Subordinated Debt

Cited as:85 FR 13982
Court:National Credit Union Administration
Publication Date:10 Mar 2020
Record Number:2020-01537
Federal Register, Volume 85 Issue 47 (Tuesday, March 10, 2020)
[Federal Register Volume 85, Number 47 (Tuesday, March 10, 2020)]
                [Proposed Rules]
                [Pages 13982-14033]
                From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
                [FR Doc No: 2020-01537]
                [[Page 13981]]
                Vol. 85
                Tuesday,
                No. 47
                March 10, 2020
                Part II
                 National Credit Union Administration
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                12 CFR Parts 701, 702, 709, et al.
                 Subordinated Debt; Proposed Rule
                Federal Register / Vol. 85 , No. 47 / Tuesday, March 10, 2020 /
                Proposed Rules
                [[Page 13982]]
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                NATIONAL CREDIT UNION ADMINISTRATION
                12 CFR Parts 701, 702, 709, and 741
                RIN 3133-AF08
                Subordinated Debt
                AGENCY: National Credit Union Administration (NCUA).
                ACTION: Proposed rule.
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                SUMMARY: The NCUA Board (Board) is proposing to amend various parts of
                the NCUA's regulations to permit low-income designated credit unions
                (LICUs), Complex Credit Unions, and New Credit Unions to issue
                Subordinated Debt for purposes of regulatory capital treatment.
                Specifically, this proposed rule would create a new subpart in the
                NCUA's final risk-based capital rule (RBC Rule) that would address the
                requirements for and regulatory capital treatment of Subordinated Debt.
                This new subpart would, among other things, contain requirements
                related to applying for authority to issue Subordinated Debt, credit
                union eligibility to issue Subordinated Debt, prepayments, disclosures,
                securities laws, and the terms of a Subordinated Debt Note. This
                proposed rule also makes various additions and amendments to other
                parts and sections of the NCUA's regulations.
                DATES: Comments must be received on or before July 8, 2020.
                ADDRESSES: You may submit written comments, identified by RIN 3133-
                AF08, by any of the following methods (Please send comments by one
                method only):
                 Federal eRulemaking Portal: http://www.regulations.gov.
                Follow the instructions for submitting comments.
                 Fax: (703) 518-6319. Include ``[Your Name]--Comments on
                Proposed Rule: Subordinated Debt'' in the transmittal.
                 Mail: Address to Gerard Poliquin, Secretary of the Board,
                National Credit Union Administration, 1775 Duke Street, Alexandria,
                Virginia 22314-3428.
                 Hand Delivery/Courier: Same as mail address.
                 Public Inspection: You may view all public comments on the Federal
                eRulemaking Portal at http://www.regulations.gov, as submitted, except
                for those we cannot post for technical reasons. The NCUA will not edit
                or remove any identifying or contact information from the public
                comments submitted. You may inspect paper copies of comments in the
                NCUA's law library at 1775 Duke Street, Alexandria, Virginia 22314, by
                appointment weekdays between 9 a.m. and 3 p.m. To make an appointment,
                call (703) 518-6546 or email [email protected].
                FOR FURTHER INFORMATION CONTACT: Tom Fay, Director of Capital Markets;
                or Justin M. Anderson, Senior Staff Attorney, Office of General
                Counsel, 1775 Duke Street, Alexandria, VA 22314-3428. Tom Fay can also
                be reached at (703) 518-1179, and Justin Anderson can be reached at
                (703) 518-6540.
                SUPPLEMENTARY INFORMATION:
                Table of Contents
                I. Background
                 A. History
                 B. Legal Authority
                 C. Credit Union Data
                 D. Summary of the Proposed Rule
                 E. Securities Law Issues
                II. Proposed Changes
                 A. Part 701--Organization and Operations of Federal Credit
                Unions
                 B. Part 702--Capital Adequacy
                 C. Subpart D--Subordinated Debt, Grandfathered Secondary
                Capital, and Regulatory Capital
                 D. Part 709--Involuntary Liquidation of Federal Credit Unions
                and Adjudication of Creditor Claims Involving Federally Insured
                Credit Unions in Liquidation
                 E. Part 741--Requirements for Insurance
                III. Regulatory Procedures
                 A. Paperwork Reduction Act
                 B. Executive Order 13132
                 C. Assessment of Federal Regulations and Policies on Families
                Part 701--Organization and Operations of Federal Credit Unions
                 Sec. 701.25 Loans to Credit Unions
                 Sec. 701.34 Designation of Low Income Status
                 Sec. 701.38 Borrowed Funds
                Part 702--Capital Adequacy
                 Sec. 702.2 Definitions
                 Sec. 702.104 Risk-Based Capital Ratio
                 Sec. 702.109 Prompt Corrective Action for Critically
                Undercapitalized Credit Unions
                 Sec. 702.205 Prompt Corrective Action for Uncapitalized New
                Credit Unions
                 Sec. 702.206 Revised Business Plans (RBP) for New Credit Unions
                 Sec. 702.207 Consideration of Subordinated Debt and
                Grandfathered Secondary Capital for New Credit Unions
                Subpart D--Subordinated Debt, Grandfathered Secondary Capital, and
                Regulatory Capital
                 Sec. 702.401 Purpose and Scope
                 Sec. 702.402 Definitions
                 Sec. 702.403 Eligibility
                 Sec. 702.404 Requirements of the Subordinated Debt and
                Subordinated Debt Note
                 Sec. 702.405 Disclosures
                 Sec. 702.406 Requirements Related to the Offer, Sale, and
                Issuance of Subordinated Debt Notes
                 Sec. 702.407 Discounting of Amount Treated as Regulatory
                Capital
                 Sec. 702.408 Preapproval To Issue Subordinated Debt
                 Sec. 702.409 Preapproval for Federally Insured, State-Chartered
                Credit Unions To Issue Subordinated Debt
                 Sec. 702.410 Interest Payments on Subordinated Debt
                 Sec. 702.411 Prior Written Approval To Prepay Subordinated Debt
                 Sec. 702.412 Effect of a Merger or Dissolution on the Treatment
                of Subordinated Debt as Regulatory Capital
                 Sec. 702.413 Repudiation Safe Harbor
                 Sec. 702.414 Regulations Governing Grandfathered Secondary
                Capital
                Part 709--Involuntary Liquidation of Federal Credit Unions and
                Adjudication of Creditor Claims Involving Federally Insured Credit
                Unions in Liquidation
                 Sec. 709.5 Payout Priorities in Involuntary Liquidation
                Part 741--Requirements of Insurance
                 Sec. 741.204 Maximum Public Unit and Nonmember Accounts, and
                Low-Income Designation
                 Sec. 741.226 Subordinated Debt
                 Sec. 741.227 Loans to Credit Unions
                I. Background
                A. History
                1. Secondary Capital for LICUs
                 In 1996, the Board finalized Sec. 701.34 of the NCUA's regulations
                to permit LICUs to raise secondary capital from foundations and other
                philanthropic-minded non-natural person members and non-members.\1\ The
                Board issued the rule to provide an additional way for a LICU to build
                regulatory capital in order to serve two specific purposes: (1) Support
                greater lending and financial services in the communities served by the
                LICU; and (2) absorb losses to prevent the LICU from failing.
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                 \1\ See 61 FR 50696 (Sept. 27, 1996) (final rule); see also 61
                FR 3788 (Feb. 2, 1996) (interim final rule); 12 CFR 701.34.
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                 In 1998, as part of the Credit Union Membership Access Act
                (CUMAA),\2\ Congress amended the Federal Credit Union Act (the Act) to
                institute a system of prompt corrective action for federally insured
                credit unions based on a credit union's level of net worth. Relevant to
                this proposed rule, CUMAA specifically defined ``net worth,'' among
                other things, to include secondary capital issued by a LICU provided
                that the secondary capital be uninsured and subordinate to all other
                claims against the LICU, including the claims of creditors,
                shareholders, and the National Credit Union Share Insurance Fund
                (NCUSIF).\3\
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                 \2\ Credit Union Membership Access Act of 1998, Public Law 105-
                219, 301, 112 Stat. 913, 929 (codified at 12 U.S.C. 1790d(o)(2)(C)
                (1998)).
                 \3\ Id.
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                [[Page 13983]]
                 In 2006, the Board further amended Sec. 701.34 to require
                regulatory approval of a LICU's secondary capital plan before the LICU
                could issue secondary capital.\4\ In the preamble to the final 2006
                rule, the Board noted that LICUs had sometimes used secondary capital
                to achieve goals different from those for which it was originally
                intended. It also highlighted a pattern of ``lenient practices'' by
                LICUs issuing secondary capital, which contributed to excessive net
                operating costs, high losses from loan defaults, and a shortfall in
                revenue.\5\ The Board stated:
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                 \4\ 71 FR 4234 (Jan. 26, 2006).
                 \5\ Id. at 4236. Before 2006, a LICU was required to submit a
                copy of its secondary capital plan to the NCUA, but it was not
                required to obtain preapproval.
                 These practices include: (1) Poor due diligence and strategic
                planning in connection with establishing and expanding member
                service programs such as ATMs, share drafts and lending (e.g.,
                member business loans (``MBLs'') real estate and subprime); (2)
                Failure to adequately perform a prospective cost/benefit analysis of
                these programs to assess such factors as market demand and economies
                of scale; (3) Premature and excessively ambitious concentrations of
                [Uninsured Secondary Capital] to support unproven or poorly
                performing programs; and (4) Failure to realistically assess and
                timely curtail programs that, in the face of mounting losses, are
                not meeting expectations. When they occur, these lenient practices
                contribute to excessive net operating costs, high losses from loan
                defaults, and a shortfall in revenues (due to non-performing loans
                and poorly performing programs)--all of which, in turn, produce
                lower than expected returns.\6\
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                 \6\ Id. at 4236-37.
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                 The Board also stated:
                 Promoting diligent practices in place of lenient ones cannot
                help but improve the safety and soundness of LICUs. Requiring prior
                approval of [an Uninsured Secondary Capital] Plan will strengthen
                supervisory oversight and detection of lenient practices in several
                ways. First, it will prevent LICUs from accepting and using
                [Uninsured Secondary Capital] for purposes and in amounts that are
                improper or unsound. Second, the approval requirement will ensure
                that [Uninsured Secondary Capital] Plans are evaluated and critiqued
                by the Region before being implemented. Third, for both the NCUA and
                the LICU, an approved [Uninsured Secondary Capital] Plan will
                document parameters to guide the proper implementation of [Uninsured
                Secondary Capital], and to measure the LICU's progress and
                performance.\7\
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                 \7\ Id. at 4237.
                 The Current Secondary Capital Rule \8\ provides that secondary
                capital accounts must:
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                 \8\ 12 CFR 701.34. The last substantive amendment to the NCUA's
                secondary capital rule were in 2010 with the addition of language
                regarding secondary capital received under the Community Development
                Capital Initiative of 2010. 75 FR 57843 (Sept. 23, 2010).
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                 Be established as an uninsured secondary capital account
                or another form of non-share account;
                 Have a minimum maturity of five years;
                 Not be insured by the NCUSIF or any governmental or
                private entity;
                 Be subordinate to all other claims against the LICU,
                including those of shareholders, creditors, and the NCUSIF;
                 Be available to cover losses that exceed the LICU's net
                available reserves and, to the extent funds are so used, a LICU may not
                restore or replenish the account under any circumstances.\9\ Further,
                losses must be distributed pro rata among all secondary capital
                accounts held by the LICU at the time the loss is realized;
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                 \9\ This generally means that when net operating losses exceed
                Retained Earnings, a LICU needs to first use the secondary capital
                funds to cover the excess amount.
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                 Not be pledged or provided by the investor as security on
                a loan or other obligation with the LICU or any other party;
                 Be evidenced by a contract agreement between the investor
                and the LICU that reflects the terms and conditions mandated by the
                Current Secondary Capital Rule and any other terms and conditions not
                inconsistent with that rule;
                 Be accompanied by a disclosure and acknowledgment form as
                set forth in the appendix to the Current Secondary Capital Rule;
                 Not be repaid, including any interest or dividends earned
                thereon, if the Board has prohibited repayment thereof under Sec. Sec.
                702.204(b)(11), 702.304(b), or 702.305(b) of the NCUA's regulations
                because the LICU is classified as ``Critically Undercapitalized''; or,
                if a LICU is a New Credit Union (as defined under Sec. 702.2 of the
                NCUA's regulations), as ``Moderately Capitalized,'' ``Marginally
                Capitalized,'' ``Minimally Capitalized,'' or ``Uncapitalized;''
                 Be recorded on the LICU's balance sheet; \10\
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                 \10\ While the Current Secondary Capital Rule requires a LICU to
                record secondary capital accounts on its balance sheet as ``equity
                accounts,'' generally accepted accounting principles in the United
                States require secondary capital accounts to generally be recorded
                as ``debt.'' See FASB (Financial Accounting Standards Board), ASC
                942-405-25-3 and 25-4. The instructions to the 5300 Call Report
                require all federally insured credit unions to report any secondary
                capital in the Liability section of the Statement of Financial
                Condition.
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                 Be recognized as net worth in accordance with the schedule
                for recognizing net worth value in subsection (c)(2) of the Current
                Secondary Capital Rule;
                 Be closed and paid out to the account investor in the
                event of a merger or other voluntary dissolution of a LICU, to the
                extent the secondary capital is not needed to cover losses at the time
                of the merger or dissolution (does not apply in the case where a LICU
                merges into another LICU); and
                 Only be repaid at maturity,\11\ except that, with the
                prior approval of the NCUA and provided the terms of the account allow
                for early repayment, a LICU may repay any portion of secondary capital
                that is not recognized as net worth.\12\
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                 \11\ A LICU may not issue a secondary capital account that
                amortizes over its stated term.
                 \12\ See 12 CFR 701.34(d).
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                 The Current Secondary Capital Rule also includes requirements
                related to secondary capital plan submissions and approvals, redemption
                of secondary capital, disclosures, and regulatory capital treatment.
                 As noted above, since the passage of the CUMAA, a LICU that issues
                secondary capital is permitted to include the aggregate outstanding
                principal amount of that secondary capital in its Net Worth. Further,
                pursuant to the NCUA's currently effective risk-based net worth
                requirements, a LICU is also permitted to include such secondary
                capital in its risk-based net worth calculation. By contrast, a non-
                LICU lacks the authority to issue secondary capital and, to the extent
                it issues any instruments analogous to secondary capital, to include
                any such instruments in either its Net Worth or its risk-based net
                worth calculation.
                 In October 2015, the Board finalized a rule to replace the current
                risk-based net worth requirement with a risk-based capital (RBC)
                requirement.\13\ Under this revised standard, a LICU will be permitted
                to include secondary capital in its RBC calculations in the same
                fashion as it currently includes secondary capital in its risk-based
                net worth calculation. With this proposed rule, the Board now proposes
                to grant certain non-LICUs the authority to issue instruments in the
                form of subordinated debt and allow those instruments to be counted in
                their respective RBC calculations. This new authority,
                [[Page 13984]]
                however, would not permit non-LICUs to include subordinated debt in Net
                Worth.
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                 \13\ 80 FR 66626 (Oct. 29, 2015). The Board has twice delayed
                the effective date for the final RBC Rule. First, in 2018, the
                effective date was delayed by one year, from January 1, 2019, to
                January 1, 2020. 83 FR 55467 (Nov. 6, 2018). Second, based on Board
                action at the December 2019 Board meeting, the effective date has
                been delayed for an additional two years from January 1, 2020 to
                January 1, 2022.
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                 As discussed in more detail in the following subsections, under
                this proposed rule, certain non-LICUs would be permitted to issue
                Subordinated Debt and include such debt in their RBC calculation. In
                addition, under this proposed rule, all LICUs would be permitted to
                issue Subordinated Debt for Regulatory Capital treatment.\14\ Under
                this proposed rule, an Issuing Credit Union (defined in Sec. 702.402
                of the proposed rule) would be subject to the various requirements
                discussed in this preamble, including, but not limited to, securities
                laws, which are further discussed in section I. (E) of this preamble.
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                 \14\ This proposal would not change the ability of a LICU to
                include Subordinated Debt in its Net Worth in the same manner in
                which it currently includes secondary capital in its net worth.
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                2. Subordinated Debt for LICUs and Certain Non-LICUs
                RBC
                 In the proposed RBC rule issued in 2015,\15\ the Board requested
                stakeholder input on supplemental capital.\16\ Specifically, the Board
                posed the following six questions:
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                 \15\ 80 FR 4340 (Jan. 27, 2015).
                 \16\ Id. at 4384. The Board notes that when the agency began to
                consider authorizing non-LICU credit unions to issue instruments
                analogous to secondary capital instruments issued by LICUs, it used
                the term ``supplemental capital'' to refer to those instruments. In
                2017, when the Board issued an advance notice of proposed rulemaking
                on this topic, the NCUA used the umbrella term ``alternative
                capital'' to refer to both supplemental capital and secondary
                capital. In light of FCUs' authority only to issue debt instruments,
                however, the Board believes that it is more appropriate and accurate
                to use the umbrella term ``Subordinated Debt'' to refer to both
                secondary capital and what was once referred to as supplemental
                capital. It is important to note that, unless the context otherwise
                requires, the term ``Subordinated Debt'' refers to BOTH types of
                debt instruments.
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                 (1) Should additional supplemental forms of capital be included in
                the RBC [ratio] numerator and how would including such capital protect
                the NCUSIF from losses?
                 (2) If yes to be included in the RBC [ratio] numerator, what
                specific criteria should such additional forms of capital reasonably be
                required to meet to be consistent with [United States generally
                accepted accounting practices (U.S. GAAP)] and the [FCU] Act, and why?
                 (3) If certain forms of certificates of indebtedness were included
                in the RBC ratio numerator, what specific criteria should such
                certificates reasonably be required to meet to be consistent with
                [U.S.] GAAP and the [FCU] Act, and why?
                 (4) In addition to amending the NCUA's RBC regulations, what
                additional changes to the NCUA's regulations would be required to count
                additional supplemental forms of capital in the NCUA's RBC ratio
                numerator?
                 (5) For [federally insured,] state-chartered credit unions, what
                specific examples of supplemental capital currently allowed under state
                law do commenters believe should be included in the RBC ratio
                numerator, and why should they be included?
                 (6) What investor suitability, consumer protection, and disclosure
                requirements should be put in place related to additional forms of
                supplemental capital? \17\
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                 \17\ Id.
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                 In response to these questions, a majority of the commenters who
                addressed supplemental capital stated that it was imperative that the
                Board consider allowing credit unions to issue additional forms of
                capital. The commenters suggested this authority was particularly
                important because credit unions are at a disadvantage in the financial
                marketplace because most lack access to additional capital outside of
                Retained Earnings.
                 While none of the commenters offered specific suggestions on how to
                implement supplemental capital, a few suggested that the Board
                promulgate broad, non-prescriptive rules to allow credit unions maximum
                flexibility in issuing supplemental capital.
                2017 Advance Notice of Proposed Rulemaking (ANPR)
                 On February 8, 2017, the Board published an ANPR to solicit
                comments on alternative forms of capital that credit unions could use
                in meeting capital standards required by statute and regulation.\18\ In
                response, the Board received 756 comments.
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                 \18\ 82 FR 9691 (Feb. 8, 2017).
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                 Of the 756 comments received, 688 appeared to be derived from one
                form letter.\19\ The form letter opposed the NCUA proceeding with a
                supplemental capital proposal, reasoning that allowing credit unions to
                issue supplemental capital would result in credit unions having an
                ownership structure similar to most tax-paying banks. It also
                maintained that credit unions have poorly managed existing secondary
                capital and suggested that, when combined with the necessary compliance
                with federal and state securities laws, this would result in widespread
                credit union failures and taxpayer bailouts. In addition, commenters
                that opposed a supplemental capital proposal generally stated that the
                FCU Act does not permit credit unions to issue supplemental capital.
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                 \19\ While there were slight modifications to some letters, the
                substance of each letter was the same.
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                 The Board disagrees with these assertions. First, most LICUs that
                have issued secondary capital generally have managed such capital well.
                Since the NCUA began requiring LICUs to obtain prior approval before
                issuing secondary capital, the Board is not aware of material losses to
                the NCUSIF resulting from the mismanagement of secondary capital.
                Further, the Board is proposing clear and robust requirements related
                to securities laws compliance, which will help ensure that Issuing
                Credit Unions are able to effectively navigate the complex framework of
                securities laws. Finally, as detailed more fully in section I. (B) of
                this preamble, section 1757(9) of the FCU Act grants a Federal Credit
                Union (FCU) the authority to issue debt instruments of the type
                contemplated by the ANPR and now by this proposed rule.\20\ The
                authority of a federally insured, state-chartered credit union (FISCU)
                to issue such instruments is derived from applicable state law.
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                 \20\ 12 U.S.C. 1757(9).
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                 In addition to the form comment letters, the Board received 68
                unique comments in response to the ANPR. Most of those comments
                supported proposing a rule to allow non-LICUs to issue an alternative
                form of capital. A majority of the commenters in favor of a proposal
                cited compliance with the NCUA's RBC Rule as the main reason for their
                support. Other reasons for support included credit union growth,
                protection from economic downturns, and providing services demanded by
                members.
                 In general, the comments lacked specificity, and very few
                commenters addressed all or even most of the questions that the Board
                posed. Nevertheless, they covered a wide range of topics and offered
                varying levels of support for certain provisions. A discussion of more
                specific commenter feedback follows. The Board notes that, as
                demonstrated by the remainder of this preamble, it considered all
                comments to the ANPR in developing this proposed rule.
                Permissible Investors
                 Commenters opining on permissible investors typically addressed two
                distinct issues: Membership of investors and classification of
                investors. Eighteen commenters addressed the membership of investors.
                More than half of these commenters believed that both members
                [[Page 13985]]
                and non-members should be permitted to invest in supplemental capital,
                citing both market and flexibility advantages for Issuing Credit
                Unions. Five commenters believed that restricting investment to members
                would help preserve the mutual, member-owned structure of credit
                unions. One commenter argued that only non-members should be
                permissible investors.
                 On the topic of investor classification, commenters were split
                almost evenly between providing maximum flexibility by permitting all
                persons to purchase supplemental capital and restricting investors to
                only non-natural persons or accredited investors. Commenters in favor
                of limiting the classes of potential investors stated that by only
                permitting more sophisticated investors, it would allow the NCUA's
                supplemental capital rule to be more flexible with respect to required
                disclosures.
                 As discussed in more detail in section II. (C)(4) of this preamble,
                the Board is proposing to allow credit unions to issue Subordinated
                Debt to both members and non-members, provided the investor meets the
                definition of either ``Entity Accredited Investor'' or ``Natural Person
                Accredited Investor.'' These terms are further discussed in sections
                II. (C)(2) and (4) of this preamble.
                Disclosures
                 Twenty-seven commenters addressed the issue of disclosures. The
                majority of these commenters urged the NCUA to model any required
                disclosures after those established by the Office of the Comptroller of
                the Currency (OCC) or the Securities and Exchange Commission (SEC).
                These commenters maintained that these disclosures provide the highest
                level of investor and credit union protection and are the most familiar
                to investors. As discussed in greater detail in section II. (C)(5) of
                this preamble, the Board generally modeled the proposed disclosures in
                this rule after those required by the OCC and SEC.
                Registration
                 Nine commenters that addressed this issue advocated against
                requiring any form of registration with the NCUA before supplemental
                capital issuances. These commenters stated that the NCUA should require
                credit unions to follow SEC rules, which would likely exempt them from
                registration with the SEC. The commenters further cited flexibility and
                cost as reasons against registering with the NCUA. In addition, three
                commenters advocated for registration, citing safety and soundness
                concerns and comparability with the OCC's rules for national banks and
                federal savings associations.
                 While the Board is not proposing a formal registration process
                similar to that employed by the SEC for securities issuances registered
                under the Securities Act of 1933, as amended (Securities Act), the
                proposed rule would require any credit union contemplating an offer or
                sale of Subordinated Debt Notes (as defined in Sec. 702.402 of the
                proposed rule) to obtain the NCUA's prior written approval before
                engaging in that activity. In addition, under this rule, every such
                offer and sale of Subordinated Debt Notes would require the preparation
                and delivery of certain offering materials to investors that conform to
                this rule's requirements and all applicable federal and state
                securities law (Offering Documents). Depending on whether a potential
                investor is an Entity Accredited Investor or a Natural Person
                Accredited Investor (each as defined in section II. (C)(2)), the
                Issuing Credit Union may need to obtain the NCUA's prior written
                approval before it uses such offering materials to offer and sell the
                Subordinated Debt Notes. See II. (C)(4) and (C)(6) of this preamble for
                detailed discussions about these requirements.
                Permissible Instruments
                 Thirty-four commenters addressed the topic of permissible
                instruments. Of these commenters, 22 favored a broad, principles-based
                approach to identifying permissible instruments, believing such an
                approach would allow credit unions to more easily meet the demands of
                investors and lower the cost of issuance. These commenters stated that
                the Board should provide a list of broad qualifications for a capital
                instrument and that any instrument fitting those qualifications should
                count as regulatory capital. While commenters did not clearly describe
                qualifications the Board should impose, some cited Basel III \21\ and
                the Current Secondary Capital Rule as possible models for the
                qualifications.
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                 \21\ Basel Committee on Banking Supervision, Basel III: A global
                regulatory framework for more resilient banks and banking systems.
                (2011).
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                 Conversely, the remaining 12 commenters addressing this topic
                stated that the Board should only permit debt instruments to count as
                regulatory capital, citing purchasers of debt lack of voting rights,
                ownership, and influence over credit unions. These commenters argued
                that limiting the type of instrument to debt was an additional
                protection against erosion of the mutual structure and potential loss
                of the credit union tax exemption. Please see the following section in
                this preamble for a detailed discussion of permissible instruments.
                B. Legal Authority
                1. Authority To Issue Subordinated Debt
                 The borrowing authority granted to FCUs by the FCU Act, along with
                FCUs' statutory authority to enter into contracts and exercise
                incidental powers necessary or required to enable the FCUs to
                effectively carry on their business, supports the legal analysis that
                FCUs are authorized to incur indebtedness through the issuance of debt
                securities of the type contemplated by this proposed rule. Section
                1757(9) of the FCU Act authorizes FCUs:
                to borrow, in accordance with such rules and regulations as may be
                prescribed by the Board, from any source, in an aggregate amount not
                exceeding, except as authorized by the Board in carrying out the
                provisions of subchapter III of this chapter, 50 per centum of its
                paid-in and unimpaired capital and surplus: Provided, That any
                Federal credit union may discount with or sell to any Federal
                intermediate credit bank any eligible obligations up to the amount
                of its paid-in and unimpaired capital.\22\
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                 \22\ 12 U.S.C. 1757(9).
                 Other than the provisions of Sec. 701.38 of the NCUA's
                regulations, which addresses borrowed funds from natural persons, the
                FCU Act does not provide any details as to the mechanisms that FCUs may
                employ to borrow.\23\ Further, section 201(b)(7) of the FCU Act
                implicitly allows credit unions to issue securities.\24\ Conversely,
                nothing in section 1757(9) or other provisions of the FCU Act appears
                to impose any specific restrictions or limitations on the mechanisms
                FCUs may employ to borrow, through the use of specific
                [[Page 13986]]
                limiting language, examples or illustrative transactions or situations,
                or otherwise. This stands in sharp contrast to many other subsections
                of section 1757 of the FCU Act which, for example, go into significant
                detail describing the types and terms of loans and extensions of credit
                that FCUs are permitted to make,\25\ and define the types of
                investments FCUs are permitted to make.\26\ In addition, the NCUA's
                regulations do not impose any specific restrictions or limitations on
                the mechanisms an FCU may employ to borrow, through the use of specific
                limiting language, examples, illustrative transactions, or situations.
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                 \23\ In contrast, certain provisions of Title 12 of the United
                States Code relating to the regulation of other types of financial
                institutions expand on the institutions' basic authority to borrow
                money, including through the issuance of securities. For example, a
                Farm Credit System member is specifically authorized to:
                 (a) Borrow money from or loan to any other institution of the
                System, borrow from any commercial bank or other lending
                institution, issue its notes or other evidence of debt on its own
                individual responsibility and full faith and credit, and invest its
                excess funds in such sums, at such times, and on such terms and
                conditions as it may determine.
                 (b) Issue its own notes, bonds, debentures, or other similar
                obligations, fully collateralized as provided in section 2154(c) of
                this title by the notes, mortgages, and security instruments it
                holds in the performance of its functions under this chapter in such
                sums, maturities, rates of interest, and terms and conditions of
                each issue as it may determine with approval of the Farm Credit
                Administration.
                 12 U.S.C.2153(a)(b).
                 \24\ Id. section 1781(b)(7)
                 \25\ Id. 1757(5).
                 \26\ Id. 1757(7); (15).
                ---------------------------------------------------------------------------
                 Overall, the lack of specific restrictions or limitations on the
                mechanisms that may be employed and the specific authority granted in
                section 1757(9) to borrow ``from any source'' indicate that borrowings
                need not be limited to the types of arrangements typically entered into
                with banks, other credit unions, and other financial institutions--
                namely, loans, lines of credit, and similar arrangements. Further, the
                specific authority provided in section 1757(1) of the FCU Act
                empowering FCUs to enter into contracts \27\ further supports the
                conclusion that FCUs have the power to enter into a variety of
                different arrangements with respect to borrowing.\28\ In addition, in
                the absence of specific restrictions and limitations, the ``incidental
                powers'' granted to FCUs in section 1757(17) of the FCU Act give
                significant discretion to FCUs with respect to how borrowings are
                effected.
                ---------------------------------------------------------------------------
                 \27\ Id. 1757(1).
                 \28\ Typical loan and line of credit arrangements entered into
                with banks, other credit unions and other financial institutions are
                clearly contractual in nature. Debt securities are also generally
                viewed as primarily contractual in nature, in large measure because
                of the terms of the securities themselves or the terms incorporated
                into the securities through an indenture, an issuing and paying
                agent agreement or similar agreement. This view of debt securities
                has been expressed in a wide variety of court cases. See, e.g., Katz
                v. Oak Industries, Inc., 508 A.2d 873, 878 (Del. Ch. 1986)) (``Under
                our law--and the law generally--the relationship between a
                corporation and the holders of its debt securities, even convertible
                debt securities, is contractual in nature.'').
                ---------------------------------------------------------------------------
                 Further support for the position that FCUs have the authority to
                issue debt securities may be found in U.S. GAAP treatment of items that
                fall in the category of ``borrowings.'' Under U.S. GAAP, liabilities
                relating to borrowed money are presented as indebtedness on an entity's
                balance sheet, and the interest paid is presented as interest expense
                on its income statement, whether the borrowings are related to typical
                loan transactions, advances under lines of credit, or the issuance of
                debt securities. While the details of the different types of
                indebtedness for borrowed money are presented as separate line items in
                an entity's balance sheet and income statement, the treatment of
                ``straight'' indebtedness (indebtedness that does not have equity/
                residual ownership features, such as convertibility into shares) as
                liabilities, and interest paid thereon as interest expense, is
                essentially the same. In addition, while the details of the different
                types of indebtedness for borrowed money are presented as separate line
                items in the statement of cash flows, borrowings, whether in the form
                of loans from financial institutions or from the issuance of debt
                securities, are all presented in the ``cash flows from financing
                activities'' section of the statement.
                 Throughout this proposed rule, the Board has included requirements
                to ensure that any Subordinated Debt issued by an Issuing Credit Union
                would be properly characterized as debt in accordance with U.S. GAAP.
                These requirements, as discussed in more detail in this preamble,
                include that the Subordinated Debt or the Subordinated Debt Note, as
                applicable, must:
                 Be in the form of a written, unconditional promise to pay
                on a specified date a sum certain in money in return for adequate
                consideration in money;
                 Have, at the time of issuance, a fixed stated maturity of
                at least five years and not more than 20 years from issuance. The
                stated maturity of the Subordinated Debt Note may not reset and may not
                contain an option to extend the maturity; and
                 Be properly characterized as debt in accordance with U.S.
                GAAP.
                 The Board notes that a FISCU's legal authority to issue
                Subordinated Debt derives from applicable state law and regulation. For
                the Subordinated Debt issued by a FISCU to qualify as regulatory
                capital under this proposed rule, however, the FISCU would be required
                to comply with all of the provisions of this rule, including the FISCU-
                specific provisions that are detailed in section II. (C)(9) of this
                preamble.
                2. The Board's Authority To Design RBC Standards
                 In addition to credit unions' authority to issue Subordinated Debt,
                the FCU Act also provides the Board with broad discretion to design the
                risk-based net worth standards.\29\ Specifically, the FCU Act provides,
                in relevant part:
                ---------------------------------------------------------------------------
                 \29\ As discussed above, the Board finalized a rule to replace
                the regulatory risk-based net worth requirement with an RBC
                requirement.
                 The Board shall design the risk-based net worth requirement to
                take account of any material risks against which the net worth ratio
                required for an insured credit union to be ``Adequately
                Capitalized'' may not provide adequate protection.\30\
                ---------------------------------------------------------------------------
                 \30\ 12 U.S.C. 1790d(d).
                 In designing such a risk-based net worth standard, Congress did not
                restrict the types of instruments the Board may include in its
                calculation of risk-based net worth, except that such calculation must
                take account of material risks that the Net Worth Ratio alone may not
                protect against. The Board, as discussed in this preamble, is proposing
                this rule to grant authority to LICUs, Complex Credit Unions, and New
                Credit Unions to issue Subordinated Debt that will count as regulatory
                capital. Based on the requirements in this proposed rule, the Board
                believes Subordinated Debt will be an additional tool that accounts for
                material risks faced by credit unions against which the Net Worth Ratio
                alone may not protect.
                 While the Board has broad discretion to create the risk-based net
                worth standard, it does not have the authority to amend the statutory
                definition of net worth. Currently, the statutory definition of net
                worth includes secondary capital issued by a LICU that is uninsured and
                subordinate to all claims against the LICU. As such, the Board notes
                two points with respect to Subordinated Debt and Net Worth. First,
                Subordinated Debt issued by a non-LICU will not be included in that
                credit union's Net Worth or Net Worth Ratio. Second, Subordinated Date
                issued by a LICU after the effective date of a final Subordinated Debt
                rule will be included in that credit union's Net Worth and Net Worth
                Ratio.
                C. Credit Union Data \31\
                ---------------------------------------------------------------------------
                 \31\ Data from NCUA Call Report.
                ---------------------------------------------------------------------------
                 As of June 30, 2019, there are 2,618 LICUs. Under this proposed
                rule, LICUs would continue to be eligible to issue Subordinated Debt.
                This proposed rule would newly authorize certain non-LICUs to be
                eligible to issue Subordinated Debt. Specifically, Complex Credit
                Unions and New Credit Unions would also be eligible to issue
                Subordinated Debt. The NCUA estimates that this proposed rule would
                allow an additional 285 non-LICUs, with total assets of $730 billion,
                to issue Subordinated Debt.
                [[Page 13987]]
                ----------------------------------------------------------------------------------------------------------------
                 Average net
                 Proposed eligible # of credit Total industry assets worth ratio
                 unions (%)
                ----------------------------------------------------------------------------------------------------------------
                LICU.......................................... 2,618 $628 billion.................... 13
                LICU--New Credit Union........................ 10 $24 million..................... 23
                Non-LICU Complex Credit Union................. 281 $730 billion.................... 11
                Non-LICU New Credit Union..................... 4 $12 million..................... 44
                ----------------------------------------------------------------------------------------------------------------
                 Proposed Not Eligible
                ----------------------------------------------------------------------------------------------------------------
                Non-LICU Non-Complex Credit Union............. 2,409 $162 billion.................... 14
                ----------------------------------------------------------------------------------------------------------------
                Total Assets and average Net Worth Ratios rounded. Only one of the 281 Non-LICU Complex Credit Unions had a Net
                 Worth Ratio category of ``Undercapitalized.''
                D. Summary of the Proposed Rule
                 This proposed rule reflects not only the responses to the ANPR
                discussed above, but also research by NCUA staff, consultation with
                outside legal counsel, and a comprehensive review of the various
                current NCUA regulations, including the Current Secondary Capital Rule.
                The Board believes this proposal represents a balance between
                flexibility for credit unions and its responsibility to safeguard the
                NCUSIF and protect the safety and soundness of credit unions.
                 This proposed rule would permit LICUs, Complex Credit Unions, and
                New Credit Unions to issue Subordinated Debt Notes for purposes of
                regulatory capital treatment.\32\ It contains a series of requirements
                with respect to the Subordinated Debt and Subordinated Debt Note,
                disclosures and offering materials, repayment (including prepayment),
                and regulatory capital treatment. It also includes an application
                procedure for both the issuance and repayment of Subordinated Debt
                Notes.
                ---------------------------------------------------------------------------
                 \32\ Regulatory capital treatment is based on the type of credit
                union issuing Subordinated Debt. As discussed throughout this
                preamble, a LICU may include Subordinated Debt in its RBC ratio and
                its Net Worth; a Complex Credit Union that is not a LICU may include
                Subordinated Debt in its RBC ratio; and a New Credit Union that is
                not a LICU may use Subordinated Debt to avail itself of various
                Prompt Corrective Actions.
                ---------------------------------------------------------------------------
                 In addition, the Board is proposing requirements related to the
                various securities law issues applicable to the offer, issuance, and
                sale of Subordinated Debt Notes. See sections I. (E) and II. (C)(6) and
                (8) in this preamble for a detailed discussion of these requirements.
                 This proposed rule also makes various additions and amendments to
                other parts and sections of the NCUA's regulations. Specifically, this
                proposed rule would include: A new section addressing limits on loans
                to other credit unions; a grandfathering of any secondary capital
                issued before the effective date of a final Subordinated Debt rule
                (Grandfathered Secondary Capital); an expansion of the borrowing rule
                to clarify that FCUs can borrow from any source; revisions to the RBC
                Rule and the payout priorities in an involuntary liquidation rule to
                account for Subordinated Debt and Grandfathered Secondary Capital; and
                cohering changes to part 741 to account for the other changes proposed
                in this rule that apply to FISCUs.
                 All secondary capital issued after the effective date of a final
                Subordinated Debt rule would be subject to the requirements for
                Subordinated Debt. This change would not impact a LICU's ability to
                include such instruments in its Net Worth.
                 As noted above, secondary capital issued before the effective date
                of a final Subordinated Debt rule would be considered Grandfathered
                Secondary Capital. This proposal would also preserve the regulatory
                capital treatment of Grandfathered Secondary Capital for 20 years after
                the effective date of a final Subordinated Debt rule. Grandfathered
                Secondary Capital, under this proposal, would generally remain subject
                to the requirements in current Sec. Sec. 701.34(b) through (d)
                (Current Secondary Capital Rule). For ease of reference, the
                requirements in the Current Secondary Capital Rule would be moved from
                their current location to a section in the new proposed subpart.
                 Finally, the Board has made cohering changes to various section of
                the NCUA's regulations. Specifically, this proposed rule includes:
                 A new Sec. 701.25, which places limits on FCU loans to
                other credit unions;
                 Recodification of Sec. 701.34 (b), (c), and (d) as Sec.
