considered a security. The Board briefly addresses each of these issues 
below.

A. Federal Securities Requirements

    Regardless of any exemption from registration and disclosure, 
credit unions issuing alternative capital must still comply with the 
SEC's broad anti-fraud regulations.\39\ The Securities Exchange Act of 
1934's (Exchange Act) general anti-fraud prohibitions are embodied in 
Sec.  10(b), which generally prohibits the use of manipulative or 
deceptive devices or contrivances that violate SEC rules in connection 
with the purchase or sale of securities. Most of the litigation brought 
with respect to the rules promulgated under Sec.  10(b) has been 
brought under the general anti-fraud provision, Rule 10b-5, which 
provides as follows:
---------------------------------------------------------------------------

    \39\ See, e.g., Regulation D, Rule 501(a): ``Users of Regulation 
D (Sec. Sec.  230.500 et seq.) should note the following:
    (a) Regulation D relates to transactions exempted from the 
registration requirements of section 5 of the Securities Act of 1933 
(the Act) (15 U.S.C. 77a et seq., as amended). Such transactions are 
not exempt from the anti-fraud, civil liability, or other provisions 
of the federal securities laws.''
---------------------------------------------------------------------------

    It shall be unlawful for any person, directly or indirectly, by the 
use of any means or instrumentality of interstate commerce, or of the 
mails or of any facility of any national securities exchange,
    (a) To employ any device, scheme, or artifice to defraud,

[[Page 9697]]

    (b) To make any untrue statement of a material fact or to omit to 
state a material fact necessary in order to make the statements made, 
in the light of the circumstances under which they were made, not 
misleading, or
    (c) To engage in any act, practice, or course of business which 
operates or would operate as a fraud or deceit upon any person, in 
connection with the purchase or sale of any security.\40\
---------------------------------------------------------------------------

    \40\ 17 CFR 240.10b-5.
---------------------------------------------------------------------------

    The primary intent of Rule 10b-5 and, more broadly, the anti-fraud 
provisions of the Securities Act of 1933 (Securities Act) and Exchange 
Act, is to prevent fraud, deceit, and incorrect or misleading 
statements or omissions in the offering, purchase and sale of 
securities. Given that intent, clear and complete disclosure is the 
critical factor in ensuring the anti-fraud provisions of the Securities 
Act and Exchange Act are not breached in any offering by credit unions, 
regardless of whether the offering is registered with the SEC under the 
Securities Act or exempt from registration.
    In the absence of SEC-mandated disclosure delivery requirements, 
the practical concern for credit unions relying on either the Section 
3(a)(5) or Regulation D, Rule 506 exemption is determining what type 
and amount of disclosure is appropriate to meet the anti-fraud 
standards. The Board is aware that the amount of disclosure varies 
depending on multiple factors, including:
     The nature of the potential investors (focusing on their 
level of sophistication);
     The nature of the security being offered (focusing on the 
complexity of the instrument);
     The nature of the business of the issuer and the industry 
in which the issuer operates (focusing on the complexity of the 
business or industry); and
     Market practices (focusing on the types of disclosure 
commonly provided by peer companies).
    In addition, the Board is aware that for any disclosure to meet the 
standards of Rule 10b-5, the disclosure must not contain any untrue 
statement of a material fact and must not omit to state a material 
fact, the absence of which renders any disclosure being made 
misleading. Further, the disclosure must be clear, accurate and 
verifiable, and should cover topics that are typically important to 
investors in making an investment decision, including:
     Material risks relating to the issuer and the industry in 
which the issuer operates;
     Material risks relating to the security being offered;
     The issuer's planned uses for the proceeds of the 
offering;
     Regulatory matters impacting the issuer and its 
operations;
     Tax issues associated with the security being offered; and
     How the securities are being offered and sold, including 
any conditions to be met in order to complete the offering.
    The Board is also aware that the Office of Comptroller of the 
Currency (OCC) promulgated regulations that require supervised banks 
issuing securities to register directly with the OCC and issue OCC 
mandated disclosures. The OCC mandated disclosures are very similar to 
those required by the SEC.\41\ The Board is considering requiring 
similar registration and disclosures for credit unions issuing 
alternative capital. The Board is concerned that without mandated 
disclosures, credit unions may be at greater risk for anti-fraud suits, 
which, if successful, would impair not only the credit union but also 
the Share Insurance Fund's ability to use secondary or supplemental 
capital to cover losses. Further, the Board also believes it is 
important that investors in credit union alternative capital 
instruments have similar protections to those provided investors in SEC 
and OCC covered entities. The Board is interested in comments on the 
following questions in particular:
---------------------------------------------------------------------------

    \41\ 12 CFR part 16.
---------------------------------------------------------------------------

     Should the Board require credit unions issuing alternative 
capital to register with NCUA?
     How could NCUA protect the Share Insurance Fund against 
potential anti-fraud claims that could impair the alternative capital's 
ability to cover losses?
     Should the Board mandate disclosures all credit unions 
issuing alternative capital must provide to investors? If the Board 
should mandate disclosures, should it base them on the SEC's, the 
OCC's, or create a unique set of disclosures for credit unions? If the 
Board creates a unique set of disclosures, what should it include in 
those disclosures? Should the level of disclosures vary based on the 
level of the investor (institutional, accredited, natural person)?
     Should the Board require credit unions to develop policies 
and procedures to ensure ongoing compliance with anti-fraud 
requirements before it begins issuing alternative capital?
    The Board is also aware that there may be potential broker-dealer 
registration issues related to secondary and supplemental capital. 
Specifically, marketing activities by a credit union and its employees 
could require the credit union to register as a broker-dealer. While 
there are exemptions available to credit unions and their employees, 
the Board notes that these exemptions are complex and require a 
thorough evaluation of a credit union's practices and the activities of 
its employees. If a credit union or its employees fail to qualify for 
an exemption, the credit union or employee could be required to 
register as a broker-dealer or face penalties for failure to comply 
with applicable rules. The Board has previously stated that federal 
credit unions are not permitted to register as broker-dealers.\42\ The 
Board invites comments on how it should ensure a credit union has 
determined if it or its employees are required to register.
---------------------------------------------------------------------------

    \42\ NCUA Letter to FCUs 10-FCU-03, Sale of Nondeposit 
Investments, December 2010.
---------------------------------------------------------------------------

    In addition, it is unlikely that credit unions and their employees 
would be subject to investment adviser registration requirements. The 
Board notes that certain marketing activities and relationships with 
other credit unions could raise investment adviser requirements. The 
Board, therefore, invites comments on this issue and if NCUA should 
require credit unions to have policies and procedures to ensure their 
activities do not trigger investment adviser registration requirements.

B. State Securities Requirements

    First, certain provisions of the Securities Act and SEC rules have 
preempted state securities laws with respect to most covered 
securities. However, states may require issuers to register with the 
state and/or pay state registration fees. Further, states may also 
pursue fraud-based claims. The Board invites comment on how it should 
ensure that any credit union issuing alternative capital has considered 
and complied with all applicable state laws.

C. Director and Officer Liability Coverage

    The Board also notes that issuing securities can affect a credit 
union's director and officer liability coverage. A lack of coverage 
could not only impair the credit union, but also threaten the Share 
Insurance Fund in the event there are losses that the credit union is 
ultimately responsible for. Before engaging in supplemental or 
secondary capital activities, therefore, credit unions will need to 
evaluate coverage to

[[Page 9698]]

ensure these activities are covered under their policy. The Board 
requests comments on if it should mandate that credit unions certify 
that they have evaluated their policies and have sufficient coverage 
before beginning secondary or supplemental capital activities.

D. Contractual Matters and Communications

    A credit union will need to address contractual provisions between 
the credit union and its investors. Often these provisions will include 
requiring ongoing communications with investors, reporting of 
compliance with the contractual covenants, and sharing of information 
with current and prospective investors. Credit unions will have to 
develop policies and procedures to comply with these covenants and 
provisions and ensure that they are not providing non-public 
information to investors that is not generally available to all 
investors. Failure to comply with the investment contracts or to 
properly monitor communications and sharing of information could 
subject the credit union to liability, which could negatively impact 
the Share Insurance Fund. As such, the Board requests comment on if it 
should mandate comprehensive policies addressing compliance with 
investment contracts, communications, and information sharing. The 
Board invites commenters to provide suggestions on the specific details 
that should be in the policy and if sufficient policies should be a 
prerequisite to engaging in supplemental or secondary capital 
activities.

VI. Other Investor Considerations

    Section 701.34(b) of NCUA's regulations limits eligible investors 
in secondary capital to institutional investors, referenced as non-
natural persons.\43\ This limitation is not required by the Act. This 
limitation prevents the sale of secondary capital to consumers who 
could lack the ability to understand the risks associated with 
secondary capital, especially when there is opportunity for confusion 
given that the low-income designated credit union is federally insured. 
Also, low-income designated credit unions can sell secondary capital to 
nonmembers. When the secondary capital regulations were written in 1996 
the purchasers of secondary capital were presumed to be foundations and 
other philanthropic-minded institutional investors.\44\
---------------------------------------------------------------------------

    \43\ 12 CFR 701.34(b).
    \44\ 61 FR 378 (Feb. 2, 1996).
---------------------------------------------------------------------------

    From an investor protection standpoint, the issue of limiting the 
sale of secondary capital and supplemental capital largely focuses on 
providing adequate protections to the purchasers through the issuance 
of initial disclosures, transparency standards with respect to 
reporting of information about the operations and performance of the 
credit union, and whether the purchaser has the necessary 
sophistication relative to the complexity and risk of the instrument. 
As discussed in more detail in the Section V, Securities Law 
Applicability, of this ANPR, the OCC requires banks issuing 
subordinated debt to comply with the securities offering disclosure 
rules in its regulations.\45\ The OCC's regulations establish 
registration statement and prospectus requirements for the offer and 
sale of securities issued, subject to exemptions and disclosure 
requirements based on the sophistication of the investor. As banks are 
not restricted in who they can sell securities to, these rules, in 
part, help provide a level of investor protection, particularly for 
less sophisticated, non-institutional investors.
---------------------------------------------------------------------------

    \45\ 12 CFR 5.47(d)(3)(iii).
---------------------------------------------------------------------------

    The issue of permissible investors is also related to anti-fraud 
considerations. As noted above, the level of disclosures necessary to 
comply with anti-fraud rules varies, in part, on the level of 
sophistication of the investors. In practice, selling to non-
sophisticated investors would likely involve a much higher initial and 
ongoing disclosure and communications burden for credit unions.
    Thus, the Board requests comment on whether the sale of secondary 
and supplemental capital should be limited to only institutional 
investors, include accredited investor, or allow for anyone to 
purchase. If the Board were to allow credit unions to sell alternative 
capital to non-accredited investors, should there be limits on the 
amount individual investors can purchase? Also, should there be 
conditions on how the sale to non-accredited investors must be handled 
to minimize potential confusion about its lack of federal insurance?
    Whether credit unions that are not low-income designated should be 
able sell supplemental capital instruments to nonmembers with equity 
like characteristics is a matter relevant to considerations about the 
mutual model of credit unions. The Board requests comments on the 
extent to which credit unions should be allowed to sell alternative 
capital with equity like characteristics to nonmembers, and if so, what 
controls are necessary to preserve the mutual ownership structure and 
democratic governance of credit unions. The Board invites comments on 
how it should structure any potential rule to avoid issues impacting 
the mutuality of credit unions, and the members' rights to govern the 
affairs of the institution.

VII. Prudential Standards for Issuing and Counting Alternative Capital 
for Prompt Corrective Action

    For a financial instrument to be considered regulatory capital for 
prompt corrective action purposes, NCUA must consider the instrument's 
degree of permanence, capacity to absorb losses as a going concern, the 
flexibility of principal and interest payments, and intended use of the 
proceeds. These characteristics are consistent with the Basel Tier 2 
capital criteria.\46\ These same criteria are also contained in the 
regulatory capital quality distinctions for the U.S. banking 
system.\47\ Provisions related to these characteristics are intended to 
ensure the funds will be available to protect the Share Insurance Fund 
and do not create incentives for credit unions to engage in unsafe or 
unsound practices.
---------------------------------------------------------------------------

    \46\ Basel III was published in December 2010 and revised in 
June 2011. The text is available at http://www.bis.org/publ/bcbs189.htm. The BCBS is a committee of banking supervisory 
authorities, which was established by the central bank governors of 
the G-10 countries in 1975. More information regarding the BCBS and 
its membership is available at http://www.bis.org/bcbs/about.htm. 
Documents issued by the BCBS are available through the Bank for 
International Settlements Web site at http://www.bis.org. See 
paragraph number 58 for criteria for inclusion in Tier 2 Capital.
    \47\ 12 U.S.C. 324.20.
---------------------------------------------------------------------------

    The function of supplemental capital is to protect the credit union 
and the Share Insurance Fund in the event of loss. Supplemental 
capital, therefore, must be able to absorb losses ahead of the Share 
Insurance Fund while not conferring control of the credit union to the 
investor. The instruments must be uninsured and cannot be guaranteed or 
secured by the credit union or its assets. These features ensure 
supplemental capital fulfils its ultimate purpose and does not result 
in unintended encumbrances to the credit union or the Share Insurance 
Fund.
    The degree of permanence is important because the instrument must 
create sufficient stability in the credit union's capital base to be 
available to cover losses over a long time period. This is the reason 
for the minimum five year maturity contained in the Basel accords, the 
U.S. banking capital regulations, and for secondary capital

[[Page 9699]]

for low-income designated credit unions. With respect to secondary 
capital, a low-income designated credit unions is allowed to have a 
call option for the portion no longer qualifying as net worth so that 
they may retire the instrument if it is no longer needed or market 
conditions allow them to reprice the capital at a lower rate. However, 
supervisory approval is needed before any call is exercised because it 
represents a potentially material change to the risk to the Share 
Insurance Fund.
    The alternative capital must be able to absorb losses while the 
institution is still a going concern, and not just in the case of 
liquidation. The existing regulatory language regarding secondary 
capital requires that it is available to ``cover operating losses.'' 
\48\ The term ``operating losses'' has been interpreted to not include 
the payment of dividends on shares.\49\ However, a credit union's 
inability to fund a dividend rate that is consistent with prevailing 
rates can create liquidity and reputation risk. Therefore, credit 
unions may need the flexibility to issue alternative capital 
instruments that are available to absorb all losses in excess of 
retained earnings, including the payment of dividends on shares.\50\ 
The Board is seeking comment on the exclusion of dividend expenses as 
an operating expense and seeks comment on how to resolve the complexity 
that can result from excluding dividend expense from losses applied to 
secondary capital but not from losses applied to supplemental capital.
---------------------------------------------------------------------------

    \48\ 12 CFR 701.34(b)(7).
    \49\ 12 CFR 701.34.
    \50\ If the Board authorizes supplemental capital, it could be 
possible for low income designated credit unions to concurrently 
offer both supplemental and secondary capital instruments. The 
differing treatment of payments on dividends could make the 
administration of losses applied to alternative capital complex and 
potentially confusing.
---------------------------------------------------------------------------

    Further, the payment of interest on the instruments must be capable 
of being cancelled on a permanent, noncumulative basis without 
constituting a default. The interest provisions must also not contain 
any feature which would provide incentive for the credit union to 
exercise a call option, such as a large increase in the interest rate. 
The flexibility of payments ensures investors cannot obviate any risk 
exposure to their principal through problematic dividend and interest 
provisions. These criteria are consistent with the criteria for 
inclusion in Tier 2 capital used by the other banking regulators \51\ 
and are contained in Basel III.\52\
---------------------------------------------------------------------------

    \51\ 12 CFR 5.47.
    \52\ Basel III was published in December 2010 and revised in 
June 2011. The text is available at http://www.bis.org/publ/bcbs189.htm. See paragraph 58 for criteria for inclusion in Tier 2 
Capital.
---------------------------------------------------------------------------

    Because of these characteristics, most alternative capital 
instruments can have relatively low liquidity for the purchaser and 
there is no guarantee of a secondary market. These characteristics also 
impact the interest rate the credit union must pay for alternative 
capital. The Board seeks comment on how to maintain protection of the 
Share Insurance Fund while minimizing the impact the criteria would 
have on the cost and marketability of the alternative capital 
instruments.

