Corporate Credit Unions; Requirements for Insurance

NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 704 and 741

Corporate Credit Unions; Requirements for Insurance

AGENCY: National Credit Union Administration (NCUA).

ACTION: Proposed rule.

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SUMMARY: The proposed rule would strengthen the capital of corporate

credit unions, reduce the risk of their investments, and improve asset-

liability management. It would return corporate credit unions to their

primary functions of serving as liquidity centers and service providers

and would protect the safety and soundness of the corporate credit

union system.

DATES: Comments must be postmarked or posted on NCUA's electronic

bulletin board by June 26, 1995.

ADDRESSES: Mail comments to Becky Baker, Secretary of the Board,

National Credit Union Administration, 1775 Duke Street, Alexandria, VA

22314-3428. Send comments to Ms. Baker via the bulletin board by

dialing 703-518-6480.

FOR FURTHER INFORMATION CONTACT: H. Allen Carver, Director, Office of

Corporate Credit Unions (703) 518-6640, at the above address.

SUPPLEMENTARY INFORMATION:

A. Background

The corporate credit union system consists of 44 corporate credit

unions serving the nation's 13,000 natural person credit unions, and

U.S. Central Credit Union serving the corporate credit unions.

Corporate credit unions provide liquidity, investment, and payment

services to credit unions. Over the years, natural person and corporate

credit unions have gradually evolved into quite different types of

institutions. In 1977, NCUA first issued Part 704, which dealt

specifically with corporate credit unions. However, it was not until

1992 that the agency broadened Part 704 to address a broad array of

corporate credit union matters. See 57 FR 22626 (May 28, 1992). The

regulation has been in effect for several years, during a time of great

change in the credit union industry. The Agency has had an opportunity

to see how the regulation has worked and to consider how it could be

improved. Last year, the Board amended Section 704.12, governing

representation issues. See 59 FR 59357 (Nov. 17, 1994). After

consulting closely with the corporate credit union industry, credit

union trade associations, and outside experts, the Board is now

proposing to amend most of the remaining sections of Part 704 and to

add several new sections.

Before analyzing the specific proposed changes, the Board wishes to

draw the attention of interested parties to a gross inequity in the

corporate credit union system. NCUA oversight and supervision of

corporate credit unions has grown in complexity in the past few years,

resulting in additional costs for NCUA's corporate credit union

program. Although NCUA examines all of the corporate credit unions,

only federally chartered corporates currently pay an operating fee to

NCUA. Federally insured corporate credit unions maintain a deposit of

one percent of insured shares with the NCUSIF, but corporates have

minimal insured shares, and the income generated is not significant. Of

course, non federally insured corporate credit unions neither pay

operating fees to NCUA nor maintain deposits with the NCUSIF.

The Board is concerned that the additional monetary burden on

federal credit unions puts them at a competitive disadvantage and is

considering ways to level the playing field. One option is to assess

all corporate credit unions an annual examination fee, to be based on

the expenses associated with the NCUA corporate program. Alternatively,

the Board could abolish the operating fee for federal corporate credit

unions, [[Page 20439]] requiring natural person credit unions to make

up the difference. Since corporate credit unions benefit natural person

credit unions, it may be appropriate to ask the latter to pay for the

whole system. The Board requests comment on these options.

B. Section-by-Section Analysis

Section 704.1--Scope

Part 704 applies directly to all federally insured corporate credit

unions. It applies to non federally insured corporate credit unions,

via Part 703 of the Rules and Regulations, if such credit unions accept

shares from federally chartered credit unions. To clarify the

application of Part 704, the Board is proposing to amend the Scope

section so that it states both that the regulation applies to all

federally insured corporate credit unions, and that non federally

insured corporate credit unions must agree, by written contract, to

adhere to the regulation and submit to NCUA examination as a condition

of receiving funds from federally insured credit unions.

The Board considered deleting from the proposed rule Section

704.1(b), which sets forth its authority to waive a requirement of Part

704. In the few years that the provision has been in effect, NCUA has

been deluged with requests for waivers. The Board is concerned that

corporate credit unions may have received the impression that

compliance with the rule is optional and that waivers are granted as a

matter of course. The Board wishes to emphasize that corporate credit

unions are expected to comply with the rule. The Board has determined

to retain Section 704.1(b) in the proposed rule, however, to make clear

its authority, in extraordinary circumstances, to waive provisions of

the regulation.

The Board proposes to add a sentence to Section 704.1(b) regarding

state- chartered credit unions. Where a state law provision is also

contained in Part 704, and a state-chartered corporate wishes to

request a waiver of that provision, the corporate must obtain state

approval of the waiver before requesting a waiver from NCUA.

Section 704.2--Definitions

Capital

The Board is proposing to revise the definition of capital. The

revised definition encompasses primary capital and secondary capital

share accounts upon which notice has not been given. These terms are

defined later in this Section. The current definition includes each of

the balance sheet accounts that comprise primary capital. As these

accounts are also listed in the definition of primary capital, it is

not necessary to list them under capital.

Commitment -

The Board is proposing to delete the phrase ``or lease financing

receivables'' from the definition of ``commitments,'' as corporate

credit unions generally do not enter into lease financing arrangements.

Corporate Service Organization (CSO)

Currently, corporate credit unions can invest in and loan to credit

union service organizations (CUSOs) as defined in Section 701.27 of the

NCUA Rules and Regulations. Section 701.27 was written with natural

person credit unions in mind and contains a broad list of permissible

activities, many of which the Board believes are inappropriate for

corporate CUSOs. Accordingly, the Board is proposing to create a new

term and establish new rules for such organizations. They would be

called ``corporate service organizations (CSOs)'' and would be limited

to serving only the corporate credit unions that have invested in or

loaned to the CSO and/or the members of such corporate credit unions.

Thus, a CSO wholly owned by ABC Corporate Credit Union could serve only

ABC and its member credit unions. If the CSO received a loan from DEF

Corporate Credit Union, it could serve ABC and its member credit unions

and DEF and its member credit unions. The Board believes that this

restriction would preserve the integrity of field of membership

requirements.

The Board is also proposing that a CSO's services be limited to

data and item processing, wire transfers, record retention and storage,

securities brokerage services, investment advisory services, and trust

services. The Board is concerned that some corporate CUSOs currently

are performing services that have nothing to do with the daily

activities of corporate credit unions, such as shared branching

services and home banking.

The Board is also proposing to require that a CSO be chartered as a

corporation under state law.

Embedded Options

Embedded options are a common feature in many investment

securities. Mortgage backed securities, federal agency structured

notes, and many other corporate obligations have features such as

maturity calls, principal prepayments, periodic and lifetime interest

rate caps, and conversion factors, over which the investor has no

control. The fact that these options can be exercised by the issuer (or

mortgage holder) and not the investor raises concerns for the Board.

These features entail substantial risks for investors that do not

properly understand and evaluate how these options impact the

performance of the investment. The function of a matched book strategy

is to immunize the effects that changing interest rates will have on

the economic value of assets and liabilities. If the characteristics of

an asset are not replicated in the corresponding source of funds, the

integrity of the match is compromised. This is especially true for

assets which have conditional cash flows that are linked to the level

of interest rates and other market factors.

One example of an investment with conditional cash flows is

mortgage backed securities. Mortgage backed securities are impacted by

the behavior of the underlying mortgage holders whose loans make up the

securities. If they elect to pay off or refinance their mortgages, the

securities will likewise pay down. The investor has no control over

this action. Prepayment risk has a substantial impact on the market

value and liquidity of an instrument and the uncertainty of the cash

flow behavior makes these securities especially difficult to match.

Many investors were caught by surprise during the rate upswing in

1994 because the market values of their securities were adversely

impacted far more than they had anticipated. The embedded options such

as prepayment extension and caps on floating rate instruments caused a

serious threat to the liquidity and solvency of many credit unions. The

risk associated with such securities cannot be ignored and it must be

factored into the matching strategies of corporate credit unions. This

is imperative because corporate credit unions must ensure that the

viability of the income, liquidity and net market value of the matched

book balance sheet is not jeopardized.

Identically Matched

The Board recognizes that it is not possible for corporate credit

unions to perfectly match all shares and certificates to identical

assets because there sometimes exists an immaterial difference in

dollar amount, the accrual methods, or the precise maturity date. To be

substantiated as immaterial, such minute differences cannot have the

effect of causing any significant exposure to changing spread

performance or the net market value of the match. The integrity of the

matched book depends upon how substantially close the match is with

regard to such factors as the dollar amounts, rate reset

[[Page 20440]] features, final maturities, and embedded options.

Long-Term Investment; Short-Term Investment

Section 704.6 of the current regulation frequently uses the phrases

``long-term (initial maturity over 1 year) investments'' and ``short-

term (initial maturity of 1 year or less) investments.'' In the

interests of simplifying the regulation, the proposed rule would simply

define, for the purpose of investment ratings, a ``long-term

investment'' as one having an initial or expected maturity greater than

one year and a ``short-term investment'' as one having an initial or

expected maturity of one year or less.'' These definitions apply only

to investment ratings in Section 704.5, which sets forth corporate

credit union investment authority in the proposed rule. ``Long-term''

and ``short-term'' have different meanings in the context of asset-

liability management.

Market Value of Portfolio Equity (MVPE)

MVPE is designed to calculate the risk that changing interest rates

will have on a corporate credit union's capital. The traditional

practice of measuring interest rate risk sensitivity was the static Gap

model. With the introduction in recent years of more dynamic income

simulation models, a more sophisticated and precise calculation of

income (and capital) at risk is possible. The evolution of asset/

liability management techniques has led to a greater understanding of

how changing interest rates impact not only earnings but capital as

well.

The Board recognizes that, like any estimation, the validity of the

MVPE is dependent upon the quality of assumptions and integrity of the

data going into the calculation. If the MVPE is intended to capture

true mark-to-market risk of capital, the discount rates in the net

present value calculations must reflect any credit, liquidity, or

option premiums that are inherent in a specific asset or liability.

The development of simulation models that calculate changes in net

worth for given changes in interest rates has changed the way many risk

managers regard interest rate sensitivity. The MVPE calculation is

significant because it is a measure that captures risk over a more long

term horizon than net interest income (NII), and as such, it serves as

a better early warning detection system. Where net interest income

calculations typically focus on income over the next 12-24 months, MVPE

captures the long-term economic risk that is inherent in the balance

sheet. It is possible for an institution's current earnings to hold

steady over the near term as the mark-to-market of the balance sheet is

rapidly deteriorating. If a risk manager only focuses on earnings, the

risk of capital depletion may go unnoticed.

MVPE is intended to show how the economic values of both sides of

the balance sheet will change in relation to one another as interest

rates change. One need only look at the toll of the 1994 bear market to

understand the ramifications of ignoring the risk of capital depletion.

The Board is therefore compelled to ensure that all liquidity providers

be cognizant of the risk exposures they take with regard to their

capital and liquidity positions.

Many institutions have borrowed short-term funds to buy long-term

assets. The inducement is typically a steep yield curve that provides

an instant spread opportunity and quick income. The contribution of

retained earnings to capital is a favorable objective but the risk of

mismatched assets and liabilities can easily produce a situation where

the market takes all the benefits away faster than the income was

produced. The ability to withstand a liquidity crisis rests on core

solvency. Maintaining core solvency, on a mark-to-market basis, in all

probable interest rate environments is imperative, and MVPE is a method

by which oversight authorities can police the capital at risk.

An institution that has negative capital on a mark-to-market basis

cannot meet the demands or obligations of a liquidity crisis, and it is

for this reason that the Board desires to expand the risk measurement

techniques employed by corporate credit unions so as to detect

unacceptable exposures of risk at the earliest opportunity and mandate

an appropriate course of corrective action whenever necessary.

The MVPE calculation serves to inform risk takers of what the

stakes are before the adverse market changes occur. By employing a

``what if'' scenario approach, risk managers can observe the changes in

MVPE to determine the cost of entertaining certain risk exposures. It

is a dynamic approach that allows the oversight authorities to know how

much is at stake and to respond before problems arise.

Net Interest Income

The standard measure of risk in income simulation calculations is

the variability of net interest income, from ``most likely''

expectations, for given changes in interest rates. The relationship

between interest bearing assets and liabilities is subject to adverse

change when market rates rise and fall. The ability to capture the

variability of returns that results from changing rates is widely

regarded as a fundamental tool for managing interest rate risk.

The policy makers at corporate credit unions need to place

limitations upon the amount of income that is subject to interest rate

risk. Net interest income simulation is useful for understanding what

variables will impact earnings and it allows the user to subject the

balance sheet to severe rate stress tests and balance sheet composition

changes.

``What if'' analysis is essential for anticipating the damage that

will result if rates move contrary to the corporate credit union's

forecast. Since credit unions cannot predict interest rates, the risk

of positioning the balance sheet for a specific purpose must be

measured in a variety of interest rate scenarios. A net interest income

simulation provides a better means for forecasting the potential risk

to income posed by changing rates. Like MVPE, it helps senior

management and the board of directors to determine if the levels of

potential risk are acceptable.

Overnight

The integrity of the corporate credit union system rests on its

ability to repay member funds, other than PCSAs and SCSAs, upon demand

and without delay. A large portion of the funds in the system is in

overnight accounts, and the bulk of those funds should remain

immediately available to meet all contingent member needs. Since

overnight transactions might span several days when a weekend or

holiday is involved, the term ``overnight'' is recognized to mean from

one business day to the next.

Penalty for Early Withdrawal

Market-based penalties on shares, deposits and liabilities are

important because they protect corporate credit unions from the

replacement risk that results when an early withdrawal by a member

credit union can only be replaced by a higher cost alternative. This

risk is tantamount to selling an investment security on the secondary

market. Corporate credit unions are financial intermediaries that

should not absorb the risk caused by members seeking an early

redemption.

Member credit unions will have an economic incentive to request

early redemption when reinvestment prospects exceed early withdrawal

penalties. Unless the penalties are assessed on a contemporaneous mark-

to-market basis, the corporate will have [[Page 20441]] to absorb the

difference between the penalty and the replacement cost. While members

may not behave in a perfect economic fashion (calculating the break-

even point), the risk exposure is still significant. The incorporation

of mark-to-market penalties is consistent with the principle of running

a matched book.

