Prompt Corrective Action

SUMMARY: In 1998, Congress amended the Federal Credit Union Act to

require the NCUA Board to adopt, by regulation, a system of ``prompt

corrective action'' to be taken by NCUA and by federally-insured credit

unions if they become undercapitalized. The new FCUA provision imposes

a series of progressively more stringent restrictions and requirements

indexed to five capital categories which it establishes for federally-

insured credit unions. It also mandates a separate system of prompt

corrective action for ``new'' credit unions and an additional risk-

based net worth requirement for ``complex'' credit unions. The proposed

rule combines the components of prompt corrective action which are

expressly prescribed by statute (except the risk-based net worth

requirement for ``complex'' credit unions) with those NCUA is

responsible for developing to suit credit unions. The rule also

establishes conforming reserve and dividend payment requirements, and

procedures for reviewing and enforcing directives imposing prompt

corrective action.

DATES: Comments must be received on or before August 16, 1999.

ADDRESSES: Direct comments 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. Please send comments by one method only.

FOR FURTHER INFORMATION CONTACT: Herbert S. Yolles, Deputy Director,

Office of Examination and Insurance, at the above address or telephone

(703) 518-6362; or Steven W. Widerman, Trial Attorney, Office of

General Counsel, at the above address or telephone (703) 518-6557.

SUPPLEMENTARY INFORMATION:

A. Background

1. The Credit Union Membership Access Act

On August 7, 1998, Congress enacted the Credit Union Membership

Access Act, Public Law No. 105-219, 112 Stat. 913 (1998). Section 103

of the statute added a new section 216 to the Federal Credit Union Act

(FCUA), 12 U.S.C. 1790d (hereinafter referred to as ``CUMAA'' or ``the

statute'' and cited as ``Sec. 1790d''). Section 1790d requires the NCUA

Board to adopt by regulation a system of ``prompt corrective action''

(sometimes referred to as ``PCA'') to be taken by NCUA when a

federally-insured ``natural person'' credit union becomes

undercapitalized. The stated purpose of Sec. 1790d is to ``resolve the

problems of insured credit unions at the least possible long-term loss

to the [National Credit Union Share Insurance Fund (NCUSIF)].''

Sec. 1790d(a)(1). The system of PCA for credit unions must take into

account the distinguishing features of credit unions: that they are

cooperatives that do not issue capital stock, must rely on retained

earnings to build net worth, and have primarily volunteer boards of

directors. Sec. 1790d(b)(1)(B).

Much of the system of PCA for credit unions is expressly prescribed

by Sec. 1790d. This includes the five net worth categories and the net

worth measures for each, the requirement to submit a Net Worth

Restoration Plan, the requirement to annually transfer a portion of

earnings to net worth, restrictions on increasing assets and on

increasing member business loans, and conditions triggering mandatory

conservatorship and liquidation. Secs. 1790d(c), (e), (f), (g), (i); 12

U.S.C. 1786(h)(1)(F) and (G), 1787(a)(3)(A). The implementing

regulations adhere to the substance of the statutory components of PCA.

To complete the framework of PCA for credit unions, CUMAA

authorizes NCUA to develop, by regulation, a comprehensive series of

discretionary supervisory actions to complement the mandatory

supervisory actions prescribed by statute. The statutory criteria for

these discretionary actions are that they must be consistent with the

purpose of Sec. 1790d, and must be ``comparable'' \1\ to the

``discretionary safeguards'' which the Federal banking agencies \2\ are

permitted to impose under section 38 of the Federal Deposit Insurance

Act, 12 U.S.C. 1831o (FDIA Sec. 38) \3\--the statute which established

prompt corrective action for federally-insured depository institutions.

Sec. 1790d(b)(1)(A); S. Rep. No. 193, 105th Cong., 2d Sess. 12 (1998)

(S. Rep.); H.R. Rep. No. 472, 105th Cong., 2d Sess. 23 (1998) (H.R.

Rep. at 23). Accordingly, the proposed implementing regulations

establish a series of discretionary supervisory actions indexed to the

``undercapitalized'' and lower net worth categories. NCUA has the

discretion to impose these restrictions and requirements to further the

purpose of prompt corrective action. Although comparable to FDIA

Sec. 38, these discretionary supervisory actions are tailored to suit

the distinctive characteristics of credit unions.

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\1\ ``Comparable'' is defined as ``parallel in substance (though

not necessarily identical in detail) and equivalent in rigor.'' S.

Rep. at 12.

\2\ The Federal banking agencies consist of the Federal Reserve

Board, the Office of Comptroller of the Currency, the Federal

Deposit Insurance Corporation (FDIC) and the Office of Thrift

Supervision. Sec. 1790d(o)(1) incorporating 12 U.S.C. 1813(z). Their

Joint Final Rule establishing a system of prompt corrective action

pursuant to 12 U.S.C. 1831o is published at 57 FR 44886 (Sept. 29,

1992).

\3\ Section 38 of the Federal Deposit Insurance Act, 12 U.S.C.

1831o, was added by section 131 of the Federal Deposit Insurance

Corporation Improvement Act, Pub. L 102-242, 105 Stat. 2236 (1991).

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For credit unions which CUMAA defines as ``new''--those in

operation less than ten years and which have $10 million or less in

assets--the statute requires NCUA to develop an alternative system of

prompt corrective action to apply in lieu of the system prescribed by

CUMAA for all other federally-insured credit unions.

Sec. 1790d(b)(2)(A); see U.S. Dept. of Treasury, Credit Unions

(Washington, D.C. 1997) at 79. The alternative system of PCA must

recognize that ``new'' credit unions initially have no net worth, need

reasonable time to accumulate net worth, and need incentives to become

``adequately capitalized'' by the time they are no longer ``new.''

Sec. 1790d(b)(2)(B). Accordingly, although it follows the ``net worth

category'' model, the system of PCA for new credit unions has relaxed

net worth ratios, allows regulatory forbearance, and offers incentives

to build net worth.

CUMAA requires NCUA to formulate the definition of a ``complex''

credit union according to the risk level of its portfolio of assets and

liabilities. Sec. 1790d(d)(1). ``Well capitalized'' and ``adequately

capitalized'' credit unions which meet that definition will be subject

to an additional ``risk-based net worth requirement'' to compensate for

``any material risks against which the [statutory net worth ratio for

``adequately capitalized''] may not provide adequate protection.''

Sec. 1790d(d)(2). The ``risk-based net worth requirement'' for

``complex'' credit unions will be the subject of a separate proposed

rule to be issued by the NCUA Board in late 1999.

CUMAA requires NCUA to implement an independent appeal process by

which affected credit unions and certain officials can appeal to the

NCUA Board decisions by NCUA staff to impose discretionary restrictions

or requirements. Sec. 1790d(k). To fulfill this mandate, the proposed

rule adds a new subpart L to part 747 of NCUA's

[[Page 27091]]

regulations, 12 CFR 747.2001, establishing procedures for issuance,

review and enforcement of directives requiring prompt corrective

action. Subpart L generally provides a right of notice of the decision

to impose a discretionary restriction or requirement, and an

opportunity to respond to the notice, an informal hearing if requested

in certain cases, and NCUA Board review of the decision.

Although not required by CUMAA, the proposed rule retains in

substance certain of NCUA's current reserve and dividend payment

requirements. In subpart C, these requirements have been modified to

reflect repeal of FCUA Sec. 116, 12 U.S.C. 1762, and to conform to

CUMAA's earnings retention requirement. Sec. 1790d(e).

Finally, in formulating regulations to implement a system of PCA

for credit unions, CUMAA required NCUA to consult with the Secretary of

the Treasury, the Federal banking agencies, and State officials having

jurisdiction over federally-insured, State-chartered credit unions.

CUMAA Sec. 301(c). To that end, the proposed rule is a product of

consultation with representatives of the Department of the Treasury,

solicitation of comments from the Federal banking agencies, and

collaboration with a committee of representative State credit union

supervisors.

2. Statutory Timetable

CUMAA set deadlines for NCUA to issue proposed rules and final

rules on PCA, and dates for those rules to take effect. Congress

directed NCUA to commence rulemaking by issuing an Advance Notice of

Proposed Rulemaking (ANPR) addressing only the ``risk-based net worth

requirement'' for ``complex'' credit unions, no later than February 3,

1999. CUMAA Sec. 301(d)(2)(A). To fulfill that requirement, NCUA issued

an ANPR soliciting public comment not only on the ``risk-based net

worth requirement'' for ``complex'' credit unions, but also regarding

PCA for ``new'' credit unions and the contents, criteria, and deadlines

for a Net Worth Restoration Plan. 63 FR 57938 (October 29, 1998). The

great majority of the 34 comments NCUA received by the January 27,

1999, deadline addressed the risk-based net worth requirement for

``complex'' credit unions, which is not the subject of this rule.

CUMAA directs NCUA to propose rules for PCA (other than the ``risk-

based net worth requirement'' for ``complex'' credit unions) no later

than May 4, 1999, and to adopt final rules no later than February 7,

2000, to take effect August 7, 2000. CUMAA Sec. 301(d)(1) and (e)(1).

While no date is prescribed for a proposed rule on the ``risk-based net

worth requirement'' for ``complex'' credit unions, NCUA is required to

issue the final no later than August 7, 2000, to take effect January 1,

2001. CUMAA Sec. 301(d)(2)(B) and (e)(2). NCUA plans to issue a

proposed rule on the ``risk-based net worth requirement'' for

``complex'' credit unions in late 1999.

3. Report to Congress

CUMAA requires NCUA to report to Congress twice in the rulemaking

process for prompt corrective action---first when proposed rules are

published, and again when final rules are adopted (February 7, 2000).

CUMAA Sec. 301(f); S. Rep. at 19; H.R. Rep. at 23. The report must

explain how NCUA's implementing regulations establish a system of PCA

which is consistent with the cooperative character of credit unions.

CUMAA Sec. 301(f)(1); see Sec. 1790d(b)(1)(B). Further, the report must

identify how NCUA's implementing regulations differ from FDIA Sec. 38

and the reasons for those differences. CUMAA Sec. 301(f)(2). NCUA

expects to report that the proposed rule is comparable in nearly all

respects to FDIA Sec. 38, i.e., that it is parallel in substance and

equivalent in rigor.

4. Notice of Proposed Rulemaking

Through this notice, NCUA invites public comment on all aspects of

its proposed rule. Broad public input addressing the proposed rule will

assist the NCUA Board in tailoring a system of prompt corrective action

that is workable, fair and effective in light of the cooperative

character of credit unions. See S. Rep. at 14. Although NCUA lacks

discretion to modify the substance of components of prompt corrective

action prescribed by statute, the proposed rule establishes a

comprehensive array of discretionary restrictions and requirements

adapted, with modifications, from FDIA Sec. 38. Comments addressing

these and other non-statutory components of the proposed rule--such as

the contents and criteria for approval of a net worth restoration plan,

and the alternative system of PCA for new credit unions-will be most

helpful.

B. Framework of Proposed Rule

The proposed rule consists of four parts. Subpart A is the system

of PCA for all federally-insured credit unions except those which meet

the statutory definition of ``new.'' Subpart B is the alternative

system of PCA which the statute required NCUA to develop exclusively

for ``new'' credit unions. For ease of access, in subparts A and B, all

of the supervisory actions which apply to a credit union in a

particular net worth category are combined in a single section devoted

exclusively to that category. The supervisory actions and corresponding

net worth categories are depicted in Appendices A and B to the preamble

of this rule. Subpart C restates certain reserve, dividend payment and

other requirements, modified to facilitate the earnings retention

requirement in subparts A and B. Finally, subpart L of part 747

provides for notice, review and enforcement of certain supervisory

actions imposed under subparts A and B.

1. Net Worth Classification

Statutory net worth categories. Section 702.101(a) sets forth the

five net worth categories which CUMAA establishes for all federally-

insured credit unions, other than those which are ``new,'' and the

corresponding net worth ratio of each. Sec. 1790d(c). The range of net

worth ratios for each net worth category (assuming no risk-based net

worth requirement) and the percentage and number of federally-insured

credit unions that fall within each category as of December 1998, are

depicted as follows:

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

Percent of all Number of all

Net worth category Net worth ratio FICUs FICUs

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``Well Capitalized''....................... 7% or above........................ 94.03 10,339

``Adequately Capitalized''................. 6% to 6.99%........................ 2.80 308

``Undercapitalized''....................... 4% to 5.99%........................ 2.06 227

``Significantly Undercapitalized''......... 2% to 3.99%........................ 0.59 65

``Critically Undercapitalized''............ Less than 2%....................... 0.51 56

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[[Page 27092]]

Adjustment of Net Worth Category. Part 702 incorporates the two

statutory criteria for requiring a downward adjustment of a credit

union's original net worth category to a lower one.\4\

Secs. 702.101(a)(4)(B) and (a)(1)-(2). First, a credit union classified

as ``undercapitalized,'' and which has a net worth ratio of less than

5%, must be downgraded to ``significantly undercapitalized'' if it

fails to timely file or implement a Net Worth Restoration Plan.\5\

Sec. 1790d(c)(1)(D)(ii). See also Sec. 702.109(g). Second, credit

unions otherwise categorized as either ``well capitalized'' or

``adequately capitalized,'' and which meet the definition of

``complex,'' will be subject to a risk-based net worth requirement.

Sec. 1790d(c)(1)(A)(ii) and (c)(1)(B)(2). Credit unions which do not

meet the risk-based requirement in either category are required to be

reclassified ``undercapitalized.'' Sec. 1790d(c)(1)(C)(ii).

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\4\ Apart from adjustments to net worth category classification,

the proposed rule gives NCUA the authority to adjust a credit

union's net worth net worth ratio to reflect the impact of certain

accounting adjustments. Sec. 702.3(d).

\5\ 5% falls mid-way between the 4% floor of the

``undercapitalized'' category and its 5.99% ceiling. See

Sec. 702.101(a)(3). An ``undercapitalized'' credit union having a

new worth ratio of between 5% and 5.99% is not subject to a downward

adjustment for failure to timely file or implement at New Worth

Restoration Plan, although it would be subject to other means of

enforcement.

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Reclassification of Net Worth Category. Apart from statutory

adjustment, CUMAA authorizes reclassification of a credit union on

safety and soundness grounds, consistent with FDIA Sec. 38(g).

Sec. 1790d(h). The proposed rule thus provides that the NCUA Board may

reclassify to the next lower net worth category a credit union

originally classified above ``significantly undercapitalized'' if that

credit union is either in an unsafe or unsound condition or has failed

to correct an unsafe or unsound practice. Secs. 702.101(b) and

702.202(d). The authority to make a final decision to reclassify on

these grounds cannot be delegated, Sec. 1790d(h)(2), and when

exercised, requires notice to the credit union and an opportunity to

respond and to request an informal hearing. Sec. 747.2003.

The statutory criteria for mandatory adjustment of a net worth

category and for discretionary reclassification on safety and soundness

grounds under part 702 are summarized as follows:

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

Grounds to reclassify Adjusted or

Original category Additional criterion or adjust category reclassified to . . .

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

``Well Capitalized''................. Must be ``complex''....