                702.414 to address Grandfathered Secondary Capital;
                 An update to Sec. 701.38 that clarifies that FCUs can
                borrow from any source;
                 Changes and additions to the final RBC Rule to account for
                Subordinated Debt issued by Complex Credit Unions and New Credit
                Unions;
                 An update to the involuntary liquidation payout priorities
                in Sec. 709.5 to account for Subordinated Debt; and
                 Changes to part 741 to account for FISCUs investing in or
                issuing Subordinated Debt and the treatment of Grandfathered Secondary
                Capital.
                 These additional regulatory changes were necessary to ensure that
                this proposal represents a comprehensive review and revision of the
                NCUA's regulations to appropriately account for Subordinated Debt.
                E. Securities Law Issues
                1. Subordinated Debt Notes Are Securities
                 The NCUA continues to believe that any Subordinated Debt Note would
                be deemed to be a ``security'' for purposes of federal and state
                securities laws. Section 2(1) of the Securities Act broadly defines the
                term ``security'' to include, among other things, any:
                 Stock;
                 Note;
                 Bond;
                 Debenture;
                 Evidence of indebtedness;
                 Investment contract; or
                 Interest or instrument commonly known as a security.\33\
                ---------------------------------------------------------------------------
                 \33\ 15 U.S.C. 77b.
                ---------------------------------------------------------------------------
                 The U.S. Supreme Court has repeatedly emphasized that the
                definition of ``security'' is quite broad. In a variety of cases
                analyzing the boundaries of the definition, the Supreme Court has
                stressed that the substantive characteristics of the instrument in
                question and the circumstances surrounding its issuance, rather than
                the mere name or title of the instrument, are of primary significance
                in determining whether the instrument, contract or arrangement in
                question will be deemed a ``security.'' While lower federal courts and
                some state courts have sometimes taken a more narrow view than the
                Supreme Court, common factors the courts generally consider in their
                analysis (particularly in the context of a debt instrument, contract or
                arrangement) include:
                 The terms of the offer;
                [[Page 13988]]
                 In particular, the character of the economic inducement
                being offered to the potential counterparty, and whether the
                characteristics are consistent with a loan or typical extension of
                credit, or such that the counterparty would anticipate a potential
                return on investment in addition to repayment of the obligation and any
                stated interest;
                 The plan of distribution;
                 In particular, how the instrument is marketed and to whom
                it is marketed, and whether the potential counterparties are
                traditional lenders/providers of credit or investors who would
                anticipate a potential return on investment in addition to repayment of
                the obligation and any stated interest; and
                 The ``family resemblance'' of the instrument to other
                instruments or arrangements that have been found to fall within the
                definition of a ``security,'' rather than having characteristics more
                akin to a loan or typical extension of credit.
                 The NCUA's definition of a ``security'' is not as broad on its face
                as the Securities Act definition, but is generally consistent with the
                federal definition, relevant case law, and interpretations by the SEC.
                Section 703.2 of the NCUA's regulations defines the term to include a
                share, participation, or other interest in property or in an enterprise
                of the issuer or an obligation of the issuer that:
                 Either is represented by an instrument issued in bearer or
                registered form or, if not represented by an instrument, is registered
                in books maintained to record transfers by or on behalf of the issuer;
                 Is of a type commonly dealt in on securities exchanges or
                markets or, when represented by an instrument, is commonly recognized
                in any area in which it is issued or dealt in as a medium for
                investment; and
                 Either is one of a class or series or by its terms is
                divisible into a class or series of shares, participations, interests,
                or obligations.\34\
                ---------------------------------------------------------------------------
                 \34\ 12 CFR 703.2.
                ---------------------------------------------------------------------------
                 For the foregoing reasons, the Board emphasizes that any issuance
                of a Subordinated Debt Note by an Issuing Credit Union must be done in
                accordance with applicable federal and state securities laws. Given the
                complexity of the securities law framework, any credit union
                contemplating an offer and sale of Subordinated Debt Notes needs to
                engage qualified legal counsel to ensure its compliance with securities
                laws before, during, and after any such offer and sale. The securities
                law information in this preamble does not constitute, and should not be
                construed or relied upon as, legal advice to any party.
                2. Federal (SEC) Registration of Subordinated Debt Notes
                 Section 5(a) of the Securities Act expresses a fundamental premise
                of the federal securities laws--that any offers and sales of securities
                must be registered with the SEC under the Securities Act, unless an
                exemption from registration is available.\35\ Sections 3 and 4 of the
                Securities Act outline a variety of exemptions from the registration
                requirements of Section 5(a).\36\ Based on either of two exemptions
                discussed below, Issuing Credit Unions will be able to offer and sell
                their Subordinated Debt Notes without registering the offering with the
                SEC under the Securities Act. Specifically, an Issuing Credit Union
                should be able to rely on either Section 3(a)(5) of the Securities Act
                or Rule 506 under Regulation D promulgated under Section 4(a)(2) of the
                Securities Act.
                ---------------------------------------------------------------------------
                 \35\ 15 U.S.C. 77e.
                 \36\ Id. 77c and 77d.
                ---------------------------------------------------------------------------
                 Section 3(a) of the Securities Act provides a series of exemptions
                from Securities Act registration based on the character of the
                securities being offered, without regard to the nature of the offering
                or the nature of the purchasers in the offering. That is, the exemption
                applies to offerings:
                 Conducted as public offerings or as private placements or
                a mix of the two;
                 Made to investors that are institutions, individuals, or
                both; and
                 Made to investors whether or not the investors meet one or
                more standards such as ``accredited investors'' or ``qualified
                institutional buyers,'' as each such term is defined in SEC
                regulations.
                 Relevant to credit unions, section 3(a)(5) of the Securities Act,
                in relevant portion, exempts securities that are issued ``by a savings
                and loan association, building and loan association, cooperative bank,
                homestead association, or similar institution, which is supervised and
                examined by State or Federal authority having supervision over any such
                institution.'' The Board anticipates that nearly all Issuing Credit
                Unions would rely on this exemption from the registration requirements
                in the Securities Act.
                 The Board notes that, in addition to the exemption in Section
                3(a)(5), Section 4(a) of the Securities Act provides certain exemptions
                based on the nature of the securities transaction and the persons
                involved in the transaction. In particular, Section 4(a)(2) provides
                certain exemptions (and authorizes the SEC to adopt related rules)
                based on the nature of the offering and the character of the offerees
                and purchasers of the securities, without regard to the character of
                the securities. That is, the exemptions apply to offerings of:
                 Equity securities, including common and preferred stock
                and options, warrants, rights and other derivative securities;
                 Debt securities, including bonds, notes and debentures;
                and
                 Hybrid securities, including convertible securities.
                 Rule 506 of Regulation D, which was adopted by the SEC under
                Section 4(a)(2) of the Securities Act, provides the specific
                requirements of one form of what is commonly referred to as the
                ``private placement'' exemption. Under Regulation D, Rule 506,
                registration under the Securities Act is not required for offerings
                that are either (i) not made via any means of general solicitation or
                advertisement and where the number of purchasers who are not
                ``accredited investors'' is limited to no more than 35, or (ii) made
                via general solicitation or advertisement but where all purchasers are
                ``accredited investors''.
                 Given the time and costs associated with offering and selling SEC-
                registered securities, the Board recognizes that many Issuing Credit
                Unions may avail themselves of an exemption from the registration
                requirements of Section 5(a) of the Securities Act. Under this proposed
                rule, the Board would not mandate a specific exemption on which an
                Issuing Credit Union could or should rely. An Issuing Credit Union
                should consult with its securities counsel in determining the
                appropriate exemption upon which to rely.
                 As discussed more fully in sections II. (C)(6) and (8) of this
                preamble, however, the Board is proposing to adopt a regulatory
                framework for the offer, issuance, and sale of Subordinated Debt Notes.
                This framework is independent of any available exemptions from the
                registration requirements of Section 5(a) of the Securities Act. It
                also generally aligns with certain disclosure requirements in the OCC's
                subordinated debt regulations. For example, the Board is proposing that
                every planned issuance of Subordinated Debt Notes would require an
                Issuing Credit Union to prepare and deliver an Offering Document to
                potential investors even though there are no SEC-mandated disclosure
                requirements for offerings of securities pursuant to the Section
                3(a)(5) exemption, and there generally are no SEC-mandated disclosure
                requirements
                [[Page 13989]]
                for offerings of securities pursuant to the Rule 506 private placement
                exemption as long as all purchasers in the offering are ``accredited
                investors.''
                 The Board believes that adopting this regulatory framework would
                benefit both Issuing Credit Unions and investors, as the framework
                would provide potential investors information that is important to
                making a decision to invest in Subordinated Debt Notes and would
                clearly define the obligations of the related Issuing Credit Unions.
                These are important benefits that can reduce the possibility of
                investor confusion or misunderstandings and can assist an Issuing
                Credit Union in defending against claims by investors that they had a
                different understanding about the Issuing Credit Union, the terms of
                the offering, or the securities based on statements made by the Issuing
                Credit Union or its agents.
                 Finally, the Board notes that the OCC also applies a regulatory
                framework to the offer, sale, and issuance of subordinated debt
                securities. The OCC's subordinated debt regulations require banks to
                comply with the OCC's registration requirements or otherwise qualify
                for an exemption under part 16 of those regulations. In particular, the
                OCC requires that any offers and sales of nonconvertible subordinated
                debt securities be made only to ``accredited investors'' and only after
                offering materials have been provided to potential investors.
                3. State Registration of Subordinated Debt Notes
                 Each state has its own securities laws and regulations and
                regulators charged with the duty of enforcing those laws and
                regulations. The states have general authority to regulate securities
                offerings and related matters occurring within or affecting their
                states. However, the federal securities laws include a number of
                provisions that substantially limit or completely preempt certain types
                of state regulation.
                 Section 18 of the Securities Act \37\ provides that securities that
                meet the definition of ``covered securities'' are not subject to any
                form of substantive state securities regulation. States do retain
                authority to pursue fraud-based enforcement claims and the ability,
                under some circumstances, to require issuers to submit notice filings
                to the state, which allows the state to collect a filing fee.
                ---------------------------------------------------------------------------
                 \37\ 15 U.S.C. 77r.
                ---------------------------------------------------------------------------
                 Securities that fall within the Section 3(a)(5) exemption, as well
                as securities issued in an exempt offering under Regulation D, Rule
                506, both meet the definition of ``covered securities.'' As a result,
                in connection with any Subordinated Debt Notes offerings by Issuing
                Credit Unions that comply with the requirements of Section 3(a)(5) or
                Regulation D, Rule 506, state securities regulators will not be
                permitted to:
                 Impose any registration, qualification or pre-clearance
                requirements on the issuer, the terms of the offering or the securities
                being offered;
                 Assess the merits of the issuer, the terms of the offering
                or the securities being offered; or
                 Require the delivery of any disclosure to potential
                purchasers of the securities in connection with the offering.
                4. Disclosure Requirements and Anti-Fraud Provisions
                 Although Section 3(a)(5) and Regulation D, Rule 506 provide
                exemptions from the registration requirements of the Securities Act,
                and reliance on those exemptions is not conditioned on the delivery of
                any required disclosure to potential investors (in the case of the
                traditional Rule 506 private placement under Rule 506(b), as long as
                all the investors are ``accredited''), the marketing and sale of the
                securities remain subject to the broad anti-fraud prohibitions of the
                Securities Exchange Act of 1934, as amended (Exchange Act).
                 The Exchange Act's general anti-fraud prohibitions are embodied in
                Sec. 10(b), which generally prohibits the use of manipulative or
                deceptive devices or contrivances that violate SEC rules in connection
                with the purchase or sale of securities.\38\ Most of the litigation
                brought with respect to the rules promulgated under Sec. 10(b) has
                been brought under the general anti-fraud provision, Rule 10b-5, which
                provides as follows:
                ---------------------------------------------------------------------------
                 \38\ 17 CFR 240.10b-5.
                 It shall be unlawful for any person, directly or indirectly, by
                the use of any means or instrumentality of interstate commerce, or
                of the mails or of any facility of any national securities exchange,
                 (a) to employ any device, scheme, or artifice to defraud,
                 (b) to make any untrue statement of a material fact or to omit
                to state a material fact necessary in order to make the statements
                made, in the light of the circumstances under which they were made,
                not misleading, or
                 (c) to engage in any act, practice, or course of business which
                operates or would operate as a fraud or deceit upon any person, in
                connection with the purchase or sale of any security.\39\
                ---------------------------------------------------------------------------
                 \39\ Id.
                 The primary intent of Rule 10b-5 (and, more broadly, the anti-fraud
                provisions of the Securities Act and the Exchange Act) is to prevent
                fraud, deceit, and incorrect or misleading statements or omissions in
                the offering, purchase and sale of securities. Given that intent, clear
                and complete disclosure is the critical factor in ensuring the anti-
                fraud provisions of the Securities Act and Exchange Act are not
                breached in any offering of securities, regardless of whether the
                offering is registered with the SEC under the Securities Act or exempt
                from registration.
                 In the absence of SEC-mandated disclosure delivery requirements,
                the practical concern for Issuing Credit Unions relying on either the
                Section 3(a)(5) or Regulation D, Rule 506 exemption is determining what
                type and amount of disclosure is appropriate to meet the anti-fraud
                standards. Relevant case law suggests that the type and amount of
                disclosure varies depending on a number of surrounding facts and
                circumstances, including:
                 The nature of the potential investors (focusing on their
                level of sophistication);
                 The nature of the security being offered (disclosure
                regarding the terms of debt instruments, preferred stock or more
                complex securities tends to be more detailed than disclosure regarding
                common stock);
                 The nature of the business of the issuer and the industry
                in which the issuer operates (detailed disclosure may be more
                appropriate in the case of complex business structures and industries);
                and
                 Market practices (focusing on the types of disclosure
                commonly provided by peer companies).
                 There are a number of advantages in using a well-written disclosure
                document in connection with any offering of securities. First, using a
                disclosure document provides both the issuer and potential investors
                with a centralized resource clearly and consistently setting forth the
                terms of the offering and the securities being offered. Second, the
                disclosure document can be used as a reference to reduce the
                possibility of investor confusion or misunderstandings and can be used
                by the issuer as a defense against claims by investors that they had a
                different understanding about the issuer, the terms of the offering, or
                the securities based on statements made by the issuer or its agents.
                For these reasons, the Board is proposing that every planned issuance
                of Subordinated Debt Notes would require the preparation and delivery
                of a written
                [[Page 13990]]
                disclosure document, each of which must meet the standards of Rule 10b-
                5.
                 In brief, for any disclosure document to meet the standards of Rule
                10b-5, the disclosure included in the document (a) must not contain any
                untrue statement of a material fact and (b) must not omit to state a
                material fact the absence of which renders any disclosure already being
                made misleading. To accomplish those ends, the disclosure must be
                clear, accurate, and verifiable. In addition, the disclosure should
                cover topics that are typically important to investors in making an
                investment decision. Common topics in this category include:
                 Material risks relating to the issuer and the industry in
                which the issuer operates;
                 Material risks relating to the security being offered;
                 The issuer's planned uses for the proceeds of the
                offering;
                 Regulatory matters impacting the issuer and its
                operations;
                 Tax issues associated with the security being offered; and
                 How the securities are being offered and sold, including
                any conditions to be met in order to complete the offering.
                 Sections 702.405, 702.406, and 702.408 of the proposed rule detail
                the Offering Document requirements for a planned issuance of
                Subordinated Debt Notes. These requirements are independent of and, in
                some cases, additive to any requirements imposed by applicable
                securities laws. The Board reiterates its expectation that credit
                unions contemplating an issuance of Subordinated Debt Notes retain
                professional advisors experienced in securities law disclosure matters
                to assist them in the preparation of related Offering Documents.
                 Beyond the disclosure topics outlined above, a credit union
                considering issuing Subordinated Debt Notes may obtain guidance as to
                the type and amount of disclosure that is appropriate for its
                securities offerings from market participants. Sophisticated investors,
                rating agencies, underwriters, placement agents, and others often exert
                significant influence over disclosure practices in exempt securities
                offerings. In some settings, such as municipal bond offerings and
                offerings under Securities Act Rule 144A \40\ (made to highly
                sophisticated ``qualified institutional buyers''), it is not uncommon
                for disclosure documents to approach the level of detail that typically
                would be provided in a registration statement for an offering
                registered with the SEC under the Securities Act.
                ---------------------------------------------------------------------------
                 \40\ 17 CFR 230.144A.
                ---------------------------------------------------------------------------
                5. Ongoing Disclosure and Reporting to Investors; Investor Relations
                 As discussed in this preamble, the SEC does not mandate any
                specific disclosure, either in form or substance, with respect to
                offers and sales of securities under the Section 3(a)(5) exemption or
                the Regulation D, Rule 506 exemption (if sales are made only to
                ``accredited investors;'' sales to other investors do require the
                issuer to deliver specific types of disclosure). Similarly, SEC rules
                do not require companies that have relied on those exemptions to
                distribute or make available any disclosure after the offering has been
                completed or at any time in the future. As noted above, the preemptive
                effect of Section 18 of the Securities Act prohibits states from
                requiring any ongoing disclosure to investors following completion of
                an offering of ``covered securities.''
                 It is often the case, however, that investors will require that the
                issuer provide some form of ongoing disclosure. Securities purchase
                agreements, or companion ``investor rights agreements,'' often specify
                the form and content of the ongoing disclosure and the frequency of
                delivery of the disclosure. Practice varies from a requirement to
                deliver quarterly and annual financial statements to disclosure in form
                and substance that mimics the disclosure an SEC-registered company
                would be required to provide to its investors. In addition, for
                issuances of debt securities under an indenture or an issuing and
                paying agent agreement, the terms of those documents commonly include
                requirements to provide certain information to the trustee or paying
                agent on an ongoing basis, and that information is either passed on
                directly to investors or is generally available to investors by request
                to the trustee or paying agent.
                 Even in the absence of mandated or contractual requirements to
                provide disclosure, Issuing Credit Unions issuing Subordinated Debt
                Notes will likely face a variety of practical, disclosure-related
                issues. For example, investors frequently contact companies in which
                they hold an interest and ask for a variety of information about the
                company, its operations, its financial performance, and its prospects.
                While an Issuing Credit Union may prefer not to respond to those
                inquiries, from an investor relations standpoint, refusing to respond
                is not likely to be practical. Although this places certain burdens on
                an Issuing Credit Union's management, maintaining open lines of
                communication with investors can have significant practical benefits,
                including assessing possible interest in future offerings of
                Subordinated Debt Notes, negotiating possible buybacks of outstanding
                Subordinated Debt Notes, or negotiating amendments or modifications to
                obligations relating to any currently outstanding Subordinated Debt
                Notes.
                 From a securities law standpoint, the type of information an
                Issuing Credit Union provides--and whether that information is provided
                only to the requesting investor, to all investors, or the marketplace--
                generally raises a number of important issues. First, any information
                that is provided must be materially correct and complete, because the
                anti-fraud provisions of the securities laws could apply to those
                communications if an investor or potential investor relies on those
                communications in connection with the purchase or sale of a security.
                In addition, sharing material, non-public information with individual
                investors without making that information generally available to all
                investors could result in potential liability for the Issuing Credit
                Union.
                 As a result, for securities law compliance and risk management
                purposes, under the proposed rule, Issuing Credit Unions issuing
                Subordinated Debt Notes must adopt policies and procedures covering
                matters such as:
                 Who is responsible and authorized to speak on behalf of
                the Issuing Credit Union;
                 What information will and will not be provided to
                requesting investors;
                 Whether that information will be made available to other
                investors; and
                 How that information will be made available to other
                investors.
                 Although an Issuing Credit Union may not need to have full-time
                personnel dedicated to an investor relations function, some personnel
                will need to take on responsibility for investor relations, and will
                need to be prepared to accurately answer questions and respond to
                appropriate requests. In addition, the responsible personnel will need
                to be trained regarding appropriate boundaries for responses to and
                discussions with investors. As noted above, there are a variety of
                securities law issues relating to communications with investors. As a
                result, for securities law compliance and risk management purposes,
                Issuing Credit Unions issuing Subordinated Debt Notes will need to
                adopt certain policies and procedures covering interactions with
                investors.
                 Finally, similar to commercial loans, lines of credit, and other
                types of debt financing, the debt security instrument
                [[Page 13991]]
                itself and/or the documents relating to debt securities issuances (for
                example, note purchase agreement, indenture, issuing and paying agent
                agreement) customarily require the issuer of debt securities to report
                its compliance (or non-compliance) with any covenants included in the
                terms of the debt securities. The frequency of reporting and the
                contents of the report can vary from situation to situation, based both
                on the demands of the investors and the term structure of the
                particular debt security. These obligations will make it necessary for
                the Issuing Credit Union to implement compliance and reporting controls
                and procedures to ensure compliance with the terms of the Subordinated
                Debt Notes generally, and for compliance with any applicable reporting
                requirements.
                6. Potential Broker-Dealer Registration Issues
                 Marketing activities by an Issuing Credit Union and its employees
                in connection with any offerings of Subordinated Debt Notes could
                require the employees to register as broker-dealers because the SEC
                interprets the definition of ``broker'' broadly to cover persons who
                play almost any active role in offers and sales of securities,
                including, under certain circumstances, employees of the issuer of the
                securities or its affiliates.
                 There are exemptions available to both an Issuing Credit Union
                itself and its employees that can excuse them from the broker-dealer
                registration requirements. Credit unions that issue securities
                typically cannot be ``brokers'' of their own securities because they
                are not involved in the purchase or sale of securities for the account
                of other persons. Similarly, credit unions that issue securities
                typically cannot be ``dealers,'' because their normal business does not
                involve buying and selling their own securities for their own account.
                Credit union employees that participate in offering-related activities
                usually will be able to rely on the exemption provided by Rule 3a4-1
                under the Exchange Act.\41\ Conditions to relying on this exemption
                include the employee:
                ---------------------------------------------------------------------------
                 \41\ 17 CFR 240.3a4-1.
                ---------------------------------------------------------------------------
                 Not receiving commissions or other compensation relating
                to the offering;
                 Not being disqualified under SEC rules due to past legal
                or regulatory issues;
                 Not being associated with a broker or dealer during the
                offering; and
                 Either limiting his or her offering-related activities,
                limiting the types of potential investors he or she interacts with, or
                limiting the number of offerings he or she participates in.
                 As a result, for securities law compliance and risk management
                purposes, discussed further in section II(C)(8) of this preamble,
                Issuing Credit Unions must adopt certain policies and procedures
                covering compliance with broker-dealer requirements.
                7. Director and Officer (``D&O'') Liability Insurance Coverage for
                Issuing Credit Unions
                 Under the proposed rule, Issuing Credit Unions considering issuing
                Subordinated Debt Notes will need to evaluate the potential impact of
                those activities on their D&O coverage. The scope of D&O liability
                coverage, amount of premiums, and terms relating to retention
                (deductibles and self-insurance) are usually different for public
                companies versus private companies. While Issuing Credit Unions will
                not be ``public'' in the same way SEC-registered entities with
                securities traded on an exchange are, entities that begin issuing
                securities to more than a limited number of ``outside'' investors must
                often make adjustments to their existing D&O policies.
                 For the reasons identified in subsections I. (E)(5), (6), and (7)
                above, the Board is proposing to require a credit union to include
                draft written policies on these issues as part of its application to
                issue Subordinated Debt Notes. See section II. (C)(8) of this preamble
                for a more detailed discussion of the application requirements.
                II. Proposed Changes
                 The following is a section-by-section analysis of the proposed
                changes. The Board invites comment on each proposed change and, where
                appropriate, has posed questions to solicit specific feedback on
                discrete aspects of the proposed rule. The Board notes that all
                references in this preamble to part 702 of the NCUA's regulations,
                including any subsection thereof, refer to the version of part 702 that
                gives effect to the final RBC Rule and which will become effective on
                January 1, 2022.
                A. Part 701--Organization and Operations of Federal Credit Unions
                1. Sec. 701.25 Loans to Credit Unions
                 The Board proposes to add a new Sec. 701.25 for FCUs making loans
                to other credit unions. This section will only apply to natural person
                credit unions; corporate credit union lending is subject to Sec.
                704.7.\42\ While this section applies to FCUs, FISCUs will be subject
                to these requirements and limitation through the proposed Sec. 741.227
                as discussed in section II. (E)(3) of this preamble. Loans from FCUs to
                other credit unions are not currently addressed in the NCUA's
                regulations. The Board believes adding a new section for loans to
                credit unions will establish policy standards and limits to support
                safety and soundness and protect the NCUSIF.
                ---------------------------------------------------------------------------
                 \42\ The NCUA is evaluating a potential proposed rule to clarify
                the extent to which corporate credit unions could purchase
                Subordinated Debt issued by natural person credit unions.
                ---------------------------------------------------------------------------
                 The loans to other credit unions section includes the following FCU
                activities: \43\
                ---------------------------------------------------------------------------
                 \43\ These requirements do not apply to natural person credit
                union investments in contributed capital of corporate credit unions,
                which is limited by 12 CFR 703.14(b).
                ---------------------------------------------------------------------------
                 Loans not subordinate to the NCUSIF or to a private
                insurer (for privately insured credit unions);
                 Subordinated Debt;
                 Grandfathered Secondary Capital; and
                 Loans or obligations subordinate to a private insurer (for
                privately insured credit unions).
                 Specifically, the proposed Sec. 701.25 will establish:
                 Limits on loans an FCU makes to other credit unions;
                 Approval and policy standards for an FCU to make loans to
                other credit unions; and
                 Requirements and limits on an FCU making investments in
                Subordinated Debt.
                 The Board proposes Sec. 701.25(a) to establish aggregate and
                single borrower limits for loans, including investments in Subordinated
                Debt, an FCU can make to other credit unions. The proposed aggregate
                limit is the same as the limit in the FCU Act on an FCU's authority to
                invest its funds in loans to other credit unions.\44\ The single
                borrower limit is consistent with the single borrower limit in Sec.
                723.4(c) for commercial loans.
                ---------------------------------------------------------------------------
                 \44\ 12 U.S.C. 1757(7)(C).
                ---------------------------------------------------------------------------
                 The Board notes that the FCU Act imposes an aggregate limit on the
                amount of loans an FCU may make to other credit unions. Specifically,
                the FCU Act authorizes an FCU to make loans to other credit unions
                that, in the aggregate, cannot exceed 25 percent of the FCU's paid-in
                and unimpaired capital and surplus.\45\ Paid-in and unimpaired capital
                and surplus is defined in NCUA regulations as:
                ---------------------------------------------------------------------------
                 \45\ Id.
                 [S]hares plus post-closing, undivided earnings. This does not
                include regular reserves or special reserves required by law,
                regulation or special agreement between the
                [[Page 13992]]
                credit union and its regulator or share insurer.\46\
                ---------------------------------------------------------------------------
                 \46\ 12 CFR part 700.
                 The proposed aggregate limit in this section, therefore, is not a
                substantive change, but a regulatory codification of the limit imposed
                by the FCU Act. The Board believes the proposed rule would clarify loan
                limits in this section and minimize the need for readers to reference
                the FCU Act when determining aggregate limits for loans to credit
                unions.
                 The Board is proposing a new single borrower limit for FCUs making
                loans to other credit unions that would be the greater of 15 percent of
                the FCU's Net Worth or $100,000, plus an additional 10 percent of the
                FCU's Net Worth if that amount is fully secured at all times with a
                perfected security interest by readily marketable collateral as defined
                in Sec. 723.2. There is no current single credit union borrower limit
                in the NCUA's regulations. The Board notes that the proposed single
                borrower limit is consistent with the single borrower limit in the
                NCUA's commercial lending and MBL rule.\47\ Because credit unions share
                many similarities with traditional corporate borrowers, the Board
                believes that basing the proposed single borrower limit in this rule on
                the commercial and MBL rule limit is appropriate. Furthermore, the 15
                percent of Net Worth single borrower limit for FCUs making loans to
                other credit unions would generally limit catastrophic losses to an FCU
                if the borrower defaults. The proposed 15 percent of Net Worth
                threshold is also consistent with the longstanding FDIC single-obligor
                limit.\48\ The Board would like to note that it is also considering a
                similar single obligor limit for uninsured deposits in future
                rulemakings.
                ---------------------------------------------------------------------------
                 \47\ Id. 723.4(c).
                 \48\ Id. 32.3(a).
                ---------------------------------------------------------------------------
                 The Board proposes Sec. 701.25(b) to establish minimum approval
                and written policy standards for an FCU that is making loans to credit
                unions. The proposal would require that an FCU's board of directors
                approve all loans to other credit unions. The Board notes that the FCU
                Act already requires an FCU's board of directors to approve all loans
                to credit unions and, as such, this proposed requirement is not
                new.\49\
                ---------------------------------------------------------------------------
                 \49\ 12 U.S.C. 1757(5)(C).
                ---------------------------------------------------------------------------
                 The proposed rule also requires an FCU lending to another credit
                union to establish written policies that address how it would manage
                the risk of its loans to credit unions and the dollar limits, both
                aggregate and single borrower, on the amount of the loans. This would
                be a new requirement for FCUs making loans to other credit unions.
                 The Board is proposing to add this requirement because it believes
                that making loans to credit unions should have similar policy
                requirements as other loans and investments. The Board also believes
                written policies can help ensure FCU lending to other credit unions
                will operate in a safe and sound manner. Policies create a framework
                for a credit union to consistently perform credit analysis and creates
                limits that are consistent with the credit union's risk tolerance and
                regulatory limits to help ensure the credit union is operating in a
                safe and sound manner.
                 The Board believes that FCUs that make loans to other natural
                person credit unions may have traditionally included policies for this
                activity in their investment or loan policies. The Board believes
                including policies for loans to other credit unions in the investment
                policy or a loan policy is sufficient for compliance with this
                requirement, since the Board's concern is with the existence of
                sufficient policies, not where they reside.
                 The Board is proposing Sec. 701.25(c) to establish minimum
                requirements and limits for an FCU that invests in Subordinated Debt,
                Grandfathered Secondary Capital or in loans and obligations issued by
                privately insured credit unions that are subordinate to a private
                insurer (PICU Subordinated Debt). The minimum requirements apply to
                both direct and indirect investments.
                 A direct investment would have the issuer of the Subordinated Debt
                as the borrower on the investing credit union's balance sheet. For
                example, credit union A purchases Subordinated Debt from credit union
                B. This results in credit union A having risk exposure (credit risk) to
                credit union B through its holding of the Subordinated Debt note.
                 An indirect investment is one in which the issuer of the
                Subordinated Debt is not identifiable on the investing credit union's
                balance sheet. An example of an indirect investment would be the
                purchase of shares in a mutual fund. For example, XYZ mutual fund
                purchases Subordinated Debt issued by credit union B. If credit union A
                purchases shares in this mutual fund, then credit union A would have an
                indirect investment in credit union B's Subordinated Debt, because only
                XYZ mutual fund would be recorded on credit union A's balance sheet.
                 The Board is proposing that an FCU must meet three criteria to make
                direct or indirect investments in Subordinated Debt, Grandfathered
                Secondary Capital or PICU Subordinated Debt. Specifically, the
                investing FCU:
                 Has, at the time of the investment, a capital
                classification of ``Well Capitalized;''
                 Does not have any outstanding Subordinated Debt or
                Grandfathered Secondary Capital with respect to which it was the
                Issuing Credit Union; and
                 Is not eligible to issue Subordinated Debt or
                Grandfathered Secondary Capital pursuant to an unexpired approval from
                the NCUA.
                 The Board is proposing the ``Well Capitalized'' capital
                classification requirement because it believes that only ``Well
                Capitalized'' FCUs should invest in obligations of natural person
                credit unions that are subordinate to the NCUSIF or to a private
                insurer. Because any of the aforementioned subordinated obligations are
                in a first loss position, even before the NCUSIF or a private insurer,
                an involuntary liquidation of the related Issuing Credit Union or
                significant write-downs of the subordinated obligations would
                potentially mean large, and likely total, losses for the holders of
                those subordinated obligations. Therefore, the Board believes it would
                not be safe and sound to allow FCUs that are classified less than
                ``Well Capitalized'' to invest in Subordinated Debt, Grandfathered
                Secondary Capital or PICU Subordinated Debt.
                 Conversely, the Board believes that a ``Well Capitalized'' FCU
                generally has sufficient Net Worth to invest in Subordinated Debt,
                Grandfathered Secondary Capital or PICU Subordinated Debt, provided
                that the risk is limited as discussed further in this section of the
                preamble.
                 The Board is also proposing that an FCU investing in Subordinated
                Debt, Grandfathered Secondary Capital, or PICU Subordinated Debt must
                not be an Issuing Credit Union of Subordinated Debt or Grandfathered
                Secondary Capital, or currently have approval from the NCUA to issue
                Subordinated Debt or Grandfathered Secondary Capital. The Board notes
                that an FCU would not be considered an Issuing Credit Union if it
                acquired Subordinated Debt or Grandfathered Secondary Capital issuance
                through a merger, as discussed further in section II. (C)(3) of this
                preamble. The Board believes that an Issuing Credit Union should not
                provide Regulatory Capital to other natural person credit unions.
                Furthermore, the potential to transmit losses between multiple Issuing
                Credit Unions that have both issued Subordinated Debt and invested in
                Subordinated Debt (loss transmission) could increase the risk of credit
                union failure and increase the
                [[Page 13993]]
                risk to the NCUSIF. For example, if an Issuing Credit Union both
                purchased and issued Subordinated Debt, losses from the Subordinated
                Debt purchased by the Issuing Credit Union could create losses on the
                Subordinated Debt issued by the Issuing Credit Union, thereby creating
                a potential loss transmission from the purchased Subordinated Debt to
                the issued Subordinated Debt. The Board is concerned that, if it does
                not restrict covered credit unions in this way, a loss incurred by an
                Issuing Credit Union would simultaneously transmit to an investing
                credit union (the credit union that is the purchaser of the issuer's
                Subordinated Debt Note). This inter credit union exposure results in an
                imprudent transmission of losses because a single loss can impact both
                institutions rather than the issuer alone. The Board believes that
                failing to prohibit inter credit union subordinated debt transactions
                will create an unsafe and unsound condition for the NCUSIF.
                 Beyond loss transmission, if the Board were to allow Issuing Credit
                Unions to invest in Subordinated Debt, the level of Net Worth in the
                credit union system could appear to increase, while the actual loss-
                absorbing capacity of the system would remain unchanged. For example,
                two LICUs each have $10 million in Net Worth, so the total Net Worth
                between the two credit unions is $20 million. If each credit union
                issued $1 million in Subordinated Debt and then sold it to the other,
                the Net Worth between the two credit unions would be $22 million. This
                would result in an artificial $2 million increase (ten percent) in Net
                Worth for the credit union system, and would increase potential loss
                transmission between the two credit unions as explained in the prior
                paragraph. The Board notes the increased total Net Worth in the system
                described above would also happen if only one credit union issued the
                Subordinated Debt and the other credit union purchased it, also
                artificially increasing the Net Worth in the system.
                 The Board is proposing limits on the amount of investment an FCU
                can make in Subordinated Debt, Grandfathered Secondary Capital, or PICU
                Subordinated Debt. The proposed limit is only on an aggregate basis,
                because single borrower limits have been addressed in the proposed
                general single credit union borrower limit. The Board is proposing an
                aggregate limit of the lesser of 25 percent of Net Worth and any amount
                of Net Worth in excess of 7 percent of total assets.
                 The Board believes a cap of 25 percent of Net Worth is appropriate
                given the higher relative risk of loss with Subordinated Debt,
                Grandfathered Secondary Capital, or PICU Subordinated Debt. This risk
                comes from the Subordinated Debt, Grandfathered Secondary Capital, or
                PICU Subordinated Debt being in a position to incur losses before the
                NCUSIF or a private insurer. In other words, the Subordinated Debt and
                Grandfathered Secondary Capital will take losses after retained
                earnings before the NCUSIF. The loss profile of Subordinated Debt and
                Grandfathered Secondary Capital would also apply to PICU Subordinated
                Debt.
                 Past loss experience in credit union involuntary liquidations shows
                that it is not unusual for the NCUSIF to take losses in a liquidation.
                Any loss to the NCUSIF in a liquidation would result in a total loss of
                the Subordinated Debt and Grandfathered Secondary Capital. The risk for
                PICU Subordinated Debt would be similar to Subordinated Debt and
                Grandfathered Secondary Capital if a private insurer takes losses.
                 The Board believes the severity of the potential loss warrants an
                aggregate limit on Subordinated Debt, Grandfathered Secondary Capital,
                and PICU Subordinated Debt of 25 percent of Net Worth. The Board also
                contemplated aggregate limits of 15 percent and 40 percent of Net
                Worth, but believes an aggregate limit of 25 percent of Net Worth
                strikes an appropriate balance between granting FCUs flexibility to
                invest, and the risks associated with Subordinated Debt, Grandfathered
                Secondary Capital, or PICU Subordinated Debt. The Board requests
                specific comment on whether the NCUA should consider a different
                aggregate limit, such as 15 percent of an FCU's Net Worth or 40 percent
                of Net Worth. The Board notes that this limit does not apply to natural
                person credit union investments in contributed capital of corporate
                credit unions, which is limited by Sec. 703.14(b).
                 The Board is also proposing another measure of the aggregate limit,
                which could further restrict the amount of an FCU's investments in
                Subordinated Debt, Grandfathered Secondary Capital, and PICU
                Subordinated Debt. This limit is the amount of Net Worth in excess of
                seven percent of total assets. An FCU would calculate the amount of Net
                Worth in excess of 7 percent and would use this measure as the
                aggregate limit if it is an amount less than 25 percent of its Net
                Worth.
                 The Board is proposing the aforementioned limit to ensure that
                total potential losses from Subordinated Debt, Grandfathered Secondary
                Capital, or PICU Subordinated Debt would not lower an FCU's Net Worth
                to below seven percent, which is ``Well Capitalized'' when measuring
                using the Net Worth Ratio. As mentioned earlier, the Board believes
                this is an important measure to promote safety and soundness when an
                FCU invests in Subordinated Debt, Grandfathered Secondary Capital, or
                PICU Subordinated Debt.
                 Examples of the aggregate limit calculations are provided below.
                 ABC FCU Has $100 Million in Net Worth and $1 Billion in Assets
                ------------------------------------------------------------------------
                 Limit type Limit calculation Total (million)
                ------------------------------------------------------------------------
                Percent of Net Worth Limit.... 25 percent of $100 $25.
                 million (Net Worth).
                Amount of Net Worth in excess $100 million (Net 30.
                 of 7%. Worth) minus [$1
                 billion (current
                 assets) times 7%].
                Maximum amount of Subordinated Lesser of the 25.
                 Debt, Grandfathered Secondary calculations.
                 Capital, and PICU
                 Subordinated Debt ABC FCU
                 invest in.
                ------------------------------------------------------------------------
                 In the above example, the percentage of Net Worth limit is the
                lesser of the measures and therefore is the binding constraint.
                [[Page 13994]]
                 LMN FCU Has $80 Million in Net Worth and $1 Billion in Assets
                ------------------------------------------------------------------------
                 Limit type Limit calculation Total (million)
                ------------------------------------------------------------------------
                Percent of Net Worth Limit.... 25 percent of $80 $20.
                 million (Net Worth).
                Amount of Net Worth in excess $80 million (Net 10.
                 of 7%. Worth) minus [$1
                 billion (current
                 assets) times 7%].