A. Approval To Issue and Notice

    The Board is considering including an application and notice 
requirement in any supplemental capital regulations it may issue.\53\ 
The Board notes that requiring a credit union to obtain approval to 
issue alternative capital and provide a notice of issuance can 
contribute to ensuring alternative capital instruments are issued in 
accordance with applicable regulations, part of a sound management 
plan, and are structured to properly protect the Share Insurance 
Fund.\54\
---------------------------------------------------------------------------

    \53\ Secondary capital provisions already require low income 
designated credit unions to obtain prior NCUA approval.
    \54\ See. 12 CFR 5.47(f) and (h) for the OCC's requirements for 
prior approval for issuance of subordinated debt and for the notice 
procedure for inclusion as tier 2 capital.
---------------------------------------------------------------------------

    The Board notes that currently NCUA requires a low-income 
designated credit union to submit a ``Secondary Capital Plan'' prior to 
the acceptance of secondary capital that includes: \55\
---------------------------------------------------------------------------

    \55\ 12 CFR 701.34(b)(1).
---------------------------------------------------------------------------

     The maximum aggregate amount of secondary capital the low-
income designated credit union plans to accept;
     The purpose for which the secondary capital will be used 
and how it will be repaid;
     Demonstration that the uses of the secondary capital 
conform to the low-income designated credit union's strategic plan, 
business plan, and budget; and
     Supporting pro forma financial statements covering a 
minimum of two years.
    The account agreement associated with any alternative capital needs 
to conform to the standards that ensure it protects the Share Insurance 
Fund and provide the credit union with flexibility in conducting its 
daily affairs. The secondary capital regulation currently requires that 
the low-income designated credit union retain the original account 
agreement and the ``Disclosure and Acknowledgment'' for the term of the 
agreement.\56\ The regulation does not specifically require a low-
income designated credit union to submit to NCUA either a draft account 
agreement with the application or the executed agreement.
---------------------------------------------------------------------------

    \56\ Id. at Sec.  701.34(b)(11).
---------------------------------------------------------------------------

    For all forms of alternative capital, the Board seeks comments on 
the utility of a prior approval process and a post-issuance 
notification process. The Board can also consider under what conditions 
prior approval would not be necessary, such as credit unions that are 
well capitalized with a successful history of issuing alternative 
capital. When prior approval would be necessary, however, the Board 
requests comments on what should be required in an application for 
authority to issue alternative capital, and how long the credit union 
would have to issue the alternative capital after approval. In 
addition, the Board request comment on the evaluation criteria NCUA 
should use to approve or deny the application, including whether or not 
certain credit unions that are already in danger of failing should be 
precluded from issuing alternative capital as a form of investor 
protection. Also, the Board seeks comment on the manner of and what 
should be included in any post-issuance notice credit unions would file 
with NCUA.

B. Subordination

    Secondary capital must be subordinate to all other claims per the 
Act.\57\ Thus, supplemental capital must have a payout priority senior 
to secondary capital but still subordinate to the Share Insurance Fund. 
The requirement that alternative capital instruments are subordinate to 
the Share Insurance Fund, uninsured shareholders, and general creditors 
is consistent with the Basel criteria for Tier 2 capital.\58\
---------------------------------------------------------------------------

    \57\ 12 U.S.C. 1790d(o)(2)(C)(ii).
    \58\ Basel III was published in December 2010 and revised in 
June 2011. The text is available at http://www.bis.org/publ/bcbs189.htm. The BCBS is a committee of banking supervisory 
authorities, which was established by the central bank governors of 
the G-10 countries in 1975. More information regarding the BCBS and 
its membership is available at http://www.bis.org/bcbs/about.htm. 
Documents issued by the BCBS are available through the Bank for 
International Settlements Web site at http://www.bis.org. See 
paragraph number 58 for criteria for inclusion in Tier 2 Capital.
---------------------------------------------------------------------------

    Unlike secondary capital, supplemental capital is not subject to 
provisions in the Act that limit flexibility in structuring payment 
priorities within and between supplemental capital instruments. For 
example, a credit union could issue a supplemental capital instrument 
with

[[Page 9700]]

two tranches, a high-yield-high-risk supporting tranche and a lower-
yielding-lower risk tranche. Credit unions could also issue 
supplemental capital instruments that have first in-first out, or last 
in-first out contractual payment priorities. This flexibility could 
help credit unions attract investors of different risk tolerances and 
profiles. The Board seeks comment on whether authorizing supplemental 
capital regulations should contain any restrictions on payment priority 
options, and if so, what should they be.

C. Limit on Amount of Supplemental Capital That Counts as Regulatory 
Capital

    While supplemental capital can protect the Share Insurance Fund and 
uninsured shares from losses, reliance on alternative capital as the 
primary source of capital is generally unsafe and unsound. Even with a 
high level of permanent capital, such as retained earnings and common 
stock, heavy reliance on alternative capital can result in wide 
fluctuations in capital measures due to the timing of its maturity and 
negative impact on earnings due to the associated costs.
    U.S. bank capital regulations require banks to hold minimum levels 
of common equity tier 1 capital, total tier 1 capital, and total tier 1 
and tier 2 capital to total risk assets that ensures that permanent 
capital is generally the primary source of regulatory capital.\59\ An 
FDIC-supervised institution must maintain the following minimum capital 
ratios: \60\
---------------------------------------------------------------------------

    \59\ 12 CFR 324.10(a).
    \60\ The standardized capital ratio calculations are defined in 
12 CFR 3.10(b). The Common Equity Tier 1 Capital Ratio is the ratio 
of Common Equity Tier 1 Capital to standardized total risk-weighted 
assets. The Tier 1 Capital Ratio is the ratio of Tier 1 Capital to 
standardized total risk-weighted assets. The Total Capital Ratio is 
the ratio of total capital (Tier 1 Capital plus Tier 2 Capital) to 
standardized total risk-weighted assets. The Leverage Ratio is 
generally Tier 1 Capital to total consolidated assets. The 
components of regulatory capital are defined in 12 CFR 3.20. Common 
Equity Tier 1 Capital is generally common stock, retained earnings, 
and accumulated other comprehensive income. Additional Tier 1 
Capital primarily includes noncumulative perpetual preferred stock. 
Tier 2 Capital generally includes limited allowance for loan and 
lease losses, certain subordinated debt and preferred stock, and 
qualifying capital minority interests.
---------------------------------------------------------------------------

     A common equity tier 1 capital ratio of 4.5 percent;
     A tier 1 capital ratio of 6 percent;
     A total capital ratio of 8 percent; and
     A leverage ratio of 4 percent.\61\
---------------------------------------------------------------------------

    \61\ Id. at Sec.  324.10(a).
---------------------------------------------------------------------------

    Additionally to be classified as well capitalized a bank must have:
     A total risk-based capital ratio of 10.0 percent or 
greater;
     A Tier 1 risk-based capital ratio of 8.0 percent or 
greater;
     A common equity tier 1 capital ratio of 6.5 percent or 
greater; and
     A leverage ratio of 5.0 percent or greater.\62\
---------------------------------------------------------------------------

    \62\ Id. at Sec.  324.403(b)(1).
---------------------------------------------------------------------------

    As a result, banks are inherently limited in how much Tier 2 forms 
of capital will be included in meeting their regulatory capital 
standards. Most forms of alternative capital likely available to credit 
unions will be in the form of subordinated debt--which does not meet 
the standards to qualify as Tier 1 capital.
    Neither the Act nor NCUA regulations limit the amount of secondary 
capital that can make up a low income designated credit union's net 
worth. Given their unique needs and mission, low-income designated 
credit unions can primarily rely on secondary capital to meet prompt 
corrective action requirements, provided their use of the proceeds and 
overall ongoing management of their secondary capital is otherwise safe 
and sound. However, the Board believes any regulation for supplemental 
capital needs to contain some method of preventing supplemental 
capital, a lower quality of capital, from becoming the primary 
component of regulatory capital for credit unions. The Board seeks 
comments on how capital regulations could be designed to limit the 
amount of supplemental capital included in regulatory capital 
calculations.
    Consistent with Basel, U.S. bank capital standards,\63\ and 
secondary capital regulations, the portion of supplemental capital that 
would be considered as regulatory capital and included in the 
calculation of the risk-based net worth requirement would be subject to 
reductions during the last five years of the life of the instrument. 
Consistent with secondary capital, at the beginning of the each of last 
five years of the life of the supplemental capital, the amount that is 
eligible to be included in the risk-based net worth requirement would 
be reduced by 20 percent of the original amount of the instrument (less 
any redemptions that may have occurred). The Board seeks comments on 
this concept and how to reflect the increasingly limited utility as 
loss absorbing capital for supplemental capital approaching maturity.
---------------------------------------------------------------------------

    \63\ 12 CFR 324.20(d)(iv).
---------------------------------------------------------------------------

    The Board also notes that changing conditions and circumstances may 
warrant early repayment of alternative capital, in part or in whole. 
The decision on early repayment must reside with the issuing credit 
union and not the holder of the instrument, to ensure the permanence of 
the instrument and prevent undue influence by investors. Currently the 
secondary capital regulations only allow for early redemption of the 
amount of secondary capital that is not recognized as net worth, with 
approval by NCUA.\64\
---------------------------------------------------------------------------

    \64\ 12 CFR 701.34(d).
---------------------------------------------------------------------------

    Regulatory controls over early repayment are necessary to protect 
the Share Insurance Fund and uninsured shares. Regulatory controls over 
early repayment are also consistent with the Basel framework for 
subordinated debt and the other banking agencies' regulations, which 
provide control over the early repayment of subordinated debt by:
     Requiring all banks to obtain prior approval to prepay or 
call subordinated debt included in tier 2 capital.\65\
---------------------------------------------------------------------------

    \65\ Id. at Sec.  5.47(d)(1)(vii).
---------------------------------------------------------------------------

     Prohibiting the holder of subordinated debt from having a 
contractual right to accelerate principal or interest payments in the 
instrument, except in the event of a receivership, insolvency, 
liquidation, or other similar proceeding.\66\
---------------------------------------------------------------------------

    \66\ Id. at Sec.  5.47(d)(2).
---------------------------------------------------------------------------

     Prohibiting the exercise of a call option in the first 
five years following issuance, except in certain very limited 
circumstances.
    Enabling regulations for supplemental capital will need to address 
the issue of prepayment and call provisions for supplemental capital. 
The options regarding the abilities of a credit union to prepay 
supplemental capital could include minimum capital measures after 
repayment, current and expected future performance measures and notice 
criteria of varying degrees. The Board invites comments on the topic of 
prepayment and call provisions for alternative capital and how it 
should structure any related requirements. Allowing credit unions 
greater flexibility to eliminate the cost of alternative capital or 
reprice the instrument under better terms could provide benefits to the 
credit union. Any alternative to the redemption process would be 
contingent on the credit union no longer relying on the alternative 
capital to achieve an appropriate level of capital.

D. Reciprocal Holdings

    Regulations for alternative capital need to address reciprocal 
holdings. Reciprocal holdings exist when two or more credit unions hold 
each other's alternative capital. Reciprocal holdings

[[Page 9701]]

of alternative capital, without some form of adjustment, would 
artificially inflate the level of capital in the credit union system, 
create loss transmission channels between credit unions, and could be 
subject to abuse.
    The Board notes a national bank or federal savings association must 
deduct investments in the capital of other financial institutions it 
holds reciprocally, where such reciprocal cross holdings result from a 
formal or informal arrangement to swap, exchange, or otherwise intent 
to hold each other's capital instruments, by applying the corresponding 
deduction approach.\67\ The Board requests comment on how NCUA should 
address this concern.
---------------------------------------------------------------------------

    \67\ 12 CFR 3.22(c)(3).
---------------------------------------------------------------------------

E. Merger

    Per the current regulation, in the event of merger of a low-income 
designated credit union (other than merger into another low-income 
designated credit union) the secondary capital accounts will be closed 
and paid out to the investor to the extent they are not needed to cover 
losses at the time of merger or dissolution. The OCC prohibits a 
covenant or provision in subordinated debt instruments that requires 
the prior approval of a purchaser or holder of the subordinated debt 
note in the case of a voluntary merger where the resulting institution 
assumes the due and punctual performance of all conditions of the 
subordinated debt note and where the agreement is not in default of the 
various other covenants.\68\
---------------------------------------------------------------------------

    \68\ 12 CFR 5.47(d)(2)(iv).
---------------------------------------------------------------------------

    In order to avoid any perceptions of an alternative capital holder 
having ownership rights, any restrictions on merger or other change of 
control must not interfere with the credit union's ability to exercise 
its business judgement and management of the credit union in a manner 
that avoids unsafe and unsound practices. The Board seeks comment on 
the issue of merging credit unions and how alternative capital should 
be treated post-merger.

F. Other Restrictions

    Supplemental capital must not contain contractual terms that would 
limit or impede the authority of NCUA or a State Supervisory Authority 
to undertake supervisory action, as necessary, to protect the issuing 
credit union's members or the Share Insurance Fund. Any such 
contractual terms would impose unsafe and unsound limits on the credit 
union's and regulators' ability to manage the institution and address 
problems. Affirmative covenants within the supplemental capital note or 
agreement must not restrict operations or potentially require a credit 
union to violate a law or regulation. Negative covenants should not 
unreasonably impair the credit union's flexibility in conducting its 
operations or interfere with management. Without these restrictions, 
contractual terms could undermine the purpose of supplemental capital 
and provide holders of these obligations with unintended rights and 
control over the credit union's operations. Any representation or 
warranties contained in the agreements that would require acceleration 
and repayment of the subordinated debt note because of a technical 
violation that does not reflect underlying credit issues could be 
contrary to safety and soundness. The Board seeks comments on the issue 
of contractual restrictions for alternative capital instruments.