``Adequately Capitalized''........... Must be ``complex''.... Fails to meet risk- Adjusted to

based net worth ``Undercapitalized''.

Requirement.

``Undercapitalized''................. Net worth ratio less Fails to timely file or ``Significantly

than 5%. implement Net Worth Undercapitalized''.

Restoration Plan.

``Well Capitalized'' or ``Adequately None................... Discretion to

Capitalized''. reclassify to next

lower category.

``Undercapitalized'' or None................... Unsafe or unsound...... Discretion to treat as

``significantly undercapitalized''. if in next lower

category.

``Well Capitalized'' or ``Adequately must be ``new''........ condition or practice.. Discretion to

Capitalized'' new credit union. reclassify to next

lower category.

``Moderately Capitalized'' or Must be ``new''........ Discretion to treat as

``Marginally Capitalized'' new if in next lower

credit union. category.

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

Notice and effective date of net worth classification. Section

1790d is silent about how and when a credit union has notice of its net

worth ratio and corresponding classification. Part 702 generally deems

a credit union to have notice of its net worth ratio and to have become

classified within the corresponding net worth category on a quarterly

basis, coinciding with the end of the credit union's quarterly dividend

period or every monthly dividend period, as the case may be.

Sec. 702.3(b)(1). This imposes no additional burden on credit unions

because the net worth ratio is derived from their financial statements,

which federally- and State-chartered credit unions already prepare

monthly.\6\ See Standard By-Law Art. VIII, Sec. 5(d). Once a credit

union has notice that a change in its net worth places it in a lower

net worth category, the credit union must notify NCUA in writing within

15 days. Sec. 702.3(c). A credit union may rely on NCUA or the

appropriate State official for notice of its net worth category only

when it is given in an examination report, notice of reclassification

on safety and soundness grounds, or notice of adjustment to its net

worth ratio to reflect an accounting adjustment. Secs. 702.3(b)(2)-(3),

747.2003(a)(1)(ii).

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\6\ Federal depository institutions rely on quarterly Call

Reports to determine the ``leverage ratio'' (the equivalent of a net

worth ratio) on a quarterly basis. Part 702 does not rely on Call

Reports to determine credit union's net worth because only credit

unions having $50 million or more in assets file them quarterly, 12

CFR 741.6(a); other credit unions file Call Reports semi-annually.

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2. Prompt Corrective Action by Net Worth Category

The following is a summary of the mandatory and discretionary

supervisory actions that apply under part 702 to each statutory net

worth category. These are also depicted in Appendix A and B to the

preamble of this rule. Each supervisory action is explained in greater

detail beginning in subsequent sections:

``Well Capitalized''. A credit union classified ``well

capitalized'' under part 702 is subject to no prompt corrective action.

``Adequately Capitalized''. A credit union classified ``adequately

capitalized'' must comply with a single mandatory supervisory action--

an ``earnings retention requirement'' under which the credit union

transfers to its regular reserve an amount of earnings equal to a

proportion of the credit union's total assets. Sec. 702.104. It is not

subject to any discretionary supervisory actions.

``Undercapitalized''. A credit union classified

``undercapitalized'' must comply with four mandatory supervisory

actions--

Transfer of earnings to its regular reserve an amount of

earnings equal to no less than 4/10ths percent of the credit union's

average total assets;

Restrict total assets to the average of the credit union's

assets over the preceding 12 calendar months (unless

[[Page 27093]]

an approved Net Worth Restoration Plan provides for increasing assets);

Submit and implement a Net Worth Restoration Plan; and

Restrict the making of member business loans (unless

primarily in the business of making such loans.

Sec. 702.105(a). An ``undercapitalized'' credit union also is

subject to one or more of the following discretionary supervisory

actions which NCUA is authorized to impose to further the purpose of

part 702: Prior approval by NCUA for acquisitions, branching, new lines

of business.

Restrict CUSO transactions and ownership.

Restrict dividends paid on shares.

Prohibit asset growth or reduce it (below the preceding

year's average.

Alter, terminate or reduce any activity.

Prohibit nonmember deposits.

Other actions no more severe than the preceding

discretionary actions.

Order new election of board of directors.

Dismiss directors or senior executive officers.

Require employment of qualified senior executive officers.

Sec. 702.105(b).

``Significantly Undercapitalized''. Credit unions classified

``significantly undercapitalized'' are subject to all of the same

mandatory and discretionary supervisory actions as an

``undercapitalized'' credit union, except for the ``no more severe''

limitation on ``other actions'' taken in addition to those enumerated

for that category. Sec. 702.106(a)-(b). A ``significantly

undercapitalized'' credit union also is subject to the following

additional discretionary supervisory actions:

Restrict senior executive officers' compensation and

bonus.

Require merger with another financial institution if

grounds exist for conservatorship or liquidation.

Sec. 702.106(b)(7) and (9).

Apart from these mandatory and discretionary supervisory actions,

the NCUA Board may place a ``significantly undercapitalized'' credit

union into conservatorship or liquidation if it ``has no reasonable

prospect of becoming `adequately capitalized'.''

Sec. 702.106(c); 12 U.S.C. 1786(h)(1)(f), 1787(a)(3)(A)(i).

``Critically Undercapitalized''. A credit union classified

``critically undercapitalized'' is subject to all of the same mandatory

and discretionary supervisory actions as a ``significantly

undercapitalized'' credit union. Sec. 702.107(a)-(b). A ``critically

undercapitalized'' credit union also is subject to the following

additional discretionary supervisory actions:

Restrict payments on uninsured secondary capital.

Require NCUA prior approval for certain actions.

Sec. 702.107(b)(9)-(10).

Apart from these mandatory and discretionary supervisory actions,

the NCUA Board must place a ``critically undercapitalized'' credit

union into conservatorship or liquidation within 90 days, unless the

NCUA Board determines that other corrective action in lieu of

conservatorship or liquidation would better achieve the purposes of

prompt corrective action. Sec. 702.107(c)(1). That determination

expires at the end of a period of no more than 180 days,

Sec. 702.107(c)(1)(C), and if not affirmed within that period, the

credit union must be conserved or liquidated. Sec. 702.107(c)(2). Even

if that determination is renewed for another period of up to 180 days,

the NCUA Board must conserve or liquidate a ``critically

undercapitalized'' credit union which remains in that category on

average for a full calendar quarter following a period of 18 months

from the date it initially became ``critically undercapitalized,

Sec. 702.107(c)(3)(i), unless certain statutory requirements for an

exception are met. Sec. 702.07(c)(3)(ii).

3. Proposed Rule Provisions Applicable to All Credit Unions

The following provisions of part 702 form the framework of prompt

corrective action under both subparts A and B, and apply to all net

worth categories:

Definitions. Section 702.2 adopts the statutory definitions set

forth in Sec. 1790d(o), with four additions. First, the term

``appropriate State official'' is defined so as to abbreviate

references throughout part 702. Sec. 702.2(a). Second, the definition

of ``Credit Union Service Organization'' (CUSO) is expanded beyond the

existing definition, 12 C.F.R. 712.3(a), which is limited to federally-

chartered credit unions. Sec. 702.2(c). This will ensure that CUSOs of

federally-insured State-chartered credit unions are within the scope of

discretionary restrictions on CUSO transactions and ownership. E.g.,

Sec. 702.105(b)(2). Third, the terms ``credit union'' and ``shares''

are defined to ensure that part 702 encompasses State-chartered credit

unions and analogous terms for shares under applicable State law.

Sec. 702.2(b) and (h). Finally, the term ``total assets' is defined as

the average of total assets reported by a credit union on its most

recent four quarterly Call Reports, or for semiannual filers, on its

two most recent semi-annual Call Reports. Sec. 702.2(i).

The statutory definition of ``net worth''--''retained earnings

balance of the credit union, as determined under generally accepted

accounting principles [GAAP]''--will in some cases distort the ``net

worth ratio'' as a true measure of actual capital strength.

Sec. 702.2(e); Sec. 1790d(o)(2)(A). The GAAP definition of ``retained

earnings'' does not include items of ``other comprehensive income''

such as unrealized gains or losses on available-for-sale (AFS)

securities (Call Report account 945).\7\ As a result, when the fair

value of AFS securities falls, that reduction is not reflected in net

worth, artificially overstating the credit union's ``net worth ratio''

and possibly forestalling appropriate prompt corrective action.\8\ In

response to this dilemma, the proposed rule authorizes the NCUA Board

to adjust a credit union's net worth ratio to reflect accounting

adjustments such as gains and losses in the fair value of AFS

securities. Sec. 702.203(d).

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\7\ Under GAAP, ``retained earnings'' consists of undivided

earnings, statutory reserves, and other appropriations as defined by

management or regulatory authorities. AICPA, Audit & Accounting

Guide: Audits of Credit Unions at Sec. 11.01 (1998).

\8\ For example, assume a credit union has retained earnings

under GAAP of $6500 and total assets of $100,000; it would have a

net worth ratio of 6.5% and would be classified ``adequately

capitalized.'' Assume that during the next quarter, the credit union

experiences an $8,000 decrease in the fair value of its available-

for-sale (AFS) securities. This unrealized loss would be reflected

in total assets (the denominator of the net worth ratio), reducing

them to $92,000. However, under the statutory definition of ``net

worth,'' the unrealized loss would not be reflected at all in

retained earnings (the numerator of the net worth ratio), and would

still be $6500. As result, the credit union would have a net worth

ratio of 7.06% and be classified ``well capitalized'' despite having

sustained a decline in the fair value of its AFS securities.

Conversely, an understated net worth ratio results when the credit

union experiences an unrealized gain in the fair value of its AFS

securities.

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Consultation With State Officials. Part 702 tracks the statutory

requirement that NCUA consult with the appropriate State credit union

official when taking prompt corrective action against a federally-

insured State-chartered credit union (FISCU). Sec. 1790d(l). Before

placing a FISCU into conservatorship or liquidation to facilitate

prompt corrective action, NCUA must consult with the appropriate State

official, provide reasons for the proposed action, give the official an

opportunity to respond, and allow the official to place the FISCU into

conservatorship or liquidation. Sec. 702.108(a). If the State official

does not concur in the conservatorship or liquidation decision, the

NCUA Board cannot proceed unless it makes certain findings of risk of

loss to the NCUSIF. Sec. 702.108(a)(3); see also 12 U.S.C.

1786(h)(2)(C), 1787(b).

[[Page 27094]]

To satisfy the requirement that NCUA ``consult and seek to work

cooperatively with State officials'' when implementing prompt

corrective action, Sec. 1790d(I)(1), part 702 generally provides

throughout for participation by the appropriate State official in

decisions about a FISCU on which prompt corrective action is

predicated. Specifically, part 702 provides that NCUA ``shall notify

the appropriate State official before taking any discretionary action''

concerning a FISCU and ``shall allow the appropriate State official to

take the proposed action independently or jointly with NCUA.''

Sec. 702.108(c). When evaluating a FISCU's Net Worth Restoration Plan,

NCUA must consult with State officials. Sec. 702.109(d)(2). To

facilitate consultation, a FISCU which submits a Net Worth Restoration

Plan to NCUA must submit a duplicate to the appropriate State official.

Sec. 702.109(a)(1). When a FISCU, or an official who it has been

ordered to dismiss, seeks review of a decision to impose a

discretionary supervisory action, the appropriate State official must

be served with a copy of all notices and decisions issued by NCUA, and

responses and requests filed by the FISCU or its official.

Sec. 747.2001(b).

C. Mandatory and Discretionary Supervisory Actions

1. Mandatory Actions Prescribed by Statute

Under the proposed rule, each of the following mandatory

supervisory actions is a self-executing legal obligation of a credit

union once it is classified within a net worth category requires that

action. The legal obligation is not triggered by notification from

NCUA.

Earnings transfer to regular reserve. The proposed rule adopts the

mandatory ``earnings retention requirement'' under which credit unions

classified ``adequately capitalized'' or lower must ``annually set

aside as net worth an amount equal to not less than 0.4% of its total

assets.'' Sec. 1790d(e)(1). However, CUMAA does not answer how or when

a credit union's total assets should be measured for this purpose, or

where the earnings set aside should be held. To measure ``total

assets,'' part 702 uses the average of the credit union's total assets

as set forth in its most recent four quarterly Call Reports or most

recent two semi-annual Call Reports, as the case may be. Sec. 702.2(i).

Measuring total assets on a single day, such as the last day the prior

quarter or prior year, would not take into account seasonal

fluctuations in asset size. The rule also directs that the resulting

amount of earnings to be set aside over the ensuing year is to be

transferred in installments to the credit union's regular reserve. A

credit union having a monthly dividend period for regular shares must

make monthly transfers of at least 8.334%, or 1/12th , of the annual

sum. Sec. 702.104(a)(1). A credit union having a quarterly or less

frequent dividend period for regular shares must make a quarterly

transfer of at least 25%, or \1/4\ of the annual sum.

Sec. 702.104(a)(2).

Part 702 also amplifies the terms of the statutory exception to the

0.4% minimum set aside. Sec. 1790d(e)(2). First, the NCUA Board

interprets the phrase ``by order'' to indicate that exceptions to 0.4%

statutory minimum are to be granted on a case-by-case basis.

Sec. 702.104(b). Second, the proposed rule implements the mandate to

``periodically review any order'' decreasing the 0.4% statutory minimum

by requiring ``review and revocation no less frequently than

quarterly,'' to coincide with the dividend period for regular shares

which is common among credit unions. Id.

Net Worth Restoration Plan. The requirement to implement a Net

Worth Restoration Plan (NWRP) emerges as the hallmark of prompt

corrective action. To restore a credit union's net worth to the

``adequately capitalized'' level, CUMAA provides that credit unions

classified ``undercapitalized'' or lower must timely submit to the NCUA

Board and implement a NWRP. Sec. 1790d(f)(1). The statute requires NCUA

to establish ``reasonable'' deadlines for submission of NWRPs; set

``expeditious'' deadlines for NCUA to act on them; allow credit unions

which fail to timely submit an NWRP a further opportunity to do so; and

allow a credit union whose NWRP is not approved an opportunity to

submit a revised NWRP. Sec. 1790d(f)(3)-(4). Further, credit unions

having less than $10 million in assets are entitled to receive

assistance in preparing an NWRP. Sec. 1790d(f)(2).

To fulfill this mandate, the proposed rule sets a 45-day period for

submitting an NWRP, and if that deadline is not met, allows an

additional 15 days to submit an NWRP. Sec. 702.109(a)(1). The NCUA

Board is required to act on an initial NWRP within 60 days, and to

provide reasons in the event of disapproval. Sec. 702.109(e)(1). When

an initial NWRP is not approved, the credit union is given 30 days to

file a revised NWRP, on which the NCUA Board is required to act within

30 days of receipt. Sec. 702.109(f). The periods for submission and

review of an initial NWRP parallel those which FDIA

Sec. 38(e)(2)(D)(ii) sets for ``capital restoration plans''--the

federally-insured depository institutions' analog to an NWRP--and are

consistent with comments on the topic received in response to the ANPR.