Permanent Capital Share Account (PCSA)

The Board recognizes that it may be difficult for some corporate

credit unions to reach the capital levels required under proposed

Section 704.12 in the timeframes provided. The reports of the General

Accounting Office and the Corporate Credit Union Study Committee both

propose the use of a form of nonredeemable membership shares to assist,

in the short-term, corporate credit unions to attain minimum capital

goals. Accordingly, the Board is proposing to create a type of

membership share that would be at risk, would not be redeemable without

written concurrence of NCUA, and would pay non cumulative dividends.

Because of these elements of permanency, up to 50 percent of primary

capital could consist of PCSAs. The Board requests comment on the

criteria NCUA should use to determine when PCSAs may be redeemed.

PCSAs would be limited to credit unions within the corporate credit

union's field of membership, would not be subject to insurance by the

NCUSIF or other deposit insurer, and could not be used to collateralize

borrowings. PCSAs would be available to absorb losses in the event of a

deficit in the corporate credit union's other primary capital accounts.

In the event of liquidation of a corporate credit union, PCSAs would be

payable only after satisfaction of all liabilities.

A corporate credit union would be required to adequately disclose

the terms and conditions of PCSAs to each subscriber. A standard form

for such disclosure is provided in the regulation.

Primary Capital

Currently, primary capital is defined as all corporate statutory

and regular reserves and undivided earnings. The Board is proposing to

amend the definition to have primary capital consist of statutory

reserves, undivided earnings, other reserves (excluding the allowance

for loan losses and accumulated gains/losses on available-for-sale

securities), net income/loss, and permanent capital share accounts

(PCSAs). No more than 50 percent of primary capital would be permitted

to be comprised of PCSAs. The proposed regulation would provide for

several benchmarks that are tied to the level of the corporate credit

union's primary capital.

Rated

Section 704.6 of the current regulation frequently requires that a

security be rated at a certain level ``by an SEC-recognized rating

agency,'' which is defined in Sec. 704.2. In the interests of

simplifying the regulation, the proposed rule would simply define

``rated'' to mean ``rated by an SEC-recognized rating agency,'' which

would then be defined.

Secondary Capital Share Account (SCSA)

The current regulation introduced the concept of membership capital

share deposits (MCSDs), which are subject to certain restrictions in

order to qualify as secondary capital. The Board is proposing to retain

this concept in a new form called secondary capital share accounts

(SCSAs). As with PCSAs, SCSAs would be limited to credit unions within

the corporate credit union's field of membership, would not be subject

to insurance by the NCUSIF or other deposit insurer, could not be used

to collateralize borrowings, and in the event of liquidation of a

corporate credit union, would be payable only after satisfaction of all

liabilities.

In order for an SCSA to count as capital, it would have to have a

minimum notice of withdrawal of two years. The Board weighed several

options in establishing the notice period. The Board believes that the

one year notice that currently exists for MCSDs is too short. If a

corporate credit union experienced problems, all of its secondary

capital could be depleted in 12 months. This is often not enough time

to resolve problems, and a total depletion of secondary capital could

threaten a corporate credit union's continued viability. The Board

believes that a two year notice period would serve to preserve capital,

yet allow maneuverability on the part of member credit unions.

Individual corporates would be free to set longer notice periods if

they wished.

The Board also proposes that SCSAs be available to absorb losses in

the event of a deficit in the corporate credit union's primary capital.

SCSAs could be used not only if a corporate credit union were

liquidated, but also to cover any losses in a continuing corporate

credit union that has depleted its level of primary capital.

The Board is concerned that all the requirements and conditions of

SCSAs are adequately disclosed to each member credit union. Therefore,

specific disclosure at the time of the opening of an SCSA, and annual

disclosure thereafter, is provided in the regulation, along with

standard forms that may be used by the corporate credit unions.

The Board notes that SCSAs are the only permitted form of secondary

capital in the proposed rule. Currently, secondary capital consists of

MCSDs and term subordinated debt. A review of the corporate credit

unions determined that none had in fact used term subordinated debt as

a way to build secondary capital. In light of this, and the Board's

belief that it is more appropriate to build capital through a corporate

credit union's members, the proposed rule would not include term

subordinated debt in secondary capital and would delete any reference

to it in the regulation. Since SCSAs would be the only component of

secondary capital, the proposed rule would simply refer to SCSAs

instead of secondary capital.

Undivided Earnings

The Board is proposing to revise the definition of ``undivided

earnings'' to remove the term ``corporate reserves,'' as that term is

not used in the proposed rule.

United States Government or its Agencies; United States Government-

Sponsored Corporations and Enterprises

The Board is proposing to delete the reference to Appendix C from

these definitions and to delete current Appendix C. Rather than having

a fixed list of agencies and enterprises, which may become erroneous as

entities are created, dissolved, or changed, the Board wishes to simply

present the definition of government agencies and enterprises and place

the responsibility of determining an entity's status on the corporate

credit union. [[Page 20442]]

Adjusted Trading; Bailment for Hire Contract; Cash Forward Agreement;

Collateralized Mortgage Obligation; Facility; Federal Funds

Transaction; Forward Rate Agreement; Futures Contract; Immediate Family

Member; Market Price; Maturity Date; Official; Option Contract; Primary

Dealer; Real Estate Mortgage Investment Conduit; Repurchase

Transaction; Residual Interest; Reverse Repurchase Transaction; Section

107(8) Institution; Senior Management Employee; Settlement Date; Short

Sale; Standby Commitment; Stripped Mortgage Backed Security; Swap

Agreement; Trade Date; Zero Coupon Bond

Currently, Part 704 incorporates by reference Part 703, which

governs federal credit union investments, except where inconsistent

with Part 704. To eliminate the confusion that has arisen over the

applicability of certain provisions of Part 703, and because Part 703

may be amended in the future, the Board is proposing to move the

relevant portions of Part 703 into Part 704. Most of these definitions

are from Part 703; some have been altered slightly. A few other

investment-related definitions have been added.

Capital of a Broker/Dealer; Claims; Corporate Reserves; Credit Union

Service Organization; Membership Capital Share Deposit; Non Credit

Union Member; Original Maturity; Other Reserves; Risk-Based Capital;

Secondary Capital; Speculative Activities; Term Subordinated Debt

The Board is proposing to eliminate all of these definitions,

primarily because the terms are not used in the proposed regulation.

The term ``claims'' is used in the appendices, but the definition,

``loans or other debt obligations,'' is deemed to be self-evident.

Section 704.3--Planning: Strategic and Business Plans

The Board is proposing to revise Sec. 704.3 to specify that the

board of directors of a corporate credit union must adopt written

strategic and business plans. The Board is concerned that the directors

of corporate credit unions might develop concepts for such plans

through discussion and brainstorming sessions, but not place them in

formal written format. The lack of written documentation would result

in the inability of the directors to monitor their success in achieving

their goals. Additionally, wording was added to require that the annual

review of the plans be documented and provided to the corporate credit

union's auditor and supervisory committee and to NCUA. -

Section 704.4--Asset/Liability Management

Matched book requirement. The evolution of ``managed'' book

strategies in the corporate credit union network has become a huge

concern to the Board. The assumption of interest rate risk by some

corporates has been demonstrably short-sighted as evidenced by the

wide-spread exposure to rising interest rates taken by many corporates

in recent years.

In some dramatic instances, portfolios were merely matched by

repricing characteristics, and not always effectively at that, which

subjected some corporate credit unions to potentially extreme

depletions of capital. The mismatches that result when short duration

liabilities are matched against longer duration investment assets

cannot be managed if the ability to sell troubled assets is forfeited

by a ``hold-to-maturity'' philosophy. Thus, the managed book approach

has, in many cases, resulted in an unmanaged wager against changing

interest rates.

The fact that most securities in corporate portfolios that can be

adversely impacted by rising rates are classified as ``hold-to-

maturity'' largely contradicts the notion that the risks associated

with these managed portfolios can be managed when and if the wrong

combination of circumstances prevails.

The Board is concerned about the potential problems that result

when corporate credit unions that ``manage'' sources and uses of funds

assume unreasonable levels of risk exposure with the overnight portion

of member funds. The growth and complexity of the floating rate

securities market has inspired many corporate credit unions to employ a

``managed'' risk approach in which maturity and average life are

disregarded in favor of matching sources and uses of funds by interest

rate reset characteristics.

This has led some corporate credit unions to assume substantial

duration mismatches when they ``match'' their overnight funds against

corresponding floating rate assets which have embedded options, long

weighted average lives, or coupons linked to inappropriate indices.

When such assets have interest rate dependent features that affect

their market values, the liquidity and solvency of the credit union can

be adversely affected. The Board believes that such risk exposures

should be identified, measured, and limited to a reasonable level of

primary capital. When such risks cannot be immunized in the matching

process, they are unacceptable.

The Board is aware that a floating rate security can have a very

short duration if it is tied to a sensitive market index, reprices

frequently, has little or no embedded option risk, and has a relatively

short final maturity. The Board also recognizes that a portion of

overnight shares at a corporate credit union represents a core amount

of funds that is essentially permanent in nature. Such core funds are

required to cover clearings and other daily activities. It is not

inappropriate for a corporate credit union to mismatch a conservative

portion of overnight funds into longer maturity assets provided that

the assets are convertible to cash without suffering a material loss.

The Board is proposing that a corporate credit union be permitted

to mismatch 25 percent of funds in the overnight book. The parameters

set forth on the assets permitted in this 25 percent portion are

established to prevent any material adverse market value effect upon

the liquidation potential of these assets if and when the need arises.

The ability to mismatch a conservative portion of the overnight account

allows corporate credit unions to augment their earnings potential in

addition to the investment of capital.

The Board does not believe that any interest rate risk should be

taken with term certificates. Any source of funds, with the exception

of capital, that has a maturity of greater than one business day must

be identically matched to an asset that has the same maturity and

repricing characteristics. The danger of entertaining duration

mismatches with member certificates is regarded to be completely

inconsistent with the charge of a liquidity facility. This activity is

not regarded to be a legitimate means of generating retained earnings

because of the risk and complexity associated with managing a

mismatched portfolio.

Portfolio pricing. It is essential for corporate credit unions to

evaluate the risk inherent in their balance sheets on a regular basis.

A frequent pricing of the investment portfolio is an important

component of risk assessment since it provides critical information

about changes in the liquidation value of the balance sheet.

Whether assets are classified as available-for-sale or hold-to-

maturity, they need to be reviewed in the context of fair market value.

The management of a corporate credit union should know at all times

where the relative market value of its balance sheet stands in order to

ensure that the core solvency of the institution is not remotely

threatened by any adverse change in market rates. [[Page 20443]]

Maximum unrealized loss on available-for-sale assets. The Board is

proposing that the aggregate loss in the accumulated unrealized gains/

losses on available-for-sale assets, net of any unrealized gains or

losses on the corresponding source of funds, be limited to a

conservative percentage of the corporate's primary capital. Consistent

with the provision that all investment securities be priced to market

on a monthly basis, the need to closely monitor the impact of changing

market rates on the available-for-sale portfolio is imperative.

The Board is also proposing that sufficient early withdrawal

penalties be in place to guarantee protection from replacement risk.

This would allow corporates to capture the economic benefit of the

liabilities that are matched against available-for-sale assets;

accordingly, it is appropriate to factor in the corresponding

liabilities when setting a maximum limit upon the aggregate loss in the

accumulated unrealized gain/loss on ``available-for-sale'' assets.

Rate shock analysis. The use of scenario analysis to measure

potential risk is not a new concept to many corporate credit unions.

This discipline is already resident in a number of corporates. The

purpose of using a rate shock calculation is to view interest rate risk

from a severe but plausible perspective. The senior management and

board of directors of a corporate should always be cognizant of

potential interest rate risk exposures before they arise.

It is clear that a perfectly matched book does not have the same

volatility that a ``managed'' mismatched book has. Depending upon how

the overnight and capital accounts are structured, they could

potentially create some exposure to changing rates. Such exposures need

to be identified, measured, related to primary capital, and reported to

all oversight authorities on a regular basis.

Rate shock analysis is a standard form of risk assessment that is

used in many industry applications. The FFIEC High Risk Stress Test for

CMOs, total return analysis, and income simulation models all feature

this approach. It is a useful and conservative practice that enhances

the risk management process.

Risk analysis, supervision and compliance. The Board is

particularly concerned that corporate credit unions have a

comprehensive risk management process in place to identify all

applicable risk exposures before and after an investment is made. The

process should ensure that such risk exposures are measured on a

regular basis and in relation to all limitations that are in place to

govern such risks.

The risk management process is a discipline that requires a large

measure of vigilance on the part of management. The impact of changing

market and credit conditions may be swift and severe. The risk

management process must be a proactive and defensive mechanism for

preserving the earnings and capital of the credit union. The more in-

depth the risk analysis and the greater the frequency of review, the

more accountable the board of directors can be in policing the risks

that are undertaken.

The board of directors of a corporate credit union is responsible

for the actions and risk exposures that the institution undertakes. In

order to effectively understand and ultimately supervise risk, the

board must receive a complete distillation of risk activities on a

timely basis. That information must summarize the actions taken and the

consequences, as stated in terms of capital at risk, that will result

when applicable risk factors change.

The board of directors cannot supervise and direct the actions of

the credit union at the line level. However, the board is obligated to

demand that management provide all of the information necessary for

board members to make fully informed decisions. Thus the reporting

element of the risk management process is no less important in the

scheme of managing risk. The board must have clear, concise summaries

of risk activities and exposures in order to carry out its oversight

responsibilities.

The Board regards risk analysis, supervision, and compliance as an

essential process for all credit unions. Risk management procedures

vary considerably among corporate credit unions and are a major

concern. The need to standardize the discipline of the risk management

process is obvious. The incorporation of a consistent framework will

bolster the integrity and viability of the corporate credit union

system.

Contingency funding. The role of all corporate credit unions as

liquidity custodians has drawn attention to a major deficiency in the

system. The disregard for contingent funding plans has been a

particularly troublesome issue. Contingency funding plans guarantee the

role of a corporate as an inviolable provider of liquidity, regardless

of the circumstances. The fact that liquidity is most scarce when it is

most required underscores the danger of not planning for unexpected

needs.

The borrowing capacity of corporate credit unions is not an

unlimited resource. Many corporate credit unions have suggested that

liquidity will be easily obtainable through repurchase agreements and

lines of credit. The reality is that many factors can impinge upon the

ability of a corporate to borrow the amount of funds for the amount of

time that is required.