                Maximum amount of Subordinated Lesser of the 10.
                 Debt, Grandfathered Secondary calculations.
                 Capital, and PICU
                 Subordinated Debt ABC FCU
                 invest in.
                ------------------------------------------------------------------------
                 In the above example, the amount of Net Worth in excess of seven
                percent limit is the lesser of the measures and therefore is the
                binding constraint.
                 The Board is proposing a paragraph that would prescribe how the
                components of the aggregate limit are calculated. The limit is based on
                an FCU's aggregate outstanding:
                 Investment in Subordinated Debt;
                 Investment in Grandfathered Secondary Capital;
                 Investment in PICU Subordinated Debt; and
                 Loans or portion of loans made by the credit union that
                are secured by any Subordinated Debt, Grandfathered Secondary Capital,
                or PICU Subordinated Debt.
                 The Board is proposing this paragraph to ensure FCUs are more
                readily aware of the components that are subject to the aggregate limit
                in this section. In proposing to include loans, or portions of loans,
                secured by the first three components, the Board is including an
                exposure that could otherwise be unaccounted for by the lending credit
                union if the secured borrower defaults.
                 The Board is proposing a paragraph for the calculation of an FCU's
                indirect investment in Subordinated Debt, Grandfathered Secondary
                Capital, or PICU Subordinated Debt. The Board is proposing this
                paragraph to ensure FCUs consistently measure indirect investment
                exposure. The credit union would be required to determine the
                percentage of a mutual fund's assets invested in such instruments and
                multiple that percentage by its own pro rata investment. This will
                ensure the credit union has an accurate evaluation of its indirect
                exposure to Subordinated Debt, Grandfathered Secondary Capital and PICU
                Subordinated Debt. In turn, this evaluation can be used to monitor
                compliance with the aggregate regulatory limit on such instruments.
                This calculation is similar to the full look-through approach for
                investment funds in Appendix A of the RBC Rule. An example of the
                calculation follows:
                 ABC Fund is a $100 million fund and has $5 million of its holdings
                in Grandfathered Secondary Capital. XYZ FCU owns $10 million of ABC
                Fund.
                 XYZ FCU's proportional ownership of the ABC Fund: $10
                million divided by $100 million equals ten percent of the fund.
                 Indirect exposure: $5 million (Grandfathered Secondary
                Capital) in ABC Fund times ten percent equals $500,000.
                 In the example above, XYZ FCU's indirect exposure, for aggregate
                limit calculation purposes, would be $500,000. This is the amount that
                would need to be included in the calculation of the aggregate limit.
                2. Sec. 701.34 Designation of Low-Income Status
                 The Current Secondary Capital Rule contains information on how a
                credit union can obtain a low-income designation and the procedures and
                regulations related to secondary capital. As discussed in section II.
                (C)(1) of this preamble, under this proposed rule, secondary capital
                and Subordinated Debt would be subject to nearly identical rules. As
                such, for ease of use, the Board is proposing to locate all regulations
                related to Subordinated Debt in proposed subpart D of part 702.
                 To accomplish this, the Board is proposing to delete subsections
                (b) through (d) and the appendix to the Current Secondary Capital Rule.
                (Subsection (a) of the Current Secondary Capital Rule would remain in
                place.) As discussed below, the Board is proposing to relocate
                subsections (b)-(d) to Sec. 702.414 of proposed subpart D to part 702.
                The Board believes having one part that addresses capital and capital
                treatment will help users more easily review all related requirements,
                including Grandfathered Secondary Capital and Subordinated Debt
                provisions.
                3. Sec. 701.38 Borrowed Funds
                 The Board is proposing to revise an FCU's borrowing authority under
                Sec. 701.38 to permit borrowing from any source. This is a change from
                the current rule, which only addresses an FCU's borrowings from
                ``natural persons.'' The Board is proposing to revise the current rule
                to clarify that an FCU may borrow from any source. This change is
                consistent with section 1757(9) of the FCU Act and, in the Board's
                view, supports an FCU's legal authority to issue Subordinated Debt
                Notes.\50\
                ---------------------------------------------------------------------------
                 \50\ Id. 1757(9) (FCUs are subject to a maximum borrowing
                authority ``in an aggregate amount not exceeding, except as
                authorized by the Board in carrying out the provisions of subchapter
                III, 50 per centum of its paid-in and unimpaired capital and
                surplus: Provided, [t]hat any Federal credit union may discount with
                or sell to any Federal intermediate credit bank any eligible
                obligations up to the'').
                ---------------------------------------------------------------------------
                 The Board also is proposing other clarifying revisions to Sec.
                701.38(a). Under the proposed rule, an FCU's borrowings would be
                evidenced by a ``written contract,'' as opposed to the more narrow
                language of current Sec. 701.38(a), which provides that a borrowing
                must be evidenced by ``a promissory note.'' The Board recognizes that,
                under current practice, borrowing contracts may take forms other than
                just a promissory note. The proposal still cites a promissory note as a
                primary example, but extends greater flexibility than current Sec.
                701.38(a) for what is an acceptable form of evidencing the borrowing.
                 The Board is also proposing to revise Sec. 701.38(a)(2) to
                introduce the term ``funds'' to modify the description of a borrowing
                transaction to make it clearer to investors that such transactions are
                not shares of the Issuing Credit Union and, therefore, are not insured
                by the NCUA. The Board regards both of these changes as important
                clarifications that will benefit credit unions and investors.
                 Lastly, the Board is proposing to revise Sec. 701.38(b) to
                reference the limitations on an FCU's maximum borrowing authority by
                citing section 1757(9) of the FCU Act and removing the current
                reference to Sec. 741.2 of the NCUA's regulations. However, under
                Sec. 741.2, a FISCU would be subject to the same borrowing limits as
                an FCU under Sec. 701.38. This technical refinement supports greater
                clarity in the regulation but does not change the amount of the
                limitation that currently applies to FCUs and FISCUs.
                [[Page 13995]]
                B. Part 702--Capital Adequacy
                1. Sec. 702.2 Definitions
                 The Board is proposing to add an introductory statement to the
                definitions section to indicate that all accounting terms not otherwise
                defined in the section will have the same meaning as in U.S. GAAP. The
                Board is adding this statement to clarify that, if an accounting term
                is not defined in the rule text, the reader should use any applicable
                definition provided under U.S. GAAP for that term. This clarifying
                statement supports the current practice of using U.S. GAAP definitions
                when an accounting term is undefined by the FCU Act or the NCUA's
                regulations.
                 The Board is amending the definition of Net Worth. In the first
                sentence of the Net Worth definition, the Board is clarifying that the
                definition of Net Worth in this section is for natural person credit
                unions and is specifying the measurement of Net Worth is as of the date
                of determination. The definition in the current rule begins with ``Net
                worth means,'' and does not explicitly state that the Net Worth
                definition is for natural person credit unions. The Board is adding
                this phrasing to avoid the possibility of confusion that the definition
                of Net Worth could apply to corporate credit unions. The Board is also
                adding the new qualifier, ``as of any date of determination,'' to
                clarify that there is an ``as of'' date, which is addressed below.
                 For clarification, the Board is proposing a technical, non-
                substantive refinement to the definition of Net Worth in paragraph (1)
                of current Sec. 702.2 by adding ``most recent'' as a reference point
                for the date of determination. Current Sec. 702.2 does not explicitly
                state that Net Worth is measured as of the most recent quarter end, but
                the Board believes that this reflects the common understanding within
                the credit union industry.
                 The Board is also proposing to change the wording regarding how
                U.S. GAAP is referenced when determining Net Worth from ``as determined
                under U.S. GAAP'' to ``as determined in accordance with U.S. GAAP.''
                The Board believes that this non-substantive revision is more accurate
                than current Sec. 702.2.
                 The Board is proposing to amend paragraph (2) in the Net Worth
                definition to include Subordinated Debt and to replace the term
                secondary capital accounts with Grandfathered Secondary Capital. It
                notes that these cohering changes are necessary based on other
                provisions of the proposed rule discussed throughout this preamble.
                 The Board is also proposing an addition to paragraph (2) that
                clarifies the amounts of Subordinated Debt and Grandfathered Secondary
                Capital that count towards Regulatory Capital.\51\ In the current rule,
                the reader would need to know that secondary capital accounts have a
                schedule to reduce the recognition of Net Worth once they have a
                remaining maturity of five years or less. The Board believes that
                referencing the recognition of Net Worth in Sec. Sec. 702.407 and
                702.414 in the proposal would add clarity in calculating New Worth for
                LICUs that have issued Subordinated Debt or Grandfathered Secondary
                Capital. The Board is also proposing some formatting changes in
                paragraph (2) by adding two subparagraphs, (A) and (B), with text
                contained in a long paragraph in the current rule. The wording is
                unchanged except for ``National Credit Union Share Insurance Fund''
                being spelled out. The Board is proposing this change to add ease for
                the reader.
                ---------------------------------------------------------------------------
                 \51\ Regulatory Capital is capital, both Net Worth and/or the
                RBC numerator, as defined by NCUA. See section II(C)(2) of the
                preamble for more details.
                ---------------------------------------------------------------------------
                 The Board is also adding new definitions for Grandfathered
                Secondary Capital and Subordinated Debt, as current Sec. 702.2 does
                not have these definitions. The definition of Grandfathered Secondary
                Capital is ``any subordinated debt issued in accordance with current
                Sec. 701.34 (recodified as Sec. 702.414 of subpart D of this part)
                or, in the case of a FISCU, with Sec. 741.204(c) before the effective
                date of a final Subordinated Debt regulation. The Board is proposing to
                add the definition of Grandfathered Secondary Capital as a way to refer
                to secondary capital issued under the current rule, as discussed in
                more detail in section II. (C)(14) of this preamble.
                 Finally, the Board is also proposing to add a definition of
                Subordinated Debt, which will be the same as the meaning in the
                proposed subpart D. The definition of Subordinated Debt is ``an Issuing
                Credit Union's borrowing that meets the requirements of this subpart,
                including all obligations and contracts related to such borrowing.''
                This definition is discussed in more detail in section II. (C)(2) of
                this preamble. The Board is adding a definition of Subordinated Debt so
                a reader of the proposed rule text outside of subpart D knows where to
                find the definition.
                2. Sec. 702.104 Risk-Based Capital Ratio
                 The Board is proposing to amend current Sec. 702.104(b)(1)(vii) to
                include both Subordinated Debt and Grandfathered Secondary Capital in
                the RBC Ratio.\52\ Current Sec. 702.104(b)(1)(vii) allows secondary
                capital accounts to be included in the RBC numerator. This change is
                necessary to properly give effect to Subordinated Debt and
                Grandfathered Secondary Capital in the RBC Ratio.
                ---------------------------------------------------------------------------
                 \52\ The RBC Ratio is calculated using a numerator and a
                denominator. The numerator includes (i) Undivided earnings; (ii)
                Appropriation for non-conforming investments; (iii) Other reserves;
                (iv) Equity acquired in merger; (v) Net income; (vi) ALLL,
                maintained in accordance with U.S. GAAP; (vii) Secondary capital
                accounts included in net worth (as defined in Sec. 702.2); and
                (viii) Section 208 assistance included in net worth (as defined in
                Sec. 702.2) and deductions for (i) NCUSIF Capitalization Deposit;
                (ii) Goodwill; (iii) Other intangible assets; and (iv) Identified
                losses not reflected in the RBC Ratio numerator. The denominator
                includes risk-weighted assets.
                ---------------------------------------------------------------------------
                 The Board is also clarifying that the amount of Subordinated Debt
                and Grandfathered Secondary Capital that is treated as Regulatory
                Capital, as discussed in section II. (C)(7) of this preamble, would be
                included as part of the RBC Ratio. Currently, the definition does not
                establish how secondary capital would be included in the RBC Ratio, but
                the Board intended that only the non-discounted portion of secondary
                capital would count in the RBC Ratio. Therefore, in this proposal, the
                Board is clarifying that only the portion of Grandfathered Secondary
                Capital and Subordinated Debt that counts as Regulatory Capital would
                be included in the RBC Ratio.
                 Currently, the RBC Rule does not specifically include secondary
                capital or obligations issued by privately insured credit unions that
                are subordinate to a private insurer in any risk weighting category. As
                such, secondary capital and obligations issued by privately insured
                credit unions that are subordinate to a private insurer would be risk
                weighted at 100 percent under the ``(a)ll other assets listed on the
                statement of financial condition not specifically assigned a different
                risk weight under this subpart'' category.\53\
                ---------------------------------------------------------------------------
                 \53\ 12 CFR 702.104(c)(2)(v)(C).
                ---------------------------------------------------------------------------
                 The Board is proposing to add a new Sec. 702.104(c)(2)(v)(B)(9)
                that would assign a 100 percent risk weight to the exposure amount of
                natural person credit union Subordinated Debt, Grandfathered Secondary
                Capital, and loans or obligations issued by privately insured credit
                unions that are subordinate to a private insurer. The Board notes that
                this proposed change will not result in a different risk weighting than
                the RBC Rule requires. Given that Grandfathered Secondary Capital,
                Subordinated Debt, and obligations issued by privately insured credit
                unions that are subordinate to a
                [[Page 13996]]
                private insurer are similar instruments that share similar risks, the
                Board believes it is appropriate to include them in the same risk
                weighting category.
                3. Sec. 702.109 Prompt Corrective Action for ``Critically
                Undercapitalized'' Credit Unions
                 Section 216(a)(2) of the FCU Act directs the NCUA to take Prompt
                Corrective Action (PCA) to resolve the problems of credit unions.\54\
                The FCU Act indexes various corrective actions to the following five
                net worth categories:
                ---------------------------------------------------------------------------
                 \54\ 12 U.S.C. 1790d(a)(2).
                ---------------------------------------------------------------------------
                 Well Capitalized;
                 Adequately Capitalized;
                 Undercapitalized;
                 Significantly Undercapitalized; and
                 Critically Undercapitalized.\55\
                ---------------------------------------------------------------------------
                 \55\ Id. 1790d(c).
                ---------------------------------------------------------------------------
                 Credit unions that fail to meet capital measures are subject to
                increasingly strict limits on their activities. The mandatory and
                discretionary supervisory actions included in the current RBC Rule aid
                in accomplishing PCA's purpose and provide a transparent guide of
                supervisory actions a credit union can expect as its capital declines.
                 Section 702.109 of the RBC Rule provides for mandatory and
                discretionary PCA for ``Critically Undercapitalized'' credit unions.
                Among the discretionary actions in Sec. 702.109 is one related to
                secondary capital. Specifically, current Sec. 702.109(b) states that,
                beginning 60 days after the effective date of classification of a
                credit union as ``Critically Undercapitalized,'' the NCUA may prohibit
                payments of principal, dividends, or interest on the credit union's
                uninsured secondary capital accounts established after August 7, 2000,
                except that unpaid dividends or interest shall continue to accrue under
                the terms of the account to the extent permitted by law.\56\
                ---------------------------------------------------------------------------
                 \56\ 12 CFR 702.109(b)(11).
                ---------------------------------------------------------------------------
                 The Board is proposing to retain the aforementioned discretionary
                action for Grandfathered Secondary Capital so as not to impact
                outstanding secondary capital agreements between LICUs and investors.
                The Board notes, however, that under this proposal the discretionary
                action, as discussed above, would be mandatory for Subordinated Debt.
                With this change, the Board intends to provide investors with
                certainty. As mentioned in section II. (C)(5) of this preamble, a
                credit union must disclose this mandatory action to all investors. The
                Board believes including this as a mandatory action will provide credit
                unions and investors with clear and transparent regulations regarding
                the agency's actions in a PCA context regarding Subordinated Debt. The
                Board notes that the mandatory treatment of this action is also
                consistent with the OCC's subordinated debt requirements.\57\
                ---------------------------------------------------------------------------
                 \57\ Id. 5.47(d)(3)(ii)(B)(2).
                ---------------------------------------------------------------------------
                4. Sec. 702.205 Prompt Corrective Action for Uncapitalized New Credit
                Unions
                 The Board is proposing to make a technical correction to Sec.
                702.205 of the RBC Rule by changing the title of this section from
                ``Mandatory liquidation of uncapitalized New Credit Union'' to
                ``Discretionary liquidation of uncapitalized New Credit Union.'' The
                Board notes that the current text of this section states that the NCUA
                may place a New Credit Union into liquidation under section
                1787(a)(1)(A) of the FCU Act.\58\ Because the term ``may'' is
                discretionary, this proposed change will better align the title of this
                section with the accompanying text.
                ---------------------------------------------------------------------------
                 \58\ 12 U.S.C. 1787(a)(1)(A).
                ---------------------------------------------------------------------------
                5. Sec. 702.206 Revised Business Plans (RBP) for New Credit Unions
                 The Board is proposing to delete paragraph (d) of Sec. 702.206 of
                the RBC Rule, which reads as follows:
                 Consideration of regulatory capital. To minimize possible long-
                term losses to the NCUSIF while the credit union takes steps to
                become ``Adequately Capitalized'', the NCUA Board shall, in
                evaluating an RBP under this section, consider the type and amount
                of any form of regulatory capital which may become established by
                NCUA regulation, or authorized by state law and recognized by NCUA,
                which the credit union holds, but which is not included in its net
                worth.
                 This section was intended as a placeholder for the eventual
                creation of a Subordinated Debt rule. As such, the Board is proposing
                to delete the text in this section and include a new Sec. 702.207 in
                the RBC Rule related to the consideration of Subordinated Debt for a
                New Credit Union. The Board addresses this new section in the following
                section of this preamble.
                6. Sec. 702.207 Consideration of Subordinated Debt for New Credit
                Unions
                 The Board is proposing a new section that would provide an
                exception from PCA for a New Credit Union that meets specific
                conditions related to Subordinated Debt. Specifically, under this
                section a New Credit Union would not be subject to mandatory and
                discretionary actions under PCA if the New Credit Union has outstanding
                Subordinated Debt that would be treated as Regulatory Capital if the
                credit union were a Complex Credit Union or a LICU. The Board notes
                that, to qualify for this proposed exception, a New Credit Union would
                have to have a Net Worth Ratio of at least one percent and issue
                Subordinated Debt in accordance with the requirements of proposed
                subpart D.
                 As discussed in section II. (C)(3) of this preamble, a non-LICU New
                Credit Union may only issue Subordinated Debt if, at the time of
                issuance, it has retained earnings of at least one percent of total
                assets. Further, under this proposal, the NCUA would only consider, for
                purposes of this exception, the non-discounted portion of any issued
                Subordinated Debt. Finally, to qualify for this exception, the Board is
                proposing to require the ratio of the New Credit Union's Net Worth,
                plus its outstanding Subordinated Debt, to its total assets be at least
                seven percent.
                 To avail itself of relief from PCA under this section, a New Credit
                Union would also be required to increase its Net Worth in a manner
                consistent with the New Credit Union's approved initial business plan
                or revised business plan. The Board believes the proposed rule allows a
                New Credit Union to use Subordinated Debt in a manner that allows the
                credit union to avoid PCA while maintaining a sufficient buffer between
                losses and the NCUSIF.
                 Even if a New Credit Union meets the foregoing criteria, the
                proposed rule reserves the Board's authority to impose PCA on a New
                Credit Union in delineated circumstances. These circumstances include
                where a New Credit Union is operating in an unsafe or unsound manner or
                has not corrected a material unsafe and unsound condition that it was,
                or should have been, aware of. However, the Board would only impose PCA
                in these circumstances after providing a New Credit Union with written
                notice and opportunity for hearing pursuant to Sec. 747.2003 of the
                NCUA's regulations.
                 For FISCUs, the Board is also proposing to include a requirement
                that the NCUA consult and seek to work cooperatively with the
                appropriate state supervisory authority (SSA) before invoking the
                reservation to impose PCA. The Board believes this reservation of
                rights will allow the NCUA to quickly and appropriately address unsafe
                or unsound conditions in a New Credit Union, regardless of whether the
                New Credit Union has issued Subordinated Debt.
                 In addition, the Board is proposing to prohibit delegation of its
                authority to take PCA against a New Credit Union that would otherwise
                qualify for an
                [[Page 13997]]
                exemption from PCA because of its issuance of Subordinated Debt. The
                Board is proposing to retain such authority because such action could
                have a direct and material impact to the NCUSIF and the subject New
                Credit Union. This proposed non-delegation provision is similar to
                others related to PCA in the RBC Rule.
                 The Board is also proposing to include in this section a statement
                that the NCUA will consider any outstanding Subordinated Debt issued by
                a New Credit Union in evaluating the credit union's revised business
                plan. Because Subordinated Debt acts as buffer between losses sustained
                by a credit union and the NCUSIF, the Board believes this change
                prudently allows New Credit Unions to avail themselves of the benefits
                of issuing Subordinated Debt while maintaining the safety and soundness
                of the NCUSIF.
                 Finally, the Board is proposing to include a provision that allows
                the Board to liquidate a New Credit Union under section 1787(a)(3)(A)
                of the FCU Act, provided that a New Credit Union's Net Worth Ratio plus
                outstanding Subordinated Debt that has been issued by that New Credit
                Union and that counts as Regulatory Capital is, as of the applicable
                date of determination, below six percent and the New Credit Union has
                no reasonable prospect of becoming ``Adequately Capitalized.'' The
                Board believes it is prudent to include procedures whereby the Board
                can address a New Credit Union that does not have a reasonable prospect
                of being ``Adequately Capitalized.''
                 The Board notes that, while Subordinated Debt can be a helpful tool
                for credit unions to meet their capital requirements, it believes that
                a credit union's business model should not rely too heavily on the
                issuance of Subordinated Debt. As such, this proposed provision
                supports the Board in fulfilling its statutory mandate of protecting
                the NCUSIF if a credit union has no reasonable prospect of becoming
                ``Adequately Capitalized'' without giving effect to any Subordinated
                Debt issued by that credit union, and is failing to reach even marginal
                levels of capitalization with Subordinated Debt.
                C. Subpart D--Subordinated Debt, Grandfathered Secondary Capital, and
                Regulatory Capital
                1. Sec. 702.401 Purpose and Scope
                 This proposed section sets out the general purpose of subpart D of
                part 702. As discussed in more detail below, this section of the
                proposal also addresses the authority for FISCUs to issue Subordinated
                Debt and the treatment of Grandfathered Secondary Capital.
                 With respect to FISCUs, the Board proposes to clarify that the
                requirements of proposed subpart D of part 702 would apply to FISCUs,
                but only to the extent FISCUs are permitted by applicable state law or
                regulation to issue debt securities of the type contemplated by this
                rule. That is, under this proposal, a FISCU may only issue Subordinated
                Debt if such issuance is permissible under its applicable state law. To
                the extent that a FISCU's state law is more restrictive than this
                proposed rule, the FISCU would be required to follow that state law.
                 With respect to secondary capital, the Board proposes to address in
                this section of the proposal both the treatment of outstanding
                Grandfathered Secondary Capital and the treatment of secondary capital
                issued in the form of Subordinated Debt after the effective date of a
                final Subordinated Debt rule.
                 With respect to any Grandfathered Secondary Capital, the Board is
                proposing to allow such Grandfathered Secondary Capital to continue to
                be governed by the regulatory requirements under which it was issued.
                For ease of reference, the Board is proposing to relocate subsections
                (b)-(d) and Appendix A of the Current Secondary Capital Rule to a new
                Sec. 702.414. As discussed in section II. (C)(14) of this preamble,
                this new section would include all of the requirements in the Current
                Secondary Capital Rule, but would make clear that LICUs are not
                permitted to conduct new issuances under proposed Sec. 702.414.
                 The Board is also proposing to prohibit Grandfathered Secondary
                Capital from receiving Regulatory Capital treatment as of 20 years from
                the effective date of a final Subordinated Debt rule. The Board notes
                that this proposed requirement would prevent Grandfathered Secondary
                Capital from perpetually receiving such grandfathered treatment. The
                Board believes 20 years would provide a LICU sufficient time to replace
                Grandfathered Secondary Capital with Subordinated Debt if such LICU
                seeks continued Regulatory Capital benefits of Subordinated Debt. The
                Board believes it is important to strike a balance between
                transitioning issuers of Grandfathered Secondary Capital to this
                proposed rule and ensuring that instruments do not indefinitely remain
                as Grandfathered Secondary Capital. The Board believes the structure of
                the proposed grandfather provision achieves this balance without
                unnecessarily disrupting the operations of LICUs, investors, and any
                outstanding secondary capital agreements.
                 Finally, the Board is also clarifying that this proposed rule would
                treat as Subordinated Debt all secondary capital issued after the
                effective date of a final Subordinated Debt rule. As such, any post-
                effective date application and/or issuance of secondary capital by a
                LICU would be subject to the requirements of this rule (except Sec.
                702.414, which, as noted above, only applies to Grandfathered Secondary
                Capital). As discussed above, this change would not alter the ability
                of a LICU to include Subordinated Debt in its Net Worth, the same way a
                LICU currently includes secondary capital in its Net Worth.
                2. Sec. 702.402 Definitions
                 This section contains proposed definitions to subpart D of 702.
                However, subpart D references some terms referenced elsewhere in the
                regulations. Therefore, for consistency purposes, the Board is
                proposing to cross-reference definitions of terms found elsewhere in
                the NCUA's regulations as follows:
                ---------------------------------------------------------------------------
                 \59\ 83 FR 55467. (Nov. 6, 2018).
                 \60\ 80 FR 66625. (Oct. 29, 2015).
                ------------------------------------------------------------------------
                 Cross-referenced term Definition
                ------------------------------------------------------------------------
                Complex Credit Union.............. The proposed rule defines the term
                 as having the same meaning as in
                 subpart A of part 702, as amended
                 by the Board on November 6,
                 2018.\59\
                Grandfathered Secondary Capital... The proposed rule defines the term
                 as any subordinated debt issued in
                 accordance with current Sec.
                 701.34 before [EFFECTIVE DATE OF
                 THE FINAL RULE].
                Net Worth......................... The proposed rule defines the term
                 as having the same meaning as in
                 Sec. 702.2.
                Net Worth Ratio................... The proposed rule defines the term
                 as having the same meaning as in
                 Sec. 702.2.
                New Credit Union.................. The proposed rule defines the term
                 as having the same meaning as in
                 Sec. 702.201, as amended by the
                 Board on October 29, 2015.\60\
                [[Page 13998]]
                
                Risk-based Capital (RBC) Ratio.... The proposed rule defines the term
                 as having the same meaning as in
                 Sec. 702.2 as amended by the
                 Board on October 29, 2015.\61\
                ------------------------------------------------------------------------
                \61\ Id.
                 In addition to the cross-referenced terms, the Board is proposing
                to define the following terms:
                 Accredited Investor. The proposed rule defines ``Accredited
                Investor'' as any Natural Person Accredited Investor or any Entity
                Accredited Investor, as applicable. The Board is aware that the SEC has
                recently published a proposed rule amending the definition of
                ``accredited investor.'' The Board will evaluate any final rule issued
                by the SEC and make changes to a final Subordinated Debt rule
                accordingly. Such changes may include substituting specific cross
                references contained in the definitions of Entity Accredited Investor
                and Natural Person Accredited Investor with a more general cross
                reference. In addition, the Board may opt to include a reference to
                sample accredited investor forms, rather than include such form in the
                rule, as the Board is proposing to do so in Sec. 702.406 of this
                proposal.
                 Appropriate Supervision Office. The proposed rule defines the term
                ``Appropriate Supervision Office'' as, with respect to any credit
                union, the Regional Office or Office of National Examinations and
                Supervision that is responsible for supervision of that credit union.
                By doing so, it provides the Board flexibility in delegating the
                responsible office, which may change as a reflection of organization
                changes within the NCUA.
                 Entity Accredited Investor. The proposed rule defines the term
                ``Entity Accredited Investor'' as an entity that, at the time of
                offering and sale of Subordinated Debt to that entity, meets the
                requirements of 17 CFR 230.501(a)(1), (2), (3), (7), or (8), which
                generally are the requirements applicable to corporate or trust
                entities and not natural persons.
                 Immediate Family Member. The proposed rule defines ``Immediate
                Family Member'' as a spouse, child, sibling, parent, grandparent, or
                grandchild (including stepparents, stepchildren, stepsiblings, and
                adoptive relationships). The proposed term is intended to be consistent
                with the definition found in the NCUA's regulations.\62\
                ---------------------------------------------------------------------------
                 \62\ Appendix A to 12 CFR part 701, Article XVIII, Sec. 1.
                ---------------------------------------------------------------------------
                 Issuing Credit Union. For the purposes of this subpart D of part
                702, the proposed rule defines ``Issuing Credit Union'' as a credit
                union that has issued, or is in the process of issuing, Subordinated
                Debt or Grandfathered Secondary Capital in accordance with the
                requirements of this proposed rule. The definition is consistent with
                the term used by OCC's regulations.\63\
                ---------------------------------------------------------------------------
                 \63\ Office of the Comptroller of the Currency, Comptroller's
                Licensing Manual: Subordinated Debt (2017), available at https://www.occ.gov/publications-and-resources/publications/comptrollers-licensing-manual/files/licensing-booklet-subordinated-debt.html. Per
                the OCC's Comptroller's Licensing Manual for Subordinated Debt, the
                bank issuing subordinated debt is referred to as the ``issuing
                bank.''
                ---------------------------------------------------------------------------
                 Low-Income Designated Credit Union (LICU). The proposed rule
                defines the term ``Low-Income Credit Union'' as a credit union
                designated as having low-income status in accordance with Sec. 701.34
                of this chapter. This definition is consistent with references to LICUs
                in the FCU Act as, ``a credit union that serves predominantly low-
                income members.'' \64\
                ---------------------------------------------------------------------------
                 \64\ 12 U.S.C. 1752(5); 1757a(b)(2)(A),); 1757a(c)(2)(B).
                ---------------------------------------------------------------------------
                 Natural Person Accredited Investor. The proposed rule defines the
                term ``Natural Person Accredited Investor'' as a natural person who, at
                the time of offering and closing of the issuance and sale of
                Subordinated Debt to that person, meets the requirements of 17 CFR
                230.501(a)(5) or (6), which generally are the requirements applicable
                to natural persons and not corporate or trust entities; provided that,
                for purposes of purchasing or holding any Subordinated Debt Note, this
                term shall not include any board member or Senior Executive Officer, or
                any Immediate Family Member of any board member or Senior Executive
                Officer, of the Issuing Credit Union.
                 Offering Document. The proposed rule defines the term ``Offering
                Document'' as the document(s) required by proposed Sec. 702.408,
                including any term sheet, offering memorandum, private placement
                memorandum, offering circular, or other similar document used to offer
                and sell Subordinated Debt Notes.
                 Pro Forma Financial Statements means projected financial statements
                that show the effects of proposed transactions as if they actually
                occurred in a variety of plausible scenarios, including both optimistic
                and pessimistic assumptions, over measurement horizons that align with
                the credit union's expected activities. For consistency, this term as
                defined here is consistent with the Evaluating Secondary Capital Plans
                supervisory guidance issued by the Board on September 16, 2019.\65\
                ---------------------------------------------------------------------------
                 \65\ Supervisory Letter No. 19-01, September (Sept. 16, 2019),
                available at https://www.ncua.gov/files/supervisory-letters/SL-19-01-evaluating-secondary-capital-plans.pdf.
                ---------------------------------------------------------------------------
                 Qualified Counsel. The proposed rule defines the term ``qualified
                counsel'' as an attorney licensed to practice law in the relevant
                jurisdiction(s) who has expertise in the areas of federal and state
                securities laws and debt transactions of the type contemplated by the
                proposed rule. The Board believes that credit unions need to engage
                legal counsel that has the requisite experience and expertise to
                represent the credit union in all aspects of a Subordinated Debt
                transaction.
                 Regulatory Capital. The proposed rule defines the term ``Regulatory
                Capital'' as (i) with respect to an Issuing Credit Union that is a LICU
                and not a Complex Credit Union, the aggregate outstanding principal
                amount of Subordinated Debt and, until [DATE 20 YEARS AFTER THE
                EFFECTIVE DATE OF THE FINAL RULE], Grandfathered Secondary Capital that
                is included in the credit union's Net Worth Ratio; (ii) with respect to
                an Issuing Credit Union that is a Complex Credit Union and not a LICU,
                the aggregate outstanding principal amount of Subordinated Debt that is
                included in the credit union's RBC Ratio; (iii) with respect to an
                Issuing Credit Union that is both a LICU and a Complex Credit Union,
                the aggregate outstanding principal amount of Subordinated Debt and,
                until [DATE 20 YEARS AFTER THE EFFECTIVE DATE OF THE FINAL RULE],
                Grandfathered Secondary Capital that is included in its Net Worth Ratio
                and in its RBC Ratio; and (iv) with respect to a New Credit Union, the
                aggregate outstanding principal amount of Subordinated Debt and, until
                [DATE 20 YEARS AFTER THE EFFECTIVE DATE OF THE FINAL RULE],
                Grandfathered Secondary Capital that is considered pursuant to proposed
                Sec. 702.207. This definition reflects the expanded eligibility of
                credit unions that may count Subordinated Debt as Regulatory Capital.
                [[Page 13999]]
                 Retained Earnings. The proposed rule defines the term ``Retained
                Earnings'' as in U.S. GAAP. The definition is consistent with the FCU
                Act, which defines Net Worth, in part, as a credit union's Retained
                Earnings balance under U.S. GAAP.\66\ Additionally, according to
                section 202 of the FCU Act, a credit union's statement of financial
                condition is generally to be reported consistent with U.S. GAAP.\67\
                ---------------------------------------------------------------------------
                 \66\ 12 U.S.C. 1757a(c)(2)(A).
                 \67\ Id. 1782(a)(6)(C)(i). This section of the FCU Act, provides
                a de minimus exception for following U.S. GAAP for credit unions
                with assets less than $10,000,000 unless prescribed by the Board or
                the appropriate SSA.
                ---------------------------------------------------------------------------
                 Senior Executive Officer. The proposed rule defines the term
                ``Senior Executive Officer'' as a credit union's chief executive
                officer (for example, president or treasurer/manager), any assistant
                chief executive officer (for example, any assistant president, any vice
                president or any assistant treasurer/manager) and the chief financial
                officer (controller). The term Senior Executive Officer also includes
                employees and contractors of an entity, such as a consulting firm,
                hired to perform the functions of positions covered by the term Senior
                Executive Officer. For consistency, this term as defined here is
                consistent with Sec. 701.14(b)(2) of the NCUA's regulations.
                 Subordinated Debt.\68\ The proposed rule would define
                ``Subordinated Debt'' as an Issuing Credit Union's borrowing that meets
                the requirements of this proposed rule, including all obligations and
                contracts related to such borrowing.
                ---------------------------------------------------------------------------
                 \68\ Secondary capital issued by LICUs after [EFFECTIVE DATE OF
                THE FINAL RULE] would be considered Subordinated Debt.
                ---------------------------------------------------------------------------
                3. Sec. 702.403 Eligibility
                 Currently, Sec. 701.34 allows only LICUs to issue Secondary
                Capital. The proposed rule increases the current eligibility beyond
                LICUs in Sec. 701.34(b) to also include Non-LICU Complex Credit Unions
                and New Credit Unions. The Board is also proposing to grant eligibility
                to credit unions that anticipate being designated as a LICU or Non-LICU
                Complex Credit Union within 24 months following their planned issuance
                of the Subordinated Debt. The Board believes these proposed changes
                will allow additional credit unions to issue Subordinated Debt that
                would count as Regulatory Capital, which could aid these credit unions
                in complying with the PCA requirements in the FCU Act and the NCUA's
                regulations.
                 Under this proposed rule, all eligible credit unions, regardless of
                designation type, are required to submit an initial application for
                preapproval under Sec. 702.408 of this section.
                LICU Eligibility
                 Consistent with the FCU Act and the Current Secondary Capital Rule,
                the Board is proposing to maintain a LICU's authority to seek the
                NCUA's approval to issue Subordinated Debt. As of June 30, 2019, credit
                unions with a LICU designation represented 49 percent of all federally
                insured credit unions with total assets of $628 billion or 41 percent
                of the total federally insured credit union assets.
                Non-LICU Eligibility
                 For the first time, the Board is proposing that the following
                categories of non-LICUs would generally be eligible to issue
                Subordinated Debt:
                (1) Complex Credit Unions
                 Under this proposed rule, a non-LICU Complex Credit Union must
                have a capital classification of at least ``Undercapitalized,'' as
                defined in the NCUA's capital standards,\69\ to be eligible to issue
                Subordinated Debt. The Board also notes that, under this proposed
                rule, the aggregate outstanding amount of Subordinated Debt issued
                by a non-LICU Complex Credit union may not exceed 100 percent of its
                Net Worth,\70\ as determined at the time of each issuance of
                Subordinated Debt. The Board is proposing this limit so that the
                non-LICU Complex Credit Union's regulatory capital is not primarily
                composed of Subordinated Debt, a lower quality form of capital. This
                approach is generally consistent with the Tier 1 and Tier 2 capital
                requirements for banks.
                ---------------------------------------------------------------------------
                 \69\ See 12 CFR 702.102.
                 \70\ See proposed 702.403(c) of the proposed rule.
                ---------------------------------------------------------------------------
                (2) New Credit Unions
                 The Board is proposing that all New Credit Unions, not just
                those that are a LICU, may be eligible to issue Subordinated Debt
                pending an NCUA-approved application as described in Sec. Sec.
                702.408 and 702.409. A ``New Credit Union'' means a federally
                insured credit union that has been both in operation for less than
                ten years and has $10 million or less in total assets.\71\ For
                purposes of this proposed rule, a New Credit Union may be a LICU or
                a non-LICU. The Board is proposing that a non-LICU New Credit Union
                have Retained Earnings equal to or greater than one percent of total
                assets to be eligible to issue Subordinated Debt. This provision is
                included to ensure the non-LICU New Credit Union has some level of
                loss-absorbing capacity before any deficit in Retained Earnings
                would be charged against the Subordinated Debt.
                ---------------------------------------------------------------------------
                 \71\ 12 CFR 702.2.
                ---------------------------------------------------------------------------
                (3) Credit unions that anticipate becoming a Complex Credit Union or
                LICU within 24 months of issuance
                 In certain circumstances, the Board is proposing to extend
                eligibility for Subordinated Debt issuance to a credit union that does
                not meet the eligibility criteria currently, but has a reasonable
                likelihood of doing so in the near future. Under this proposal, an
                ineligible credit union that can demonstrate through an acceptable pro
                forma analysis that it is reasonably projected to become eligible
                within 24 months after issuance (that is, expects to become a non-LICU
                Complex Credit Union or a LICU within that timeframe) can obtain
                approval as well. Pro forma analysis should include projections of
                expected earnings and growth in a variety of plausible scenarios that,
                at a minimum include the required 24-month measurement horizon.
                Aspiring credit unions are also subject to the requirements of
                Sec. Sec. 702.408 and 702.409 for preapproval and must include in
                their applications documents to evidence how they will successfully
                become a LICU (see Sec. 701.34(a) requirements) or a Complex Credit
                Union within the 24-month period immediately following a planned
                issuance. The Board is providing this flexibility for aspiring credit
                unions that may consider Subordinated Debt as a potential source of
                funding within the required timeframe to support future growth while
                increasing Regulatory Capital.