The NCUA Board has declined to set a deadline by which a credit union

having less than $10 million in assets must request assistance in

preparing an NWRP; under the proposed rule, NCUA will provide

assistance simply ``upon timely request.'' Sec. 702.109(b).

CUMAA is silent as to the contents of an NWRP, and sets just a

single standard for approving one. Sec. 1790d(f)(5). As comments

received in response to the ANPR suggested, the NCUA Board has examined

the contents and criteria that FDIA Sec. 38 prescribes for a ``capital

restoration plan.'' With certain additions and adjustments to

distinguish between credit unions and other depository institutions,

the NCUA Board proposes to require for an NWRP much of the content

information that FDIA Sec. 38(e)(2)(B) demands of a ``capital

restoration plan.'' Accordingly, section 702.109(c) requires a proposed

NWRP to specify--

The steps the credit union will take to become

``adequately capitalized'';

A specific timetable for increasing net worth during each

year in which the NWRP will be in effect;

How the credit union will comply with the mandatory and

discretionary restrictions or requirements imposed on it under this

part;

The types and levels of activities in which the credit

union will engage;

The amount of earnings the credit union will transfer to

its regular reserve account pursuant to the earnings retention

requirement in section 702.104; and

In the case of a plan submitted by a credit union which

has been reclassified under Sec. 702.101(b) on safety and soundness

grounds, the steps the credit union will take to correct the unsafe or

unsound practice(s) or condition(s).

Sec. 702.109(c)(1) (i)-(vi).

Finally, an NWRP must be accompanied by pro-forma financial

statements covering the next two years, and financial data submitted in

connection with an NWRP must generally conform to GAAP. Sec. 702.109

(c)(2) and (c)(4).

Similarly, to supplement the single statutory criterion for

approval of a NWRP--that it be ``based on realistic assumptions'' and

be ``likely to succeed in restoring * * * net worth''--the NCUA Board

proposes to adopt as appropriate for approving an NWRP the additional

criteria which FDIA

[[Page 27095]]

Sec. 38(e)(2)(c) establishes for accepting a ``capital restoration

plan,'' with significant modifications addressed below. To be approved,

section 702.109(d) requires an NWRP to--

Be based on realistic assumptions and likely to succeed in

restoring net worth;

Comply with content requirements in section 702.109(c);

Not unreasonably increase the credit union's exposure to

risk (including credit risk, interest-rate risk, and other types of

risk); and be supported by appropriate assurances from the credit union

that it will comply with the plan until it has remained ``adequately

capitalized'' for four (4) consecutive calendar quarters.

Whereas a ``capital restoration plan'' cannot ``appreciably

increase'' risk exposure, an NWRP must ``not unreasonably increase the

credit union's exposure to risk.'' (emphasis added.) Compare FDIA

Sec. 38(e)(2)(C)(I)(III) with Sec. 702.109(d)(3). This permits a credit

union with little or no risk exposure to incur reasonable exposure to

improve net worth. Approval of a ``capital plan'' requires a financial

``guarantee'' of compliance until ``the institution becomes adequately

capitalized on average during each of 4 consecutive calendar

quarters,'' and ``appropriate assurances'' of performance. FDIA

Sec. 38(e)(2)(c)(ii). Section 702.109(d)(4) combines and condenses this

pair of requirements into a single, criterion appropriate for credit

unions--requiring ``appropriate assurances'' of compliance with the

NWRP until the credit union ``has remained `adequately capitalized' for

four (4) consecutive calendar quarters'' on an absolute basis rather

than just on average. The NCUA Board may delegate to its Regional

Directors the authority to evaluate an NWRP according to the proposed

criteria.

Restriction on increase in assets. Part 702 adopts CUMAA's

limitation on increasing assets, which provides that a credit union

classified ``undercapitalized'' or lower shall ``not generally permit

its average total assets to increase'' unless doing so is consistent

with the credit union's approved NWRP and the credit union increases

assets and net worth at the rate the Plan prescribes. Sec. 1790d(g)(1);

Sec. 702.105(a)(3). However, the statute does not specify the period

over which ``average total assets'' should be calculated for purposes

of limiting asset growth. Therefore, to avoid seasonal fluctuations in

asset size, section 702.105(a)(3) relies on the definition of total

assets in section 702.2(i).

In many cases, at the time a credit union becomes subject to the

limit on increasing assets, its total assets already will exceed the

average for the preceding twelve months, raising the question whether

it should be required to reduce assets to that level. Section

702.105(b)(4) gives the NCUA Board discretionary authority to prohibit

a credit union classified ``undercapitalized'' or lower from increasing

its total assets or an individual category of assets beyond an absolute

level, or even to require the credit union to reduce total assets or a

category of assets. Due to the availability of this complementary

restriction, the NCUA Board declines to interpret the statutory asset

limitation as requiring a reduction in assets to the level of average

total assets over the preceding 12 months.

Restriction on increase in member business loans. CUMAA prohibits

credit unions classified ``undercapitalized'' or lower from ``mak[ing]

any increase in the total amount of member business loans * * *

outstanding at that credit union at any one time * * *'' 1790d(g)(2).

This imposes a freeze on member business lending, rather than confining

it to an average. Part 702 incorporates within this restriction the

exemptions Title II of CUMAA prescribes for ``a credit union chartered

for the purpose of making, or that has a history of primarily making,

member business loans to its members,'' or which is designated low

income, or which participates in the Community Development Financial

Institutions program. 12 U.S.C. 1757a(b). Applying these exemptions to

the proposed rule's member business loan restriction will ensure that

prompt corrective action does not defeat the net worth restoration

efforts of credit unions which rely heavily on member business lending.

Part 702's member business loan restriction is imposed

``[n]otwithstanding'' the Title II maximum on member business loans--

1.75 times net worth for less than ``well capitalized'' credit unions;

12.25% of assets for those which are ``well capitalized'' (but not

``complex''). 12 U.S.C. 1757a(a)(1). This makes it clear that the part

702 restriction is overriding. Thus, a credit union cannot claim to be

entitled to increase member business loans to the Title II maximum

before the part 702 restriction can take effect.

Conservatorship and Liquidation. CUMAA prescribes criteria for

allowing and for mandating conservatorship and liquidation of a credit

union classified ``significantly undercapitalized'' or ``critically

undercapitalized,'' Sec. 1790d(i) (1)-(2), and amends the FCUA

accordingly. CUMAA Sec. 301(b). Section 702.106(b) faithfully reflects

the statutory authority to place a ``significantly undercapitalized''

credit union into conservatorship or liquidation to facilitate prompt

corrective action upon finding that the credit union ``has no

reasonable prospect of becoming adequately capitalized.'' 12 U.S.C.

1786(h)(1)(F), 1787(a)(3)(A)(i).

In the case of a ``critically undercapitalized'' credit union,

regardless of its prospect of becoming ``adequately capitalized,'' the

NCUA Board must--

not later than 90 days after the date on which an insured credit

union becomes critically undercapitalized--

(A) appoint a conservator or liquidating agent for the credit union;

or (B) take such other action as the Board determines would better

achieve the purpose of [Sec. 1790d], after documenting why the

action would better achieve that purpose.

Sec. 1790d(i)(1). Section 702.107(c) restates this mandate.

The statute provides that the determination to take other

corrective action shall ``cease to be effective not later than the end

of the 180-day period beginning on the date on which the determination

is made,'' and the credit union shall be placed into conservatorship or

liquidation ``unless the Board makes a new determination * * * before

the end of the effective period of the prior determination'' that

continuing other corrective action will further the purpose of

Sec. 1790d. Sec. 1790d(d)(2). Section 702.107(c)(2) implements this

procedure for renewing other corrective action in lieu of

conservatorship and liquidation. The NCUA Board interprets the

``documenting'' prerequisite for initially taking other corrective

action as setting a standard for renewing that determination.

Regardless whether other corrective action restores net worth, the

NCUA Board is required by statute to place the credit union into

liquidation ``if [it] is critically undercapitalized on average during

the calendar quarter beginning 18 months after the date on which the

credit union became critically undercapitalized.'' Sec. 1790d(i)(3)(A).

An exception to mandatory liquidation is allowed, however, and other

corrective action may continue, if the NCUA Board makes three findings:

That the credit union has substantially complied with a

Net Worth Restoration Plan requiring improvement in net worth since the

date the plan was approved;

[[Page 27096]]

That the credit union has positive net income or a

sustainable upward trend in earnings; and

That the credit union is viable and not expected to fail.

Sec. 1790d(i)(3)(B).

The mandate for liquidation of a ``critically undercapitalized''

credit union after 18 months, and the grounds for an exception to it,

are incorporated in section 702.107(c)(3).\9\

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

\9\ The authority to elect among conservatorship, liquidation,

or other action concerning a ``critically undercapitalized'' credit

union cannot be delegated unless the credit union has less than

$5,000,000 in assets. Sec. 1790d(l)(4)(A). If made by delegation,

the decision is directly appealable to the NCUA Board.

Sec. 1790d(i)(4)(B); Sec. 702.107(c)(4). Finally, a ``significantly

undercapitalized'' or ``critically undercapitalized'' credit union

which is placed into conservatorship or liquidation under part 702

retains the right to challenge NCUA Board's decision in court within

10 days. 12 U.S.C. 1786(h)(3), 1787(a)(1)(b).

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

Although faithful to the statutory language, section 702.107(c) is

phrased to reveal flexibility that may not be apparent. First, the

effective period of a determination to take ``other corrective action''

need not extend for the maximum duration of 180 days. The NCUA Board

has the discretion to establish a shorter effective period. Further,

the NCUA Board may reconsider any determination periodically, and

reverse and discontinue the ``other corrective action'' altogether. To

continue the action beyond an effective period, the NCUA Board must

make a new finding prior to the end of the effective period that its

``other corrective action'' still furthers the purpose of prompt

corrective action. If the new finding is made, the ``other corrective

action'' can continue for a new effective period that is appropriate to

achieve the ``other corrective action,'' which the NCUA Board may

specify as any period of up to 180 days from the date of the

determination. The new determination still can be reconsidered

periodically, and renewed for an additional effective period or

discontinued.

Second, if the credit union first became ``critically

undercapitalized'' at the end of a calendar quarter, the last possible

day for ``other corrective action'' may be as soon as 18 months plus 3

months of the next calendar quarter, for a total of 21 months. If the

date the credit union first became ``critically undercapitalized'' was

other than the end of a calendar quarter, the last possible day for

``other corrective action'' would extend to the end of the calendar

quarter following the 21 months, for a total of up to 23 months.\10\

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

\10\ In any event, a credit union's net worth ratio need only

average 2% or more over the full calendar quarter following 18

months from the date the credit union was first classified

``critically undercapitalized.''

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

2. Discretionary Actions Under Statutory Authority

CUMAA requires NCUA to develop discretionary supervisory actions to

complement the mandatory ones it prescribes, provided they are

consistent with the purpose of prompt corrective action, and are

``comparable'' to the ``discretionary safeguards'' in FDIA Sec. 38.

Sec. 1790d(b)(1)(A). The discretionary supervisory actions NCUA

proposes are generally allocated among the five statutory net worth

categories in part 702 by corresponding capital category in FDIA

Sec. 38.\11\ Throughout the proposed rule, the use of discretionary

actions is conditioned upon furthering the purpose of part 702.

However, NCUA is not required to give mandatory supervisory actions an

opportunity to improve net worth before resorting to discretionary

actions. Except as noted, there is no limit to the number or sequence

in which the NCUA Board imposes one or more discretionary actions. Each

discretionary requirement and restriction is adapted as follows from

FDIA Sec. 38 with appropriate modifications to suit the distinct

features of credit unions in the net worth categories established by

statute and those developed for ``new'' credit unions:

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

\11\ The Federal banking agencies' Joint Final Rule does not

restate or establish by regulation the ``discretionary safeguards''

prescribed in FDIA Sec. 38; it merely incorporates them by general

reference to the statute. See, e.g., 12 CFR 325.105(a)(2). However,

FDIA Sec. 38(b)(1)'s five capital categories and corresponding range

of ``leverage ratios'' (the equivalent of a net worth ratio) are the

same as part 702's five net worth categories and corresponding range

of net worth ratios. Compare FDIA Sec. 38(b)(1) with Sec. 1790d(c);

see e.g., 12 CFR 325.103(b).

Part 702--Discretionary Supervisory Actions

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

Applies in which

Discretionary supervisory action statutory and ``new'' Comparison with FDIA Sec. 38 and

net worth categories appropriateness of discretionary actions for

---------------------------------------------------------------------------------credit unions.-----------------

1. Requiring NCUA prior approval for Statutory: NCUA may prohibit a credit union ``from,

acquisitions, branching, new lines ``Undercapitalized'' directly or indirectly, acquiring any interest

of business. and lower. in any CUSO or credit union, establishing or

New: ``Moderately acquiring any additional branch office, or

Capitalized'' and engaging in any new line of business unless the

lower. NCUA Board has approved the credit union's net

worth restoration plan, the credit union is

implementing its plan, and the NCUA Board

determines that the proposed action is

consistent with and will further the objectives

of that plan.'' Sec. 702.105(b)(1). This

authority extends to ownership interests in a

CUSO and is a discretionary supervisory action

in part 702, whereas in FDIA Sec. 38 the

approval plan is a mandatory supervisory

action.

2. Restricting transactions with and Statutory: NCUA may restrict transactions between a credit

ownership of CUSOs. ``Undercapitalized'' union and its wholly- or partially-owned

and lower. CUSO(s), and require that credit union to

New: ``Moderately reduce or divest its ownership interest in a

Capitalized'' and CUSO. Sec. 702.105(b)(2). This is an analog to

lower. FDIA Sec. 38(f)(2)(B), which restricts a

depository institution from transactions with

its affiliate institutions. The authority to

require a credit union to reduce or divest it

ownership interest in a CUSO is appropriate

because CUSO ownership can be a drain on the

credit union's financial resources and

attention at a time when both need to be

devoted to improving net worth.

3. Restricting dividends paid........ Statutory: NCUA may restrict the dividend rates a credit

``Undercapitalized'' union pays on shares to the prevailing rates

and lower. paid on comparable accounts and maturities in

New: ``Moderately the region where the credit union is located,

Capitalized'' and but may not apply this restriction

lower. retroactively to dividends on shares already

issued. Sec. 702.105(b)(3). This is an analog

to the FDIA Sec. 38(f)(2)(c), which imposes

the same restriction on interest rates. In

order not to undermine the ability of a credit

union to attract new members, the rate

reduction is limited to ``prevailing rates paid

on comparable accounts'' in the region, thus

permitting a credit union to remain competitive

in the rates it pays.

[[Page 27097]]

4. Prohibiting or reducing asset Statutory: NCUA may place an absolute limit on increases in

growth. ``Undercapitalized'' assets generally or on increases in a

and lower. particular asset category, or may compel the

New: ``Moderately credit union to reduce its total assets or a

Capitalized'' and certain category of assets. Sec.

lower. 702.105(b)(4). This is a modified version of

the FDIA provision ``restricting the

institution's asset growth more stringently''

than limiting increases in total average

assets. FDIA Sec. 38(f)(2)(D). This authority

is appropriate for credit unions because it can

be targeted to limit growth in one or more

specific asset categories and complements the

mandatory action limiting assets to total

average assets. See Sec. 702.105(a)(3).