Corporate credit unions must evaluate all viable resources of

liquidity on a regular basis and understand how changes in market

factors will impact those resources over time. For example, it may be

unreasonable to assume that borrowing capacity is not hindered by

severe economic circumstances. The corporate must know that it can

provide liquidity in normal or catastrophic situations. The board of

directors needs to be assured that the plan to meet liquidity needs is

realistic and up-to-date.

Modeling. The Board wishes to quantify more precisely how the

proposed changes to Part 704 will affect corporate credit union

earnings and capital accumulation. To this end, NCUA will conduct

analytical assessments of these changes through simulation modeling

techniques using a sampling of corporate credit union balance sheets.

Interested parties who believe the proposed changes, if implemented,

would adversely affect corporate credit unions' ability to serve their

members are requested to submit the results of similar assessments to

support their positions.

Section 704.5--Investments

The Board is proposing to modify and move the policies section of

current Sec. 704.6 to proposed Sec. 704.4. The remaining sections of

current Sec. 704.6 would be revised and recodified at proposed

Sec. 704.5. The Board is also proposing to include the relevant

provisions of Part 703, governing federal credit union investments, in

proposed Part 704, rather than simply incorporating them by reference,

as is done currently. Sections 703.4 and 703.5, with some

modifications, would be included in Sec. 704.5, and Sec. 703.2, which

provides definitions, would be included in proposed Sec. 704.2.

Proposed Sec. 704.5(a) would replace current Sec. 704.6(b)(2)(i),

except that the reference to investments authorized by Part 703 would

be deleted. This paragraph would also explain the operation of the

divestiture provisions set forth in the remainder of the section.

Finally, this paragraph would address investments that must be

classified as available-for-sale and the limit on investments in any

one issuer. While the current rule bases all investment limitations on

a percentage of assets, the [[Page 20444]] proposed rule would base

those limitations on a percentage of primary capital. This would

encourage the building of primary capital.

The Board has determined that a corporate credit union should not

be permitted to invest in any non federally insured state banks, trust

companies, and mutual savings banks, so current Sec. 704.6(b)(2)(ii) is

not included in proposed Sec. 704.5.

Proposed Sec. 704.5(b) would replace current Sec. 704.6(b)(i),

except that it would refer to CSOs rather than CUSOs. In addition, the

limit on investments in CSOs would move to new Sec. 704.7, which would

address a number of issues relating to CSOs.

Proposed Sec. 704.5(c) would authorize corporate credit unions to

invest in U.S. Central Corporate Credit Union.

Proposed Sec. 704.5(d) would establish limits on investments in

domestic banks for the first time. Proposed Sec. 704.5(e) would replace

current Sec. 704.6(b)(2)(iii), except that it would add an entity

rating requirement for foreign banks and establish limits on

investments in foreign banks in any one country and in all foreign

banks.

Proposed Sec. 704.5 (f) and (g) would replace current

Sec. 704.6(b)(2) (iv) and (v) respectively. Proposed Sec. 704.5(h)

would replace current Sec. 704.6(b)(2)(vi), except that it would revise

the stress test and would require corporate credit unions test their

CMOs/REMICs on a monthly basis. Corporate credit unions would have to

test floating as well as fixed rate CMOs.

Proposed Sec. 704.5 (i)-(k) would set forth the relevant authorized

activities listed in Sec. 703.4, and proposed Sec. 704.5(l) would set

forth most of the prohibitions listed in Sec. 703.5. The Board is

proposing additionally to prohibit corporate credit unions from buying

or selling swap agreements, option contracts, and forward rate

agreements, and making deposits in non federally insured state banks,

trust companies, and mutual savings banks. While federal natural person

credit unions may purchase stripped mortgage backed securities and CMO/

REMIC residuals to reduce interest rate risk, the Board is proposing to

prohibit corporate credit unions from purchasing such securities for

any purpose. The Board is also proposing to lower the maturity date on

permissible zero coupon securities from 10 years Pto 5.

Finally, the Board notes that Sec. 107(15)(B) of the Federal Credit

Union Act authorizes federal credit unions to invest in mortgage

related securities as defined in Sec. 3(a)(41) of the Securities

Exchange Act of 1934, 15 U.S.C. 78c(a)(41). Until recently, that

definition required that a security be backed by promissory notes

secured by a first lien on real estate, upon which is located ``a

dwelling or mixed residential and commercial structure.'' Because of

this, a mortgage related security did not include a security backed by

purely commercial mortgages. The Riegle Community Development and

Regulatory Improvement Act of 1994, enacted on September 23, 1994,

amended the Exchange Act to provide that the underlying notes of a

mortgage related security may be directly secured by a first lien on

real estate upon which is located one or more commercial structures.

Thus, federal credit unions were granted the statutory authority to

invest in commercial mortgage related securities.

Under Sec. 107(15), however, this authority is ``subject to such

regulations as the Board may prescribe.'' It is the Board's view that

federal credit unions may not purchase commercial mortgage related

securities until explicitly permitted to do so by regulation. The Board

has not yet issued a regulation permitting federal natural person

credit unions to purchase such securities but will consider the matter

in its upcoming review of Part 703. The Board will also consider at

that time whether commercial mortgage related securities are

appropriate for corporate credit unions. In the meantime, to eliminate

potential confusion, the proposed rule explicitly prohibits corporate

credit unions from purchasing such securities.

Section 704.6--Capital Goals, Objectives, and Strategies

The proposed rule would substitute ``CSO'' for ``CUSO'' and would

require a cost/benefit analysis and impact study when an activity might

have a material effect on a corporate credit union. When an impact

study must be conducted, the proposed rule would require that it be on

a corporate's earnings, in addition to its capital position.

Section 704.7--Corporate Service Organizations (CSOs)

As noted in the definitions section, the Board is proposing to

revise the CUSO concept for corporate credit unions. Currently, Part

704 incorporates much of Sec. 701.27 by reference. Because of the

proposed change in terminology, and the determination that some of the

provisions of Sec. 701.27 are not applicable to corporate credit union

service organizations, proposed Sec. 704.7 contains all of the

necessary regulations governing CSOs. Therefore, the proposed rule does

not reference Sec. 701.27.

Proposed Sec. 704.7(a) would incorporate most of the definitions in

current Sec. 701.27(c). Proposed Sec. 704.7(b) would limit a

corporate's aggregate investments in and loans to member and non member

CSOs to 15 percent of capital at the time the investment or loan is

made. The current rule allows a corporate to invest 15 percent of

capital in and loan 15 percent of capital to CUSOs. The Board has

determined that it is inappropriate to allow corporate credit unions to

risk 30 percent of capital in such organizations. The Board has added

``member or non member'' to the limitation to clarify that loans to and

investments in all CSOs are governed by the Sec. 704.7, regardless of

whether the CSO is a member of the corporate credit union or not.

Proposed Sec. 704.7(b) would incorporate some of the limitations of

Sec. 701.27 (b) and (d). Proposed Sec. 704.7(c) would incorporate the

conflicts provisions of Sec. 701.27(d)(6). Proposed Sec. 704.7(d) would

replace the accounting and information access provisions of

Sec. 701.27(d)(7).

Finally, proposed Sec. 704.7(e) would require a corporate credit

union to take steps to bring its investments and loans in line with the

new regulation. Under the proposed rule, corporate credit unions would

not be authorized to invest in or loan to CUSOs. If a CUSO already

meets the CSO requirements, an investment in or loan to the CUSO

becomes an investment in or loan to a CSO, and there is no problem. If

a CUSO can meet the CSO requirements with some slight adjustments, as

for example, eliminating a service that a CSO may not perform, it is

expected that this be accomplished by the effective date of the

regulation. If there is no way that a CUSO can meet the CSO

requirements, a corporate credit union must divest itself of any

investments in the CUSO by the effective date of the regulation. Any

loan to such a CUSO must be terminated if permitted by contract. If not

permitted, a corporate credit union may retain the loan on its books

but may not renew or extend it.

Section 704.8--Lending

The Board is proposing to revise Sec. 704.7(b)(1), which would be

codified at Sec. 704.8(b)(1), to tighten the limitation on aggregate

loans to one member credit union. In the existing regulation, loans to

one borrower are limited to the corporate credit union's capital or 10

percent of the corporate credit union's shares and capital, whichever

is greater. Under the proposed regulation, the aggregate of loans to

one member credit union would be limited to the corporate credit

union's primary capital. The [[Page 20445]] Board believes that the

existing limitation is far too permissive and poses a potential threat

to the NCUSIF. In several of the larger corporate credit unions, the

current limitation could allow one member to borrow in excess of $1

billion. Limiting total loans to one borrower to the amount of a

corporate credit union's primary capital would greatly reduce the

exposure to the corporate credit union and the NCUSIF and, in addition,

would provide an incentive to the corporate credit union to increase

its level of primary capital.

The Board is proposing to eliminate Sec. 704.7(b)(2) and (3),

regarding loans to members that are not credit unions and to credit

unions that are not members. Proposed Sec. 704.8(b)(5) would explicitly

prohibit a corporate from making a loan to a non member or a natural

person member. Except for providing overdraft protection for a clearing

account, a corporate credit union would also be prohibited from making

a loan to a trade association member. Loans to CSO members would be

governed by proposed Sec. 704.7. The proposed rule would require any

loan to a trade association member to be fully collateralized.

Section 704.9--Borrowing

The Board is proposing to tighten the limitations on the amount a

corporate credit union may borrow. In the existing regulation, a

corporate credit union is permitted to borrow up to 10 times capital or

50 percent of shares (excluding shares created by the use of member

reverse repurchase agreements) and capital, whichever is greater. In

the proposed regulation, the wording is changed to indicate whichever

is less. The Board has determined that tying borrowing authority more

closely to the level of capital would encourage capital growth.

Additionally, unless extremely strong capital existed, the corporate

would not be permitted to borrow up to 50 percent of shares and

capital. The more well capitalized a corporate credit union, the higher

borrowing capacity it would have. The Board views this as an

enhancement to the safety and soundness of the corporate credit union

system.

This section is also revised in the proposed regulation to restrict

a corporate credit union to borrowing only to meet liquidity needs,

except for issuing a minimum amount of commercial paper to maintain a

market presence. As a liquidity center, a corporate credit union must

have the ability to borrow funds under certain circumstances to ensure

that liquidity remains available to meet member credit unions' needs.

However, the Board wishes to make it clear that corporate credit unions

should not be borrowing in order to fund investment transactions to

enhance net income. Therefore, the proposed regulation also requires

that the need for borrowing be documented, in writing, and that the

documentation be provided to the corporate credit union's auditor and

supervisory committee and to NCUA.

Finally, in acknowledging that there may exist extraordinary

circumstances under which a corporate credit union may need to borrow

in excess of the limitation set forth in this section, the regulation

allows a corporate credit union to submit a request to NCUA for

additional borrowing authority.

Section 704.10--Services

The Board is proposing to revise this section to eliminate the list

of services a corporate credit union may provide. Currently, corporate

credit unions may provide services involving investments, liquidity

management, payment systems, and correspondent services. The Board

believes that this authority has, on occasion, been interpreted too

broadly. Accordingly, the Board is proposing simply to say that

corporate credit unions may provide services to their member credit

unions, intending that to mean traditional loan, deposit and payment

services. A corporate credit union wishing to provide other types of

services should contact NCUA to determine whether such services are

permissible.

The Board is also proposing to clarify that a corporate credit

union may provide services only to its members. Historically, two

corporate credit unions might informally agree between themselves for

one to provide services to the members of the other. These types of

correspondent arrangements are permissible for natural person credit

unions, but only when the agreements are formalized in writing and

certain other requirements are met. The Board has determined that such

arrangements, even if formalized, are inappropriate for corporate

credit unions and is proposing to state that explicitly in the

regulation.

Corporate credit unions have also argued that they are authorized

to provide services to non member credit unions pursuant to Sec. 701.26

of the NCUA Rules and Regulations, which provides that a federal credit

union may enter into a contract with one or more credit unions or other

organizations ``for the purpose of sharing, utilizing, renting,

leasing, purchasing, selling, and/or joint ownership of fixed assets or

engaging in activities and/or services which relate to the daily

operations of credit unions.'' NCUA never intended this provision to

authorize corporate credit unions to provide services to non member

credit unions. Such an interpretation would make field of membership

limitations meaningless. The provision was intended to allow natural

person credit unions to jointly contract to obtain services from a non

credit union third party. In any event, the Board has the opportunity

now to clarify that Sec. 701.26 does not authorize corporate credit

unions to provide services to non member credit unions.

Finally, corporate credit unions have argued that they can accept

deposits from non member credit unions pursuant to Section 107(7)(G) of

the Federal Credit Union Act, 12 USC 1757(7)(G), which authorizes

federally chartered credit unions to invest in the shares or deposits

of any central credit union. The Board has determined that corporate

credit unions may only accept shares or deposits from members, pursuant

to its authority, under Section 120(a) of the Federal Credit Union Act,

12 USC 1766(a), to issue regulations governing corporate credit unions.

--

Section 704.11--Fixed Assets

The Board is proposing to revise Sec. 704.11(b)(1) to change the

limitation on the amount a corporate credit union may invest in fixed

assets without a waiver from NCUA. In the existing regulation, a

corporate credit union may invest up to 15 percent of capital in fixed

assets. In the proposed regulation, the limitation has been revised to

15 percent of primary capital. While all of the corporates are

presently in compliance with the proposed limitation, some may wish to

make large fixed asset investments in the future. The Board views the

proposed limit as a further incentive for corporate credit unions to

build stronger levels of primary capital.

Additionally, references to the Director, Office of Examination and

Insurance have been changed to NCUA in the proposed rule. These

references relate to the submission of waivers from the fixed asset

limitation. For the time being, waivers should be submitted to the

Director, Office of Corporate Credit Unions. Waivers may need to be

submitted elsewhere in the future, however, if NCUA offices are

restructured. Finally, the Board is proposing to eliminate the

provision regarding a corporate credit union proceeding with its

investment if it does not receive notification of the action taken on

its request within 45 days. This will ensure that NCUA has adequate

time to review any corporate credit union request to invest more than

15 [[Page 20446]] percent of primary capital in fixed assets.