VIII. Supporting Regulatory Changes

A. 701.32--Payment on Shares by Public Unit Nonmembers

    Due to the potential use of alternative capital as a funding source 
similar to public units and nonmembers, the NCUA Board is seeking 
comment on Sec.  701.32 of NCUA's regulations as it prescribes limits 
placed on these accounts.
    Section 1757(6) of the FCU Act grants federal credit unions the 
power ``to receive from its members, from other credit unions, from an 
officer, employee, or agent of those nonmember units of Federal, Indian 
tribal, State, or local governments and political subdivisions thereof 
enumerated in section 1787 of this title and in the manner so 
prescribed, from the Central Liquidity Facility, and from nonmembers in 
the case of credit unions serving predominately low-income members (as 
defined by the Board) payments, representing equity, on--(A) shares 
which may be issued at varying dividend rates; (B) share certificates 
which may be issued at varying dividend rates and maturities; and (C) 
share draft accounts authorized under section 1785(f) of this title; 
subject to such terms, rates, and conditions as may be established by 
the board of directors, within limitations prescribed by the Board.'' 
\69\
---------------------------------------------------------------------------

    \69\ 12 U.S.C. 1785(f).
---------------------------------------------------------------------------

    Currently the regulation limits total public unit and nonmember 
shares to 20 percent of the total shares of the federal credit union or 
$3 million, whichever is greater.\70\ Federal credit unions seeking to 
exceed the limit must:
---------------------------------------------------------------------------

    \70\ 12 CFR 701.32(b)(1).
---------------------------------------------------------------------------

     Adopt a specific written plan concerning the intended use 
of these shares and provide it to the Regional Director before 
accepting the funds; and
     Submit a written request to the Regional Director for a 
new maximum level of public unit and nonmember shares.\71\
---------------------------------------------------------------------------

    \71\ Id. at Sec.  701.32(b)(2).
---------------------------------------------------------------------------

    Under Sec.  741.204, federally insured state chartered credit 
unions must adhere to the requirements of Sec.  701.32 regarding public 
unit and nonmember accounts.\72\ This regulation also addresses a 
federally insured state chartered credit union obtaining a low-income 
designation, as provided under state law, in order to accept nonmember 
accounts other than from public units or other credit unions.\73\ 
Additionally this section addressed the ability of a federally insured 
state chartered credit union to receive and redeem secondary capital 
consistent with Sec.  701.34 and consistent with applicable state law 
and regulation.\74\
---------------------------------------------------------------------------

    \72\ Id. at Sec.  741.204(a).
    \73\ Id. at Sec.  741.204(b).
    \74\ Id. at Sec.  741.204(c) and (d).
---------------------------------------------------------------------------

    Because the limitations the NCUA board may prescribe to these 
accounts is not statutory, the NCUA Board is interested in comments on 
revisions to this regulation which would reduce the regulatory burden 
of the waiver process but still provide for adequate protection of the 
Share Insurance Fund.

B. 701.34--Designation of Low-Income Status; Acceptance of Secondary 
Capital Accounts by LICUs

    Section 701.34 of NCUA's Rules and Regulations sets out the 
requirements and process for a credit union to receive a low-income 
designation, the criteria for accepting secondary capital and the 
inclusion of secondary capital as regulatory capital. NCUA is seeking 
comment on whether the criteria and process for obtaining the low 
income designation, the criteria for issuing secondary capital, and the 
criteria for inclusion of secondary capital as regulatory capital 
should be in separate regulations.
    Section 701.34 could be solely focused on the process to receive a 
low-income designation. A new section of 701 could be used to address:
     The authority and requirements of secondary capital;
     Grandfathering treatment of existing secondary capital in 
the event of regulatory changes;

[[Page 9702]]

     Requirement to comply with all applicable federal and 
state laws in the issuance of secondary capital;
     Requirements for written contract agreements covering the 
terms and conditions of the secondary capital;
     Requirements for disclosures and acknowledgement;
     Investor suitability; and
     Prohibitions.
    The items specific to secondary capital's and supplemental 
capital's inclusion in regulatory capital and related capital adequacy 
issues could be consolidated into Section 702--Capital Adequacy, 
including:
     Standards for alternative capital instruments to be 
counted as regulatory capital;
     Any limits on the amount of alternative capital counted as 
regulatory capital;
     The role of supplemental capital in approval of a net 
worth restoration plan;
     Provisions for discounting regulatory capital treatments 
such as violations of applicable laws or regulation, including any 
deficiency cure alternatives; and
     Risk weight for an investment in supplemental capital.

C. Payout Priorities

    To conform the regulatory payout priorities for supplemental 
capital, the payout priorities for an involuntary liquidation will need 
to be revised.\75\ Supplemental capital would be listed in the payout 
priority after uninsured shareholders and the Share Insurance Fund.
---------------------------------------------------------------------------

    \75\ 12 CFR 709.5.
---------------------------------------------------------------------------

D. Other Regulations

    The Board seeks comments on any other related changes to existing 
regulations, such as:
     Modifying the definition of insured shares in 741.4(b) to 
exclude any equity shares allowed under state law, if they are in fact 
uninsured;
     Modifying 741.9 to provide for the existence of uninsured 
accounts issued under state law by FISCUs; and
     Any cohering changes to part 745 as necessary.

    By the National Credit Union Administration Board on January 19, 
2017.
Gerard Poliquin,
Secretary of the Board.
[FR Doc. 2017-01713 Filed 2-7-17; 8:45 am]
BILLING CODE P



                                                                                                                                                                                                                 9691

                                                    Proposed Rules                                                                                                Federal Register
                                                                                                                                                                  Vol. 82, No. 25

                                                                                                                                                                  Wednesday, February 8, 2017



                                                    This section of the FEDERAL REGISTER                       • Fax: (703) 518–6319. Use the                     potential implications for credit unions,
                                                    contains notices to the public of the proposed          subject line described above for email.               including the credit union tax
                                                    issuance of rules and regulations. The                     • Mail: Address to Gerald Poliquin,                exemption; and (8) overall regulatory
                                                    purpose of these notices is to give interested          Secretary of the Board, National Credit               changes the Board would need to make
                                                    persons an opportunity to participate in the            Union Administration, 1775 Duke                       to permit supplemental capital, improve
                                                    rule making prior to the adoption of the final          Street, Alexandria, Virginia 22314–
                                                    rules.
                                                                                                                                                                  secondary capital standards, and
                                                                                                            3428.                                                 provide or modify related supporting
                                                                                                               • Hand Delivery/Courier: Same as                   authorities. The Board has posed a
                                                    NATIONAL CREDIT UNION                                   mail address.                                         number of specific questions on these
                                                                                                               Public Inspection: You can view all                and other topics, but invites comments
                                                    ADMINISTRATION
                                                                                                            public comments on NCUA’s Web site                    on any and all aspects of alternative
                                                    12 CFR Parts 701, 702, 703, 709, 741,                   at http://www.ncua.gov/Legal/Regs/                    capital.
                                                    and 745                                                 Pages/PropRegs.aspx as submitted,
                                                                                                            except for those we cannot post for                   I. Background
                                                                                                                                                                  II. Current Secondary Capital Standards
                                                    Alternative Capital                                     technical reasons. NCUA will not edit or
                                                                                                                                                                  III. Current and Prospective Use of
                                                                                                            remove any identifying or contact                           Alternative Capital
                                                    AGENCY: National Credit Union                           information from the public comments
                                                    Administration.                                                                                               IV. Supplemental Capital Legal Authority
                                                                                                            submitted. You may inspect paper                            and Potential Taxation Implications
                                                    ACTION: Advance notice of proposed                      copies of comments in NCUA’s law                      V. Securities Law Applicability
                                                    rulemaking.                                             library at 1775 Duke Street, Alexandria,              VI. Other Investor Considerations
                                                                                                            Virginia 22314, by appointment                        VII. Prudential Standards for Issuing and
                                                    SUMMARY:   The NCUA Board (Board) is                                                                                Counting Alternative Capital for Prompt
                                                    issuing this advanced notice of                         weekdays between 9 a.m. and 3 p.m. To
                                                                                                            make an appointment, call (703) 518–                        Corrective Action
                                                    proposed rulemaking (ANPR) to solicit                                                                         VIII. Supporting Regulatory Changes
                                                    comments on alternative forms of                        6546 or send an email to OGCMail@
                                                    capital federally insured credit unions                 ncua.gov.                                             I. Background
                                                    could use in meeting capital standards                  FOR FURTHER INFORMATION CONTACT:                         In 1998, Congress passed the Credit
                                                    required by statute and regulation. For                 Steve Farrar, Supervisory Financial                   Union Membership Access Act
                                                    purposes of this ANPR, alternative                      Analyst, at (703) 518–6360; or Justin                 (CUMAA) which amended the Act to
                                                    capital includes two different categories:              Anderson, Senior Staff Attorney, Office               mandate a system of prompt corrective
                                                    Secondary capital and supplemental                      of General Counsel, at (703) 518–6540.                action for federally insured natural
                                                    capital. Secondary capital is currently                 You may also contact them at the                      person credit unions (credit unions).1
                                                    permissible under the Federal Credit                    National Credit Union Administration,                 The prompt corrective action system
                                                    Union Act (Act) only for low-income                     1775 Duke Street, Alexandria, Virginia                incorporates capital standards for credit
                                                    designated credit unions to issue and to                22314.                                                unions. The Act indexes a credit union’s
                                                    be counted toward both the net worth                    SUPPLEMENTARY INFORMATION: At its                     prompt corrective action status to five
                                                    ratio and the risk-based net worth                      October 2016 meeting, the Board held a                categories: Well capitalized, adequately
                                                    requirement of NCUA’s prompt                            public briefing on the topic of                       capitalized, undercapitalized,
                                                    corrective action standards. The Board                  alternative capital for credit unions.                significantly undercapitalized, and
                                                    is considering changes to the secondary                 This ANPR provides relevant                           critically undercapitalized.2 As a credit
                                                    capital regulation for low-income                       background information and seeks                      union’s capital level falls, its
                                                    designated credit unions. There are no                  comment on a broad range of                           classification among the prompt
                                                    other forms of alternative capital                      considerations with respect to                        corrective action categories can decline
                                                    currently authorized. However, the                      alternative capital for federally insured             below well capitalized, thus exposing it
                                                    Board is also considering whether or not                credit unions. This ANPR addresses                    to an expanding range of mandatory and
                                                    to authorize credit unions to issue                     topics including: (1) NCUA’s authority                discretionary supervisory actions
                                                    supplemental capital instruments that                   to include alternative capital for prompt             designed to remedy the problem and
                                                    would only count towards the risk-                      corrective action purposes; (2) credit                minimize any loss to the National Credit
                                                    based net worth requirement.                            unions’ authority to issue alternative                Union Share Insurance Fund (Share
                                                    DATES: Comments must be received on                     forms of capital; (3) prudential                      Insurance Fund).3
                                                    or before May 9, 2017.                                  standards regarding the extent to which                  The Act defines a credit union’s
                                                    ADDRESSES: You may submit comments                      various forms of instruments would                    capital level based on a net worth ratio
                                                    by any one of the following methods                     qualify as capital for prompt corrective              requirement for all credit unions and a
                                                    (Please send comments by one method                     action purposes and credit union                      risk-based net worth requirement for
                                                    only):                                                  eligibility for the sale of alternative               credit unions the Board defines as
jstallworth on DSK7TPTVN1PROD with PROPOSALS




                                                       • Federal eRulemaking Portal: http://                capital; (4) the utility and suitability of
                                                    www.regulations.gov. Follow the                         supplemental capital for credit unions;                  1 The Credit Union Membership Access Act of

                                                    instructions for submitting comments.                   (5) standards for investor protection,                1998, HR 1151, Public Law 105–219, 112 Stat. 913
                                                       • Email: Address to regcomments@                     including disclosure requirements and                 (1998).
                                                                                                                                                                     2 12 U.S.C. 1790d(c); 12 CFR part 702; 65 FR 8560
                                                    ncua.gov. Include ‘‘[Your name]—                        investor eligibility criteria for the
                                                                                                                                                                  (Feb. 18, 2000); see 702 subpart C for categories for
                                                    Comments on Advance Notice of                           purchase of alternative capital; (6)                  ‘‘new’’ credit unions.
                                                    Proposed Rulemaking for Supplemental                    implications of securities law for                       3 Id. at § 1790d(e), (f) and (g); 12 CFR 702 subpart

                                                    Capital’’ in the email subject line.                    supplemental and secondary capital; (7)               B.



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                                                    9692                 Federal Register / Vol. 82, No. 25 / Wednesday, February 8, 2017 / Proposed Rules

                                                    complex.4 The Act also provides the                     are not designated as low-income might                 commenters suggested credit union
                                                    NCUA Board with broad discretion to                     be authorized to issue and count only                  authority to issue supplemental capital
                                                    design the risk-based net worth                         for inclusion in the risk-based net worth              was particularly important as credit
                                                    requirement. However, the net worth                     requirement.                                           unions are at a disadvantage in the
                                                    ratio is defined in the Act as a credit                    The risk-based net worth requirement                financial market because most lack
                                                    union’s ratio of net worth to total assets.             for federally insured credit unions is                 access to additional capital outside of
                                                    The Act defines net worth as: 5                         based on a risk-based net worth ratio                  retained earnings. While none of the
                                                       • The retained earnings balance of the               calculation in Part 702 of NCUA’s Rules                commenters offered specific suggestions
                                                    credit union, as determined under                       and Regulations.8 Per the Board’s                      on how to implement supplemental
                                                    generally accepted accounting                           October 2015 final rule, on January 1,                 capital, a few did suggest that the Board
                                                    principles, together with any amounts                   2019, the risk-based net worth                         should promulgate broad, non-
                                                    that were previously retained earnings                  requirement will be updated to replace                 prescriptive rules to allow credit unions
                                                    of any other credit union with which                    the risk-based net worth ratio with a                  maximum flexibility in issuing
                                                    the credit union is combined;                           new risk-based capital ratio.9                         supplemental capital.
                                                       • Secondary capital of a low-income                     During the risk-based capital                          As the Board did not receive
                                                    designated credit union that is                         rulemaking process, the Board asked for                comments with sufficient detail in
                                                    uninsured and subordinate to all other                  stakeholder input on supplemental                      response to the RBC proposal, the Board
                                                    claims of the credit union, including the               capital. Specifically, in the January 2015             is again posing the six questions listed
                                                    claims of creditors, shareholders, and                  risk-based capital (RBC) proposal the                  above for commenters to consider and
                                                    the Share Insurance Fund; and 6                         NCUA Board posed the following six                     address. Throughout this ANPR, the
                                                      • Certain assistance provided under                   questions: 10                                          Board will expand on these six
                                                    section 208 of the Act pursuant to                         1. Should additional supplemental                   questions and ask more specific
                                                    NCUA regulations.7                                      forms of capital be included in the RBC                questions about the structure, form,
                                                       As noted above, per the Act,                         numerator and how would including                      regulations, and requirements related to
                                                    secondary capital is currently only                     such capital protect the Share Insurance               supplemental capital, as well as relevant
                                                    permissible for low-income designated                   Fund from losses?                                      changes and improvements to secondary
                                                    credit unions to issue and to be counted                   2. If yes, to be included in the RBC                capital. The Board encourages all
                                                    toward the net worth ratio. NCUA also                   numerator, what specific criteria should               stakeholders to address in detail as
                                                    counts secondary capital issued by low-                 such additional forms of capital                       many of these questions as possible and
                                                    income designated credit unions as net                  reasonably be required to meet to be                   provide the Board with specific
                                                    worth for the risk-based net worth ratio.               consistent with Generally Accepted                     comments and responses. The Board
                                                       The Board notes that, NCUA cannot                    Accounting Practices (GAAP) and the                    intends these questions to be a starting
                                                    change the Act’s definition of net                      Act, and why?                                          point for commenters to present their
                                                    worth—only Congress can. However,                          3. If certain forms of certificates of              thoughts, but invites comments on all
                                                    the Board has broad discretion in                       indebtedness were included in the risk                 aspects of alternative capital
                                                    designing the risk-based net worth                      based capital ratio numerator, what                       Throughout this ANPR the Board
                                                    requirement. Thus, it is possible for the               specific criteria should such certificates             discusses several complex topics and
                                                    Board to authorize a credit union that is               reasonably be required to meet to be                   uses terms to refer to specific forms of
                                                    not low-income designated to issue                      consistent with GAAP and the Act, and                  capital. In addition to supplemental,
                                                    alternative capital instruments that                    why?                                                   secondary, and alternative capital, the
                                                                                                               4. In addition to amending NCUA’s                   Board will use the term ‘‘regulatory
                                                    would count towards satisfying the risk-
                                                                                                            RBC regulations, what additional                       capital’’ when referring to financial
                                                    based net worth requirement—but not
                                                                                                            changes to NCUA’s regulations would                    instruments issued by credit unions or
                                                    the net worth ratio. (See the discussion
                                                                                                            be required to count additional                        banks, that include both equity and
                                                    of legal authority in Section IV). For
                                                                                                            supplemental forms of capital in                       debt, and other financial statement
                                                    purposes of this ANPR, the term
                                                                                                            NCUA’s RBC ratio numerator?                            account which meet the criteria
                                                    supplemental capital includes any form
                                                                                                               5. For state-chartered credit unions,               contained in regulations for inclusion in
                                                    of capital instruments credit unions that
                                                                                                            what specific examples of supplemental                 the calculation of capital adequacy
                                                       4 In 2000, NCUA adopted part 702 of NCUA Rules
                                                                                                            capital currently allowed under state                  measures.
                                                    and Regulations to implement the Act’s system of        law do commenters believe should be
                                                    prompt corrective action.                               included in the RBC ratio numerator,                   II. Current Secondary Capital
                                                       5 Id. at § 1790d(o)(3); 12 CFR 702.2(g) and (k).     and why should they be included?                       Standards
                                                       6 In 1996, the NCUA Board authorized low-               6. What investor suitability, consumer                 The Act’s definition of net worth
                                                    income designated credit unions, including state        protection, and disclosure requirements
                                                    chartered credit unions to the extent permitted by
                                                                                                                                                                   states that secondary capital must be
                                                    state law, to count as capital uninsured secondary
                                                                                                            should be put in place related to                      ‘‘uninsured and subordinate to all other
                                                    capital. At the time, the Board recognized that it      additional forms of supplemental                       claims of the credit union, including the
                                                    was difficult for low-income designated credit          capital?                                               claims of creditors, shareholders, and
                                                    unions to accumulate capital only through retained         In response to these questions, a
                                                    earnings. The Board, therefore, permitted low-
                                                                                                                                                                   the Share Insurance Fund.’’ 11 This
                                                    income designated credit unions to use the
                                                                                                            majority of the commenters who                         means that any secondary capital issued
                                                    borrowing authority in the Act to issue secondary       addressed supplemental capital stated                  by a low-income designated credit
                                                    capital accounts. This authority would allow these      that it was imperative that the Board                  union must be the most subordinated
jstallworth on DSK7TPTVN1PROD with PROPOSALS