5. Alter, reduce or terminate any Statutory: NCUA may compel a credit union to alter, reduce

activity by credit union or its CUSO. ``Undercapitalized'' or terminate any activity in which it or its

and lower. CUSO engages. Secs. 702.105(b)(5),

New: ``Moderately 702.106(b)(5), 702.107(b)(5). This is adapted

Capitalized'' and from FDIA's similar restriction, but is

lower. extended to CUSOs and is without the

prerequisite that the subject activity poses

``excessive risk to the institution. `` FDIA

Sec. 38(f)(2)(E). This is appropriate for

credit unions because activities which may not

be excessively risky still may distract the

attention of management, compromise a CUSOs

internal controls, or pose cost efficiency or

conflict of interest problems--all of which can

impact on net worth.

6. Prohibiting nonmember deposits.... Statutory: NCUA may prohibit a credit union from accepting

``Undercapitalized'' all or certain nonmember deposits as otherwise

and lower. permitted under 12 U.S.C. 1757(6) and 12 CFR

New: ``Moderately 701.32. Sec. 702.105(b)(6). This is an analog

Capitalized'' and to the FDIA Sec. 38 provision prohibiting

lower. deposits from correspondent banks. FDIA Sec.

38(f)(2)(G). This restriction may serve a

critical purpose for credit unions when large

nonmember depositors are unduly influential in

credit union affairs affecting its net worth.

7. Other actions to further the Statutory: NCUA may ``restrict or require such other action

purpose of part 702. ``Undercapitalized'' as [it] determines will carry out the purpose

and lower. of [part 702] better than any of the

New: ``Moderately [discretionary] actions prescribed [for that

Capitalized'' and category.]'' Secs. 702.106(b)(10),

lower. 702.107(b)(11). For the ``undercapitalized''

category only, however, ``such other

restriction or requirement [must be] no more

severe than the [other discretionary] actions

prescribed'' for that category. Sec.

702.105(b)(7). FDIA Sec. 38(f)(2)(J) is

analogous, but without the ``no more severe''

limitation. NCUA has added the ``no more

severe'' limitation to ensure that in the case

of an ``undercapitalized'' credit union--whose

net worth ratio may, for example, be just tens

of basis points short of ``adequately

capitalized''--that the least intrusive means

is used to further the purpose of part 702.

This is not the case with ``significantly

undercapitalized'' and ``critically

undercapitalized'' credit unions, who, by

definition, are not near to being ``adequately

capitalized.''

8. Ordering new election of board of Statutory: As one means of improving management, NCUA may

directors. ``Undercapitalized'' compel a credit union to hold a new election of

and lower. its board of directors. Sec. 702.105(c)(1).

New: ``Moderately FDIA Sec. 38(f)(2)(F)(i) is identical. This

Capitalized'' and action is an appropriate means of improving

lower. management where the board of directors is

determined to be responsible for a net worth

deficiency and is either unwilling or not

capable of taking action needed to correct the

deficiency. NCUA intervention is minimal

because a new election gives the credit union

membership an opportunity to change member

representation on the board of directors,

possibly eliminating the need for further

action by NCUA. For ``undercapitalized'' credit

unions only, this and other means of

``improving management'' may be imposed only

after NCUA takes one or more of the

discretionary prescribed for that category

(i.e., Sec. 702.105(b)(1)-(7)) or determines

that none of those actions would further the

purpose of part 702.\12\ Sec. 702.105(c).

Similarly to ``other actions'' in paragraph 7

above, this is to ensure that the least extreme

discretionary action is used in the case of a

credit union whose net worth ratio may fall

just short of being ``adequately capitalized.''

9. Dismissing directors or senior Statutory: As a second means of improving management, NCUA

executive officers. ``Undercapitalized'' may require a credit union to dismiss one or

and lower. more directors or senior executive officers.

New: ``Moderately Sec. 702.105(c)(2). This action is appropriate

Capitalized'' and when a surgical approach to replacing

lower. management is warranted. FDIA Sec.

38(f)(2)(F)(ii) is identical, except that it

provides a period of protection from dismissal

for persons who have held office 180 or fewer

days prior to the date the institution was

classified ``undercapitalized'' or lower. The

theory behind this period of protection from

dismissal is that such persons have not held

office long enough to be responsible for net

worth problems causing the institution to be

classified ``undercapitalized'' or lower. NCUA

proposes to eliminate this period of protection

so that no official who is responsible for a

credit union's rapidly declining net worth, or

who is incapable reversing the decline, can

have a ``safe harbor'' from dismissal. This

action is subject to the prerequisite only in

the ``undercapitalized'' category that other

discretionary actions in that category be used

first or be determined not to further the

purpose of part 702. Subpart L of part 747

provides a specific review procedure for

dismissals pursuant to this action. 12 CFR

747.2004.

10. Employing qualified senior Statutory: As a third means of improving management, NCUA

executive officers. ``Undercapitalized'' may require the credit union to employ

and lower. qualified senior executive officers, who may be

New: ``Moderately subject to the NCUA Board's approval. Sec.

Capitalized'' and 702.105(c)(3). FDIA Sec. 38(f)(2)(F)(iii) is

lower. identical. This action can be a means of

supplementing existing management, or replacing

a dismissed officer, with persons who are

competent to deal with and to correct the

causes of declining net worth. NCUA can

authorize the credit union to identify and to

hire a sufficiently qualified person, or NCUA

may condition hiring upon its approval of the

credit union's candidate. This action is

subject to the prerequisite in the

``undercapitalized'' category only that other

discretionary actions in that category be used

first or be determined not to further the

purpose of part 702.

[[Page 27098]]

11. Restricting senior executive Statutory: NCUA may limit or reduce the compensation a

officers' compensation and bonus. ``Significantly credit union pays to its senior executive

Undercapitalized'' and officers; limit, reduce, or prohibit bonuses

lower. paid to such officers; or condition payment of

New: ``Marginally either compensation or a bonus upon NCUA

Capitalized'' and approval. Secs. 702.106(b)(7), 702.107(b)(7).

lower. FDIA Sec. 38(f)(4)(A) is similar except that

it does not authorize unilaterally limiting,

reducing or prohibiting compensation or

bonuses. Instead, it provides for approval by

the appropriate Federal banking agency for

compensation in excess of the officer's average

compensation over the 12 calendar months

preceding classification of the credit union as

``significantly undercapitalized'' or lower,

and for a bonus in any amount. Such approval

for either is prohibited if an institution has

failed to submit an acceptable ``capital

restoration plan.'' FDIA Sec. 38(f)(4)(B).

12. Requiring merger if grounds exist Statutory: NCUA may require a credit union to merge with

for conser-vatorship or liquidation. ``Significantly another financial institution, but only if

Undercapitalized'' and grounds exist to place the credit union into

lower. conservatorship or liquidation. Sec.

New: ``Marginally 702.106(b)(9), 702.107(b)(9). The statutory

Capitalized'' and grounds for conserving or liquidating a

lower. ``significantly undercapitalized'' or

``critically undercapitalized'' credit union to

facilitate prompt corrective action is whether

the credit union has a reasonable prospect of

becoming ``adequately capitalized.'' 12 U.S.C.

1786(h)(1)(F), 1787(a)(3)(A)(i). FDIA Sec.

38(f)(2)(A)(iii) is analogous, requiring an

institution to be acquired by a depository

institution holding company, or to combine with

another depository institution if grounds exist

for conservatorship or receivership. This

action is appropriate for credit unions because

NCUA's insistence on merger with another

financial institution gives credit union

management the opportunity to consummate a

merger to avoid inevitable conservatorship or

liquidation, thereby permitting the credit

union to survive in merged form.

13. Restrict payments on uninsured Statutory: ``Critically NCUA may prohibit a credit union, beginning 60

secondary capital. Undercapitalized''. days after it becomes ``critically

New: ``Minimally undercapitalized'', from making payments of

Capitalized'' and principal or interest on uninsured secondary

``Uncapitalized''. capital.'' Sec. 702.107(b)(9). This is

analogous to FDIA Sec. 38(h)(2)'s restriction

on payment of principal and interest on

subordinated debt. However, for Federal banking

agencies that restriction is a mandatory

supervisory action, whereas in part 702 it is

discretionary. This restriction will have

limited effect because only low-income credit

unions are permitted by law to accept uninsured

secondary capital. 12 U.S.C. 1757(6).

14. Require NCUA prior approval for Statutory: ``Critically NCUA may require a credit union to obtain its

certain actions. Undercapitalized''. approval before engaging in certain activities

New: ``Minimally on the operational level, such as entering into

Capitalized'' and a material transaction outside the normal

``Uncapitalized''. course of business, amending by-laws, or

changing accounting methods. Sec.

702.107(b)(10). FDIA Sec. 38(i) imposes a

similar ``prior approval'' requirement which

addresses the same actions and a few others not

relevant to credit unions.

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

\12\ The ``prerequisite'' provisions in the proposed rule--Secs. 702.104(b)(7) and (c), 702.105(b)(10),

702.106(b)(10), 702.107(b)(11)--requiring certain discretionary actions to be taken before other more

stringent or intrusive discretionary actions, are modeled conversely to FDIA Sec. 38(f)(3), which establishes

a ``presumption in favor of certain actions'' (requiring merger, restricting transactions with affiliates, and

restricting interest rates) which are relatively more stringent than other available discretionary actions.

D. Alternative Prompt Corrective Action for New Credit Unions

CUMAA charged NCUA with the responsibility of developing ``a system

of prompt corrective action that shall apply to new credit unions'' in

lieu of the system of statutory PCA applicable to all other federally-

insured credit unions. Sec. 1790d(b)(2)(A). The statute defines a

``new'' credit union as having been in operation for less than 10 years

and having $10 million or less in assets, Sec. 1790d(o)(4). In

addition, it requires the alternative system of PCA for new credit

unions to:

Recognize that new credit unions initially have no net

worth, and must be given reasonable time to accumulate net worth;

Create adequate incentives for new credit unions to become

``adequately capitalized'' by the time they either are in operation for

more than 10 years or reach $10 million in total assets;

Impose appropriate restrictions and requirements on new

credit unions that do not make sufficient progress toward becoming

``adequately capitalized''; and

Prevent evasion of the purpose of part 702.

Sec. 1790d(b)(2)(B).

In carrying out this mandate, the NCUA Board has relied upon two

resources--comments on the topic in response to the ANPR and the advice

of a ``new'' credit union committee assembled by NCUA for the purpose

of studying field staff experience in dealing with new credit unions

over the last decade. Among the members of the committee is a combined

81 years of field experience with credit unions and 10 years of private

sector credit union experience.

A consensus of ANPR comments recommended that NCUA create a system

of PCA for new credit unions which--

Follows a modified ``net worth category'' model;

Allows for gradual capital accumulation;

Allows new credit unions to have no net worth in the early

years;

Sets no minimum on earnings transfers to the regular

reserve; and

Allows regulatory forbearance in imposing supervisory

actions.

Based on field experience with new credit unions over the last 10

years, the ``new'' credit union committee made the following findings:

The ability to accumulate capital through earnings is

limited during a new credit union's early years of operation due to

small asset size, the low ratio of loans to assets, and high fixed

expenses;

Historical data and field experience indicate that it

takes between 3 and 5 years for a new credit union to accumulate a net

worth of 2%;

A business plan which establishes a strategy for achieving

operational and financial objectives, and which is revised on an

ongoing basis to reflect changing business conditions, is essential;

[[Page 27099]]

A credit union which is unable to meet even modest net

worth goals (established in its business plan) in its early years is

unlikely to become ``adequately capitalized'' by the end of 10 years;

Member business lending, although permitted for new credit

unions, involves significant risks and requires a level of expertise

not normally present in newly-chartered credit unions;

Net worth categories for new credit unions should allow

for gradual accumulation of net worth over 10 years; and

Discretionary supervisory actions should be imposed

commensurately with a new credit union's failure to meet net worth

goals and the consequent increase in risk of loss to the NCUSIF.

The NCUA Board believes that the system of prompt corrective action

for new credit unions which it proposes in subpart B reflects the

intent of CUMAA, while incorporating the recommendations of commenters

and the findings of the ``new'' credit union committee.

1. Provisions Applicable to All New Credit Unions

Section 702.2(f) adopts the statutory definition of a ``new''

credit union--in operation for less than 10 years and having $10

million or less in assets--which determines which credit unions will be

subject to the alternative system of prompt corrective action under

subpart B. For purposes of subpart B, a new credit union begins

``operation'' when it engages in a transaction that is required by GAAP

to be reflected in the credit union's financial statement. The

statutory definition significantly expands the definition in section

116 of the FCUA, which CUMAA repeals. CUMAA Sec. 301(g)(3). The

repealed provision defined a ``new'' credit union as having been in

operation less than 4 years or having assets of less than $500,000. 12

U.S.C. 1762(a)(2).

Subpart B augments the new statutory definition. First, it makes

clear that ``[a] credit union which exceeds $10 million in total assets

may become ``new'', or may regain that status, ``if its total assets

fall below $10 million while it is still in operation for less than 10

years.'' Sec. 702.201(b). Second, it addresses the impact of a ``spin-

off'' of a group in determining whether the newly-formed or surviving

credit union has been in operation less than 10 years. Sec. 702.201(c).

Third, it allows the NCUA Board to deny ``new'' status under subpart B

to any credit union formed primarily to qualify as ``new'' for purposes

of subpart A. Sec. 702.201(d).

Subpart B incorporates by reference the general provisions of part

702 concerning measurement of net worth, notice to a new credit union

of its net worth ratio and the effective date of classification in the

corresponding net worth category, notice to NCUA of a change in net

worth category, and adjustments to a credit union's net worth ratio to

reflect accounting adjustments. Sec. 702.202(b) incorporating 702.3.

Similarly to subpart A, subpart B provides for reclassification of new

credit unions in certain net worth categories due to the existence of

an unsafe or unsound condition or practice. Sec. 702.202(d).

2. Net Worth Categories for New Credit Unions

Following the ``net worth category'' model of subpart A, subpart B

establishes six net worth categories for new credit unions, denominated

to indicate that they are building net worth anew, rather than

restoring it from decline. Sec. 702.202(c). The net worth categories,

corresponding net worth ratio range for each (assuming no risk-based

net worth requirement), and corresponding number of years in which a

new credit union is reasonably expected, but not required, to attain

each category, are depicted below:

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

New credit union net worth Net worth ratio Expected by year-

category (percent) end of operation

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

``Well Capitalized''.......... 7 or above........... n/a

``Adequately Capitalized''.... 6 to 6.99............ 10th

``Moderately Capitalized''.... 3.5 to 5.99.......... 7th

``Marginally Capitalized''.... 2 to 3.49............ 5th

``Minimally Capitalized''..... 0 to 1.99............ 3rd

``Uncapitalized''............. Less than 0.......... n/a

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

In general, the net worth categories for new credit unions are

designed to allow gradual accumulation of net worth over a ten year

period. The ``minimally capitalized'' and ``marginally capitalized''

categories reflect the finding that it generally takes up to 3 years

for a newly-chartered credit union to develop positive net worth and

may take up to 5 years to attain a 2% net worth. The time frame in

which a new credit union is ``reasonably expected'' to reach a given

net worth category is a guide only, based on NCUA field experience; it

does not establish a mandatory deadline nor trigger any supervisory

action. Unlike subpart A, subpart B establishes an ``uncapitalized''

category which permits credit unions having no net worth to continue

operating under limited time constrains before mandatory supervisory

action must be taken. As commenters and the ``new'' credit union

committee have emphasized, new credit unions which eventually succeed

in becoming ``adequately capitalized'' may suffer periods of negative

net worth while striving toward that goal, particularly in the early

years of operation.