Section 704.12--Corporate Credit Union Reserves

A number of sources (including Congress, the General Accounting

Office, and the Corporate Credit Union Study Committee) have expressed

concern over the relativity low levels of capital in corporate credit

unions. The proposed regulation provides for several very specific

changes to the corporate credit union reserve structure. The existing

regulation establishes specific levels of capital that corporate credit

unions must maintain, based on risk-weighted assets. Currently,

corporate credit unions must maintain a ratio of 4 percent of primary

capital to risk-weighted assets and a ratio of 8 percent of total

capital to risk-weighted assets.

Under proposed Sec. 704.12(a), corporate credit unions would have

to reach capital levels based on primary capital to average daily

assets. The Board is proposing the changes to the reserve requirements

in order to emphasize the need for stronger primary capital. The

regulation provides for incremental increases in the minimum ratio of

primary capital to average daily assets until the level of 4 percent is

achieved by January 1, 1998. (The increments are 2.5 percent by January

1, 1996 and 3 percent by January 1, 1997.) The regulation does allow

for a possible waiver from the requirements at the first two intervals.

However, the Board is committed to building primary capital in

corporate credit unions. Any waiver request from this requirement must

include very specific time frames, with supporting documentation, for

reaching the regulatory capital level.

Proposed Sec. 704.12(b) would require that all corporate credit

unions maintain a minimum of 10 percent capital to risk-weighted

assets. Under the existing regulation, corporate credit unions are

required to maintain a capital to risk-weighted assets ratio of 8

percent. Although the major focus will be on primary capital, the Board

sees a continued need to provide a measure of capital compared to risk-

weighted assets. Risk-weighting of assets does provide some delineation

of the risk in a corporate credit union's balance sheet. The amount of

capital available to cover the risks associated with the balance sheet

is valuable information to corporate credit union officials as well as

NCUA. Currently, all corporate credit unions with the exception of U.S.

Central have capital to risk-weighted assets in excess of 10 percent.

Proposed Sec. 704.12(i) would require that each corporate credit

union develop a written projection detailing its action plan to achieve

the primary capital requirements established in Sec. 704.12(a). As part

of the plan, a corporate credit union will need to make reserve

transfers at levels that will ensure compliance with the minimum

primary capital requirements. At a minimum, corporate credit unions

that have already met the minimum 4 percent primary capital

requirement, must make reserve transfers as set forth in

Sec. 704.12(j).

Section 704.12(j) establishes the required reserve transfers for

corporate credit unions. The proposed rule makes certain changes to

conform to the proposed definitions of primary capital and capital to

risk-weighted asset ratios. There are five reserve transfer categories.

All corporate credit unions would be required to maintain minimum

primary capital to average daily assets of 4 percent and capital to

risk-weighted assets of 10 percent. Therefore, Category 1 begins when

these ratios are at 4 percent and 10 percent respectively. Once the

primary capital ratio is greater than 6 percent, and the capital to

risk-weighted assets ratios is greater than 20 percent, reserve

transfers are no longer required. For the purposes of reserve

transfers, it is proposed that PCSAs be excluded from primary capital.

The Board is proposing to eliminate the term ``risk-based

capital.'' In the current regulation, risk-based capital includes

primary capital and secondary capital up to 100 percent of primary

capital. Risk-based capital is used in comparison to risk-weighted

assets to establish minimum risk-based capital ratios for reserving

purposes. In the proposed regulation, reserve transfers are based on

primary capital to average daily assets and capital to risk-weighted

assets. There would no longer be any specific category of risk-based

capital.

Section 704.13--Representation

As noted earlier, the Board amended the representation section of

Part 704 last year. In light of the proposed changes to the definition

of ``member,'' the Board is proposing to delete certain provisions that

were designed to ensure that corporate credit unions were controlled by

their member credit unions. These provisions would no longer be

necessary if only representatives of member credit unions are permitted

to vote and stand for election. The Board is also proposing to

specifically state that the provisions of Sec. 701.14 of the Rules and

Regulations, governing changes in officials and senior executive

officers in credit unions that are newly chartered or in troubled

condition. This provision always was intended to apply to corporate

credit unions, as it is not inconsistent with any provision in Part

704. However, the provision refers to NCUA Regional Directors, and in

light of the centralization of the corporate credit union program, its

application to corporate credit unions may have been unclear.

Accordingly, the Board is proposing to specifically include Sec. 701.14

in Part 704, changing the reference from ``Regional Director'' to

``NCUA.'' As with requests for waivers to the fixed asset limitation,

notices required under Sec. 701.14 should be filed, for the time being,

with the Director, Office of Corporate Credit Unions.

Section 704.14--Audit Requirements

In the existing regulation, this section deals only with the need

for an annual audit. The only change relating to the annual audit in

the proposed regulation is the addition of wording to clearly specify

that the annual opinion audit will include a letter of reportable

conditions.

The Board is proposing to add a new Sec. 704.14(b) to include a

requirement for an internal auditor function in corporate credit unions

with assets in excess of $100 million. The requirement would also apply

to corporates with assets under $100 million, if so ordered by NCUA.

The Board realizes that not all corporate credit unions can readily

afford to hire a full-time internal auditor. Based on the asset size

and complexity of the institution, the corporate could hire a part-time

internal auditor or contract with an outside firm to perform the

internal auditor function. The proposed regulation requires that the

internal auditor report directly to the chair of the corporate credit

union's supervisory committee. The regulation provides specific minimum

responsibilities that the internal auditor must perform. Finally, the

internal auditor's findings and reports must be documented and made

available for review to the outside auditor and NCUA.

Section 704.15--Contracts/Written Agreements

The Board is not proposing any changes to this provision.

Section 704.16--State-Chartered Corporate Credit Unions

The Board is proposing to add new Sec. 704.16(b) to put non

federally insured state-chartered corporate credit unions that receive

funds from federally insured credit unions on notice that they are

considered ``institution-affiliated parties'' within Section 206(r)

[[Page 20447]] of the Federal Credit Union Act and subject to all of

the enforcement provisions of the Act.

Section 704.17--Fidelity Bond Coverage

The Board is proposing only minor changes to this Section. Section

704.17(d) would be amended to clarify that the minimum bond coverage is

based on a corporate credit union's average daily assets as of the

preceding December 31. The Board notes that in current Sec. 704.17(f),

the deductibles are based on a corporate credit union's primary capital

to risk asset ratio. Since the proposed regulation eliminates this

ratio, another one must be used. The Board is proposing that it be the

primary capital ratio and specifically requests comments on this issue.

Section 704.18--Effective Date

The Board is proposing to make any final regulation on these

matters effective January 1, 1996. However, although not stated in the

proposed regulation itself, the Board is also considering requiring

compliance with Sec. 704.5, governing investments, 30 days after the

final rule is published in the Federal Register. Investments purchased

before that date would be governed by the regulation in effect at the

time of purchase. The Board is proposing to make the investment

provisions applicable before the remainder of the regulation to deter

corporate credit unions from ``loading up'' on investments that would

no longer be permissible after January 1, 1996. All investments,

regardless of when acquired, would be subject to the asset-liability

provisions of proposed Section 704.4. In order to accomplish this

objective, it may be necessary for the Board to issue a final rule in

two separate stages with different effective dates, or to issue one

rule with a 30 day effective date, but with a delayed compliance date

for all sections other than Secs. 704.2, Definitions, and 704.5,

Investments.

Appendix A--Summary of Risk Weights and Risk Categories for

Corporate Credit Unions

The major focus of the Board's proposed amendments to the risk

weight schedule is the risk weighting of certain mortgage-backed

securities. The current regulation weights CMOs based on their

response to the interest-rate sensitivity test, and the Board has

determined that this is inappropriate in a scheme designed to

address credit risk. In the proposed rule, mortgage-backed

securities, including pass throughs and certain CMOs (but not

stripped mortgage backed securities), that are issued or guaranteed

by a U.S. Government agency or U.S. Government-sponsored enterprise

are assigned to the risk weight category appropriate to the issuer

or guarantor. Generally, a privately-issued mortgage backed security

meeting certain criteria, as set forth in the proposed regulation,

is treated as essentially an indirect holding of the underlying

assets, and assigned to the same risk category as the underlying

assets. Privately-issued mortgage backed securities whose structures

do not qualify them to be regarded as indirect holdings of the

underlying assets are assigned to the 100 percent risk category.

While the risk category to which mortgage backed securities is

assigned will generally be based upon the issuer or guarantor or, in

the case of privately-issued mortgage backed securities, the assets

underlying the security, any class of a mortgage backed security

that can absorb more than its pro rata share of loss without the

whole issue being in default, is assigned to the 100 percent risk

category.

The specific changes being proposed are as follows. In Category

1, the Board is proposing to delete item (g), claims on or

unconditionally guaranteed by sovereign central governments of

``AAA'' rated countries. Its inclusion in the current rule was

inadvertent, as such investments are not permissible for corporate

credit unions.

In Category 2, 20 percent risk weight, the Board is proposing to

delete the material at the end of Category 2, addressing bank

ratings. Proposed Section 704.5 sets forth the minimum ratings for

deposits in banks. The Board is also proposing to delete items (j)

and (k), which are certain types of repurchase transactions. Such

transactions should be risk weighted according to the type of

collateral involved. Item (m), CMOs/REMICs that pass the interest

rate sensitivity test, would also be deleted from the regulation. As

noted above, the proposed rule risk weights CMOs based on the

issuer, guarantor, or assets underlying the security. Finally, the

Board is proposing to change the risk weighting of claims on foreign

banks from 20 percent to 50 percent.

In Category 3, 50 percent risk weight, the Board is proposing to

delete item (b), CMOs that pass the interest rate sensitivity test,

and replace it with privately-issued mortgage backed securities that

meet certain criteria relating to credit risk. Claims on foreign

banks would be added to this category.

In Category 4, 100 percent risk weight, the Board is proposing

to delete investments in CUSOs from item (a), as corporate credit

unions would not be permitted to hold such investments from the

effective date of this regulation. The proposed rule would add item

(b), loans to and investments in CSOs, and replace item (e),

membership capital share deposits, with permanent and secondary

capital share accounts. The Board is also proposing to delete item

(d), hold-in-custody repurchase agreements, as the risk weighting of

such agreements should be based on the underlying collateral. The

Board is proposing to delete item (f), stripped mortgage backed

securities and item (g), residual interests of CMOs/REMICs. Under

the proposed rule, these investments would not be permissible for

corporate credit unions. In this category, the Board is also

proposing to add an item for other claims on private obligors, to

make it clear that unless a claim on a private obligor is guaranteed

or insured by a U.S. Government agency or enterprise, is

collateralized by such a claim, or is secured or collateralized by

highly liquid and reliable collateral, it is risk-weighted at 100

percent.

Appendix C--Model Forms

As noted earlier, the Board is proposing to delete the current

Appendix C as unnecessary and potentially confusing. The proposed

rule contains a new Appendix C, which features model disclosure

forms for permanent and secondary capital share accounts. Corporate

credit unions that use these forms will be deemed to be in

compliance with the proposed disclosure requirements of Sec. 704.2.

Section 741.3--Other Requirements

The Board is proposing to amend Sec. 741.3 of the NCUA Rules and

Regulations, governing requirements for insured credit unions, to

prohibit federally insured credit unions from transacting business with

corporate credit unions that do not comply with Part 704 and are not

examined by NCUA.

Regulatory Procedures

Regulatory Flexibility Act

The NCUA Board certifies that the proposed rule, if made final,

will not have a significant economic impact on small credit unions

(those under $1 million in assets). The rule applies only to corporate

credit unions, all of which have assets well in excess of $1 million.

Accordingly, a Regulatory Flexibility Analysis is not required.

Paperwork Reduction Act

The proposed rule contains a requirement for the collection of

additional information and a maintenance of documentation by a

corporate credit union. The proposed rule requires that each corporate

credit union develop and implement certain policies and plans and

document compliance with such policies and plans. The proposed rule

also requires that certain information regarding asset-liability

management and investments be sent to NCUA or maintained in the records

of the corporate credit union.

The paperwork requirements will be submitted to the Office of

Management and Budget (OMB) for review under the Paperwork Reduction

Act. Written comments on the paperwork requirements should be forwarded

directly to the OMB Desk Officer indicated below at the following

address: OMB Reports Management Branch, New Executive Office Building,

Room 10202, Washington, DC 20530. Attn: Milo Sunderhauf. NCUA will

publish a notice in the Federal Register [[Page 20448]] once OMB action

is taken on the submitted request.

Executive Order 12612

Executive Order 12612 requires NCUA to consider the effect of its

actions on state interests. It states that: ``Federal action limiting

the policy-making discretion of the states should be taken only where

constitutional authority for the action is clear and certain, and the

national activity is necessitated by the presence of a problem of

national scope.'' The risk of loss to federally insured credit unions

and the NCUSIF caused by actions of corporate credit unions are

concerns of national scope. The proposed rule would help assure that

proper safeguards are in place to ensure the safety and soundness of

corporate credit unions.

The rule applies to all corporate credit unions that accept funds

from federally insured credit unions. The NCUA Board believes that the

protection of such credit unions, and ultimately the NCUSIF, warrants

application of the proposed rule to non federally insured corporate

credit unions. The NCUA Board, pursuant to Executive Order 12612, has

determined that this rule may have an occasional direct effect on the

states, on the relationship between the national government and the

states, or on the distribution of power and responsibilities among the

various levels of government. However, the potential risk to the NCUSIF

without these changes justifies them.

List of Subjects

12 CFR Part 704

Credit unions, Reporting and recordkeeping requirements.

12 CFR Part 741

Bank deposit insurance, Credit unions, Reporting and recordkeeping

requirements.

By the National Credit Union Administration Board on April 13,

1995.

Becky Baker,

Secretary of the Board.

For the reasons set forth in the preamble, NCUA proposes to amend

12 CFR chapter VII as follows:

1. Part 704 is revised to read as follows:

PART 704--CORPORATE CREDIT UNIONS

Sec.

704.1 Scope.

704.2 Definitions.

704.3 Planning; strategic and business plans.

704.4 Asset/liability management.

704.5 Investments.

704.6 Capital goals, objectives, and strategies.

704.7 Corporate Service Organizations (CSOs).

704.8 Lending.

704.9 Borrowing.

704.10 Services.

704.11 Fixed assets.

704.12 Corporate credit union reserves.

704.13 Representation.

704.14 Audit requirements.

704.15 Contracts/written agreements.

704.16 State-chartered corporate credit unions.

704.17 Fidelity bond coverage.

704.18 Effective date.

Appendix A to Part 704--Summary of Risk Weights and Risk Categories for

Corporate Credit Unions

Appendix B to Part 704--Off-Balance Sheet Credit Conversion Factors

Appendix C to Part 704--Model Forms

Authority: 12 U.S.C. 1762, 1766(a), 1781, and 1789.

