Prompt Corrective Action

Federal RegisterFeb 18, 2000

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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 702, 741 and 747

Prompt Corrective Action

AGENCY:

National Credit Union Administration (NCUA).

ACTION:

Final rule.

SUMMARY:

In 1998, Congress amended the Federal Credit Union Act to establish minimum capital standards for federally-insured credit unions and to require the NCUA Board to adopt, by regulation, a system of “prompt corrective action” to restore the capital level of credit unions which become inadequately capitalized. The NCUA Board issued a proposed rule combining the components of prompt corrective action expressly prescribed by statute with those the statute required NCUA to develop to suit the distinctive needs and characteristics of credit unions. As revised to reflect public comments and to incorporate other improvements, the final rule establishes a comprehensive framework of mandatory and discretionary supervisory actions indexed to five statutory net worth categories; an alternative system of prompt corrective action for credit unions which meet the statutory definition of “new”; conforming reserve and dividend payment requirements; and procedures for reviewing and enforcing directives imposing prompt corrective action.

DATES:

Effective August 7, 2000.

FOR FURTHER INFORMATION CONTACT:

Herbert S. Yolles, Deputy Director, Office of Examination and Insurance, (703) 518-6360; or Steven W. Widerman, Trial Attorney, Office of General Counsel, (703) 518-6557, at National Credit Union Administration, 1775 Duke Street, Alexandria, VA 22314-3428.

SUPPLEMENTARY INFORMATION:

I. Background

A. The Credit Union Membership Access Act

On August 7, 1998, Congress enacted the Credit Union Membership Access Act, Pub. L. 105-219, 112 Stat. 913 (1998). Section 301 of the statute added a new section 216 to the Federal Credit Union Act (“FCUA”), 12 U.S.C. 1790d (hereinafter referred to as “CUMAA” or “the statute” and cited as “§ 1790d”). Section 1790d requires the NCUA Board to adopt by regulation a system of “prompt corrective action” (“PCA”) to restore the net worth of federally-insured “natural person” credit unions which become inadequately capitalized. The purpose of PCA is to “resolve the problems of insured credit unions at the least possible long-term loss to the [National Credit Union Share Insurance Fund (“NCUSIF”)].” § 1790d(a)(1).

The statute designates three principal components of PCA: (1) A framework combining mandatory actions prescribed by statute with discretionary actions developed by NCUA; (2) an alternative system of PCA to be developed by NCUA for credit unions which CUMAA defines as “new”; and (3) a risk-based net worth requirement to apply to credit unions which NCUA defines as “complex.” The first and second principal components are the subject of this final rule. In formulating the rule, NCUA was required to consult with the Secretary of the Treasury, the Federal banking agencies, and State officials having jurisdiction over federally-insured, State-chartered credit unions. CUMAA § 301(c).

For credit unions other than those which meet the statutory definition of a “new” credit union, CUMAA mandated a framework of mandatory and discretionary supervisory actions indexed to five statutory net worth categories. The mandatory actions and conditions triggering conservatorship and liquidation are expressly prescribed by statute. § 1790d(e), (f), (g), (i); 12 U.S.C. 1786(h)(1)(F), 1786(a)(3)(A)(1). To supplement the mandatory actions, the statute charged NCUA with developing discretionary actions which are “comparable”

to the “discretionary safeguards” available under section 38 of the Federal Deposit Insurance Act (“FDIA § 38”)—the statute that applies PCA to other federally-insured depository institutions.

12 U.S.C. 1831o; § 1790d(b)(1)(A); S. Rep. No. 193, 105th Cong., 2d Sess. 12 (1998) (S. Rep.); H.R. Rep. No. 472, 105th Cong., 2d Sess. 23 (1998) (H. Rep.).

“Comparable” is defined as “parallel in substance (though not necessarily identical in detail) and equivalent in rigor.” S. Rep. at 12.

Section 38 of the Federal Deposit Insurance Act, 12 U.S.C. 1831o, was added by section 131 of the Federal Deposit Insurance Corporation Improvement Act, Pub. L. No. 102-242, 105 Stat. 2236 (1991). The Joint Final Rule implementing FDIA § 38, 12 U.S.C. 1831o, is published at 57 FR 44886 (Sept. 29, 1992).

For credit unions which CUMAA defines as “new”—those which have been in operation less than ten years and have $10 million or less in assets—the statute directed NCUA to develop an alternative system of PCA to apply in lieu of the system of PCA for all other federally-insured credit unions. § 1790d(b)(2)(A);

See also

§ 703.306(d).

Finally, a commenter urged NCUA to establish a cooperative fund to which credit unions could contribute “net worth” to be accessed by other credit unions as needed. While it is not appropriate for NCUA to sponsor such a fund, it certainly would be an appropriate private sector initiative for credit unions which are authorized to contribute to such a fund.

B. Subpart A—Net Worth Classification

1. Section 702.3—Net Worth Measures

CUMAA expressly prescribes the exclusive measures which determine a credit union's net worth category classification—a credit union's net worth ratio and, if “complex,” its RBNW requirement. § 1790d(c); § 702.101(a). One commenter nonetheless advocated making a credit union's income, as reflected by income simulation models, a factor in determining its net worth category classification, insisting that the net worth ratio is too narrow a measure. Although income simulation models are a valid tool in assessing safety and soundness independently of PCA, CUMAA does not give NCUA discretion to establish additional criteria for determining a credit union's net worth category classification.

2. Section 702.101—Measures and Effective Date of Net Worth Classification

Effective date.

The proposed rule provided that a credit union generally would be deemed to have notice of its net worth ratio and corresponding net worth category classification as of “the last day of the credit union's most recent dividend period for regular shares, but no less frequently than quarterly.”

64 FR at 27108. Since most credit unions have a monthly dividend period for regular shares, this effectively required monthly measurement of the net worth ratio.

In infrequent cases, a credit union would have notice of a decline in its net worth category classification through or as a result of its most recent final report of examination (indicating a flaw in calculating in net worth ratio, for example), or when it was notified by NCUA that it had been reclassified to a lower net worth category on safety and soundness grounds. § 702.101(b)(2)-(3).

Twenty-five commenters addressed this provision. Two were unable to distinguish between “notice” and the “effective date” of classification, while one predicted that credit unions will find it difficult to determine net worth on their own. Two commenters supported the “effective date” provision while fourteen commenters opposed it. The opponents felt that determining net worth monthly was too frequent and,

therefore, too burdensome. Various alternatives were suggested—quarterly net worth determination, annual net worth determination, net worth determination to coincide with the Call Report periods, modification of the Call Report to incorporate the formula for calculating the net worth ratio, with an abbreviated March 30 and September 31 version of the Call Report for semiannual filers to file. In addition, the commenters insisted that more time is needed between the period-end when net worth is determined and the effective date of classification, when a credit union must undertake the applicable “mandatory supervisory actions.”

In response to these concerns, NCUA has modified and improved upon the proposed rule in two key ways. First, to reduce the frequency of measuring net worth, the final rule determines a credit union's net worth ratio at the end of each calendar quarter to coincide with the end of the Call Report period, without regard to the credit union's dividend period for regular shares. § 702.101(a). Moreover, to ease the burden of calculating the net worth ratio, NCUA plans to incorporate within the Call Report a “PCA Worksheet” which quarterly and semi-annual filers may rely upon to compute the net worth ratio on their own. For the first and third quarters, semiannual filers will have the option to complete and maintain a corresponding “PCA Worksheet” (instead of filing it with NCUA) or to otherwise calculate their net worth ratio.

Second, the final rule no longer deems a credit union to “have notice of its net worth ratio” as of a certain date, but instead, establishes an “effective date” of net worth classification. The “effective date” of a credit union's classification within a net worth category—the date by which it must undertake the actions applicable to credit unions in that category—generally is “the last day of the month following the calendar quarter” for which the credit union's net worth ratio is determined. § 702.101(b)(1). This extends to approximately thirty days the period between quarter-end and the effective date—more time than is permitted to file the corresponding Call Report.

Notice by credit union of change in net worth category.

The proposed rule generally gave credit unions 15 days from the last day of the most recent dividend period for regular shares to notify NCUA of a change in net worth ratio if that change “places the credit union in a lower net worth category.” 64 FR 27108. Three commenters urged a role reversal in this regard—that NCUA should inform credit unions when their net worth classification changes. This is no longer necessary because the final rule eases the burden on credit unions substantially by making the period for measuring a credit union's net worth coincide with the Call Report period, and incorporating the “PCA worksheet” in the Call Report which already is required to be filed with NCUA (except by semiannual filers for the March 31 and September 30 quarters).

The requirements to notify NCUA of a change in category classification are modified accordingly. The “PCA Worksheet” filed with the Call Report will give notice to NCUA of a change in net worth ratio from quarter to quarter, and any resulting change in classification. Thus, credit unions are no longer required to give separate notice to NCUA of a change in net worth category for the quarters for which they file a Call Report. § 702.101(c)(1). This leaves two instances where the final rule requires a credit union to give separate notice to NCUA—semiannual Call Report filers whose net worth classification declines in the first and third quarters, and those whose classification declines due to recalculation of their net worth ratio by or as a result of an examination report. § 702.101(c)(2)-(3). In all cases, written notice to NCUA is required only to report a decline in net worth

category,

not merely a change in net worth ratio.

On a related issue of “notice,” one commenter asked whether a less than “adequately capitalized” credit union should inform its membership of its net worth category classification. There is no requirement for a credit union to disclose its net worth classification. However, an independent accountant who renders an opinion on the credit union's financial statements, in following Generally Accepted Auditing Standards (GAAS), may choose to disclose the credit union's classification in a footnote. In addition, Call Report data used to calculate a credit union's net worth ratio is publicly available.

Adjustment of net worth ratio.

CUMAA's definition of “net worth”—GAAP retained earnings—does not encompass items of “other comprehensive income” such as accumulated unrealized gains and losses on “available-for-sale” (AFS) securities in a credit union's investment portfolio (Call Report account no. 945).

See

Statement of Financial Accounting Standards (“SFAS”) No. 130, “Reporting Comprehensive Income.” Thus, while such unrealized gains and losses are not reflected in the numerator of the net worth ratio, they

are

reflected in the denominator—total assets. As a result, when the fair value of AFS securities falls, the credit union's net worth ratio is artificially overstated.

See

64 FR at 27093 & n.8. To remedy this distortion, the proposed rule gave NCUA latitude “to adjust a credit union's net worth ratio to reflect the impact of accounting adjustments made for items of ‘other comprehensive income’.” 64 FR at 27108.

For example, assume a credit union has retained earnings under GAAP of $6500 and total assets of $100,000; it would have a net worth ratio of 6.5% and would be classified “adequately capitalized.” If, during the next quarter, the credit union experiences an $8,000 decrease in the fair value of its AFS securities, that unrealized loss would be reflected in total assets (the denominator of the net worth ratio), reducing them to $92,000, but would not be reflected at all in retained earnings (the numerator of the net worth ratio), which still would be $6500. As a result, the credit union would have a net worth ratio of 7.06% and be classified “well capitalized” despite having sustained a decline in the fair value of its AFS securities.

