Organization and Operations of Federal Credit Unions

NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 701, 709 and 741

Organization and Operations of Federal Credit Unions

AGENCY: National Credit Union Administration (NCUA).

ACTION: Interim final rule with request for comments.

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SUMMARY: This interim rule authorizes credit unions serving

predominantly low-income members to raise secondary capital from

foundations and other philanthropic-minded institutional investors.

Increased capital will in turn enable these credit unions to make more

loans and improve other financial services for the limited income

groups and communities they serve.

This rule establishes a new section in NCUA's Regulations providing

authority for secondary capital accounts and amending existing

regulatory provisions concerning designation of low-income status. The

rule also amends an existing rule to address the authority of federally

insured state credit unions to issue secondary capital accounts, and

amends another rule to establish that secondary capital accounts are

paid after all other claims in the event of liquidation.

Secondary capital accounts will not be issued as share accounts and

will not establish voting or ownership rights. The applicability of

this rule is limited to credit unions having a low-income designation

from NCUA or the appropriate state regulator.

DATES: The interim rule is effective January 25, 1996. Comments must be

received on or before April 1, 1996.

ADDRESSES: Comments should be directed to Becky Baker, Secretary of the

Board. Mail or hand-deliver comments to National Credit Union

Administration, 1775 Duke Street, Alexandria, Virginia 22314-3428. Fax

comments to (703) 518-6319. Post comments on NCUA's electronic bulletin

board by dialing (703) 518-6480. Please send comments by one method

only.

FOR FURTHER INFORMATION CONTACT: Joyce Jackson, Special Assistant,

Office of Community Development Credit Unions, at the above address or

telephone (703) 518-6610, or David Marquis, Director, Office of

Examination and Insurance, or Stephen Austin, Director of the

Department of Supervision, Office of Examination and Insurance, both at

the above address or telephone (703) 518-6360, or Robert M. Fenner,

General Counsel, at the above address or telephone (703) 518-6540.

SUPPLEMENTARY INFORMATION:

Background

As of November, 1995, there were 260 federally insured credit

unions designated by NCUA or the appropriate state regulator as serving

predominantly low-income members. Like other credit unions serving

members of limited financial means, these credit unions perform an

important mission of providing loans and other financial services to

individuals and communities who most need these services and most often

do not have them available from other sources. Like all insured credit

unions, the low-income designated credit unions are, as a group, quite

healthy and financially strong. For example, the average net capital

ratio for low-income designated credit unions as of May, 1995 was 9.8

percent.

Individual low-income designated credit unions find it difficult,

however, in view of the limited resources of their members, to

accumulate capital. (As cooperatives, credit unions build their primary

capital--statutory reserves--solely by setting aside a portion of their

income each accounting period.) To ease this burden, and to facilitate

an additional opportunity for low-income designated credit unions to

build capital that will support greater lending and financial services

in their communities, the NCUA Board is issuing this interim final rule

authorizing secondary capital accounts. These capital accounts, to the

extent that low-income designated credit unions choose to offer them,

will supplement rather than reduce existing statutory reserve

requirements.

Overview

The Board has established certain key safety and soundness elements

in this interim rule to ensure both that secondary capital accounts

serve the purpose of capital--i.e. that they are available to absorb

loss and thus prevent losses to members or the failure of the

institution--and that there is no misunderstanding on the part of

investors as to the nature of the accounts and the risks involved.

Included are the following:

The accounts may be offered only to organizational

investors, not to natural person members or other natural person

investors.

The accounts are subordinate to all other claims on the

assets of the credit union.

The accounts are not insured by the National Credit Union

Share Insurance Fund or any other government entity, and may not be

offered as share accounts. It is anticipated that credit unions will

issue these accounts as a form of subordinated debt.

Funds in the accounts must be available to cover losses,

after depletion of reserves and undivided earnings, but prior to

liquidation of the credit union.

The accounts must have a minimum maturity of five years.

These and other key provisions must be reflected in an

account agreement and in disclosures prescribed as an Appendix to the

interim rule.