Sec. 704.1 Scope.

(a) This part establishes special rules for all federally insured

corporate credit unions. Non-federally insured corporate credit unions

must agree, by written contract, to both adhere to the requirements of

this part and submit to examinations, as determined by NCUA, as a

condition of receiving shares or deposits from federally insured credit

unions. This part grants certain additional authorities to federal

corporate credit unions. Except to the extent that they are

inconsistent with this part, other provisions of NCUA's Rules and

Regulations (12 CFR Parts 700-795) and the Federal Credit Union Act

apply to federally chartered corporate credit unions and federally

insured state-chartered corporate credit unions to the same extent that

they apply to other federally chartered and federally insured state-

chartered credit unions, respectively.

(b) The NCUA Board has the authority to issue orders which vary

from this Part. This authority is provided under Section 120(a) of the

Federal Credit Union Act, 12 U.S.C. 1766(a). Requests by state-

chartered corporate credit unions for waivers to this part must be

approved by the state regulator before being submitted to NCUA.

Sec. 704.2 Definitions.

Adjusted trading means any method or transaction used to defer a

loss whereby a corporate credit union sells a security to a vendor at a

price above its current market price and simultaneously purchases or

commits to purchase from the vendor another security at a price above

its current market price.

Asset-backed securities (ABS) means all securities supported by

installment loans or leases or by revolving lines of credit. This

definition excludes those securities referred to in the financial

markets as mortgage-backed securities (MBS) which includes

collateralized mortgage obligations (CMOs) and real estate mortgage

investment conduits (REMICs).

Average daily assets means the daily average of net assets

calculated on the basis of assets at the close of each day in the

period.

Average life means the weighted average time to principal repayment

with the amount of the principal paydowns (both scheduled and

unscheduled) as the weights.

Bailment for hire contract means a contract whereby a third party,

bank, or other financial institution, for a fee, agrees to exercise

ordinary care in protecting the securities held in safekeeping for its

customers.

Capital means the total of all primary capital and secondary

capital share accounts upon which notice of withdrawal has not been

given.

Cash forward agreement means an agreement to purchase or sell a

security with delivery and acceptance being mandatory and at a future

date in excess of thirty (30) days from the trade date.

Collateralized mortgage obligation (CMO) means a multi-class bond

issue collateralized by whole loan mortgages or mortgage-backed

securities (MBS).

Commitment means any unconditional arrangement that obligates a

corporate credit union to extend credit in the form of loans; to

purchase loans, securities or other assets; or to participate in loans

and leases. Commitments also include overdraft facilities, revolving

credit, home equity, and mortgage lines of credit, and similar

transactions. An obligation is conditional if the corporate credit

union is not automatically obligated to extend funds.

Corporate credit union means an organization that:

(1) Is chartered under Federal or state law as a credit union;

(2) Receives shares from and provides loan services to credit

unions;

(3) Is operated primarily for the purpose of serving other credit

unions;

(4) Is designated by NCUA as a corporate credit union;

(5) Limits natural person members to the minimum required by state

or federal law to charter and operate the credit union; and

(6) Does not condition the eligibility of any credit union to

become a member on that credit union's membership in any other

organization. [[Page 20449]]

Corporate service organization (CSO) means an entity that:

(1) Serves only corporate credit unions that have made investments

in or loans to the entity and/or the member credit unions of such

corporate credit unions;

(2) Limits the services it provides to data and item processing,

wire transfers, record retention and storage, securities brokerage

services, investment advisory services, and trust services; and

(3) Is chartered as a corporation under state law.

Credit equivalent amount means the face amount of each off-balance

sheet item multiplied by a credit conversion factor outlined in

Appendix B of this part.

Embedded options mean characteristics of certain assets and

liabilities which give the issuer of the instrument the ability to

change the features such as final maturity, rate, principal amount and

average life. These options include, but are not limited to, caps,

floors, and prepayment options. These options are found in most

mortgage-backed securities, structured notes, and some Network

instruments.

Expected maturity means the date on which all remaining principal

amounts of an instrument or bond are anticipated to be paid off on the

basis of projected payment assumptions.

Facility means the home office of a corporate credit union or any

suboffice thereof including, but not necessarily limited to, wire

service, telephonic station, or mechanical teller station.

Federal funds transaction means a short-term or open-ended transfer

of funds between U.S. depository institutions.

-Federally issued CMO/REMIC means a CMO or REMIC which is issued by

a U.S. Government agency or a U.S. Government-sponsored corporation or

enterprise.

-Foreign bank means an institution which is organized under the

laws of a country other than the United States, which is engaged in the

business of banking, and which is recognized as a bank by the banking

supervisory authority of the country in which it is organized.

--Forward rate agreement means an over-the-counter market

instrument that allows two parties to trade interest rates on a

notional principal amount for a specified time period in the future.-

--Futures contract means a contract for the future delivery of

commodities, including certain government securities, sold on

commodities exchanges.

-Identically matched means matched, to the extent possible, by

amount, repricing, behavior, and final maturity. Any embedded options,

such as calls, caps, and prepayments, must be replicated in the

corresponding source or use of funds.

-Immediate family member means a person related by blood, marriage,

or adoption.

-Long-term investment means, for the purpose of issue ratings, an

investment that has an initial maturity, or expected maturity, greater

than one year.

--Market price means the price at which a security can be bought or

sold.

-Market value of portfolio equity (MVPE) means the net market value

of all assets and liabilities, including their embedded options. This

reflects the liquidation value of the balance sheet.

-Material means an amount that exceeds 5 percent of the corporate

credit union's capital.

--Maturity date means the date on which a security matures, and

shall not mean the call date or the average life of the security.

-Member reverse repurchase transaction means an integrated

transaction in which a corporate credit union purchases a security from

one of its member credit unions under agreement by that member credit

union to repurchase the same security at a specified time in the

future. The corporate credit union then sells that same security, on

the same day, to a third party, under agreement to repurchase it on the

same date on which the corporate credit union is obligated to return

the security to its member credit union.

-Net assets means total assets less Central Liquidity Facility

(CLF) stock subscriptions, CLF loans guaranteed by the NCUSIF, U.S.

Central CLF certificates, and member reverse repurchase transactions.

-Net interest income means the difference between income earned on

interest bearing assets and interest paid on interest bearing

liabilities.

-Official means any director or committee member.

-Option contract means a right, but not an obligation, to buy or

sell a security at a specified price and settlement date in the future.

-Overnight means having a maturity or call date of one business

day.

-Penalty for early withdrawal of a share, deposit, or liability

means a fee which will, at a minimum, fully compensate a corporate

credit union for the difference between fair value and book value of

the asset that is divested (including any accumulated unrealized losses

since the asset was purchased), or the replacement cost of funds, to

meet the demand for early withdrawal.

-Permanent capital share account (PCSA). (1) PCSA means a share

account that:

-(i) Is restricted to credit unions within a corporate credit

union's field of membership;

-(ii) Is not subject to share insurance coverage by the NCUSIF or

other deposit insurer;

-(iii) Cannot be used by member credit unions to collateralize

borrowings;

-(iv) Is available to absorb losses in the event of a deficit in

other primary capital accounts in the corporate credit union;

-(v) In the event of liquidation of the corporate credit union, is

payable only after satisfaction of all liabilities of the liquidation

estate including uninsured obligations to shareholders and the NCUSIF;

-(vi) Is redeemable only with the written concurrence of NCUA; and

-(vii) Pays noncumulative dividends.

-(2) The terms and conditions of permanent capital share accounts

must be disclosed at the time an account is opened. The board of

directors of the member credit union must acknowledge those terms and

conditions by signing a disclosure form. A copy of the disclosure form

must be given to the member credit union, with the original retained by

the corporate credit union.

-Primary capital means statutory reserves, undivided earnings,

other reserves (excluding the allowance for loan losses and accumulated

unrealized gains/losses on available-for-sale securities), net income

(loss), and permanent capital share accounts (PCSAs). No more than 50

percent of primary capital may be comprised of PCSAs.

-Primary dealer means a bank or investment dealer authorized to buy

and sell government securities in direct dealings with the Federal

Reserve Bank of New York in its execution of Fed open market

operations.

-Privately issued CMO/REMIC means a CMO or REMIC that qualifies as

a permissible investment for a federal credit union pursuant to the

provisions of Section 107(15)(B) of the Federal Credit Union Act.

-Rated, in the context of investments under Sec. 704.5, means rated

by an SEC-recognized rating agency. An SEC-recognized rating agency is

any firm recognized by the Securities and Exchange Commission (SEC) as

qualified to assign risk ratings to various investment instruments

required to be registered with the SEC.

Real Estate Mortgage Investment Conduit (REMIC) means a nontaxable

entity formed for the sole purpose of holding a fixed pool of mortgages

[[Page 20450]] secured by an interest in real property and issuing

multiple classes of interests in the underlying mortgages.

--Repurchase transaction means a transaction in which a corporate

credit union agrees to purchase a security from a counterpart and to

resell the same or any identical security to that counterpart at a

later date.

--Residual interest means the remainder cash flows from a CMO or

REMIC transaction after payments due bondholders and trust

administrative expenses have been satisfied.

--Reverse repurchase transaction means a transaction whereby a

corporate credit union agrees to sell a security to a purchaser and to

repurchase the same or any identical security from that purchaser at a

future date and at a specified price.

-Risk-weighted assets means the sum of total balance sheet assets

and off-balance sheet credit equivalent amounts multiplied by their

appropriate risk weights.

-Secondary capital share account. (1) Secondary capital share

account means a share account that:

-(i) Is restricted to credit unions within a corporate credit

union's field of membership;

-(ii) Is not subject to share insurance coverage by the NCUSIF or

other deposit insurer;

-(iii) Is established, at a minimum, as a two year notice account;

-(iv) Cannot be used by member credit unions to collateralize

borrowings;

-(v) Is available to absorb losses in the event of a deficit in

primary capital in the corporate credit union; and

-(vi) In the event of liquidation of the corporate credit union, is

payable only after satisfaction of all liabilities of the liquidation

estate including uninsured obligations to shareholders and the NCUSIF.

-(2) Notwithstanding the notice requirement, in the case of a

member credit union's merger or liquidation, a corporate credit union

shall return the member's secondary capital shares, less any penalty

for early withdrawal, within 30 days of written notification from NCUA.

-(3) The terms and conditions of secondary capital share accounts

must be disclosed at the time an account is opened. The board of

directors of the member credit union must acknowledge those terms and

conditions by signing a disclosure form. A copy of the disclosure form

must be given to the member credit union, with the original retained by

the corporate credit union. A statement of the terms and conditions of

a secondary capital share account must be provided to member credit

unions annually. The annual disclosure statement must be signed by the

chairman of the board of the corporate credit union.

Section 107(8) institution means an institution described in

Section 107(8) of the Federal Credit Union Act (12 U.S.C. 1757(8)).

-Senior management employee means the corporate credit union's

chief executive officer, any assistant chief executive officer (e.g.,

any assistant president, any vice president or any assistant treasurer/

manager) and the chief financial officer (controller).

Settlement date means the date originally agreed to by a corporate

credit union and a counterpart for settlement of the purchase or sale

of a security.

--Short sale means the sale of a security not owned by the seller.

Short-term investment means, for the purpose of issue ratings, an

investment that has an initial maturity, or expected maturity, of one

year or less.

Standby commitment means a commitment to either buy or sell a

security, on or before a future date, at a predetermined price. The

seller of the commitment is the party receiving payment for assuming

the risk associated with committing either to purchase a security in

the future at a predetermined price, or to sell a security in the

future at a predetermined price. The seller of the commitment is

required to either accept delivery of a security (in the case of a

commitment to buy) or make delivery of a security (in the case of a

commitment to sell), in either case at the option of the buyer of the

commitment.

Stripped mortgage-backed security (SMBS) means a security that

represents either the principal or interest only portion of the cash

flows of an underlying pool of mortgages.

Swap agreement means a contract to exchange interest payments that

are based upon a specified dollar amount (the ``notional'') at

specified dates in the future.

Trade association means an association of organizations or persons

formed to promote their common interests. The term includes entities

owned or controlled directly or indirectly by such an association but

does not include credit unions.

Trade date means the date a corporate credit union originally

agrees, whether orally or in writing, to enter into the purchase or

sale of a security.

Undivided earnings means all forms of retained earnings, except:

(1) Regular or statutory reserves; and

(2) Valuation allowances established to meet the full and fair

disclosure requirements of Sec. 702.3 of this chapter.

United States depository institutions means offices or branches

(foreign and domestic) of federally insured banks and depository

institutions chartered and headquartered in the United States, Puerto

Rico, and U.S. territories and possessions. This includes banks, mutual

or stock savings banks, savings or building and loan associations,

cooperative banks, credit unions, international banking facilities of

domestic depository institutions, and U.S. chartered depository

institutions owned by entities outside of the United States.

United States Government or its agencies means the United States

Government or instrumentalities of the United States whose debt

obligations are fully and explicitly guaranteed as to the timely

payment of principal and interest by the full faith and credit of the

United States Government.

United States Government-sponsored corporations and enterprises

means agencies originally established or chartered to serve public

purposes specified by Congress, but whose obligations are not

explicitly guaranteed by the full faith and credit of the United States

Government.

Wholesale corporate credit union means a corporate credit union

that serves other corporate credit unions.

Zero coupon bond means a debt obligation that makes no periodic

interest payments but instead is sold at a discount from its face

value. The holder of a zero coupon bond realizes the rate of return

through the gradual appreciation of the security, which is redeemed at

face value on a specified maturity date.