While five commenters supported this remedy in whole or in part, seventeen predicted that the market volatility of AFS securities would adversely impact net worth. Credit unions wishing not to reflect unrealized losses in net worth, it is claimed, would be tempted to inappropriately classify their securities as “held-to-maturity” under SFAS No. 115.

NCUA shares this concern. Moreover, its own research discloses that, at present, the proposed adjustment would have a limited impact—just a single credit union would be reclassified to a lower net worth category if the adjustment were applied to reflect an unrealized loss. Therefore, the final rule abandons the “adjustment of net worth ratio” provision, leaving the denominator of the net worth ratio unaffected. Yet, to not take account of the impact of material unrealized losses on investment securities, regardless of accounting classification, would pose a relevant, tangible risk to the NCUSIF. Accordingly, NCUA plans to address unrealized losses which are sufficiently material to affect a credit union's net worth classification as a safety and soundness concern.

SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” provides for classification of securities as either “held-to-maturity,” “available-for-sale,” or “trading.”

Reclassification based on supervisory criteria other than net worth.

The proposed rule gave NCUA discretion to reclassify a credit union to the next lower net worth category (but not lower than “significantly undercapitalized”) if it determined, after notice and opportunity for a hearing, that the credit union either was “in an unsafe or

unsound condition” or “has not corrected an unsafe or unsound practice.” 64 FR at 27109. Following CUMAA's mandate, this section is modeled on a parallel provision of FDIA § 38. § 1790d(h); 12 U.S.C. 1831o(g).

NCUA received various comments suggesting modifications to the grounds for reclassification under this provision. One advocated establishing precise criteria defining an unsafe or unsound practice or condition to ensure that the discretion to reclassify a credit union to a lower net worth category is exercised equitably. Given the historically subjective and sometimes unique nature of safety and soundness issues, NCUA prefers to review individual situations on a case-by-case basis, rather than to rely on objectively quantifiable standards which might limit the latitude to respond to an unsafe or unsound practice or condition.

Another commenter urged NCUA to revise the reclassification provision to exempt a credit union which is complying with an approved net worth restoration plan. To do so would make section 702.102(b) inconsistent with the parallel provision of FDIA § 38, which CUMAA instructs NCUA to follow. 12 U.S.C. 1831o(g). In addition, CUMAA is clear that PCA is available to address safety and soundness problems in addition to, not instead of, supervisory actions. § 1790d(n); § 702.1(d). In practice, however, adherence to an approved net worth restoration plan which provides for correcting such conditions and problems will mitigate against the need to exercise the discretion to downgrade a credit union.

Two commenters expressed concern about abuse of the reclassification authority. One worried that it will be used as a pretext to force a supervisory assisted merger. Another noted that the proposed provision puts no limit on how frequently within a given period of time a credit union can be reclassified downward, theoretically permitting an “adequately capitalized” credit union to be downgraded repeatedly in a relatively short period until it is “significantly undercapitalized” on the basis of the same or similar offending practices or conditions.

NCUA acknowledges these concerns, but believes the opportunities for abuse of the reclassification authority are minimal. First, the opportunity to force an assisted merger by reclassification is limited to a single instance— reclassification from “undercapitalized” to “significantly undercapitalized.” The statutory authority to insist on merger as a last resort to spare the credit union from conservatorship or liquidation is available only in the “significantly undercapitalized” and “critically undercapitalized” categories, §§ 702.203(c), 702.204(c), and part 702 does not authorize reclassification to the latter category on safety and soundness grounds. § 702.102(b). Second, NCUA is prohibited from delegating its authority to reclassify on safety and soundness grounds. § 1790d(h)(2); § 702.102(c). Absent exceptional circumstances, the NCUA Board does not anticipate using its authority under § 702.102(b) to reclassify a credit union downward by more than a single category in a 12-month period regardless of the variety and number of unsafe or unsound conditions or practices. As a final measure of protection against abuse, subpart L of part 747 provides a reclassified credit union the opportunity for a hearing to challenge the reclassification. § 747.2003.

C. Subpart B—Mandatory Supervisory Actions

1. Section 702.201—Earnings Transfer to Regular Reserve

The first of the four MSAs prescribed by CUMAA requires all but “well capitalized” credit unions to annually transfer earnings equivalent to 0.4% of total assets to net worth. § 1790d(e)(1). An exception to that minimum is allowed, subject to periodic review, if necessary to avoid a significant redemption of shares. § 1790d(e)(2). For the purpose of measuring total assets, the proposed rule used the average of total assets as set forth in the most recent four quarterly Call Reports or most recent two semi-annual Call Reports, as the case may be. 64 FR at 27109. The annual sum was to be transferred to the regular reserve at a monthly or quarterly rate corresponding to the dividend period for regular shares, but no less frequently than quarterly. An exception to the 0.4% minimum was permitted on a case-by-case basis, subject to a minimum quarterly review, if the statutory prerequisites were met.

Id.

Two commenters construed the proposed provision to permit only “adequately capitalized” credit unions to seek a reduction below the minimum amount of the earnings transfer, making the rule inconsistent with CUMAA. In fact, a reduction below the minimum percentage equivalent of total assets is available to all credit unions having a net worth of less than 7%. In the final rule, the criteria for approval and review of such a reduction are fully set forth in § 702.201, which applies to “adequately capitalized” credit unions.

The criteria are incorporated fully by reference in sections 702.202(a)(1), 702.203(a)(1), 702.204(a)(1) which apply to “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized” credit unions, respectively.

Following the practice originated under former FCUA § 116, 12 U.S.C. 1762(b) (repealed), for seeking “§ 116 assistance,” NCUA plans to require credit unions to apply to the appropriate Regional Director when seeking a reduction below the minimum quarterly reserve transfer. At the request of a commenter, the burden of preparing a request for a “reduction in earnings transfer” is addressed in the Paperwork Reduction Act notice in section III. below.

Eleven commenters addressed the rate of transfer prescribed in the proposed rule. Three commenters were comfortable with a monthly reserve transfer, but the vast majority contended that the monthly rate was too frequent and too burdensome. One of these suggested that the earnings transfer coincide with the filing of the Call Report.

In response to comments and on NCUA's own initiative, the final rule restructures this MSA to establish a single, uniform schedule for transferring earnings to net worth, to conform with other provisions of the rule. First, the required minimum earnings transfer to the regular reserve now takes place at a uniform quarterly rate of 0.1% of “total assets for the current quarter,” without regard to the dividend period for regular shares. § 702.201(a). Second, as the basis for calculating the quarterly equivalent of 0.1% of “total assets for the current quarter,” the final rule relies on whichever method of calculating its total assets—the average of the most recent four calendar quarter-end balances, the monthly average over the quarter, the daily average over the quarter, or the quarter-end balance—the credit union has chosen under section 702.2(j).

The final rule bases the quarterly equivalent of 0.1% of total assets on the credit union's “total assets

for the current quarter,

” not its total assets solely at the end of the quarter in which it first became “adequately capitalized” or lower. This means that the amount of the increase in net worth will fluctuate quarterly as the 0.1% equivalent of total assets is recalculated for each succeeding quarter in which a transfer is required (until the credit union is “well capitalized”.) As total assets increase or decrease quarter by quarter, the amount represented by 0.1% of assets will fluctuate accordingly. These modifications conform to the Call Report schedule now used to determine

net worth classification on a calendar quarter basis.

For example, as shown in Table 1 below, a credit union which declines to “adequately capitalized” in the first quarter of 2001 makes no transfer of earnings in that quarter because the effective date of classification is 4/30/2001. The credit union makes the transfer (attributable to the first quarter classification) by the end of the second quarter based on total assets for the then-“current quarter,”

i.e.,

total assets as of 6/30/2001. Assuming the credit union remains “adequately capitalized” in the second and third quarters, the transfer (attributable to each quarter's classification) will be made by the end of the next quarter based on total assets for the then-“current quarter,”

i.e.,

total assets as of 9/30/2001 and 12/31/2001, respectively.

ER18FE00.000

Because the transfer is always attributed to the prior quarter's net worth classification, it makes no difference if the credit union's net worth ratio exceeds 7 percent during the quarter in which the transfer is actually made. The classification as “well capitalized” does not become effective until the last day of the month following the quarter, when the credit union may discontinue making the transfer.

Finally, one commenter inquired whether the proposed rule should be modified to permit the transfer of the equivalent of more than 0.1% of its total assets per quarter, should a credit union's board of directors elect to do so. The final rule has been revised to indicate that a credit union “must increase its net worth quarterly by an amount equivalent to

at least

1/10th percent (0.1%) of its total assets for the current quarter” and then “must quarterly transfer that amount (

or more by choice

) to its regular reserve,” but cannot be compelled to transfer more than 0.1% of its total assets. § 702.201(a) (emphasis added).

2. Sections 702.202(a)(2), 702.206—Net Worth Restoration Plans

Deadlines.

The proposed rule generally established a period of 45 calendar days from quarter-end to submit an NWRP; if that deadline was not met, an additional 15 days was allowed.

Id.

Fourteen commenters sought a longer period for filing an NWRP—four suggesting 60 days; three suggesting 90 days; four simply seeking more time; and three advocating 45 to 60 days following the end of a reasonable time period for closing the books and preparing financial statements. There were no comments on the additional 15-day period.

The final rule effectively extends the period for filing an NWRP as the commenters urged. Section 702.101(b)(1) establishes that the effective date of net worth classification is the last day of the month following the quarter-end at which the net worth ratio is determined, thus inserting an interval of approximately 30 days. Accordingly, section 702.206(a) is revised to commence the original 45-day period on the effective date of net worth classification, rather than at quarter-end. This gives credit unions a maximum of approximately 75 days from quarter-end to timely file an NWRP. With the additional 15-day period available to credit unions which fail to file timely, § 702.206(a)(4), the final rule allows a maximum of approximately 90 days to file an NWRP.

The proposed rule established a period of 60 calendar days after receiving an initial NWRP for NCUA to notify the credit union of its approval or disapproval, and to provide reasons in the event of the latter. 64 FR at 27112. Three commenters urged NCUA to shorten the period for evaluating NWRPs. Two commenters were content to leave the evaluation period at 60 days, provided that the final rule allows the credit union to operate under a submitted NWRP pending NCUA's decision, and deems the NWRP approved if there is no decision within the 60-day period.

In view of the need for promptness inherent in PCA, NCUA concludes that it is unfair to give credit unions less time to submit an NWRP than NCUA has to evaluate it. Therefore, the period for NCUA to evaluate an NWRP has been shortened to 45 calendar days from the day the NWRP is received. § 702.206(f)(1). The credit union still may not operate under the submitted NWRP during this period. However, if no decision is made at the expiration of 45 days, however, the final rule provides that the NWRP is deemed approved. § 702.206(f)(2).