When the remaining maturity of a secondary capital account

is less than five years, the credit union will reflect through a

footnote to its financial statement, and NCUA will recognize, the

capital value of the account as a percentage of the account's face

value, on a sliding scale ranging from 80% of face value (four years to

less than five years remaining maturity) to zero (less than one year

remaining maturity).

Additional Explanation of Amendments

This interim rule contains four separately numbered amendments. The

following is an additional explanation of each.

Amendment 1 removes from Section 701.32 of NCUA's rules the

provisions concerning designation of low-income status. Those

provisions are now placed in new Section 701.34. As a result, Section

701.32 now deals solely with the limitations on federally insured

credit unions receiving nonmember shares above certain levels without

prior NCUA approval. Such shares include public unit shares in all

federally insured credit unions and other nonmember shares in the case

of low-income designated credit unions. Section 701.34 contains the

provisions related solely to low-income designated credit unions: The

rules concerning designation of low-income status and the new

provisions concerning receipt of secondary capital accounts.

Because secondary capital accounts are not share accounts, they are

not subject to the Section 701.32 limitations. A reference in Section

701.32(b)(1) to ``accounts'' is replaced

[[Page 3789]]

with ``shares'' to eliminate any possible confusion over the fact that

Section 701.32 is limited in its applicability to nonmember share

accounts.

Amendment 2 establishes the new Section 701.34. Section 701.34(a)

contains the provisions concerning designation of low-income status,

Section 701.34(b) contains the provisions authorizing secondary capital

accounts and setting forth the terms and conditions for these accounts,

and Section 701.34(c) establishes the sliding scale capital values for

accounts with remaining maturities of less than five years.

As previously discussed, the Board has established a number of

requirements in this interim rule to ensure both that these accounts

actually serve as capital and that there is no misunderstanding on the

part of investors as to the risks involved. A credit union offering

these accounts must adopt a written plan addressing how the credit

union will use the funds and how the credit union will meet liquidity

needs to repay the funds upon maturity. The plan must be submitted to

the appropriate NCUA Regional Director. The submission is for purposes

of notice to NCUA; the credit union need not await NCUA approval.

Other requirements include that the accounts may be offered only to

nonnatural person investors, that the accounts have a minimum maturity

of five years, that they are not insured, that they may not be provided

as security on other obligations of the accountholder, that the

accounts will not ``carry over'' in the event of merger into a credit

union that is not low-income designated, that claims represented by

these accounts are subordinate to all other claims on the credit union,

and that they are available to cover losses. The accounts may not be

offered as share accounts. Lowincome designated Federal credit unions

that choose to offer these accounts will do so pursuant to their

borrowing authority, and this will presumably be the case for

federally-insured state chartered credit unions as well, depending on

their authority under state law.

Funds in secondary capital accounts must be available to cover

losses in an operating credit union, i.e. the funds are available

without having to liquidate the credit union. The funds must be

available to cover losses that exceed available ``reserves and

undivided earnings''. For this purpose, reserves and undivided earnings

are exclusive of all allowance accounts for loan and investment losses,

inasmuch as such allowance accounts are already earmarked to cover

other anticipated losses.

To avoid overreliance on the availability of these temporary

accounts to cover future operating losses, the rule establishes a

declining scale for the capital value of accounts with less than five

years remaining maturity. (All of the funds, however, will continue to

be at risk to cover losses that exceed reserves and undivided

earnings.) Accounts with remaining maturities of at least four years

but less than five are counted as capital at 80 percent of face value,

remaining maturities of at least three but less than four years are

counted at 60 percent, and so on, to the point of less than one year

remaining maturity, where the account reflects no capital value. In

addition to preventing overstatement of the true value of these

accounts as continuing capital, this feature will encourage credit

unions to continually replenish their sources of maturing secondary

capital to the extent such funds are needed to support ongoing lending

programs and other operations. The reduced capital value of the

accounts will be shown through a footnote to the credit union's

financial statement.