Sec. 704.3 Planning; strategic and business plans. -

(a) The board of directors of a corporate credit union shall adopt

a written strategic plan with appropriate objectives and goals. This

plan will be reviewed periodically during the year to determine that

the goals are being accomplished. At least annually, the strategic plan

will be reviewed and updated. These reviews will be documented in

writing and provided upon request to the auditor, supervisory

committee, and NCUA. -

(b) A written business plan will be prepared for any material

expenditure in fixed assets, new products and services, or investments

in a CSO and/or for any planned field of membership expansion. Such

plans shall be provided upon request to the auditor, supervisory

committee, and NCUA. [[Page 20451]]

Sec. 704.4- Asset/liability management. -

(a) Matching. All shares and deposits, exclusive of permanent

capital share accounts and secondary capital share accounts, whether

fixed or variable rate, must be identically matched to a corresponding

asset. An identical match means that any factor which impacts the cash

flows of an asset must be identically replicated in the corresponding

liability. The corporate's capital is exempt from the matching

requirement. The overnight shares of a corporate credit union are

subject to the matching requirement with the following exception: Up

to, but no more than, 25 percent of a corporate credit union's

overnight shares and deposits (based on the average daily overnight

balance for the preceding calendar year) can be matched against

variable rate securities with a final maturity of three years or less

provided that the following provisions are met: the security coupon

reprices at least monthly, the coupon formula is tied to an appropriate

market index (such as LIBOR, PRIME, Fed funds and Treasury Bills) not a

lagging indicator (such as COFI); the change in coupon formula is not

inverse to or a multiple of the change in the market index, and, if the

asset is a marketable security, is classified as ``available for

sale''.-

(b) Unmatched embedded option limitation. A corporate credit union

is limited to an aggregate amount of instruments that possess unmatched

embedded options of no more than capital. -

(c) Penalty for early withdrawal. All shares and deposits must

either be non redeemable or include a fair value penalty for early

withdrawal as defined in Sec. 704.2. -

(d) Portfolio pricing. The fair value of all investment securities,

regardless of classification, must be calculated and documented on a

monthly basis using reliable market price indicators. Such

documentation shall be provided upon request to the auditor,

supervisory committee, and NCUA. -

(e) Maximum unrealized loss on ``available-for-sale'' assets. The

aggregate loss in the accumulated unrealized gains/losses on

``available-for-sale'' assets, net of any unrealized gains/losses on

the corresponding source of funds, may not exceed 15 percent of primary

capital excluding accumulated unrealized gains/losses on available for

sale securities. Any violation of this limit must be addressed with a

corrective action that reduces the loss below the maximum allowed

within 10 days.

-(f) Rate shock analysis. A corporate credit union must perform a

monthly ``shock test'' calculation to show the impact upon its net

interest income and market value of portfolio equity (MVPE) for an

immediate and sustained tandem shift in interest rates of plus and

minus 300 basis points. The MVPE cannot change by more than plus or

minus 25 percent for a plus or minus 300 basis point rate shock. The

documentation for these calculations must include the balance sheet

categories, interest rates, and other assumptions used. This

information must be presented to a senior committee that includes board

membership and provided upon request to the auditor, supervisory

committee and NCUA.

-(g) Risk analysis. A corporate credit union must identify and list

all risks associated with an asset or source of funds prior to purchase

or issuance. Where applicable, the risk analysis must include, at a

minimum, liquidity, market, credit, legal, systems/operations,

sovereign, exchange, and management risks. The risk analysis shall be

maintained with other supporting documentation in a permanent record,

which shall be provided upon request to the auditor, supervisory

committee, and NCUA.

-(h) Risk supervision. A corporate credit union must identify,

measure, and document the risks associated with all assets. The measure

of risk exposure and a comparison of such exposure to board policy

limits must be reported in writing on a quarterly basis. Such reports

shall be provided upon request to the auditor, supervisory committee,

and NCUA.

-(i) Risk compliance. A corporate credit union must review all

investment assets on a monthly basis for compliance with NCUA Rules and

Regulations and board of director policies to determine whether any

such assets require divestiture. The results and analysis shall be

provided upon request to the auditor, supervisory committee, and NCUA.

-(j) Contingency funding. A corporate credit union must develop a

contingency funding plan that ranks, in order of priority, all sources

of liquidity, by category and amount, that are available to service an

immediate outflow of member funds. The plan must analyze the impact

that potential changes in fair value will have on the disposition of

assets in a variety of interest rate scenarios and be reviewed by a

committee of the board no less frequently than annually or as market

and business conditions dictate. The plan and annual review shall be

provided upon request to the auditor, supervisory committee, and NCUA.

-(k) Policies. Corporate credit unions must develop and implement

comprehensive written policies, which shall be reviewed annually and

provided upon request to the auditor, supervisory committee, and NCUA.

The policies must address, at a minimum, the following:

-(1) Diversification of assets by issuer, type and risk;

-(2) Approved issuers, instruments, and broker-dealers;

-(3) Liabilities, including pricing strategies, diversification and

penalties for early withdrawal;-

(4) Limits on the maximum permitted change in net interest income

as calculated for a plus and minus 300 basis point rate shock; -

(5) Acceptable credit risk; -

(6) Authorization of and limitations on persons/committees involved

with asset/liability management.

Sec. 704.5 Investments.

-(a) A corporate credit union may invest in those securities,

deposits, and obligations set forth in Sections 107(7), 107(8), and

107(15)(B) of the Federal Credit Union Act (12 U.S.C. 1757(7), 1757(8),

and 1757(15)(B)), except as provided in this section. Any asset that

has the potential to be divested must be classified as available-for-

sale. An asset downgraded by the same rating agency used when the

investment was purchased must be divested within 10 business days of

the downgrade. Other than investments in wholesale corporate credit

unions, CSOs, and repurchase transactions, the aggregate of a corporate

credit union's investments in any one institution, issuer, or trust is

limited to 25 percent of the corporate credit union's primary capital

at the time of purchase.

-(b) A corporate credit union may invest in CSOs, as defined in

Sec. 704.2 and subject to the limitations of Sec. 704.7.

-(c) A corporate credit union may invest in deposits in, the sale

of Federal Funds to, and debt obligations of wholesale corporate credit

unions.

-(d)(1) A corporate credit union may invest in deposits in, the

sale of Federal Funds to, and debt obligations of Section 107(8)

institutions subject to the following requirements:

-(i) The institution must have assets of at least US $5 billion and

an entity rating no lower than B (or equivalent);

-(ii) The investment must be rated no lower than A-1 (or

equivalent) for short-term investments and no lower than AA (or

equivalent) for long-term investments; and

-(iii) The investment must be denominated in United States dollars.

-

(2) A written evaluation of lines of exposure to all Section 107(8)

[[Page 20452]] institutions must be prepared quarterly by qualified

staff and approved by an appropriate committee of the board so that

changes in credit quality can be detected at the earliest opportunity.

This approval must be documented in the minutes of the committee and be

provided upon request to the auditor, supervisory committee, and NCUA.

-(e)(1) A corporate credit union may invest in deposits in, the

sale of Federal Funds to, and debt obligations of foreign banks,

subject to the following requirements: -

(i) The bank must have assets of at least US $20 billion and an

entity rating no lower than A/B (or equivalent); -

(ii) The investment must be rated no lower than A-1 (or equivalent)

for short-term investments and no lower than AA (or equivalent) for

long-term investments; -

(iii) The investment must be denominated in United States dollars;

-

(iv) The country in which the issuing bank is organized must be

rated AAA (or equivalent) for political and economic stability; -

(v) Aggregate investments in banks in any single foreign country

are limited to 50 percent of the corporate credit union's primary

capital at the time of purchase; and -

(vi) Aggregate investments in all foreign banks are limited to 300

percent of the corporate credit union's primary capital at the time of

purchase. -

(2) A written evaluation of lines of exposure to all foreign banks

must be prepared quarterly by qualified staff and approved by an

appropriate committee of the board so that changes in credit quality

can be detected at the earliest opportunity. This approval must be

documented in the minutes of the committee and be provided upon request

to the auditor, supervisory committee, and NCUA. -

(f) A corporate credit union may invest in marketable debt

obligations of corporations chartered in the United States, provided

that the obligations are rated not lower than A-1 (or equivalent) for

short-term investments and not lower than AA- (or equivalent) for long-

term investments. A marketable obligation is one that may be sold with

reasonable promptness at a price which corresponds reasonably to its

fair value. This authority does not apply to debt obligations that are

convertible into the stock of the corporation.

-(g) A corporate credit union may invest in asset-backed securities

subject to the following requirements:

-(1) Rated not lower than AAA (or equivalent); and

-(2) Having an average life at the time of purchase not to exceed 5

years.

-(h) A corporate credit union may invest in federally and privately

issued CMOs/REMICs, subject to the following limitations:

(1) All investments in fixed rate CMOs/REMICs must meet the

following NCUA-modified FFIEC High Risk Security Test requirements:

(i) The weighted average life of the security may not exceed 5

years at the time of purchase;

(ii) The weighted average life may not extend by more than 2 years

nor contract by more than 3 years for an instantaneous shift in market

rates of plus or minus 300 basis points;

(iii) The investment's price may not decline by more than 10

percent for an instantaneous shift in market rates of plus or minus 300

basis points.

(2) All investments in floating rate CMOs/REMICs must meet the

following NCUA-modified FFIEC High Risk Security Test requirements:

(i) The weighted average life of the security may not exceed 5

years at the time of purchase;

(ii) The weighted average life may not extend by more than 2 years

nor contract by more than 3 years for an instantaneous shift in market

rates of plus or minus 300 basis points;

(iii) The investment's price may not decline by more than 5 percent

for an instantaneous shift in market rates of plus or minus 300 basis

points.

(3) The prepayment assumption for the underlying mortgages shall be

based on an industry standard median prepayment estimate or the median

estimate of no fewer than five independent brokerage firms, at least

one of which must be a primary dealer. When estimates from specific

dealers are used, those dealers must be approved by an appropriate

committee and listed along with monthly test results. The same industry

standard or selection of dealers must be used for all CMO/REMIC

securities each time the tests are performed. In computing the average

life of a CMO/REMIC investment, it must be assumed that the anticipated

rate of prepayment remains constant over the remaining life of the

mortgage collateral.

(4) Any CMO/REMIC security that fails the average life standard or

the price sensitivity test shall be divested within 10 business days.

(5) Results of monthly CMO/REMIC tests must be documented and

reviewed by an appropriate committee and maintained in a permanent

record. Such results shall be provided upon request to the auditor,

supervisory committee, and NCUA.

(i) A corporate credit union may enter into a cash forward

agreement to purchase or sell a security, provided that:

(1) The period from the trade date to the settlement date does not

exceed one hundred and twenty (120) days;

(2) If the credit union is the purchaser, it has written cash flow

projections evidencing its ability to purchase the security;

(3) If the credit union is the seller, it owns the security on the

trade date; and

(4) The cash forward agreement is settled on a cash basis at the

settlement date.

(j)- A corporate credit union may enter into a repurchase or

reverse repurchase transaction provided that the collateral securities

are permissible investments for corporate credit unions and the

transaction is priced to reflect accrued interest, the risk of the

securities, and the term of the trade. A corporate credit union

purchasing a security in a repurchase transaction must take physical

possession of the security, receive written confirmation of the

purchase and a safekeeping receipt from a third party under a written

bailment for hire contract, or be recorded as the owner of the security

through the Federal Reserve Book-Entry System. A corporate credit union

obtaining funds from a reverse repurchase transaction may not invest

those funds for a term greater than the maturity date of the reverse

repurchase transaction. A repurchase transaction shall be considered to

have a credit exposure of 5 percent of the principal and accrued

interest outstanding on the transaction for the purpose of the

limitation on investments in a single institution, issuer, or trust set

forth in paragraph (a) of this section.

(k) A corporate credit union may invest in a mutual fund if the

investments and investment transactions of the fund are legally

permissible for corporate credit unions.

(l) A corporate credit union is prohibited from:

(1) Purchasing or selling a standby commitment, except as provided

in Sec. 701.21(i) of this Chapter;

(2) Buying or selling a futures contract, forward rate agreement,

swap agreement, or option contract;

(3) Engaging in adjusted trading;

(4) Engaging in a short sale;

(5) Purchasing a stripped mortgage-backed security or residual

interest in a CMO/REMIC;

(6) Purchasing a zero coupon security with a maturity date that is

more than 5 years from the settlement date for purchase of the

security, except for funds matched against primary capital;

[[Page 20453]]

(7) Making deposits in nonfederally insured state banks, trust

companies, and mutual savings banks; and

(8) Purchasing commercial mortgage-related securities.

(m) A corporate credit union's officials, senior management

employees, and immediate family members of such individuals, may not

receive pecuniary consideration in connection with the making of an

investment or deposit by the corporate credit union. The prohibition

contained in this subsection also applies to any employee not otherwise

covered if the employee is directly involved in investments or

deposits. All transactions not specifically prohibited by this

paragraph must be conducted at arm's length and in the interest of the

credit union.

Sec. 704.6 Capital goals, objectives and strategies.

(a) General. Corporate credit unions shall adopt formal, written

goals (both long-term and short-term), objectives and strategies,

including a budgetary process, for the building of capital.

(b) Impact study. Where a proposed new service or program, purchase

or lease of a fixed asset, or investment in or loan to a CSO may have a

material effect on a corporate credit union, the corporate credit union

shall perform a cost/benefit analysis of the activity and a study of

its impact on the earnings and capital position of the corporate credit

union.

(c) Monitoring. Management will establish monitoring standards and

procedures to periodically review and reassess the capital position of

the corporate credit union and will document these reviews.

Sec. 704.7 Corporate service organizations (CSOs).

(a) The aggregate of all investments in and loans to member and non

member CSOs shall not exceed 15 percent of a corporate credit union's

capital at the time the investment or loan is made. A corporate credit

union may not use this authority to acquire control, directly or

indirectly, of another financial institution, or to invest in shares,

stocks or obligation of another financial institution, insurance

company, trade association, liquidity facility, or similar

organization. A CSO must be operated as an entity separate from any

credit union. A corporate credit union investing in or lending to a CSO

must take those steps necessary to ensure that it will not be held

liable for the obligations of the CSO.

(b) An official or senior management employee of a corporate credit

union which has invested in or loaned to a CSO, and immediate family

members of such an individual, may not receive, either directly or

indirectly, any salary, commission, investment income, or other income

or compensation, from the CSO. This prohibition extends to any other

corporate credit union employee if such employee deals directly with

the CSO.

