CUNA Comment Letter

NCUA’s Proposed Rule on Investment and Deposit Activities and Regulatory Flexibility Program (Parts 703 and 742)

February 25, 2003

Ms. Becky Baker
Secretary of the Board
National Credit Union Administration
1775 Duke Street
Alexandria, Virginia 22314-3428

Dear Ms. Baker:

The Credit Union National Association (CUNA) appreciates the opportunity to comment on NCUA’s proposed rule on investment and deposit activities. By way of background, CUNA represents more than 90 percent of our nation’s 10,000 state and federal credit unions. This letter was developed under the auspices of CUNA’s Federal Credit Union Subcommittee, chaired by Mr. Christopher Jillson, President and CEO of Sandia Federal Credit Union, Albuquerque, New Mexico.

General Comments

CUNA strongly supports NCUA’s efforts to review the area of investments and propose changes to its regulations that will facilitate investment activities for federal credit unions. This initiative in fully consistent with the changes in the incidental powers regulation and with NCUA’s Regulatory Flexibility program, which CUNA wholeheartedly endorsed. We believe this proposal contains important and beneficial changes for federal credit unions in the area of investments and successfully incorporates a number of the comments received in response to the Advance Notice of Proposed Rulemaking (ANPR) that NCUA issued on October 18, 2001 with regard to possible changes to the investment rules.

Broker-Dealer Requirements

In the ANPR, NCUA outlined possible changes with regard to the minimum criteria that a broker-dealer must meet in order for a federal credit union (FCU) to transact business with that broker-dealer. NCUA has decided not to include these changes in the proposed rule. We agree with NCUA’s current position that the existing rules represent prudent minimum criteria that a broker-dealer must meet in order for a FCU to purchase and sell investments through the broker-dealer. We would also welcome additional guidance from NCUA with regard to this issue.

In both the ANPR and the proposed rule, NCUA proposes to allow FCUs to use the services of depository institutions whose broker-dealer activities are regulated by a state regulatory agency. As outlined in the comment letter we submitted in response to the ANPR, we support this change, which will provide FCUs with greater access to broker-dealers.

Safekeeper Requirements

In the ANPR, NCUA proposed more stringent safekeeper requirements. In the comment letter we submitted in response to the ANPR, we expressed concerns with regard to these requirements. We are pleased that NCUA has reviewed these comments and now agrees that the more stringent standards in the ANPR would not effectively address the concerns in this area. As with the broker-dealer requirements, credit unions would appreciate more guidance in this area, especially guidance that is directed to small and mid-sized credit unions, since these credit unions usually do not have a large enough portfolio to enter into arrangements with the more well known safekeepers and broker-dealers.

In the proposed rule, NCUA has proposed adding a due diligence requirement to require FCUs to review the safekeeper’s financial condition, in addition to the current requirement to investigate the safekeeper’s background in order to determine the safekeeper’s reputation and compliance with laws and regulations. NCUA also proposed to require FCUs to retain the documentation their boards of directors used to approve the use of the safekeeper to the same extent that this must be done in the broker-dealer context. We believe that these changes represent improvements on the changes outlined in the ANPR and that these are prudent measures that FCUs will be willing to undertake.

As outlined in the comment letter we submitted in response to the ANPR, CUNA strongly supports NCUA’s proposal to expand permissible safekeepers to include state-regulated trust companies.

Expanded Investment Authorities

The ANPR included a proposal that would have expanded the investment authority of FCUs by removing the regulatory prohibition on investments such as variable rate instruments tied to a foreign currency or interest rate; financial derivatives; short sales; mortgage-backed security interest and principal strips; residual interests in collateralized mortgage obligations; mortgage servicing rights; commercial mortgage-related securities; and zero coupon securities with remaining maturities greater than ten years. However, to obtain these expanded authorities, an FCU would have had to apply for each authority individually and demonstrate it had the ability and expertise to manage the new investments in a safe and sound manner.

In the comment letter submitted in response to the ANPR, CUNA strongly supported such an expansion, but did not agree that the agency should require an FCU to apply for each new authority. Rather, we supported a notice process under which an FCU would notify its regional office that it is proceeding with a new investment authority and a brief summary of its risk management capabilities. We continue to support such an approach.

In contrast to the ANPR, the proposed rule will incorporate the investment pilot program as a means of evaluating and granting expanded investment authority to FCUs, and NCUA will also issue guidelines for approval of such activities in an effort to educate FCUs about the program. Although we would prefer the approach as outlined in the comment letter we submitted in response to the ANPR, we would also support the NCUA’s use of pilot programs in the area of investments and want to work with the agency as it moves forward in utilizing this process for credit unions that want to engage in new activities.

In addition to the pilot program, the proposed rule will permit credit unions that are eligible under the Regulatory Flexibility Program (RegFlex) to purchase Commercial Mortgage Related Securities (CMRS), up to fifty percent of the FCU’s net worth, if the CMRS: 1) are rated in one of the two highest rating categories by at least one nationally recognized statistical rating organization; 2) otherwise meet the definitions of mortgage related security under securities laws with regard to ownership, origination, and the secured status; and 3) have an underlying pool of loans containing more than fifty loans with no one loan representing more than ten percent of the pool. We support this change and believe that these criteria should address any safety and soundness concerns.