Unlike subpart A, there is no downward adjustment of a new credit

union's net worth category if fails to comply with any particular

supervisory action. Compare Sec. 702.101(a)(4)(ii) with

Sec. 702.202(c)(3). However, new credit unions categorized as either

``well capitalized'' or ``adequately capitalized,'' and which meet the

definition of ``complex,'' will be subject to a risk-based net worth

requirement. Sec. 1790d(c)(1)(A)(ii) and (c)(1)(B)(2). Like credit

unions subject to subpart A, new credit unions which do not meet the

risk-based requirement in either category will be reclassified

``moderately capitalized.''

3. Prompt Corrective Action for New Credit Unions by Net Worth Category

``Well Capitalized'' and ``Adequately Capitalized''. New credit

unions classified ``well capitalized'' and ``adequately capitalized''

under subpart B are treated the same as their counterparts in subpart

A. Thus, a ``well capitalized'' new credit union is subject to no

prompt corrective action at all. An ``adequately capitalized'' credit

union is subject to a single mandatory supervisory action--the

requirement to transfer to the credit union's regular reserve earnings

equal to not less than 4/10th percent of its average total assets.

Sec. 702.203. The alternative system of

[[Page 27100]]

prompt corrective action subjects an ``adequately capitalized'' new

credit union to the same supervisory action as its counterpart in

subpart A in order to facilitate a smooth transition to subpart A at

the end of 10 years or by the time the credit union accumulates assets

of $10 million or more.

``Moderately Capitalized,'' ``Minimally Capitalized'' and

``Marginally Capitalized''. Credit unions in these categories are

subject to three mandatory supervisory actions which are similar to

those which apply to credit unions categorized ``undercapitalized'' or

lower in subpart A. The first is the requirement to annually transfer

earnings to its regular reserve; however, for new credit unions there

is no required minimum percentage of average total assets to determine

the amount to be transferred. Sec. 702.204(a)(1). The second is the

restriction on increasing the credit union's total amount of member

business loans until the credit union becomes ``adequately

capitalized'' unless it qualifies under 12 U.S.C. 1757a(b) for any of

the exemptions from the statutory maximum on member business loans.\13\

Sec. 702.204(a)(3). Third, each time a credit union fails to timely

meet the net worth goals prescribed in its current approved business

plan, it must submit a revised business plan to the NCUA Board for

approval and implementation. Sec. 702.204(a)(2). Because new credit

unions in these categories are not restoring net worth, but are

building it, they are not required to submit Net Worth Restoration

Plans.

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\13\ The NCUA Board will consider, for ``new'' credit unions

only, whether to narrow the restriction on increasing members

business loans to the origination of such loans. In that even, a

``new'' credit union would be prohibited from increasing member

business loans which it originates, but would not necessarily be

prohibited from participating in member business loans originated by

another credit union which has expertise in originating such loans.

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In both subparts A and B, a credit union is subject to mandatory

and discretionary supervisory actions when it becomes classified

``undercapitalized'' or lower under subpart A or ``moderately

capitalized'' or lower under subpart B. Under subpart A, a credit union

also becomes subject to discretionary supervisory actions according to

its classification among those net worth categories. Under subpart B,

however, NCUA's authority to impose discretionary supervisory actions

upon a new credit union is triggered by the failure to meet a net worth

goal prescribed in the credit union's then-current business plan.

Sec. 702.204(b). In that event, the credit union becomes obligated to

comply with the mandatory supervisory action requiring it to submit a

revised business plan to NCUA for approval (which will set new net

worth goals and timetables). NCUA then is authorized to impose one or

more of discretionary supervisory actions according to the new credit

union's net worth category, which incorporates as follows the

discretionary actions in its corresponding statutory net worth

category:

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

It is subject to the

same discretionary Subpart A section

If a new credit union is actions as a credit No. incorporated by

classified union in subpart A reference

classified as

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

``Moderately Capitalized''.. ``Undercapitalized'' 702.105(b)-(c)

``Marginally Capitalized''.. ``Significantly 702.106(b)

Undercapitalized''.

``Minimally Capitalized''... ``Critically 702.107(b)

Undercapitalized''.

``Uncapitalized''........... ``Critically 702.107(b)

Undercapitalized''.

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

Whereas a net worth restoration plan under subpart A is designed to

restore net worth, the NCUA Board has developed the revised business

plan (RBP) under subpart B to build net worth. While an RBP shares

similar submission and decision deadlines and criteria for approval

with an NWRP, the required contents of an RBP is broader in scope.

First, the RBP calls for the credit union to progressively update the

business plan elements originally required for charter approval, and to

revise them as warranted by circumstances and experience since the date

of charter. Sec. 702.208(b)(1). Second, among other information, the

RBP must specify the amount of earnings the credit union will transfer

to its regular reserve (in view of the fact that subpart B sets no

minimum) and establish at least quarterly targets for increasing net

worth in each year in which the RBP is in effect. Sec. 702.208(b)(2).

Approval of RBP is effectively a charter to operate for the period

covered by the plan.

Finally, as with a ``significantly undercapitalized'' credit union

under subpart A, subpart B gives the NCUA Board discretion to place the

credit union into conservatorship or liquidation pursuant to 12 U.S.C.

Secs. 1786(h)(1)(F), 1787(a)(3)(A)(i), if there is no reasonable

prospect that the credit union will become ``adequately capitalized.''

Sec. 702.204(c). Providing conservatorship and liquidation as an option

is consistent with the purpose of prompt corrective action. Regardless

of a new credit union's inadequate net worth at present, it should be

allowed to survive under prompt corrective action if there is a

reasonable prospect that it will be ``adequately capitalized'' by the

time it is in operation for 10 years. Conversely, when a new credit

union has no prospect of eventually becoming ``adequately

capitalized,'' it is consistent with the purpose of prompt corrective

action to prevent that credit union from exposing the NCUSIF to greater

risk of loss.

``Uncapitalized''. The net worth classification of

``uncapitalized'' is designed to permit a new credit union to

periodically and temporarily operate while having negative net worth.

As commenters and NCUA's ``new'' credit union committee suggested, new

credit unions which eventually become ``adequately capitalized'' may,

while striving toward that goal, suffer periods when they have no net

worth, particularly in the early years of operation. In view of this

reality, the proposed rule treats a new credit union which is

``uncapitalized'' when it commences operating differently than one

which subsequently declines from a higher net worth category to

``uncapitalized.''

A new credit union which is classified ``uncapitalized'' when it

commences operating need only adhere to the requirements and net worth

goals set forth in its initial business plan, approved at the time its

charter was granted. That business plan (in the required pro-forma

financial statement) may set quite modest net worth goals, allowing the

credit union to remain ``uncapitalized'' for a substantial period. The

authority to impose discretionary supervisory actions under section

702.207(b) is triggered only when the credit union fails to meet those

net worth goals (as is the mandatory

[[Page 27101]]

supervisory action requiring the credit union to file a revised

business plan).

A new credit union classified in a net worth category above

``uncapitalized,'' which declines to that category from a higher one

may continue operating, but is required (like other less than

``adequately capitalized'' credit unions) both to transfer earnings to

its regular reserve and to not increase the total amount of member

business loans. Sec. 702.207(a)(1) and (3). However, within a period of

time set by the NCUA Board, but not to exceed 90 days from the date the

credit union declined to ``uncapitalized,'' the credit union must

submit an RBP which provides for alternative means of funding the

credit union's earnings deficit. Sec. 702.207(a)(2). If the credit

union fails to submit an RBP within the time prescribed by the NCUA

Board, the credit union may be liquidated. Sec. 702.207(c)(1). If the

credit union remains ``uncapitalized'' 90 calendar days following

approval of that RBP, the proposed rule requires the NCUA Board to

liquidate the credit union. Sec. 702.207(c)(2). The credit union can

avoid mandatory liquidation at this point, however, only if it

documents to the NCUA Board's satisfaction that it still is viable and

has a reasonable prospect of becoming ``adequately capitalized.'' Id.

4. Incentives for New Credit Unions

Apart from regulatory forbearance in imposing discretionary

supervisory actions, the NCUA Board proposes three types of incentives

for new credit unions to become ``adequately capitalized'' before they

are either in operation for more than 10 years or reach $10 million in

total assets. Sec. 1790d(b)(2)(B).\14\ The first two of these

incentives can be funded under 12 U.S.C. 1766(f)(2)(A) and (i)(3).

First, NCUA will offer training in management, lending and product

development for directors, officers and employees of new credit unions.

Sec. 702.209(a). This is envisioned as classroom training to generally

educate officials in matters of importance to a new credit union's

long-term survival. This training may commence before a new credit

union begins operating and should continue as needed.

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\14\ Once chartered and in operation, a new credit union is

eligible to receive special assistance under FCUA Sec. 208, 12

U.S.C. 1788, ``to prevent the closing of an insured credit union

which the Board has determined is in danger of closing.''

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

Second, NCUA will offer individualized guidance and training to

directors, officers and employees of new credit unions in the

preparation and revision of business plans. Sec. 702.209(b). The

purpose of this incentive is to build the skills within the credit

union that are needed to revise business plans as required under

subpart B, so that credit union management eventually is able to do so

without assistance. Therefore, this incentive will consist neither of

classroom training on the one hand, nor of engaging an outside

consultant perform the service of revising the business plan for the

credit union, on the other hand. Instead, an expert on business plans

will be engaged to work on-site with credit union management to revise

the credit union's individual business plan. This experience should

build the skills of credit union management in addressing, through the

credit union's business plan, the causes of its inability to improve

net worth.

Third, a new credit union will be eligible to join and receive the

benefits of NCUA's Small Credit Union Program. Sec. 702.209(c). Under

this program, an economic development specialist will be assigned at

the Regional level to train and serve as a mentor to officials and

management, and to advise and assist in areas such as--

Arranging to receive mentoring by another credit union or

trade association;

Interacting with community organizations, trade

associations, and other government agencies that may impact the credit

union;

Expanding fields of membership, where appropriate;

Developing requests for financial assistance; and

Developing and preparing business plans, capitalization

plans, and marketing plans, Call Reports, financial statements and

other reports.

NCUA Instruction no. 6052.00 (March 24, 1999) at 3-4.

E. Reserve Requirements To Conform to Prompt Corrective Action

Subpart C retains much of the substance of the current reserve

transfer and dividend payment, modified to reflect the repeal of FCUA

Sec. 116, 12 U.S.C. 1762, and to conform with the requirements imposed

by CUMAA. The ``statutory reserve'' requirement has been eliminated as

inconsistent with CUMAA. The allowance for loan losses will no longer

be combined with the regular reserve, and the subsequent reversing of

the current period provision will no longer be allowed. The segregated

regular reserve is retained in a form that comports with the earnings

retention requirement in subparts A and B, and without noted

adjustments. Sec. 702.301(b). Reserve transfers continue to be

reflected in the regular reserve account. Sec. 702.301(c).

Provisions of full and fair disclosure are retained in a revised

form. Sec. 702.302. Subpart C addresses implementation of full and fair

disclosure but excludes references to NCUA's Accounting Manual for

Federal Credit Unions. Sec. 702.301(b). Further, subpart C omits terms

which may have suggested that proper full and fair disclosure

implementation requires audited financial statements. Id.

The requirement to maintain an allowance for loan losses was

retained for credit unions regardless of asset size. Sec. 702.302(d).

The allowance must provide for estimates of existing probable loses

inherent in the loan portfolio. Sec. 702.302(d)(2). The descriptive

language was revised to reflect current guidance under Generally

Accepted Accounting Principles.

The restriction on the payment of dividends was retained in

substance. Amended language was added to address instances in which

dividend payments cannot be made because credit union operations,

allowance estimates, and/or reserve transfer requirements create a

deficit condition in undivided earnings. Sec. 702.303(a). In that

event, subpart C provides that only a credit union classified ``well

capitalized'' may transfer of funds from its regular reserve to

undivided earnings to pay dividends, provided that doing so will not

cause the credit union to decline from ``well capitalized.''

Sec. 702.303(b)(1). Credit unions which can not meet these conditions

may pay dividends from funds transferred from the regular reserve only

with the permission of the appropriate Regional Director.

Sec. 702.303(b).

Finally, as with current section 702, subpart C will apply to

State-as well as federally-chartered credit unions as provided under 12

CFR 741.3(a)(2).

F. Issuance, Review and Enforcement of Directives Imposing Prompt

Corrective Action

Subpart L of part 747 establishes the means to challenge

discretionary supervisory actions imposed by NCUA under authority of

part 702. 12 C.F.R. 747.2001 et seq. CUMAA provides that ``material

supervisory determinations, including decisions to require prompt

corrective action, made * * * by [NCUA] officials other than the [NCUA]

Board may be appealed to the [NCUA] Board'' through an independent

appellate process required under 12 U.S.C. 4806(a)-(b), or ``pursuant

to separate procedures prescribed by regulation.'' Sec. 1790d(k). The

NCUA Board established a Supervisory Review Committee to fulfill the

requirements of

[[Page 27102]]

Sec. 4806,\15\ but has concluded that a more expeditious process is

needed to facilitate prompt corrective action. Therefore, the proposed

rule incorporates, by regulation, the substance of the Federal banking

agencies' procedure for giving notice and an opportunity to respond

before issuing a directive imposing prompt corrective action. See,

e.g., 12 C.F.R. 308.201. For purposes of section 747.2002, NCUA staff

decisions to impose discretionary supervisory actions under subpart A

or B of part 702 are considered material supervisory decisions.

Sec. 747.2001(a).

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

\15\ See Interpretive Ruling and Policy Statement 95-1, 60 FR

14795 (March 20, 1995).

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Notice, opportunity to respond, and review of directive. Under

section 747.2002, the NCUA Board must generally give advance notice to

a credit union when it intends to issue a directive imposing a

discretionary supervisory action. Sec. 747.2002(a)(1). Such a directive

may take effect immediately only when necessary to further the purpose

of prompt corrective action. Sec. 747.2002(a)(2). The credit union may

then respond, explaining why the proposed action is not appropriate and

requesting that the directive not be issued or be modified.

Sec. 747.2002(c). However, the credit union is not entitled to a

hearing, nor does Sec. 4806 require the opportunity to have one. The

NCUA Board may then decide not to issue the directive or to issue it as

proposed or as modified. Sec. 747.2002(d). The NCUA Board's decision is

final. Under this procedure, a credit union which already is subject to

a discretionary supervisory action may request reconsideration of a

directive due to changed circumstances. Sec. 747.2002(f).