The interim rule sets forth prescribed disclosures, as Appendix A

to section 701.34, that must be provided to investors in secondary

capital accounts, and requires that signed originals of the disclosure

and account agreement be retained by the credit union at least for the

life of the agreement.

Amendment 3 updates NCUA's regulatory provisions for federally

insured state credit unions related to low-income designation and

receipt of secondary capital accounts. This amendment revises Part 741

Requirements for Insurance by adding a new 741.204(c) and making

conforming amendments to Section 741.204(b). The new 741.204(c)

establishes that state chartered federally insured credit unions may

offer secondary capital accounts on the same terms and conditions as

Federal credit unions, as long as the credit union has a low-income

designation pursuant to 741.204(b) and the accounts are not

inconsistent with state law or regulation. State chartered credit

unions must submit their plan to both the Regional Director and their

state supervisor, and should coordinate with the state supervisor to

confirm that these accounts are permissible under state law and to

determine whether preapproval of the state supervisor is required.

Amendment 4 revises Section 709.5 Payout Priorities in Involuntary

Liquidation by adding a new Section 709.5(b)(8) to establish that

secondary capital accounts in low-income designated credit unions are

paid after all other claims in the event of involuntary liquidation.

Also, Section 709.5(e) is revised to specify that, in the unlikely

event of a liquidation surplus, secondary capital holders would be

repaid before payment of a liquidation dividend.

Effective Date; Interim Rule; Comment Period

Although this amendment is being issued as an interim final rule

and is effective immediately, the NCUA Board encourages credit unions

to submit comments. Comments may be submitted on or before April 1,

1996.

Because this rule provides a new authority to low-income designated

credit unions and use of the authority is voluntary, the NCUA Board

finds that good cause exists for an immediate effective date. Moreover,

the Board finds it necessary and appropriate to act quickly in this

matter in order to allow credit unions an additional avenue to meet the

matching fund requirements established by the Community Development

Financial Institutions (CDFI) Fund. 60 FR 54110, 54112 (October 19,

1995).

Institutions, including credit unions, seeking funds under the CDFI

Program are to submit applications to CDFI by January 29, 1996. NCUA is

aware of several low-income credit unions that have submitted or will

submit applications to CDFI. CDFI will in turn grant funding in the

form of loans, deposits/shares, or capital grants to qualifying

institutions. However, one of the major qualifications of the CDFI

Program is the requirement that the institution ``obtain matching funds

from sources other than the Federal government.'' 60 FR at 54112.

Institutions must have ``firm commitments for the matching funds

requirements * * * not later than July 1, 1996.'' 60 FR 54136.

This interim rule will provide low-income credit unions that have

applied for CDFI funds with a method of raising secondary capital that

may be counted as matching funds for either capital grants or loans,

depending on the approach ultimately followed by the CDFI Fund. If this

was a proposed rule and not an interim rule with an immediate effective

date, federally-insured credit unions would have a very limited window

of opportunity from the date of a final rule to solicit secondary

capital funds. Any delay in the effective date of this rule is contrary

to the best interests of federally-insured credit

[[Page 3790]]

unions which qualify under the CDFI Program.

Request for Comments

Although this interim rule is effective immediately, the NCUA Board

welcomes comment on any aspect of the rule. After the close of the

comment period and analysis of the comments, the Board will determine

whether any changes in the rule are necessary or appropriate.

Regulatory Procedures

Regulatory Flexibility Act

The NCUA Board certifies that this rule will not have a significant

impact on a substantial number of small credit unions. The rule affects

only low-income designated credit unions, and imposes no mandatory

regulatory burden on those credit unions. Rather, it increases

flexibility by providing a new method of raising capital through

secondary capital accounts. Accordingly, a Regulatory Flexibility

Analysis is not required.