Finally, one commenter proposed supplementing the existing requirement that NCUA seek and consider the appropriate State official's views when evaluating an NWRP submitted by a federally-insured, State-chartered credit union (“FISCU”). In those cases, the commenter urged, NCUA should be required to promptly notify the State official of its decision to approve or disapprove the FISCU's NWRP. The final rule has been modified accordingly. § 702.206(f)(3).

Assistance to small credit unions.

CUMAA expressly provides that “upon timely request by a credit union with total assets of less than $10 million,” NCUA shall “assist that credit union in preparing [an NWRP].” § 1790d(f)(2). The final rule conforms to this mandate. § 702.206(b). Similarly, assistance in the form of training to prepare and revise a business plan (the equivalent of an NWRP for “new” credit unions) will be available to “new” credit unions under subpart C of part 702. § 702.309(a). A commenter insisted that NCUA provide assistance in preparing an NWRP to any credit union, regardless of asset size. NCUA declines to exceed the statutory mandate in this regard absent evidence

that credit unions generally lack the ability to prepare an NWRP themselves.

Contents:

The proposed rule required an NWRP to specify: (1) The steps the credit union will take to become “adequately capitalized”; (2) a timetable for increasing net worth annually; (3) plans to comply with the mandatory and discretionary supervisory actions imposed on the credit union; (4) the types and levels of activities in which the credit union will engage; (5) the projected amount of its earnings transfer to the regular reserve; and (6), if the credit union has been reclassified on safety and soundness grounds, the steps it will take to correct the unsafe or unsound practice(s) or condition(s). Pro-forma financial statements covering the next two years also were required. 64 FR 27112.

Eight commenters found the proposed content requirements too inflexible, suggesting that share growth be allowed even when it causes a temporary decline in net worth ratio.

Compare

§ 702.202(a)(3)(i). Similarly, twelve commenters suggested that an NWRP which permits asset growth to create earnings is preferable to one which simply shrinks the balance sheet to increase net worth. Another commenter discouraged reliance on a uniform timetable for increasing net worth that applies to all credit unions.

The proposed rule required “a timetable for increasing net worth for each year in which the [NWRP] will be in effect.” 64 FR 27112. To allow for greater flexibility over the duration of an NWRP, the final rule now requires “a quarterly timetable for the steps the credit union will take to increase its net worth ratio so that it becomes ‘adequately capitalized’ by the end of the term of the NWRP, and to remain so for four (4) consecutive calendar quarters.” 702.206(c)(1)(i). Thus, a credit union must specify the steps it will take to increase its net worth ratio by the end of the term of the NWRP, but need not pledge to increase its net worth ratio in each quarter or year the NWRP is in effect. The final rule also adds the caveat for credit unions that qualify as “complex” that the RBNW requirement “may require a net worth ratio higher than six percent (6%) to become ‘adequately capitalized.”’

Id.

The proposed rule required financial data accompanying an NWRP to comply with GAAP. 64 FR at 27112. The final rule abandons this requirement to conform with NCUA policy requiring only Call Reports submitted by credit unions having $10 million or more in assets to adhere to GAAP. 12 CFR 741.6(b).

One commenter asked that NCUA enumerate in the final rule examples of steps for building net worth that a credit union should include in its NWRP. Consistent with NCUA's belief that there is no “one size fits all” prescription for restoring net worth, neither the proposed nor the final rule sets a standardized duration for all NWRPs, nor enumerates the steps that may or may not be appropriate for all credit unions to implement. The preferred approach is for a credit union to develop a unique NWRP prescribing individualized, positive steps to restore net worth, which NCUA will evaluate on a case-by-case basis.

The proposed rule required an NWRP to be accompanied by pro forma financial statements “covering the next 2 years.” 64 FR at 27112. One commenter apparently inferred from this that NWRPs are limited to a term of two years, and suggested permitting a term of up to 5 years. In fact, neither the proposed nor the final rule set a time limit for NWRPs; to do so would be inconsistent with the flexible approach needed for an NWRP to succeed. To confirm that the term of an NWRP is not linked to the period covered by supporting pro forma financial statements, NCUA has modified the final rule to require pro forma financial statements for

a minimum

of 2 years. § 702.206(c)(2). Ideally, the accompanying pro forma financial statements will cover the entire period of the NWRP.

The proposed rule required an NWRP to specify “how the credit union will comply with the mandatory and discretionary supervisory [actions] imposed on it under [part 702].” 64 FR at 27112. This led three commenters to infer that this required an NWRP to cover all possible discretionary actions, rather than only those NCUA actually has imposed on it. The final rule is revised to confirm that an NWRP need only address the discretionary supervisory actions actually “imposed on it by the NCUA Board.” § 702.206(c)(1)(iii).

Critria for approval.

To the single criterion prescribed by CUMAA for approving an NWRP—that it “is based on realistic assumptions and is likely to succeed in restoring * * * net worth”—the proposed rule added that an NWRP must (1) comply with the content requirements for an NWRP; (2) not unreasonably increase the credit union's risk exposure; and (3) be supported by appropriate assurances that the credit union will comply with the NWRP until the credit union has remained “adequately capitalized” for four consecutive calendar quarters. 64 FR at 27112.

One commenter urged NCUA to add, as a criterion in evaluating an NWRP, “the limited ability of credit unions to raise net worth.” NCUA declines to make this an explicit criterion because the entire system of PCA for credit unions already reflects the distinctions between credit unions and other depository institutions. A principal one of these is the limited ability of credit unions to raise capital. Moreover, to maintain a flexible process for evaluating NWRPs, the criteria for approving an NWRP has deliberately been held to a minimum, and the proposed rule deliberately articulates those criteria in general terms.

The final rule abandons the criterion requiring “appropriate assurances from the credit union that it will comply with the plan until it has remained ‘adequately capitalized’ for four consecutive quarters.” 64 FR at 27112. This criterion was adapted from FDIA § 38, which requires such “appropriate assurances” to be secured by a financial guarantee of compliance. 12 U.S.C. 1831o(e)(2)(C)(ii). NCUA never considered demanding a financial guarantee of compliance from credit unions because part 702 elsewhere provides remedies for failure to implement an NWRP. § 747.2005(b)(2). However, the objective of remaining “adequately capitalized” for four consecutive quarters is valid and properly belongs in an NWRP's timetable of steps for increasing the net worth ratio. Therefore, the final rule inserts that objective as a timetable requirement among the contents of an NWRP. § 702.206(c)(1)(i).

One commenter asked how frequently NCUA plans to review implementation of an NWRP to determine material compliance by the credit union.

See

§ 702.102(a)(4)(ii)(B). NCUA believes that assessing the implementation and results of an NWRP is a supervision issue to be dealt with at the regional level on a case-by-case basis. Therefore, the final rule sets no schedule or standards for measuring material compliance with an NWRP.

The final rule introduces a new criterion for evaluating an NWRP—the impact of “regulatory capital” in any form that may become established by NCUA regulation, or authorized by State law and recognized by NCUA, but which is not included in net worth.

§ 702.206(e). NCUA recognizes that

regulatory capital, if established, would be available to absorb losses which the NCUSIF otherwise would absorb. Thus, the final rule adds the following criterion: “To minimize possible long-term losses to the NCUSIF while the credit union takes steps to become ‘adequately capitalized,’ the NCUA Board shall, in evaluating an NWRP under [section 702.206], consider the type and amount of any [such] forms of regulatory capital * * * which the credit union holds, but which is not included in net worth.” § 702.206(e). This also is a criterion in evaluating a revised business plan submitted by a “new” credit union. § 703.306(d).

At present, only secondary capital accounts established for low-income designated credit unions under 12 CFR 701.34 qualify as net worth. § 1790d(o)(2)(B).

3. Section 702.202(a)(3)—Restriction on Asset Growth

The third of four MSAs prescribed by CUMAA requires a credit union having a net worth ratio of less than 6% to “not generally permit its average total assets to increase,” except as provided in an approved NWRP, and so long as assets and net worth increased at the rate the NWRP prescribes. § 1790d(g)(1). To compute “average total assets,” the proposed rule used the average of total assets reported in the most recent four quarterly Call Reports or most recent two semi-annual Call Reports. 64 FR 27109. Pending approval of such an NWRP, the proposed rule absolutely barred asset growth, allowing no exceptions.

Id.

Seventeen comments addressed the mandatory asset growth restriction. Three commenters objected to basing “average total assets” on the prior four quarters. One objected that doing so would penalize credit unions whose assets had grown over the past year, compelling them to immediately reduce actual total assets to the average. The more a credit union's assets had increased, the greater the impact of a reduction to the average. As explained earlier, the final rule offers four options for measuring “average total assets.” The method a credit union chooses under section 702.2(j) will establish the asset growth “ceiling.” § 702.202(a)(3).

Many commenters condemned the rigidity of the asset growth restriction pending approval of an NWRP, observing that it is essentially a freeze on total assets that is detrimental to credit unions. For example, one commenter pointed out that the restriction, as proposed, prohibits the collection of interest income, which would increase a credit union's net worth—precisely the objective of PCA. Another cited revenue from lending as an “important driver” of return on average assets that should not be restricted. Another favored excepting U.S. Treasury securities and IRA accounts from the definition of “total assets” to allow for asset growth outside the NWRP. Eleven commenters advocated allowing an exception to the restriction when asset growth creates earnings. Allowing exceptions for this purpose, they urge, is preferable to shrinking the balance sheet to increase the net worth ratio. In this regard, NCUA recognizes that member allegiance to credit unions may cause member share accounts to grow even when rates are below prevailing market rates.

In response to these comments and on its own initiative, NCUA reconsidered the statutory language which provides that a credit union shall “not generally permit its average total assets to increase.” § 1790d(g)(1). As the Senate Banking Committee has acknowledged, “[t]he term ‘generally’ allows the NCUA to make carefully delineated exceptions to the asset growth restrictions if the exceptions are consistent with the purpose of [§ 1790d].” S. Rep. at 14. NCUA is convinced that absolute application of the asset growth restriction is inconsistent with the purpose of PCA because it would bring to a halt a credit union's normal business operations. This has led NCUA to relax the asset growth restriction by making carefully delineated exceptions, available under certain conditions, pending approval of an NWRP.

The final rule is revised to allow total assets to increase, pending approval of an NWRP, by reason of increases in the following categories. First, total accounts receivable and accrued income on loans or investments. This exception allows the accrual of income items, which increases net worth. § 702.202(a)(3)(ii)(A)(

). Second, cash and cash equivalents. This exception permits continued receipt of member deposits (for example, automated clearing house payroll deposits) and collection of cash payments of interest income. § 702.202(a)(3)(ii)(A)(

). Third, total loans outstanding, subject to a maximum equivalent to the sum of total assets plus the quarter-end balance of unused commitments to lend and unused lines of credit. § 702.202(a)(3)(ii)(A)(

). Under this exception, a credit union may make loans in the normal course of business from liquid assets available at the time it is classified “undercapitalized” or lower, and to honor unused commitments (such as unused revolving loans or unused commitments for member business loans) existing at that time.