                                                    credit unions to build capital to support greater       consider allowing credit unions access
                                                    lending and financial services to their members and
                                                                                                                                                                   item on the balance sheet (first loss
                                                    their communities, and to absorb losses to protect
                                                                                                            to additional forms of capital. The                    position after retained earnings) and any
                                                    them from failing. To ensure the safety and                                                                    losses to secondary capital must be pro-
                                                                                                              8 Unless otherwise noted, throughout this ANPR
                                                    soundness of secondary capital activity, the 1996                                                              rated equally—that is without
                                                    rule imposed various restrictions on its use and        references to prompt corrective action, risk-based
                                                    structure. At this time, prompt corrective action and   capital, and citations to Part 702 refer to Part 702   preference or priority. The practical
                                                    the associated definition of net worth was not yet      as revised by the Board at its October 2015 meeting.   effect is that low-income designated
                                                    part of the Act. 61 FR 50696 (Sept. 27, 1996).            9 80 FR 66626 (Oct. 29, 2015).
                                                       7 12 U.S.C. 1790d(o)(2).                               10 80 FR 4340, 4384 (Jan. 27, 2015).                  11 12   U.S.C. 1790d(o)(C)(ii).



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                                                                          Federal Register / Vol. 82, No. 25 / Wednesday, February 8, 2017 / Proposed Rules                                                   9693

                                                    credit unions cannot include payment                     discount how much a secondary capital                 natural person credit unions, and leave
                                                    priority structures within or between                    account contributes to the credit union’s             the provisions specific to federal credit
                                                    secondary capital instruments to                         net worth value based on the following                union issuance authority in Part 701.
                                                    enhance investors’ interests.                            schedule: 14
                                                                                                                                                         III. Current and Prospective Use of
                                                      NCUA’s rules and regulations also
                                                                                                                                                         Alternative Capital
                                                    contain various provisions addressing                                                             Net worth
                                                    the prudent and appropriate issuance                                                               value of
                                                                                                                                                            This section provides information on
                                                                                                                  Remaining maturity                   original
                                                                                                                                                         community bank use of subordinated
                                                    and use of secondary capital by low-                                                               balance
                                                    income designated credit unions. These                                                               debt and low-income designated credit
                                                                                                                                                      (percent)
                                                    provisions are as follows:                                                                           unions’ use of secondary capital. This
                                                      • Low-income designed credit                           Four to less than five years ..          80 section also provides information on the
                                                    unions:                                                  Three to less than four years            60 projected impact of risk-based capital
                                                      Æ May only accept secondary capital                    Two to less than three years             40 standards on complex credit unions to
                                                    accounts from non-natural person                         One to less than two years ..            20 estimate the potential need for
                                                                                                             Less than one year ...............        0
                                                    members and non-natural person                                                                       supplemental capital for risk-based net
                                                    nonmembers.                                                                                          worth requirement purposes. This
                                                      Æ Must submit and receive approval                        Since 2006, low-income credit unions
                                                                                                                                                         information provides a basis for
                                                    by NCUA of a Secondary Capital Plan.                     may request NCUA approval to redeem
                                                                                                                                                         estimating the potential for use of
                                                      Æ Must execute a Disclosure and                        the portion of secondary capital no
                                                                                                                                                         supplemental capital, the purpose of its
                                                    Acknowledgement statement.                               longer included in net worth if:
                                                                                                                                                         use, the potential purchasers, and the
                                                      • A secondary capital account:                            • The credit union will have a post-
                                                                                                                                                         related costs. The Board is interested in
                                                      Æ Must be uninsured;                                   redemption net worth classification of at
                                                                                                                                                         receiving comments concerning
                                                      Æ Have a minimum maturity of five                      least adequately capitalized;
                                                                                                                                                         projections on the volume of
                                                    years with a reduction in the                               • The discounted secondary capital
                                                                                                                                                         supplemental capital that credit unions
                                                    recognition of the net worth value of                    has been on deposit at least two years;
                                                                                                                                                         would be likely to issue. The Board also
                                                    accounts with less than five years of                    and
                                                                                                                                                         seeks specific comments on the
                                                    remaining maturity;                                         • The discounted secondary capital
                                                                                                                                                         structures of supplemental capital
                                                      Æ Must be subordinate to all other                     will not be needed to cover losses prior
                                                                                                                                                         instruments that would be beneficial,
                                                    claims, including those of shareholders,                 to the final maturity date.       15
                                                                                                                                                         why credit unions will issue
                                                    creditors and the Share Insurance Fund;                     With respect to secondary capital, the
                                                                                                                                                         supplemental capital, and how it fits
                                                      Æ Must be available to cover                           Board specifically seeks comments on
                                                                                                                                                         into the credit union’s business model.
                                                    operating losses that exceed net                         the following:
                                                                                                                                                         The Board is also interested in any
                                                    available reserves and to extent losses                     • Whether or not to permit a low-
                                                                                                                                                         comments about who will purchase
                                                    are applied the accounts must not be                     income designated credit union to sell
                                                                                                                                                         supplemental capital. Since the costs
                                                    restored;                                                secondary capital to non-institutional
                                                                                                                                                         associated with supplemental capital
                                                      Æ Cannot be pledged by investors as                    investors (see Sections V and VI for
                                                                                                                                                         are significant to the issuing credit
                                                    security on a loan;                                      more discussion on investor protection
                                                                                                                                                         union, the Board seeks comments on
                                                      Æ Are subject to restrictions of                       and suitability issues), and whether this
                                                                                                                                                         how any regulations should address the
                                                    dividends as provided in prompt                          would be for members only or any
                                                                                                                                                         issue of the cost of the instrument and
                                                    corrective action; and                                   party.
                                                                                                                                                         any items that may be helpful in
                                                      Æ May only in certain circumstances                       • Allowing for broader call options
                                                                                                                                                         reducing the cost while maintaining
                                                    be redeemed early and only with prior                    for the low-income designated credit
                                                                                                                                                         adequate protection for investors and
                                                    NCUA approval.12                                         union, other than just the portion no
                                                                                                                                                         the Share Insurance Fund.
                                                      The regulations allow NCUA to                          longer counting as net worth and subject
                                                    prohibit a low-income designated credit                  to NCUA approval, if provided for in the A. Community Bank Use of
                                                    union classified as critically                           secondary capital contract.                 Subordinated Debt
                                                    undercapitalized from paying principal,                     • Relaxation of pre-approval of             Community bank use of subordinated
                                                    dividends, or interest on secondary                      issuing secondary capital if a low-         debt increased in 2016. As of June, 30,
                                                    capital. This provision is to ensure                     income designated credit union meets        2016, the amount outstanding was $831
                                                    secondary capital is available to cover                  certain conditions such as being at least million compared to $479 million as of
                                                    losses while the low-income designated                   adequately capitalized and having prior December 31, 2016.16 Despite the
                                                    credit union is operating as a going                     experience issuing secondary capital.       increase, subordinated debt is only 0.34
                                                    concern. These payment restrictions are                     • Inclusion of more flexibility to fund percent of total community bank capital.
                                                    consistent with limitations on principal                 dividend payments as an operating loss      The stated purpose of recent issuances
                                                    and interest payments imposed by the                     if provided for in the contract.            of subordinated debt by community
                                                    federal banking regulators for                              • Any other prudential restrictions on banks generally fall into three
                                                    subordinated debt issued by banks.13                     secondary capital that should be            categories:
                                                      Further, due to the fact that secondary                considered.                                    • Facilitate mergers and acquisitions;
                                                    capital is not a permanent form of                          • Reorganization of the regulation to       • Redemption of preferred stock held
                                                    capital, NCUA’s regulations reduce the                   improve clarity by moving to part 702       by the U.S. Treasury Department due to
                                                    portion of secondary capital that is                     (Prompt Corrective Action) all matters
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                                                                                                                                                         increasing costs; and
                                                    included in the net worth ratio as it                    related to how the instrument must be          • Fund organic growth.17
                                                    approaches maturity. Once the                            structured to qualify for capital              While the interest rate paid on
                                                    remaining maturity is less than five                     treatment. This would move these            community bank subordinated debt can
                                                    years, the regulations require low-                      conditions to the section of NCUA rules vary significantly, generally the interest
                                                    income designated credit unions to                       and regulations applicable to all insured
                                                                                                                                                                     16 FDIC  Quarterly, Volume 10, Number 2, page 18.
                                                      12 12 CFR 701.34.                                        14 Id. at § 701.34(c).                                17 Based  on review of a sample of SEC Form D
                                                      13 12 CFR 5.47(d)(3)(ii)(B)(3).                          15 Id. at § 701.34(d).                              filed by issuers.



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                                                    9694                 Federal Register / Vol. 82, No. 25 / Wednesday, February 8, 2017 / Proposed Rules

                                                    rate is from 300 to 400 basis points over               credit union. The interest rate paid by                   • Poor due diligence, inaccurate cost
                                                    ten year treasury note rates.18                         the four largest holders of the                         benefit analysis and weak strategic
                                                    Additionally community banks report                     outstanding secondary capital ranges                    planning in connection with
                                                    expenses associated with sales                          from 0.14 percent to 3.5 percent.                       establishing and expanding member
                                                    commissions, ranging from 1.25 percent                     Secondary capital does, however,                     service programs funded by secondary
                                                    to 3 percent, and fees along with legal                 significantly benefit a low-income                      capital.
                                                    and operational costs.19 Most buyers of                 designated credit union’s net worth                       • Concentrations of secondary capital
                                                    bank subordinated debt are reported to                  ratio. The secondary capital adds an                    to support unproven or poorly
                                                    be pension funds, mutual funds, other                   average of nearly 300 basis points to the               performing programs.
                                                    banks, and high net worth investors.20                  net worth ratio, which brings the                         • Failure to realistically assess and
                                                                                                            average from just below 7 percent to                    timely curtail programs not meeting
                                                    B. Low-Income Designated Credit Union
                                                                                                            near 10 percent. Out of the 73 low-                     expectations.
                                                    Use of Secondary Capital
                                                                                                            income designated credit unions with                      • Use of secondary capital solely to
                                                      As of June 30, 2016, there were 2,426                 secondary capital, 66 have a net worth                  delay prompt corrective action.
                                                    low-income designated credit unions.                    ratio greater than the well capitalized 7                 • Insufficient liquidity to repay
                                                    Only 73 low-income designated credit                    percent level. Without the secondary                    secondary capital at maturity.
                                                    unions (about 3 percent) report total                   capital, 25 of the 66 would have a net
                                                    outstanding secondary capital of $181                   worth ratio less than 7 percent.22                      C. Potential for Credit Unions’ Use of
                                                    million.21 Since December 31, 2011, the                    The Board notes that low-income                      Supplemental Capital
                                                    number of low-income designated credit                  designated credit unions that have                         The potential use of supplemental
                                                    unions has increased by 117 percent,                    issued secondary capital have a higher                  capital is difficult to predict due to the
                                                    from 1,119 to 2,426. However, the                       failure rate than other low-income                      probable changes in market factors such
                                                    number of low-income designated credit                  designated credit unions. The average                   as interest rates, demographics, and
                                                    unions with outstanding secondary                       annual failure rate for low-income                      competition. Since supplemental capital
                                                    capital has ranged from 72 to 79 during                 designated credit unions with secondary                 would only increase a credit union’s
                                                    this period.                                            capital was 2.9 percent from 2000–2013,                 risk-based capital ratio, the most likely
                                                       The $181 million in outstanding                      compared to 0.8 percent for low-income                  users would be those credit unions with
                                                    secondary capital equates to 13 percent                 designated credit unions without                        net worth ratios above the well
                                                    of the total net worth of the low-income                secondary capital during the same                       capitalized level but with a risk-based
                                                    designated credit unions that issued it—                period.23 In a few failures of low-income               capital below or near the minimum
                                                    with an average balance of about $2.5                   designated credit unions, the assets in                 needed to be well capitalized.
                                                    million. However, outstanding                           the credit union grew rapidly around                       The following table contains an
                                                    secondary capital is concentrated in                    the time the secondary capital was                      estimate of the number of credit unions
                                                    four low-income designated credit                       issued, which in turn led to higher                     likely to issue supplemental capital and
                                                    unions, which hold 74 percent of the                    losses to the Share Insurance Fund.                     the potential amount of supplemental
                                                    total secondary capital outstanding.                    NCUA has noted a pattern of poor                        capital that might be issued. Using Call
                                                    When excluding these four low-income                    practices in some low-income                            Report data as of December 31, 2015,
                                                    designated credit unions, the average                   designated credit unions with secondary                 applied to FICUs with more than $100
                                                    amount of secondary capital is under                    capital that could account for the higher               million in assets,25 results in the
                                                    $700,000 per low-income designated                      failure rate, including: 24                             following:

                                                    Number of credit unions that do not have a low-income designation with a net worth ratio greater than 8% and an estimated                         140.
                                                      risk-based capital ratio less than 13.5%.
                                                    Net worth of the 140 credit unions that do not have a low-income designation with a net worth ratio greater than 8% and an                        $9.2 billion.
                                                      estimated risk-based capital ratio less than 13.5%.
                                                    Maximum amount of subordinated debt that could be issued with a limit set at 50% of net worth 26 ............................................     $4.5 billion.
                                                    Amount of supplemental capital needed by the 140 to achieve a 13.5% risk-based capital ratio ..................................................   $1.0 billion.