                FISCU Eligibility
                 A FISCU's authority to issue Subordinated Debt, if any, is set
                forth in applicable state law and regulation. Such state laws may be
                narrower or broader than those for FCUs. However, to the extent a FISCU
                may issue Subordinated Debt under applicable state law and regulation,
                it would be bound by proposed Sec. 741.226.
                Prohibition on Issuing and Investing in Subordinated Debt
                 For the reasons discussed in sections II. (A)(1) and II. (B)(3) of
                this preamble, the Board is proposing to prohibit, except in limited
                circumstances, a credit union from both issuing and investing in
                Subordinated Debt.
                 At the time of issuance of any Subordinated Debt, an Issuing Credit
                Union may not have any investments, direct or indirect, in Subordinated
                Debt or Grandfathered Secondary Capital (or any interest therein) of
                another credit union. If a credit union acquires Subordinated Debt or
                Grandfathered Secondary Capital in a merger or other consolidation, the
                Issuing Credit Union may still issue Subordinated Debt, but it may not
                invest (directly or indirectly) in the Subordinated Debt or
                Grandfathered Secondary Capital of any other credit union while any
                Subordinated Debt Notes issued by the Issuing Credit Union remain
                outstanding.
                [[Page 14000]]
                4. Sec. 702.404 Requirements of the Subordinated Debt and Subordinated
                Debt Notes
                 The Current Secondary Capital Rule allows LICUs to issue secondary
                capital to ``non-natural person members and non-natural person
                nonmembers.'' \72\ Under the Current Secondary Capital Rule, a
                secondary capital account must:
                ---------------------------------------------------------------------------
                 \72\ Id. 701.34(b).
                ---------------------------------------------------------------------------
                 Be in the form of a written contract;
                 Be an uninsured, non-share account;
                 Have a minimum maturity of five years;
                 Not be insured by the NCUSIF;
                 Be subordinate to all other claims;
                 Not be pledged or provided by the account investor as
                security on a loan or other obligation with the LICU or any other
                party;
                 Be available to cover operating losses realized by the
                LICU that exceed its net available reserves, and to the extent funds
                are so used, the LICU must not restore or replenish the account under
                any circumstances. Losses must be distributed pro-rata among all
                Secondary Capital accounts held by the LICU at the time the losses are
                realized; and
                 Be recorded as an equity account entitled uninsured
                Secondary Capital account.
                Subordinated Debt Note Requirements
                 The Board is proposing changes to the requirements of the Current
                Secondary Capital Rule. The proposed changes include additional
                requirements to help ensure the Subordinated Debt Notes are clearly
                issued as debt, rather than equity, pursuant to the authority in the
                FCU Act for an FCU to borrow from any source.\73\ Due to the
                cooperative structure of credit unions, and the members' rights to
                govern the affairs of them, FCUs do not have the authority to issue
                equity instruments. Therefore, it is essential for Subordinated Debt
                issued by FCUs to be considered debt rather than equity.
                ---------------------------------------------------------------------------
                 \73\ 12 U.S.C. 1757(9).
                ---------------------------------------------------------------------------
                 The Board notes that FISCUs may not be restricted under applicable
                state law and regulation to issuing only debt instruments. However, the
                Board is proposing that the debt requirement apply to both FCUs and
                FISCUs at this time. As insurer, the Board believes that the framework
                for the types of instruments that would qualify for Regulatory Capital
                should be consistent for all credit unions. The Board is requesting
                comments as to whether the NCUA should allow instruments other than
                debt instruments for FISCUs. If so, what specific instruments,
                including a detailed description, should be allowed? \74\
                ---------------------------------------------------------------------------
                 \74\ Instruments to be considered must be permissible under
                applicable state law.
                ---------------------------------------------------------------------------
                 As part of the Subordinated Debt Note requirements, the Board is
                proposing to require that a Subordinated Debt Note be in the form of a
                written debt agreement. This requirement aligns with requirements in
                debt transactions of the type contemplated by this rule, which
                typically require written debt agreements.
                 Under the proposed rule, Subordinated Debt Notes must, at the time
                of issuance, have a fixed stated maturity of at least five years but no
                more than twenty years from issuance. The Current Secondary Capital
                Rule requires the Secondary Capital account to have a minimum maturity
                of five years, but does not have a maximum. A minimum maturity of five
                years is proposed, as it should create sufficient stability and
                longevity within a credit union's capital base to be available to cover
                losses. The Board is proposing the maximum maturity of 20 years to help
                ensure the Subordinated Debt is properly characterized as debt rather
                than equity. Generally, by its nature, debt has a stated maturity,
                whereas equity does not. The proposal is consistent with the OCC's
                subordinated debt regulation for a minimum maturity of five years,
                although that regulation does not have a maximum.\75\ Because U.S.
                national banks can issue equity, the distinction of a debt versus
                equity characterization for subordinated debt under the OCC's
                regulations is not as critical as it is for FCUs.
                ---------------------------------------------------------------------------
                 \75\ 12 CFR 5.47(d)(1)(i).
                ---------------------------------------------------------------------------
                 Under proposed Sec. 709.5(b), the Board is proposing that an
                Issuing Credit Union's Subordinated Debt be subordinate to all other
                claims in liquidation and have the same payout priority as all other
                Subordinated Debt, including Grandfathered Secondary Capital issued by
                the Issuing Credit Union. This proposed provision is substantially
                similar to the Current Secondary Capital Rule and the OCC's
                subordinated debt regulations. The FCU Act requires secondary capital
                accounts to be subordinate to all other claims against the Issuing
                Credit Union.\76\ Further, the Board is not proposing a separate class
                for Subordinated Debt issued by non-LICU Complex Credit Unions or non-
                LICU New Credit Unions at this time.
                ---------------------------------------------------------------------------
                 \76\ See 12 U.S.C. 1757a(c)(2)(B)(ii); 1790d(o)(2)(C)(ii).
                ---------------------------------------------------------------------------
                 The Board is proposing that any Subordinated Debt Note must be
                unsecured. This provision is consistent with the OCC's subordinated
                debt regulations,\77\ and is not required in the Current Secondary
                Capital Rule. The Board is proposing this requirement because allowing
                arrangements that legally or economically secure Subordinated Debt
                would enhance the seniority of the Subordinated Debt in the event of
                liquidation of a credit union, which would be contrary to the proposed
                ``subordinate to all other claims'' requirement and the FCU Act, as
                discussed above. Additionally, if the Subordinated Debt Notes were
                secured by an asset of the Issuing Credit Union, it may interfere with
                the Issuing Credit Union's operations as it forces the Issuing Credit
                Union to direct assets or resources to secure the Subordinated Debt
                Note.
                ---------------------------------------------------------------------------
                 \77\ 12 CFR 5.47(d)(1)(iv).
                ---------------------------------------------------------------------------
                 The proposed rule also prohibits two specific arrangements which,
                from an economic standpoint, would effectively act as a security
                arrangement for Subordinated Debt: (1) A sinking fund,\78\ and (2) a
                compensating balance or any other funds or assets subject to a legal
                right of offset, as defined by applicable state law.\79\ These
                arrangements, in essence, create a secured arrangement from an economic
                standpoint between the investor and Issuing Credit Union. In the event
                of the Issuing Credit Union's liquidation, these arrangements would
                function like collateral and be applied to the obligations of the
                Subordinated Debt. As a result, the Subordinated Debt Note could, in
                essence, become senior in right of payment to other credit obligations,
                thus limiting its ability to absorb losses and protect the NCUSIF.
                ---------------------------------------------------------------------------
                 \78\ An example of a sinking fund arrangement is one that would
                require an FCU to periodically put aside money for the gradual
                repayment of the subordinated debt.
                 \79\ An example of a compensating balance arrangement is where
                the investor would require an FCU to maintain a minimum balance in a
                bank account during the term of the debt.
                ---------------------------------------------------------------------------
                 The Board is proposing that, at the end of each of its fiscal years
                (or more frequently as determined by the Issuing Credit Union), the
                Issuing Credit Union must apply its issued Subordinated Debt to cover
                any deficit in Retained Earnings on a pro rata basis among all holders
                of the Subordinated Debt and Grandfathered Secondary Capital of the
                Issuing Credit Union. While this is similar to the Current Secondary
                Capital Rule, it clarifies the frequency and timing of applying the
                Subordinated Debt to credit union losses, thus providing more
                transparency to investors of Subordinated Debt. The current rule is
                silent on the timing and
                [[Page 14001]]
                frequency of applying Secondary Capital to credit union losses.
                 The Board is proposing that, except for approved prepayments
                discussed in sections II. (C)(11) and (12) of this preamble, the
                Subordinated Debt Note must be payable in full only at maturity. The
                Board is proposing this new provision to clarify that Subordinated Debt
                can only be prepaid with prior written approval from the NCUA as
                discussed in section II. (C)(11) of this preamble. While the Current
                Secondary Capital Rule does not include this provision, it does require
                the NCUA's approval to prepay secondary capital that no longer counts
                towards the credit union's Regulatory Capital.\80\ As such, this
                provision would not impose additional burden on credit unions.
                ---------------------------------------------------------------------------
                 \80\ 12 CFR 701.34(d).
                ---------------------------------------------------------------------------
                 The Board is proposing to require disclosure by the Issuing Credit
                Union of any prepayment penalties or restrictions on prepayment of a
                Subordinated Debt Note. While the Current Secondary Capital Rule does
                not contain this restriction, the Board believes this proposed
                requirement provides additional protection and transparency for
                Subordinated Debt Note investors.
                 The Board is proposing changes to the permissible investors for
                Subordinated Debt. The proposed rule expands a credit union's current
                authority by allowing Subordinated Debt to be issued to Natural Person
                Accredited Investors and Entity Accredited Investors, except that no
                board member or Senior Executive Officer, and no Immediate Family
                Member of such board member or Senior Executive Officer, of the Issuing
                Credit Union may purchase or hold any Subordinated Debt Note issued by
                that Issuing Credit Union.
                 Under the proposed rule, Accredited Investors would be required to
                attest to their accredited status using a form that is substantially
                similar to the form contained in proposed Sec. 702.406(c). This
                provision helps Issuing Credit Unions with their obligations to limit
                offers and sales of their Subordinated Debt Notes to qualified
                Accredited Investors.
                Subordinated Debt Restrictions
                 The restrictions section of the proposed rule adds provisions
                similar to those found in the OCC's subordinated debt rule,\81\ and
                also include provisions found in the Current Secondary Capital Rule. In
                general, these provisions are necessary to avoid undue restrictions on
                a credit union's authority or ability to manage itself in a safe and
                sound manner, ensure the Subordinated Debt is characterized as debt in
                accordance with U.S. GAAP, and prevent agreements that would interfere
                with the NCUA's supervision of credit unions.
                ---------------------------------------------------------------------------
                 \81\ Id. 5.47.
                ---------------------------------------------------------------------------
                 The Board is proposing a restriction that no Subordinated Debt or
                Subordinated Debt Note be insured by the NCUA. This provision is
                consistent with the Current Secondary Capital Rule, which requires
                secondary capital accounts to be uninsured per the FCU Act.\82\
                Similarly, the OCC's subordinated debt regulations require that
                subordinated debt issued by national banks or federal savings
                associations not be insured by the FDIC.\83\ One benefit of
                Subordinated Debt that counts as Regulatory Capital is that it acts as
                a buffer to protect the depositors at a credit union as well as the
                NCUSIF. To allow Subordinated Debt to be insured by the NCUA would be
                contrary to this benefit and the payout priorities discussed previously
                in this section and in section II. (D)(1) of this preamble.
                ---------------------------------------------------------------------------
                 \82\ 12 U.S.C. 1757a(c)(2)(B)(ii); 1790d(o)(2)(C)(ii).
                 \83\ 12 CFR 5.47(d)(ii).
                ---------------------------------------------------------------------------
                 The Board is proposing a restriction that the Subordinated Debt
                Note not include any express or implied terms that make it senior to
                any other Subordinated Debt or Grandfathered Secondary Capital. The
                Current Secondary Capital Rule contains a condition that Secondary
                Capital accounts are subordinate to all other claims. Similarly, the
                OCC's subordinated debt regulations require subordinated debt issued by
                national banks or federal savings associations to be subordinate to all
                depositors.\84\ The proposed restriction clarifies the Current
                Secondary Capital Rule's intent by not allowing any express or implied
                terms that may be contrary to the proposed requirement that
                Subordinated Debt be subordinate to all other claims as discussed
                earlier in this section.
                ---------------------------------------------------------------------------
                 \84\ Id. 5.47(d)(1).
                ---------------------------------------------------------------------------
                 The Board is proposing a restriction that the issuance of
                Subordinated Debt may not cause a credit union to exceed the borrowing
                limit in Sec. 701.38 for FCUs or, for a FISCU, any more restrictive
                state borrowing limit. While this restriction is not explicit in the
                Current Secondary Capital Rule, the borrowing limit is not a new
                regulation and the restriction currently applies to the issuance of
                secondary capital. The Board is proposing to include this provision to
                clarify that the borrowing limit does apply to Subordinated Debt
                issuances as they are considered borrowings for the Issuing Credit
                Union.
                 The Board is proposing a new restriction not found in the Current
                Secondary Capital Rule that the Subordinated Debt Note not provide the
                investor with any management or voting rights in the Issuing Credit
                Union. To allow management or voting rights for Subordinated Debt
                investors would lead to some loss of control of the credit union by the
                credit union's board. Per the FCU Act, ``the management of a Federal
                credit union shall be by a board of directors, a supervisory committee,
                and where the bylaws so provide, a credit committee.'' \85\ Further,
                the FCU Act states the board of directors ``shall have the general
                direction and control of the affairs of the Federal credit union.''
                \86\ Therefore, allowing Subordinated Debt investors to have some
                control of the Issuing Credit Union would be contrary to requirements
                of the FCU Act.
                ---------------------------------------------------------------------------
                 \85\ 12 U.S.C. 1761(a).
                 \86\ Id. 1761b.
                ---------------------------------------------------------------------------
                 The Board is proposing that Subordinated Debt Notes not be eligible
                to be pledged or provided by the investor as security for a loan from
                or other obligation owing to the Issuing Credit Union. This provision
                is consistent with the Current Secondary Capital Rule \87\ and the
                OCC's subordinated debt regulations.\88\ Allowing such a transaction
                with the Subordinated Debt Note as collateral would result in the
                Issuing Credit Union loaning funds to the investor secured by debt owed
                by the Issuing Credit Union to the investor. As a result, such an
                arrangement does not provide a risk mitigation benefit to an Issuing
                Credit Union.
                ---------------------------------------------------------------------------
                 \87\ 12 CFR 701.34(b)(8).
                 \88\ Id. 5.47(d)(1)(v).
                ---------------------------------------------------------------------------
                 The Board is proposing a restriction that the Subordinated Debt
                Note may not include any term or condition that would require a credit
                union to prepay or accelerate payment of principal or interest. This
                provision is not in the Current Secondary Capital Rule, but is
                consistent with the OCC's subordinated debt regulations.\89\ The
                Current Secondary Capital Rule and this proposal both require
                preapproval to pay Grandfathered Secondary Capital or Subordinated Debt
                prior to maturity as discussed in section II. (C)(11) of this preamble.
                Therefore, including such a term or condition in the Subordinated Debt
                Note may place a credit union in default should the NCUA not approve a
                request to prepay.
                ---------------------------------------------------------------------------
                 \89\ Id. 5.47(d)(1)(vii).
                ---------------------------------------------------------------------------
                [[Page 14002]]
                 The Board is proposing a restriction that a Subordinated Debt Note
                not include a term or condition that would trigger an event of default
                based on the credit union's default on other debts. This provision is
                not in the Current Secondary Capital Rule and the OCC's subordinated
                debt regulations do not specifically address this provision. However,
                the OCC's Comptroller's Licensing Manual for Subordinated Debt \90\
                includes an example of a reasonable default trigger as one where the
                trigger is based on the bank having defaulted on other debts, but it
                includes a threshold for the amount of defaulted debt, such as a
                certain percent of capital. The Board is seeking comment on whether it
                should include a threshold trigger, rather than restrict all defaults
                based on a credit union's default on other debts (and, if so, what the
                threshold should be).
                ---------------------------------------------------------------------------
                 \90\ Office of the Comptroller of the Currency, Comptroller's
                Licensing Manual: Subordinated Debt (2017), available at https://www.occ.gov/publications-and-resources/publications/comptrollers-licensing-manual/files/licensing-booklet-subordinated-debt.html.
                ---------------------------------------------------------------------------
                 The Board is proposing that the terms of a Subordinated Debt Note
                may not require the credit union to make any form of payment other than
                in cash. A similar provision is not in the Current Secondary Capital
                Rule. However, the Board believes this provision is appropriate, as to
                allow other forms of payment that may not be liquid or may have price
                volatility (for example, foreign currency) results in an Issuing Credit
                Union taking on more risk.
                Negative Covenant Provisions
                 Similar to the section above, the Board has added a negative
                covenants \91\ section. This section includes requirements similar to
                the OCC's subordinated debt regulations.\92\ Should a credit union
                agree to such provisions, the NCUA would consider the practice unsafe
                and unsound, for the reasons discussed below. Further, these
                provisions, if agreed to, could potentially interfere with the NCUA's
                supervision of a credit union.
                ---------------------------------------------------------------------------
                 \91\ A ``negative covenant'' is a clause found in loan
                agreements that prohibits a borrower from an activity.
                 \92\ 12 CFR 5.47(d).
                ---------------------------------------------------------------------------
                 The Board is proposing that a Subordinated Debt Note may not
                contain covenants that require an Issuing Credit Union to maintain a
                minimum amount of Retained Earnings or other financial performance
                provision. Although the Current Secondary Capital Rule does not contain
                this prohibition, this requirement is consistent with the OCC's
                subordinated debt regulations.\93\ To require a credit union to
                maintain a minimum amount of Retained Earnings or other financial
                performance provision could impede the operations of the credit or
                cause the credit union to take on excessive risk to maintain this
                requirement and avoid default.
                ---------------------------------------------------------------------------
                 \93\ Id. 5.47(d)(2)(i).
                ---------------------------------------------------------------------------
                 The Board proposes to prohibit covenants that unreasonably restrict
                an Issuing Credit Union's ability to raise capital through issuance of
                additional Subordinated Debt. This new provision is consistent with the
                OCC's Subordinated Debt regulations.\94\ The ability to issue
                Subordinated Debt provides eligible credit unions a long-term, stable
                source of funding for expansion and the coverage of losses. Therefore,
                such a covenant could impede operations and the financial well-being of
                the Issuing Credit Union and would be considered unsafe and unsound.
                ---------------------------------------------------------------------------
                 \94\ Id. 5.47(d)(2)(ii).
                ---------------------------------------------------------------------------
                 The Board is proposing prohibiting covenants that provide for
                default of Subordinated Debt as a result of an Issuing Credit Union's
                compliance with any law, regulation, or supervisory directive from the
                NCUA (or SSA, if applicable). The Board believes it is unsafe and
                unsound to allow such a covenant, as it would hamper the NCUA's or
                SSA's ability to effectively supervise the credit union or subject the
                credit union to escalated administrative actions for failure to follow
                a directive to avoid default on the Subordinated Debt. Further, it
                could potentially cause monetary fines against the credit union from
                failure to follow a law or regulation in order to avoid default.
                 The Board is proposing a new provision which would prohibit
                covenants that provide for default of the Subordinated Debt as the
                result of a change in the ownership, management, or organizational
                structure, or charter of an Issuing Credit Union provided that the
                Issuing Credit Union or resulting institution, as applicable:
                 Following such change, agrees to perform all obligations,
                terms, and conditions of the Subordinated Debt; and
                 At the time of such change, is not in material default of
                any provision of the Subordinated Debt Note, after giving effect to the
                applicable cure period of not less than 30 calendar days.
                 The proposed prohibition is substantially similar to the OCC's
                subordinated debt regulations.\95\ Change in management or
                organizational structure or charter of the Issuing Credit Union should
                have no impact on the Subordinated Debt as it would still be an
                obligation of the Issuing Credit Union under these circumstances.
                Further, to allow such a provision would provide a level of control to
                the investor over the affairs of the Issuing Credit Union. This would
                be contrary to the proposed Subordinated Debt restriction on allowing
                the investor with any management or voting rights in the Issuing Credit
                Union discussed earlier in this section.
                ---------------------------------------------------------------------------
                 \95\ 12 CFR 5.47(d)(2)(iii).
                ---------------------------------------------------------------------------
                 Additionally, in the case of a merger, as discussed in section II.
                (C)(12) of the preamble, the Board is proposing that Subordinated Debt
                can be assumed by the continuing credit union. However, whether the
                Subordinated Debt counts as Regulatory Capital would still be based on
                the continuing credit union's eligibility as discussed in section II.
                (C)(3) of this preamble.
                 The Board is proposing a new provision that prohibits covenants
                that provide for default of the Subordinated Debt as the result of an
                act or omission of any third party. The Board believes that agreeing to
                such a provision would be unsafe and unsound for an Issuing Credit
                Union. While credit unions are expected to perform due diligence over
                third parties utilized, a credit union does not control the acts or
                omissions of the third parties. As such, it is not a reasonable
                expectation for the actions of a third party to trigger default or
                acceleration of payment of the Subordinated Debt.
                Default Covenants
                 The Board is proposing that Subordinated Debt Notes that include
                default covenants must provide the Issuing Credit Union with a
                reasonable cure period of not less than 30 calendar days. This new
                provision provides protection for Issuing Credit Unions by ensuring a
                reasonable cure period in the event of default. Further, this provision
                is consistent with the guidance issued by the OCC.\96\
                ---------------------------------------------------------------------------
                 \96\ Office of the Comptroller of the Currency, Comptroller's
                Licensing Manual: Subordinated Debt, 19 (2017), available at https://www.occ.gov/publications-and-resources/publications/comptrollers-licensing-manual/files/licensing-booklet-subordinated-debt.html
                (stating that ``a bank should have a reasonable opportunity to cure
                the default.'').
                ---------------------------------------------------------------------------
                Minimum Denominations
                 In order to provide additional protections to purchasers of
                Subordinated Debt Notes who are Natural Person Accredited Investors,
                the Board is proposing that Subordinated Debt Notes sold or transferred
                to Natural Person Accredited Investors be made in
                [[Page 14003]]
                minimum denominations of $100,000. In addition, resales of Subordinated
                Debt Notes to Natural Person Accredited Investors could only be made in
                minimum denominations of $10,000. Requiring larger denomination notes,
                and preventing them from being broken into smaller denominations helps
                ensure that the purchasers of the Subordinated Debt Notes are
                sophisticated, high net worth individuals.
                 The Board notes that an Issuing Credit Union may establish a larger
                minimum denomination for any issue of Subordinated Debt Notes sold to
                Natural Person Accredited Investors, as long as any such minimum
                denominations are adequately disclosed to potential investors and
                reflected in the related transaction documents. Under the proposed
                rule, there would be no minimum denomination requirements for
                Subordinated Debt Notes sold to Entity Accredited Investors because
                those purchasers are corporate entities who, in the Board's view, are
                sufficiently sophisticated in financial matters such that the
                additional protections afforded by large minimum denomination are not
                necessary.
                 The Board notes that, since 1995, the OCC has imposed a $250,000
                minimum denomination requirement in sales of nonconvertible
                subordinated debt, which are limited to ``accredited investors.''
                Further, in 1992, the OCC proposed a minimum denomination of $100,000
                for such sales, but increased it to $250,000 in the corresponding final
                rule.\97\ Recognizing the potential for overlap in market participants
                for Subordinated Debt Notes issued by Issuing Credit Unions and
                national bank nonconvertible debt instruments, the Board specifically
                requests comment on whether the NCUA's minimum denomination
                requirements should correspond with the OCC's requirements. In other
                words, (a) should the NCUA require minimum denominations of $250,000 in
                sales of Subordinated Debt Notes to Natural Person Accredited
                Investors, and (b) should the NCUA impose a minimum denomination
                requirement on sales of Subordinated Debt Notes to Entity Accredited
                Investors and, if so, should it be $10,000, $250,000, or a different
                threshold?
                ---------------------------------------------------------------------------
                 \97\ 59 FR 54789, 54792 (Nov. 2, 1994).
                ---------------------------------------------------------------------------
                5. Sec. 702.405 Disclosures
                 As discussed in section I. (E)(2) of this preamble, the federal
                securities laws and related SEC rules do not require an issuer of
                securities to provide any particular level of disclosure to potential
                investors in securities that are offered, issued, and sold pursuant to
                most exemptions from the registration requirements of the Securities
                Act, nor do they mandate the content of any disclosure an issuer
                chooses to provide. Although the SEC makes it clear that its ``anti-
                fraud'' rules apply to all offers and sales of securities, whether
                registered or exempt from registration, disclosure practices vary
                widely.\98\
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                 \98\ See 17 CFR 230.501(a) (``Users of Regulation D (230.500)
                should note the following: (a) Regulation D relates to transactions
                exempted from the registration requirements of section 5 of the
                Securities Act. . . Such transactions are not exempt from the anti-
                fraud, civil liability, or other provisions of the federal
                securities laws.'').
                ---------------------------------------------------------------------------
                 The Board believes that adopting a regulatory framework for the
                offer, issuance, and sale of Subordinated Debt Notes will benefit both
                Issuing Credit Unions and investors. Such a framework will provide
                potential investors information that is important to making a decision
                to invest in Subordinated Debt Notes of Issuing Credit Unions, and will
                clearly define the obligations of Issuing Credit Unions. The framework
                will also clarify various other investment considerations that an
                Issuing Credit Union should disclose to potential investors before
                their investment.
                 The Board further believes this framework will help promote
                investor confidence, which is particularly important in view of credit
                unions' relative inexperience offering and selling securities. In
                addition, the Board believes that the proposed disclosure requirements
                will reduce the risk of investor claims against an Issuing Credit
                Union, which will provide at least two key benefits. Reducing investor
                claims may encourage credit unions concerned with the risks associated
                with the offer and sale of securities to take advantage of
                opportunities to raise capital through the sale of Subordinated Debt
                Notes. It also helps protect the interests of credit union members, as
                such claims could have an adverse effect on the safety and soundness of
                an Issuing Credit Union.
                 The proposed rule requires an Issuing Credit Union to deliver an
                Offering Document to potential investors in Subordinated Debt Notes and
                prescribes certain specific disclosures to be made in the Offering
                Document and in the Subordinated Debt Note itself. Section 702.405
                covers the disclosure requirements for the Subordinated Debt Note,
                while the disclosure requirements for the Offering Document are
                addressed in Sec. 702.408.
                 Section 702.405 requires that certain disclosure legends be
                prominently displayed on the face of the Subordinated Debt Note, and
                that certain additional disclosures be included elsewhere in the body
                of the Subordinated Debt Note.\99\ The Board's intention in proposing
                these requirements is to alert potential investors of a number of
                important matters regarding an investment in a Subordinated Debt Note.
                Because the required disclosures are required to be included in the
                Subordinated Debt Note itself, both initial investors (purchasers of
                the Subordinated Debt Note directly from the Issuing Credit Union) and
                persons who subsequently acquire the Subordinated Debt Note will have
                ready access to the information.
                ---------------------------------------------------------------------------
                 \99\ A ``legend'' is a statement on a security, often noting
                restrictions on transfer or sale or other material limitations
                related to the security.
                ---------------------------------------------------------------------------
                 Paragraph (a) of Sec. 702.405 requires that certain disclosure
                legends be prominently displayed on the face of the Subordinated Debt
                Note. Some of the required legends identify risks specific to an
                investment in any Subordinated Debt Notes of Issuing Credit Unions,
                including the:
                 Prohibition on a holder of a Subordinated Debt Note from
                using the note as collateral for a loan from the Issuing Credit Union;
                 Possibility that a portion of, or all of, the principal
                amount of a Subordinated Debt Note would be reduced to cover any
                deficit in retained earnings at the end of a credit union's fiscal year
                (or more frequently, as determined by the Issuing Credit Union), with
                the result that the amount equal to such reduction would no longer by
                payable on such Subordinated Debt Note; and
                 Prohibition on redemption or prepayment of all or a
                portion of outstanding Subordinated Debt Notes prior to maturity, other
                than in limited circumstances involving advance approval of the NCUA or
                in connection with a voluntary liquidation of the Issuing Credit Union.
                 Other required legends, such as the requirement to inform investors
                that the Subordinated Debt Notes are not shares in the Issuing Credit
                Union and are not insured by the NCUA, are similar to those that are
                required in offerings of securities by other types of regulated
                financial institutions. The required legend noting that the issuance
                and sale of the Subordinated Debt Note are not registered under the
                Securities Act is intended to alert potential investors that the
                Subordinated Debt Note does not benefit from all of the protections
                that are provided by Securities Act registration, and the disclosure
                legend language identifying the restrictions on
                [[Page 14004]]
                the sale or other transfer of Subordinated Debt Notes by holders
                informs holders of the notes that they are not freely tradeable,
                alerting them to the fact that the Subordinated Debt Notes may not be
                liquid investments supported by an active (or any) secondary trading
                market.
                 This last legend combines elements of legends typically included in
                securities offered, issued and sold in offerings made pursuant to
                certain exemptions from the registration requirements of the Securities
                Act and elements that relate to other parts of the proposed rule that
                are unique to offers and sales of Subordinated Debt Notes, including
                the prohibition on sales or resales to members of the Issuing Credit
                Union's board, Senior Executive Officers and/or Immediate Family
                Members of board members or Senior Executive Officers.
                 In paragraph (b) of Sec. 702.405, the Board proposes a requirement
                that an Issuing Credit Union include certain additional disclosures in
                the body of the Subordinated Debt Note. As is the case with the
                disclosure legends required by paragraph (a) of Sec. 702.405, the
                purpose of these disclosures is to inform potential investors of a
                number of important matters regarding an investment in the Subordinated
                Debt Note.
                 The disclosures required under paragraph (b) in the proposed rule
                are intended to draw attention to certain potential repayment risks if
                an Issuing Credit Union is:
                 Subject to an involuntary liquidation;
                 ``Undercapitalized'' (for credit unions that are not New
                Credit Unions) or ``Moderately Capitalized'' (for credit unions that
                are New Credit Unions) and fails to submit or implement an acceptable
                restoration plan; or
                 Classified as ``Critically Undercapitalized'' (for credit
                unions that are not New Credit Unions) or ``Uncapitalized'' (for credit
                unions that are New Credit Unions).
                 The required disclosure regarding the consequences of an
                involuntary liquidation must describe the payout priority and level of
                subordination as provided in Sec. 709.5(b). The disclosure regarding
                ``Undercapitalized'' or ``Moderately Capitalized'' status of an Issuing
                Credit Union must address the additional restrictions and requirements
                that would be imposed on the Issuing Credit Union if it fails to submit
                an acceptable net worth restoration plan, capital restoration plan, or
                revised business plan or if it materially fails to implement a plan
                that was approved by the NCUA (which restrictions and requirement are
                those applicable to a ``Significantly Undercapitalized'' credit union,
                for credit unions that are not New Credit Unions) or a ``Marginally
                Capitalized'' credit union (for credit unions that are New Credit
                Unions).
                 The disclosure regarding an Issuing Credit Union that has been
                classified as ``Critically Undercapitalized'' or ``Uncapitalized'' must
                indicate that, beginning 60 days after the effective date of the
                ``Critically Undercapitalized'' or ``Uncapitalized'' classification,
                the Issuing Credit Union is prohibited from paying principal of, or
                interest on, its Subordinated Debt Notes until it is reauthorized to do
                so by the NCUA, in writing (although unpaid interest may continue to
                accrue).
                 Finally, paragraph (b) also requires an Issuing Credit Union to
                provide an overview of the risks associated with authority of the NCUA
                or any applicable SSA to conserve or liquidate a credit union under
                federal or state law. As noted in the discussion of Sec. 702.408, in
                addition to making these disclosures in the Subordinated Debt Note,
                substantially similar disclosures will also be required to be included
                in the Offering Document.
                 Certain of the disclosures required by the proposed rule correspond
                to disclosure requirements set forth in the Current Secondary Capital
                Rule, including that Secondary Capital is not insured by the NCUA and
                that Secondary Capital is subordinate to all other claims on the assets
                of the Issuing Credit Union, including member shareholders, creditors,
                and the NCUSIF. The Board acknowledges, however, that the disclosure
                requirements for all Subordinated Debt Notes in Sec. 702.405 of the
                proposed rule exceed current disclosure requirements in the Current
                Secondary Capital Rule.
                 As discussed earlier in this section, the Board believes that its
                proposed regulatory framework for the offer, issuance, and sale of
                Subordinated Debt Notes will benefit both Issuing Credit Unions and
                investors in a number of ways, including promoting investor confidence
                and reducing investor claims. Further, the requirements underlying this
                framework, including these proposed disclosures, have been in use in
                securities offerings for a number of years and are familiar to
                investors, market professionals, and legal advisors. Accordingly, the
                Board believes that the benefit from these proposed disclosure
                requirements far outweighs any associated burden associated in
                complying with them.
                6. Sec. 702.406 Requirements Related to the Offer, Sale, and Issuance
                of Subordinated Debt Notes
                 In addition to specifying the disclosures required to be provided
                to potential investors in Subordinated Debt Notes, the proposed rule
                addresses other key components of a regulatory framework for the offer,
                issuance, and sale of Subordinated Debt Notes. The provisions of Sec.
                702.406 cover a number of those key components, including:
                 Delivery requirements of Offering Documents to potential
                investors;
                 Limitations on the types of investors who may purchase and
                hold Subordinated Debt Notes (either in the initial sale of the
                Subordinated Debt Notes or in connection with any resales or other
                transfers of Subordinated Debt Notes);
                 Qualification standards for trustees engaged by an Issuing
                Credit Union; and
                 Policies and procedures to be followed by Issuing Credit
                Unions in connection with offers, issuances, and sales of their
                Subordinated Debt Notes.
                 Paragraph (a) of Sec. 702.406 obligates an Issuing Credit Union to
                deliver an Offering Document that satisfies the requirements of Sec.
                702.408(e) to each purchaser of its Subordinated Debt Notes. While
                Sec. 702.408(e) specifies certain disclosure topics that must be
                addressed in every Offering Document, paragraph (a) of Sec. 702.406
                reminds Issuing Credit Unions that those are the minimum required
                disclosures and, depending on the surrounding facts and circumstances,
                additional disclosure may be necessary to provide potential investors
                with material information relevant to an investment decision.
                 The proposed rule's obligation to provide such further material
                information as may be necessary to make the required disclosures, in
                the light of the circumstances under which those disclosures have been
                made, not misleading, is consistent with the anti-fraud concepts
                embodied in the federal securities laws. These include Rule 10b-5 under
                the Exchange Act.\100\ As noted earlier, the anti-fraud rules apply to
                all offers and sales of securities, whether or not such offers and
                sales are registered under the Securities Act.
                ---------------------------------------------------------------------------
                 \100\ 17 CFR 240.10b-5. In pertinent part, the rule provides:
                 It shall be unlawful for any person, directly or indirectly, by
                the use of any means or instrumentality of interstate commerce, or
                of the mails or of any facility of any national securities exchange
                . . . (b) To make any untrue statement of a material fact or to omit
                to state a material fact necessary in order to make the statements
                made, in the light of the circumstances under which they were made,
                not misleading . . . in connection with the purchase or sale of any
                security.
                ---------------------------------------------------------------------------
                [[Page 14005]]
                 Paragraph (a) also addresses the timing of delivery of the Offering
                Document by an Issuing Credit Union, requiring that the document be
                delivered in a reasonable time before any issuance and sale. The
                ``reasonable time'' requirement is consistent with a number of SEC
                rules relating to securities offerings exempt from Securities Act
                registration.\101\ While the Board believes an Issuing Credit Union
                should determine what constitutes a reasonable time, the intent of the
                requirement is to ensure that potential investors receive the Offering
                Document sufficiently in advance of making a purchase decision so to
                provide them with a meaningful opportunity to review the document and,
                if desired, consult with financial and/or legal advisors.
                ---------------------------------------------------------------------------
                 \101\ See, e.g., 17 CFR 230.506(b).
                ---------------------------------------------------------------------------
                 Paragraphs (b) and (c) of Sec. 702.406 impose limitations on who
                may invest in Subordinated Debt Notes, and cover both initial
                purchasers of Subordinated Debt Notes (purchasers buying Subordinated
                Debt Notes in the initial issuance from an Issuing Credit Union) and
                subsequent purchasers or transferees of Subordinated Debt Notes who
                acquire the securities from an existing holder of a note.
                 Paragraph (b) prohibits issuances and sales of Subordinated Debt
                Notes outside of the United States (any one of the states thereof,
                including the District of Columbia, its territories, and its
                possessions). The Board determined not to allow non-US investors from
                purchasing or holding any Subordinated Debt Notes because the risks and
                complexities associated with offshore offerings of securities
                outweighed the potential benefits to credit unions, especially given
                that credit unions generally are not significantly involved in foreign
                transactions. The Board specifically is requesting comment as to
                whether this restriction unduly limits the marketability and
                functionality of Subordinated Debt Notes issuances.
                 Paragraph (c) prohibits issuances and sales of Subordinated Debt
                Notes to persons other than Accredited Investors. The definition of
                ``Accredited Investor'' in Sec. 702.402 includes two types of
                Accredited Investors; the definitions of ``Entity Accredited
                Investors'' and ``Natural Person Accredited Investors'' tie to the
                categories included in the definition of ``Accredited Investor'' in
                Rule 501(a) of Regulation D under the Securities Act, with one
                important exception.\102\ The definition of ``Accredited Investor''
                omits certain persons affiliated with an Issuing Credit Union--board
                members and senior executive officers of an Issuing Credit Union are
                not ``Accredited Investors'' for purposes of the proposed rule, nor are
                Immediate Family Members of any such board member or senior executive
                officer. As a result, board members and senior executive officers of
                the Issuing Credit Union and their Immediate Family Members are
                prohibited from purchasing or holding Subordinated Debt Notes of that
                Issuing Credit Union.
                ---------------------------------------------------------------------------
                 \102\ 17 CFR 230.501(a).
                ---------------------------------------------------------------------------
                 The Board believes that limiting the potential pool of investors is
                appropriate given the risks involved in investing in securities that
                share the characteristics of Subordinated Debt Notes. It also believes
                that investors should possess a level of sophistication that permits
                them to understand the terms of Subordinated Debt Notes and adequately
                assess the risks involved in an investment in this type of security and
                in the Issuing Credit Union. The Board notes that the OCC restricts
                sales of national banks' nonconvertible Subordinated Debt to Accredited
                Investors, but does not impose this restriction on other sales of
                Subordinated Debt instruments.\103\ The Board specifically is
                requesting comment on whether restricting sales of Subordinated Debt
                Notes to Accredited Investors unduly limits the marketability and
                functionality of Subordinated Debt Notes issuances.
                ---------------------------------------------------------------------------
                 \103\ 12 CFR part 5.
                ---------------------------------------------------------------------------
                 As noted above, the proposed rule also distinguishes between
                Natural Person Accredited Investors and Entity Accredited Investors.