These exceptions to the asset growth restriction in section 702.202 are available provided the credit union does not offer rates on shares in excess of prevailing rates on shares and deposits in its relevant market area, and does not open new branches. § 702.202(a)(3)(ii)(B). A credit union which does not avail itself of the exceptions is not subject to the limitations on rates and branching.

4. Section 702.204(a)(4)—Restriction on Member Business Loans

The last of the four “mandatory supervisory actions” prescribed by CUMAA prohibits credit unions having a net worth ratio of less than 6% from “mak[ing] any increase in the total amount of member business loans * * * outstanding at that credit union at any one time.” The restriction takes effect regardless whether the credit union has reached the statutory ceiling on member business loans (“MBLs”) in 12 U.S.C. 1757a(a)(1). § 1790d(g)(2).

The proposed rule followed Title II of CUMAA, 12 U.S.C. 1757a(b), in exempting from the MBL restriction credit unions chartered for the purpose of making, or that have a history of primarily making, MBLs, or which are designated low income, or which qualify as community development financial institutions. 64 FR at 27109. NCUA declines the invitation by two commenters to expand the exemption to include

any

credit union which makes MBLs. To so drastically extend the exemptions would neutralize this MSA in derogation of CUMAA. § 1790d(n).

The final rule is revised to clarify the MBL restriction in three ways. § 702.202(a)(4). First, to expressly confirm that for PCA purposes the definition of MBLs includes unused MBL commitments, unless otherwise noted. Second, to impose the restriction on the dollar amount of member business lending, rather than linking it to an average or a percentage of total assets. Third, to indicate that the “total dollar amount of [MBLs]” is measured “as of the preceding quarter-end,”

i.e.,

the quarter-end preceding the effective date of classification of the credit union as “undercapitalized”' or lower.

D. Subpart B—Discretionary Supervisory Actions

Table 1 below displays the fourteen DSAs which the final rule applies as indicated to the “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized” net worth categories. All fourteen DSAs apply in the “moderately capitalized” and lower net worth categories (<6% net worth ratio) of the alternative system of PCA for “new” credit unions. § 702.304(b). Because DSAs are available only as

necessary to carry out the purpose of PCA, NCUA generally does not anticipate resorting to the DSAs available in a particular net worth category unless a credit union fails to timely implement or comply with an approved NWRP, which includes its timetable of steps to increase its net worth ratio.

ER18FE00.001

Consistent with its statutory mandate, NCUA attempted in the proposed rule to craft DSAs which are “comparable” with the “discretionary safeguards” available under the system of PCA that applies to banks, yet which suit the distinctive needs and characteristics of credit unions.

See

§ 1790d(b)(1)(A). The DSAs are allocated among the statutory net worth categories (Table 3) approximately as they are allocated among the net worth categories in FDIA § 38, 12 U.S.C. 1831o.

ER18FE00.002

1. Section 702.204(b) and (c)—“First Tier” and “Second Tier” of “Undercapitalized” Category

An overwhelming number of commenters objected, with respect to DSAs, that the “undercapitalized” category generally treats a credit which is just a few basis points short of a 6% net worth ratio,

i.e.,

nearly “adequately capitalized,” as harshly as a credit union which is just a few basis point above a 3.99% net worth ratio,

i.e.,

nearly “significantly undercapitalized.” One commenter went further, observing that there was insufficient differentiation among the range of DSAs available in each of the three categories.

To correct this inequity, eight commenters advocated that DSAs should not be available at all to be imposed on credit unions in the “undercapitalized” category. Eighteen commenters urged imposing a moratorium on the imposition of DSAs for a period of time to allow the “mandatory supervisory actions” to succeed in restoring net worth. Seven commenters suggested that the final rule should exempt a credit union from DSAs when “normal growth” in assets alone depresses its net worth ratio below 6 percent. Two commenters urged NCUA to abandon DSAs altogether and to rely instead on its statutory authority to reclassify a credit union to the next lower net worth category on grounds of an unsafe or unsound practice or condition. § 702.102(b).

In considering these comments, NCUA notes that the “discretionary safeguards” under the banks” system of PCA—to which DSAs are required to be “comparable”—generally do not become available until an institution's net worth falls below 4%.

Therefore, to provide a degree of relief to credit unions marginally below a 6% net worth ratio, the final rule divides the “undercapitalized” category into a “first tier” and a “second tier” only for purposes of imposing DSAs. The “first tier” consists of credit unions having a net worth ratio of between 5% and 5.99%, as well as those “complex” credit unions which are classified “undercapitalized” by reason of failing to meet an RBNW requirement. The “second tier” consists of credit unions having a net worth ratio of 4% to 4.99%.

FDIA § 38's five capital categories are denominated identically to CUMMA's five net worth categories.

Compare

12 U.S.C. 1831o(b)(1)

with

§ 1790d(c)(1). However, the “leverage ratios” corresponding to each capital category were established by the Federal banking agencies rather than by FDIA § 38 itself, whereas CUMAA itself established the net worth ratios corresponding to each net worth category.

Compare

Joint Final Rule, 57 FR at 44867

with

§ 1790d(c)(1). FDIA § 38 generally classifies an institution as “adequately capitalized,” and thus no longer subject to “discretionary safeguards,” when its leverage ratio reaches 4%. 57 FR at 44867.

See, e.g.,

12 CFR 325.103(b)(2)(A). In contrast, CUMAA does not classify a credit union as “adequately capitalized” until its net worth ratio reaches 6%. § 1790d(c)(1)(B). Significantly, CUMAA requires part 702 to be “comparable” to FDIA § 38 itself, rather to the Joint Final Rule. § 1790d(b)(1)(A)(ii). Thus, the DSAs prescribed in the final rule are “comparable” by corresponding category—rather than by equivalent leverage ratio in the Joint Final Rule—to the “discretionary safeguards” in FDIA § 38.

Under the final rule, a credit union which is in the “first tier” of the “undercapitalized” category is subject to the DSAs applicable in that category (lines 1-6 and 8-10, Table 2 above) only if it fails to comply with any of the four applicable MSAs (

i.e.,

submit NWRP, earnings transfer to net worth, asset growth restriction, and MBL restriction) or fails to timely implement an approved NWRP, which includes meeting the timetable of steps to increase its net worth ratio. § 702.202(c).

A credit union which is in the “second tier” of the “undercapitalized” category is subject to all of the DSAs available in that category regardless whether it is in compliance with the applicable MSAs and is timely implementing an approved NWRP. § 702.202(b). Moreover, CUMAA expressly classifies to the “significantly undercapitalized” category any credit union in the “second tier” (4 to 4.99% net worth ratio) which fails to timely submit an NWRP for approval, or materially fails to implement an approved NWRP. § 1790d(c)(1)(C); § 702.202(a)(2).

ER18FE00.003

2. Revisions to Individual Discretionary Supervisory Actions.

Comments on the DSAs in the proposed rule, 64 FR at 27096-27098, generally fall into two categories—those wishing that a specific DSA would more closely parallel its corresponding “discretionary safeguard” under the banks' system of PCA, and those wishing NCUA would further modify specific DSAs to suit credit unions. The final rule does some of both.

Requiring prior approval for acquisitions, branching, new lines of business.

The proposed rule gave NCUA the discretion to prohibit a credit union from, among other things, “directly or indirectly, acquiring any interest in a CUSO or credit union” unless it is “consistent with and will further the objectives of [an approved NWRP].” 64 FR at 27096, line 1. Although no comments addressed this DSA, NCUA has decided that the limitation on acquiring interests in a CUSO or credit unions was too narrow, and should be expanded to prohibit acquiring an interest in “any business entity or financial institution.” In the final rule, this DSA has been modified accordingly. § 702.202(b)(1).

Prohibiting or reducing asset growth.

Separately from the MSA restricting asset growth, the proposed rule authorized NCUA to prohibit growth in all or a category of assets, or require the credit union to reduce all or a category of assets. 64 FR 27097, line 4. Characterizing this DSA as a potential threat to a credit union's survival, several commenters encouraged NCUA to be flexible in imposing this DSA when a credit union is properly implementing an approved NWRP that permits asset growth linked with increasing net worth. This concern is well taken in view of the relief from the MSA that CUMAA gives to credit unions operating under an approved NWRP that allows assets to increase in tandem with net worth. § 1790d(g)(1). NCUA will not permit this DSA to be used to effectively reinstate the MSA. Moreover, NCUA does not anticipate imposing this DSA when assets are growing pursuant to an NWRP which NCUA approved. A possible exception would be to limit or reduce a particular category of assets that poses an obstacle to restoring net worth.

Two commenters contend that this DSA is unnecessary because it duplicates the MSA restricting asset growth, § 702.202(a)(3). The MSA and this DSA are not comparable, however, because they serve different purposes. The MSA imposes a ceiling on asset growth to compel the credit union to develop a strategy for increasing its net worth ratio to 6% or more. Uncontrolled asset growth without attention to building net worth simply erodes the net worth ratio. This DSA, in contrast, is available to selectively limit or reduce growth in one or more specific asset categories, if needed to “fine tune” the asset growth that an approved NWRP allows. § 702.202(b)(4).

In lieu of limiting a credit union's asset growth, one commenter suggested limiting the risk on the investment of those assets by establishing minimum spreads, tightening lending procedures, and restricting investment options. NCUA prefers to retain this DSA as proposed because the suggested approach would necessitate an unworkable and intolerable level of micromanagement.

Restricting dividends or interest paid.

As proposed, this DSA permits NCUA to prospectively restrict the dividend or interest rates a credit union pays to the prevailing rates paid on comparable accounts and maturities in its vicinity. 64 FR at 27096, line 2. One commenter urged excluding this DSA altogether, condemning it as an overreaction to a specific problem—paying high rates to

attract deposits—that plagued troubled thrift institutions in the 1980s, but does not affect credit unions now. In addition, this commenter claimed that this DSA adversely impacts members—depriving them of dividend and interest income—but would not have a disciplinary impact on management. NCUA disagrees because this DSA does not eliminate dividends and interest altogether; it merely establishes a reasonable ceiling on dividend and interest rates. This would prevent management from imprudently offering higher than prevailing rates to attract deposits that would inflate assets.

As proposed, the ceiling on rates was set at “prevailing rates * * * in the region where the credit union is located.” 64 FR at 27109. In response to a commenter's suggestion, the final rule sets the ceiling at “prevailing rates” in the credit union's “relevant market area.” § 702.202(b)(3). In addition, the scope of this DSA has been expanded to include interest rates because some State-chartered credit unions accept interest-bearing deposits not denominated as shares.

See

§ 702.2(i). The final rule otherwise retains this DSA as proposed.

Alter, reduce or terminate activity of credit union or CUSO.