Paperwork Reduction Act

NCUA has determined that the requirements that low-income

designated credit unions choosing to offer secondary capital accounts

must adopt a written plan, send a copy of the plan to their NCUA

Regional Director, and have account contract documents and disclosure

forms constitute collection of information requirements under the

Paperwork Reduction Act of 1995. The Paperwork Reduction Act and

regulations of the Office of Management and Budget (OMB) require that

the public be provided an opportunity to comment on information

collection requirements, including an agency's estimate of the burden

of the collection of information. NCUA believes that these requirements

are essential both to ensure the safe and sound operation of a

secondary capital program and to ensure that account holders fully

understand the nature of their investment in the credit union and the

risks involved.

NCUA estimates that the increase in paperwork requirements will

affect less than 50 credit unions. The requirements will affect only

those credit unions that have a low-income designation and voluntarily

choose to offer secondary capital accounts. NCUA estimates that it

should reasonably take no more than three hours to comply with the

paperwork requirements. This translates to 150 burden hours. The NCUA

Board invites comment on: (1) Whether the collection of information is

necessary for the proper performance of the functions of NCUA,

including whether the information will have practical utility; (2) the

accuracy of NCUA's estimate of the burden of the collection of

information; (3) ways to enhance the quality, utility, and clarity of

the information to be collected; and (4) ways to minimize the burden of

the collection on respondents, including through the use of automated

collection techniques or other forms of information technology. Send

comments to Suzanne Beauchesne, National Credit Union Administration,

1775 Duke Street, Alexandria, VA 22314-3428. Comments should be

postmarked by April 2, 1996.

NCUA will, after 60 days from the effective date of the interim

rule, submit the paperwork requirements to OMB for review under the

Paperwork Reduction Act and publish a notice to that effect in the

Federal Register. NCUA will also publish a notice in the Federal

Register once OMB takes action on the submission. Federally insured

credit unions are not required, pursuant to the terms of the Paperwork

Reduction Act, to comply with paperwork requirements until OMB approval

and an OMB control number are received. Low-income designated credit

unions that choose to offer secondary capital accounts will be

expected, however, as a matter of safety and soundness, to adopt

written plans, forward a copy of the credit union's plan to the

Regional Director (and state supervisor in the case of state credit

unions) and use account contract documents and disclosure forms that

meet the requirements of this rule in every respect. Failure to do so

may jeopardize the ability of low-income designated credit unions to

use this authority pending completion of the rulemaking process.

Executive Order 12612

Executive Order 12612 requires NCUA to consider the effects of its

actions on state interests. This rule has no adverse effects on state

interests. The rule provides additional authority for federally insured

state chartered credit unions, but only to the extent not inconsistent

with state law and regulations. The NCUA Board, however, specifically

requests the comments of State credit union regulators to obtain their

guidance in how the rule may affect their credit unions.

List of Subjects in 12 CFR Parts 701, 709 and 741

Bank deposit insurance, Credit unions, Reporting and recordkeeping

requirements.

By the National Credit Union Administration Board on January 25,

1996.

Becky Baker,

Secretary of the Board.

Accordingly, NCUA amends 12 CFR chapter VII as follows:

PART 701--ORGANIZATION AND OPERATIONS OF FEDERAL CREDIT UNIONS

1. The authority citation for part 701 continues to read as

follows:

Authority: 12 U.S.C. 1752(5), 1755, 1756, 1757, 1759, 1761a,

1761b, 1766, 1767, 1782, 1784, 1787, 1789 and Public Law 101-73.

Section 701.6 is also authorized by 31 U.S.C. 3717. Section 701.31

is also authorized by 12 U.S.C. 1601, et seq., 42 U.S.C. 1981 and 42

U.S.C. 3601-3610. Section 701.35 is also authorized by 12 U.S.C.

4311-4312.

2. Section 701.32 is amended by revising the section heading and

paragraphs (a) and (b)(1) to read as follows:

Sec. 701.32 Payment on shares by public units and nonmembers.

(a) Authority. A Federal credit union may, to the extent permitted

under Section 107(6) of the Act and this section, receive payments on

shares, (regular shares, share certificates, and share draft accounts)

from public units and political subdivisions thereof (as those terms

are defined in Sec. 745.1) and nonmember credit unions, and to the

extent permitted under the Act, this section and Sec. 701.34, receive

payments on shares (regular shares, share certificates, and share draft

accounts) from other nonmembers.