The proposal recognizes that FCUs are permitted to provide mortgage servicing as an incidental power, as long as it owns the loan. As we outlined in the comment letter submitted in response to the ANPR, we urge NCUA to extend this further and allow FCUs to purchase mortgage servicing rights from any legitimate mortgage originator.

Discretionary Control of Investments

In the ANPR, NCUA proposed to raise the cap on the amount of investments that an FCU may delegate to an investment advisor to control. Currently, an FCU may delegate discretionary control of investments to an investment advisor, so long as the aggregate amount does not exceed 100% of the FCU’s net capital at the time of the delegation. RegFlex eligible credit unions are exempt from this limitation and in the ANPR, NCUA proposed lifting this limitation for all FCU’s. In the comment letter submitted in response to the ANPR, CUNA supported the lifting of this restriction for all FCUs.

NCUA has now determined that no changes will be made with regard to this limitation. CUNA continues to support the removal of this limitation. We believe that NCUA should set guidelines for credit unions to follow in exceeding the cap and develop a process under which an FCU would notify the regional office that it is exceeding the cap and provide a very brief explanation of how it is meeting the agency’s guidelines, as opposed to a prior approval process.

Under the proposed rule, NCUA will require FCU boards of directors to notify the regional office within five days after receiving notice that the limitation has been exceeded. The FCU must then develop a plan to bring the FCU in compliance with this requirement within a reasonable time. We believe the five-day limitation is too restrictive and request more flexibility in this area to take into account the differences in size and complexity among credit unions that may prevent some from meeting this time requirement. We suggest that the notification should be no less than ten business days and that the rule should clarify that any reasonable means, including electronic notification, should be sufficient. We also suggest that NCUA provide more guidance on the content of the plan that FCUs must develop in order to bring the FCU into compliance.

Investment Credit Ratings

In the ANPR, NCUA requested comment on whether standards should be set in connection with the current requirement that FCUs conduct a credit analysis for any investment that is not issued by or fully guaranteed by various instrumentalities of the United States government. NCUA has now determined that the current rule sufficiently encourages FCUs to adopt prudent credit review practices and that no revisions are necessary at this time. CUNA fully supports this conclusion.

Borrowing Repurchase Agreements

In the ANPR, NCUA proposed allowing an FCU the flexibility to invest the proceeds from a borrowing repurchase agreement at its discretion, without regard to whether the purchased investment matures after the maturity of the borrowing repurchase agreement. In the comment letter we submitted in response to the ANPR, we strongly supported this change, along with guidance from NCUA for FCUs in this area that would address issues such as the avoidance of pyramiding investments using borrowed funds.

In the proposed rule, NCUA has determined to leave in place the prohibition on purchasing an investment with the proceeds from a borrowing repurchase transaction if the purchased investment matures after the maturity of the borrowing repurchase transaction. However, the proposal will permit this for RegFlex eligible FCUs in an amount not to exceed the credit union’s net worth.

We would like to take this opportunity to reiterate our support for removing this prohibition for all FCUs, in addition to those that are RegFlex eligible. We do not believe that removing this prohibition will raise liquidity or safety and soundness concerns, which has been the justification for imposing the prohibition.

Purchase of Equity Linked Options

Similar to the ANPR, the proposed rule will permit FCUs to purchase equity-linked options for the sole purpose of offering equity-linked dividends to their members, subject to certain eligibility requirements with regard to: 1) maximum shares permitted in the program; 2) minimum counterparty rating; 3) collateral requirements; 4) option proceeds that fund dividend costs only; 5) final maturity of the options that coincide with the maturity of the share account; and 6) minimum monthly reporting requirements. CUNA has strongly supported this added flexibility for FCUs, which has been successfully implemented under the investment pilot program.

Investment Advisors

CUNA has no objection to the proposed requirement for FCUs to analyze the background of the firm for which an investment advisor works, in addition to the investment advisor and associated personnel. However, we encourage NCUA to clarify the meaning of the term "associated personnel." Credit unions want to conduct proper due diligence in this area, but are concerned as to how extensive this review will need to be in order to cover all "associated personnel."

Additional Investment Authority

Flexible investment authority for federal credit unions is critical to their ability to serve their members and meet the demands of a changing financial marketplace. We realize that the agency does not have the authority to change statutory limitations on credit union investments. However, CUNA’s Renaissance Commission has identified a number of restricted investment activities in which relief could be meaningful. These activities, some of which would be less risky than changes NCUA is already proposing, include investments such as:

CUNA also supports changes such as allowing credit unions to treat loan participations as either a loan or an investment.

CUNA is already working with NCUA and the House Financial Services Committee on issues such as increased authority to invest in CUSOs, and we will be looking carefully for further opportunities to expand the investment opportunities for federal credit unions without jeopardizing safety and soundness.

Thank you for the opportunity to comment on NCUA’s proposed rule on investment and deposit activities. If Board members or agency staff have questions about our comments, please give Associate General Counsel Mary Dunn or me a call at 202-638-5777.

Sincerely,

Jeffrey Bloch
Assistant General Counsel