                                                      The Board is interested in                            IV. Supplemental Capital Legal                          unions defined as complex.’’ 27 The risk-
                                                    commenter’s thoughts on whether credit                  Authority and Potential Taxation                        based net worth requirement for credit
                                                    unions that are not designated as low-                  Implications                                            unions meeting the definition of
                                                    income use of supplemental capital                                                                              ‘‘complex’’ was first applied on the
                                                                                                            A. Risk-Based Net Worth Requirement
                                                    could affect the availability of secondary                                                                      basis of data in the Call Report as of
                                                    capital for low-income designated credit                  In addition to the Act’s requirements                 March 31, 2001.28 Since its inception,
                                                    unions. If so, are there any measures the               related to the net worth ratio, the Act                 the risk-based net worth requirement
                                                    Board could take to protect against this?               requires the Board to design ‘‘a risk-                  has included secondary capital issued
                                                                                                            based net worth requirement for credit
                                                       18 Based on review of a sample of capital market       22 Secondary capital is estimated to add an             26 The Board would contemplate some limit on
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                                                    announcements and publications of completed             average of 414 basis points to the risk-based capital   how much supplemental capital will count for risk-
                                                    offerings.                                              ratio that will go into effect on January 1, 2019.      based capital requirements to ensure it remains a
                                                                                                              23 See. Secondary Capital Best Practices Guide
                                                       19 Based on review of a sample of SEC Form D                                                                 supplemental but not the primary source of capital.
                                                                                                            available at https://www.ncua.gov/services/Pages/       For illustration purposes the estimate uses a 50%
                                                    filed by issuers.
                                                                                                            small-credit-union-learning-center/Documents/
                                                       20 Based on review of a sample of capital market                                                             limit so that it would not become the primary form
                                                                                                            secondary-capital-guide.pdf.
                                                    announcements, publication of completed offerings,        24 Id.                                                of capital held by these credit unions.
                                                                                                                                                                      27 12 U.S.C. 1790d(d)(1).
                                                    and SEC Form D.                                           25 The new risk-based net worth requirements
                                                                                                                                                                      28 65 FR 44950 (July 20, 2000).
                                                       21 NCUA Call Report data.                            will only apply to credit unions with assets of $100
                                                                                                            million or more.



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                                                                            Federal Register / Vol. 82, No. 25 / Wednesday, February 8, 2017 / Proposed Rules                                                   9695

                                                    by low-income designated credit                            alternative capital.31 Other than as a                 credit unions may ‘‘borrow, in
                                                    unions.                                                    form of debt, there is no other explicit               accordance with such rules and
                                                       While the Act defined the term ‘‘net                    authority in the Act for federal credit                regulations as may be prescribed by the
                                                    worth,’’ it did not define the risk-based                  unions to issue an instrument that is                  Board, from any source.’’ Currently,
                                                    net worth requirement, nor how to                          uninsured and could be structured as                   NCUA’s regulations only contain a rule
                                                    calculate any corresponding risk-based                     loss absorbing capital. As a result, the               addressing when federal credit unions
                                                    ratio. In contrast to the narrow                           Board believes only the borrowing                      borrow from natural persons. Given that
                                                                                                               authority is available for federal credit              the wording of the Act could suggest a
                                                    definition of net worth, the lack of a
                                                                                                               unions to issue supplemental capital.32                federal credit union’s borrowing
                                                    statutory prescription for the risk-based
                                                                                                               This means that federal credit unions                  authority is contingent on rules and
                                                    net worth requirement gives the Board
                                                                                                               could only issue supplemental capital                  regulations prescribed by the Board, it
                                                    the latitude to include within that
                                                                                                               as subordinated debt. However, the                     may appear to investors that federal
                                                    requirement items that would not meet
                                                                                                               Board invites commenters to identify                   credit unions are restricted to only
                                                    the statutory definition of ‘‘net worth’’                                                                         borrowing from natural persons. While
                                                    but otherwise serve as capital in                          any other provisions of the Act they
                                                                                                               believe could provide alternative                      the Board disagrees with this reading of
                                                    protecting the Share Insurance Fund                                                                               the Act, the Board is concerned that
                                                                                                               authority for federal credit unions to
                                                    from losses when a credit union fails.                                                                            some supplemental capital investors
                                                                                                               issue supplemental capital instruments
                                                    Given the statutory objective of prompt                                                                           may question a federal credit union’s
                                                                                                               other than as subordinated debt.
                                                    corrective action ‘‘to resolve the                                                                                authority to issue supplemental capital
                                                    problems of insured credit unions at the                   C. Supplemental Capital Relationship to                instruments to anyone other than
                                                    least possible long-term loss’’ to the                     Secondary Capital                                      natural persons. Clarity and certainty
                                                    Share Insurance Fund, the Board                               Supplemental capital and secondary                  about a federal credit union’s borrowing
                                                    believes it should explore expanded                        capital are similar in that, for federal               authority may be important to the sale
                                                    options for credit unions to build capital                 credit unions, both are uninsured                      of supplemental capital—by expanding
                                                    beyond retained earnings.                                  accounts issued as borrowings and                      the potential investor base and reducing
                                                       For a credit union defined as complex                   subject to applicable statutory                        unnecessary transaction complications.
                                                    to be classified well capitalized, the Act                 borrowing limits. Secondary capital,                   With respect to this topic, the Board is
                                                    requires the credit union to have a net                    however, is included in the statutory                  interested in commenter’s views on
                                                    worth ratio of 7 percent or greater (6                     definition of net worth and counts                     whether the Board should promulgate a
                                                    percent for adequately capitalized) and                    towards both the net worth ratio and the               more comprehensive borrowing rule as
                                                    to meet the applicable risk-based net                      risk-based net worth requirement.                      part of any authorization of
                                                    worth requirement. Starting in January                     Supplemental capital is not included                   supplemental capital, and what the rule
                                                    2019, the risk-based net worth                             the statutory definition of net worth and              should address.
                                                    requirement will require the risk-based                    can only be considered for inclusion in                E. Authority for Federally Insured State
                                                    capital ratio to be 10 percent or greater                  the computation of the risk-based net                  Chartered Credit Unions To Issue
                                                    to be well capitalized (8 percent for                      worth requirement.                                     Supplemental Capital
                                                    adequately capitalized). The Act                              Supplemental capital would have to
                                                    classifies a credit union as                               be subordinate to the Share Insurance                    The authority under which a federally
                                                    undercapitalized if it is unable to                        Fund and uninsured shareholders in the                 insured state chartered credit union
                                                                                                               payout priorities. However, since                      could issue alternative capital
                                                    achieve the applicable risk-based net
                                                                                                               secondary capital, per the Act, must be                instruments is distinct from whether
                                                    worth requirement, even if it has a high
                                                                                                               subordinate to all other claims,                       and to what extent NCUA, as insurer,
                                                    net worth ratio, thus subjecting the
                                                                                                               supplemental capital would be senior to                would recognize it as regulatory capital
                                                    credit union to the corresponding
                                                                                                               secondary capital in the payout                        for prompt corrective action purposes. A
                                                    prompt corrective action supervisory
                                                                                                               priorities. Credit unions issuing                      federally insured state chartered credit
                                                    consequences.29
                                                                                                               supplemental capital could be provided                 union’s authority to issue supplemental
                                                    B. Authority To Issue Supplemental                         flexibility to include payment priority                capital would be derived from
                                                    Capital                                                    structures within or between                           applicable state law and regulation
                                                                                                               supplemental capital instruments to                    regarding its ability to issue liability and
                                                       The authority for low-income                                                                                   equity instruments. Such state laws may
                                                                                                               enhance investors’ interests.
                                                    designated credit unions to issue                                                                                 be narrower or broader than those for
                                                    secondary capital is established in the                    D. Need for Comprehensive Borrowing                    federal credit unions. Recognition as
                                                    Act. Conversely, there is no express                       Rule for Federal Credit Unions                         regulatory capital will depend on the
                                                    authority for credit unions not                              The Board is considering expanding                   characteristics of the instrument and its
                                                    designated as low-income to issue                          the borrowing rule to clarify this                     availability to protect the Share
                                                    alternative forms of capital. However,                     authority for federal credit unions. As                Insurance Fund—which would be based
                                                    the Act does provide federal credit                        noted above, the Act states that federal               on uniform criteria that apply to all
                                                    unions with relatively broad authority                                                                            federally insured credit unions. (see
                                                    to borrow from any source in                                  31 Authority to issue capital instruments for       section VI for more discussion)
                                                    accordance with such rules and                             FISCUs is determined under applicable state law.         For federal credit unions, the Act
                                                    regulations as may be prescribed by the                       32 In December 2010, the Board issued Letter to
                                                                                                                                                                      limits the aggregate amount of borrowed
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                                                    Board.30 The Board has reviewed all                        Federal Credit Unions 10–FCU–03: Sales of              funds to 50 percent of paid-in and
                                                                                                               Nondeposit Investments, which stated that federal
                                                    applicable sections of the Act to                          credit unions are not authorized under the Act to      unimpaired capital and surplus.33 Per
                                                    determine the ability of federal credit                    sell nondeposit investments directly to their
                                                    unions to issue various types of                           members. After further consideration, the Board          33 Section 700.2 of NCUA Rules and Regulations

                                                    financial instruments that could serve as                  believes federal credit unions have the authority to   defines Paid-in and unimpaired capital and surplus
                                                                                                               issue supplemental capital instruments under the       as shares plus post-closing, undivided earnings.
                                                                                                               borrowing authority in the Act, even though these      This does not include regular reserves or special
                                                      29 12   U.S.C. 1790d(c)(1)(C)(ii).                       instruments may be considered securities for           reserves required by law, regulation or special
                                                      30 12   U.S.C. 1757(9).                                  purposes of state and federal securities laws.                                                  Continued




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                                                    9696                   Federal Register / Vol. 82, No. 25 / Wednesday, February 8, 2017 / Proposed Rules

                                                    § 741.2, NCUA’s rules and regulations                      Federally insured state chartered credit            register with the Securities Exchange
                                                    limit borrowing by federally insured                       unions are exempt from federal income               Commission (SEC), issue SEC mandated
                                                    state chartered credit unions to 50                        tax under § 501(c)(14)(A) of the Internal           disclosures, and comply with the SEC’s
                                                    percent of paid-in and unimpaired                          Revenue Code. Section 501(c)(14)(A) of              broad anti-fraud rules. The Board,
                                                    capital and surplus. The regulation does                   the Internal Revenue Code provides for              however, is aware that there are two
                                                    provide the ability for state credit                       exemption from federal income taxes for             exemptions that would likely be
                                                    unions to obtain a waiver up to the                        state credit unions without capital stock           available to credit unions:
                                                    amount of borrowing allowed under                          organized and operated for mutual                      • Section 3(a)(5) of the Securities Act,
                                                    state law.34 The Board is not aware of                     purposes without profit. At this time,              which is available to certain types of
                                                    any federally insured state chartered                      there does not appear to be an                      financial institutions, including credit
                                                    credit unions that have requested a                        established definition of ‘‘capital stock’’         unions, for the issuance of any type of
                                                    waiver to the borrowing limit in the past                  used by the IRS. It is possible federally           security to any type of investor; 37 and
                                                    decade. While authority to issue                           insured state chartered credit unions in               • Rule 506 under Regulation D under
                                                    alternative capital instruments for                        some states will have broad authority to            the Securities Act, which is available to
                                                    federally insured state chartered credit                   issue supplemental capital instruments              any entity offering any type of security,
                                                    union is determined under state law, it                    that have the characteristics of capital            provided that purchasers of the
                                                    is possible that some states will only                     stock, and by doing so could subject                securities are ‘‘accredited investors’’
                                                    allow their credit unions to issue                         themselves to taxation. The Board                   (although sales to a limited number of
                                                    alternative capital instruments under                      therefore requests comment on whether               investors who are not accredited are
                                                    applicable borrowing authority. As                         NCUA should limit the types of                      also possible under certain
                                                    NCUA’s borrowing limit for federally                       instruments issued by federally insured             circumstances).38
                                                    insured state chartered credit union is                    state chartered credit unions to those                 While these exemptions are likely to
                                                    not statutory, the Board can entertain                     that would clearly not meet the                     relieve credit unions of the
                                                    removing this limit and requests                           definition of capital stock. Other options          requirements to register with the SEC
                                                    comment on this option.                                    the Board could consider, include                   and issue SEC mandated disclosures,
                                                                                                               requiring a federally insured state                 there are a number of other issues that
                                                    F. Potential Taxation Implications                         chartered credit unions to provide a                credit unions must consider and comply
                                                      The Board recognizes that                                formal opinion from the IRS that the                with before issuing any instrument that
                                                    supplemental capital could have an                         supplemental capital instrument it is               would be considered a security. The
                                                    impact on the credit union tax                             issuing will not be classified as capital           Board briefly addresses each of these
                                                    exemption. The Act specifically                            stock or requiring the credit union to              issues below.
                                                    exempts federal credit unions from                         provide projections in advance of
                                                    taxation by the United States or by any                    issuing the supplemental capital                    A. Federal Securities Requirements
                                                    State or local taxing authority, except                    demonstrating that it can afford to be                 Regardless of any exemption from
                                                    real and personal property taxes.35 With                   taxed and the benefits of the                       registration and disclosure, credit
                                                    respect to federal credit unions, the                      supplemental capital outweigh the cost              unions issuing alternative capital must
                                                    Board is aware that part of the basis for                  of any taxes it might become subject to.            still comply with the SEC’s broad anti-
                                                    the credit union tax exemption was that                    G. Mutual Ownership Structure of                    fraud regulations.39 The Securities
                                                    Congress recognized most credit unions                     Credit Unions                                       Exchange Act of 1934’s (Exchange Act)
                                                    could not access the capital markets to                                                                        general anti-fraud prohibitions are
                                                    raise capital.36 If all credit unions, not                    The Board also invites comments on               embodied in § 10(b), which generally
                                                    just low-income designated credit                          the potential effect supplemental capital           prohibits the use of manipulative or
                                                    unions, have the ability to access the                     may have on the mutual ownership                    deceptive devices or contrivances that
                                                    capital markets to meet capital                            structure and governance of credit                  violate SEC rules in connection with the
                                                    standards, it could call into question                     unions. The Board invites comments on               purchase or sale of securities. Most of
                                                    one of the bases for the credit union tax                  how it should structure any potential               the litigation brought with respect to the
                                                    exemption. The Board invites comments                      rule to avoid issues impacting the                  rules promulgated under § 10(b) has
                                                    on this topic and would like to hear                       mutuality of credit unions, and the                 been brought under the general anti-
                                                    from stakeholders on the possible                          members’ rights to govern the affairs of            fraud provision, Rule 10b–5, which
                                                    impact a supplemental capital rule may                     the institution. Specifically, the Board            provides as follows:
                                                    have on the federal credit union tax                       invites comments on restrictions it                    It shall be unlawful for any person,
                                                    exemption.                                                 might impose on characteristics of                  directly or indirectly, by the use of any
                                                       Unlike federal credit unions, the Act                   supplemental capital to avoid these                 means or instrumentality of interstate
                                                    does not exempt federally insured state                    issues, such as: Non-voting and limits              commerce, or of the mails or of any
                                                    chartered credit unions from taxation.                     on covenants in the investment                      facility of any national securities
                                                                                                               agreement that may give investors levels            exchange,
                                                    agreement between the credit union and its                 of control over the credit union.                      (a) To employ any device, scheme, or
                                                    regulator or share insurer. 12 CFR 700.2.
                                                      34 12 CFR 741.2.
                                                                                                               V. Securities Law Applicability                     artifice to defraud,
                                                      35 12 U.S.C. 1768.                                         The Board believes that both                        37 17  CFR 240.3a5.
                                                      36 It is noteworthy that, in 1951, thrift institutions
                                                                                                               secondary and supplemental capital
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                                                                                                                                                                     38 Id. at § 230.506.
                                                    lost their tax exemption. The Senate report to the         would be considered securities for                     39 See, e.g., Regulation D, Rule 501(a): ‘‘Users of
                                                    Revenue Act of 1951 stated that mutual savings
                                                    banks and savings and loan associations were losing        purposes of state and federal securities            Regulation D (§§ 230.500 et seq.) should note the
                                                    their tax exemption because they had evolved into          laws. The Board invites comment on                  following:
                                                    commercial bank competitors. In addition, thrifts          this topic and its relationship to credit              (a) Regulation D relates to transactions exempted
                                                    had evolved from mutual organizations to ones that         unions issuing securities as                        from the registration requirements of section 5 of
                                                    operated in a similar manner to banks. Finally, the                                                            the Securities Act of 1933 (the Act) (15 U.S.C. 77a
                                                    exemption had given thrifts a competitive                  supplemental capital.                               et seq., as amended). Such transactions are not
                                                    advantage over taxable commercial banks and life             Being subject to securities laws can              exempt from the anti-fraud, civil liability, or other
                                                    insurance companies.                                       impose requirements on the issuer to                provisions of the federal securities laws.’’