Review of reclassification to lower category. CUMAA requires the

NCUA Board to exercise its authority to reclassify a credit union on

safety and soundness grounds ``under regulations comparable to [FDIA

Sec. 38(g)].'' Sec. 1790d(h)(1). That provision requires that an

institution may be reclassified on safety and soundness grounds only

after ``notice and an opportunity for hearing.'' FDIA Sec. 38(g)(1). To

that end, the NCUA Board has adopted in section 747.2003 a version of

the Federal banking agencies' procedure for notice of proposed

reclassification and an opportunity to respond and to request a

hearing. See, e.g., 12 C.F.R. 308.202. This procedure applies to

reclassification pursuant to section 702.101(b) or 702.202(d) of part

702.

Under section 747.2003, the NCUA Board must give notice of its

intention to reclassify a credit union, or to treat it as if it were

the next lower net worth category, on safety and soundness grounds.

Sec. 747.2003(a). The notice must include reasons for the

reclassification. Sec. 747.2003(a)(2)(ii). The credit union may then

respond, explaining why it is not in an unsafe or unsound condition or

has not corrected an unsafe or unsound practice and providing evidence

to support its position. Sec. 747.2003(a)(3). The credit union also may

request a hearing and the opportunity to present witnesses at the

hearing. Sec. 747.2003(a)(4).

If requested, a hearing shall be held before a presiding officer

designated by the NCUA Board, but shall not be a formal adjudication

subject to the Administrative Procedure Act, 5 U.S.C. 554-557, nor to

the Uniform Rules of Practice and Procedure, 12 C.F.R. 747.1.

Sec. 747.2003(a)(5) and (6)(A). At the hearing, the credit union may

introduce relevant documents, present oral argument, and if authorized,

present witnesses. Sec. 747.2003(a)(6)(i). At the close of the hearing

the presiding officer shall make a recommended decision to the NCUA

Board, Sec. 747.2003(a)(7), and the NCUA Board shall then decide

whether to reclassify the credit union. Sec. 747.2003(a)(8). The

decision of the NCUA Board is final. Apart from appointing a presiding

officer to conduct a hearing and to recommend a decision, the NCUA

Board may not delegate its authority to reclassify a credit union.

Sec. 747.2003(c); Sec. 1790d(h)(2). Under this procedure, a credit

union which has been reclassified may seek reconsideration.

Sec. 747.2003(b).

Review of dismissal of director or officer. FDIA Sec. 38 requires

that a director or senior executive officer dismissed pursuant to a

discretionary supervisory action ``may obtain review of that order by

filing a written petition for reinstatement. * * *'' FDIA Sec. 38(n).

In order to give directors and senior officers dismissed under part 702

a comparable opportunity for review, the NCUA Board has adopted in

section 747.2004 of this subpart a procedure similar to that developed

by the Federal banking agencies. See, e.g., 12 C.F.R. Sec. 308.203.

Under section 747.2004, when the NCUA Board directs the credit

union to dismiss a director or senior executive officer, it must also

serve that person with a copy of the directive. Sec. 747.2004(a). The

affected person may then file a written request for reinstatement,\16\

which may include a request for an informal hearing before the NCUA

Board and the opportunity to present witness testimony at the hearing.

Sec. 747.2004(b). The dismissal shall remain in effect while the

request for reinstatement is pending. Sec. 747.2004(b)(3).

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\16\ The credit union which was directed to dismiss a director

or officer may not seek reinstatement of the dismissed director or

officer under section 747.2004, but that credit union may challenge

the directive under Sec. 747.2002.

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

Under section 747.2004, the procedure for conducting an informal

hearing before a presiding officer designated by the NCUA Board is

identical to that which section 747.2003 provides in cases of

reclassification, except as follows. First, the affected person may

appear at the hearing through counsel if he or she wishes.

Sec. 747.2004(d)(1). Second, the affected person bears the burden of

proving that his or her continued employment would materially

strengthen the credit union's ability to become ``adequately

capitalized'' or to correct an unsafe or unsound condition, as the case

may be. Sec. 747.2004(e). Third, if the NCUA Board, after hearing,

denies reinstatement, it must provide reasons for its action.

Sec. 747.2004(g). The NCUA Board's decision is final.

Enforcement of supervisory actions. CUMAA amended the FCUA to

ensure that supervisory actions imposed under part 702 to facilitate

prompt corrective action are enforceable. 12 U.S.C. Secs. 1786(k)(1)

and (2)(A). When a credit union fails to comply with a directive

imposing a discretionary requirement or restriction, the NCUA Board may

apply to the appropriate U.S. District Court to enforce that directive.

Sec. 747.2005(a). Alternatively, the NCUA Board may assess a civil

money penalty against a credit union (and any institution affiliated

party acting in concert with it) which violates or fails to comply with

a directive, or fails to implement an approved net worth restoration

plan under subpart A or revised business plan under subpart B.

Sec. 747.2005(b). Finally, subpart L allows the NCUA Board to enforce a

directive under part 702 ``through any other judicial or administrative

proceeding authorized by law.'' Sec. 747.2005(c).

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Regulatory Procedures

Regulatory Flexibility Act

The Regulatory Flexibility Act requires NCUA to prepare an analysis

describing any significant economic impact a proposed regulation may

have on a substantial number of small credit unions (primarily those

under $1 million in assets). The NCUA Board has determined and

certifies that the proposed rule, if adopted, will not have a

significant economic impact on a substantial number of small credit

unions. Thus, a Regulatory Flexibility Analysis is not required.

Paperwork Reduction Act

NCUA has determined that five requirements of the proposed rule

constitute collections of information under the Paperwork Reduction

Act. The requirements are: (1) To provide written notice to the

regional director and state supervisory authority, if appropriate, of a

change to the credit union's net worth ratio that places the credit

union in a lower net worth category; (2) To submit a net worth

restoration plan if the credit union is undercapitalized, significantly

undercapitalized, or critically undercapitalized; (3) To submit a

revised net worth restoration plan when the initial plan is not

approved; (4) For new credit unions, to submit a revised business plan;

and (5) For new credit unions, to submit a new revised business plan

when the revised business plan is not approved. NCUA is submitting a

copy of the proposed regulation to the Office of Management and Budget

(OMB) for its review.

NCUA estimates that 500 federally insured credit unions would have

to prepare a notice to the regional director and state supervisory

authority of a change to the credit union's net worth ratio. It is

expected that this would take 1 hour per year, resulting in a total

burden of 500 hours. NCUA estimates that 300 federally insured credit

unions would be required to submit a net worth restoration plan, and

each plan would require an average of 60 hours to prepare, resulting in

18,000 burden hours. NCUA further estimates that 30 federally insured

credit unions' initial plans would not be approved, requiring an

additional burden of 30 hours each and a total of 900 burden hours.

NCUA estimates 50 new federally insured credit unions would be required

to submit a revised business plan, and each plan would require an

average of 80 hours to prepare, for a total burden of 4,000 hours. NCUA

further estimates that 10 new federally insured credit unions' plans

would not be approved, requiring an additional burden of 40 hours each,

for a total of 400 hours. In total, the burden created by the proposed

rule is 23,800 hours. It is NCUA's view that the additional

requirements are necessary for affected federally insured credit unions

to adequately address the net worth requirements of the proposed rule.

The Paperwork Reduction Act of 1995 and OMB regulations 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. The NCUA Board invites comment on:

(1) whether the collection of information is necessary; (2) the

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

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

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

collection of information. Comments should be sent to: OMB Reports

Management Branch, New Executive Office Building, Room 10202,

Washington, D.C. 20503; Attention: Alex T. Hunt, Desk Officer for NCUA.

Please send NCUA a copy of any comments you submit to OMB.

Executive Order 12612

Executive Order 12612 requires NCUA to consider the effect of its

actions on state interests. As prescribed by CUMAA, part 702 applies to

all federally-insured credit unions, including federally-insured,

State-chartered credit unions. Accordingly, it may have a direct effect

on the States, on the relationship between the national government and

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

the various levels of government. This impact is an unavoidable

consequence of carrying out the statutory mandate to adopt a system of

prompt corrective action for federally-insured credit unions.

Agency Regulatory Goal

NCUA's goal is clear, understandable regulations that impose a

minimal regulatory burden. Although much of the language of this rule

is mandated by Congress, we request your comments on whether the

proposed rule is understandable and minimally intrusive if implemented

as proposed.

List of Subjects

12 CFR Part 702

Credit unions, Reporting and recordkeeping requirements.

12 CFR Part 747

Administrative practices and procedures, Credit unions.

By the National Credit Union Administration Board on May 3,

1999.

Becky Baker,

Secretary of the Board.

Accordingly, it is proposed that 12 CFR, parts 702 and 747 be

amended as set forth below:

Part 702 is revised to read as follows:

PART 702--PROMPT CORRECTIVE ACTION

Sec.

702.1 Authority, purpose, scope, and other supervisory authority.

702.2 Definitions.

702.3 Measure, notice and effective date of net worth

classification.

Subpart A--Statutory Prompt Corrective Action

702.101 Statutory net worth categories.

702.102 Complex credit unions defined [Reserved].

702.103 Risk-based net worth requirements for complex credit unions

[Reserved].

702.104 Prompt corrective action for ``adequately capitalized''

credit unions.

702.105 Prompt corrective action for ``undercapitalized'' credit

unions.

702.106 Prompt corrective action for ``significantly

undercapitalized'' credit unions.

702.107 Prompt corrective action for ``critically

undercapitalized'' credit unions.

702.108 Consultation with State officials on proposed prompt

corrective action.

702.109 Net worth restoration plans.

Subpart B--Alternative Prompt Corrective Action for New Credit Unions

702.201 Scope and definition.

702.202 Net worth categories for new credit unions.

702.203 Prompt corrective action for ``adequately capitalized'' new

credit unions.

702.204 Prompt corrective action for ``moderately capitalized'' new

credit unions.

702.205 Prompt corrective action for ``marginally capitalized'' new

credit unions.

702.206 Prompt corrective action for ``minimally capitalized'' new

credit unions.

702.207 Prompt corrective action for ``uncapitalized'' new credit

unions.

702.208 Revised business plans for new credit unions.

702.209 Incentives for new credit unions.

Subpart C--Reserves

702.301 Reserves

702.302 Full and fair disclosure of financial condition.

702.303 Payment of dividends.

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

Sec. 702.1 Authority, purpose, scope, and other supervisory authority.

(a) Authority. This part (except for subpart C) and subpart L of

part 747 of this chapter are issued by the National

[[Page 27108]]

Credit Union Administration pursuant to section 216 of the Federal

Credit Union Act (FCUA), 12 U.S.C. 1790d (section 1790d), as added by

section 301 of the Credit Union Membership Access Act, Public Law 105-

219, 112 Stat. 913 (1998). Subpart C of this part is issued pursuant to

FCUA section 120, 12 U.S.C. 1766.

(b) Purpose. The express purpose of prompt corrective action under

section 1790d is to resolve the problems of federally-insured credit

unions at the least possible long-term loss to the National Credit

Union Share Insurance Fund. This part carries out the purpose of prompt

corrective action by establishing a framework of supervisory

requirements and restrictions designed to restore and improve the

capital levels of federally-insured credit unions according to a credit

union's net worth ratio.

(c) Scope. This part implements the provisions of section 1790d as

they apply to federally-insured credit unions, whether federally- or

state-chartered; to such credit unions defined as ``new'' pursuant to

12 U.S.C. 1790d(b)(2); and to such credit unions defined as ``complex''

pursuant to 12 U.S.C. 1790d(d). Certain of these provisions also apply

to officers and directors of federally-insured credit unions. This Part

does not apply to corporate credit unions. Procedures for issuing,

reviewing and enforcing orders and directives issued under this part

are set forth in subpart L of Part 747 of this chapter, 12 CFR

747.2001.

(d) Other supervisory authority. Neither FCUA section 1790d nor

this Part in any way limits the authority of the NCUA Board under any

other provision of law to take additional supervisory actions to

address unsafe or unsound practices or conditions, or violations of

applicable law or regulations. Action taken under this part may be

taken independently of, in conjunction with, or in addition to any

other enforcement action available to the NCUA Board, including

issuance of cease and desist orders, orders of prohibition, suspension

and removal, or assessment of civil money penalties, or any other

actions authorized by law.

Sec. 702.2 Definitions.

Except as provided below, the terms used in this part have the same

meanings as set forth in FCUA sections 101 and 216, 12 U.S.C. 1752,

1790d.

(a) Appropriate State official means the commission, board or other

supervisory authority having jurisdiction over credit unions chartered

by the State which chartered the affected credit union.

(b) Credit union means a federally-insured, federally-chartered or

State-chartered, unless otherwise indicated.

(c) CUSO means a credit union service organization defined for

purposes of this part as a legal entity established under state law,

which is owned in whole or in part by one of more federally-insured

credit unions (including a state-chartered credit union) and which--

(1) Provides services associated with the routine operations of

credit unions; or

(2) Engages in activities incidental to the conduct of a credit

union; or

(3) Engages in activities that further or facilitate the purposes

of a credit union; or

(4) Furnishes services to a credit union.

(d) NCUSIF means the National Credit Union Share Insurance Fund as

defined by 12 U.S.C. 1783.

(e) Net worth means the retained earnings balance of the credit

union as determined under generally accepted accounting principles.

With respect to a credit union designated low-income (as defined in 12

U.S.C. 1757(6)), net worth includes secondary capital accounts that are

uninsured and subordinate to all other claims against the low-income

credit union, including the claims of creditors, shareholders and the

NCUSIF.

(f) Net worth ratio means, with respect to a credit union, the

ratio of the net worth of the credit union to the total assets of the

credit union.

(g) New credit union means a federally-insured credit union which

both has been in operation for less than ten (10) years and has

$10,000,000 or less in total assets.

(h) Shares means insured shares as defined in 12 CFR 741.4(b)(2).

(i) Total assets means the average of the total assets reported

(including those that reasonably should be reported) by the credit

union on the line entitled ``TOTAL ASSETS'' on its most recent four (4)

quarterly Call Reports, or for a semi-annual filer, on its most recent

two (2) semi-annual Call Reports.

Sec. 702.3 Measures, notice and effective date of net worth

classification.

(a) Net worth measures. For purposes of this part, a credit union's

net worth category classification will be determined by two measures:

(1) The net worth ratio as defined in Sec. 702.2(f); and

(2) The risk-based net worth requirement applicable to a credit

union defined as ``complex'' under Sec. 702.102.

(b) Notice and effective date of net worth classification. For

purposes of this part, a federally-insured credit union shall have

notice of its net worth ratio (including any applicable risk-based net

worth requirement) and shall be classified within the corresponding net

worth category as of the earliest to occur of:

(1) The last day of the credit union's most recent dividend period

for regular shares, but no less frequently than quarterly; or

(2) The date the credit union received its most recent final report

of examination; or

(3) The date the credit union received written notice from the NCUA

Board or, if State-chartered, the appropriate State official of

reclassification based on safety and soundness grounds as provided

under Secs. 702.101(b) and 702.202(d) of this part, or of an adjustment

to its net worth ratio as provided under paragraph (d) of this section.