(c) Prior to making an investment in or loan to a CSO, a corporate

credit union must obtain a written agreement that the CSO will:

(1) Follow GAAP;

(2) Provide financial statements to the corporate credit union at

least quarterly;

(3) Obtain an annual CPA audit and provide a copy to the corporate

credit union; and

(4) Allow the auditor, supervisory committee, and NCUA complete

access to its books, records, and any other pertinent documentation.

(d) A corporate credit union with an investment in, or a loan to, a

credit union service organization (CUSO) as defined in Sec. 701.27 of

this chapter must, by January 1, 1996, divest of the investment,

terminate the loan if contractually possible, or ensure that the

organization meets the requirements of this section and Sec. 704.2. If

the loan cannot legally be terminated by January 1, 1996 it cannot be

renewed or extended upon its next renewal or extension date.-

Sec. 704.8 Lending.

(a) Policies. A corporate credit union shall develop, implement,

and adhere to written loan policies which address, at a minimum:

(1) Loan types and limits;

(2) Documentation for each loan and line of credit;

(3) Security;

(4) Analysis of financial and operational data;

(5) Monitoring standards; and

(6) Review and reassessment of the credit quality of the member

credit union.

(b) General. Each loan or line of credit limit will be determined

after analyzing the financial and operational soundness of the member

credit union and the ability of the member credit union to repay the

loan. Loans are limited as follows:

(1) Loans to member credit unions. The maximum aggregated amount in

loans and approved lines of credit to any one member credit union,

excluding pass-through and guaranteed loans from the CLF and the NCUSIF

and repurchase transactions, shall not exceed the corporate credit

union's primary capital.

(2) Loans to CSOs. A corporate credit union may make loans and

issue lines of credit to CSOs, as defined in Sec. 704.2 and subject to

the limitations of Sec. 704.7

(3) Participation loans with other corporate credit unions. A

corporate credit union is permitted to participate in a loan with

another corporate credit union and must retain an interest of at least

5 percent of the face amount of the loan. The participation agreement

may be executed at any time prior to, during, or after disbursement. A

participating corporate credit union must exercise the same due

diligence as if it were the originating corporate credit union.

(4) Prepayment penalties. If provided for in the loan contract, a

corporate credit union is authorized to assess prepayment penalties on

loans made to member credit unions.

(5) Prohibitions. A corporate credit union may not make loans,

issue lines of credit, or otherwise provide loan services to non

members or natural person members. Except for providing overdraft

protection for clearing accounts, a corporate credit union may not

provide loan services to member trade associations. A loan or line of

credit provided to a member trade association for the purpose of

overdraft protection must be fully collateralized by any security which

is permissible under Sec. 704.5.

Sec. 704.9 Borrowing.

A corporate credit union may borrow up to 10 times capital or 50

percent of shares (excluding shares created by the use of member

reverse repurchase agreements) and capital, whichever is less. Other

that the issuance of the minimum amount of commercial paper to maintain

a market presence, a corporate credit union may borrow only to meet

liquidity needs. The need must be documented in writing and provided

upon request to the auditor, supervisory committee, and NCUA. CLF

borrowings, as agent member for natural person credit unions, and

borrowed funds created by the use of repurchase agreements are excluded

from this limit. In the event of extreme liquidity demands from its

member credit unions, a corporate credit union may submit a request to

NCUA for additional borrowing authority.

Sec. 704.10 Services.

A corporate credit union may provide services only to its members,

subject to the limitations of this Part. A corporate credit union may

not provide services to non members through the correspondent credit

union authority or pursuant to Sec. 701.26 of this

chapter. [[Page 20454]]

Sec. 704.11 Fixed assets.

(a) General. A corporate credit union's ownership in fixed assets

shall be limited as described in Sec. 701.36 of this chapter, except

that in lieu of Sec. 701.36 (c)(1) through (4), paragraph (b) of this

section applies.

(b) Investment in fixed assets. (1) A corporate credit union may,

invest in fixed assets where the aggregate of all such investments does

not exceed 15 percent of primary capital.

(2) A corporate credit union shall submit requests to exceed the

limitation of paragraph (b)(1) of this section to NCUA. Requests shall

be supplemented by such statements and reports as NCUA may require. If

NCUA determines that the proposal will not adversely affect the

corporate credit union, it will respond in writing and an aggregate

dollar amount or percentage of primary capital will be approved for

investment in fixed assets.

Sec. 704.12 Corporate Credit Union Reserves.

(a) Minimum Primary Capital Ratio. The primary capital ratio is

computed by dividing primary capital by average daily assets for the

month. Each corporate credit union shall maintain a minimum primary

capital ratio as follows:

(1) By January 1, 1996, primary capital shall be at least 2.5

percent of average daily assets. If this level of primary capital is

not achieved, the corporate must submit a request for a waiver of this

requirement to NCUA. The waiver request must provide an acceptable plan

for meeting the requirement. This waiver request must be submitted to

NCUA no later than 90 days prior to the effective date of this

requirement.

(2) By January 1, 1997, primary capital shall be at least 3.0

percent of average daily assets. If this level of primary capital is

not achieved, the corporate must submit a request for a waiver of this

requirement to NCUA. The waiver request must provide an acceptable plan

for meeting the requirement. This waiver request must be submitted to

NCUA no later than 90 days prior to the effective date of this

requirement.

(3) By January 1, 1998, primary capital must be at least 4.0

percent of average daily assets. Thereafter, each corporate credit

union will be required to maintain a minimum primary capital to average

daily assets ratio of 4.0 percent. Any corporate credit union that does

not meet this provision will be considered to be inadequately

capitalized and must submit to NCUA a plan of action to achieve this

capital level within an acceptable period of time. This plan must be

submitted to NCUA within 30 calendar days of the month-end in which

minimum primary capital fell below 4.0 percent.

(b) Capital to risk-weighted assets ratio. The capital to risk-

weighted assets ratio is computed by dividing capital by total risk-

weighted assets at month end. Each corporate credit unions shall

maintain capital of at least 10.0 percent of risk-weighted assets. Any

corporate credit union that does not meet this provision will be

considered to be inadequately capitalized and must submit to NCUA a

plan of action to achieve this capital level within an acceptable

period of time. This plan must be submitted to NCUA within 30 calendar

days of the month-end in which capital fell below 10.0 percent of risk-

weighted assets.

(c) Failure to comply with minimum capital requirements. NCUA will

review each plan of action to achieve stated levels of capital as put

forth in paragraphs (a) and (b) of this section. NCUA will make a

determination as to the viability of the plan of action, and analyze

the impact of the capital level on the corporate credit union and its

member credit unions. If it is determined that a plan of action is not

viable, the corporate credit union's board of directors will be

required to merge or accept other corrective action as set forth by

NCUA.

(d) Procedures. Balance sheet assets and credit equivalent amounts

for off- balance sheet items are assigned to a risk-weight category.

The total dollar amount in each category shall be multiplied by the

risk-weight assigned to that category. The sum of the categories

comprises risk-weighted assets.

(e) Frequency. Each corporate credit union shall calculate and

document the ratio of primary capital to average daily assets and

capital to risk-weighted assets each month. Documentation of such

calculations shall be maintained and provided upon request to the

auditor, supervisory committee, and NCUA.

(f) Risk weights for balance sheet assets. Each balance sheet asset

shall be assigned a risk weight of 0 percent, 20 percent, 50 percent,

and 100 percent as indicated in Appendix A of this part.

(g) Other considerations. (1) An investment in the shares of a

mutual fund is assigned to the risk category appropriate to the highest

risk-weighted asset that the fund is permitted to hold.

(2) Accruals will be assigned the risk-weighting of the underlying

asset that they represent.

(h) Credit conversion factors for off-balance sheet Items. Off-

balance sheet items will be risk-weighted each month using credit

conversion factors as indicated in Appendix B of this part.

(i) Interim reserve accumulation. Corporate credit unions will be

required to accumulate sufficient amounts of primary capital to meet

the requirements of paragraph (a) of this section. Each corporate

credit union must prepare a written projection, including assumptions

utilized, which shows compliance with the minimum primary capital

requirements each year through the accumulation of net income and

reserve transfers, the issuance of PCSAs, and/or the shrinkage of the

corporate credit union's assets. The written projection must be

provided upon request to the auditor, supervisory committee, and NCUA.

In addition, each corporate credit union must meet the reserve transfer

requirements outlined in paragraph (j) of this section.

(j) Required reserve transfers. The amount that a corporate credit

union is required to transfer or set aside in reserves is based on both

the corporate credit union's primary capital and capital to risk-

weighted assets ratios. For the purposes of calculating required

reserve transfers, PCSAs shall be excluded from primary capital. Ranges

of capital ratios have been established. These capital ratio ranges are

then associated with 1 of 5 corresponding categories in determining the

required reserve transfer. To qualify for a lower reserve transfer

category, the capital ratio must fall in both the primary capital and

capital to risk-weighted assets ratio ranges of the applicable

category. The corporate credit union shall set aside an amount equal to

the appropriate required reserve transfer percentage multiplied by the

corporate credit union's average daily assets for the transfer period

multiplied by the number of days in the transfer period divided by 365.

(1) Category 1 requires a corporate reserve transfer percentage of

20 basis points of average daily assets when either the primary capital

ratio is greater than 4.0 percent and less than 4.75 percent or the

capital to risk-weighted assets ratio is greater than 10.0 percent and

less than 11.0 percent.

(2) Category 2 requires a corporate reserve transfer percentage of

15 basis points of average daily assets when either the primary capital

ratio is greater than 4.75 percent and less than 5.25 percent or the

capital to risk-weighted assets ratio is greater than 11.0 percent and

less than 14.0 percent.

(3) Category 3 requires a corporate reserve transfer percentage of

10 basis points of average daily assets when either the primary capital

ratio is greater [[Page 20455]] than 5.25 percent and less than 5.75

percent or the capital to risk-weighted assets ratio is greater than

14.0 percent and less than 17.0 percent.

(4) Category 4 requires a corporate reserve transfer percentage of

5 basis points of average daily assets when either the primary capital

ratio is greater than 5.75 percent and less than 6.0 percent or the

capital to risk-weighted assets ratio percentage is greater than 17.0

percent and less than 20.0 percent.

(5) Category 5 requires a corporate reserve transfer percentage of

0 basis points when the primary capital ratio is greater than 6.0

percent and the capital to risk-weighted assets ratio percentage is

greater than 20.0 percent.

(k) Full and fair disclosure. Corporate credit unions must provide

reserves necessary for full and fair disclosure as specified in

Sec. 702.3 of this chapter.

Sec. 704.13 Representation.

(a) Board representation. The board shall be determined as

stipulated in the standard corporate federal credit union bylaws

governing election procedures, provided that:

(1) The chair of the board may not serve simultaneously as an

officer, director, or employee of a credit union trade association;

(2) A majority of directors may not serve simultaneously as

officers, directors, or employees of the same credit union trade

association or its affiliates (not including chapters or other subunits

of a state trade association); and -

(3) For purposes of meeting the requirements of paragraphs (a)(2)

and (a)(3) of this section, an individual may not serve as a director

or chair of the board if that individual holds a subordinate employment

relationship to another employee who serves as an officer, director, or

employee of a credit union trade association.

(b) Representatives of member credit unions. (1) A member credit

union may appoint one of its members or officials as a representative

to the corporate credit union. The representative shall be empowered to

attend membership meetings, to vote, and to stand for election on

behalf of the member. Only a member credit union representative is

eligible to vote and to stand for election. No individual may serve as

the representative of more than one member credit union in the same

corporate credit union.

(2) Any vacancy on the board of a corporate credit union caused by

a representative being unable to complete his or her term shall be

filled by the board of the corporate credit union according to its

bylaws governing the filling of board vacancies.

(c) Recusal provision. (1) No director, committee member, officer,

or employee of a corporate credit union shall in any manner, directly

or indirectly, participate in the deliberation upon or the

determination of any question affecting his or her pecuniary interest

or the pecuniary interest of any entity (other than the corporate

credit union) in which he or she is interested, except if the matter

involves general policy applicable to all members, such as setting

dividend or loan rates or fees for services.

(2) An individual is ``interested'' in an entity if he or she:

(i) Serves as a director, officer, or employee of the entity;

(ii) Has a business, ownership, or deposit relationship with the

entity; or

(iii) Has a business, financial, or familial relationship with an

individual whom he or she knows has a pecuniary interest in the entity.

(3) In the event of the disqualification of any directors, by

operation of paragraph (c)(1) of this section, the remaining qualified

directors present at the meeting, if constituting a quorum with the

disqualified directors, may exercise, by majority vote, all the powers

of the board with respect to the matter under consideration. Where all

of the directors are disqualified, the matter must be decided by the

members of the corporate credit union.

(4) In the event of the disqualification of any committee member by

operation of paragraph (c)(1) of this section, the remaining qualified

committee members, if constituting a quorum with the disqualified

committee members, may exercise, by majority vote, all the powers of

the committee with respect to the matter under consideration. Where all

of the committee members are disqualified, the matter shall be decided

by the board of directors.

(d) Administration. (1) A corporate credit union shall be under the

direction and control of its board of directors. While the board may

delegate the performance of administrative duties, the board is not

relieved of its responsibility for their performance. The board may

employ a chief executive officer who shall have such authority and such

powers as delegated by the board to conduct business from day to day.

Such chief executive officer must answer solely to the board of the

corporate credit union, and may not be an employee of a credit union

trade association.

(2) The provisions of Sec. 701.14 of this chapter apply to

corporate credit unions, except that where reference is made to

``Regional Director,'' substitute ``NCUA.''

Sec. 704.14 Audit requirements.

(a) Annual audit. (1) The corporate credit union supervisory

committee shall cause an annual opinion audit, which shall include a

reportable conditions letter (i.e. management letter) to be made by an

independent, duly licensed certified public account (CPA) and shall

submit the audit report to the board of directors. A summary of the

audit report shall be submitted to the membership at the next annual

meeting.

(2) The CPA's audit workpapers shall be provided upon request to

NCUA.

(3) A copy of the audit report and reportable conditions letter

(i.e. management letter) shall be submitted to NCUA, within 30 days

after receipt by the board of directors.

(b) Internal auditor function. (1) A corporate credit union with

net assets in excess of $100 million as of the preceding December 31,

or as ordered by NCUA, will be required to employ or contract the

services of an internal auditor.

(2) The internal auditor will report directly to the chairperson of

the corporate credit union's supervisory committee.