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                                                                          Federal Register / Vol. 82, No. 25 / Wednesday, February 8, 2017 / Proposed Rules                                                 9697

                                                       (b) To make any untrue statement of                      • Material risks relating to the                    registration issues related to secondary
                                                    a material fact or to omit to state a                    security being offered;                                and supplemental capital. Specifically,
                                                    material fact necessary in order to make                    • The issuer’s planned uses for the                 marketing activities by a credit union
                                                    the statements made, in the light of the                 proceeds of the offering;                              and its employees could require the
                                                    circumstances under which they were                         • Regulatory matters impacting the                  credit union to register as a broker-
                                                    made, not misleading, or                                 issuer and its operations;                             dealer. While there are exemptions
                                                       (c) To engage in any act, practice, or                   • Tax issues associated with the                    available to credit unions and their
                                                    course of business which operates or                     security being offered; and                            employees, the Board notes that these
                                                    would operate as a fraud or deceit upon                     • How the securities are being offered              exemptions are complex and require a
                                                    any person, in connection with the                       and sold, including any conditions to be               thorough evaluation of a credit union’s
                                                    purchase or sale of any security.40                      met in order to complete the offering.                 practices and the activities of its
                                                       The primary intent of Rule 10b–5 and,                    The Board is also aware that the                    employees. If a credit union or its
                                                    more broadly, the anti-fraud provisions                  Office of Comptroller of the Currency                  employees fail to qualify for an
                                                    of the Securities Act of 1933 (Securities                (OCC) promulgated regulations that                     exemption, the credit union or
                                                    Act) and Exchange Act, is to prevent                     require supervised banks issuing                       employee could be required to register
                                                    fraud, deceit, and incorrect or                          securities to register directly with the               as a broker-dealer or face penalties for
                                                    misleading statements or omissions in                    OCC and issue OCC mandated                             failure to comply with applicable rules.
                                                    the offering, purchase and sale of                       disclosures. The OCC mandated                          The Board has previously stated that
                                                    securities. Given that intent, clear and                 disclosures are very similar to those                  federal credit unions are not permitted
                                                    complete disclosure is the critical factor               required by the SEC.41 The Board is                    to register as broker-dealers.42 The
                                                    in ensuring the anti-fraud provisions of                 considering requiring similar                          Board invites comments on how it
                                                    the Securities Act and Exchange Act are                  registration and disclosures for credit                should ensure a credit union has
                                                    not breached in any offering by credit                   unions issuing alternative capital. The                determined if it or its employees are
                                                    unions, regardless of whether the                        Board is concerned that without                        required to register.
                                                    offering is registered with the SEC under                mandated disclosures, credit unions                       In addition, it is unlikely that credit
                                                    the Securities Act or exempt from                        may be at greater risk for anti-fraud                  unions and their employees would be
                                                    registration.                                            suits, which, if successful, would impair              subject to investment adviser
                                                       In the absence of SEC-mandated                        not only the credit union but also the                 registration requirements. The Board
                                                    disclosure delivery requirements, the                    Share Insurance Fund’s ability to use                  notes that certain marketing activities
                                                    practical concern for credit unions                      secondary or supplemental capital to                   and relationships with other credit
                                                    relying on either the Section 3(a)(5) or                 cover losses. Further, the Board also                  unions could raise investment adviser
                                                    Regulation D, Rule 506 exemption is                      believes it is important that investors in             requirements. The Board, therefore,
                                                    determining what type and amount of                      credit union alternative capital                       invites comments on this issue and if
                                                    disclosure is appropriate to meet the                    instruments have similar protections to                NCUA should require credit unions to
                                                    anti-fraud standards. The Board is aware                 those provided investors in SEC and                    have policies and procedures to ensure
                                                    that the amount of disclosure varies                     OCC covered entities. The Board is                     their activities do not trigger investment
                                                    depending on multiple factors,                           interested in comments on the following                adviser registration requirements.
                                                    including:                                               questions in particular:
                                                       • The nature of the potential                            • Should the Board require credit                   B. State Securities Requirements
                                                    investors (focusing on their level of                    unions issuing alternative capital to                     First, certain provisions of the
                                                    sophistication);                                         register with NCUA?                                    Securities Act and SEC rules have
                                                       • The nature of the security being                       • How could NCUA protect the Share                  preempted state securities laws with
                                                    offered (focusing on the complexity of                   Insurance Fund against potential anti-                 respect to most covered securities.
                                                    the instrument);                                         fraud claims that could impair the                     However, states may require issuers to
                                                       • The nature of the business of the                   alternative capital’s ability to cover                 register with the state and/or pay state
                                                    issuer and the industry in which the                     losses?                                                registration fees. Further, states may
                                                    issuer operates (focusing on the                            • Should the Board mandate                          also pursue fraud-based claims. The
                                                    complexity of the business or industry);                 disclosures all credit unions issuing                  Board invites comment on how it
                                                    and                                                      alternative capital must provide to                    should ensure that any credit union
                                                       • Market practices (focusing on the                   investors? If the Board should mandate                 issuing alternative capital has
                                                    types of disclosure commonly provided                    disclosures, should it base them on the                considered and complied with all
                                                    by peer companies).                                      SEC’s, the OCC’s, or create a unique set               applicable state laws.
                                                       In addition, the Board is aware that                  of disclosures for credit unions? If the
                                                    for any disclosure to meet the standards                 Board creates a unique set of                          C. Director and Officer Liability
                                                    of Rule 10b–5, the disclosure must not                   disclosures, what should it include in                 Coverage
                                                    contain any untrue statement of a                        those disclosures? Should the level of                   The Board also notes that issuing
                                                    material fact and must not omit to state                 disclosures vary based on the level of                 securities can affect a credit union’s
                                                    a material fact, the absence of which                    the investor (institutional, accredited,               director and officer liability coverage. A
                                                    renders any disclosure being made                        natural person)?                                       lack of coverage could not only impair
                                                    misleading. Further, the disclosure must                    • Should the Board require credit                   the credit union, but also threaten the
                                                    be clear, accurate and verifiable, and                   unions to develop policies and
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                                                                                                                                                                    Share Insurance Fund in the event there
                                                    should cover topics that are typically                   procedures to ensure ongoing                           are losses that the credit union is
                                                    important to investors in making an                      compliance with anti-fraud                             ultimately responsible for. Before
                                                    investment decision, including:                          requirements before it begins issuing                  engaging in supplemental or secondary
                                                       • Material risks relating to the issuer               alternative capital?                                   capital activities, therefore, credit
                                                    and the industry in which the issuer                        The Board is also aware that there                  unions will need to evaluate coverage to
                                                    operates;                                                may be potential broker-dealer
                                                                                                                                                                     42 NCUA Letter to FCUs 10–FCU–03, Sale of
                                                      40 17   CFR 240.10b–5.                                   41 12   CFR part 16.                                 Nondeposit Investments, December 2010.



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                                                    9698                    Federal Register / Vol. 82, No. 25 / Wednesday, February 8, 2017 / Proposed Rules

                                                    ensure these activities are covered                          From an investor protection                            so, what controls are necessary to
                                                    under their policy. The Board requests                    standpoint, the issue of limiting the sale                preserve the mutual ownership
                                                    comments on if it should mandate that                     of secondary capital and supplemental                     structure and democratic governance of
                                                    credit unions certify that they have                      capital largely focuses on providing                      credit unions. The Board invites
                                                    evaluated their policies and have                         adequate protections to the purchasers                    comments on how it should structure
                                                    sufficient coverage before beginning                      through the issuance of initial                           any potential rule to avoid issues
                                                    secondary or supplemental capital                         disclosures, transparency standards                       impacting the mutuality of credit
                                                    activities.                                               with respect to reporting of information                  unions, and the members’ rights to
                                                                                                              about the operations and performance of                   govern the affairs of the institution.
                                                    D. Contractual Matters and
                                                                                                              the credit union, and whether the
                                                    Communications                                                                                                      VII. Prudential Standards for Issuing
                                                                                                              purchaser has the necessary
                                                       A credit union will need to address                    sophistication relative to the complexity                 and Counting Alternative Capital for
                                                    contractual provisions between the                        and risk of the instrument. As discussed                  Prompt Corrective Action
                                                    credit union and its investors. Often                     in more detail in the Section V,                             For a financial instrument to be
                                                    these provisions will include requiring                   Securities Law Applicability, of this                     considered regulatory capital for prompt
                                                    ongoing communications with                               ANPR, the OCC requires banks issuing                      corrective action purposes, NCUA must
                                                    investors, reporting of compliance with                   subordinated debt to comply with the                      consider the instrument’s degree of
                                                    the contractual covenants, and sharing                    securities offering disclosure rules in its               permanence, capacity to absorb losses as
                                                    of information with current and                           regulations.45 The OCC’s regulations                      a going concern, the flexibility of
                                                    prospective investors. Credit unions                      establish registration statement and                      principal and interest payments, and
                                                    will have to develop policies and                         prospectus requirements for the offer                     intended use of the proceeds. These
                                                    procedures to comply with these                           and sale of securities issued, subject to                 characteristics are consistent with the
                                                    covenants and provisions and ensure                       exemptions and disclosure requirements                    Basel Tier 2 capital criteria.46 These
                                                    that they are not providing non-public                    based on the sophistication of the                        same criteria are also contained in the
                                                    information to investors that is not                      investor. As banks are not restricted in                  regulatory capital quality distinctions
                                                    generally available to all investors.                     who they can sell securities to, these                    for the U.S. banking system.47
                                                    Failure to comply with the investment                     rules, in part, help provide a level of                   Provisions related to these
                                                    contracts or to properly monitor                          investor protection, particularly for less                characteristics are intended to ensure
                                                    communications and sharing of                             sophisticated, non-institutional                          the funds will be available to protect the
                                                    information could subject the credit                      investors.                                                Share Insurance Fund and do not create
                                                    union to liability, which could                              The issue of permissible investors is                  incentives for credit unions to engage in
                                                    negatively impact the Share Insurance                     also related to anti-fraud considerations.                unsafe or unsound practices.
                                                    Fund. As such, the Board requests                         As noted above, the level of disclosures                     The function of supplemental capital
                                                    comment on if it should mandate                           necessary to comply with anti-fraud                       is to protect the credit union and the
                                                    comprehensive policies addressing                         rules varies, in part, on the level of                    Share Insurance Fund in the event of
                                                    compliance with investment contracts,                     sophistication of the investors. In                       loss. Supplemental capital, therefore,
                                                    communications, and information                           practice, selling to non-sophisticated                    must be able to absorb losses ahead of
                                                    sharing. The Board invites commenters                     investors would likely involve a much                     the Share Insurance Fund while not
                                                    to provide suggestions on the specific                    higher initial and ongoing disclosure                     conferring control of the credit union to
                                                    details that should be in the policy and                  and communications burden for credit                      the investor. The instruments must be
                                                    if sufficient policies should be a                        unions.                                                   uninsured and cannot be guaranteed or
                                                    prerequisite to engaging in                                  Thus, the Board requests comment on                    secured by the credit union or its assets.
                                                    supplemental or secondary capital                         whether the sale of secondary and                         These features ensure supplemental
                                                    activities.                                               supplemental capital should be limited                    capital fulfils its ultimate purpose and
                                                                                                              to only institutional investors, include                  does not result in unintended
                                                    VI. Other Investor Considerations                         accredited investor, or allow for anyone                  encumbrances to the credit union or the
                                                       Section 701.34(b) of NCUA’s                            to purchase. If the Board were to allow                   Share Insurance Fund.
                                                    regulations limits eligible investors in                  credit unions to sell alternative capital                    The degree of permanence is
                                                    secondary capital to institutional                        to non-accredited investors, should                       important because the instrument must
                                                    investors, referenced as non-natural                      there be limits on the amount individual                  create sufficient stability in the credit
                                                    persons.43 This limitation is not                         investors can purchase? Also, should                      union’s capital base to be available to
                                                    required by the Act. This limitation                      there be conditions on how the sale to                    cover losses over a long time period.
                                                    prevents the sale of secondary capital to                 non-accredited investors must be                          This is the reason for the minimum five
                                                    consumers who could lack the ability to                   handled to minimize potential                             year maturity contained in the Basel
                                                    understand the risks associated with                      confusion about its lack of federal                       accords, the U.S. banking capital
                                                    secondary capital, especially when there                  insurance?                                                regulations, and for secondary capital
                                                    is opportunity for confusion given that                      Whether credit unions that are not
                                                    the low-income designated credit union                    low-income designated should be able                        46 Basel III was published in December 2010 and
                                                    is federally insured. Also, low-income                    sell supplemental capital instruments to                  revised in June 2011. The text is available at http://
                                                    designated credit unions can sell                         nonmembers with equity like                               www.bis.org/publ/bcbs189.htm. The BCBS is a
                                                    secondary capital to nonmembers.                          characteristics is a matter relevant to                   committee of banking supervisory authorities,
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                                                                                                                                                                        which was established by the central bank
                                                    When the secondary capital regulations                    considerations about the mutual model                     governors of the G–10 countries in 1975. More
                                                    were written in 1996 the purchasers of                    of credit unions. The Board requests                      information regarding the BCBS and its
                                                    secondary capital were presumed to be                     comments on the extent to which credit                    membership is available at http://www.bis.org/bcbs/
                                                    foundations and other philanthropic-                      unions should be allowed to sell                          about.htm. Documents issued by the BCBS are
                                                                                                                                                                        available through the Bank for International
                                                    minded institutional investors.44                         alternative capital with equity like                      Settlements Web site at http://www.bis.org. See
                                                                                                              characteristics to nonmembers, and if                     paragraph number 58 for criteria for inclusion in
                                                      43 12   CFR 701.34(b).                                                                                            Tier 2 Capital.
                                                      44 61   FR 378 (Feb. 2, 1996).                            45 12   CFR 5.47(d)(3)(iii).                              47 12 U.S.C. 324.20.