The proposed rule authorized NCUA to “[r]equire the credit union or its CUSO to reduce, alter or terminate any activity.” 64 FR at 27097, line 5. Two commenters pointed out that this DSA omits the prerequisite built in to the corresponding “discretionary safeguard”—that the activity in question must “pose[] excessive risk” to the credit union. 12 U.S.C. 1831o(f)(2)(E). Accordingly, the final rule has been revised to make “excessive risk” a prerequisite to imposing this DSA. § 702.202(b)(5).

Two other commenters urged that NCUA consider, as a factor in imposing this DSA, the ownership structure of the CUSO. When a CUSO is owned by multiple credit unions, a restriction on its activities could have an adverse impact on credit unions which are not subject to PCA. NCUA declines to make this an explicit criterion for imposing this DSA, but acknowledges that it is a valid mitigating factor when multiple-credit union ownership of a CUSO is involved.

Prohibiting nonmember deposits.

The proposed rule authorized NCUA to “prohibit [a] credit union from accepting nonmember deposits” as otherwise permitted under federal or state law. 64 FR at 27097, line 6. Two commenters criticized this DSA for permitting an outright ban on nonmember deposits, suggesting instead that nonmember deposits be subject to a rate ceiling, as in section 702.202(b)(3). The final rule retains this DSA as proposed to ensure that credit unions are operated by and for their members as they build net worth. § 702.202(b)(6). This DSA is an important tool for preventing undue influence on a credit union by nonmembers, and overreliance on nonmembers by the credit union.

New election of directors; dismissal of directors or senior executive officers.

As a means of improving management, the proposed DSAs authorized NCUA “to order a new election of the credit union's board of directors” or to “dismiss [individual] directors or senior executive officers.” 64 FR at 27097, lines 8 and 9. Commenters overwhelmingly opposed this DSA primarily because it strikes at a sacred and distinctive characteristic of credit unions—the member-elected board of directors which serves without compensation.

On the one hand, ordering a new election of directors does not compel a credit union to replace its board of directors with an NCUA-designated slate; it simply requires the membership to reconsider its choice of directors. On the other hand, wholesale election of the board of directors may be an overreaction when a credit union's net worth is marginally below 6%. Thus, for the “undercapitalized” category only (in both tiers), the final rule deletes the authority to order a new election of the board of directors; however, the unconditional discretion to dismiss individual directors or senior executive officers is retained. § 702.202(b)(7). In the “significantly undercapitalized” and “critically undercapitalized” categories, the discretion to order a new election of directors, and to dismiss a director or senior officer, remains unrestricted. §§ 702.203(b)(8), 702.204(b)(8).

In the “undercapitalized” category, the proposed rule allowed NCUA to dismiss directors or senior executive officers, and to order a credit union to employ qualified senior officers, only if NCUA “first [took] one or more of the [DSAs prescribed for that category] or determined that none of those [DSAs] would further the purpose of [part 702].” 64 FR at 27110. One commenter criticized this prerequisite as depriving NCUA of tools for “improving management” which it may need above all other DSAs to target the source of net worth problems at the outset. NCUA concurs and has deleted this prerequisite from the final rule, thus permitting directors and officers of an “undercapitalized” credit union to be dismissed without regard to the other DSAs available in that category. § 702.202(b)(7).

Restricting senior executive officers' compensation.

For “significantly undercapitalized” or “critically undercapitalized” credit unions, the proposed rule gave NCUA an additional means of improving management—the discretion to limit or reduce compensation to a senior executive officer; to limit or proscribe a bonus to such officer; or to condition payment of compensation or a bonus upon NCUA approval. 64 FR at 27097, line 10. Four commenters objected that this DSA does not square with the parameters built in to the corresponding “discretionary safeguard.” While the corresponding provision requires prior approval to pay a bonus of any amount, it requires prior approval to pay compensation only when it exceeds the officer's “average rate of compensation * * * during the 12 calendar months preceding the calendar month in which the institution became undercapitalized.” 12 U.S.C. 1831o(f)(4)(A). In addition, the corresponding provision does not permit a reduction of compensation already set above the ceiling before that safeguard was imposed. Accordingly, this DSA has been modified in two ways. First, to require NCUA approval only to pay a bonus of any amount, or to compensate an officer in an amount exceeding his or her “rate of compensation * * * during the four (4) calendar quarters preceding the effective date of classification of the credit union as ‘significantly undercapitalized.”’ Second, to exclude the authority to reduce compensation already set above the ceiling before the DSA is imposed. § 702.203(b)(10).

Restricting payments on uninsured secondary capital.

For “critically undercapitalized” credit unions only, the proposed rule gave NCUA the discretion, beginning 60 days after a credit union becomes “critically undercapitalized,” to prohibit payment of principal or dividends on uninsured secondary capital accounts (although unpaid dividends would continue to accrue). 64 FR at 27098, line 13. The sole commenter protested that this DSA would change the terms of existing secondary capital account agreements, require new disclosures, and make these already high-risk, limited-reward investments (available only from low-income designated credit unions) unattractive to potential investors. To protect existing secondary capital accounts, this DSA is revised to apply only to those accounts established after August 7, 2000 (the effective date of the final rule). § 702.204(b)(11). The disclosure requirements for those

accounts (

see

appendix to 12 CFR 701.34), will be modified to reflect the prospective application of section 702.204(b)(11). In addition, since uninsured secondary capital accounts of low income-designated credit unions are structured as interest-paying debt, the final rule expands this DSA to include “interest.”

Requiring NCUA prior approval for certain operations.

For “critically undercapitalized” credit unions only, the proposed rule gave NCUA discretion to require its prior approval before a credit could undertake certain routine activities. 64 FR at 27098, line 13. One such activity is “[e]ntering into any material transaction other than in the usual course of business” or any similar action requiring prior notice to NCUA.

Id.

The sole commenter on this DSA sought a definition of a “material” transaction. NCUA declines to define “material” because it is best judged on a case-by-case basis. Instead, however, the final rule replaces the examples of material transactions enumerated in the proposed DSA with a blanket exemption for material transactions that fall within the scope of an approved NWRP. § 702.204(b)(12)(i).

Other action to carry out PCA.

The proposed rule gave NCUA the discretion to “restrict or require such other action * * * as [it] determines will carry out the purposes of [part 702] better than any of the [DSAs expressly ] prescribed,” respectively, in the “undercapitalized” or lower categories. 64 FR at 27097, line 7. For the “undercapitalized” category, however, the proposed rule imposed a prerequisite—that “such other action” could be imposed only if it were “no more severe” than the other DSAs available in that category.

Id.

No comments addressed the conditional or unconditional version of this provision. Nonetheless, NCUA has decided that the “no more severe” limitation on this DSA would be unworkable in practice because it is too subjective a standard of comparison. Hence, in the final rule, all three categories contain the identical DSA allowing “such other action” provided only that it “carr[ies] out the purposes of PCA better than any of the actions prescribed” for the “undercapitalized” category. §§ 702.202(b)(9), 702.203(b)(11), 702.204(b)(13).

Other DSAs.

NCUA received no comments addressing two of the proposed DSAs: “Restricting transactions with and ownership of a CUSO,” 64 FR at 27096, line 2, and “Requiring merger if grounds exist for conservatorship or liquidation.” 64 FR at 27098, line 11. They are retained as proposed. §§ 702.202(b)(2), 702.203(b)(12).

3. Conservatorship and Liquidation

Discretionary conservatorship or liquidation.

Reflecting the terms of CUMAA, the proposed rule gave NCUA discretion to place a “significantly undercapitalized” or “critically undercapitalized” credit union into conservatorship or liquidation if that credit union “has no reasonable prospect of becoming ‘adequately capitalized.’ ” 64 FR at 27110, 27111; 12 U.S.C. 1786(h)(1)(F), 1787(a)(3)(A)(i). One commenter addressing this provision insisted that a credit union in either of these categories be permitted the option of merging with another credit union to avoid conservatorship or liquidation. This is precisely the purpose of the DSA entitled “Requiring merger if grounds exist for conservatorship or liquidation” (line 11, Table 2 above), available in both categories. §§ 702.203(b)(12), 702.204(b)(14). As explained in the preamble to the proposed rule, “[t]his action is appropriate * * * because NCUA's insistence on merger with another financial institution gives credit union management the opportunity to consummate a merger to avoid inevitable conservatorship or liquidation, thereby permitting the credit union to survive in merged form.” 64 FR at 27908.

See

12 U.S.C. 1831o(f)(2)(A)(iii) (requiring institution to be acquired by holding company or to combine with another institution if grounds exist for conservatorship or receivership). Because the DSA requiring merger is available as an option for a credit union to preempt conservatorship or liquidation, the discretionary liquidation and conservatorship authority is retained as proposed. §§ 702.203(c).

Mandatory conservatorship and liquidation.

Following the mandate of CUMAA, § 1790d(i)(1), the proposed rule required NCUA to place a “critically undercapitalized” credit union into conservatorship or liquidation within 90 days, unless NCUA determines that “other corrective action” in lieu of conservatorship or liquidation would better achieve the purposes of PCA. 64 FR at 27111. That determination, which must be documented, expires at the end of a period of no more than 180 days. If the determination is not affirmed before the period ends, NCUA must conserve or liquidate the credit union. The determination that “other corrective action” would better achieve the purpose of PCA may be renewed for additional periods of up to 180 days.

However, renewals which extend the full 180-day period will be limited to two and part of a third because of a statutory 18-month maximum period for “other corrective action” to succeed.

Neither the original effective period of a determination to take “other corrective action,” nor an extension of that period, need extend for the maximum duration of 180 days. The NCUA Board has the discretion to establish a shorter original or renewed effective period; to reconsider any determination periodically; and to reverse and discontinue the “other corrective action” altogether. To renew a prior effective period, the NCUA Board must make and document a new finding prior to expiration of the present effective period that its “other corrective action” still furthers the purpose of PCA. § 702.204(c)(1)(iii).

Under the proposed rule, NCUA must conserve or liquidate a surviving “critically undercapitalized” credit union, regardless of the impact of “other corrective action,” if that credit union is “critically undercapitalized” (2% net worth ratio) on average for a full calendar quarter beginning 18 months from the date it first was classified as such. 64 FR at 27111. This is the case even if the credit union manages to exceed a 2 percent net worth ratio on any of the preceding effective dates of classification during the 18 month period. A credit union may evade mandatory liquidation at this point only if NCUA certifies that the credit union (1) has, since the date of approval, substantially complied with an NWRP requiring improvement in net worth; (2) has positive net income or a sustainable upward trend in earnings; and (3) is viable and not expected to fail. § 1790d(i)(3)(B).

The authority to elect among conservatorship, liquidation, or other action concerning a “critically undercapitalized” credit union cannot be delegated unless the credit union has less than $5,000,000 in assets. § 1790d(i)(4)(A). if made by delegation, the decision is directly appealable to the NCUA Board. § 1790d(i)(4)(B); § 702.204(c)(4). Finally, a “significantly undercapitalized” or “critically undercapitalized” credit union which is placed into conservatorship or liquidation under part 702 retains the right to challenge NCUA Board's decision in court within 10 days. 12 U.S.C. 1786(h)(3), 1787(a)(1)(b).