(b) Limitations. (1) Unless a greater amount has been approved by

the Regional Director, the maximum amount of all public unit and

nonmember shares shall not, at any given time, exceed 20% of the total

shares of the federal credit union or $1.5 million, whichever is

greater.

* * * * *

3. Section 701.34 is added by redesignating paragraph (d) of

Sec. 701.32 as paragraph (a) of Sec. 701.34, by revising the third

sentence of newly designated paragraph (a)(1) and by adding new

paragraphs (b) and (c) and an Appendix as follows:

Sec. 701.34 Designation of low-income status; receipt of secondary

capital accounts by low-income designated credit unions.

(a) Designation of low-income status. (1) * * * The designation may

be removed by the Regional Director upon notice to the federal credit

union if the definitions set forth in paragraphs (a)(2)

[[Page 3791]]

and (3) of this section are no longer met. * * *

* * * * *

(b) Receipt of secondary capital accounts by low-income designated

credit unions. A Federal credit union having a designation of low

income status pursuant to paragraph (a) of this section may offer

secondary capital accounts to nonnatural person members and nonnatural

person nonmembers on the following conditions:

(1) Prior to offering secondary capital accounts, the credit union

shall adopt, and forward to the appropriate NCUA Regional Director, a

written plan for use of the funds in the secondary capital accounts and

subsequent liquidity needs to meet repayment requirements upon maturity

of the accounts.

(2) The secondary capital account must be established as a

subordinated debt account or other form of non-share account.

(3) The maturity of the secondary capital account must be for a

minimum of five years.

(4) The secondary capital account must not be redeemable prior to

maturity.

(5) The secondary capital account shall not be insured by the

National Credit Union Share Insurance Fund or any governmental or

private entity.

(6) The secondary capital account holder's claim against the credit

union must be subordinate to all other claims including those of

shareholders, creditors and the National Credit Union Share Insurance

Fund.

(7) Funds in the secondary capital account (including both

principal and interest) must be available to cover operating losses

realized by the credit union that exceed its net available reserves and

undivided earnings (i.e., reserves and undivided earnings exclusive of

allowance accounts for loan and investment losses), and to the extent

funds are so used, the credit union shall under no circumstances

restore or replenish the account. Losses shall be distributed pro-rata

among all secondary capital accounts held by the credit union at the

time the losses are realized.

(8) The secondary capital account may not be pledged or provided by

the account-holder as security on a loan or other obligation with the

credit union or any other party.

(9) In the event of merger or other voluntary dissolution of the

credit union, other than merger into another low-income designated

credit union, the secondary capital accounts will, to the extent they

are not needed to cover losses at the time of merger or dissolution, be

closed and paid out to the account-holder.

(10) A secondary capital account contract agreement must be

executed between an authorized representative of the account holder and

the credit union accurately establishing the terms and conditions of

this section and containing no provisions inconsistent therewith.

(11) A disclosure and acknowledgment as set forth in the Appendix

to this section must be provided to and executed by an authorized

representative of the secondary capital account holder at the time of

entering into the account agreement, and original copies of the account

agreement and the disclosure and acknowledgment must be retained by the

credit union for the term of the agreement.

(c) Accounting treatment; weighted value for purposes of

recognizing capital value of secondary capital accounts. A low-income

designated credit union that issues secondary capital accounts pursuant

to paragraph (b) of this section shall record the funds on its balance

sheet in an equity account entitled ``secondary capital account''. For

such accounts with remaining maturities of less than five years, the

credit union shall reflect the capital value of the accounts in a

footnote to its financial statement in accordance with the following

scale:

1. Four to less than five years remaining maturity--80 percent.

2. Three to less than four years remaining maturity--60 percent.

3. Two to less than three years remaining maturity--40 percent.

4. One to less two years remaining maturity--20 percent.

5. Less than one year remaining maturity--0 percent

Appendix to Sec. 701.34

Disclosures and acknowledgment in the following form must be

provided to any investor in secondary capital accounts in a low-

income designated credit union.