                While this distinction matters in important ways for offers and sales
                of Subordinated Debt Notes, including minimum denomination
                requirements, Offering Document approval processes, and resale
                provisions, it does not alter the Board's belief that every investor in
                Subordinated Debt Notes must be sophisticated and able to assess the
                risks inherent in this type of investment. Rather, the Board believes
                that Entity Accredited Investors are likely to be even more
                sophisticated investors than Natural Person Accredited Investors and,
                therefore, some of the restrictions that the proposed rule places on
                Natural Person Accredited Investors are not necessary for the
                protection of Entity Accredited Investors. The Board recognizes that
                the OCC does not distinguish between categories of Accredited Investors
                in this same way. Therefore, the Board specifically requests comment on
                whether this distinction between Entity Accredited Investors and
                Natural Person Accredited Investors unduly limits the marketability and
                functionality of Subordinated Debt Notes issuances.
                 The Board also believes it is inappropriate to permit an Issuing
                Credit Union's board members, Senior Executive Officers, or their
                Immediate Family Members to purchase or hold Subordinated Debt Notes
                due to conflict of interest and anti-fraud concerns that certain of
                those such individuals exercise control over the Issuing Credit Union
                and have, or could gain, access to material non-public information in
                respect of the Issuing Credit Union and/or the Subordinated Debt Notes.
                The Board specifically is requesting comment as to whether this
                restriction unduly limits the marketability and functionality of
                Subordinated Debt Notes issuances.
                 For the same reasons as there are restrictions on initial
                purchasers of Subordinated Debt Notes, paragraph (c), paragraph (g),
                and Sec. 702.404(a)(10) operate together to prohibit the reissuance or
                resale of Subordinated Debt Notes to persons other than Accredited
                Investors. They also prohibit the reissuance, resale, or other transfer
                of Subordinated Debt Notes to an Issuing Credit Union's board members,
                senior executive officers, or their Immediate Family Members.
                 Further, the ability to reissue or resell Subordinated Debt Notes
                after their initial issuance depends on the nature of the initial
                purchaser of the securities. Subordinated Debt Notes initially
                purchased by an Entity Accredited Investor may be reissued or resold
                only to another Entity Accredited Investor, while Subordinated Debt
                Notes initially purchased by a Natural Person Accredited Investor may
                be reissued or resold to an Entity Accredited Investor or a Natural
                Person Accredited Investor.
                 Paragraph (c) of Sec. 702.406 also requires an Issuing Credit
                Union to take certain steps to verify the Accredited Investor status of
                potential purchasers. Issuing Credit Unions will be required to obtain
                a Certificate of Accredited Investor Status from each potential
                purchaser and take additional steps to verify a potential investor's
                status by reviewing specific financial information from tax returns,
                brokerage statements and similar documentation, or by receiving a
                certification of a potential investor's status as an Accredited
                Investor from a broker-dealer, registered investment adviser, attorney,
                or certified public accountant. These verification requirements and
                methods are substantially similar to the requirements and methods
                provided in Rule 506(c) of Regulation D under the Securities
                [[Page 14006]]
                Act.\104\ The Board believes that following practices that have been in
                use in securities offerings for a number of years and which are
                familiar to investors, market professionals, and legal advisors will
                allow Issuing Credit Unions to more easily implement investor
                verification protocols that meet the requirements of the proposed rule.
                ---------------------------------------------------------------------------
                 \104\ See 17 CFR 230.506(c).
                ---------------------------------------------------------------------------
                 Paragraph (d) of Sec. 702.406 sets qualification standards for
                trustees engaged by Issuing Credit Unions in connection with issuances
                and sales of Subordinated Debt Notes. Under the proposed rule, an
                Issuing Credit Union is not required to engage a trustee.\105\ However,
                if an Issuing Credit Union chooses to engage a trustee, the trustee
                must meet the qualification requirements of the Trust Indenture Act of
                1939, as amended (TIA), related TIA rules, and any applicable state law
                qualification requirements.
                ---------------------------------------------------------------------------
                 \105\ With certain exceptions, trustees generally are required
                only in connection with offerings of debt securities registered
                under the Securities Act.
                ---------------------------------------------------------------------------
                 Because of the significance of the trustee's role in issuances of
                debt securities, the Board believes it is appropriate to impose these
                standards to ensure the competence, independence, and financial
                soundness of the trustee, and that employing the market-accepted
                qualification standards set forth in the TIA sufficiently addresses
                those matters. Even if an offering of debt securities has a qualified
                trustee, however, the indenture administered by that qualified trustee
                does not need to meet all of the requirements of the TIA applicable to
                the form and content of indentures.\106\
                ---------------------------------------------------------------------------
                 \106\ 15 U.S.C. 77aaa-77bbbb.
                ---------------------------------------------------------------------------
                 Paragraph (e) of Sec. 702.406 covers sales practices of an Issuing
                Credit Union relating to offers, issuances, and sales of Subordinated
                Debt Notes, including at any office of the Issuing Credit Union. In
                this context, an ``office'' means any premises used by the Issuing
                Credit Union that is identified to the public through advertising or
                signage using the Issuing Credit Union's name, trade name, or logo.
                 The proposed rule permits sales activities by an Issuing Credit
                Union of its own Subordinated Debt Notes if the Issuing Credit Union
                completes a written application and receives approval from its
                Appropriate Supervision Office. The application requires, in
                significant part, that the Issuing Credit Union provide a written
                description of its plan to comply with the sales practices requirements
                delineated in paragraph (e).
                 The substantive requirements of paragraph (e) are intended to
                prescribe acceptable sales practices that are consistent with general
                industry norms for sales of securities, while discouraging sales
                practices the Board believes are inappropriate for credit unions and
                will help reduce the possibility that an Issuing Credit Union,
                affiliated credit union service organization (CUSO), or their
                respective employees violate applicable securities laws.
                 In particular, the proposed rule prohibits the payment of direct or
                indirect compensation in the form of commissions, bonuses, or similar
                payments to any employee of the Issuing Credit Union or a CUSO who
                assists in the marketing and sale of the Issuing Credit Union's
                Subordinated Debt Notes. The prohibition does not apply to payments
                made to securities personnel of registered broker-dealers or payments
                otherwise permitted by applicable law, provided that such payments are
                consistent with industry norms.
                 Paragraph (e) also places limits on the Issuing Credit Union and/or
                CUSO personnel who may engage in the marketing and sales efforts. Under
                the proposed rule, marketing activities and sales may only be
                undertaken by regular, full-time employees of the Issuing Credit Union
                and/or securities personnel who are subject to supervision by a
                registered broker-dealer (who may be employees of the Issuing Credit
                Union's affiliated CUSO that is assisting in the marketing and sale of
                the Issuing Credit Union's Subordinated Debt Notes).
                 All sales, including resales, of securities must comply with
                applicable securities laws. Paragraph (g) of Sec. 702.406 prescribes
                the ways in which Subordinated Debt Notes may be resold following their
                initial sale by an Issuing Credit Union. Subordinated Debt Notes sold
                by an Issuing Credit Union pursuant to an exemption from registration
                under the Securities Act may only be resold pursuant to the same or
                another exemption from registration under the Securities Act. This
                resale exemption may be the same one on which an Issuing Credit Union
                relied in connection with the initial sale of the Subordinated Debt
                Notes or it may be another available exemption.
                7. Sec. 702.407 Discounting of Amount Treated as Regulatory Capital
                 The Board is proposing to adopt the current Sec. 701.34
                requirements for discounting the Subordinated Debt amount for
                Regulatory Capital purposes with a technical refinement on the
                calculation of the amount.
                 The Current Secondary Capital Rule requires a credit union to use
                the lesser of the remaining balance of the accounts after any
                redemption and losses; or the original amount of secondary capital
                reduced by 20 percent annually starting once the remaining maturity of
                the Secondary Capital is less than five years. This treatment is
                consistent with the treatment of subordinated debt by the FDIC and the
                OCC.
                 The Board is proposing to simplify how a credit union would base
                its discounting calculation on the net amount outstanding at the time
                the credit union conducts its calculation. This means that, if a credit
                union prepays any of its Subordinated Debt, the amount that would be
                discounted would be the net amount that remains after the prepayment.
                By doing this, the Board is making the proposed rule more consistent
                with the FDIC and OCC treatment of subordinated debt that counts
                towards Tier 2 capital.\107\
                ---------------------------------------------------------------------------
                 \107\ 12 CFR 3.20(d)(iv); 12 CFR 324.20(d)(iv).
                ---------------------------------------------------------------------------
                 For example, if ABC FCU originally issued a $20 million
                Subordinated Debt Note and prepays $10 million of the original note,
                the balance treated as Regulatory Capital would be calculated using the
                remaining outstanding amount ($10 million), not the original
                Subordinated Debt Note ($20 million).
                 The following chart shows the outstanding balance of the
                Subordinated Debt, on a percentage basis that counts as Regulatory
                Capital:
                ------------------------------------------------------------------------
                 Balance treated as Regulatory
                 Remaining maturity Capital (percent)
                ------------------------------------------------------------------------
                Four to less than five years...... 80
                Three to less than four years..... 60
                Two to less than three years...... 40
                One to less than two years........ 20
                Less than one year................ 0
                ------------------------------------------------------------------------
                 The proposed rule would require an Issuing Credit Union to apply
                the percentage of the outstanding Subordinated Debt that counts as
                Regulatory Capital included in the Net Worth and/or the RBC Ratio to
                each quarter-end Call Report cycle, because Net Worth and the RBC
                Ratios are required to be calculated at quarter-end. For example, if
                ABC FCU has $10 million in outstanding Subordinated Debt, the full
                amount would count towards Regulatory Capital if it matures in five
                years or more. Once the
                [[Page 14007]]
                remaining maturity of the Subordinated Debt is less than five years,
                the amount of outstanding Subordinated Debt that counts towards
                Regulatory Capital will reduce by 20 percent annually. This means that
                the amount that would count towards Regulatory Capital would be:
                 $10 million if the remaining maturity is at least five
                years;
                 $8 million if the remaining maturity is at least four
                years and less than five years;
                 $6 million if the remaining maturity is at least three
                years and less than four years;
                 $4 million if the remaining maturity is at least two years
                and less than three years;
                 $2 million if the remaining maturity is at least one year
                and less than two years; and
                 No amount would count towards Regulatory Capital if the
                maturity is less than one year.
                 As discussed in section II. (C)(11) of this preamble, the proposal
                would create a new authority to allow FCUs to prepay Subordinated Debt
                if the prepayment option is clearly disclosed in the Subordinated Debt
                Note and approval is granted by the Appropriate Supervision Office, in
                writing. As discussed above, if an FCU does prepay a portion of the
                Subordinated Debt, only the remaining outstanding balance of the
                Subordinated Debt would be used to calculate the balance treated as
                Regulatory Capital.
                8. Sec. 702.408 Preapproval To Issue Subordinated Debt
                 The Board is proposing that eligible credit unions be required to
                submit an application and receive written preapproval from the NCUA
                before issuing Subordinated Debt. Currently, under the Current
                Secondary Capital Rule, a federally chartered LICU must receive
                approval of its secondary capital plan by the NCUA before it may offer
                secondary capital accounts. A federally insured, state-chartered LICU
                must receive approval of its secondary capital plan by the applicable
                SSA, with the NCUA's concurrence, before it may offer secondary
                capital.
                 The Board remains dedicated to a requirement for an eligible credit
                union to obtain written preapproval before issuing Subordinated Debt as
                it views this step as an important prudential safeguard. The Board
                believes a preapproval process is part of a credit union's sound
                management plan, and helps the NCUA ensure that planned debt securities
                are structured in such a manner as to appropriately protect the NCUSIF.
                 As discussed below, the Board proposes to require a credit union to
                include information on 15 specific topics in its initial application to
                issue Subordinated Debt. The Board recognizes the many potential
                benefits that an issuance of Subordinated Debt Notes may confer on an
                Issuing Credit Union, but it also appreciates the concomitant
                complexities and risks. The decision to offer and sell securities such
                as Subordinated Debt Notes should be made only after careful
                consideration, preparation, and diligence by the Issuing Credit Union,
                including with professional advisors as warranted. For this reason, the
                Board is proposing to continue to require all credit unions
                contemplating an offer, issuance, and sale of Subordinated Debt Notes
                to receive the NCUA's prior written approval before engaging in such
                activity.
                Background
                 In 2006,\108\ the Board amended Sec. 701.34 to add a requirement
                for regulatory approval of a LICU's secondary capital plan before it
                could issue such accounts. The Board highlighted, by requiring prior
                approval of a secondary capital plan, that it was strengthening
                supervisory oversight and detection of lenient practices in several
                ways. First, it will prevent LICUs from accepting and using secondary
                capital for purposes and in amounts that are improper or unsound.
                Second, the approval requirement will ensure that secondary capital
                plans are evaluated and critiqued by the NCUA Regional Director before
                being implemented. Third, for both the NCUA and LICUs, an approved
                secondary capital plan will document parameters to guide the proper
                implementation of secondary capital, and to measure the LICU's progress
                and performance.\109\
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                 \108\ 71 FR 4234 (Jan. 26, 2006). The last substantive
                amendments to the NCUA's secondary capital regulations took place in
                2010 with the addition of language regarding secondary capital
                received under the Community Development Capital Initiative of 2010.
                75 FR 57843 (Sept. 23, 2010).
                 \109\ 71 FR 4234, 4237 (Jan. 26, 2006).
                ---------------------------------------------------------------------------
                 In September 2019, the NCUA issued a Letter to Credit Unions,\110\
                ``Evaluating Secondary Capital Plans,'' which included a Supervisory
                Letter to NCUA staff. The Supervisory Letter provided information about
                the authority of LICUs to offer secondary capital accounts and
                specified a consistent framework for the analysis and approval or
                denial of secondary capital plans submitted to the NCUA for approval.
                ---------------------------------------------------------------------------
                 \110\ Supervisory Letter No. 19-01, (Sept. 16, 2019), available
                at https://www.ncua.gov/files/supervisory-letters/SL-19-01-evaluating-secondary-capital-plans.pdf.
                ---------------------------------------------------------------------------
                 As part of this proposed rule, the Board is looking to enhance and
                clarify much of the existing secondary capital account plan
                requirements in paragraphs (b), (c), and (d) of the Current Secondary
                Capital Rule by adding similar provisions to the proposed Sec. 702.408
                of the proposed rule to govern the issuance of Subordinated Debt. All
                of the current secondary capital plan requirements are incorporated
                into these proposed rule requirements with additional provisions aimed
                at greater clarification of the NCUA's expectations for diligence and
                supporting analysis. The proposed review and analysis of a credit
                union's Subordinated Debt documents by the NCUA is intended to make the
                preapproval process more efficient while ensuring that credit union
                applicants comply with applicable laws and regulations and that the
                issuance of Subordinated Debt represents a safe and sound endeavor.
                 The NCUA's analysis of applications will be fact-specific to each
                credit union's situation at the time a credit union submits its
                Subordinated Debt application documents for approval. It is important
                to note that these proposed preapproval requirements specifically state
                that the requirements represent the minimum information an eligible
                credit union must include in the application.
                Preapproval for FISCUs To Issue Subordinated Debt
                 Under this proposed rule, a FISCU would be subject to the
                preapproval requirements in Sec. 702.408. Under this proposal, FISCUs
                would also be subject to the requirements of Sec. 702.409, which, as
                discussed in section II. (C)(9) of this preamble, would contain
                additional preapproval requirements for FISCUs.
                Preapproval Requirements and Steps
                 The Board is proposing the following preapproval requirements as
                part of an initial application process. Questions from the NCUA arising
                during the proposed preapproval process could result in the need for a
                credit union to submit additional documents. In addition, certain
                credit unions will need preapproval of the Offering Documents depending
                on whether the investor is a Natural Person Accredited Investor or an
                Entity Accredited Investor as outlined in Sec. 702.408(d).
                [[Page 14008]]
                ------------------------------------------------------------------------
                 Preapproval and reporting steps Proposed rule section
                ------------------------------------------------------------------------
                Initial Application and NCUA Approval Sec. 702.408(b) and (c).
                 Process.
                Offering Documents and NCUA Approval Sec. 702.408(d) through
                 Process, Submission of Offering Documents (g).
                 after use.
                Submission of All Documents after Issuance. Sec. 702.408(i).
                ------------------------------------------------------------------------
                Initial Application To Issue Subordinated Debt
                 The Board is proposing that all eligible \111\ credit unions be
                required to submit an initial application (Sec. 702.408(b)) to the
                Appropriate Supervision Office that, at a minimum, includes the
                following 15 items:
                ---------------------------------------------------------------------------
                 \111\ Proposed 702.403.
                ---------------------------------------------------------------------------
                 (1) A statement indicating how the credit union qualifies to issue
                Subordinated Debt given the eligibility requirements of Sec. 702.403
                with additional supporting analysis if anticipating to meet the
                requirements of a LICU or Complex Credit Union within 24 months after
                issuance of the Subordinated Debt. The Board is proposing to grant
                credit unions that do not yet meet the eligibility requirements the
                opportunity to obtain preapproval if they can reasonably demonstrate
                they will become an eligible LICU or Complex Credit Union within the
                24-month timeframe. A credit union's supporting analysis must indicate
                which of the eligibility criteria it anticipates meeting.
                 For an eligible credit union, the Board does not believe this
                proposed requirement will add any significant burden. For a credit
                union that is not yet eligible, this proposed requirement will allow
                the Board to determine if such credit union may reasonably become
                eligible within the required time period;
                 (2) The maximum aggregate principal amount of Subordinated Debt
                Notes and the maximum number of discrete issuances of Subordinated Debt
                Notes that the credit union is proposing to issue within the period
                allowed under subsection (k) of this section, which is one year from
                the approval of the initial application or Offering Document, depending
                on whether the investor is a Natural Person Accredited Investor or an
                Entity Accredited Investor. The Board is adopting the requirement from
                the paragraph (b)(1)(i) of the Current Secondary Capital Rule for the
                maximum aggregate amount and expanding this to include multiple
                issuances. The Board recognizes the potential efficiency gains for both
                the NCUA and the credit union in providing a preapproval decision
                authorizing a number of discrete issuances within the period allowed as
                doing so could be more convenient in meeting the credit union's goals
                while eliminating the prospect of multiple application reviews by the
                NCUA. If an initial application contemplates more than one issuance in
                the period allowed,\112\ the credit union should include details of
                each of the planned issuance amounts including, but not limited to; the
                dollar amounts for each issuance, the estimated issuance dates and
                maturities, and any other contractual terms of the individual
                Subordinated Debt Notes. The credit union must ensure its aggregate
                principal amount of Subordinated Debt issuance does not exceed the
                maximum borrowing limit set forth in Sec. 741.2 of the NCUA's
                regulations or cause a credit union to be in violation of any other
                applicable regulatory limits or requirements, or any written agreement
                or other approved plan with the NCUA.
                ---------------------------------------------------------------------------
                 \112\ Proposed 702.408(k).
                ---------------------------------------------------------------------------
                 As part of this requirement, the Board is requesting an analysis to
                support that a credit union has considered all other borrowing needs,
                as well as contingent liquidity needs, over the life of the planned
                Subordinated Debt issuance and has measured the aggregate amount of all
                borrowing activities. If a credit union's proposed Subordinated Debt
                issuance would increase the overall borrowing amounts to an unsafe
                level at any time over the life of the Subordinated Debt, the NCUA will
                deem this exposure to be unsafe and unsound.
                 (3) The estimated number of investors and the status of such
                investors (Natural Person Accredited Investors and/or Entity Accredited
                Investors) to whom the credit union intends to offer and sell the
                Subordinated Debt Notes. Paragraph (b) of the Current Secondary Capital
                Rule limits eligible investors in secondary capital to member or
                nonmember non-natural person investors.\113\ The Current Secondary
                Capital Rule's limitation prevents the sale of secondary capital to
                consumers who could lack the ability to understand the risks associated
                with an uninsured secondary capital account.
                ---------------------------------------------------------------------------
                 \113\ 12 CFR 701.34(b).
                ---------------------------------------------------------------------------
                 The Board is proposing to revise the investor requirement from non-
                natural person investors to Accredited Investors in accordance with the
                provisions of Regulation D of the Securities Act.
                 The specific identification and certification of an Accredited
                Investor is a requirement of the proposed Sec. 702.406(c). The
                certification requires a credit union receive an unambiguous, signed,
                one-page certification from any potential investor of a Subordinated
                Debt Note. Depending on whether the Subordinated Debt Notes are sold
                exclusively to Entity Accredited Investors or whether the potential
                investors include at least one Natural Person Accredited Investor
                determines if a credit union would need to have its Offering Documents
                approved for use by the NCUA.
                 The Board is proposing to require a credit union to specify the
                number of investors because this information will be used in the NCUA's
                evaluation of a credit union's analysis of the use of Subordinated Debt
                and its safe and sound management. Further, the Board is proposing to
                require credit unions to identify the classification of potential
                investors, because such classification will impact additional review
                steps in the proposed preapproval process.
                 (4) A statement identifying any outstanding Subordinated Debt and
                Grandfathered Secondary Capital previously issued by the credit union.
                The Board does not see this as a significant burden for credit unions
                because they have an incumbent risk management responsibility to track
                and manage their issuance. The Board is proposing to require this
                information because it will assist the NCUA in verifying if a credit
                union has prior experience with Subordinated Debt;
                 (5) A copy of the credit union's strategic plan, business plan, and
                budget, and an explanation of how the credit union intends to use the
                Subordinated Debt in conformity with those plans. The Board is
                clarifying the expectation that a credit union demonstrate how a
                planned issuance complies with each of its strategic, business, and
                budgeting plans consistent with its board's approved intentions. The
                NCUA issued a Supervisory Letter in September 2019 providing guidance
                to field staff regarding the authority of LICUs to offer Secondary
                Capital accounts.\114\ The Supervisory Letter clarifies the framework
                the NCUA uses to analyze
                [[Page 14009]]
                and approve or deny Secondary Capital plans.
                ---------------------------------------------------------------------------
                 \114\ Supervisory Letter No. 19-01, (Sept. 16, 2019), available
                at https://www.ncua.gov/files/supervisory-letters/SL-19-01-evaluating-secondary-capital-plans.pdf.
                ---------------------------------------------------------------------------
                 With the proposed rule, the Board's expectation is that a credit
                union have a clear business objective for offering Subordinated Debt as
                envisioned and must explain how the additional costs and risks are
                acceptable and consistent with the credit union's business model. The
                plan must explain why the Subordinated Debt plan is consistent with a
                credit union's mission, budget, and strategic goals.
                 An eligible credit union must also explain how (when necessary) its
                strategic plan, business plan, and budget will need to be updated if
                the initial application to issue Subordinated Debt is approved.\115\ As
                part of this endeavor, a credit union will need to make clear in its
                application that it has the expertise to safely and soundly manage the
                planned use(s) of Subordinated Debt or has budgeted to obtain the
                necessary expertise and will secure it before deploying an approved
                Subordinated Debt issuance. The Board believes this requirement will
                demonstrate a credit union's due diligence in developing a plan to
                issue Subordinated Debt or Grandfathered Secondary Capital.
                ---------------------------------------------------------------------------
                 \115\ An eligible credit union does not need to explicitly
                incorporate the secondary capital plan into its board-approved
                strategic plan, business plan, and budget until the plan is approved
                by the NCUA, and then only to the extent it is necessary and
                material enough to warrant a change to the credit union's approved
                plans and budget.
                ---------------------------------------------------------------------------
                 (6) An analysis of how the credit union will provide for liquidity
                to repay the Subordinated Debt upon maturity of the Subordinated Debt.
                The Board sees this as a critical requirement of the initial
                application and notes that this is a requirement in the Current
                Secondary Capital Rule. Generally, Subordinated Debt plans involve a
                combination of new services and balance sheet activities, which
                introduce the potential to increase risk to earnings and capital if
                they are not adequately identified, measured, monitored, and
                controlled.
                 A credit union should also guard against future threats to its
                liquidity; this is of particular importance to the final determination
                about whether an application is a safe and sound endeavor. A credit
                union's ability to demonstrate it can reliably estimate liquidity needs
                and changes in its liquidity positions that result from Subordinated
                Debt over a multi-year horizon is necessary for both a credit union and
                the NCUA to understand the potential future threats.
                 A credit union that uses a leveraged growth strategy that
                significantly increases its credit, interest rate, and liquidity risks
                may find it has potentially excessive liquidity risk under some adverse
                scenarios. Excessive liquidity risk can arise from large increases in
                nonperforming loans and/or significant unrealized losses on
                investments. The credit union should understand how these risks arise,
                what drives such risks (for example, unmet growth targets, rising
                unemployment, recession, rapid changes in interest rates, etc.), and
                understand whether the risks could pose a threat when a Subordinated
                Debt obligation comes due.
                 A credit union's reliance on Subordinated Debt can be destabilizing
                if the credit union fails to replace the Subordinated Debt with net
                worth (typically by building its retained earnings) over time. If the
                Subordinated Debt matures during a time when it is experiencing
                financial distress and is in a weakened capital position, a credit
                union may not be able to replace Subordinated Debt with a new issuance.
                A market for such a credit union to issue new Subordinated Debt could
                disappear, leaving the credit union with an abrupt decline in loss-
                absorbing capital when it is most needed. These factors, and
                availability of investors at the time of potential reissuance,
                underscore why a credit union needs to have a reasonable and
                supportable projection of its future liquidity positions and earnings
                under a variety of plausible scenarios, including both optimistic and
                pessimistic assumptions, over measurement horizons that align with the
                credit union's expected activities.
                 The analysis must include an explanation of how Subordinated Debt
                is to be repaid and how the credit union's liquidity planning is
                utilizing a range of possible economic conditions or its initial
                application may be found deficient for safety and soundness reasons.
                The analysis should also incorporate the credit union's reliance on
                other funding alternatives.
                 (7) Pro Forma Financial Statements (balance sheet, income
                statement, and statement of cash flows), including any off-balance
                sheet items, covering at least five years. Analytical support for key
                assumptions and key assumption changes must be included in the
                application. Key assumptions include, but are not limited to, interest
                rate, liquidity, and credit loss scenarios. The Board notes that
                current Sec. 701.34 requires a LICU to submit a minimum of two years
                of Pro Forma Financial Statements.\116\ As discussed below, the Board
                is proposing to expand and clarify this requirement to ensure credit
                unions evaluate risks associated with issuing Subordinated Debt.
                Analytical support for key assumptions and the respective changes must
                be included in the application. Key assumptions include, but are not
                limited to, interest rate, liquidity, and credit loss scenarios.
                ---------------------------------------------------------------------------
                 \116\ 12 CFR 701.34(b)(1)(v).
                ---------------------------------------------------------------------------
                 The Board is proposing to extend the time horizon of the pro forma
                financial statements to five years compared to the Current Secondary
                Capital Rule of two years.\117\ Given the minimum maturity requirement
                of five years \118\ and the full amount available for Regulatory
                Capital treatment with a remaining maturity in excess of five years,
                the Board is proposing that the analysis supporting the pro forma
                financials be extended to the same five years. The Board is interested
                in receiving comments on this change.
                ---------------------------------------------------------------------------
                 \117\ Id.
                 \118\ This is a requirement of both the current rule (12 CFR
                701.34(b)(4)) and the proposed rule (proposed 702.404(a)(2)).
                ---------------------------------------------------------------------------
                 The pro forma financial statements are a critical part of the
                credit union's analysis to show the effects of proposed transactions as
                if they actually occurred. Pro forma financial statements are a
                routine, yet essential, tool for documenting and testing the soundness
                of the assumptions a credit union relies on to project future
                performance. Subordinated Debt can have a significant impact on a
                credit union's revenues and expenses. Such borrowings are interest
                bearing and can have a higher cost than most forms of borrowing because
                they are uninsured and subordinate to all other claims. There are also
                other potential costs associated with a credit union's safe and sound
                oversight of Subordinated Debt (for example, staffing needs, expanded
                credit union systems, third-party assistance, and other costs
                associated with expanding services).
                 When developing pro forma financial statements, an eligible credit
                union should include projections of expected earnings in a variety of
                plausible scenarios, including both optimistic and pessimistic
                assumptions, over measurement horizons that align with the credit
                union's expected activities. In addition, analyses should address the
                sensitivity of any key underlying assumptions to reasonable changes in
                their amount/degree. Forecasting earnings and Regulatory Capital under
                different market risk factors is a sound practice for credit unions. To
                properly identify and measure the range of potential outcomes, a credit
                union needs to conduct scenario analysis to see how different key
                assumptions affect
                [[Page 14010]]
                earnings and net worth for a variety of plausible scenarios.
                 A credit union needs to determine if the aggregate amount of
                Subordinated Debt, coupled with other planned uses identified in its
                plan is appropriate given the institution's risk-management processes
                and staff experience. Both the people and the processes should be
                prepared to handle the use of Subordinated Debt. A credit union's board
                of directors should ensure that the credit union can manage the volume
                and/or complexity of planned activities, especially in cases where such
                activities represent a material increase above what has been managed
                historically.
                 The NCUA expects a credit union to use sound practices when
                producing pro forma financial statements. When evaluating pro forma
                financials, the NCUA will consider, in particular, whether a credit
                union:
                 Performed a cost/benefit analysis (including impact on
                balance sheet and operations) for any new products or services;
                 Developed pro forma financials that take into account a
                range of plausible assumptions (optimistic and pessimistic) for both
                growth and portfolio performance metrics;
                 Used reasonable and supportable underlying assumptions to
                generate scenario analyses;
                 Used underlying assumptions and treatment of assets and
                liabilities consistently across the various supporting analyses. For
                example, a credit union should be consistent, where appropriate, across
                the various risk assessments and forecasts, such as projected activity
                levels, interest rates on assets and liabilities, measures of on-
                balance-sheet liquidity, and underlying assumptions about growth and
                performance of assets and liabilities (defaults, prepayments,
                maturities, replacement of maturities, etc.).
                 Addressed its ability, under pessimistic scenarios, to
                respond to adverse event risks under its contingency funding plan
                strategies (for example, credit deterioration in a recessionary
                environment, unmet growth objectives, adverse rate environments, etc.).
                 Modeled the risk characteristics of increased borrowings
                and/or adding higher risk loans and investments to portfolios (if
                relied on in the Secondary Capital plan) adequately for credit,
                liquidity, and interest rate risk purposes.
                 (8) A statement indicating how the credit union will use the
                proceeds from the issuance and sale of the Subordinated Debt. The Board
                has proposed to retain this requirement from the Current Secondary
                Capital Rule,\119\ as a credit union must identify the purpose of
                issuing Subordinated Debt with specific reason(s), or strategy, behind
                the planned use of Subordinated Debt. The intended reason or strategy
                for using Subordinated Debt should be the primary basis for the maximum
                aggregate amount an eligible credit union states in its plan.
                ---------------------------------------------------------------------------
                 \119\ 12 CFR 701.34(b)(1)(ii).
                ---------------------------------------------------------------------------
                 The complexity of Subordinated Debt strategies ranges from
                straightforward plans (for example, those that call for a one-for-one
                redeployment of proceeds into cash, loans, and/or investments of the
                same aggregate amount) to more complex plans that reflect a combination
                of additional borrowings and asset redeployments, increasing risk and/
                or the size of a credit union's balance sheet.
                 The Board recognizes various ways a credit union may use
                Subordinated Debt to its benefit, which include, but are not limited
                to:
                 Restoring Regulatory Capital to a minimum desired level
                due to unexpected losses or strong and sustained asset growth that
                outpaced its ability to build Regulatory Capital through Retained
                Earnings;
                 Increasing Regulatory Capital to a desired level relative
                to the level of risk inherent in its operations;
                 Increasing Regulatory Capital to a desired level to
                support future growth or other member service initiatives; and
                 Enhancing earnings by increasing the level of lending or
                investing a credit union could otherwise achieve.
                 The potential incremental increase in risk taken by issuing
                Subordinated Debt can be significant, and the NCUA generally views
                growth strategies that involve a high degree of leverage as higher
                risk.\120\ When adopting such a strategy, a credit union should
                carefully assess its plan to identify any material risks to earnings
                and net worth, and properly identify and measure the degree of risk
                posed by the strategy;
                ---------------------------------------------------------------------------
                 \120\ For the purposes of this letter, ``leverage'' refers to
                funding activity outside a credit union's customary deposit base.
                ---------------------------------------------------------------------------
                 (9) A statement identifying the governing law specified in the
                Subordinated Debt Notes and the documents pursuant to which the
                Subordinated Debt Notes will be issued. The Board is requesting the
                credit union to identify the governing law in respect of the
                Subordinated Debt Notes and the documents pursuant to which the
                Subordinated Debt Notes will be issued. The intent of this requirement
                is to ensure that an Issuing Credit Union has engaged with legal
                counsel qualified to render legal advice in that jurisdiction and has
                considered the venues where controversies, should they arise, could be
                litigated.
                 (10) A draft written policy governing the offer, and issuance, and
                sale of the Subordinated Debt, developed in consultation with Qualified
                Counsel. For this requirement, an Issuing Credit Union must include a
                draft written policy that governs the offer, issuance, and sale of the
                Subordinated Debt with its initial application.
                 The proposed rule would require an Issuing Credit Union to develop
                the policy in consultation with qualified legal counsel. Given the
                complexities and risks inherent in any securities offering, the Board
                believes it is important for an Issuing Credit Union to consult with
                legal advisors with expertise in securities offerings of the type
                contemplated by the proposed rule and the application of the related
                federal and state securities laws.
                 The draft policy required by paragraph (10) of the proposed rule
                specifies the minimum topics an Issuing Credit Union must assess and
                address for securities law compliance and risk management purposes,
                including its investor relations and communications plans. An Issuing
                Credit Union can, and should, include any other topic it determines is
                appropriate and/or necessary for a complete securities program in the
                draft policy. See section I. (E)(5) of this preamble for more
                information about considerations an Issuing Credit Union should address
                in its investor relations plans.
                 (11) A schedule that provides an itemized statement of all expenses
                incurred or expected to be incurred by the credit union in connection
                with the offer, issuance, and sale of the Subordinated Debt Notes to
                which the initial application relates, other than underwriting
                discounts and commissions or similar compensation payable to broker-
                dealers acting as placement agents. The schedule must include, as
                applicable, fees and expenses of counsel, auditors, any trustee or
                issuing and paying agent or any transfer agent, and printing and
                engraving expenses. If the amounts of any items are not known at the
                time of filing of the initial application, the credit union must
                provide estimates, clearly identified as such. Such a schedule must
                include, as applicable, fees and expenses of counsel, auditors, any
                trustee or issuing and paying agent or any transfer agent, and printing
                and engraving expenses. If the amounts of any items are not known at
                the time of filing of the initial application, a credit
                [[Page 14011]]
                union must provide estimates, clearly identified as such.
                 The Board is proposing this requirement to ensure an Issuing Credit
                Union takes into account the other potential costs to it associated
                with overseeing Subordinated Debt in a safe and sound manner (for
                example, staffing needs, expanded credit union systems, third-party
                assistance, and other costs associated with expanding services). This
                initial application requirement can be submitted as part of a budgeting
                plan in the initial application requirement number four, but must have
                the itemized statement of all expenses related to the issuance of
                Subordinated Debt.
                 (12) In the case of a New Credit Union, a statement that it is
                subject to either an approved initial business plan or revised business
                plan, as required by this part, and how the proposed Subordinated Debt
                would conform with the approved plan. Unless the New Credit Union has a
                LICU designation pursuant to Sec. 701.34, it must also include a plan
                for replacing the Subordinated Debt with Retained Earnings before the
                credit union ceases to meet the definition of New Credit Union in Sec.
                702.2 of this part. The Board believes this will add minimal burden to
                a New Credit Union that is applying for Subordinated Debt authority,
                while also increasing the efficiency of the NCUA's review.
                 Unless a New Credit Union has a LICU designation pursuant to Sec.
                701.34(a), it must also include a plan for replacing the Subordinated
                Debt with Retained Earnings before the credit union ceases to meet the
                definition of New Credit Union in Sec. 702.2. The Board is proposing
                this requirement to ensure that, when a New Credit Union no longer
                meets the definition of New Credit Union as defined in Sec. 702.2, the
                credit union is either eligible to continue receiving Regulatory
                Capital treatment for its Subordinated Debt, or the credit union has a
                plan to replace the Subordinated Debt with Retained Earnings. Such a
                plan would ensure that, when a New Credit Union ceases to meet the
                definition of New Credit Union, it would remain safe and sound.
                 The Board notes that, without such a plan, when a New Credit
                Union's Subordinated Debt ceases to be counted as Regulatory Capital,
                it would immediately be subject to PCA.
                 (13) A statement describing any investments the credit union has in
                the Subordinated Debt of any other credit union, and the manner in
                which the credit union acquired such Subordinated Debt, including
                through a merger or other consolidation. Eligibility details can be
                seen in proposed Sec. 702.403. The Board believes such a requirement
                will impose minimal burden on an applicant credit union, while aiding
                the NCUA in determining a credit union's compliance with Sec.
                702.403(b) of this proposed rule;
                 (14) A signature page signed by the credit union's principal
                executive officer, principal financial officer or principal accounting
                officer, and a majority of the members of its board of directors.
                Amendments to an initial application must be signed and filed with the
                NCUA in the same manner as the initial application. The Board is
                proposing this requirement to ensure that both a credit union's senior
                management and board are aware of and have approved the credit union's
                plan for issuing Subordinated Debt; and
                 (15) Any additional information requested in writing by the
                Appropriate Supervision Office. The Board is proposing this requirement
                to ensure the NCUA has adequate information to assess an applicant
                credit union's suitability to issue Subordinated Debt in a manner the
                agency determines to be safe and sound. The Board notes that this is
                not a new requirement; current Sec. 701.34 states that the information
                required to be provided by a credit union is the minimum information
                necessary for the NCUA to review a secondary capital plan.\121\
                ---------------------------------------------------------------------------
                 \121\ 12 CFR 701.34(b)(1).
                ---------------------------------------------------------------------------
                Decision on Initial Application
                 The NCUA's review of an initial application to issue Subordinated
                Debt is intended to evaluate an eligible credit union's compliance with
                applicable laws and regulations and determine whether its application
                and documents represent a safe and sound endeavor for the credit union.
                The NCUA's analysis will be fact-specific to each credit union's
                situation at the time a credit union submits its initial application
                for approval.
                 With this proposed rule, the Board is increasing the review time of
                the initial application to 60 days from the Current Secondary Capital
                Rule's period of 45 days.\122\ The Board is also proposing to remove
                the automatic approval provision in circumstances in which an applicant
                is not notified by the NCUA within the 60-day review period. The
                Appropriate Supervision Office may also extend the deadline for the
                review of the initial application in cases where it has requested
                additional documents or has determined that the application is
                incomplete. The Board believes the expanded requirements for initial
                applications are broader than the current rule requirements and that
                the enhanced description of diligence expectations will require a more
                thorough review by the Appropriate Supervision Office.
                ---------------------------------------------------------------------------
                 \122\ Id. 701.34(b)(2)).
                ---------------------------------------------------------------------------
                 The Board is also proposing a conditional approval by which the
                Appropriate Supervision Office may approve the initial application with
                certain conditions. For example, the Appropriate Supervision Office may
                approve an aggregate principal amount less than the original request
                given the overall risk to the credit union. The NCUA may allow other
                conditional approvals such as maintaining a minimum level of net worth
                during the term of the Subordinated Debt, limiting the uses as
                prescribed in the initial application of the Subordinated Debt
                proceeds, or other limitations or conditions the NCUA deems necessary
                to protect the NCUSIF. The Appropriate Supervision Office will state
                the reasons to support the partial or conditional approval as part of
                the written determination. The Board notes that this is current agency
                practice with respect to secondary capital applications, and allows the
                Appropriate Supervision Office to adequately address concerns it may
                have with an application without unduly restricting a credit union's
                ability to issue Subordinated Debt.