The effective date when a credit union first became “critically undercapitalized” typically will fall one month after the end of a calendar quarter. Thus, the last possible day for “other corrective action” will be no more than 23 months from the effective date (18 calendar months from the effective date, plus two months to the end of the calendar quarter, plus the subsequent 3 months of the next calendar quarter), absent NCUA certification that the criteria for an exception to liquidation have been met.

NCUA received no comments on this mandatory liquidation procedure. It is retained as proposed, § 702.204(c), with

two exceptions. First, both the statute and the proposed rule were silent regarding the method for calculating whether a credit union “is ‘critically undercapitalized’ on average for a full calendar quarter” beginning 18 months after the effective date of classification as such. The final rule now designates “a monthly average basis” over the calendar quarter as the required method. § 702.204(c)(3)(i). Second, the statute and proposed rule are silent regarding how to treat a “critically undercapitalized” credit union once it is certified as meeting the criteria for an exception to mandatory liquidation. § 702.204(c)(3)(ii). The final rule now requires NCUA to review that certification “at least quarterly” and to then either recertify the credit union or “promptly place [it] into liquidation * * *” § 702.204(c)(3)(iii).

4. Consultation With State Officials

CUMAA requires NCUA to consult with the appropriate State official when imposing PCA against a FISCU. § 1790d(l). Under the proposed rule, before conserving or liquidating a FISCU, NCUA must “seek the views” of the appropriate State official, provide reasons for the proposed action, give the official an opportunity to respond, and allow the official to implement the conservatorship or liquidation. 64 FR at 27111. If the State official disagrees with NCUA's determination to conserve or liquidate, NCUA can proceed only if it makes findings of risk of loss to the NCUSIF. 64 FR at 27112;

See also

§ 702.206(b).

NCUA currently provides guidance indirectly, as needed by any credit union in preparing its initial business plan for charter approval under Interpretive Ruling and Policy Statement 99-1, 63 FR 71998, 72019 (December 30, 1998).

The final rule also retains as an incentive a “new” credit union's eligibility to join NCUA's “Small Credit Union Program.” § 702.307(c).

See

NCUA Instruction no. 6052.00 (March 24, 1999).

F. Subpart D—Reserves

This subpart of the proposed rule retained much of the substance of NCUA's current reserve transfer and dividend payment requirements, modified to reflect the repeal of 12 U.S.C. 1762, and to conform with CUMAA. 64 FR at 27115. The proposed rule eliminated the “statutory reserve”; retained the regular reserve, in which reserve transfers will be reflected; retained the requirement to maintain an allowance for loan losses, but decoupled it from the regular reserve; barred subsequent reversing of the current period provision; retained full and fair disclosure provisions in revised form; and retained restrictions on the payment of dividends when there is a deficit in undivided earnings.

64 FR27101.

As commenters have suggested, NCUA plans to explain the new reserve requirements, citing specific examples, in future NCUA Letters to Credit Unions.

Two commenters contend that there is no longer a need for a regular reserve because fear of a decline in net worth classification alone is sufficient to deter an outflow of capital through dividends. Because part 702 now imposes a quarterly earnings transfer requirement on credit unions having a net worth of less than 7%, maintaining the regular reserve is necessary to facilitate and measure earnings retention. § 702.401(b). Credit unions are accustomed to relying on the regular reserve account as an appropriation of undivided earnings.

The final rule imports from the former part 702 conditions for charging losses to the regular reserve, modified to conform to CUMAA. § 702.401(c). Under that provision, credit unions may charge losses to the regular reserve, provided that the charge will not cause the credit union's net worth classification to fall below “well capitalized.” Otherwise, the credit union must receive the approval of NCUA or the appropriate State Official before charging losses to the regular reserve.

Under the proposed rule, “a dual declaration by the treasurer and

president” was required to support the credit union's Statement of Financial Condition. 64 FR at 27115. One commenter was confused as to whether “president” refers to the person who, at some credit unions, serves as president of the board, or to the person who is the credit union's chief executive officer. This is clarified in the final rule by requiring “a dual declaration by the treasurer and chief executive officer” of the credit union. § 702.402(c).

Ten commenters objected to the provision regarding payment of dividends when undivided earnings are depleted because it effectively permits only “well capitalized” credit unions to transfer earnings from the regular reserve to pay dividends. 64 FR at 27115. Less than “well capitalized” credit unions may do so only with approval of NCUA or the appropriate State official. § 702.403(b). The commenters insist that the rule be modified to allow “adequately capitalized” credit unions to pay dividends from the regular reserve. Allowing less than “well capitalized” credit unions to pay dividends from the regular reserve would defeat the purpose of the earnings retention requirement which applies to credit unions having a net worth ratio of less than 7%.

In reference to the source from which dividends must be paid, the final rule is amended to exclude the words “post-closing, post-transfer “ modifying “undivided earnings.” § 702.403(a). Permitting dividends to be paid from post-closing undivided earnings would preclude accurate computation of net income for the period.

Part 702 generally applies to both federally-chartered credit unions and FISCUs. As proposed, however, this subpart applied to federally-chartered credit unions expressly, but to FISCUs only through incorporation by reference in general terms in 12 CFR 741.3(a)(1). For purposes of clarity and consistency with the other subparts of part 702, subpart C is revised in the final rule to expressly cover “federally-insured credit unions,” thus combining both federally-chartered credit unions and FISCUs. As discussed immediately below, 12 CFR 741.3. confirms that all of part 702 (and subpart L of part 747) applies to FISCUs.

G. Section 741.3—Application to FISCUs

The proposed rule failed to revise part 741.3 of chapter VII to indicate that FISCUs are subject to PCA as a prerequisite for insurance. Current section 741.3(a)(1) requires FISCUs to “meet, at a minimum, the statutory reserve and full and fair disclosure requirements imposed on federal credit unions by [former 12 U.S.C. 1762 and current part 702].” Section 1762 of Title 12 was repealed by CUMAA and current part 702 survives pending the effective date of this final rule; both addressed only reserves and associated matters. To ensure that FISCUs, as a prerequisite of insurance, will meet the requirements imposed under all components of PCA, the final rule revises section 741.3(a)(1) to read: “State-chartered credit unions are subject to section 216 of the Act, 12 U.S.C. 1790d, and to part 702 and subpart L of part 747 of this chapter.”

In addition, the final rule modifies the conditions in section 741.3(a)(2) for charging losses to the regular reserve. Currently, that section allows losses other than loan losses to be charged without the approval of NCUA and the appropriate State official if the FISCU's net worth ratio is at least 6 percent and the charge will not cause the ratio to decline by more than 50 basis points. To conform to the requirements of CUMAA, part 702 permits loss charges without approval only if the credit union's net worth ratio is at least 7 percent and the charge will not cause the ratio to decline below 7 percent. § 702.401(c). To ensure that FISCUs, as a prerequisite of insurance, will comply with the new conditions imposed in part 702 for charging losses to the regular reserve, the final rule revises section 741.3(a)(2) to reflect the 7 percent minimum and to otherwise require the approval of the appropriate State official.

H. Subpart L of Part 747—Issuance, Review and Enforcement of Orders Imposing Prompt Corrective Action

1. Section 747.2001—Scope

CUMMA provides that “material supervisory determinations, including decisions to require prompt corrective action, made * * * by [NCUA] officials other than the [NCUA] Board may be appealed to the [NCUA] Board” through an independent appellate process * * * pursuant to separate procedures prescribed by regulation.” § 1790d(k). Section 747.2001 establishes an independent process for appealing “material supervisory decisions” to impose PCA under part 702 (Table 5). For purposes of subpart L, NCUA staff decisions to impose a DSA (including dismissal of a director or senior executive officer) are considered “material supervisory decisions.” § 747.2001(a). In the case of FISCUs seeking independent review under subpart L, this section provides that the parties (

i.e.,

NCUA and credit union and/or a dismissed director or officer) shall serve upon the appropriate State official the documents filed or issued in connection with a proceeding under subpart L. NCUA received no comments on this section.

ER18FE00.005

2. Section 747.2002—Discretionary Supervisory Actions

Section 747.2002 provides for prior notice and an opportunity to be heard before a DSA is imposed. The NCUA Board must give advance notice of its intention to impose a DSA , § 747.2002(a)(1), except when necessary to further the purpose of PCA. § 747.2002(a)(2). The credit union may then challenge the proposed action in writing and request that the DSA not be imposed or be modified. § 747.2002(c). However, the credit union is not entitled to a hearing. The NCUA Board, or an independent person designated by the NCUA Board, may then decide not to issue the directive or to issue it as proposed or as modified, § 747.2002(d); that decision is final. A credit union which already is subject to a DSA may request reconsideration and rescission due to changed circumstances. § 747.2002(f).

NCUA received 17 comments recommending modifications to § 747.2002. These include expanding

the opportunity to be heard into a full evidentiary hearing; establishing a panel of credit union industry officials to review specific challenges to DSAs and make recommendations to NCUA; establishing an independent council to periodically review PCA implementation and recommend revisions to part 702. Nine commenters urged involving either a mediator or an ombudsman in the appeal process for DSAs. Another contended that an already-existing DSA should be deemed modified or withdrawn if NCUA fails to decide a request for modification or rescission within 60 days.

NCUA received two comments advocating substitute alternative procedures. One alternative was a three-level appeal process commencing with a full evidentiary hearing before the appropriate Regional Director, followed by another full hearing before an NCUA-appointed presiding officer, with direct appeal of that decision to U.S. District Court, bypassing the NCUA Board altogether. The other alternative was a full evidentiary hearing in which NCUA would have the burden of justifying the proposed DSA, and the DSA would not take effect until all appeals were exhausted.

In general, involving panels and councils in the appeal process, and expanding it beyond an opportunity to be heard in writing, would undermine the overall objective of PCA—to act promptly. On the other hand, involving NCUA's ombudsman in the appeal process, and setting a time limit for NCUA to decide requests to modify, to not issue, or to rescind DSAs is appropriate. Accordingly, the final rule revises section 747.2002(f) to provide that if NCUA fails to decide a request to modify or rescind an existing DSA within 60 days, that DSA shall be deemed modified or rescinded. In addition, a new subsection 747.2002(g) is introduced to permit a credit union to request the recommendation of NCUA's ombudsman to not issue or to modify a proposed DSA, or to rescind an existing DSA, as the case may be.

3. Section 747.2003—Reclassification to Lower Net Worth Category

The NCUA Board is authorized to reclassify a credit union to the next lower net worth category on grounds of an unsafe or unsound practice or condition, provided the credit union is first given notice and an opportunity for a hearing. §§ 702.102(b), 702.302(d). In such cases, therefore, section 747.2003 requires the NCUA Board to give notice of its intention to reclassify a credit union, § 747.2003(a), and describe the practice(s) and/or condition(s) justifying reclassification. § 747.2003(b). The credit union may then challenge the reclassification, provide evidence supporting its position, and request an informal hearing and the opportunity to present witnesses. § 747.2003(c).