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                                                                          Federal Register / Vol. 82, No. 25 / Wednesday, February 8, 2017 / Proposed Rules                                                      9699

                                                    for low-income designated credit                            Because of these characteristics, most             agreement.56 The regulation does not
                                                    unions. With respect to secondary                        alternative capital instruments can have              specifically require a low-income
                                                    capital, a low-income designated credit                  relatively low liquidity for the                      designated credit union to submit to
                                                    unions is allowed to have a call option                  purchaser and there is no guarantee of                NCUA either a draft account agreement
                                                    for the portion no longer qualifying as                  a secondary market. These                             with the application or the executed
                                                    net worth so that they may retire the                    characteristics also impact the interest              agreement.
                                                    instrument if it is no longer needed or                  rate the credit union must pay for                       For all forms of alternative capital, the
                                                    market conditions allow them to reprice                  alternative capital. The Board seeks                  Board seeks comments on the utility of
                                                    the capital at a lower rate. However,                    comment on how to maintain protection                 a prior approval process and a post-
                                                    supervisory approval is needed before                    of the Share Insurance Fund while                     issuance notification process. The Board
                                                    any call is exercised because it                         minimizing the impact the criteria                    can also consider under what conditions
                                                    represents a potentially material change                 would have on the cost and                            prior approval would not be necessary,
                                                    to the risk to the Share Insurance Fund.                 marketability of the alternative capital              such as credit unions that are well
                                                       The alternative capital must be able to               instruments.                                          capitalized with a successful history of
                                                    absorb losses while the institution is                                                                         issuing alternative capital. When prior
                                                    still a going concern, and not just in the               A. Approval To Issue and Notice
                                                                                                                                                                   approval would be necessary, however,
                                                    case of liquidation. The existing                           The Board is considering including an              the Board requests comments on what
                                                    regulatory language regarding secondary                  application and notice requirement in                 should be required in an application for
                                                    capital requires that it is available to                 any supplemental capital regulations it               authority to issue alternative capital,
                                                    ‘‘cover operating losses.’’ 48 The term                  may issue.53 The Board notes that                     and how long the credit union would
                                                    ‘‘operating losses’’ has been interpreted                requiring a credit union to obtain                    have to issue the alternative capital after
                                                    to not include the payment of dividends                  approval to issue alternative capital and             approval. In addition, the Board request
                                                    on shares.49 However, a credit union’s                   provide a notice of issuance can                      comment on the evaluation criteria
                                                    inability to fund a dividend rate that is                contribute to ensuring alternative                    NCUA should use to approve or deny
                                                    consistent with prevailing rates can                     capital instruments are issued in                     the application, including whether or
                                                    create liquidity and reputation risk.                    accordance with applicable regulations,               not certain credit unions that are
                                                    Therefore, credit unions may need the                    part of a sound management plan, and                  already in danger of failing should be
                                                    flexibility to issue alternative capital                 are structured to properly protect the                precluded from issuing alternative
                                                    instruments that are available to absorb                 Share Insurance Fund.54                               capital as a form of investor protection.
                                                    all losses in excess of retained earnings,                  The Board notes that currently NCUA                Also, the Board seeks comment on the
                                                    including the payment of dividends on                    requires a low-income designated credit               manner of and what should be included
                                                    shares.50 The Board is seeking comment                   union to submit a ‘‘Secondary Capital                 in any post-issuance notice credit
                                                    on the exclusion of dividend expenses                    Plan’’ prior to the acceptance of                     unions would file with NCUA.
                                                    as an operating expense and seeks                        secondary capital that includes: 55
                                                    comment on how to resolve the                               • The maximum aggregate amount of                  B. Subordination
                                                    complexity that can result from                          secondary capital the low-income                         Secondary capital must be
                                                    excluding dividend expense from losses                   designated credit union plans to accept;              subordinate to all other claims per the
                                                    applied to secondary capital but not                        • The purpose for which the                        Act.57 Thus, supplemental capital must
                                                    from losses applied to supplemental                      secondary capital will be used and how                have a payout priority senior to
                                                    capital.                                                 it will be repaid;                                    secondary capital but still subordinate
                                                       Further, the payment of interest on                      • Demonstration that the uses of the               to the Share Insurance Fund. The
                                                    the instruments must be capable of                       secondary capital conform to the low-                 requirement that alternative capital
                                                    being cancelled on a permanent,                          income designated credit union’s                      instruments are subordinate to the Share
                                                    noncumulative basis without                              strategic plan, business plan, and                    Insurance Fund, uninsured
                                                    constituting a default. The interest                     budget; and                                           shareholders, and general creditors is
                                                    provisions must also not contain any                        • Supporting pro forma financial                   consistent with the Basel criteria for
                                                    feature which would provide incentive                    statements covering a minimum of two                  Tier 2 capital.58
                                                    for the credit union to exercise a call                  years.                                                   Unlike secondary capital,
                                                    option, such as a large increase in the                     The account agreement associated                   supplemental capital is not subject to
                                                    interest rate. The flexibility of payments               with any alternative capital needs to                 provisions in the Act that limit
                                                    ensures investors cannot obviate any                     conform to the standards that ensure it               flexibility in structuring payment
                                                    risk exposure to their principal through                 protects the Share Insurance Fund and
                                                    problematic dividend and interest                                                                              priorities within and between
                                                                                                             provide the credit union with flexibility             supplemental capital instruments. For
                                                    provisions. These criteria are consistent                in conducting its daily affairs. The
                                                    with the criteria for inclusion in Tier 2                                                                      example, a credit union could issue a
                                                                                                             secondary capital regulation currently                supplemental capital instrument with
                                                    capital used by the other banking                        requires that the low-income designated
                                                    regulators 51 and are contained in Basel                 credit union retain the original account                56 Id.at § 701.34(b)(11).
                                                    III.52
                                                                                                             agreement and the ‘‘Disclosure and                      57 12 U.S.C. 1790d(o)(2)(C)(ii).
                                                                                                                                                                     58 Basel III was published in December 2010 and
                                                      48 12
                                                                                                             Acknowledgment’’ for the term of the
                                                              CFR 701.34(b)(7).                                                                                    revised in June 2011. The text is available at http://
                                                      49 12   CFR 701.34.                                                                                          www.bis.org/publ/bcbs189.htm. The BCBS is a
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                                                       50 If the Board authorizes supplemental capital, it   www.bis.org/publ/bcbs189.htm. See paragraph 58        committee of banking supervisory authorities,
                                                    could be possible for low income designated credit       for criteria for inclusion in Tier 2 Capital.         which was established by the central bank
                                                                                                               53 Secondary capital provisions already require
                                                    unions to concurrently offer both supplemental and                                                             governors of the G–10 countries in 1975. More
                                                    secondary capital instruments. The differing             low income designated credit unions to obtain prior   information regarding the BCBS and its
                                                    treatment of payments on dividends could make the        NCUA approval.                                        membership is available at http://www.bis.org/bcbs/
                                                    administration of losses applied to alternative            54 See. 12 CFR 5.47(f) and (h) for the OCC’s
                                                                                                                                                                   about.htm. Documents issued by the BCBS are
                                                    capital complex and potentially confusing.               requirements for prior approval for issuance of       available through the Bank for International
                                                       51 12 CFR 5.47.                                       subordinated debt and for the notice procedure for    Settlements Web site at http://www.bis.org. See
                                                       52 Basel III was published in December 2010 and       inclusion as tier 2 capital.                          paragraph number 58 for criteria for inclusion in
                                                    revised in June 2011. The text is available at http://     55 12 CFR 701.34(b)(1).                             Tier 2 Capital.



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                                                    9700                  Federal Register / Vol. 82, No. 25 / Wednesday, February 8, 2017 / Proposed Rules

                                                    two tranches, a high-yield-high-risk                         • A total risk-based capital ratio of              decision on early repayment must reside
                                                    supporting tranche and a lower-                           10.0 percent or greater;                              with the issuing credit union and not
                                                    yielding-lower risk tranche. Credit                          • A Tier 1 risk-based capital ratio of             the holder of the instrument, to ensure
                                                    unions could also issue supplemental                      8.0 percent or greater;                               the permanence of the instrument and
                                                    capital instruments that have first in-                      • A common equity tier 1 capital ratio             prevent undue influence by investors.
                                                    first out, or last in-first out contractual               of 6.5 percent or greater; and                        Currently the secondary capital
                                                    payment priorities. This flexibility                         • A leverage ratio of 5.0 percent or               regulations only allow for early
                                                    could help credit unions attract                          greater.62                                            redemption of the amount of secondary
                                                    investors of different risk tolerances and                   As a result, banks are inherently                  capital that is not recognized as net
                                                    profiles. The Board seeks comment on                      limited in how much Tier 2 forms of                   worth, with approval by NCUA.64
                                                    whether authorizing supplemental                          capital will be included in meeting their                Regulatory controls over early
                                                    capital regulations should contain any                    regulatory capital standards. Most forms              repayment are necessary to protect the
                                                    restrictions on payment priority options,                 of alternative capital likely available to            Share Insurance Fund and uninsured
                                                    and if so, what should they be.                           credit unions will be in the form of                  shares. Regulatory controls over early
                                                                                                              subordinated debt—which does not                      repayment are also consistent with the
                                                    C. Limit on Amount of Supplemental                        meet the standards to qualify as Tier 1               Basel framework for subordinated debt
                                                    Capital That Counts as Regulatory                         capital.                                              and the other banking agencies’
                                                    Capital                                                      Neither the Act nor NCUA regulations               regulations, which provide control over
                                                      While supplemental capital can                          limit the amount of secondary capital                 the early repayment of subordinated
                                                    protect the Share Insurance Fund and                      that can make up a low income                         debt by:
                                                    uninsured shares from losses, reliance                    designated credit union’s net worth.                     • Requiring all banks to obtain prior
                                                    on alternative capital as the primary                     Given their unique needs and mission,                 approval to prepay or call subordinated
                                                    source of capital is generally unsafe and                 low-income designated credit unions                   debt included in tier 2 capital.65
                                                    unsound. Even with a high level of                        can primarily rely on secondary capital                  • Prohibiting the holder of
                                                    permanent capital, such as retained                       to meet prompt corrective action                      subordinated debt from having a
                                                    earnings and common stock, heavy                          requirements, provided their use of the               contractual right to accelerate principal
                                                    reliance on alternative capital can result                proceeds and overall ongoing                          or interest payments in the instrument,
                                                    in wide fluctuations in capital measures                  management of their secondary capital                 except in the event of a receivership,
                                                    due to the timing of its maturity and                     is otherwise safe and sound. However,                 insolvency, liquidation, or other similar
                                                    negative impact on earnings due to the                    the Board believes any regulation for                 proceeding.66
                                                    associated costs.                                         supplemental capital needs to contain                    • Prohibiting the exercise of a call
                                                      U.S. bank capital regulations require                   some method of preventing                             option in the first five years following
                                                    banks to hold minimum levels of                           supplemental capital, a lower quality of              issuance, except in certain very limited
                                                    common equity tier 1 capital, total tier                  capital, from becoming the primary                    circumstances.
                                                    1 capital, and total tier 1 and tier 2                    component of regulatory capital for                      Enabling regulations for supplemental
                                                    capital to total risk assets that ensures                 credit unions. The Board seeks                        capital will need to address the issue of
                                                    that permanent capital is generally the                   comments on how capital regulations                   prepayment and call provisions for
                                                    primary source of regulatory capital.59                   could be designed to limit the amount                 supplemental capital. The options
                                                                                                              of supplemental capital included in                   regarding the abilities of a credit union
                                                    An FDIC-supervised institution must
                                                                                                              regulatory capital calculations.                      to prepay supplemental capital could
                                                    maintain the following minimum
                                                                                                                 Consistent with Basel, U.S. bank                   include minimum capital measures after
                                                    capital ratios: 60
                                                                                                              capital standards,63 and secondary                    repayment, current and expected future
                                                      • A common equity tier 1 capital ratio                  capital regulations, the portion of
                                                    of 4.5 percent;                                                                                                 performance measures and notice
                                                                                                              supplemental capital that would be                    criteria of varying degrees. The Board
                                                      • A tier 1 capital ratio of 6 percent;                  considered as regulatory capital and
                                                      • A total capital ratio of 8 percent;                                                                         invites comments on the topic of
                                                                                                              included in the calculation of the risk-              prepayment and call provisions for
                                                    and                                                       based net worth requirement would be                  alternative capital and how it should
                                                      • A leverage ratio of 4 percent.61                      subject to reductions during the last five            structure any related requirements.
                                                      Additionally to be classified as well                   years of the life of the instrument.                  Allowing credit unions greater
                                                    capitalized a bank must have:                             Consistent with secondary capital, at the             flexibility to eliminate the cost of
                                                                                                              beginning of the each of last five years              alternative capital or reprice the
                                                      59 12   CFR 324.10(a).                                  of the life of the supplemental capital,              instrument under better terms could
                                                      60 The   standardized capital ratio calculations are    the amount that is eligible to be                     provide benefits to the credit union.
                                                    defined in 12 CFR 3.10(b). The Common Equity Tier
                                                    1 Capital Ratio is the ratio of Common Equity Tier        included in the risk-based net worth                  Any alternative to the redemption
                                                    1 Capital to standardized total risk-weighted assets.     requirement would be reduced by 20                    process would be contingent on the
                                                    The Tier 1 Capital Ratio is the ratio of Tier 1 Capital   percent of the original amount of the                 credit union no longer relying on the
                                                    to standardized total risk-weighted assets. The Total     instrument (less any redemptions that
                                                    Capital Ratio is the ratio of total capital (Tier 1                                                             alternative capital to achieve an
                                                    Capital plus Tier 2 Capital) to standardized total        may have occurred). The Board seeks                   appropriate level of capital.
                                                    risk-weighted assets. The Leverage Ratio is               comments on this concept and how to
                                                    generally Tier 1 Capital to total consolidated assets.    reflect the increasingly limited utility as           D. Reciprocal Holdings
                                                    The components of regulatory capital are defined in
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                                                                                                              loss absorbing capital for supplemental                  Regulations for alternative capital
                                                    12 CFR 3.20. Common Equity Tier 1 Capital is
                                                    generally common stock, retained earnings, and            capital approaching maturity.                         need to address reciprocal holdings.
                                                    accumulated other comprehensive income.                      The Board also notes that changing                 Reciprocal holdings exist when two or
                                                    Additional Tier 1 Capital primarily includes              conditions and circumstances may                      more credit unions hold each other’s
                                                    noncumulative perpetual preferred stock. Tier 2           warrant early repayment of alternative
                                                    Capital generally includes limited allowance for
                                                                                                                                                                    alternative capital. Reciprocal holdings
                                                    loan and lease losses, certain subordinated debt and      capital, in part or in whole. The
                                                                                                                                                                      64 12  CFR 701.34(d).
                                                    preferred stock, and qualifying capital minority
                                                    interests.                                                 62 Id.at § 324.403(b)(1).                              65 Id. at § 5.47(d)(1)(vii).
                                                       61 Id. at § 324.10(a).                                  63 12 CFR 324.20(d)(iv).                               66 Id. at § 5.47(d)(2).