                 Upon receiving an initial application, the Appropriate Supervision
                Office will evaluate a credit union's:
                 Compliance with the proposed initial application
                requirements and all other NCUA regulations;
                 Ability to manage and safely offer, issue, and sell the
                proposed Subordinated Debt; and
                 Financial condition, operational condition, risk
                management practices and board oversight.
                 In addition, the Appropriate Supervision Office will evaluate the
                safety and soundness of the proposed use of the Subordinated Debt, and
                any other factors the Appropriate Supervision Office determines are
                relevant. This reflects the minimum of the information the Appropriate
                Supervision Office will evaluate.
                Financial Condition
                 In evaluating a credit union's request to issue Subordinated Debt,
                the NCUA will evaluate a credit union's current and prospective
                financial condition. If a credit union is already experiencing serious
                financial difficulties, it may not have the financial or operational
                capacity to handle any additional challenges associated with
                Subordinated Debt, especially riskier endeavors. In particular, the
                NCUA will
                [[Page 14012]]
                evaluate a Subordinated Debt application to determine whether:
                 Planned activities potentially result in a concentration
                of high-risk characteristics (credit, liquidity, or interest rate risk)
                that can pose an undue threat to the credit union's earnings or
                Regulatory Capital;
                 Planned activities potentially worsen factors and trends
                that are contributing to existing safety and soundness concerns that
                have not yet been resolved; and
                 A credit union has a reasonable exit strategy if its
                actual growth and financial performance were to fall short of necessary
                breakeven levels.
                Operational Condition
                 In evaluating a credit union's initial application, the NCUA will
                also consider its existing knowledge of the credit union's current
                operational condition, its track record in managing new programs
                successfully, and prior experience (if any) with Subordinated Debt. A
                key consideration is whether a credit union has the resident knowledge,
                experience, expertise, and resources necessary to handle any higher
                levels of risk. This includes having personnel in the right positions,
                as well as having staff with adequate experience and knowledge.
                 The NCUA will also evaluate whether management and the board have
                demonstrated the ability to promptly and successfully address existing
                and potential problems and risks, and the potential need to recruit
                additional staff or outsource specific activities to a third party.
                 As part of its assessment of an initial application, the NCUA will
                determine if a credit union is venturing into new or higher-risk
                programs and activities that appear to be outside the institution's
                prior experience. A credit union should also assess this and explain
                how it intends to address any material gaps in the adequacy of
                technical staff and managerial oversight, and any lack of experience
                with the proposed strategies and activities in the application
                documents.
                 If a credit union is contemplating an increase in risk limits (and
                exposure) above its historical tolerance levels, it is critical that
                the board of directors has been adequately informed. The credit union
                board may also need to authorize changes in other board-approved
                policies. A credit union's application should clearly and conspicuously
                acknowledge the risk implications and reflect a commitment from the
                board that any necessary changes to policies, procedures, and personnel
                (or third-party support) will be approved.
                 The Appropriate Supervision Office will appraise the quality,
                capability, and leadership expertise of the individuals who guide and
                supervise a credit union. Credit unions should address the following as
                part of the initial application requirements, including (but not
                limited to):
                 Does the credit union operate in compliance with laws and
                regulations?
                 Does the credit union perform satisfactorily in key areas,
                such as its capital level, asset quality, earnings, liquidity, and
                interest rate risk management?
                 Does the board of directors appropriately govern the
                credit union's operations, including the establishment of its
                strategies and the approval of budgets?
                 Does the board understand the key risks facing the credit
                union?
                 Are management decisions consistent with the direction set
                by the board of directors?
                 Does management respond quickly to address shortcomings
                resulting from failed internal control processes, audits, and
                examinations?
                 Does management implement policies and a culture that
                promotes the safe and effective operation of the credit union?
                 Does management inform the board of its progress in
                executing strategies and performance against budget?
                 These questions speak to the capability of a credit union's
                leadership team, which are reflected in the Management (M) component of
                a credit union's CAMEL rating. The Appropriate Supervision Office uses
                this information when considering a request for approval of an initial
                application because a credit union's leadership is crucial in
                overseeing risk management for planned activities.
                Risk-Management Processes and Credit Union Board Oversight
                 A credit union's board of directors is responsible for establishing
                an adequate risk management framework through its policies, procedures,
                and risk limits. Policies and practices need to be consistent with the
                credit union's business strategies and reflect the board's risk
                tolerance, taking into account the credit union's financial condition.
                In reviewing a credit union's application documents, the Appropriate
                Supervision Office needs to determine whether the credit union has or
                will take appropriate steps to address:
                 Existing policies and procedures that will need to be
                updated, and/or new policies and procedures that will need to be
                adopted,
                 The necessary staff expertise and qualifications to handle
                new activities are in place or will be retained, and
                 The impact of any planned borrowing and increased balance
                sheet leverage will be integrated properly into the credit union's risk
                reporting and contingency funding plan.
                 While a credit union's board of directors is ultimately responsible
                for the credit union's strategic direction and policies, it is expected
                that they generally delegate the responsibility for executing and
                maintaining an appropriate risk management framework to senior
                management. Senior management then becomes responsible for both an
                initial assessment and the subsequent governance of Subordinated Debt
                activities.
                 Board members should ensure that the types and levels of risk
                inherent in any Subordinated Debt issuance are within their approved
                tolerances, and direct senior management to revise a plan when
                appropriate. Ultimately, the board should approve the initial
                application for submission to the NCUA. The board ensures that the
                credit union is staffed appropriately to handle the planned activities,
                and should understand the associated risks. They should remain informed
                by being briefed periodically by responsible staff. This is consistent
                with the NCUA's expectations for governance over any major risk
                activity.
                 The NCUA will also assess the extent of credit union management's
                involvement in the development of the application and whether a credit
                union relied on third-party vendors in supporting its analysis. The
                NCUA assesses the use of third parties when reviewing an application
                from a credit union that has engaged the services of a vendor to
                evaluate due diligence to determine whether any third-party agreements
                adequately preserve the credit union's legal and business interests.
                Offering Document
                 Once an Issuing Credit Union has completed the application and
                approval process specified in paragraphs (a) through (c) of Sec.
                702.408, it may proceed with an offer, sale, and issuance of
                Subordinated Debt Notes, but only if it meets certain additional
                requirements regarding the form and content of the Offering Document it
                intends to use in connection with its planned offering. Paragraphs (d)
                through (g) of Sec. 702.408 address the required use of Offering
                Documents, disclosure requirements specifying the minimum scope and
                coverage of disclosures to be included in Offering Documents, and the
                NCUA's
                [[Page 14013]]
                review process for Offering Documents intended to be used in offerings
                where the potential investors include one or more Natural Person
                Accredited Investors.
                 Consistent with the requirements of Sec. 702.406(a), paragraph (d)
                of Sec. 702.408 proposes that an Issuing Credit Union that has
                received initial approval of its application must prepare an Offering
                Document for each planned issuance of Subordinated Debt Notes. If
                potential investors in a planned offering of Subordinated Debt Notes
                include one or more Natural Person Accredited Investors, the Issuing
                Credit Union may only distribute an Offering Document to any potential
                investor after the Offering Document has been declared ``approved for
                use'' by the NCUA. Paragraph (d) also reiterates the requirement set
                forth in Sec. 702.406(a) that an Offering Document be provided to each
                potential investor a reasonable time prior to any issuance and sale of
                Subordinated Debt Notes. The intent of the requirement is to ensure
                that potential investors receive the Offering Document with sufficient
                time to review the Offering Document before making a purchase decision
                and, if desired, consult with financial and/or legal advisors.
                Requirements for All Offering Documents
                 Paragraph (e) of Sec. 702.408 specifies the minimum scope and
                coverage of disclosures a credit union must include in its Offering
                Documents. The required disclosures include basic information about the
                Issuing Credit Union, the Subordinated Debt Notes, and any
                underwriter(s) or placement agent(s) engaged by the Issuing Credit
                Union to assist it in connection with the offering. The Offering
                Document must also include a discussion of risk factors that describes
                the material risks associated with the purchase of the Subordinated
                Debt Notes. The Board recognizes that these risks may vary from one
                Issuing Credit Union to another, so an Issuing Credit Union should
                tailor the required disclosures and discussion of material risk factors
                to address any special or distinctive characteristics of its business,
                field of membership, or geographic location that are reasonably likely
                to have a material impact on the Issuing Credit Union's future
                financial performance.
                 Paragraph (e) also requires that the Offering Document contain
                disclosures that cover the same items addressed in paragraphs (a) and
                (b) of Sec. 702.405, which requires certain disclosure legends to
                appear on the face of the Subordinated Debt Note itself and certain
                additional disclosures to be included in the body of the Subordinated
                Debt Note. Those requirements are discussed in detail in ``--Sec.
                702.405 Disclosures.'' Consistent with the requirements of Sec.
                702.405, paragraph (e) also states that Issuing Credit Unions are
                obligated to provide such further material information as may be
                necessary to make the required disclosures, in the light of the
                circumstances under which those disclosures have been made, not
                misleading. This obligation is consistent with the anti-fraud concepts
                embodied in the federal securities laws, including Rule 10b-5 under the
                Exchange Act, which apply to all offers and sales of securities.
                 Further, paragraph (e) of Sec. 702.408 requires an Issuing Credit
                Union to provide details regarding the material terms of the
                Subordinated Debt Notes being offered. Because the terms of the
                Subordinated Debt Notes are likely to vary from one offering to
                another, the Board believes it is important that Issuing Credit Unions
                provide details regarding specific terms and provisions of the
                particular Subordinated Debt Notes being offered and sold in each
                instance. To that end, the disclosure is required to address the
                following, at a minimum:
                 (1) Principal amount, interest rate, payment terms, maturity date,
                and any provisions relating to prepayment of the Subordinated Debt
                Notes;
                 (2) All material covenants, both affirmative and negative, that
                govern the Subordinated Debt Notes, including the covenants required to
                be included pursuant to the proposed rule;
                 (3) Any legends required by applicable state law (which legends are
                in addition to any legends required to be included on the face of the
                Subordinated Debt Notes by the NCUA's regulations or any applicable
                state law);
                 (4) An additional legend in the form prescribed by the proposed
                rule that informs potential investors that securities regulators,
                including the SEC, and the NCUA have not passed on the merits of or
                approved the offering, or any of the terms of the Subordinated Debt
                Notes or the disclosures provided to potential investors by the Issuing
                Credit Union in the Offering Document; and
                 (5) That the offer and sale of the Subordinated Debt Notes have not
                been registered with the SEC under the Securities Act and the
                securities will be issued pursuant to exemptions from those
                registration requirements.
                 The Board notes that these types of legends are routinely included
                in securities Offering Documents, including those used by other types
                of financial institutions. Such legends serve to inform potential
                investors that the NCUA and other regulators do not assess the merits
                of any investment offering and, further, that the Issuing Credit Union
                is responsible for the disclosure in the Offering Document, whether or
                not the NCUA or any other regulator has reviewed the document.
                 Paragraphs (f) and (g) of Sec. 702.408 outline certain important
                differences in the offering process for Subordinated Debt Notes that
                will be offered to any Natural Person Accredited Investors (whether the
                offering is directed only to Natural Person Accredited Investors or to
                both Natural Person Accredited Investors and Entity Accredited
                Investors) versus the offering process for sales that will be made
                solely to Entity Accredited Investors. The Board believes that Natural
                Person Accredited Investors, while sophisticated and able to assess the
                risks inherent in investing in Subordinated Debt Notes, can benefit
                from receiving an Offering Document that has been subject to review by
                the NCUA. On the other hand, the Board believes that Entity Accredited
                Investors are likely to be even more sophisticated investors than
                Natural Person Accredited Investors and, therefore, more capable of
                assessing the disclosures provided in the Offering Document, even one
                that has not been subject to the NCUA's review.
                 For offerings that will include Natural Person Accredited Investors
                as potential purchasers (no matter how many), an Issuing Credit Union
                must submit a draft of its Offering Document to the NCUA for review,
                complete the review process, and have the draft declared ``approved for
                use'' by the NCUA before its first use.\123\ The purpose of the review
                process is to permit the NCUA to assess an Issuing Credit Union's
                compliance with the proposed rule's disclosure requirements and provide
                the Issuing Credit Union the opportunity to address the NCUA's
                questions and comments. Through this process, the Issuing Credit Union
                will provide any additional information requested by the NCUA and file
                any amendment(s) to its Offering Documents in response to the Agency's
                questions, comments, and concerns so as to allow the NCUA to reach a
                conclusion either to declare an Offering Document ``approved for use''
                or to disapprove the Offering Document as inadequate.
                ---------------------------------------------------------------------------
                 \123\ The NCUA expects that this review process will be an
                iterative one between NCUA staff and the Issuing Credit Union,
                similar to that between the OCC and national banks or between the
                SEC and parties seeking to have their registration statements
                declared effective by the SEC.
                ---------------------------------------------------------------------------
                [[Page 14014]]
                 An Issuing Credit Union that issues Subordinated Debt Notes that
                will be offered exclusively to Entity Accredited Investors will not be
                required to submit a draft of its Offering Document to the NCUA for
                review and declaration as ``approved for use.'' Once the Issuing Credit
                Union has received the approval of its application under paragraph (c)
                of Sec. 702.408 and has completed the drafting of an Offering Document
                that it affirms meets all the disclosure requirements included in the
                proposed rule, the Issuing Credit Union may use that Offering Document
                immediately, without the need to receive any ``approved for use''
                declaration or other clearance from the NCUA.
                 In all instances, the proposed rule will require an Issuing Credit
                Union to file a copy of each Offering Document with the NCUA within two
                business days of its first use. This requirement ensures that the NCUA
                has contemporaneous notice of activity in the credit union Subordinated
                Debt market, and it generally aligns with filing requirements imposed
                by other federal regulators on issuances of securities.
                Material Changes to Initial Application or Offering Documents
                 In the event that an Issuing Credit Union's circumstances
                materially change after the NCUA has approved an initial application,
                but before the closing of the relevant offer and sale of Subordinated
                Debt Notes, paragraph (h) requires an Issuing Credit Union to submit an
                amended application before it continues its Subordinated Debt Notes
                offering. In the amended application, the Issuing Credit Union must
                describe the event or change and receive approval from the NCUA before
                it may complete the offer and sale of the related Subordinated Debt
                Notes. This amended application filing and approval requirement applies
                to any offering--whether an offering made solely to Entity Accredited
                Investors or an offering that includes Natural Person Accredited
                Investors. An Issuing Credit Union must determine what constitutes a
                ``material change'' in its circumstances and whether that change
                warrants the submission of an amended application. The Board encourages
                credit unions to consult with legal and other professional advisors in
                making that determination, and further recognizes that credit unions
                may be guided by concepts of materiality found in the securities laws.
                 Similarly, if, after an Offering Document has been ``approved for
                use'' but before the closing of the relevant offer and sale of
                Subordinated Debt Notes, a material event arises or a material change
                in fact occurs that, individually or in the aggregate, results in an
                ``approved for use'' Offering Document containing any untrue statement
                of material fact, or omitting to state a material fact necessary in
                order to make statements made in the Offering Document not misleading
                in light of the circumstances under which they were made, paragraph (h)
                requires the Issuing Credit Union (and any person acting on its behalf)
                to discontinue any offers or sales of the Subordinated Debt Notes.
                 The proposed rule requires an Issuing Credit Union to revise the
                Offering Document and to submit any such amended Offering Document to
                the NCUA to be ``approved for use'' before the credit union resumes any
                offers or sales of Subordinated Debt Notes. If there is a material
                change in circumstances after an Issuing Credit Union has first used an
                Offering Document in an offer and sale of Subordinated Debt Notes made
                exclusively to Entity Accredited Investors, the proposed rule requires
                an Issuing Credit Union to determine, in accordance with applicable
                securities laws, whether such change warrants delivery of a revised
                Offering Document to potential investors. However, the Board reminds
                all Issuing Credit Unions of the continuing applicability of the anti-
                fraud provisions of the federal securities laws to in-progress
                offerings and the importance of considering whether continued use of an
                Offering Document that has not been amended to reflect material events
                or changes could be inconsistent with those provisions. An Issuing
                Credit Union must file any revised Offering Document with the NCUA
                within two business days of its first use.
                 The failure of an Issuing Credit Union to comply with the
                application amendment and/or Offering Document amendment requirements
                could result in the NCUA imposing administrative remedies available
                under the FCU Act, including prohibiting the Issuing Credit Union from
                issuing any additional Subordinated Debt for a specified period and/or
                determining not to treat the Subordinated Debt as Regulatory Capital.
                Notification of Subordinated Debt Issuance
                 Paragraph (i) of Sec. 702.408 proposes a notice and recordkeeping
                provision that would require an Issuing Credit Union to notify its
                Appropriate Supervision Office no later than ten business days after
                the closing of a Subordinated Debt Note issuance and sale and, as part
                of the notice filing, to submit documents relating to the issuance and
                sale to the NCUA, including, but not limited to:
                 A copy of the executed Subordinated Debt Note;
                 Any purchase agreement used;
                 Any indenture or other transaction document used to issue
                the Subordinated Debt Notes;
                 Copies of signed Accredited Investor Certificates from all
                investors;
                 Documents (other than Offering Documents previously filed
                with the NCUA) provided to investors related to the offer and sale of
                the Subordinated Debt Note; and
                 Any other material documents governing the issuance, sale
                or administration of the Subordinated Debt Notes.
                Resubmissions
                 Paragraph (j) of Sec. 702.408 provides that, if the NCUA provides
                a written adverse determination in respect of any application to offer
                and sell Subordinated Debt Notes and/or any Offering Document (if the
                offer and sale will be made to any Natural Person Accredited
                Investors), an Issuing Credit Union may amend such application or
                Offering Document to cure the deficiencies noted in the written
                determination and re-file such application or Offering Document with
                the NCUA in accordance with the rule's provisions. The Board notes that
                both the application and Offering Document approval processes may be
                iterative, at times requiring multiple submissions by an Issuing Credit
                Union before the NCUA provides its approval.
                 The Board notes, however, there could be instances when an Issuing
                Credit Union's application and/or Offering Document will not be
                approved by the NCUA. In such instances, the NCUA will provide a
                written determination specifying the reasons for the disapproval.
                Paragraph (j) also provides that an Issuing Credit Union may appeal the
                NCUA's decision in respect of any application and/or Offering Document
                under subpart A of part 746 of the NCUA's regulations.\124\
                ---------------------------------------------------------------------------
                 \124\ 12 CFR part 746, subpart A.
                ---------------------------------------------------------------------------
                 The Board proposes to expire an Issuing Credit Union's authority to
                issue Subordinated Debt Notes one year from the later of the date the
                Issuing Credit Union received NCUA approval of its initial application,
                if the proposed offering is to be made solely to Entity Accredited
                Investors, or the ``approved for use'' date of the applicable Offering
                Document if the proposed offering will include any Natural Person
                Accredited Investors. The Board specifically is requesting comment as
                to whether this
                [[Page 14015]]
                one-year limit, which is intended in part to ensure that an Issuing
                Credit Union does not offer and sell Subordinated Debt Notes following
                a material change in the information on which the NCUA relied in
                approving the offer and sale of that Issuing Credit Union's
                Subordinated Debt Notes, unduly limits the marketability and
                functionality of Subordinated Debt Notes issuances.
                 The proposed rule provides the right for an Issuing Credit Union to
                file a written request for one or more extensions of the one-year limit
                with the Appropriate Supervision Office, provided any such request is
                filed at least 30 calendar days before the expiration of the applicable
                period noted above. A credit union's extension request must demonstrate
                good cause for an extension(s) and address whether such an extension
                will pose any material securities law implications.
                Filing Requirements
                 Paragraph (l) of Sec. 702.408 specifies the mechanics of filing
                required disclosure and transactional documents with the NCUA, while
                paragraph (m) notes that the NCUA may require filing fees to accompany
                certain filings. The Board notes that other federal regulators assess,
                or have reserved the right to assess, filing fees in connection with
                securities offerings under their jurisdiction.
                 The Board is requesting comment as to whether the imposition of
                filing fees would unduly limit the marketability and functionality of
                Subordinated Debt Notes issuances. Specifically, if the NCUA were to
                assess any such filing fees, on what should the NCUA base the fee
                structure and why? For example, should the NCUA follow the filing fee
                structures of other federal regulators and, if so, which regulators?
                Should LICUs and/or New Credit Unions be exempt from any filing fee
                requirements, or should they have a reduced fee structure?
                9. Sec. 702.409 Preapproval for FISCUs To Issue Subordinated Debt
                 The Board is proposing to include a section that details the
                application procedures specific to FISCUs. Under the Current Secondary
                Capital Rule, a FISCU must submit its secondary capital plan to both
                the NCUA and its SSA. The SSA is responsible for rendering a decision
                on such plan with the concurrence of the NCUA. The Board notes that
                this requirement has proved problematic in some instances.
                Specifically, some states do not have regulations that address the
                evaluation of secondary capital plans. In some cases, this has resulted
                in a conflict between the requirements of the Current Secondary Capital
                Rule and the applicable state laws of some SSAs.
                 Based on lessons learned from the Current Secondary Capital Rule
                and the fact Subordinated Debt stands in front of the NCUSIF as loss
                absorbing capital, the Board is proposing to change the approval
                process for FISCUs seeking to issue Subordinated Debt. Under this
                proposed rule, a FISCU must still submit the information required under
                Sec. 702.408 to both the NCUA and its SSA. However, the Board is
                proposing to shift the responsibility for rendering a decision from the
                states to the NCUA. As such, the proposed rule states that the NCUA
                will render all decisions on FISCU Subordinated Debt applications, but
                will only approve a Subordinated Debt application after obtaining the
                concurrence of the credit union's SSA. The Board believes this
                maintains the supervisory authority of the SSA while shifting the
                responsibility for rendering decisions to the NCUA. The Board notes
                that while it is changing the process for FISCU application approvals,
                it is not changing the current process for approvals of FISCU
                applications to prepay Subordinated Debt. As discussed in section II.
                (C)(11) of this preamble, a FISCU seeking approval to prepay
                Subordinated Debt must still seek approval from its SSA before
                submitting an application to prepay to the NCUA.
                 In addition, the Board is considering adding a requirement in a
                final Subordinated Debt rule that would require a FISCU to submit with
                its application an attestation that it has consulted with its SSA and
                the Subordinated Debt it is proposing to issue is permissible under
                state law. The Board believes this requirement may be useful to and
                efficient for both the NCUA and a FISCU. Such a requirement would
                ensure a FISCU is permitted to issue Subordinated Debt under state law
                before the credit union and the NCUA expend resources on the credit
                union's application. The Board invites feedback on this requirement.
                 This section of the proposed rule also states that the NCUA will
                notify a FISCU's SSA before issuing a decision to ``approve for use'' a
                FISCU's Offering Document and any amendments thereto, under proposed
                Sec. 702.408. Because rendering a decision to ``approve for use'' an
                Offering Document is an iterative process, the Board is not proposing
                to seek the SSA's concurrence on this decision. The Board believes that
                obtaining such concurrence may delay the review process and negatively
                impact credit unions, while providing little utility to the supervision
                by an SSA. The Board believes that concurrence in the decision to
                approve a FISCU's application and notice of a decision to ``approve for
                use'' a FISCU's Offering Document strikes a balance between involvement
                by the appropriate SSA and the NCUA's role as insurer.
                 The Board is also proposing to include in this section a
                requirement stating that if the Appropriate Supervision Office has
                reason to believe that a Subordinated Debt issuance by a FISCU could
                subject that FISCU to federal income taxation, the Appropriate
                Supervision Office may require the FISCU to provide:
                 (1) A written legal opinion, satisfactory to the NCUA, from
                nationally recognized tax counsel or letter from the Internal Revenue
                Service indicating whether the proposed Subordinated Debt would be
                classified as capital stock for federal income tax purposes and, if so,
                describing any material impact of federal income taxes on the FISCU's
                financial condition; or
                 (2) A Pro Forma Financial Statement (balance sheet, income
                statement, and statement of cash flows), covering a minimum of five
                years, that shows the impact of the FISCU being subject to federal
                income tax.
                 This proposed section further provides that, should such
                information be required, a FISCU may determine in its sole discretion
                whether the information it provides is in the form articulated in
                either (1) or (2) above.
                 The Board notes that FISCUs are exempt from federal income taxation
                under Sec. 501(c)(14) of the Internal Revenue Code.\125\ Conversely,
                FCUs are exempt from federal income taxation under the FCU Act.\126\
                Section 501(c)(14) of the Internal Revenue Code exempts state-chartered
                credit unions that are operating on a not-for-profit basis, organized
                without capital stock, and operating for mutual purposes. While FCUs
                may only permissibly issue Subordinated Debt under their borrowing
                authority, it is possible that a FISCU, under state law, could issue an
                instrument that otherwise meets that requirements of subpart D of part
                702, but may have a structure akin to capital stock. The Board is
                therefore proposing a backstop provision to protect the safety and
                soundness of FISCUs that may propose to issue an instrument that an
                Appropriate Supervision Office has reason to believe could be treated
                as capital stock.
                ---------------------------------------------------------------------------
                 \125\ IRC 501(c)(14).
                 \126\ 12 U.S.C. 1768.
                ---------------------------------------------------------------------------
                 In such limited situations, the Board is proposing to require a
                FISCU to demonstrate that the instrument will
                [[Page 14016]]
                either not be treated by the Internal Revenue Service as capital stock
                or that, if an instrument is treated as capital stock (thereby
                subjecting the FISCU to federal income taxation), the associated costs
                can be safely absorbed by the FISCU. While the Board expects there to
                be few instances in which this provision is invoked, if any, its
                inclusion in the proposed rule protects against all possible
                circumstances to ensure the ongoing safety and soundness of FISCUs that
                issue Subordinated Debt. The Board believes this proposed provision
                would ensure that a FISCU conducts thorough due diligence on the
                ramifications of issuing an instrument that could subject it to federal
                income taxation, and demonstrate that either such instrument will not
                subject the credit union to taxation or that it has the financial
                capabilities to remain in a safe and sound condition with the added
                expense of federal income taxation.
                10. Sec. 702.410 Interest Payments on Subordinated Debt
                 In purchasing Subordinated Debt from credit unions, investors face
                certain regulatory uncertainties. For example, the FCU Act and the
                NCUA's regulations provide authority to prohibit dividend or interest
                payments in specified scenarios. In its PCA regulations, the Board
                specifically lists restrictions on the payment of interest on secondary
                capital as an option for ``Critically Undercapitalized'' credit
                unions.\127\ Even for a credit union with a more favorable net worth
                classification, PCA authorities allow the Board to ``restrict or
                require such other action as [it] determines will carry out the purpose
                of [the PCA provisions] better than'' the specifically listed
                authorities.\128\ These discretionary authorities may make it difficult
                for investors to gauge risks related to Subordinated Debt purchases,
                resulting in more extensive disclosure requirements and higher costs
                for Issuing Credit Unions.
                ---------------------------------------------------------------------------
                 \127\ As discussed in section II. (B)(3) of this preamble, the
                Board is proposing to make cohering changes to this section of the
                PCA regulations to address Grandfathered Secondary Capital and
                Subordinated Debt.
                 \128\ 12 CFR 702.107; 702.108.
                ---------------------------------------------------------------------------
                 To address this investor uncertainty, the Board is considering
                multiple approaches. First, the Board is proposing provisions that
                would prohibit interest payments on Subordinated Debt for any
                ``Critically Undercapitalized'' credit union. The proposed rule would
                make this mandatory for Subordinated Debt (it is currently a specified
                discretionary authority under the NCUA's regulations).\129\ This
                approach aligns with banking law,\130\ which prohibits interest on
                subordinated debt for ``Critically Undercapitalized'' banks, except
                where the institution requests and receives regulatory approval.
                Standardizing this preclusion is consistent with what the market is
                accustomed to for subordinated debt of national banks. The Board has
                included proposed disclosures that would be required to address this
                risk of PCA requirements (see section II. (C)(5) of this preamble).
                ---------------------------------------------------------------------------
                 \129\ Id. 702.109(b)(11).
                 \130\ 12 U.S.C. 1831o(h)(2).
                ---------------------------------------------------------------------------
                 Second, the Board is proposing a safe harbor for interest payments
                on Subordinated Debt for any credit union in a net worth category more
                favorable than ``Critically Undercapitalized.'' Under this safe harbor,
                the NCUA would not prohibit interest payments on Subordinated Debt for
                such credit unions, provided that a list of criteria are satisfied (see
                proposed Sec. 702.410(c)). These qualifying criteria provide that a
                credit union must have issued the Subordinated Debt in an arms-length
                transaction, in the ordinary course of business, with no evidence of
                intent to hinder or defraud the Issuing Credit Union or its creditors.
                In addition, the Subordinated Debt must comply with the proposed
                issuance requirements. The proposed rule also clarifies that the safe
                harbor neither waives nor affects other authorities the NCUA may
                exercise in any of its regulatory, conservatorship, or liquidating
                agent capacities.
                 The Board invites comment on whether it should retain the proposed
                interest safe harbor or eliminate it. While the safe harbor could make
                debt pricing more favorable for Issuing Credit Unions, such an impact
                remains to be seen. Conversely, such a safe harbor could cost the
                NCUSIF, as the Board may be unable to limit interest payments for
                Issuing Credit Unions subject to PCA.
                 In considering the interest safe harbor, the Board notes that
                neither the FDIC nor the OCC provide similar relief in connection with
                the subordinated debt of their regulated banking institutions. While
                the scope of this safe harbor would be unique in the subordinated debt
                market, the Board believes it could make Subordinated Debt issued by
                Issuing Credit Unions a more viable product at a lower cost. In hopes
                of increasing viability, the Board is willing to consider this interest
                safe harbor and welcomes comment on this issue.
                11. Sec. 702.411 Prior Written Approval To Prepay Subordinated Debt
                 Consistent with the Current Secondary Capital Rule, the proposed
                rule requires a credit union to receive prior written approval from the
                Appropriate Supervision Office to prepay Subordinated Debt. However,
                the Board is proposing to expand a credit union's authority to prepay
                any portion of the Subordinated Debt. Under the Current Secondary
                Capital Rule, only the portion of the secondary capital that no longer
                counts as Regulatory Capital may be approved for prepayment. The Board
                believes this proposed change will provide credit unions additional
                flexibility to effectively manage issued Subordinated Debt.
                 In addition, the Board notes that if the terms of the Subordinated
                Debt Note allow prepayment (call option), the prepayment option and the
                requirements of this proposed section of the regulation must clearly be
                disclosed in the Subordinated Debt Note. The Board is adding this
                requirement to ensure investors receive adequate disclosure of a credit
                union's option to prepay the issued Subordinated Debt and the
                regulatory requirements related to such prepayment.
                 To obtain approval to prepay, the proposed rule requires a credit
                union to submit an application to the Appropriate Supervision Office.
                To provide regulatory relief, the proposed requirements of the
                application are less prescriptive than the Current Secondary Capital
                Rule, and more comparable to the OCC's subordinated debt
                regulations.\131\ To request early redemption of secondary capital, the
                Current Secondary Capital Rule requires a LICU to demonstrate to the
                NCUA that the: \132\
                ---------------------------------------------------------------------------
                 \131\ 12 CFR 5.47(f)(2)); (g)(1)(ii).
                 \132\ Id. 7022.34(d)(1).
                ---------------------------------------------------------------------------
                 LICU will have a post-redemption net worth classification
                of ``Adequately Capitalized'' per part 702 of this chapter;
                 Discounted secondary capital has been on deposit for at
                least two years;
                 Discounted secondary capital will not be needed to cover
                losses prior to maturity;
                 LICU's books and records are current and reconciled;
                 Proposed redemption will not jeopardize other current
                sources of funding; and
                 LICU's board of directors authorized the request to
                redeem.
                 Under this proposal, a credit union must provide an application for
                [[Page 14017]]
                prepayment to the Appropriate Supervision Office. However, the required
                items are a change from the Current Secondary Capital Rule. The Board
                believes that normally, the proposed required items for prepayment
                should provide the Appropriate Supervision Office with the appropriate
                information to make a sound decision on prepayment. A credit union must
                provide, at a minimum, a copy of the Subordinated Debt Note (including
                any agreements reflecting the terms and conditions of the Subordinated
                Debt) and an explanation of why the credit union believes it still
                would hold an amount of capital commensurate with its risk post
                redemption. The Board believes this information will allow the
                Appropriate Supervision Office to adequately determine the safety and
                soundness of prepaying Subordinated Debt.
                 The Board notes, however, that this proposed rule clarifies that
                the information discussed above is the minimum information required in
                an application for approval to prepay Subordinated Debt, and that an
                Appropriate Supervision Office may request additional information if
                needed. The OCC's subordinated debt regulations have similar
                flexibility. Allowing a request for additional information ensures the
                Appropriate Supervision Office has all the relevant information to make
                an appropriate decision regarding the prepayment.
                FISCU Application To Prepay Subordinated Debt
                 Before submitting an application seeking prepayment authority to
                the NCUA, a FISCU must obtain written approval from its SSA. This
                process differs from the proposed original issuance approval process
                under Sec. 702.409 as discussed in section II. (C)(9) of this
                preamble, which would allow for simultaneous submission to the NCUA and
                SSA. The proposed requirement of prior approval by the SSA before a
                credit union applies to the NCUA for prepayment approval provides the
                SSA the first review and opportunity to render a decision on a FISCU's
                application to prepay, and acknowledges the SSA's role with safety and
                soundness relative to FISCUs. The NCUA's role as final approver
                reflects the nature of Subordinated Debt as protection for the NCUSIF.
                NCUA Decision on Application To Prepay Subordinated Debt
                 The Board is proposing to retain a 45-day timeline to review and
                respond to a prepayment request. However, the proposed rule would make
                one change to the approval process. Currently, if an Issuing Credit
                Union does not receive a response from the Appropriate Supervision
                Office within 45 days, the request to prepay is deemed approved. Under
                the proposed rule, automatic approvals no longer occur. This change is
                consistent with the removal of automatic approvals for the proposed
                original issuance approval process as discussed in section II. (C)(8).
                12. Sec. 702.412 Effect of a Merger or Dissolution on the Treatment of
                Subordinated Debt as Regulatory Capital
                 Paragraph (b)(9) of the Current Secondary Capital Rule states that
                ``. . . in the event of merger or other voluntary dissolution of a
                LICU, other than merger into another LICU, the secondary capital
                accounts will be closed and paid out to the account investor to the
                extent they are not needed to cover losses at the time of merger or
                dissolution.'' \133\ The Board is proposing to retain the general
                framework in current paragraph (b)(9), but to make several adjustments
                to account for the additional types of credit unions that may issue
                Subordinated Debt and provide additional flexibility to a resulting
                credit union in a merger.
                ---------------------------------------------------------------------------
                 \133\ Id. 34(b)(9).
                ---------------------------------------------------------------------------
                 Specifically, the Board is proposing to permit the acquisition of
                Subordinated Debt in a merger or assumption transaction regardless of
                the classification of the resulting credit union. Currently, this is
                only permissible if both the resulting and merging credit unions are
                LICUs. The Board believes this change will provide additional
                flexibility to credit unions, while, as discussed in the next
                paragraph, maintaining controls on the Regulatory Capital treatment of
                Subordinated Debt. The Board also notes that this provision could be a
                benefit to investors, as the Subordinated Debt could remain outstanding
                and earning interest versus being repaid.
                 Under this proposed rule, the Regulatory Capital treatment of any
                acquired Subordinated Debt would be contingent on several factors.
                First, if the resulting credit union is a LICU, Complex Credit Union,
                or New Credit Union, it may acquire the Subordinated Debt of the
                merging credit union, and the non-discounted portion of such
                Subordinated Debt will continue to be treated as Regulatory Capital.
                Irrespective of the foregoing, if the resulting credit union is not a
                LICU, the acquired Subordinated Debt will not count toward that credit
                union's Net Worth. Acquired Subordinated Debt will only count toward a
                resulting credit union's Net Worth if such credit union is a LICU.
                 If the resulting credit union is not a LICU, Complex Credit Union,
                or New Credit Union, the Board is proposing to provide two options for
                addressing the assumed Subordinated Debt. First, if permitted by the
                terms of the Subordinated Debt Note, the resulting credit union can
                apply to the NCUA for approval to prepay the Subordinated Debt. If the
                NCUA grants such approval, the Subordinated Debt may be repaid in
                accordance with the requirements related to prepayment, discussed in
                section II. (C)(11) of this preamble.
                 Second, the resulting credit union may continue to hold the
                acquired Subordinated Debt, but such Subordinated Debt will not be
                treated as Regulatory Capital unless the resulting credit union becomes
                a LICU, Complex Credit Union, or New Credit Union. In the event the
                resulting credit union becomes one of the aforementioned types of
                credit unions, the Board is proposing to allow any non-discounted
                portion of acquired Subordinated Debt to immediately be treated as
                Regulatory Capital upon the resulting credit union being designated as
                a LICU, Complex Credit Union, or New Credit Union. If the resulting
                credit union never becomes a credit union eligible to receive
                Regulatory Capital treatment of the acquired Subordinated Debt, such
                Subordinated Debt may continue to be held by the resulting credit union
                or prepaid, in accordance with the prepayment section of this proposed
                rule, but, in either case, such Subordinated Debt will never receive
                Regulatory Capital treatment. Further, acquisition of Subordinated Debt
                in a merger does not permit an ineligible credit union to issue its own
                Subordinated Debt. This proposed rule only allows an ineligible credit
                union to hold acquired Subordinated Debt until maturity.
                 The Board believes the proposed treatment of acquired Subordinated
                Debt is consistent with the safety and soundness goals of this proposed
                rule and provides resulting credit unions with flexibility to exercise
                business judgment in determining how to proceed with acquired
                Subordinated Debt.
                 The Board is also proposing to address voluntary liquidations in
                this section of the rule. Specifically, the Board is proposing to
                permit a credit union to prepay Subordinated Debt as part of a
                voluntary liquidation. Any such prepayment must, however, be conducted
                in accordance with the prepayment requirements of the proposed rule
                (see Sec. 702.411). The
                [[Page 14018]]
                Board believes it is appropriate to require a credit union to apply for
                approval to prepay Subordinated Debt in a voluntary liquidation, as it
                is incumbent upon the NCUA to determine if the Subordinated Debt will
                or could be needed to cover any losses that a credit union may incur
                during liquidation.
                13. Sec. 702.413 Repudiation Safe Harbor
                 The FCU Act provides multiple authorities to the Board as
                conservator or liquidating agent that could affect Subordinated Debt.
                For example, in both conservatorships and liquidations the FCU Act
                provides the Board the authority to repudiate contracts.\134\ The Board
                can also enforce contracts that might otherwise have provided for
                default, acceleration, or the exercise of other rights upon insolvency
                or appointment of a conservator or liquidating agent. Any of these
                authorities could affect a potential investor's evaluation of an
                Issuing Credit Union's Subordinated Debt.
                ---------------------------------------------------------------------------
                 \134\ 12 U.S.C. 1787(c).