(3) The internal auditor's responsibilities will include, but are

not limited to, the review of ongoing compliance with statutory and

regulatory requirements, adherence to the corporate credit union's own

policies and procedures, testing of the accuracy and completeness of

recordkeeping and operation functions, ensuring adequate control

measures are in place, apprising the supervisory committee of all

findings, and providing appropriate recommendations to address concerns

and deficiencies relating to the condition or operations of the

corporate credit union.

(4) The internal auditor's reports, findings, and recommendations

will be in writing. Oral presentations by the internal auditor to the

supervisory committee will be documented in the supervisory committee

minutes. All documentation relating to the work of the internal auditor

will be provided upon request to the external auditor and NCUA.

Sec. 704.15 Contracts/written agreements.

Services, facilities, personnel, or equipment shared with any party

shall be supported by a written contract, with the duties and

responsibilities of each party specified and the allocation of service

fee/expenses fully supported and documented. [[Page 20456]]

Sec. 704.16 State-chartered corporate credit unions.

(a) This part does not expand the powers and authorities of any

state-chartered corporate credit union, beyond those powers and

authorities provided under the laws of the state in which it was

chartered. -

(b) A state-chartered corporate credit union that is not insured by

the National Credit Union Share Insurance Fund, but that receives funds

from federally insured credit unions, is considered an ``institution-

affiliated party'' within the meaning of Section 206(r) of the Federal

Credit Union Act, 12 U.S.C. 1786(r).

Sec. 704.17 Fidelity bond coverage.

(a) Scope. This section provides the fidelity bond requirements for

employees and officials in corporate credit unions.

(b) Review of coverage. The board of directors of each corporate

credit union shall, at least annually, carefully review the bond

coverage in force to determine its adequacy in relation to risk

exposure and to the minimum requirements in this section.

(c) Minimum coverage; Approved forms. Every corporate credit union

will maintain bond coverage with a company holding a certificate of

authority from the Secretary of the Treasury. All bond forms, and any

riders and endorsements which limit the coverage provided by approved

bond forms, must receive the prior written approval of the NCUA Board.

The Corporate Credit Union Discovery Bond (NCUA 100) and Standard Form

24 with Credit Union Bond Conversion Endorsement are approved for use

by corporate credit unions. Credit Union Blanket Bond Form 581 and Form

23--Extended Form, may also be utilized by corporate credit unions.

Fidelity bonds must provide coverage for the fraud and dishonesty of

all employees, directors, officers, and supervisory and credit

committee members. Notwithstanding the foregoing, all bonds must

include a provision, in a form approved by the NCUA Board, requiring

written notification by surety to the Board: When the bond of a credit

union is terminated in its entirety; or when bond coverage is

terminated, by issuance of a written notice, on an employees, director,

officer, supervisory or credit committee member. Said notification

shall be sent to the Secretary of the NCUA Board or designee and shall

include a brief statement of cause for termination.

(d) Minimum; coverage amounts. (1) The minimum amount of bond

coverage will be computed based on the corporate credit union's average

daily assets as of December 31 of the preceding year. The following

table lists the minimum requirements:

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

Minimum

Net assets bond

(million)

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

Less than $50 million--.................................... $1.0

$50--$99 million........................................... 2.0

$100--$499 million......................................... 4.0

$500--$999 million......................................... 6.0

$1.0--$1.999 billion....................................... 8.0

$2.0--$4.999 billion....................................... 10.0

$5.0--$9.999 billion....................................... 15.0

$10--$24.999 billion....................................... 20.0

$25.0 billion plus......................................... 25.0

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

(2) It is the duty of the board of directors of each corporate

credit union to provide adequate protection to meet its unique

circumstances by obtaining, when necessary, bond coverage in excess of

the above minimums. -

(e) Reduced coverage; NCUA approval. Any proposal for reduced

coverage must be approved in writing by the NCUA Board at least 20 days

in advance of the proposed effective date of the reduction. -

(f) Deductibles. (1) The maximum amount of deductibles allowed are

based on the corporate credit union's primary capital ratio as defined

in Sec. 704.12(a). The following table sets out the maximum

deductibles:

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

Primary capital ratio Maximum deductible

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

Less than 4.0 percent.............. 7.5 percent of primary capital.

4.0--7.99 percent.................. 10.0 percent of primary capital.

8.0--11.99 percent................. 12.0 percent of primary capital.

Greater than 12.0 percent.......... 15.0 percent of primary capital. -

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

(2) A deductible may be applied separately to one or more insuring

clauses in a blanket bond. Deductibles in excess of those showing in

this section must have the written approval of the NCUA Board at least

20 days prior to the effective date of the deductibles. -

(g) Additional coverage. The NCUA Board may require additional

coverage for any corporate credit union when, in the opinion of the

Board, current coverage is insufficient. The board of directors of the

corporate credit union must obtain additional coverage within 30 days

after the date of written notice from the NCUA Board.

Sec. 704.18 Effective date.

The regulations in this part are effective beginning January 1,

1996.

Appendix A to Part 704--Summary of Risk Weights and Risk Categories

for Corporate Credit Unions

Category 1: Zero Percent Risk Weight.

a. Coin and currency on hand or physically in transit.

b. Balances due from and claims on Federal Reserve Banks.

c. Claims on and portions of claims that are unconditionally

guaranteed by the U.S. Government or its agencies.

d. Claims collateralized by cash or eligible deposits.

e. CLF subscriptions, including U.S. Central CLF Participation

Certificates, and CLF Pass-Through Loans from the CLF through U.S.

Central to the corporate credit unions.

f. Asset Accounts related to Member Reverse Repurchase

Agreements without indemnity obligation.

g. Accrued Interest Receivable on the above.

Category 2: 20 Percent Risk Weight.

a. Items, other than coin and currency, in process of

collection.

b. Claims on or portions of claims guaranteed by U.S.

Government-sponsored corporations and enterprises.

c. Claims conditionally guaranteed by the U.S. Government or its

agencies or U.S. Government-sponsored corporations and enterprises.

d. Claims or portions of claims (including Repurchase

Agreements) collateralized by securities issued by the U.S.

Government or its agencies or U.S. Government-sponsored corporations

and enterprises.

e. General obligation claims on state and local governments

located in the United States.

-f. Claims on U.S. depository institutions (including Federal

Funds sold)

-g. Claims on a corporate credit union.

-h. Asset accounts related to Member Reverse Repurchase

Agreements with indemnity obligation.

-i. Asset-backed securities with remaining weighted average

lives of 3 years or less.

-j. Secured loans to credit unions.

-k. Accrued Interest Receivable on the above.

Category 3: 50 Percent Risk Weight.

-a. Asset-backed securities with remaining weighted average

lives greater than 3 years.

-b. Privately-issued mortgage-backed securities provided that:

(1) The security is structured so that it is treated as an indirect

holding of the underlying assets;\1\ (2) If the

[[Page 20457]] security is backed by a pool of conventional

mortgages, 1- to 4-family residential, or multifamily residential

properties, each underlying mortgage must have been made in

accordance with prudent underwriting standards, be performing in

accordance with its original terms, and not be 90 days or more past

due or carried in nonaccrual status; (3) If the security is backed

by privately-issued mortgage-backed securities, each underlying

security qualifies for the 50 percent risk category at the time the

pool is originated; and (4) if the security is backed by a pool of

multifamily residential mortgages, principal and interest payments

on the security are not 30 days or more past due.

\1\A private-issued mortgage-backed security may be treated as

an indirect holding of the underlying assets provided that: (1) The

underlying assets are held by an independent trustee and the trustee

has a first priority, perfected security interest in the underlying

assets on behalf of the holders of the security; (2) either the

holder of the security has an undivided pro rata ownership interest

in the underlying mortgage assets or the trust or single purpose

entity (or conduit) that issues the security has no liabilities

unrelated to the issued securities; (3) the security is structured

such that the cash flow from the underlying assets in all cases

fully meets the cash flow requirements of the security without undue

reliance on any reinvestment income; and (4) there is no material

reinvestment risk associated with any funds awaiting distribution to

the holders of the security. In addition, if the underlying assets

of a mortgage-backed security are composed of more than one type of

asset, for example, U.S. Government-sponsored agency securities and

privately-issued pass-through securities that qualify for the 50

percent risk category, the entire mortgage-backed security is

generally assigned to the category appropriate to the highest risk-

weighted asset underlying the issue. Thus, in this example, the

security would receive the 50 percent risk weight appropriate to the

privately-issued pass-through securities.

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

-c. Accrued Interest Receivable on the above.

-d. Claims on foreign banks (including Fed Funds sold).

Category 4: 100 Percent Risk Weight for All Other Assets

Including, but NOT LIMITED to:

-a. Loans to CUSOs outstanding as of January 1, 1996.

-b. Loans to and Investments in CSOs.

-c. Unsecured loans to credit unions.

-d. All fixed assets, including land, buildings, furniture,

fixtures, equipment, automobiles, and leasehold improvements.

-e. Permanent capital share account and secondary capital share

account investments in a corporate credit union.

-f. Any mortgage-backed securities that do not meet the criteria

for assignment to a lower risk weight (including any classes of

mortgage-backed securities that can absorb more than their pro rata

share of loss without the whole issue being in default).-

-g. Zero Coupon Securities.

-h. Claims on U.S. chartered corporations and bank holding

companies, including commercial paper and corporate bonds.

-i. Mutual Funds that do not qualify for a lower risk weighting.

-j. Prepaid Assets.

-k. Accounts Receivable and other receivables.

-l. NCUSIF Deposit

-m. Mortgage servicing rights.

-n. Intangible assets.

-o. All other claims on private obligors.

-p. Accrued Interest Receivable on the above.

Appendix B to Part 704--Off-Balance Sheet Credit Conversion Factors

Zero Percent Credit Conversion Factor:

-Unused portions of credit lines with original maturities of 6

months or less, or which are unconditionally cancelable.

50 Percent Credit Conversion Factor:

-a. Unused portions of credit lines with original maturities

exceeding 6 months.

-b. Commitments to participate in a loan or loan package.

100 Percent Credit Conversion Factor:

-a. Irrevocable standby letters of credit guaranteeing financial

performance (including VISA letters of credit issued by corporate

credit unions on behalf of their members, or standby letters of

credit backing Industrial Revenue Bonds).

-b. Forward Commitments to purchase an asset or perform under a

lease contract.

-c. Securities held in safekeeping loaned with indemnification.

Other off-balance sheet items will be addressed on a case-by-case

basis by NCUA.

Appendix C to Part 704--Model Forms

This appendix contains three sample forms intended for use by

corporate credit unions to aid in compliance with the permanent

capital share account and secondary capital share account disclosure

requirements of Sec. 704.2. Corporate credit unions that use these

forms will be in compliance with those requirements.

C-1 Sample disclosure for opening of secondary capital share

account.

Terms and Conditions of Secondary Capital Share Account

-(1) A secondary capital share account is not subject to share

insurance coverage by the NCUSIF or other deposit insurer.

-(2) A member credit union may withdraw shares from its

secondary capital share account only with two years' notice, except

where the member credit union is merging or liquidating. If a member

credit union merges, the corporate credit union will return the

member's secondary capital shares, less any penalty for early

withdrawal, within 30 days of written notification from NCUA.

-(3) Secondary capital share accounts cannot be used by member

credit unions to collateralize borrowings.

-(4) Secondary capital share accounts are available to absorb

losses in the event of a deficit in primary capital in the corporate

credit union.

-(5) Where the corporate credit union is liquidated, secondary

capital share accounts are payable only after satisfaction of all

liabilities of the liquidation estate including uninsured

obligations to shareholders and the NCUSIF.

I have read the above terms and conditions and I understand

them. I further agree to maintain in the credit union's files the

annual notice of terms and conditions of the secondary capital share

account.

Signatures of Directors and Date

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Name of member credit union:

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Address of member credit union:

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C-2 Sample annual notice of terms and conditions of secondary

capital share account.

Terms and Conditions of Secondary Capital Share Account

(1) A secondary capital share account is not subject to share

insurance coverage by the NCUSIF or other deposit insurer.

(2) A member credit union may withdraw shares from its secondary

capital share account only with two years' notice, except where the

member credit union is merging or liquidating. If a member credit

union merges, the corporate credit union will return the member's

secondary capital shares, less any penalty for early withdrawal,

within 30 days of written notification from NCUA.

-(3) Secondary capital shares cannot be used by member credit

unions to collateralize borrowings.

-(4) Secondary capital share accounts are available to absorb

losses in the event of a deficit in primary capital in the corporate

credit union.

-(5) Where the corporate credit union is liquidated, secondary

capital share accounts are payable only after satisfaction of all

liabilities of the liquidation estate including uninsured

obligations to shareholders and the NCUSIF. -----

Mailed to member - ----------------------------------------------------

Month/Year.

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Signature of the Chairman of the Board

C-3 Sample disclosure for opening of permanent capital share

account.

Terms and Conditions of Permanent Capital Share Account

-(1) A permanent capital share account is not subject to share

insurance coverage by the NCUSIF or other deposit insurer.

-(2) Permanent capital shares are not redeemable without the

written concurrence of NCUA.

-(3) Permanent capital share accounts cannot be used by member

credit unions to collateralize borrowings.

-(4) Permanent capital share accounts are available to absorb

losses in the event of a deficit in other primary capital accounts

in the corporate credit union.

-(5) Where the corporate credit union is liquidated, permanent

capital share accounts are payable only after satisfaction of all

liabilities of the liquidation estate including uninsured

obligations to shareholders and the NCUSIF.

-(6) Permanent capital share account dividends are

noncumulative.

I have read the above terms and conditions and I understand

them.

Signatures of Directors and Date

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Name of member credit union: --

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Address of member credit union: --

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PART 741--REQUIREMENTS FOR INSURANCE

-2. The authority citation for part 741 continues to read as

follows:

[[Page 20458]] Authority: 12 U.S.C. 1757, 1766, and 1781-1790.

Section 741.11 is also authorized by 31 U.S.C. 3717.

-3. Section 741.3 is amended by revising the heading and adding new

paragraph (c) to read as follows:

Sec. 741.3 Other requirements.

* * * * *

(c) Adhere to the requirements stated in Part 703 of this chapter

concerning transacting business with corporate credit unions.

[FR Doc. 95-10149 Filed 4-25-95; 8:45 am]

BILLING CODE 7535-01-P