(c) Notice by credit union of change in net worth category. A

federally-insured credit union shall provide written notice to the NCUA

Board and, if State-chartered, to the appropriate State official, of a

change in its net worth ratio that places the credit union in a lower

net worth category no later than 15 calendar days after the effective

date of the change as determined under paragraphs (b) (1) and (2) of

this section. Written notice to the NCUA Board shall be deemed

effective if it is delivered to the appropriate Regional Director and,

if State-chartered, to the appropriate State official. Failure to

provide such notice to the NCUA Board within 15 calendar days, or

failure to provide such notice altogether, in no way alters the

effective date of a change of net worth classification under this

subparagraph, nor the affected credit union's legal obligations under

this part.

(d) Adjustment of net worth ratio. To effectuate and further the

purpose of this part, the NCUA Board and, in the case of a State-

chartered credit union, the NCUA Board or appropriate State official,

may adjust a credit union's net worth ratio to reflect the impact of

accounting adjustments made for items of ``other comprehensive income''

such as accumulated unrealized gains and losses on available-for-sale

securities when the failure to do so would overstate or understate the

credit union's net worth ratio, thereby either permitting it to evade

appropriate prompt corrective action or subjecting it to unwarranted

prompt corrective action.

[[Page 27109]]

Subpart A--Statutory Prompt Corrective Action

Sec. 702.101 Statutory net worth categories.

(a) Net worth categories. Except for credit unions defined as

``new'' under subpart B of this part, a federally-insured credit union

shall be classified--

(1) Well capitalized if it has a net worth ratio of seven percent

(7%) or greater and also meets any applicable risk-based net worth

requirement under Sec. 702.102;

(2) Adequately capitalized if it has a net worth ratio of six

percent (6%) or more but less than seven percent (7%), and also meets

any applicable risk-based net worth requirement under Sec. 702.102;

(3) Undercapitalized if it has a net worth ratio of four percent

(4%) or more but less than six percent (6%), or fails to meet any

applicable risk-based net worth requirement under Sec. 702.102;

(4) Significantly undercapitalized if it:

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

four percent (4%); or

(ii) Has a net worth ratio of two percent (2%) or more but less than

five percent (5%), and either--

(A) Fails to submit an acceptable net worth restoration plan within

the time prescribed in section 702.109; or

(B) Materially fails to implement a net worth restoration plan

accepted by the NCUA Board;

(5) Critically undercapitalized if it has a net worth ratio of less

than two percent (2%).

(b) Reclassification based on supervisory criteria other than net

worth. The NCUA Board may reclassify a ``well capitalized'' credit

union as ``adequately capitalized'' and may require an ``adequately

capitalized'' or ``undercapitalized'' credit union to comply with

certain mandatory or discretionary supervisory actions as if it were in

the next lower net worth category (each of such actions hereinafter

referred to generally as ``reclassification'') in the following

circumstances:

(1) Unsafe or unsound condition. The NCUA Board has determined,

after notice and opportunity for hearing pursuant to Sec. 747.2003 of

this chapter, that the credit union is in an unsafe or unsound

condition; or

(2) Unsafe or unsound practice. The NCUA Board has determined,

after notice and opportunity for hearing pursuant to Sec. 747.2003 of

this chapter, that the credit union had notice of, but has not

corrected an unsafe or unsound practice.

(c) Non-delegation. The NCUA Board may not delegate its authority

to reclassify a credit union under paragraph (b) of this section.

(d) Consultation with State officials. The NCUA Board shall seek

and consider the views of the appropriate State official before

reclassifying a credit union under paragraph (b) of this section.

Sec. 702.102 Complex credit unions defined [Reserved].

Sec. 702.103 Risk-based net worth requirements for complex credit

unions [Reserved].

Sec. 702.104 Prompt corrective action for ``adequately capitalized''

credit unions.

(a) Earnings transfer. If a federally-insured credit union becomes

``adequately capitalized,'' it must annually transfer to its regular

reserve account earnings equivalent to not less than \4/10\ths percent

(0.4%) of its total assets as defined by Sec. 702.2(i), at the

following rates:

(1) In the case of a credit union having a monthly dividend period

for regular shares, at a rate of at least eight and one-third percent

(8.334%) per month of the annual amount; and

(2) In the case of a credit union having a quarterly, semi-annual

or annual dividend period for regular shares, at a rate of at least

twenty five percent (25%) per quarter of the annual amount.

(b) Reduction in earnings transfer. On a case-by-case basis and

subject to review and revocation no less frequently than quarterly, the

NCUA Board may permit the credit union to transfer an amount that is

less than the equivalent of \4/10\ths percent (0.4%) of its total

assets, to the extent the credit union demonstrates to the NCUA Board

that such lesser amount--

(1) Is necessary to avoid a significant redemption of shares; and

(2) Would further the purpose of this part.

Sec. 702.105 Prompt corrective action for ``undercapitalized'' credit

unions.

(a) Mandatory action by credit union. If a federally-insured credit

union becomes ``undercapitalized,'' it must immediately--

(1) Earnings transfer. Transfer earnings to its regular reserve

account as provided in Sec. 702.104;

(2) Submit net worth restoration plan. Submit a net worth

restoration plan pursuant to Sec. 702.109;

(3) Restrict increase in assets. Not permit the credit union's

assets to increase beyond its total assets as defined by Sec. 702.2(i),

unless--

(i) The NCUA Board has approved a net worth restoration plan which

provides for an increase in total assets; and

(ii) The assets of the credit union are increasing consistent with the

approved plan; and

(iii) The credit union's net worth ratio is increasing at a rate that

is consistent with the approved plan;

(4) Restrict member business loans. Not increase the total amount

of member business loans until the credit union becomes ``adequately

capitalized'' unless it qualifies for an exception under 12 U.S.C.

1757a(b).

(b) Discretionary action by NCUA. Subject to the applicable

procedures for issuing, reviewing and enforcing directives set forth in

subpart L of part 747 of this chapter, the NCUA Board may, with respect

to any ``undercapitalized'' credit union, or a director, officer or

employee of such credit union, take one or more of the following

actions, if it determines that those actions are necessary to carry out

the purpose of this part:

(1) Requiring prior approval for acquisitions, branching, new lines

of business. Prohibit a credit union from, directly or indirectly,

acquiring any interest in any CUSO or credit union, establishing or

acquiring any additional branch office, or engaging in any new line of

business, unless the NCUA Board has approved the credit union's net

worth restoration plan, the credit union is implementing its plan, and

the NCUA Board determines that the proposed action is consistent with

and will further the objectives of that plan;

(2) Restricting transactions with and ownership of CUSO. Restrict

the credit union's transactions with a CUSO, or require the credit

union to reduce or divest its ownership interest in a CUSO;

(3) Restricting dividend paid. Restrict the dividend rates the

credit union pays on shares to the prevailing rates paid on comparable

accounts and maturities in the region where the credit union is

located, as determined by the NCUA Board, except that dividend rates

already paid on shares acquired before imposing a restriction under

this paragraph may not be retroactively restricted;

(4) Prohibiting or reducing asset growth. Prohibit any growth

whatsoever in the credit union's assets or in a category of assets, or

require the credit union to reduce its assets or a category of assets;

(5) Alter, reduce or terminate activity. Require the credit union

or its CUSO to alter, reduce, or terminate any activity;

(6) Prohibiting nonmember deposits. Prohibit the credit union from

accepting all or certain nonmember deposits as

[[Page 27110]]

otherwise permitted under 12 U.S.C. 1757(6) and Sec. 701.32 of this

chapter, or under applicable State law;

(7) Other action no more severe. Restrict or require such other

action by the credit union as the NCUA Board determines will carry out

the purpose of this part better than any of the actions prescribed in

paragraphs (b) (1) through (6) of this section, provided that such

other restriction or requirement is no more severe than the actions

prescribed in paragraphs (b) (1) through (6).

(c) Prerequisite for improving management. The NCUA Board may take

any of the following actions provided that it first takes one or more

of the actions prescribed in paragraphs (b) (1) through (7) of this

section or determines that none of those actions would further the

purpose of this part:

(1) New election of directors. Order a new election of the credit

union's board of directors;

(2) Dismissing directors or senior executive officers. Require the

credit union to dismiss from office any director or senior executive

officer, provided however, that a dismissal under this clause shall not

be construed to be a formal administrative action for removal under 12

U.S.C. 1786(g);

(3) Employing qualified senior executive officers. Require the

credit union to employ qualified senior executive officers (who, if the

NCUA Board so specifies, shall be subject to its approval).

Sec. 702.106 Prompt corrective action for ``significantly

undercapitalized'' credit unions.

(a) Mandatory action by credit union. Immediately upon becoming

``significantly undercapitalized,'' a federally-insured credit union

must--

(1) Earnings transfer. Transfer earnings to its regular reserve

account as provided in Sec. 702.104;

(2) Submit net worth restoration plan. Submit a net worth

restoration plan pursuant to Sec. 702.109;

(3) Restrict increase in assets. Not permit the credit union's

assets to increase beyond its total assets as defined by section

702.2(i), except as provided in Sec. 702.105(a)(3);

(4) Restrict member business loans. Not increase the total amount

of member business loans except as provided in Sec. 702.105(a)(4).

(b) Discretionary actions by NCUA. Subject to the applicable

procedures for issuing, reviewing and enforcing directives set forth in

subpart L of part 747 of this chapter, the NCUA Board may, with respect

to any ``significantly undercapitalized'' credit union, or a director,

officer or employee of such credit union, take one or more of the

following actions if it determines that those actions are necessary to

carry out the purpose of this part:

(1) Requiring prior approval for acquisitions, branching, new lines

of business. Prohibit a credit union from, directly or indirectly,

acquiring any interest in any CUSO or credit union, establishing or

acquiring any additional branch office, or engaging in any new line of

business, except as provided in Sec. 702.105(b)(1);

(2) Restricting transactions with and ownership of CUSO. Restrict

the credit union's transactions with a CUSO, or require the credit

union to divest or reduce its ownership interest in a CUSO;

(3) Restricting dividend paid. Restrict the dividend rates that the

credit union pays on shares as provided in Sec. 702.105(b)(3);

(4) Prohibiting or reducing asset growth. Prohibit any growth

whatsoever in the credit union's assets or in a category of assets, or

require the credit union to reduce assets or a category of assets;

(5) Alter, reduce or terminate activity. Require the credit union

or its CUSO(s) to alter, reduce, or terminate any activity;

(6) Prohibiting nonmember deposits. Prohibit the credit union from

accepting all or certain nonmember deposits as otherwise permitted

under 12 U.S.C. 1757(6) and Sec. 701.32 of this chapter, or under

applicable State law;

(7) Restricting senior executive officers' compensation. Limit or

reduce payment of compensation to any senior executive officer, limit

or prohibit payment of a bonus to such officer, or condition payment of

compensation or a bonus to such officer upon the NCUA Board's prior

approval;

(8) Improving management. Order a new election of board of

directors; dismiss directors or senior executive officers; or employ

qualified senior executives, all as provided in Sec. 702.105(c),

without the prerequisite that applies to that section;

(9) Requiring merger. Require the credit union to merge with

another financial institution if one or more grounds exist for placing

the credit union into conservatorship pursuant to 12 U.S.C.

1786(h)(1)(F), or into liquidation pursuant to 12 U.S.C.

1787(a)(3)(A)(i);

(10) Other actions. Restrict or require such other action by the

credit union as the NCUA Board determines will carry out the purpose of

this part better than any of the actions prescribed in paragraphs

(b)(1) through (9) of this section.

(c) Discretionary conservatorship or liquidation if no prospect of

becoming ``adequately capitalized.'' Notwithstanding any other actions

required or permitted to be taken under this section, when a credit

union becomes ``significantly undercapitalized'' (including by

reclassification under Sec. 702.101(b)), the NCUA Board may place the

credit union into conservatorship pursuant to 12 U.S.C. 1786(h)(1)(F),

or into liquidation pursuant to 12 U.S.C. 1787(a)(3)(A)(i), provided

that the credit union has no reasonable prospect of becoming

``adequately capitalized.''

Sec. 702.107 Prompt corrective action for ``critically

undercapitalized'' credit unions.

(a) Mandatory action by credit union. Immediately upon becoming

``critically undercapitalized,'' a federally-insured credit union

must--

(1) Earnings transfer. Transfer earnings to its regular reserve

account as provided in Sec. 702.104;

(2) Submit net worth restoration plan. Submit a net worth

restoration plan pursuant to Sec. 702.109;

(3) Restrict increase in assets. Not permit the credit union's

assets to increase beyond its total assets as defined by Sec. 702.2(i),

except as provided in Sec. 702.105(a)(3);

(4) Restrict member business loans. Not increase the total amount

of member business loans except as provided in Sec. 702.105(a)(4).

(b) Discretionary actions by NCUA. Subject to the applicable

procedures for issuing, reviewing and enforcing directives set forth in

subpart L of part 747 of this chapter, the NCUA Board may, with respect

to any ``critically undercapitalized'' credit union, or a director,

officer or employee of such credit union, take one or more of the

following actions if it determines that those actions are necessary to

carry out the purpose of this part:

(1) Requiring prior approval for acquisitions, branching, new lines

of business. Prohibit a credit union from, directly or indirectly,

acquiring any interest in any CUSO or credit union, establishing or

acquiring any additional branch office, or engaging in any new line of

business, except as provided by Sec. 702.105(b)(1);

(2) Restricting transactions with and ownership of CUSO. Restrict

the credit union's transactions with a CUSO, or require the credit

union to divest or reduce its ownership interest in a CUSO;

(3) Restricting dividend paid. Restrict the dividend rates that the

credit union pays on shares as provided in Sec. 702.105(b)(3);

[[Page 27111]]

(4) Prohibiting or reducing asset growth. Prohibit any growth

whatsoever in the credit union's assets or in a category of assets, or

require the credit union to reduce assets or a category of assets;

(5) Alter, reduce or terminate activity. Require the credit union

or its CUSO(s) to alter, reduce, or terminate any activity;

(6) Prohibiting nonmember deposits. Prohibit the credit union from

accepting all or certain nonmember deposits as otherwise permitted

under 12 U.S.C. 1757(6) and Sec. 701.32 of this chapter, or under

applicable State law;

(7) Restricting senior executive officers' compensation. Limit or

reduce payment of compensation to any senior executive officer, limit

or prohibit payment of a bonus to such officer, or condition payment of

compensation or a bonus to such officer upon the NCUA Board's approval;

(8) Improving management. Order a new election of board of

directors; dismiss directors or senior executive officers; or employ

qualified senior executive officers, all as provided in

Sec. 702.105(c), but without the prerequisite required in that section;

(9) Restrictions on payments on uninsured secondary capital.