                ---------------------------------------------------------------------------
                 With respect to repudiation, the Board, including its lawfully
                appointed designee, has the authority to repudiate any contract within
                a reasonable period following appointment as conservator or liquidating
                agent for an insured credit union. This authority is subject only to a
                conservator's or liquidating agent's discretionary decision that the
                contract is both burdensome and that repudiation will promote orderly
                administration of a credit union's affairs. Repudiation generally
                limits recourse by introducing limits on both time and type of
                recourse. The time for determination of damages is the date of
                appointment of the conservator or liquidating agent and the type of
                recourse is limited to ``actual direct compensatory'' damages. Punitive
                or exemplary damages, damages for lost profit or opportunity, and
                damages for pain and suffering are excluded from the scope of actual
                direct compensatory damages, and case law further defines the
                boundaries of permitted damages. Permissible damages elements that are
                approved as a claim (after proceeding through the administrative claims
                process) become eligible for payment at their related priority under 12
                CFR 709.5(b), subject to availability of funds.
                 Thus, a conservator's or liquidating agent's repudiation authority
                is broad and could affect a Subordinated Debt investor's rights to
                payment. While the extent of impact could vary substantially based on
                individual circumstances, the Board believes the exercise of this power
                in connection with Subordinated Debt would have the least consequence
                in involuntary liquidation scenarios. In such a scenario, a credit
                union will generally be insolvent (or at least ``Critically
                Undercapitalized''), and only in unusual cases will funds be available
                to fully pay approved claims beyond those of the NCUSIF and uninsured
                shareholders.\135\ In many cases Subordinated Debt may have been
                entirely extinguished to cover deficits before a liquidation occurs.
                Therefore, the Board believes the issue of repudiating Subordinated
                Debt contracts in liquidation contexts is unlikely to make a
                measureable difference to any Subordinated Debt purchaser.
                ---------------------------------------------------------------------------
                 \135\ 12 CFR 709.5(b)(6).
                ---------------------------------------------------------------------------
                 On the other hand, the conditions under which the Board may invoke
                its conservatorship authorities are broader than those that apply to
                liquidations. They include a credit union's consent, violation of an
                order to cease and desist, or concealment of books and records, among
                others. In the case of conservatorships, a conservator has the power to
                repudiate Subordinated Debt contracts in situations where a credit
                union remains solvent. Such repudiation, if exercised, could
                substantially affect the timing of a holder's receipt of principal,
                along with interest payments that may have otherwise continued. While
                conservatorships are rare, the possibility of such action creates
                additional uncertainty regarding a purchaser's ability to value the
                Subordinated Debt at the time of purchase. This additional uncertainty
                could, in turn, affect the cost and marketability of Subordinated Debt
                issued under the proposed rule.
                 To address this uncertainty, the Board has included a safe harbor
                in the proposed rule by which it would prevent the conservator's
                exercise of repudiation authority when a conserved credit union is
                solvent. Like the proposed safe harbor related to interest payments,
                the proposed rule establishes a list of criteria that, if satisfied,
                would qualify a Subordinated Debt instrument for the repudiation safe
                harbor. To qualify, a credit union must have issued the Subordinated
                Debt in an arms-length transaction, in the ordinary course of business,
                with no evidence of intent to hinder or defraud the Issuing Credit
                Union or its creditors. In addition, the Subordinated Debt must comply
                with all of the proposed requirements of the proposed rule. The safe
                harbor described in the proposed rule also clarifies that it neither
                waives nor affects other authorities the NCUA may exercise in any of
                its regulatory, conservatorship, or liquidating capacities.\136\ In
                liquidation contexts, the safe harbor would not apply, for the reasons
                stated above.
                ---------------------------------------------------------------------------
                 \136\ These criteria are similar to those that apply to assets
                transferred in connection with a securitization or participation, as
                set forth in 12 CFR 709.9. In the securitization and participation
                context, the NCUA's safe harbor in 12 CFR 709.9 does not extend to
                repudiation itself, but is limited to the reclamation of related
                collateral when the Board exercises the repudiation power. Unlike
                the safe harbor for securitization and participations, the proposed
                safe harbor would prohibit repudiation altogether in the
                circumstances described.
                ---------------------------------------------------------------------------
                 The Board invites comment on whether it should retain the proposed
                repudiation safe harbor or eliminate it. While the safe harbor could
                make Subordinated Debt pricing more favorable for credit unions, such
                an impact remains to be seen. Conversely, the safe harbor could cost
                the NCUSIF, as the Board may be unable to repudiate Subordinated Debt
                contracts that a conserved credit union is unable to service, creating
                or increasing financial distress.
                14. Sec. 702.414 Regulations Governing Grandfathered Secondary Capital
                 As discussed in section II. (C)(1) of this preamble, the Board is
                proposing to grandfather secondary capital issued by LICUs before the
                effective date of any final Subordinated Debt rule. For clarity and
                ease of use, therefore, the Board is proposing to include the Current
                Secondary Capital Rule in subpart D as Sec. 702.414, with minor
                modifications. The Board believes this proposed change would aid LICUs
                in quickly finding the rules applicable to Grandfathered Secondary
                Capital, while maintaining the Board's objective to house all capital
                related rules for natural person credit union in one part. The Board is
                also proposing to delete the Current Secondary Capital Rule to avoid
                having two nearly identical rules on secondary capital.
                 The Board notes that, under this proposed rule, there would be some
                technical differences between the Current Secondary Capital Rule and
                proposed Sec. 702.414. Such differences serve to clarify that a LICU
                may only follow the rules in this section for Grandfathered Secondary
                Capital, and that the proposed rule does not permit a LICU to continue
                offering secondary capital under the Current Secondary Capital Rule.
                 In addition, proposed Sec. 702.414(a)(2) would include a statement
                indicating that any issuances of secondary capital not completed by the
                effective date of a final Subordinated Debt rule are, as of such
                effective date, would be subject to the requirements applicable to
                [[Page 14019]]
                Subordinated Debt discussed elsewhere in this preamble. The Board is
                proposing this requirement to ensure all issuances of secondary capital
                not yet completed would be subject to the requirements of this proposed
                rule. The Board is, however, requesting specific comment on what it
                should set as the implementation date for such provision. While the
                Board wants to ensure future issuances of secondary capital are subject
                to the requirements of this rule, it is not intending to negatively
                impact LICUs that are close to issuing secondary capital under a
                secondary capital plan that was approved before the effective date of a
                final Subordinated Debt rule. The Board encourages commenters to
                identify what would be a reasonable amount of time to allow LICUs to
                conduct such issuances.
                 This proposed section also makes a minor technical correction in
                proposed Sec. 702.414(b)(1), which instructs a LICU how to properly
                account for secondary capital on its balance sheet. The Current
                Secondary Capital Rule requires a LICU to record secondary capital as
                equity. This is, however, inaccurate, as U.S. GAAP requires such
                instrument to be accounted for as debt rather than equity. As such,
                this proposed change merely reflects the proper accounting treatment of
                secondary capital, and is not a substantive change.
                D. Part 709--Involuntary Liquidation of Federal Credit Unions and
                Adjudication of Creditor Claims Involving Federally Insured Credit
                Unions in Liquidation
                1. Sec. 709.5 Payout Priorities in Involuntary Liquidation
                 The Board is proposing to make conforming changes to the section of
                part 709 that addresses payout priorities in involuntary liquidations.
                Currently, Sec. 709.5(b) lists secondary capital as the last priority
                for payout when a LICU is liquidated. In accordance with the FCU Act,
                secondary capital must be subordinate to all other claims against a
                LICU, including claims of other creditors, the NCUSIF, and
                shareholders.\137\ Because this is a statutory provision, the Board is
                required to maintain Subordinated Debt issued by LICUs as the last in
                the list of payout priorities.
                ---------------------------------------------------------------------------
                 \137\ 12 U.S.C. 1757a(c)(2)(B)(ii); 1790d(o)(2)(C)(ii).
                ---------------------------------------------------------------------------
                 Under the proposed rule, Subordinated Debt for LICUs, Complex
                Credit Unions, and New Credit Unions will be the same instrument and
                subject to the same regulation. Secondary capital and proposed
                Subordinated Debt also both function as capital that is subordinate to
                all claims, including those by the NCUSIF, general creditors, and
                shareholders. As such, the Board believes it is appropriate to include
                Subordinated Debt in the last payout priority when a natural person,
                federally insured credit union is liquidated. Further, to address
                Grandfathered Secondary Capital, discussed in section II. (C)(1) of
                this preamble, the last payout priority will clarify that such
                Grandfathered Secondary Capital continues to remain the last payout
                priority position.
                E. Part 741--Requirements for Insurance
                 The Board is proposing to make several changes to part 741 to
                ensure consistency with the other proposed changes in this rule.
                Specifically, the Board is proposing to amend Sec. 741.204 and add new
                Sec. Sec. 741.226, and 741.227.
                1. Sec. 741.204 Maximum Public Unit and Nonmember Accounts, and Low-
                Income Designation
                 Currently, Sec. 741.204 includes the rules and requirements for
                low-income FISCUs. Among these requirements is a discussion of how a
                low-income FISCU can apply for authority to issue secondary capital.
                Because secondary capital will, under the proposed rule, be included as
                part of Subordinated Debt and will no longer be included in Sec.
                701.34, the Board is proposing to make clarifying amendments to this
                section.
                 Specifically, the Board is proposing to change the cross reference
                in this section to proposed Sec. 702.414 and clarify that this section
                only applies to secondary capital issued before the effective date of
                any final Subordinated Debt regulation. As discussed in the next
                section of this preamble, the Board is proposing to add a section to
                part 741 to address the requirements that apply to a FISCU seeking
                approval to issue Subordinated Debt after the effective date of a final
                Subordinated Date rule.
                2. Sec. 741.226 Subordinated Debt
                 The Board is proposing to add a new section in subpart B of part
                741 to instruct a FISCU to comply with the requirements of subpart D of
                part 702 before it may issue Subordinated Debt. The new proposed
                section also clarifies that a FISCU may only issue Subordinated Debt in
                accordance with subpart D of part 702 if such issuance complies with
                applicable state law and regulation. As discussed in section II. (C)(9)
                of this preamble, subpart D to part 702 includes application procedures
                specific to FISCUs. This proposed new section is clarifying in nature
                and does not result in a substantive change for FISCUs.
                3. Sec. 741.227 Loans to Other Credit Unions
                 The Board is proposing to include a new section in part 741 that
                would make the limitation on loans to credit unions included in
                proposed new Sec. 701.25 applicable to all federally insured credit
                unions. As discussed in section II. (A)(1) of this preamble, the Board
                is proposing a new Sec. 701.25 to address safety and soundness
                concerns with loans between credit unions. Because the concerns
                discussed in relation to Sec. 701.25 are not unique to FCUs, the Board
                believes it is prudent to extend the requirements of that section to
                all credit unions.
                III. Regulatory Procedures
                A. Paperwork Reduction Act
                 The Paperwork Reduction Act of 1995 (PRA) applies to rulemakings in
                which an agency by rule creates a new paperwork burden on regulated
                entities or modifies an existing burden (44 U.S.C. 3507(d)). For
                purposes of the PRA, a paperwork burden may take the form of a
                reporting, recordkeeping, or a third-party disclosure requirement,
                referred to as an information collection.
                 NCUA is seeking comments on the information collection requirement
                of a proposed new subsection to part 702 that addresses requirements
                and regulatory capital treatment of subordinate debt. A request for a
                new OMB control number has been submitted to the Office of Management
                and Budget (OMB) for review and approval. The request contains
                information collection requirements associated with applying for
                authority to issue subordinated debt, credit union eligibility to issue
                subordinate debt, prepayments and disclosures. These information
                collection requirements apply to low-income credit unions (LICUs),
                complex and new credit unions.
                 The initial application requirement to issue subordinated debt can
                be found in Sec. 702.408(b) and is estimated to impact 25 credit
                unions annually and is estimated to take 100 hours per respondent.
                Following approval of the initial application, an issuing credit union
                must prepare and submit for each issuance of subordinated debt, an
                offering document for NCUA approval. This offering document is
                estimated to take each of the 25 issuing credit unions 40 hours to
                prepare. Additional reporting requirements covered under Sec. Sec.
                702.406, 702.408, 702.409, 702.411, and 702.414 involve requests for
                additional information, extensions, and prepayments. An issuing credit
                union must provide a copy of the approved
                [[Page 14020]]
                offering document to each investor (Sec. 701.408(d)), and a FISCU must
                also provide a copy to its state supervisory authority (Sec.
                702.409(a)); averaging an hour per respondent. Recordkeeping
                requirements to maintain records prescribed by this proposed rule is
                estimated to average 15 minutes per record. Proposed new Sec.
                701.25(b) requires federally insured credit unions to establish a
                written policies for making loans to other credit unions. This
                recordkeeping requirement to retain this policy update is estimated to
                average 30 minutes and would impact 3,300 credit union.
                 Information collection requirement reported under Sec. 702.414 are
                currently cleared under OMB control number 3133-0140, Secondary Capital
                for Low-Income Designated Credit Unions. This burden will be
                consolidated under this request for a new OMB control number and 3133-
                0140 will be discontinued upon prolongation of this rule.
                 OMB Control Number: 3133-NEW.
                 Title of information collection: Subordinated Debt.
                 Estimated number of respondents: 3,300.
                 Estimated number of responses per respondent: 1.12.
                 Estimated total annual responses: 3,703.
                 Estimated burden per response: 1.53.
                 Estimated total annual burden: 5,662.
                 The NCUA invites comments on: (a) Whether the proposed collection
                of information is necessary for the proper performance of the functions
                of the agency, including whether the information will have practical
                utility; (b) the accuracy of the agency's estimate of the burden of the
                proposed collection of information, including the validity of the
                methodology and assumptions used; (c) ways to enhance the quality,
                utility and clarity of the information to be collected; and (d) ways to
                minimize the burden of the collection of information on those who are
                to respond, including through the use of appropriate automated,
                electronic, mechanical, or other technological collection techniques or
                other forms of information technology.
                 All comments are a matter of public records. Comments submitted in
                response to this document will be summarized and included in the
                request for OMB approval. Comments regarding the information collection
                requirements of this rule should be sent to (1) Dawn Wolfgang, NCUA PRA
                Clearance Officer, 1775 Duke Street, Alexandria, VA 22314, Suite 6032,
                or email at [email protected] and the (1) Office of Information and
                Regulatory Affairs, Office of Management and Budget, Attention: Desk
                Officer for NCUA, New Executive Office Building, Room 10235,
                Washington, DC 20503, or email at [email protected].
                B. Executive Order 13132
                 Executive Order 13132 encourages independent regulatory agencies to
                consider the impact of their actions on state and local interests. The
                NCUA, an independent regulatory agency as defined in 44 U.S.C. 3502(5),
                voluntarily complies with the executive order to adhere to fundamental
                federalism principles.
                 This proposed rule does not have substantial direct effects 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. The NCUA has therefore determined that
                this final rule does not constitute a policy that has federalism
                implications for purposes of the executive order.
                C. Assessment of Federal Regulations and Policies on Families
                 The NCUA has determined that this rule will not affect family well-
                being within the meaning of section 654 of the Treasury and General
                Government Appropriations Act, 1999, Public Law 105-277, 112 Stat. 2681
                (1998).
                List of Subjects
                12 CFR Part 701
                 Advertising, Aged, Civil rights, Credit, Credit unions, Fair
                housing, Individuals with disabilities, Insurance, Marital status
                discrimination, Mortgages, Religious discrimination, Reporting and
                recordkeeping requirements, Sex discrimination, Signs and symbols,
                Surety bonds.
                12 CFR Part 702
                 Credit unions, Reporting and recordkeeping requirements.
                12 CFR Part 709
                 Claims, Credit unions.
                12 CFR Part 741
                 Bank deposit insurance, Credit unions, Reporting and recordkeeping
                requirements.
                 By the NCUA Board on January 23, 2020.
                Gerard Poliquin,
                Secretary of the Board.
                 For the reasons discussed above, the NCUA is proposing to amend 12
                CFR parts 701, 702, 709, and 741 as follows:
                PART 701--ORGANIZATION AND OPERATION OF FEDERAL CREDIT UNIONS
                0
                1. The authority citation for part 701 continues to read as follows:
                 Authority: 12 U.S.C. 1752(5), 1755, 1756, 1757, 1758, 1759,
                1761a, 1761b, 1766, 1767, 1782, 1784, 1785, 1786, 1787, 1788, 1789.
                Section 701.6 is also authorized by 15 U.S.C. 3717. Section 701.31
                is also authorized by 15 U.S.C. 1601 et seq.; 42 U.S.C. 1981 and
                3601-3610. Section 701.35 is also authorized by 42 U.S.C. 4311-4312.
                0
                2. Add Sec. 701.25 to read as follows:
                Sec. 701.25 Loans to credit unions.
                 (a) Limits. A federal credit union may make loans, including
                investments in Subordinated Debt, to other credit unions, including
                corporate credit unions and privately insured credit unions, subject to
                the following limits:
                 (1) Aggregate limit. The aggregate principal amount of loans to
                other credit unions may not exceed 25 percent of the federal credit
                union's paid-in and unimpaired capital and surplus.
                 (2) Single borrower limit. The aggregate principal amount of loans
                made to any one credit union may not exceed the greater of 15 percent
                of the federal credit union's Net Worth, as defined in part 702 of this
                chapter, at the time of the closing of the loan or $100,000, plus an
                additional 10 percent of the federal credit union's Net Worth if the
                amount that exceeds the federal credit union's 15 percent general limit
                is fully secured at all times with a perfected security interest by
                readily marketable collateral as defined in Sec. 723.2 of this
                chapter.
                 (b) Approval and policies. A federal credit union's board of
                directors must approve all loans to other credit unions and establish
                written policies for making such loans. The written policies must, at a
                minimum, include the following:
                 (1) How the federal credit union will manage the credit risk of
                loans to other credit unions; and
                 (2) The limits on the aggregate principal amount of loans the
                federal credit union can make to other credit unions. The policies must
                specify the limits on the aggregate principal amount of loans the
                federal credit union can make to all other credit unions and the
                aggregate principal amount of loans the federal credit union can make
                to any single credit union; provided that any limits included in such
                policies do not exceed the limits in this section.
                 (c) Investment in Subordinated Debt--(1) Eligibility. A federal
                credit union may only invest, directly or indirectly, in the
                Subordinated Debt of federally
                [[Page 14021]]
                insured, natural person credit unions, or in loans or obligations
                issued by a privately insured credit union that are subordinate to the
                private insurer; provided that the investing federal credit union:
                 (i) Has at the time of the investment, a capital classification of
                ``Well Capitalized,'' as defined in part 702 of this chapter;
                 (ii) Does not have any outstanding Subordinated Debt or
                Grandfathered Secondary Capital, in each case with respect to which it
                was the Issuing Credit Union (as defined in part 702 of this chapter);
                and
                 (iii) Is not eligible to issue Subordinated Debt or Grandfathered
                Secondary Capital pursuant to an unexpired approval from the NCUA under
                subpart D of part 702 of this chapter.
                 (2) Aggregate limit--(i) Aggregate limit. A federal credit union's
                aggregate investment (direct or indirect) in the Subordinated Debt and
                Grandfathered Secondary Capital of any federally insured, natural
                person credit union, and in loans or obligations issued by a privately
                insured credit union that are subordinate to the private insurer, may
                not cause such aggregate investment to exceed, at the time of the
                investment, the lesser of:
                 (A) 25 percent of the investing federal credit union's Net Worth at
                the time of the investment; and
                 (B) Any amount of Net Worth in excess of seven percent (7%) of
                total assets.
                 (ii) Calculation of aggregate limit. The amount subject to the
                limit in subsection (A) of this section is calculated at the time of
                investment, and is based on a federal credit union's aggregate
                outstanding:
                 (A) Investment in Subordinated Debt;
                 (B) Investment in Grandfathered Secondary Capital;
                 (C) Investment in loans or obligations issued by a privately
                insured credit union that are subordinate to the private insurer; and
                 (D) Loans or portion of loans made by the credit union that is
                secured by any Subordinated Debt, Grandfathered Secondary Capital, or
                loans or obligations issued by a privately insured credit union that
                are subordinate to the private insurer.
                 (3) Indirect investment. A federal credit union must determine its
                indirect exposure by calculating its proportional ownership share of
                each exposure held in a fund, or similar indirect investment. The
                federal credit union's exposure to the fund is equal to the exposure
                held by the fund as if they were held directly by the federal credit
                union, multiplied by the federal credit union's proportional ownership
                share of the fund.
                0
                3. In Sec. 701.34,
                0
                a. Revise the section heading;
                0
                b. Remove and reserve paragraph (b); and
                0
                c. Remove paragraphs (c) and (d) and Appendix to Sec. 701.34.
                 The revision reads as follows:
                Sec. 701.34 Designation of low income status.
                * * * * *
                0
                4. Revise Sec. 701.38 to read as follows:
                Sec. 701.38 Borrowed funds.
                 (a) Federal credit unions may borrow funds from any source;
                provided that:
                 (1) The borrowing is evidenced by a written contract, such as a
                signed promissory note, that sets forth the terms and conditions
                including, at a minimum, maturity, prepayment, interest rate, method of
                computation of interest, and method of payment;
                 (2) The written contract and any solicitation with respect to such
                borrowing contain clear and conspicuous language indicating that:
                 (i) The funds represent money borrowed by the federal credit union;
                and
                 (ii) The funds do not represent shares and, therefore, are not
                insured by the National Credit Union Administration.
                 (b) A federal credit union is subject to the maximum borrowing
                authority of an aggregate amount not exceeding 50 percent of its paid-
                in and unimpaired capital and surplus. Provided that any federal credit
                union may discount with or sell to any federal intermediate credit bank
                any eligible obligations up to the amount of its paid-in and unimpaired
                capital (12 U.S.C. 1757(9)).
                PART 702--CAPITAL ADEQUACY
                0
                5. The authority citation for part 702 continues to read as follows:
                 Authority: 12 U.S.C. 1766(a), 1790d.
                0
                6. In Sec. 702.2:
                0
                a. Add a sentence after the first sentence of the introductory text;
                0
                b. Add a definition for ``Grandfathered Secondary Capital'' in
                alphabetical order;
                0
                c. Amend the definition of ``Net Worth'' by revising the introductory
                text and paragraphs (1) and (2); and
                0
                d. Add a definition for ``Subordinated Debt'' in alphabetical order.
                 The additions and revision read as follows:
                Sec. 702.2 Definitions.
                 * * * All accounting terms not otherwise defined herein have the
                meanings assigned to them in accordance with United States generally
                accepted accounting principles (U.S. GAAP). * * *
                * * * * *
                 Grandfathered Secondary Capital means any subordinated debt issued
                in accordance with Sec. 701.34 of this chapter (recodified as Sec.
                702.414) or, in the case of a federally insured, state-chartered credit
                union, with Sec. 741.204(c) of this chapter before [EFFECTIVE DATE OF
                THE FINAL RULE].
                * * * * *
                 Net Worth means, with respect to any federally insured, natural
                person credit union, as of any date of determination:
                 (1) The retained earnings balance of the credit union at the most
                recent quarter end, as determined in accordance with U.S. GAAP, subject
                to paragraph (3) of this definition.
                 (2) With respect to a low-income designated credit union, the
                outstanding principal amount of Subordinated Debt treated as Regulatory
                Capital in accordance with Sec. 702.407, and the outstanding principal
                amount of Grandfathered Secondary Capital treated as Regulatory Capital
                in accordance with Sec. 702.414, in each case that is:
                 (i) Uninsured; and
                 (ii) Subordinate to all other claims against the credit union,
                including claims of creditors, shareholders, and the National Credit
                Union Share Insurance Fund.
                * * * * *
                 Subordinated Debt has the meaning as provided in subpart D of this
                part.
                * * * * *
                0
                7. In Sec. 702.104, revise paragraph (b)(1)(vii) and add paragraph
                (c)(2)(v)(B)(9) to read as follows:
                Sec. 702.104 Risk-based capital ratio.
                * * * * *
                 (b) * * *
                 (1) * * *
                 (vii) The outstanding principal amount of Subordinated Debt treated
                as Regulatory Capital in accordance with Sec. 702.407 and the
                outstanding principal amount of Grandfathered Secondary Capital treated
                as Regulatory Capital in accordance with Sec. 702.414; and
                * * * * *
                 (c) * * *
                 (2) * * *
                 (v) * * *
                 (B) * * *
                 (9) Natural person credit union Subordinated Debt, Grandfathered
                Secondary Capital, and loans or obligations issued by a privately
                insured credit union that are subordinate to the private insurer.
                * * * * *
                [[Page 14022]]
                0
                8. Amend Sec. 702.109 by:
                0
                a. Redesignating paragraphs (a)(3) and (4) as paragraphs (a)(4) and
                (5), respectively;
                0
                b. Adding new paragraph (a)(3); and
                0
                c. Revising paragraph (b)(11).
                 The addition and revision read as follows:
                Sec. 702.109 Prompt corrective action for critically
                undercapitalized credit unions.
                 (a) * * *
                 (3) Restrictions on payments on Subordinated Debt. Beginning 60
                days after the effective date of a federally insured, natural person
                credit union being classified by the NCUA as ``Critically
                Undercapitalized'', that credit union shall not pay principal of or
                interest on its Subordinated Debt, except that unpaid interest shall
                continue to accrue under the terms of the related Subordinated Debt
                Note (as defined in subpart D of this part), to the extent permitted by
                law;
                * * * * *
                 (b) * * *
                 (11) Restrictions on payments on Grandfathered Secondary Capital.
                Beginning 60 days after the effective date of classification of a
                credit union as ``Critically Undercapitalized'', prohibit payments of
                principal, dividends or interest on the credit union's Grandfathered
                Secondary Capital (as defined in subpart D of this part), except that
                unpaid dividends or interest shall continue to accrue under the terms
                of the account to the extent permitted by law;
                * * * * *
                0
                10. Revise Sec. 702.205(d) to read as follows:
                Sec. 702.205 Prompt corrective action for uncapitalized new credit
                unions.
                * * * * *
                 (d) Discretionary liquidation of an uncapitalized new credit union.
                In lieu of paragraph (c) of this section, an uncapitalized new credit
                union may be placed into liquidation on grounds of insolvency pursuant
                to 12 U.S.C. 1787(a)(1)(A).
                Sec. 702.206 [Amended]
                0
                11. Amend Sec. 702.206 by removing paragraph (d), and redesignating
                paragraphs (e) through (h) as (d) through (g), respectively.
                0
                12. Redesignate Sec. Sec. 702.207 through 702.210 as Sec. Sec.
                702.208 through 702.211, respectively, and add new Sec. 702.207 to
                read as follows:
                Sec. 702.207 Consideration of Subordinated Debt and Grandfathered
                Secondary Capital for new credit unions.
                 (a) Exception from prompt corrective action for new credit unions.
                The requirements of Sec. Sec. 702.204 and 702.205 do not apply to a
                new credit union if, as of the applicable date of determination, each
                of the following conditions is satisfied:
                 (1) The new credit union has outstanding Subordinated Debt or
                Grandfathered Secondary Capital;
                 (2) The Subordinated Debt or Grandfathered Secondary Capital would
                be treated as Regulatory Capital under subpart D of this part if the
                new credit union were a Complex Credit Union or a low income-designated
                credit union;
                 (3) The ratio of the new credit union's Net Worth (including the
                amount of its Subordinated Debt and Grandfathered Secondary Capital
                treated as Regulatory Capital (as defined in subpart D of this part))
                to its total assets is at least seven percent (7%); and
                 (4) The new credit union's Net Worth is increasing in a manner
                consistent with the new credit union's approved initial business plan
                or RBP.
                 (b) Consideration of Subordinated Debt and Grandfathered Secondary
                Capital in evaluating an RBP. The NCUA shall, in evaluating an RBP
                under this subpart B, consider a new credit union's aggregate
                outstanding principal amount of Subordinated Debt and Grandfathered
                Secondary Capital.
                 (c) Prompt corrective action based on other supervisory criteria--
                (1) Application of prompt corrective action to an exempt new credit
                union. The NCUA Board may apply prompt corrective action to a new
                credit union that is otherwise exempt under paragraph (a) of this
                section in the following circumstances:
                 (i) Unsafe or unsound condition. The NCUA Board has determined,
                after providing the new credit union with written notice and
                opportunity for hearing pursuant to Sec. 747.2003 of this chapter,
                that the new credit union is in an unsafe or unsound condition; or
                 (ii) Unsafe or unsound practice. The NCUA Board has determined,
                after providing the new credit union with written notice and
                opportunity for hearing pursuant to Sec. 747.2003 of this chapter,
                that the new credit union has not corrected a material unsafe or
                unsound practice of which it was, or should have been, aware.
                 (2) Non-delegation. The NCUA Board may not delegate its authority
                under paragraph (c) of this section.
                 (3) Consultation with state officials. The NCUA Board shall consult
                and seek to work cooperatively with the appropriate state official
                before taking action under paragraph (c) of this section and shall
                promptly notify the appropriate state official of its decision to take
                action under paragraph (c) of this section.
                 (d) Discretionary liquidation. Notwithstanding paragraph (a) of
                this section, the NCUA may place a new credit union into liquidation
                pursuant to 12 U.S.C. 1787(a)(3)(A), provided that the new credit
                union's ratio under paragraph (a)(3) of this section is, as of the
                applicable date of determination, below six percent (6%) and the new
                credit union has no reasonable prospect of becoming ``Adequately
                Capitalized'' under Sec. 702.202.
                 (e) Restrictions on payments on Subordinated Debt. Beginning 60
                days after the effective date of a new credit union being classified by
                the NCUA as ``Uncapitalized'', the new credit union shall not pay
                principal of or interest on its Subordinated Debt, except that unpaid
                interest shall continue to accrue under the terms of the related
                Subordinated Debt Note, to the extent permitted by law.
                0
                13. Redesignate subparts D and E as subparts E and F, respectively, and
                add new subpart D to read as follows:
                Subpart D--Subordinated Debt, Grandfathered Secondary Capital, and
                Regulatory Capital
                Sec.
                702.401 Purpose and scope.
                702.402 Definitions.
                702.403 Eligibility.
                702.404 Requirements of the Subordinated Debt and Subordinated Debt
                Note.
                702.405 Disclosures.
                702.406 Requirements related to the offer, sale, and issuance of
                Subordinated Debt Notes.
                702.407 Discounting of amount treated as Regulatory Capital.
                702.408 Preapproval to issue Subordinated Debt.
                702.409 Preapproval for federally insured, state-chartered credit
                unions to issue Subordinated Debt.
                702.410 Interest payments on Subordinated Debt.
                702.411 Prior written approval to prepay Subordinated Debt.
                702.412 Effect of a merger or dissolution on the treatment of
                Subordinated Debt as Regulatory Capital.
                702.413 Repudiation safe harbor.
                702.414 Regulations governing Grandfathered Secondary Capital.
                Appendix A to Subpart D of Part 702--Disclosure and Acknowledgement
                Form
                Subpart D--Subordinated Debt, Grandfathered Secondary Capital, and
                Regulatory Capital
                Sec. 702.401 Purpose and scope.
                 (a) Subordinated Debt. This subpart sets forth the requirements
                applicable to all Subordinated Debt issued by a federally insured,
                natural person credit union, including the NCUA's review
                [[Page 14023]]
                and approval of that credit union's application to issue or prepay
                Subordinated Debt. This subpart shall apply to a federally insured,
                state-chartered credit union only to the extent that such federally
                insured, state-chartered credit union is permitted by applicable state
                law to issue debt instruments of the type described in this subpart. To
                the extent that such state law is more restrictive than this subpart
                with respect to the issuance of such debt instruments, that state law
                shall apply. Any secondary capital, as that term is used in the Federal
                Credit Union Act, issued after [EFFECTIVE DATE OF THE FINAL RULE] is
                Subordinated Debt and subject to the requirements of this subpart.
                 (b) Grandfathered Secondary Capital. Any secondary capital issued
                under Sec. 701.34 of this chapter before [EFFECTIVE DATE OF THE FINAL
                RULE] is governed by Sec. 702.414. Grandfathered Secondary Capital
                will no longer be treated as Regulatory Capital as of [DATE 20 YEARS
                AFTER THE EFFECTIVE DATE OF THE FINAL RULE].
                Sec. 702.402 Definitions.
                 To the extent they differ, the definitions in this section apply
                only to Subordinated Debt and not to Grandfathered Secondary Capital.
                (Definitions applicable to Grandfathered Secondary Capital are in Sec.
                702.414.) All other terms in this subpart and not expressly defined
                herein have the meanings assigned to them elsewhere in this part. For
                ease of use, certain key terms are included below using cross citations
                to other sections of this part where those terms are defined.
                 Accredited Investor means a Natural Person Accredited Investor or
                an Entity Accredited Investor, as applicable.
                 Appropriate Supervision Office means, with respect to any credit
                union, the Regional Office or Office of National Examinations and
                Supervision that is responsible for supervision of that credit union.
                 Complex Credit Union has the same meaning as in subpart A of this
                part.
                 Entity Accredited Investor means an entity that, at the time of
                offering and closing of the issuance and sale of Subordinated Debt to
                that entity, meets the requirements of 17 CFR 230.501(a)(1), (2), (3),
                (7), or (8).
                 Grandfathered Secondary Capital means any subordinated debt issued
                in accordance with Sec. 701.34 of this chapter (recodified as Sec.
                702.414 of subpart D of this part) or, in the case of a federally
                insured, state-chartered credit union, with Sec. 741.204(c) of this
                chapter, before [EFFECTIVE DATE OF THE FINAL RULE].
                 Immediate Family Member means spouse, child, sibling, parent,
                grandparent, or grandchild (including stepparents, stepchildren,
                stepsiblings, and adoptive relationships).
                 Issuing Credit Union means, for purposes of this subpart, a credit
                union that has issued, or is in the process of issuing, Subordinated
                Debt or Grandfathered Secondary Capital in accordance with the
                requirements of this subpart.
                 Low-Income designated Credit Union (LICU) is a credit union
                designated as having low-income status in accordance with Sec. 701.34
                of this chapter.
                 Natural Person Accredited Investor means a natural person who, at
                the time of offering and closing of the issuance and sale of
                Subordinated Debt to that person, meets the requirements of 17 CFR
                230.501(a)(5) or (6); provided that, for purposes of purchasing or
                holding any Subordinated Debt Note, this term shall not include any
                board member or Senior Executive Officer of the Issuing Credit Union or
                any Immediate Family Member of any board member or Senior Executive
                Officer of the Issuing Credit Union.
                 Net Worth has the same meaning as in Sec. 702.2.
                 Net Worth Ratio has the same meaning as in Sec. 702.2.
                 New Credit Union has the same meaning as in Sec. 702.201.
                 Offering Document means the document(s) required by Sec. 702.408,
                including any term sheet, offering memorandum, private placement
                memorandum, offering circular, or other similar document used to offer
                and sell Subordinated Debt Notes.
                 Pro Forma Financial Statements means projected financial statements
                that show the effects of proposed transactions as if they actually
                occurred in a variety of plausible scenarios, including both optimistic
                and pessimistic assumptions, over measurement horizons that align with
                the credit union's expected activities.
                 Qualified Counsel means an attorney licensed to practice law in the
                relevant jurisdiction(s) who has expertise in the areas of federal and
                state securities laws and debt transactions similar to those described
                in this subpart.
                 Regulatory Capital means:
                 (1) With respect to an Issuing Credit Union that is a LICU and not
                a Complex Credit Union, the aggregate outstanding principal amount of
                Subordinated Debt and, until [DATE 20 YEARS AFTER THE EFFECTIVE DATE OF
                THE FINAL RULE], Grandfathered Secondary Capital that is included in
                the credit union's Net Worth Ratio;
                 (2) With respect to an Issuing Credit Union that is a Complex
                Credit Union and not a LICU, the aggregate outstanding principal amount
                of Subordinated Debt that is included in the credit union's RBC Ratio;
                 (3) With respect to an Issuing Credit Union that is both a LICU and
                a Complex Credit Union, the aggregate outstanding principal amount of
                Subordinated Debt and, until [DATE 20 YEARS AFTER THE EFFECTIVE DATE OF
                THE FINAL RULE], Grandfathered Secondary Capital that is included in
                its Net Worth Ratio and in its RBC Ratio; and
                 (4) With respect to a New Credit Union, the aggregate outstanding
                principal amount of Subordinated Debt and, until [DATE 20 YEARS AFTER
                THE EFFECTIVE DATE OF THE FINAL RULE], Grandfathered Secondary Capital
                that is considered pursuant to Sec. 702.207.
                 Retained Earnings has the same meaning as in United States GAAP.
                 RBC Ratio has the same meaning as in Sec. 702.2.
                 Senior Executive Officer means a credit union's chief executive
                officer (for example, president or treasurer/manager), any assistant
                chief executive officer (e.g., any assistant president, any vice
                president or any assistant treasurer/manager) and the chief financial
                officer (controller). The term ``Senior Executive Officer'' also
                includes employees and contractors of an entity, such as a consulting
                firm, hired to perform the functions of positions covered by the term
                Senior Executive Officer.
                 Subordinated Debt means an Issuing Credit Union's borrowing that
                meets the requirements of this subpart, including all obligations and
                contracts related to such borrowing.
                 Subordinated Debt Note means the written contract(s) evidencing the
                Subordinated Debt.
                Sec. 702.403 Eligibility.
                 (a) Subject to receiving approval under Sec. 702.408 or 702.409, a
                credit union may issue Subordinated Debt only if, at the time of such
                issuance, the credit union is:
                 (1) A Complex Credit Union with a capital classification of at
                least ``Undercapitalized,'' as defined in Sec. 702.102;
                 (2) A LICU;
                 (3) Able to demonstrate to the satisfaction of the NCUA that it
                reasonably anticipates becoming either a Complex Credit Union meeting
                the requirements of paragraph (a)(1) of this section or a LICU within
                24 months
                [[Page 14024]]
                after issuance of the Subordinated Debt Notes; or
                 (4) A new credit union with Retained Earnings equal to or greater
                than one percent (1%) of assets.
                 (b) At the time of issuance of any Subordinated Debt, an Issuing
                Credit Union may not have any investments, direct or indirect, in
                Subordinated Debt or Grandfathered Secondary Capital (or any interest
                therein) of another credit union. If a credit union acquires
                Subordinated Debt or Grandfathered Secondary Capital in a merger or
                other consolidation, the Issuing Credit Union may still issue
                Subordinated Debt, but it may not invest (directly or indirectly) in
                the Subordinated Debt or Grandfathered Secondary Capital of any other
                credit union while any Subordinated Debt Notes issued by the Issuing
                Credit Union remain outstanding.
                 (c) If the Issuing Credit Union is a Complex Credit Union that is
                not also a LICU, the aggregate outstanding principal amount of all
                Subordinated Debt issued by that Issuing Credit Union may not exceed
                100 percent of its Net Worth, as determined at the time of each
                issuance of Subordinated Debt.
                Sec. 702.404 Requirements of the Subordinated Debt and Subordinated
                Debt Note.