If requested, an informal hearing is conducted by a presiding officer designated by the NCUA Board. § 747.2003(d). At the hearing, the credit union may introduce relevant documents, present oral argument, and if authorized, present witnesses. § 747.2003(e). The presiding officer then makes a recommended decision to the NCUA Board, § 747.2003(e)(4), which then issues a final decision whether to reclassify the credit union. § 747.2003(f). The NCUA Board may not delegate the authority to make the final decision to reclassify. §§ 702.102(c), 747.2003(h); § 1790d(h)(2).

NCUA received seven comments on this section. Five sought to allow credit unions to be represented by counsel at an informal hearing challenging reclassification. NCUA concurs and has revised section 747.2003(e)(1) accordingly. Another commenter insisted upon a formal evidentiary hearing instead of an informal hearing. NCUA believes that the length of time that a formal hearing entails would undermine the promptness objective of PCA. The final commenter advocated that NCUA delegate its authority to reclassify on safety and soundness grounds to an independent person outside NCUA. As mentioned earlier, however, this is among the few actions NCUA is forbidden to delegate. § 702.102(c).

4. Section 747.2004—Dismissal of Director or Senior Executive Officer

The NCUA Board is authorized to issue a DSA directing a credit union to dismiss a director or senior executive officer. § 702.202(b)(7). In such cases, § 747.2004 requires the NCUA Board to serve the dismissed person with a copy of the directive issued to the credit union, accompanied by a notice of the right to seek reinstatement by the NCUA Board. § 747.2004(a)-(b). That person may then challenge the dismissal and request for reinstatement,

and may request an informal hearing and the opportunity to present witness testimony. § 747.2004(c). The dismissal remains in effect while the request for reinstatement is pending. § 747.2004(g).

The credit union which was directed to dismiss a director or officer may not seek reinstatement of the dismissed director or officer under section 747.2004, but that credit union may challenge the directive under section 747.2002.

If requested, a hearing is conducted by an NCUA Board-designated presiding officer under procedures identical to those which section 747.2003 prescribes in cases of reclassification, with two exceptions. First, the dismissed person bears the burden of proving that his or her continued employment would materially strengthen the credit union's ability to become “adequately capitalized” or to correct an unsafe or unsound condition, as the case may be. § 747.2004(e)(4). Second, if the NCUA Board's final decision is to deny reinstatement, it must provide reasons for its decision. § 747.2004(f).

NCUA received two comments in response to this section. The first urged reversal of the burden of proof, thus requiring NCUA to prove that the dismissed person's continued employment would not materially strengthen the credit union's ability to become “adequately capitalized” or to correct an unsafe or unsound condition. NCUA declines to reverse the burden of proof because section 747.2004(e)(4) emulates FDIA § 38, which imposes the burden of justifying reinstatement on the dismissed person.

E.g.,

12 CFR 308.203.

5. Section 747.2005—Enforcement of Orders Imposing Prompt Corrective Action

CUMAA amended the FCUA to ensure that supervisory actions imposed under part 702 are enforceable. 12 U.S.C. §§ 1786(k)(1) and (2)(A). When a credit union fails to comply with an MSA or DSA, NCUA may apply to the appropriate U.S. District Court to enforce that action. § 747.2005(a). Alternatively, the NCUA Board may assess a civil money penalty against a credit union (and any institution-affiliated party acting in concert with it) which violates or fails to comply with an MSA or DSA, or fails to implement an approved NWRP under subpart B or revised business plan under subpart C. § 747.2005(b). Finally, subpart L allows the NCUA Board to enforce an MSA or DSA under part 702 “through any other judicial or administrative proceeding authorized by law.” § 747.2005(c). NCUA received no comments on this section. It is retained without modification in the final rule.

I. Banking Industry Trade Association Comments

The three principal banking industry trade associations generally supported the proposed rule, agreeing that much of it is comparable to FDIA § 38, but nonetheless recommended as follows:

1. Incorporate benchmarks or a mandatory timetable for determining whether or not a new credit union is making reasonable, steady progress in

accumulating net worth. The preamble of the final rule retains the proposed non-mandatory benchmarks established to guide “new” credit unions in building net worth (

see

Table 4 above);

2. Commence the additional 15-day period given to file an NWRP on the date NCUA issues its notice that the credit union has not timely filed its NWRP, rather than on the date the credit union receives that notice. NCUA continues in the final rule to use the date of receipt to measure the additional period because the time consumed by mailing or delivery could unreasonably shorten the period by several days. § 702.206(a)(4);

3. Decide whether to compel the sale of assets on a case-by-case basis as part of an NWRP. Consistent with this suggestion, part 702 contemplates case-by-case approval of an NWRP that may provide for reduction in assets, and case-by-case imposition of the DSA to reduce assets generally or a specific category of assets (line 5, Table 1 above);

4. Expand the DSA requiring “other actions to carry out PCA” (line 10, Table 1 above) to enumerate examples of such “other actions,” such as limiting management fees. The final rule deliberately articulates this DSA in general terms to maximize flexibility and to avoid suggesting that the “other actions” available under this DSA are limited to the enumerated examples.

E.g.

§ 702.202(b)(9);

5. Eliminate as unwarranted the “other actions no more severe” limitation on the scope of the DSA requiring “other actions to carry out PCA” (line 10, Table 1 above) in the “undercapitalized” category. NCUA concurs and the final rule abandons that limitation.

Id.;

6. Either eliminate the “adjustment to net worth” proposed to reflect items of “other comprehensive income” such as accumulated unrealized gains and losses on AFS securities (Call Report account no. 945), or modify it to reflect the adjustment that applies to banks. For the reasons explained in section II.B. above, the “adjustment to net worth” has been deleted from the final rule;

7. In measuring total assets, use average total assets over the preceding Call Report period, rather than the average of total assets over the preceding four quarterly Call Report periods. For all purposes except calculating the risk-based net worth requirement for “complex” credit unions, the final rule gives credit unions a choice of four methods to calculate “total assets,” including the average of month-end balances over the quarter. § 702.2(j);

8. Implement two additional MSAs: prohibit payments to third parties which would leave the credit union “undercapitalized”; and require prior approval of acquisitions, new branches, new lines of business until the NWRP has been approved. NCUA lacks the authority to implement MSAs beyond the four expressly prescribed by CUMAA, § 702.202(a), nor to impose MSAs on “well capitalized” or “adequately capitalized” credit unions beyond the single MSA (earnings transfer to net worth) CUMAA imposes on the latter. § 702.201;

9. Eliminate “prerequisite for improving management” requiring NCUA to resort to all other DSAs before ordering a new election of the board of directors, or dismissing directors or senior executive officers, or requiring qualified senior officers to be hired (lines 7, 8 and 9, Table 2). NCUA concurs and has deleted this prerequisite from the “undercapitalized” category. §§ 702.202(b)(7)-(8); and

10. Restore to three of the DSAs (lines 5, 8 and 11, Table 2 above) the criterion built into the corresponding “discretionary safeguard,” to achieve comparability with FDIA § 38. With regard to two of these DSAs, the final rule is revised accordingly. §§ 702.202(b)(5), 702.203(b)(10). With regard to the last DSA (line 8, Table 1), however, the 180-day period protecting directors and officers from dismissal remains omitted from the final rule because a credit union official who is responsible for declining net worth, or who is incapable of reversing the decline, is not entitled to a “safe harbor” from dismissal. § 702.202(b)(7).

III. Regulatory Procedures

Regulatory Flexibility Act

The Regulatory Flexibility Act requires NCUA to prepare an analysis describing any significant economic impact a final regulation may have on a substantial number of small credit unions (primarily those under $1 million in assets). The final rule implements the statutory requirements of prompt corrective action, including net worth parameters, expressly mandated by CUMAA.

For the purpose of this analysis, credit unions under $1 million in assets will be considered small entities. As of June 30, 1999, there were 1,690 such entities, with a total of $807.3 million in assets, with an average asset size of $0.5 million. These small entities make up 15.6 percent of all credit unions, but only 0.2 percent of all credit union assets.

The final rule requires all federally-insured credit unions to determine their net worth ratio (primarily using Call Report data). The rule sets forth additional requirements, including development of an NWRP or an RBP if the credit union's net worth ratio falls below established thresholds.

The NCUA Board does not believe that the proposed regulation would impose reporting or recordkeeping burdens that require specialized professional skills not available to them. Further, NCUA estimates fewer than 100 of these small entities will meet the net worth ratios which trigger the requirements of the regulation.

Paperwork Reduction Act

The reporting requirements in part 702 have been submitted to the Office of Management and Budget. Under the Paperwork Reduction Act of 1995, no person is required to respond to a collection of information unless it displays a valid OMB number. The control number will be displayed in the table at 12 CFR part 795.

Executive Order 13132

NCUA Executive Order 13132 encourages independent regulatory agencies to consider the impact of their regulatory actions on state and local interests. NCUA, an independent regulatory agency as defined in 44 U.S.C. 3502(5), voluntarily adheres to the fundamental federalism principles addressed by the executive order. This final rule will apply to all federally-insured credit unions, including federally-insured, state-chartered credit unions. Accordingly, it may have a direct effect on the States, on the relationship between the national government and the states, or on the distribution of power and responsibilities among the various levels of government. This impact is an unavoidable consequence of carrying out the statutory mandate to adopt a system of PCA to apply to all federally-insured credit unions. Throughout the rulemaking process, NCUA staff has consulted with a committee of representative of state regulators regarding the impact of PCA on state-chartered credit unions. The committee's comments and suggestions are reflected in the final rule.

Small Business Regulatory Enforcement Fairness Act

The Small Business Regulatory Enforcement Fairness Act of 1996 (Pub. L. 104-121) provides generally for congressional review of agency rules. A reporting requirement is triggered in instances where NCUA issues a final

rule as defined by section 551 of the Administrative Procedure Act, 5 U.S.C. 551. The Office of Management and Budget has determined that this rule is not a major rule.

List of Subjects

12 CFR Part 702 and 741

Credit unions, Reporting and recordkeeping requirements.

12 CFR Part 747

Administrative practices and procedures, Credit unions.

By the National Credit Union Administration Board on February 3, 2000.

Becky Baker,

Secretary of the Board.

Accordingly, 12 CFR parts 702, 741 and 747 are amended as set forth below:

Part 702 is revised to read as follows:

PART 702—PROMPT CORRECTIVE ACTION

Sec.

702.1

Authority, purpose, scope and other supervisory authority.

702.2

Definitions.

Subpart A—Net Worth Classification

702.101

Measure and effective date of net worth classification.

702.102

Statutory net worth categories.

702.103

Risk portfolios defined. [Reserved]

702.104

Thresholds to define complex credit unions. [Reserved]

702.105

RBNW components to calculate risk-based net worth requirement. [Reserved]

702.106

Alternative components to calculate risk-based net worth requirement. [Reserved]

Subpart B—Mandatory and Discretionary Supervisory Actions

702.201

Prompt corrective action for “adequately capitalized” credit unions.