An original, signed copy must be retained by the credit union.

Disclosure and Acknowledgment

I, ________ (name of signatory), hereby acknowledge and agree to

the following in my capacity as ________ (official position or

title) of ________ (name of institutional investor):

________ (name of institutional investor) has committed

________ (amount of funds) to a secondary capital account with

________ (name of credit union).

The funds committed to the secondary capital account

are committed for a period of ____ years and are not redeemable

prior to ________.

The secondary capital account is not a share account

and the funds committed to the secondary capital account are not

insured by the National Credit Union Share Insurance Fund or any

other governmental or private entity.

The funds committed to the secondary capital account and any

interest paid to the account may be used by ________ (name of credit

union) to cover any and all operating losses that exceed the credit

union's net available reserves and undivided earnings (i.e.,

reserves and undivided earnings exclusive of allowance accounts for

loan and investment losses), and in the event the funds are so used

________ (name of credit union) will under no circumstances restore

or replenish those funds to ________ (organization).

In the event of liquidation of ________ (name of credit

union), the funds committed to the secondary capital account shall

be subordinate to all other claims on the assets of the credit

union, including claims of member shareholders, creditors and the

National Credit Union Share Insurance Fund.

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(signature)

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(official title)

PART 709--INVOLUNTARY LIQUIDATION OF FEDERAL CREDIT UNIONS AND

ADJUDICATION OF CREDITOR CLAIMS INVOLVING FEDERALLY INSURED CREDIT

UNIONS IN LIQUIDATION

4. The authority citation for part 709 continues to read as

follows:

Authority: 12 U.S.C. 1766; Public Law 101-73, 103 Stat. 183, 530

(1989) (12 U.S.C. 1787 et seq.).

5. Section 709.5 is amended by revising paragraphs (b)(6) and

(b)(7), by adding a new paragraph (b)(8) and by revising the last

sentence of paragraph (e) to read as follows:

Sec. 709.5 Payout priorities in involuntary liquidation.

(a) * * *

(b) * * *

(6) Shareholders to the extent of their respective uninsured shares

and the National Credit Union Share Insurance Fund to the extent of its

payment of share insurance;

(7) In a case involving liquidation of a corporate credit union,

membership capital share deposits of corporate credit unions; and

(8) In a case involving liquidation of a low-income designated

credit union, any outstanding secondary capital accounts issued

pursuant to the authority of Secs. 701.34 or 741.204(c) of this

chapter.

* * * * *

(e) * * * If a surplus remains after making distribution in full on

all allowed claims described in paragraphs (b)(1) through (b)(8) of

this section, such

[[Page 3792]]

surplus shall be distributed pro rata to the credit union's

shareholders.

PART 741--REQUIREMENTS FOR INSURANCE

6. The authority citation for part 741 continues to read as

follows:

Authority: 12 U.S.C. 1757, 1766, and 1781-1790.

7. Section 741.204 is amended by revising the third sentence of

paragraph (b) and adding a new paragraph (c) to read as follows:

Sec. 741.204 Maximum public unit and nonmember accounts, and low-

income designation.

* * * * *

(a) * * *

(b) * * * The designation will be made and reviewed by the state

regulator on the same basis as that provided in Sec. 701.34(a) of this

chapter for federal credit unions. * * *

(c) Receive secondary capital accounts only if the credit has a

low-income designation pursuant to paragraph (b) of this section, and

then only in accordance with the terms and conditions authorized for

Federal credit unions pursuant to Sec. 701.34 of this chapter and to

the extent not inconsistent with applicable state law and regulation.

State chartered federally insured credit unions offering secondary

capital accounts must submit the plan required by Sec. 701.34 to both

the state supervisory authority and the NCUA Regional Director.

[FR Doc. 96-2018 Filed 2-1-96; 8:45 am]

BILLING CODE 7535-01-P