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                                                                            Federal Register / Vol. 82, No. 25 / Wednesday, February 8, 2017 / Proposed Rules                                              9701

                                                    of alternative capital, without some                       regulators’ ability to manage the                       greater.70 Federal credit unions seeking
                                                    form of adjustment, would artificially                     institution and address problems.                       to exceed the limit must:
                                                    inflate the level of capital in the credit                 Affirmative covenants within the                          • Adopt a specific written plan
                                                    union system, create loss transmission                     supplemental capital note or agreement                  concerning the intended use of these
                                                    channels between credit unions, and                        must not restrict operations or                         shares and provide it to the Regional
                                                    could be subject to abuse.                                 potentially require a credit union to                   Director before accepting the funds; and
                                                       The Board notes a national bank or                      violate a law or regulation. Negative                     • Submit a written request to the
                                                    federal savings association must deduct                    covenants should not unreasonably                       Regional Director for a new maximum
                                                    investments in the capital of other                        impair the credit union’s flexibility in                level of public unit and nonmember
                                                    financial institutions it holds                            conducting its operations or interfere                  shares.71
                                                    reciprocally, where such reciprocal                        with management. Without these                            Under § 741.204, federally insured
                                                    cross holdings result from a formal or                     restrictions, contractual terms could                   state chartered credit unions must
                                                    informal arrangement to swap,                              undermine the purpose of supplemental                   adhere to the requirements of § 701.32
                                                    exchange, or otherwise intent to hold                      capital and provide holders of these                    regarding public unit and nonmember
                                                    each other’s capital instruments, by                       obligations with unintended rights and                  accounts.72 This regulation also
                                                    applying the corresponding deduction                       control over the credit union’s                         addresses a federally insured state
                                                    approach.67 The Board requests                             operations. Any representation or                       chartered credit union obtaining a low-
                                                    comment on how NCUA should address                         warranties contained in the agreements                  income designation, as provided under
                                                    this concern.                                              that would require acceleration and                     state law, in order to accept nonmember
                                                    E. Merger                                                  repayment of the subordinated debt note                 accounts other than from public units or
                                                                                                               because of a technical violation that                   other credit unions.73 Additionally this
                                                       Per the current regulation, in the                      does not reflect underlying credit issues
                                                    event of merger of a low-income                                                                                    section addressed the ability of a
                                                                                                               could be contrary to safety and                         federally insured state chartered credit
                                                    designated credit union (other than                        soundness. The Board seeks comments
                                                    merger into another low-income                                                                                     union to receive and redeem secondary
                                                                                                               on the issue of contractual restrictions                capital consistent with § 701.34 and
                                                    designated credit union) the secondary                     for alternative capital instruments.
                                                    capital accounts will be closed and paid                                                                           consistent with applicable state law and
                                                    out to the investor to the extent they are                 VIII. Supporting Regulatory Changes                     regulation.74
                                                    not needed to cover losses at the time                                                                               Because the limitations the NCUA
                                                                                                               A. 701.32—Payment on Shares by                          board may prescribe to these accounts is
                                                    of merger or dissolution. The OCC                          Public Unit Nonmembers
                                                    prohibits a covenant or provision in                                                                               not statutory, the NCUA Board is
                                                    subordinated debt instruments that                           Due to the potential use of alternative               interested in comments on revisions to
                                                    requires the prior approval of a                           capital as a funding source similar to                  this regulation which would reduce the
                                                    purchaser or holder of the subordinated                    public units and nonmembers, the                        regulatory burden of the waiver process
                                                    debt note in the case of a voluntary                       NCUA Board is seeking comment on                        but still provide for adequate protection
                                                    merger where the resulting institution                     § 701.32 of NCUA’s regulations as it                    of the Share Insurance Fund.
                                                    assumes the due and punctual                               prescribes limits placed on these
                                                                                                                                                                       B. 701.34—Designation of Low-Income
                                                    performance of all conditions of the                       accounts.
                                                                                                                                                                       Status; Acceptance of Secondary
                                                    subordinated debt note and where the                         Section 1757(6) of the FCU Act grants
                                                                                                                                                                       Capital Accounts by LICUs
                                                    agreement is not in default of the                         federal credit unions the power ‘‘to
                                                    various other covenants.68                                 receive from its members, from other                       Section 701.34 of NCUA’s Rules and
                                                       In order to avoid any perceptions of                    credit unions, from an officer,                         Regulations sets out the requirements
                                                    an alternative capital holder having                       employee, or agent of those nonmember                   and process for a credit union to receive
                                                    ownership rights, any restrictions on                      units of Federal, Indian tribal, State, or              a low-income designation, the criteria
                                                    merger or other change of control must                     local governments and political                         for accepting secondary capital and the
                                                    not interfere with the credit union’s                      subdivisions thereof enumerated in                      inclusion of secondary capital as
                                                    ability to exercise its business                           section 1787 of this title and in the                   regulatory capital. NCUA is seeking
                                                    judgement and management of the                            manner so prescribed, from the Central                  comment on whether the criteria and
                                                    credit union in a manner that avoids                       Liquidity Facility, and from                            process for obtaining the low income
                                                    unsafe and unsound practices. The                          nonmembers in the case of credit unions                 designation, the criteria for issuing
                                                    Board seeks comment on the issue of                        serving predominately low-income                        secondary capital, and the criteria for
                                                    merging credit unions and how                              members (as defined by the Board)                       inclusion of secondary capital as
                                                    alternative capital should be treated                      payments, representing equity, on—(A)                   regulatory capital should be in separate
                                                    post-merger.                                               shares which may be issued at varying                   regulations.
                                                                                                               dividend rates; (B) share certificates                     Section 701.34 could be solely
                                                    F. Other Restrictions                                      which may be issued at varying                          focused on the process to receive a low-
                                                      Supplemental capital must not                            dividend rates and maturities; and (C)                  income designation. A new section of
                                                    contain contractual terms that would                       share draft accounts authorized under                   701 could be used to address:
                                                    limit or impede the authority of NCUA                      section 1785(f) of this title; subject to                  • The authority and requirements of
                                                    or a State Supervisory Authority to                        such terms, rates, and conditions as may                secondary capital;
                                                    undertake supervisory action, as                           be established by the board of directors,                  • Grandfathering treatment of existing
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                                                    necessary, to protect the issuing credit                   within limitations prescribed by the                    secondary capital in the event of
                                                    union’s members or the Share Insurance                     Board.’’ 69                                             regulatory changes;
                                                    Fund. Any such contractual terms                             Currently the regulation limits total
                                                    would impose unsafe and unsound                            public unit and nonmember shares to 20                    70 12  CFR 701.32(b)(1).
                                                    limits on the credit union’s and                           percent of the total shares of the federal                71 Id. at § 701.32(b)(2).
                                                                                                               credit union or $3 million, whichever is                  72 Id. at § 741.204(a).
                                                      67 12   CFR 3.22(c)(3).                                                                                            73 Id. at § 741.204(b).
                                                      68 12   CFR 5.47(d)(2)(iv).                                69 12   U.S.C. 1785(f).                                 74 Id. at § 741.204(c) and (d).




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                                                    9702                   Federal Register / Vol. 82, No. 25 / Wednesday, February 8, 2017 / Proposed Rules

                                                       • Requirement to comply with all                      DEPARTMENT OF ENERGY                                  Corporation (NERC), the Commission-
                                                    applicable federal and state laws in the                                                                       certified Electric Reliability
                                                    issuance of secondary capital;                           Federal Energy Regulatory                             Organization (ERO), submitted proposed
                                                       • Requirements for written contract                   Commission                                            Reliability Standard PRC–012–2 for
                                                    agreements covering the terms and                                                                              approval. The purpose of proposed
                                                    conditions of the secondary capital;                     18 CFR Part 40                                        Reliability Standard PRC 012–2 is to
                                                                                                                                                                   ensure that remedial action schemes
                                                       • Requirements for disclosures and                    [Docket No. RM16–20–000]
                                                                                                                                                                   (RAS) do not introduce unintentional or
                                                    acknowledgement;                                                                                               unacceptable reliability risks to the bulk
                                                                                                             Remedial Action Schemes Reliability
                                                       • Investor suitability; and                           Standard                                              electric system. In addition, the
                                                       • Prohibitions.                                                                                             Commission proposes to approve the
                                                                                                             AGENCY: Federal Energy Regulatory                     associated violation risk factors and
                                                       The items specific to secondary                       Commission.                                           violation severity levels,
                                                    capital’s and supplemental capital’s                     ACTION: Notice of proposed rulemaking.                implementation plan, and effective date
                                                    inclusion in regulatory capital and                                                                            proposed by NERC. NERC also
                                                    related capital adequacy issues could be                 SUMMARY:   The Federal Energy                         submitted proposals to retire two
                                                    consolidated into Section 702—Capital                    Regulatory Commission proposes to                     currently-effective Reliability Standards
                                                    Adequacy, including:                                     approve Reliability Standard PRC–012–                 and to withdraw three Reliability
                                                       • Standards for alternative capital                   2 (Remedial Action Schemes) submitted                 Standards that are pending review
                                                    instruments to be counted as regulatory                  by the North American Electric                        before the Commission. While
                                                    capital;                                                 Reliability Corporation. The purpose of               proposing to approve Reliability
                                                                                                             proposed Reliability Standard PRC–
                                                       • Any limits on the amount of                         012–2 is to ensure that remedial action
                                                                                                                                                                   Standard PRC–012–2, the Commission
                                                    alternative capital counted as regulatory                                                                      seeks clarifying comments addressing
                                                                                                             schemes do not introduce unintentional                ‘‘limited impact’’ RAS. Based on
                                                    capital;                                                 or unacceptable reliability risks to the              comments and information received, the
                                                       • The role of supplemental capital in                 bulk electric system.                                 Commission may issue directives as
                                                    approval of a net worth restoration plan;                DATES: Comments are due April 10,                     appropriate.
                                                       • Provisions for discounting                          2017
                                                    regulatory capital treatments such as                                                                          I. Background
                                                                                                             ADDRESSES:    Comments, identified by
                                                    violations of applicable laws or                         docket number, may be filed in the                    A. Section 215 and Mandatory
                                                    regulation, including any deficiency                     following ways:                                       Reliability Standards
                                                    cure alternatives; and                                     • Electronic Filing through http://                   2. Section 215 of the FPA requires a
                                                       • Risk weight for an investment in                    www.ferc.gov. Documents created                       Commission-certified ERO to develop
                                                    supplemental capital.                                    electronically using word processing                  mandatory and enforceable Reliability
                                                                                                             software should be filed in native                    Standards, subject to Commission
                                                    C. Payout Priorities                                     applications or print-to-PDF format and               review and approval.1 Once approved,
                                                       To conform the regulatory payout                      not in a scanned format.                              the Reliability Standards may be
                                                    priorities for supplemental capital, the                   • Mail/Hand Delivery: Those unable                  enforced by the ERO subject to
                                                    payout priorities for an involuntary                     to file electronically may mail or hand-              Commission oversight, or by the
                                                    liquidation will need to be revised.75                   deliver comments to: Federal Energy                   Commission independently.2 In 2006,
                                                    Supplemental capital would be listed in                  Regulatory Commission, Secretary of the               the Commission certified NERC as the
                                                    the payout priority after uninsured                      Commission, 888 First Street, NE.,                    ERO pursuant to section 215 of the
                                                    shareholders and the Share Insurance                     Washington, DC 20426.                                 FPA.3
                                                    Fund.                                                      Instructions: For detailed instructions
                                                                                                             on submitting comments and additional                 B. Order No. 693
                                                    D. Other Regulations                                     information on the rulemaking process,                  3. On March 16, 2007, the
                                                                                                             see the Comment Procedures Section of                 Commission issued Order No. 693,
                                                      The Board seeks comments on any                        this document.
                                                    other related changes to existing                                                                              approving 83 of the 107 Reliability
                                                                                                             FOR FURTHER INFORMATION CONTACT:                      Standards filed by NERC, including
                                                    regulations, such as:
                                                                                                             Syed Ahmad (Technical Information),                   Reliability Standards PRC–015–1
                                                      • Modifying the definition of insured                    Office of Electric Reliability, Division            (Remedial Action Scheme Data and
                                                    shares in 741.4(b) to exclude any equity                   of Reliability Standards and Security,              Documentation) and PRC–016–1
                                                    shares allowed under state law, if they                    888 First Street NE., Washington, DC                (Remedial Action Scheme
                                                    are in fact uninsured;                                     20426, Telephone: (202) 502–8718,                   Misoperation).4 Reliability Standard
                                                      • Modifying 741.9 to provide for the                     Syed.Ahmad@ferc.gov.                                PRC–015–1 requires transmission
                                                    existence of uninsured accounts issued                   Alan Rukin (Legal Information), Office                owners, generator owners, and
                                                    under state law by FISCUs; and                             of the General Counsel, Federal                     distribution providers to maintain a
                                                      • Any cohering changes to part 745 as                    Energy Regulatory Commission, 888
                                                    necessary.                                                 First Street NE., Washington, DC                      1 16 U.S.C. 824o(c), (d) (2012).
                                                                                                               20426, Telephone: (202) 502–8502,                     2 Id.824o(e).
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                                                      By the National Credit Union                             Alan.Rukin@ferc.gov.                                  3 North American Electric Reliability Corp., 116

                                                    Administration Board on January 19, 2017.                                                                      FERC ¶ 61,062 (ERO Certification Order), order on
                                                                                                             SUPPLEMENTARY INFORMATION:                            reh’g and compliance, 117 FERC ¶ 61,126 (2006),
                                                    Gerard Poliquin,
                                                                                                               1. Pursuant to section 215 of the                   order on compliance, 118 FERC ¶ 61,190, order on
                                                    Secretary of the Board.                                  Federal Power Act (FPA), the                          reh’g, 119 FERC ¶ 61,046 (2007), aff’d sub nom.
                                                    [FR Doc. 2017–01713 Filed 2–7–17; 8:45 am]               Commission proposes to approve                        Alcoa Inc. v. FERC, 564 F.3d 1342 (D.C. Cir. 2009).
                                                                                                                                                                     4 Mandatory Reliability Standards for the Bulk-
                                                    BILLING CODE P                                           proposed Reliability Standard PRC–                    Power System, Order No. 693, FERC Stats. and Regs.
                                                                                                             012–2 (Remedial Action Schemes). The                  ¶ 31,242, order on reh’g, Order No. 693–A, 120
                                                      75 12   CFR 709.5.                                     North American Electric Reliability                   FERC ¶ 61,053 (2007).



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Document Created: 2017-02-08 02:59:38
Document Modified: 2017-02-08 02:59:38
CategoryRegulatory Information
CollectionFederal Register
sudoc ClassAE 2.7:
GS 4.107:
AE 2.106:
PublisherOffice of the Federal Register, National Archives and Records Administration
SectionProposed Rules
ActionAdvance notice of proposed rulemaking.
DatesComments must be received on or before May 9, 2017.
ContactSteve Farrar, Supervisory Financial Analyst, at (703) 518-6360; or Justin Anderson, Senior Staff Attorney, Office of General Counsel, at (703) 518-6540. You may also contact them at the National Credit Union Administration, 1775 Duke Street, Alexandria, Virginia 22314.
FR Citation82 FR 9691 
CFR Citation12 CFR 701
12 CFR 702
12 CFR 703
12 CFR 709
12 CFR 741
12 CFR 745

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