Beginning 60 days after a credit union becomes ``critically

undercapitalized,'' prohibit payments of principal or dividends on the

credit union's uninsured secondary capital accounts, except that unpaid

dividends shall continue to accrue under the terms of the account to

the extent permitted by law;

(10) Requiring prior approval. Require a ``critically

undercapitalized'' credit union to obtain the NCUA Board's prior

written approval before doing any of the following:

(i) Entering into any material transaction other than in the usual

course of business, including any investment, expansion, acquisition,

sale of assets, or other similar action with respect to which the

credit union is required to provide notice to the NCUA Board;

(ii) Extending credit for transactions deemed highly leveraged by the

NCUA Board or, if State-chartered, by the appropriate State official;

(iii) Amending the credit union's charter or bylaws, except to the

extent necessary to carry out any other requirement of any law,

regulation, or order;

(iv) Making any material change in accounting methods;

(v) Paying dividends on new share accounts at a rate that would

increase the credit union's weighted average cost of funds to a level

significantly exceeding the prevailing rates of interest on insured

deposits in its normal market areas;

(11) Other action. Restrict or require such other action by the

credit union as the NCUA Board determines will carry out the purpose of

this part better than any of the actions prescribed in paragraphs

(b)(1) through (10) of this section;

(12) Requiring merger. Require the credit union to merge with

another financial institution if one or more grounds exist for placing

the credit union into conservatorship pursuant to 12 U.S.C.

1786(h)(1)(F), or into liquidation pursuant to 12 U.S.C.

1787(a)(3)(A)(i).

(c) Mandatory conservatorship, liquidation or action in lieu

thereof. (1) Action within 90 days. Notwithstanding any other actions

required or permitted to be taken under this section (and regardless of

a credit union's prospect of becoming ``adequately capitalized''), the

NCUA Board must, within 90 calendar days after a credit union becomes

``critically undercapitalized''--

(i) Conservatorship. Place the credit union into conservatorship

pursuant to 12 U.S.C. 1786(h)(1)(G); or

(ii) Liquidation. Liquidate the credit union pursuant to 12 U.S.C.

1787(a)(3)(A)(ii); or

(iii) Other corrective action. Take other corrective action in lieu of

conservatorship or liquidation to better achieve the purpose of this

part, provided that the NCUA Board documents why such action in lieu of

conservatorship or liquidation would do so.

(2) Renewal of other corrective action. A determination by the NCUA

Board to take other corrective action in lieu of conservatorship or

liquidation under paragraph (c)(1)(iii) of this section shall expire

after an effective period ending no later than 180 calendar days after

the determination is made, and the credit union shall be immediately

placed into conservatorship or liquidation under paragraphs (c)(1)(i)

and (ii) of this section, unless the NCUA Board makes a new

determination under paragraph (c)(1)(ii) of this section before the end

of the effective period of the prior determination;

(3) Mandatory liquidation after 18 months. (i) Generally.

Notwithstanding paragraphs (c)(1) and (2) of this section, the NCUA

Board must place a credit union into conservatorship or liquidation if

it remains ``critically undercapitalized'' on average for a full

calendar quarter following a period of 18 months from the date on which

the credit union first became ``critically undercapitalized'';

(ii) Exception. Notwithstanding paragraph (c)(3)(i) of this section

section, the NCUA Board may continue to take other corrective action in

lieu of conservatorship or liquidation if it certifies that the credit

union--

(A) Has been in substantial compliance with an approved net worth

restoration plan requiring consistent improvement in net worth since

the date the net worth restoration plan was approved;

(B) Has positive net income or has an upward trend in earnings that

the NCUA Board projects as sustainable; and

(C) is viable and not expected to fail.

(4) Nondelegation. The NCUA Board may not delegate its authority

under paragraphs (c)(1) through (3) of this section unless the credit

union has less than $5,000,000 in total assets. A credit union shall

have a right of direct appeal to the NCUA Board of any decision made

under this section by delegated authority.

Sec. 702.108 Consultation with State officials on proposed prompt

corrective action.

(a) Consultation on proposed conservatorship or liquidation. Before

placing a federally-insured State-chartered credit union into

conservatorship (pursuant to 12 U.S.C. 1786(h)(1)(F) or (G)) or

liquidation (pursuant to 12 U.S.C. 1787(a)(3)) as permitted or required

under this part to facilitate prompt corrective action--

(1) The NCUA Board shall seek the views of the appropriate State

official (as defined in Sec. 702.2(a)), and give him or her an

opportunity to place the credit union into conservatorship or

liquidation;

(2) The NCUA Board shall, upon timely request of the appropriate

State official, promptly provide him or her with a written statement of

the reasons for the proposed conservatorship or liquidation, and

reasonable time to respond to that statement;

(3) If the appropriate State official makes a timely written

response that disagrees with the proposed conservatorship or

liquidation and gives reasons for that disagreement, the NCUA Board

shall not place the credit union into conservatorship or liquidation

unless it first considers the views of the appropriate State official

and determines that--

(i) The NCUSIF faces a significant risk of loss if the credit union is

not

[[Page 27112]]

placed into conservatorship or liquidation; and

(ii) Conservatorship or liquidation is necessary to reduce any loss

that the NCUSIF either is expected to incur or risks incurring with

respect to the credit union.

(b) Nondelegation. The NCUA Board may not delegate any

determination under paragraph (a)(3) of this section.

(c) Notification when taking discretionary action. The NCUA Board

shall seek the views of the appropriate State official before taking

any discretionary action with respect to a federally-insured State-

chartered credit union, and shall allow the appropriate State official

to take the proposed action independently or jointly with NCUA.

Sec. 702.109 Net worth restoration plans

(a) Schedule for filing. (1) Generally. A federally-insured credit

union shall file a written net worth restoration plan (Plan) with the

appropriate Regional Director and, if State-chartered, the appropriate

State official within 45 calendar days of becoming either

``undercapitalized,'' ``significantly undercapitalized'' or

``critically undercapitalized,'' unless the NCUA Board notifies the

credit union in writing that its Plan is to be filed within a different

period.

(2) Exception. An ``adequately capitalized'' credit union that is

required, on safety and soundness grounds under Sec. 702.101(b), to

comply with supervisory actions as if it were ``undercapitalized'' is

not required to submit a Plan solely due to the reclassification.

(3) Filing of additional plan. Notwithstanding paragraph (a)(1) of

this section, a credit union that has already submitted and is

operating under a Plan approved under this section is not required to

submit an additional Plan due to a change in net worth ratio or

reclassification under Sec. 702.101(b), unless the NCUA Board notifies

the credit union that it must submit a new Plan. A credit union that is

notified to submit a new or revised Plan shall file the Plan in writing

with the appropriate Regional Director within 45 calendar days of

receiving such notice, unless the NCUA Board notifies the credit union

in writing that the Plan is to be filed within a different period.

(4) Failure to timely file plan. When a credit union fails to

timely file a Plan pursuant to paragraph (a)(1) or (3) of this section,

the NCUA Board shall promptly notify the credit union that it has

failed to file a Plan and that it has 15 calendar days from receipt of

that notice within which to file a Plan.

(b) Assistance in preparing plan. Upon timely request by a credit

union having total assets of less than $10 million (regardless how many

years it has been in operation), the NCUA Board shall provide

assistance in preparing a plan required to be filed under paragraph (a)

of this section.

(c) Contents of plan. A net worth restoration plan must--

(1) Specify--

(i) The steps the credit union will take to become ``adequately

capitalized'';

(ii) A specific timetable for increasing net worth during each year in

which the Plan will be in effect;

(iii) The amount of earnings equivalent to not less than 4/10ths

percent (0.4%) of its total assets that the credit union will transfer

to its regular reserve account under section 702.104(a), or such lesser

amount as the credit union justifies to the NCUA Board under section

702.104(b);

(iv) How the credit union will comply with the mandatory and

discretionary restrictions or requirements imposed on it under this

part;

(v) the types and levels of activities in which the credit union will

engage; and

(vi) if required to submit a plan due to reclassification under section

Sec. 702.101(b), the steps the credit union will take to correct the

unsafe or unsound practice(s) or condition(s);

(2) Include pro forma financial statements covering the next two

years;

(3) Contain such other information as the NCUA Board has required;

and

(4) With respect to a credit union having assets of $10 million or

more, financial data submitted in connection with its net worth

restoration plan must be prepared in accordance with generally accepted

accounting principles (GAAP) unless the NCUA Board instructs otherwise.

(d) Criteria for approval of plan. The NCUA Board shall not accept

a net worth restoration plan unless the plan--

(1) Complies with paragraph (c) of this section;

(2) Is based on realistic assumptions, and is likely to succeed in

restoring the credit union's net worth;

(3) Would not unreasonably increase the credit union's exposure to

risk (including credit risk, interest-rate risk, and other types of

risk); and

(4) Is supported by appropriate assurances from the credit union

that it will comply with the plan until it has remained ``adequately

capitalized'' for four (4) consecutive calendar quarters.

(e) Review of plan. (1) Notice of decision. Within 60 calendar days

after receiving a Plan under this part, the NCUA Board will notify the

credit union in writing whether the Plan has been approved, and shall

provide reasons for its decision in the event of disapproval.

(2) Consultation with state officials. In the case of a Plan

submitted by a federally-insured State-chartered credit union, the NCUA

Board shall, when evaluating the Plan, seek and consider the views of

the appropriate State official.

(f) Plan not approved. (1) Submission of revised plan. If a Plan is

not approved by the NCUA Board, the credit union shall submit a revised

Plan within 30 calendar days of receiving notice of disapproval, unless

it is notified in writing by the NCUA Board that the revised Plan is to

be filed within a different period. Upon receipt of notice of

disapproval of a Plan, an ``undercapitalized'' credit union having a

net worth ratio of less than five percent (5%) shall remain subject to

all of the provisions of this part applicable to ``significantly

undercapitalized'' credit unions until a new or revised Plan submitted

by the credit union is approved by the NCUA Board.

(2) Notice of decision on revised plan. Within 30 calendar days

after receiving a revised Plan under paragraph (f)(1) of this section,

the NCUA Board shall notify the credit union in writing whether the

revised Plan is approved. The Board may extend the time within which

notice of its decision shall be provided.

(g) Failure to submit or implement plan. Any ``undercapitalized''

credit union having a net worth ratio of less than five percent (5%)

which fails to submit a written Plan within the applicable period

provided in this section, or which fails in any material respect to

timely implement an approved Plan, shall be remain subject to all of

the provisions of this part applicable to ``significantly

undercapitalized'' credit unions.

(h) Amendment of plan. A credit union that has filed an approved

Plan may, after prior written notice to and approval by the NCUA Board,

amend its Plan to reflect a change in circumstance. Until such time as

a proposed amendment has been approved, the credit union shall

implement the Plan as approved prior to the proposed amendment.

[[Page 27113]]

Subpart B--Alternative Prompt Corrective Action for New Credit

Unions

Sec. 702.201 Scope and definition

(a) Scope. This subpart B applies exclusively to credit unions

defined in paragraph (b) of this section as ``new'' pursuant to 12

U.S.C. 1790d(b)(2) in lieu of subpart A of this part.

(b) New credit union defined. A ``new'' credit union for purposes

of this section is a federally-insured credit union that has both been

in operation for less than ten (10) years and has total assets of not

more than $10 million. A credit union which exceeds $10 million in

total assets may become ``new'' if its total assets subsequently fall

below $10 million while it is still in operation for less than 10

years.

(c) Effect of spin-offs. A credit union formed as the result of a

``spin-off'' of a group from the field of membership of an existing

credit union is deemed to be in operation since the effective date of

the ``spin-off.'' A credit union whose total assets decline below $10

million because a group within its field of membership has been ``spun-

off'' is eligible to become ``new'' if it has been in operation less

than 10 years.

(d) Actions to evade statutory prompt corrective action. If the

NCUA Board determines that a credit union was formed as a result of a

``spin-off,'' or was expanded by merger or by the addition of a group

to its field of membership, primarily to qualify as ``new'' under this

subpart, the credit union shall be deemed subject to prompt corrective

action under subpart A of this part.

Sec. 702.202 Net worth categories for new credit unions.

(a) Net worth measures. For purposes of this part, a new credit

union's net worth category classification will be determined by its net

worth ratio as defined in Sec. 702.2(f), and any risk-based net worth

requirement applicable to a new credit union defined as ``complex''

under Sec. 702.102.

(b) Notice and effective date of net worth classification of new

credit union. A new federally-insured credit union shall have notice of

its net worth ratio (including any applicable risk-based net worth

requirement), and shall be classified within the corresponding net

worth category under this subpart, effective as provided in

Sec. 702.3(b).

(c) Net worth categories. A federally-insured credit union defined

as ``new'' under this section shall be classified--

(1) Well capitalized if it has a net worth ratio of seven percent

(7%) or greater and also meets any applicable risk-based net worth

requirement under Sec. 702.102;

(2) Adequately capitalized if it has a net worth ratio of six

percent (6%) or more but less than seven percent (7%), and also meets

any applicable risk-based net worth requirement under Sec. 702.102;

(3) Moderately capitalized if it has a net worth ratio of three and

one-half percent (3.5%) or more but less than six percent (6%), or

fails to meet any applicable risk-based net worth requirement under

Sec. 702.102;

(4) Marginally capitalized if it has a net worth ratio of two

percent (2%) or more but less than three and one-half percent (3.5%);

(5) Minimally capitalized if it has a net worth ratio of zero

percent (0%) or greater but less than two percent (2%);

(6) Uncapitalized if it has a net worth ratio of less than zero

percent (0%) (e.g., a deficit in retained earnings).

(d) Reclassification based on supervisory criteria other than net

worth. Subject to Sec. 702.101(c) and (d), the NCUA Board may

reclassify a ``well capitalized'' new credit union as ``adequately

capitalized'' and may require an ``adequately capitalized,''

``moderately capitalized'' or marginally capitalized'' new credit union

to comply with certain statutory or discretionary supervisory actions

as if it were in the next lower net worth category (each of such

actions is hereinafter referred to generally as ``reclassification'')

in either of the circumstances prescribed in Sec. 702.101(b).

Sec. 702.203 Prompt corrective action for ``adequately capitalized''

new credit unions.

Until an ``adequately capitalized'' new credit union becomes ``well

capitalized,'' it must annually transfer earnings to its regular

reserve account as provided in Sec. 702.104.

Sec. 702.204 Prompt corrective action for ``moderately capitalized''

new credit unions.

(a) Mandatory action by new credit union. If a new credit union

becomes ``moderately capitalized'' (including by reclassification under

Sec. 702.202(d)), it must immediately--

(1) Earnings transfer. Annually transfer earnings to its regular

reserve account in an amount and at a rate reflected in the credit

union's initial or revised business plan;

(2) Submit revised business plan. Submit a revised business plan

pursuant to Sec. 702.208 if its net worth ratio has not increased

consistent with its then-present business plan;

(3) Restrict member business loans. Not increase the total amount

of member business loans until the credit union becomes ``adequately

capitalized'' unless it qualifies for an exception under 12 U.S.C.

1757a(b).

(b) Discretionary actions by NCUA. Subject to the applicable

procedures set forth in subpart L of part 747 of this chapter for

issuing, reviewing and enforcing directives, the NCUA Board may take

one or more of the actions prescribed in Sec. 702.105(b) and (c) if the

credit union's net worth has not increased consistent with its then-

present business plan.

(c) Discretionary conservatorship or liquidation. Notwithstanding

any other actions required or permitted to be taken

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