702.202

Prompt corrective action for “undercapitalized” credit unions.

702.203

Prompt corrective action for “significantly undercapitalized” credit unions.

702.204

Prompt corrective action for “critically undercapitalized” credit unions.

702.205

Consultation with State officials on proposed prompt corrective action.

702.206

Net worth restoration plans.

Subpart C—Alternative Prompt Corrective Action for New Credit Unions

702.301

Scope and definition.

702.302

Net worth categories for new credit unions.

702.303

Prompt corrective action for “adequately capitalized” new credit unions.

702.304

Prompt corrective action for “moderately capitalized,” “marginally capitalized” and “minimally capitalized” new credit unions.

702.305

Prompt corrective action for “uncapitalized” new credit unions.

702.306

Revised business plans for new credit unions.

702.307

Incentives for new credit unions.

Subpart D—Reserves

702.401

Reserves.

702.402

Full and fair disclosure of financial condition.

702.403

Payment of dividends.

Authority:

12 U.S.C. 1766(a), 1790d.

§ 702.1

Authority, purpose, scope and other supervisory authority.

(a)

Authority.

Subparts A, B and C of this part and subpart L of part 747 of this chapter are issued by the National Credit Union Administration pursuant to section 216 of the Federal Credit Union Act (FCUA), 12 U.S.C. 1790d (section 1790d), as added by section 301 of the Credit Union Membership Access Act, Pub. L. No. 105-219, 112 Stat. 913 (1998). Subpart D of this part is issued pursuant to FCUA section 120, 12 U.S.C. 1766.

(b)

Purpose.

The express purpose of prompt corrective action under section 1790d is to resolve the problems of federally-insured credit unions at the least possible long-term loss to the National Credit Union Share Insurance Fund. This part carries out the purpose of prompt corrective action by establishing a framework of mandatory and discretionary supervisory actions, applicable according to a credit union's net worth ratio, designed primarily to restore and improve the net worth of federally-insured credit unions.

(c)

Scope.

This part implements the provisions of section 1790d as they apply to federally-insured credit unions, whether federally- or state-chartered; to such credit unions defined as “new” pursuant to section 1790d(b)(2); and to such credit unions defined as “complex” pursuant to section 1790d(d). Certain of these provisions also apply to officers and directors of federally-insured credit unions. This part does not apply to corporate credit unions. Procedures for issuing, reviewing and enforcing orders and directives issued under this part are set forth in subpart L of part 747 of this chapter, 12 CFR 747.2001

et seq.

(d)

Other supervisory authority.

Neither § 1790d nor this part in any way limits the authority of the NCUA Board or appropriate State official under any other provision of law to take additional supervisory actions to address unsafe or unsound practices or conditions, or violations of applicable law or regulations. Action taken under this part may be taken independently of, in conjunction with, or in addition to any other enforcement action available to the NCUA Board or appropriate State official, including issuance of cease and desist orders, orders of prohibition, suspension and removal, or assessment of civil money penalties, or any other actions authorized by law.

§ 702.2

Definitions

Except as provided below, the terms used in this part have the same meanings as set forth in FCUA sections 101 and 216, 12 U.S.C. 1752, 1790d.

(a)

Appropriate regional director

means the director of the NCUA regional office having jurisdiction over federally-insured credit unions in the state where the affected credit union is principally located.

(b)

Appropriate State official

means the commission, board or other supervisory authority having jurisdiction over credit unions chartered by the State which chartered the affected credit union.

(c)

Credit union

means a federally-insured, natural person credit union, whether federally- or State-chartered, as defined by 12 U.S.C. 1752(6).

(d)

CUSO

means a credit union service organization as described in 12 CFR 712

et seq.

for federally-chartered credit unions, and as defined under State law for State-chartered credit unions.

(e)

NCUSIF

means the National Credit Union Share Insurance Fund as defined by 12 U.S.C. 1783.

(f)

Net worth

means the retained earnings balance of the credit union at quarter end as determined under generally accepted accounting principles. Retained earnings consists of undivided earnings, regular reserves, and any other appropriations designated by management or regulatory authorities. This means that only undivided earnings and appropriations of undivided earnings are included in net worth. For low income-designated credit unions, net worth also includes secondary capital accounts that are uninsured and subordinate to all other claims, including claims of creditors, shareholders and the NCUSIF. For any credit union, net worth does not include the allowance for loan and lease losses account.

(g)

Net worth ratio

means the ratio of the net worth of the credit union (as defined in paragraph (f) of this section to the total assets of the credit union (as defined by a measure chosen under paragraph (j) of this section.

(h)

New credit union

means a federally-insured credit union which both has been in operation for less than ten (10) years and has $10,000,000 or less in total assets.

(i)

means deposits, shares, share certificates, share drafts, or any other depository account authorized by federal or state law.

(j)

Total assets

(1) Total assets means a credit union's total assets as measured by either—

(i)

Average quarterly balance.

The average of quarter-end balances of the four most recent calendar quarters; or

(ii)

Average monthly balance.

The average of month-end balances over the three calendar months of the calendar quarter; or

(iii)

Average daily balance.

The average daily balance over the calendar quarter; or

(iv)

Quarter-end balance.

The quarter-end balance of the calendar quarter as reported on the credit union's Call Report, and for semi-annual filers as calculated for the quarters ending March 31 and September 30.

(2) For each quarter, a credit union must elect a measure of total assets from paragraph (j)(1) of this section to apply for all purposes under this part except §§ 702.103 through 702.106 [risk-based net worth requirement].

Subpart A—Net Worth Classification

§ 702.101

Measures and effective date of net worth classification

(a)

Net worth measures.

For purposes of this part, a credit union must determine its net worth category classification at the end of each calendar quarter using two measures:

(1) The net worth ratio as defined in § 702.2(g); and

(2) If defined as “complex” under § 702.104, the applicable risk-based net worth requirement.

(b)

Effective date of net worth classification.

For purposes of this part, the effective date of a federally-insured credit union's net worth category classification shall be the most recent to occur of:

(1) The last day of the calendar month following the end of the calendar quarter; or

(2) The date the credit union's net worth ratio is recalculated by or as a result of its most recent final report of examination; or

(3) The date the credit union received written notice from NCUA or, if State-chartered, the appropriate State official, of reclassification on safety and soundness grounds as provided under §§ 702.102(b) or 702.302(d).

(c)

Notice by credit union of change in net worth category.

(1) When filing a quarterly or semi-annual Call Report, a federally-insured credit union need not otherwise notify the NCUA Board of a change in its net worth ratio that places the credit union in a lower net worth category;

(2) A federally-insured credit union which files its Call Reports semi-annually shall give written notice to the NCUA Board and, if State-chartered, to the appropriate State official, of a change in its net worth ratio for the quarters ending March 31 and September 30, if that change places the credit union in a lower net worth category,

provided however,

that this paragraph does not apply when a credit union has been notified by NCUA or, if State-chartered, by the appropriate State official, of a change in its net worth ratio that places the credit union in a lower net worth category;

(3) Written notice as required under paragraph (c)(2) of this section shall be given no later than 15 calendar days after the effective date of the change in net worth category, and shall be deemed given upon receipt by the appropriate Regional Director and, if State-chartered, by the appropriate State official.

(4) Failure to timely file a Call Report or to timely provide notice as required under this section in no way alters the effective date of a change in net worth classification under this subparagraph, or the affected credit union's corresponding legal obligations under this part.

§ 702.102

Statutory net worth categories.

(a)

Net worth categories.

Except for credit unions defined as “new” under subpart B of this part, a federally-insured credit union shall be classified (Table 1)—

(1)

Well capitalized

if it has a net worth ratio of seven percent (7%) or greater and also meets any applicable risk-based net worth requirement under §§ 702.105 and 702.106; or

(2)

Adequately capitalized

if it has a net worth ratio of six percent (6%) or more but less than seven percent (7%), and also meets any applicable risk-based net worth requirement under §§ 702.105 and 702.106 below; or

(3)

Undercapitalized

if it has a net worth ratio of four percent (4%) or more but less than six percent (6%), or fails to meet any applicable risk-based net worth requirement under §§ 702.105 and 702.106; or

(4)

Significantly undercapitalized

if it

(i) Has a net worth ratio of two percent (2%) or more but less than four percent (4%); or

(ii) Has a net worth ratio of four percent (4%) or more but less than five percent (5%), and either—

(A) Fails to submit an acceptable net worth restoration plan within the time prescribed in § 702.206; or

(B) Materially fails to implement a net worth restoration plan approved by the NCUA Board; or

(5)

Critically undercapitalized

if it has a net worth ratio of less than two percent (2%).

ER18FE00.006

(b)

Reclassification based on supervisory criteria other than net worth.

The NCUA Board may reclassify a “well capitalized” credit union as “adequately capitalized” and may require an “adequately capitalized” or “undercapitalized” credit union to comply with certain mandatory or discretionary supervisory actions as if it were in the next lower net worth category (each of such actions hereinafter referred to generally as “reclassification”) in the following circumstances:

(1)

Unsafe or unsound condition.

The NCUA Board has determined, after notice and opportunity for hearing pursuant to § 747.2003 of this chapter, that the credit union is in an unsafe or unsound condition; or

(2)

Unsafe or unsound practice.

The NCUA Board has determined, after notice and opportunity for hearing pursuant to § 747.2003 of this chapter, that the credit union has not corrected a material unsafe or unsound practice of which it was, or should have been, aware.

(c)

Non-delegation.

The NCUA Board may not delegate its authority to reclassify a credit union under paragraph (b) of this section.

(d)

Consultation with State officials.

The NCUA Board shall consult and seek to work cooperatively with the appropriate State official before reclassifying a federally-insured State-chartered credit union under paragraph (b) of this section, and shall promptly notify the appropriate State official of its decision to reclassify.

§ 702.103

Risk portfolios defined. [Reserved]

§ 702.104

Thresholds to define complex credit unions. [Reserved]

§ 702.105

RBNW components to calculate risk-based net worth requirement. [Reserved]

§ 702.106

Alternative components to calculate risk-based net worth requirement. [Reserved]

Subpart B—Mandatory and Discretionary Supervisory Actions

§ 702.201

Prompt corrective action for “adequately capitalized” credit unions

(a)

Earnings transfer.

Beginning the effective date of classification as “adequately capitalized” or lower, a federally-insured credit union must increase its net worth quarterly by an amount equivalent to at least

1/10

th percent (0.1%) of its total assets for the current quarter, and must quarterly transfer that amount (or more by choice) from undivided earnings to its regular reserve account, until it is “well capitalized.”

(b)

Reduction in earnings transfer.

On a case-by-case basis and subject to review and revocation no less frequently than quarterly, the NCUA Board may permit the credit union to quarterly transfer an amount that is less than the equivalent of 1/10th percent (0.1%) of its total as

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