                 (a) Requirements. At a minimum, the Subordinated Debt or the
                Subordinated Debt Note, as applicable, must:
                 (1) Be in the form of a written, unconditional promise to pay on a
                specified date a sum certain in money in return for adequate
                consideration in money;
                 (2) Have, at the time of issuance, a fixed stated maturity of at
                least five years and not more than 20 years from issuance. The stated
                maturity of the Subordinated Debt Note may not reset and may not
                contain an option to extend the maturity;
                 (3) Be subordinate to all other claims in liquidation under Sec.
                709.5(b) of this chapter, and have the same payout priority as all
                other outstanding Subordinated Debt and Grandfathered Secondary
                Capital;
                 (4) Be properly characterized as debt in accordance with U.S. GAAP;
                 (5) Be unsecured, including, without limitation, prohibiting the
                establishment of any legally enforceable claim against funds earmarked
                for payment of the Subordinated Debt through:
                 (i) A compensating balance or any other funds or assets subject to
                a legal right of offset, as defined by applicable state law; or
                 (ii) A sinking fund, such as a fund formed by periodically setting
                aside money for the gradual repayment of the Subordinated Debt.
                 (6) Be applied by the Issuing Credit Union at the end of each of
                its fiscal years (or more frequently as determined by the Issuing
                Credit Union) in which the Subordinated Debt remains outstanding to
                cover any deficit in Retained Earnings on a pro rata basis among all
                holders of the Subordinated Debt and Grandfathered Secondary Capital of
                the Issuing Credit Union; it being understood that any amounts applied
                to cover a deficit in Retained Earnings shall no longer be considered
                due and payable to the holder(s) of the Subordinated Debt or
                Grandfathered Secondary Capital;
                 (7) Except as provided in Sec. Sec. 702.411 and 702.412(c), be
                payable in full by the Issuing Credit Union or its successor or
                assignee only at maturity;
                 (8) Disclose any prepayment penalties or restrictions on
                prepayment;
                 (9) Be offered, issued, and sold only to Entity Accredited
                Investors or Natural Person Accredited Investors, in accordance Sec.
                702.406; and
                 (10) Be re-offered, reissued, and resold only to an Entity
                Accredited Investor (if the initial offering, issuance, and sale was
                solely made to Entity Accredited Investors) or any Accredited Investor
                (if the initial offering, issuance, and sale involved one or more
                Natural Person Accredited Investors).
                 (b) Restrictions. The Subordinated Debt or the Subordinated Debt
                Note, as applicable, must not:
                 (1) Be structured or identified as a share, share account, or any
                other instrument in the Issuing Credit Union that is insured by the
                National Credit Union Administration;
                 (2) Include any express or implied terms that make it senior to any
                other Subordinated Debt issued under this subpart or Grandfathered
                Secondary Capital;
                 (3) Cause the Issuing Credit Union to exceed the borrowing limit in
                Sec. 741.2 of this chapter or, for federally insured, state-chartered
                credit unions, any more restrictive state borrowing limit;
                 (4) Provide the holder thereof with any management or voting rights
                in the Issuing Credit Union;
                 (5) Be eligible to be pledged or provided by the investor as
                security for a loan from, or other obligation owing to, the Issuing
                Credit Union;
                 (6) Include any express or implied term, condition, or agreement
                that would require the Issuing Credit Union to prepay or accelerate
                payment of principal of or interest on the Subordinated Debt prior to
                maturity, including investor put options;
                 (7) Include an express or implied term, condition, or agreement
                that would trigger an event of default based on the Issuing Credit
                Union's default on other debts;
                 (8) Include any condition, restriction, or requirement based on the
                Issuing Credit Union's credit quality or other credit-sensitive
                feature; or
                 (9) Require the Issuing Credit Union to make any form of payment
                other than in cash.
                 (c) Negative covenants. A Subordinated Debt Note must not include
                any provision or covenant that unduly restricts or otherwise acts to
                unduly limit the authority of the Issuing Credit Union or interferes
                with the NCUA's supervision of the Issuing Credit Union. This includes,
                but is not limited to, a provision or covenant that:
                 (1) Requires the Issuing Credit Union to maintain a minimum amount
                of Retained Earnings or other metric, such as a minimum Net Worth Ratio
                or minimum asset, liquidity, or loan ratios;
                 (2) Unreasonably restricts the Issuing Credit Union's ability to
                raise capital through the issuance of additional Subordinated Debt;
                 (3) Provides for default of the Subordinated Debt as a result of
                the Issuing Credit Union's compliance with any law, regulation, or
                supervisory directive from the NCUA or, if applicable, the state
                supervisory authority;
                 (4) Provides for default of the Subordinated Debt as the result of
                a change in the ownership, management, or organizational structure or
                charter of the Issuing Credit Union; provided that, following such
                change, the Issuing Credit Union or the resulting institution, as
                applicable:
                 (i) Agrees to perform all of the obligations, terms, and conditions
                of the Subordinated Debt; and
                 (ii) At the time of such change, is not in material default of any
                provision of the Subordinated Debt Note, after giving effect to the
                applicable cure period described in paragraph (d) of this section.
                 (5) Provides for default of the Subordinated Debt as the result of
                an act or omission of any third party, including but not limited to a
                credit union service organization, as defined in Sec. 712.1(d) of this
                chapter.
                 (d) Default covenants. A Subordinated Debt Note that includes
                default covenants must provide the Issuing Credit Union with a
                reasonable cure period of not less than 30 calendar days.
                 (e) Minimum denominations of issuances to Natural Person Accredited
                Investors. An Issuing Credit Union may only issue Subordinated Debt
                Notes to Natural Person Accredited Investors in minimum denominations
                of $100,000, and cannot exchange any such
                [[Page 14025]]
                Subordinated Debt Notes after the initial issuance or any subsequent
                resale for Subordinated Debt Notes of the Issuing Credit Union in
                denominations less than $10,000. Each such Subordinated Debt Note, if
                issued in certificate form, must include a legend disclosing that it
                cannot be exchanged for Subordinated Debt Notes of the Issuing Credit
                Union in denominations less than $100,000, and Subordinated Debt Notes
                issued in book-entry or other uncertificated form shall include
                appropriate instructions prohibiting the exchange of such Subordinated
                Debt Notes for Subordinated Debt Notes of the Issuing Credit Union in
                denominations that would violate the foregoing restrictions.
                Sec. 702.405 Disclosures.
                 (a) An Issuing Credit Union must disclose the following language
                clearly, in all capital letters, on the face of a Subordinated Debt
                Note:
                 THIS OBLIGATION IS NOT A SHARE IN THE ISSUING CREDIT
                UNION AND IS NOT INSURED BY THE NATIONAL CREDIT UNION
                ADMINISTRATION.
                 THIS OBLIGATION IS UNSECURED AND SUBORDINATE TO ALL
                CLAIMS AGAINST THE ISSUING CREDIT UNION AND IS INELIGIBLE AS
                COLLATERAL FOR A LOAN BY THE ISSUING CREDIT UNION.
                 AMOUNTS OTHERWISE PAYABLE HEREUNDER MAY BE REDUCED IN
                ORDER TO COVER ANY DEFICIT IN RETAINED EARNINGS OF THE ISSUING
                CREDIT UNION. AMOUNTS APPLIED TO COVER ANY SUCH DEFICIT WILL RESULT
                IN A CORRESPONDING REDUCTION OF THE PRINCIPAL AMOUNT OF ALL
                OUTSTANDING SUBORDINATED DEBT ISSUED BY THE ISSUING CREDIT UNION,
                AND WILL NO LONGER BE DUE AND PAYABLE TO THE HOLDERS OF SUCH
                SUBORDINATED DEBT. AMOUNTS APPLIED TO COVER ANY SUCH DEFICIT MUST BE
                APPLIED AMONG ALL HOLDERS OF SUCH SUBORDINATED DEBT PRO RATA BASED
                ON THE AGGREGATE AMOUNT OF SUBORDINATED DEBT OWED BY THE ISSUING
                CREDIT UNION TO EACH SUCH HOLDER AT THE TIME OF APPLICATION.
                 THIS OBLIGATION CAN ONLY BE REPAID AT MATURITY OR IN
                ACCORDANCE WITH 12 CFR 702.411. THIS OBLIGATION MAY ALSO BE REPAID
                IN ACCORDANCE WTH 12 CFR PART 710 IF THE ISSUING CREDIT UNION
                VOLUNTARILY LIQUIDATES.
                 THE NOTE EVIDENCING THIS OBLIGATION HAS NOT BEEN AND
                WILL NOT BE REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED
                (THE ``SECURITIES ACT''), OR THE SECURITIES LAWS OF ANY STATE OF THE
                UNITED STATES OR ANY OTHER JURISDICTION, AND MAY BE ISSUED, SOLD,
                PLEDGED, OR OTHERWISE TRANSFERRED ONLY (A) AS PERMITTED IN THE NOTE
                AND TO A PERSON WHOM THE ISSUER OR SELLER REASONABLY BELIEVES IS [AN
                ``ACCREDITED INVESTOR'' (AS DEFINED IN 12 CFR 702.402)] [AN ``ENTITY
                ACCREDITED INVESTOR'' (AS DEFINED IN 12 CFR 702.402)] (THAT IS NOT A
                MEMBER OF THE ISSUING CREDIT UNION'S BOARD, A SENIOR EXECUTIVE
                OFFICER OF THE ISSUING CREDIT UNION (AS THAT TERM IS DEFINED IN 12
                CFR 702.402), OR ANY IMMEDIATE FAMILY MEMBER OF ANY SUCH BOARD
                MEMBER OR SENIOR EXECUTIVE OFFICER), PURCHASING FOR ITS OWN ACCOUNT,
                (1) TO WHOM NOTICE IS GIVEN THAT THE SALE, PLEDGE, OR OTHER TRANSFER
                IS BEING MADE IN RELIANCE ON THE EXEMPTION FROM SECURITIES ACT
                REGISTRATION PROVIDED BY SECTION 3(a)(5) OF THE SECURITIES ACT, OR
                (2) IN ACCORDANCE WITH ANOTHER EXEMPTION FROM THE REGISTRATION
                REQUIREMENTS OF THE SECURITIES ACT (SUBJECT TO THE DELIVERY OF SUCH
                CERTIFICATIONS, LEGAL OPINIONS, OR OTHER INFORMATION AS THE ISSUING
                CREDIT UNION MAY REASONABLY REQUIRE TO CONFIRM THAT SUCH SALE,
                PLEDGE, OR TRANSFER IS BEING MADE PURSUANT TO AN EXEMPTION FROM, OR
                IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF
                THE SECURITIES ACT), (B) IN COMPLIANCE WITH THE CERTIFICATION AND
                OTHER REQUIREMENTS SPECIFIED IN THE [INDENTURE OR OTHER DOCUMENT
                PURSUANT TO WHICH THE SUBORDINATED DEBT NOTE IS ISSUED] REFERRED TO
                HEREIN, AND (C) IN ACCORDANCE WITH ANY APPLICABLE SECURITIES LAWS OF
                ANY STATE OF THE UNITED STATES AND ANY OTHER APPLICATION
                JURISDICTION.
                 (b) An Issuing Credit Union must also clearly and accurately
                disclose in the Subordinated Debt Note:
                 (1) The payout priority and level of subordination, as described in
                Sec. 709.5(b) of this chapter, that would apply in the event of the
                involuntary liquidation of the Issuing Credit Union;
                 (2) A general description of the NCUA's regulatory authority that
                includes, at a minimum:
                 (i) If the Issuing Credit Union is ``Undercapitalized'' or, if the
                Issuing Credit Union is a New Credit Union, ``Moderately Capitalized''
                (each as defined in this part), and fails to submit an acceptable Net
                Worth restoration plan, capital restoration plan, or revised business
                plan, as applicable, or materially fails to implement such a plan that
                was approved by the NCUA, the Issuing Credit Union may be subject to
                all of the additional restrictions and requirements applicable to a
                ``Significantly Undercapitalized'' credit union or, if the Issuing
                Credit Union is a New Credit Union, a ``Marginally Capitalized'' New
                Credit Union;
                 (ii) Beginning 60 days after the effective date of an Issuing
                Credit Union being classified as ``Critically Undercapitalized'' or, in
                the case of a New Credit Union, ``Uncapitalized,'' the Issuing Credit
                Union shall not pay principal of or interest on its Subordinated Debt,
                until reauthorized to do so by the NCUA; provided, however, that unpaid
                interest shall continue to accrue under the terms of the Subordinated
                Debt Note, to the extent permitted by law.
                 (3) The risk factors associated with the NCUA's or, if applicable,
                the state supervisory authority's, authority to conserve or liquidate a
                credit union under the Federal Credit Union Act (FCU Act) or applicable
                state law.
                Sec. 702.406 Requirements related to the offer, sale, and issuance
                of Subordinated Debt Notes.
                 (a) Offering Document. An Issuing Credit Union or person acting on
                behalf of or at the direction of any Issuing Credit Union may only
                issue and sell Subordinated Debt Notes if, a reasonable time prior to
                the issuance and sale of any Subordinated Debt Notes, each purchaser of
                a Subordinated Debt Note receives an Offering Document that meets the
                requirements of Sec. 702.408(e) and such further material information,
                if any, as may be necessary to make the required disclosures in that
                Offering Document, in the light of the circumstances under which they
                are made, not misleading.
                 (b) Territorial limitations. An Issuing Credit Union may only
                offer, issue, and sell Subordinated Debt Notes in the United States of
                America (including any one of the states thereof and the District of
                Columbia), its territories, and its possessions.
                 (c) Accredited Investors. An Issuing Credit Union may only offer,
                issue, and sell Subordinated Debt to Accredited Investors, and the
                terms of any Subordinated Debt Note must include the restrictions in
                Sec. 702.404(a)(10); provided that no Subordinated Debt Note may be
                issued, sold, resold, pledged, or otherwise transferred to a member of
                the board of the Issuing Credit Union, any Senior Executive Officer of
                the Issuing Credit Union, or any Immediate Family Member of any such
                board member or Senior Executive Officer. Prior to the offer of any
                Subordinated Debt Note, the Issuing Credit Union must receive a signed,
                one-page, unambiguous certification from any potential investor of a
                Subordinated Debt Note. The certification must be in substantially the
                following form:
                [[Page 14026]]
                CERTIFICATE OF ACCREDITED INVESTOR STATUS
                 Except as may be indicated by the undersigned below, the
                undersigned is an accredited investor, as that term is defined in
                Regulation D under the Securities Act of 1933, as amended (the
                ``Act''). In order to demonstrate the basis on which it is
                representing its status as an accredited investor, the undersigned
                has checked one of the boxes below indicating that the undersigned
                is:
                 [ ] A bank as defined in Section 3(a)(2) of the Act, or any
                savings and loan association or other institution as defined in
                Section 3(a)(5)(A) of the Act whether acting in its individual or
                fiduciary capacity; a broker or dealer registered pursuant to
                Section 15 of the Securities Exchange Act of 1934; an insurance
                company as defined in Section 2(a)(13) of the Act; an investment
                company registered under the Investment Company Act of 1940 or a
                business development company as defined in Section 2(a)(48) of that
                act; a small business investment company licensed by the U.S. Small
                Business Administration under Section 301(c) or (d) of the Small
                Business Investment Act of 1958; a plan established and maintained
                by a state, its political subdivisions, or any agency or
                instrumentality of a state or its political subdivisions, for the
                benefit of its employees, if such plan has total assets in excess of
                $5,000,000; an employee benefit plan within the meaning of the
                Employee Retirement Income Security Act of 1974, if the investment
                decision is made by a plan fiduciary, as defined in Section 3(21) of
                such act, which is either a bank, savings and loan association,
                insurance company, or registered investment adviser, or if the
                employee benefit plan has total assets in excess of $5,000,000 or,
                if a self-directed plan, with investment decisions made solely by
                persons that are accredited investors;
                 [ ] A private business development company as defined in Section
                202(a)(22) of the Investment Advisers Act of 1940;
                 [ ] An organization described in Section 501(c)(3) of the
                Internal Revenue Code; a corporation; a Massachusetts or similar
                business trust; or a partnership, not formed for the specific
                purpose of acquiring the securities offered, with total assets in
                excess of $5,000,000;
                 [ ] A natural person whose individual net worth, or joint net
                worth with the undersigned's spouse, at the time of this purchase
                exceeds $1,000,000 (excluding the value of the person's primary
                residence);
                 [ ] A natural person who had individual income in excess of
                $200,000 in each of the two most recent years or joint income with
                the undersigned's spouse in excess of $300,000 in each of those
                years and has a reasonable expectation of reaching the same income
                level in the current year;
                 [ ] A trust with total assets in excess of $5,000,000, not
                formed for the specific purpose of acquiring the securities offered,
                whose purchase is directed by a person who has such knowledge and
                experience in financial and business matters that he or she is
                capable of evaluating the merits and risks of the prospective
                investment; or
                 [ ] An entity in which all of the equity holders are accredited
                investors by virtue of their meeting one or more of the above
                standards.
                 The undersigned understands that [NAME OF ISSUING CREDIT UNION]
                (the ``Credit Union'') is required to verify the undersigned's
                accredited investor status AND ELECTS TO DO ONE OF THE FOLLOWING:
                 [ ] Allow the Credit Union's representative to review the
                undersigned's tax returns for the two most recently completed years
                and provide a written representation of the undersigned's reasonable
                expectation of reaching the income level necessary to qualify as an
                accredited investor during the current year;
                 [ ] Allow the Credit Union's representative to: (1) Obtain a
                written representation from the undersigned that states that all
                liabilities necessary to make a determination of net worth have been
                disclosed; and (2) review one or more of the following types of
                documentation dated within the past three months: bank statements,
                brokerage statements, tax assessments, appraisal reports as to
                assets, or a consumer report from a nationwide consumer reporting
                agency;
                 [ ] Provide the Credit Union with a written confirmation from
                one of the following persons or entities that such person or entity
                has taken reasonable steps to verify that the undersigned is an
                accredited investor within the prior three months and has determined
                that the undersigned is an accredited investor:
                 A registered broker-dealer;
                 An investment adviser registered with the Securities
                Exchange Commission;
                 A licensed attorney who is in good standing under the
                laws of the jurisdictions in which such attorney is admitted to
                practice law; or
                 A certified public accountant who is duly registered
                and in good standing under the laws of the place of such
                accountant's residence or principal office.
                 In Witness Whereof, the undersigned has executed this
                Certificate of Accredited Investor Status effective as of ___, 20_.
                Name of Investor
                [Name of Authorized Representative
                Title of Authorized Representative]
                Signature
                Address
                Address
                Phone Number
                Email Address
                 (d) Use of trustees. If using a trustee in connection with the
                offer, issuance, and sale of Subordinated Debt Notes, the trustee must
                meet the requirements set forth in the Trust Indenture Act of 1939, as
                amended, and any rules promulgated thereunder, including requirements
                for qualification set forth in section 310 thereof, and any applicable
                state law.
                 (e) Offers, issuances, and sales of Subordinated Debt Notes. Offers
                issuances, and sales of Subordinated Debt Notes are required to be made
                in accordance with the following requirements:
                 (1) Application to offer, issue, and sell at offices of Issuing
                Credit Union. If the Issuing Credit Union intends to offer and sell
                Subordinated Debt Notes at one or more of its offices, the Issuing
                Credit Union must first apply in writing to the Appropriate Supervision
                Office indicating that it intends to offer, issue, and sell
                Subordinated Debt Notes at one or more of its offices. The application
                must include, at a minimum, the physical locations of such offices and
                a description of how the Issuing Credit Union will comply with the
                requirements of this subsection;
                 (2) Decision on application. Within 60 calendar days (which may be
                extended by the Appropriate Supervision Office) after the date of
                receipt of a complete application described in paragraph (e)(1) of this
                section, the Appropriate Supervision Office will provide the Issuing
                Credit Union with a written determination on its application to conduct
                offering and sales activity from its office(s). Any denial of an
                Issuing Credit Union's application under this section will include the
                reasons for such denial;
                 (3) Commissions, bonuses, or comparable payments. In connection
                with any offering and sale of Subordinated Debt Notes (whether or not
                conducted at offices of the Issuing Credit Union), an Issuing Credit
                Union shall not pay, directly or indirectly, any commissions, bonuses,
                or comparable payments to any employee of the Issuing Credit Union or
                any affiliated Credit Union Service Organizations (CUSOs) assisting
                with the offer, issuance, and sale of such Subordinated Debt Notes, or
                to any other person in connection with the offer, issuance, and sale of
                Subordinated Debt Notes; except that compensation and commissions
                consistent with industry norms may be paid to securities personnel of
                registered broker-dealers as otherwise permitted by applicable law;
                 (4) Issuances by tellers. No offers or sales may be made by tellers
                at the teller counter of any Issuing Credit Union, or by comparable
                persons at comparable locations;
                 (5) Permissible issuing personnel. In connection with an offering
                or sale of Subordinated Debt Notes (whether or not conducted at offices
                of the Issuing Credit Union), such activity may be conducted only by
                regular, full-time employees of the Issuing Credit Union or by
                securities personnel who are subject to supervision by a registered
                broker-dealer, which securities personnel may be employees of the
                Issuing Credit Union's affiliated CUSO that is assisting the Issuing
                Credit Union
                [[Page 14027]]
                with the offer, issuance, and sale of the Subordinated Debt Notes;
                 (6) Issuance practices, advertisements, and other literature used
                in connection with the offer and sale of Subordinated Debt Notes. In
                connection with an offering or sale of Subordinated Debt Notes (whether
                or not conducted at offices of the Issuing Credit Union), issuance
                practices, advertisements, and other issuance literature used in
                connection with offers and issuances of Subordinated Debt Notes by
                Issuing Credit Unions or any affiliated CUSOs assisting with the offer
                and issuance of such Subordinated Debt Notes shall be subject to the
                requirements of this subpart; and
                 (7) Office of an Issuing Credit Union. For purposes of this
                subsection, an ``office'' of an Issuing Credit Union means any premises
                used by the Issuing Credit Union that is identified to the public
                through advertising or signage using the Issuing Credit Union's name,
                trade name, or logo.
                 (f) Securities laws. An Issuing Credit Union must comply with all
                applicable federal and state securities laws.
                 (g) Resales. All resales of Subordinated Debt Notes issued by an
                Issuing Credit Union by holders of such Subordinated Debt Notes must be
                made pursuant to Rule 144 under the Securities Act of 1933, as amended
                (17 CFR 230.144) (other than paragraphs (c), (e), (f), (g) and (h) of
                such Rule), Rule 144A under the Securities Act of 1933, as amended (17
                CFR 230.144A), or another exemption from registration under the
                Securities Act of 1933, as amended. Subordinated Debt Notes must
                include the restrictions on resales in Sec. 702.404(a)(10).
                Sec. 702.407 Discounting of amount treated as Regulatory Capital.
                 The amount of outstanding Subordinated Debt that may be treated as
                Regulatory Capital shall reduce by 20 percent per annum of the initial
                aggregate principal amount of the applicable Subordinated Debt (as
                reduced by prepayments or amounts extinguished to cover a deficit under
                Sec. 702.404(a)(6)), as required by the following schedule:
                ------------------------------------------------------------------------
                 Balance
                 treated as
                 Remaining maturity Regulatory
                 Capital
                 (percent)
                ------------------------------------------------------------------------
                Four to less than five years............................... 80
                Three to less than four years.............................. 60
                Two to less than three years............................... 40
                One to less than two years................................. 20
                Less than one year......................................... 0
                ------------------------------------------------------------------------
                Sec. 702.408 Preapproval to issue Subordinated Debt.
                 (a) Scope. This section requires all credit unions to receive
                written preapproval from the NCUA before issuing Subordinated Debt.
                Procedures related specifically to applications from federally insured,
                state-chartered credit unions are contained in Sec. 702.409. A credit
                union seeking approval to offer and sell Subordinated Debt at one or
                more of its offices must also follow the application procedures in
                Sec. 702.406(e). All approvals under this section are subject to the
                expiration limits specified in paragraph (k) of this section.
                 (b) Initial application to issue Subordinated Debt. A credit union
                requesting approval to issue Subordinated Debt must first submit an
                application to the Appropriate Supervision Office that, at a minimum,
                includes:
                 (1) A statement indicating how the credit union qualifies to issue
                Subordinated Debt given the eligibility requirements of Sec. 702.403
                with additional supporting analysis if anticipating to meet the
                requirements of a LICU or Complex Credit Union within 24 months after
                issuance of the Subordinated Debt;
                 (2) The maximum aggregate principal amount of Subordinated Debt
                Notes and the maximum number of discrete issuances of Subordinated Debt
                Notes that the credit union is proposing to issue within the period
                allowed under paragraph (k) of this section;
                 (3) The estimated number of investors and the status of such
                investors (Natural Person Accredited Investors and/or Entity Accredited
                Investors) to whom the credit union intends to offer and sell the
                Subordinated Debt Notes;
                 (4) A statement identifying any outstanding Subordinated Debt or
                Grandfathered Secondary Capital previously issued by the credit union;
                 (5) A copy of the credit union's strategic plan, business plan, and
                budget, and an explanation of how the credit union intends to use the
                Subordinated Debt in conformity with those plans;
                 (6) An analysis of how the credit union will provide for liquidity
                to repay the Subordinated Debt upon maturity of the Subordinated Debt;
                 (7) Pro Forma Financial Statements (balance sheet, income
                statement, and statement of cash flows), including any off-balance
                sheet items, covering at least five years. Analytical support for key
                assumptions and key assumption changes must be included in the
                application. Key assumptions include, but are not limited to, interest
                rate, liquidity, and credit loss scenarios;
                 (8) A statement indicating how the credit union will use the
                proceeds from the issuance and sale of the Subordinated Debt;
                 (9) A statement identifying the governing law specified in the
                Subordinated Debt Notes and the documents pursuant to which the
                Subordinated Debt Notes will be issued;
                 (10) A draft written policy governing the offer, and issuance, and
                sale of the Subordinated Debt, developed in consultation with Qualified
                Counsel, which, at a minimum, addresses:
                 (i) Compliance with all applicable federal and state securities
                laws and regulations;
                 (ii) Compliance with applicable securities laws related to
                communications with investors and potential investors, including, but
                not limited to: Who may communicate with investors and potential
                investors; what information may be provided to investors and potential
                investors; ongoing disclosures to investors; who will review and ensure
                the accuracy of the information provided to investors and potential
                investors; and to whom information will be provided;
                 (iii) Compliance with any laws that may require registration of
                credit union employees as broker-dealers; and
                 (iv) Any use of outside agents, including broker-dealers, to assist
                in the marketing and issuance of Subordinated Debt, and any limitations
                on such use.
                 (11) A schedule that provides an itemized statement of all expenses
                incurred or expected to be incurred by the credit union in connection
                with the offer, issuance, and sale of the Subordinated Debt Notes to
                which the initial application relates, other than underwriting
                discounts and commissions or similar compensation payable to broker-
                dealers acting as placement agents. The schedule must include, as
                applicable, fees and expenses of counsel, auditors, any trustee or
                issuing and paying agent or any transfer agent, and printing and
                engraving expenses. If the amounts of any items are not known at the
                time of filing of the initial application, the credit union must
                provide estimates, clearly identified as such;
                 (12) In the case of a New Credit Union, a statement that it is
                subject to either an approved initial business plan or revised business
                plan, as required by this part, and how the proposed Subordinated Debt
                would conform with the approved plan. Unless the New Credit Union has a
                LICU designation pursuant to Sec. 701.34 of this chapter, it must also
                include a plan for replacing the Subordinated Debt with Retained
                Earnings before the credit union ceases
                [[Page 14028]]
                to meet the definition of New Credit Union in Sec. 702.2;
                 (13) A statement describing any investments the credit union has in
                the Subordinated Debt of any other credit union, and the manner in
                which the credit union acquired such Subordinated Debt, including
                through a merger or other consolidation;
                 (14) A signature page signed by the credit union's principal
                executive officer, principal financial officer or principal accounting
                officer, and a majority `of the members of its board of directors.
                Amendments to an initial application must be signed and filed with the
                NCUA in the same manner as the initial application; and
                 (15) Any additional information requested in writing by the
                Appropriate Supervision Office.
                 (c) Decision on initial application. Upon receiving an initial
                application submitted under this subsection and any additional
                information requested in writing by the Appropriate Supervision Office,
                the Appropriate Supervision Office will evaluate, at a minimum, the
                credit union's compliance with this subpart and all other NCUA
                regulations, the credit union's ability to manage and safely offer,
                issue, and sell the proposed Subordinated Debt, the safety and
                soundness of the proposed use of the Subordinated Debt, the overall
                condition of the credit union, and any other factors the Appropriate
                Supervision Office determines are relevant.
                 (1) Written determination. Within 60 calendar days (which may be
                extended by the Appropriate Supervision Office) after the date of
                receipt of a complete application, the Appropriate Supervision Office
                will provide the credit union with a written determination on its
                application. In the case of a full or partial denial, or conditional
                approval under paragraph (c)(2) of this section, the written decision
                will state the reasons for the denial or conditional approval.
                 (2) Conditions of approval. Any approval granted by an Appropriate
                Supervision Office under this section may include one or more of the
                following conditions:
                 (i) Approval of an aggregate principal amount of Subordinated Debt
                that is lower than what the credit union requested;
                 (ii) Any applicable minimum level of Net Worth that the credit
                union must maintain while the Subordinated Debt Notes are outstanding;
                 (iii) Approved uses of the Subordinated Debt; and
                 (iv) Any other limitations or conditions the Appropriate
                Supervision Office deems necessary to protect the NCUSIF.
                 (d) Offering Document. Following receipt of written approval of its
                initial application, an Issuing Credit Union must prepare an Offering
                Document for each issuance of Subordinated Debt Notes. In addition, as
                required in paragraph (f) of this section, an Issuing Credit Union that
                intends to offer Subordinated Debt Notes to any Natural Person
                Accredited Investors must have the related Offering Document declared
                ``approved for use'' by the NCUA before its first use. At a reasonable
                time prior to any issuance and sale of Subordinated Debt Notes, the
                Issuing Credit Union must provide each investor with an Offering
                Document as described in this section. All Offering Documents must be
                filed with the NCUA within two business days after their respective
                first use.
                 (e) Requirements for all Offering Documents. (1) Minimum
                information required in an Offering Document. An Offering Document
                must, at a minimum, include the following information:
                 (i) The name of the Issuing Credit Union and the address of its
                principal executive office;
                 (ii) The initial principal amount of the Subordinated Debt being
                issued;
                 (iii) The name(s) of any underwriter(s) or placement agents being
                used for the issuance;
                 (iv) A description of the material risk factors associated with the
                purchase of the Subordinated Debt Notes, including any special or
                distinctive characteristics of the Issuing Credit Union's business,
                field of membership, or geographic location that are reasonably likely
                to have a material impact on the Issuing Credit Union's future
                financial performance;
                 (v) The disclosures described in Sec. 702.405 and such additional
                material information, if any, as may be necessary to make the required
                disclosures, in the light of the circumstances under which they are
                made, not misleading;
                 (vi) Provisions related to the interest, principal, payment,
                maturity, and prepayment of the Subordinated Debt Notes;
                 (vii) All material affirmative and negative covenants that may or
                will be included in the Subordinated Debt Note, including, but not
                limited to, the covenants discussed in this subpart;
                 (viii) Any legends required by applicable state law; and
                 (ix) The following legend, displayed on the cover page in prominent
                type or in another manner:
                 None of the Securities and Exchange Commission (the ``SEC''),
                any state securities commission or the National Credit Union
                Administration has passed upon the merits of, or given its approval
                of, the purchase of any Subordinated Debt Notes offered or the terms
                of the offering, or passed on the accuracy or completeness of any
                Offering Document or other materials used in connection with the
                offer, issuance, and sale of the Subordinated Debt Notes. Any
                representation to the contrary is unlawful. These Subordinated Debt
                Notes have not been registered under the Securities Act of 1933, as
                amended (the ``Act'') and are being offered and sold to [an Entity
                Accredited Investor][an Accredited Investor] (as defined in 12 CFR
                702.402) pursuant to an exemption from registration under the Act;
                however, neither the SEC nor the NCUA has made an independent
                determination that the offer and issuance of the Subordinated Debt
                Notes are exempt from registration.
                 (2) Legibility requirements. An Issuing Credit Union's Offering
                Document must comply with the following legibility requirements:
                 (i) Information in the Offering Document must be presented in a
                clear, concise, and understandable manner, incorporating plain English
                principles. The body of all printed Offering Documents shall be in type
                at least as large and as legible as 10-point type. To the extent
                necessary for convenient presentation, however, financial statements
                and other tabular data, including tabular data in notes, may be in type
                at least as large and as legible as 8-point type. Repetition of
                information should be avoided. Cross-referencing of information within
                the document is permitted; and
                 (ii) Where an Offering Document is distributed through an
                electronic medium, the Issuing Credit Union may satisfy legibility
                requirements applicable to printed documents, such as paper size, type
                size and font, bold-face type, italics and red ink, by presenting all
                required information in a format readily communicated to offerees and,
                where indicated, in a manner reasonably calculated to draw the
                attention of offerees to specific information.
                 (f) Offering Documents approved for use in offerings of
                Subordinated Debt to any Natural Person Accredited Investors--(1)
                Filing of a Draft Offering Document. An Issuing Credit Union that
                intends to offer Subordinated Debt Notes to any Natural Person
                Accredited Investors must file a draft Offering Document with the NCUA
                and have such draft Offering Document declared ``approved for use'' by
                the NCUA before its first use.
                 (i) Request for additional information, clarifications, or
                amendments. Prior to declaring any Offering Document ``approved for
                use,'' the NCUA may ask
                [[Page 14029]]
                questions, request clarifications, or direct the Issuing Credit Union
                to amend certain sections of the draft Offering Document. The NCUA will
                make any such requests in writing.
                 (ii) Written determination. Within 60 calendar days (which may be
                extended by the NCUA) after the date of receipt of each of the initial
                filing and each filing of additional information, clarifications, or
                amendments requested by the NCUA under paragraph (f)(1)(i) of this
                section, the NCUA will provide the Issuing Credit Union with a written
                determination on the applicable filing. The written determination will
                include any requests for additional information, clarifications, or
                amendments, or a statement that the Offering Document is ``approved for
                use.''
                 (2) Filing of a final Offering Document. At such time as the NCUA
                declares an Offering Document ``approved for use'' in accordance with
                paragraph (f)(1)(ii) of this section, the Issuing Credit Union may then
                use that Offering Document in the offer and sale of the Subordinated
                Debt Notes. The Issuing Credit Union must file a copy of each of its
                Offering Documents with the NCUA within two business days after their
                respective first use.
                 (g) Filing of an Offering Document for offerings of Subordinated
                Debt exclusively to Entity Accredited Investors. An Issuing Credit
                Union that is offering Subordinated Debt exclusively to Entity
                Accredited Investors is not required to have its Offering Document
                ``approved for use'' by the NCUA under paragraph (f) of this section
                before using it to offer and sell the Subordinated Debt Notes. As
                described in this section, however, the Issuing Credit Union must file
                a copy of each of its Offering Documents with the NCUA within two
                business days after their respective first use.
                 (h) Material changes to any initial application or Offering
                Document--(1) Reapproval of initial application. If any material event
                arises or material change in fact occurs after the approval of the
                initial application by the NCUA, but prior to the completion of the
                offer and sale of the related Subordinated Debt Notes, then no person
                shall offer or sell Subordinated Debt Notes to any other person until
                an amendment to the Offering Document reflecting the event or change
                has been filed with and approved by the NCUA.
                 (2) Reapproval of Offering Document. If an Offering Document must
                be approved for use under paragraph (f) of this section, and any event
                arises or change in fact occurs after the approval for use of any
                Offering Document, and that event or change in fact, individually or in
                the aggregate, results in the Offering Document containing any untrue
                statement of material fact, or omitting to state a material fact
                necessary in order to make statements made in the Offering Document not
                misleading in light of the circumstances under which they were made,
                then no person shall offer or sell Subordinated Debt Notes to any other
                person until an amendment reflecting the event or change has been filed
                with and ``approved for use'' by the NCUA.
                 (3) Failure to request reapproval. If an Issuing Credit Union fails
                to comply with paragraph (h)(1) or (2) of this section, the NCUA may,
                at its discretion, exercise the full range of administrative remedies
                available under the FCU Act, including:
                 (i) Prohibiting the Issuing Credit Union from issuing any
                additional Subordinated Debt for a specified period; and/or
                 (ii) Determining not to treat the Subordinated Debt as Regulatory
                Capital.
                 (i) Notification. Not later than 10 business days after the closing
                of a Subordinated Debt Note issuance and sale, the Issuing Credit Union
                must submit to the Appropriate Supervision Office:
                 (1) A copy of each executed Subordinated Debt Note;
                 (2) A copy of each executed purchase agreement, if any;
                 (3) Any indenture or other transaction document used to issue the
                Subordinated Debt Notes;
                 (4) Copies of signed certificates of Accredited Investor status, in
                a form similar to that in Sec. 702.406(c), from all investors;
                 (5) All documentation provided to investors related to the offer
                and sale of the Subordinated Debt Note (other than any Offering
                Document that was previously filed with the NCUA); and
                 (6) Any other material documents governing the issuance, sale or
                administration of the Subordinated Debt Notes.
                 (j) Resubmissions. An Issuing Credit Union that receives any
                adverse written determination from the Appropriate Supervision Office
                with respect to the approval of its initial application or any
                amendment thereto or, if applicable, the approval for use of an
                Offering Document or any amendment thereto, may cure any reasons noted
                in the written determination and refile under the requirements of this
                section. This subsection does not prohibit an Issuing Credit Union from
                appealing an Appropriate Supervision Office's decision under subpart A
                of part 746 of this chapter.
                 (k) Expiration of authority to issue Subordinated Debt. (1) Any
                approvals to issue Subordinated Debt Notes under this section expire
                one year from the later of the date the Issuing Credit Union receives:
                 (i) Approval of its initial application, if the Issuing Credit
                Union is offering Subordinated Notes exclusively to Entity Accredited
                Investors; or
                 (ii) The initial approval for use of its Offering Document, if the
                Issuing Credit Union is offering Subordinated Debt Notes to any Natural
                Person Accredited Investors.
                 (2) Failure to issue all or part of the maximum aggregate principal
                amount of Subordinated Debt Notes approved in the initial application
                process within the applicable period specified in paragraph (k) of this
                section will result in the expiration of the NCUA's approval. An
                Issuing Credit Union may file a written extension request with the
                Appropriate Supervision Office. The Issuing Credit Union must
                demonstrate good cause for any extension(s), and must file the request
                at least 30 calendar days before the expiration of the applicable
                period specified in paragraph (k) of this section or any extensions
                granted under paragraph (k) of this section. In any such written
                application, the Issuing Credit Union must address whether any such
                extension poses any material securities law implications.
                 (l) Filing requirements and inspection of documents. (1) Except as
                otherwise provided in this section, all initial applications, Offering
                Documents, amendments, notices, or other documents must be filed with
                the NCUA electronically at http://www.NCUA.gov. Documents may be signed
                electronically using the signature provision in Rule 402 under the
                Securities Act of 1933, as amended (17 CFR 230.402).
                 (2) Provided the Issuing Credit Union filing the document has
                complied with all requirements regarding the filing, the date of filing
                of the document is the date the NCUA receives the filing. An electronic
                filing that is submitted on a business day by direct transmission
                commencing on or before 5:30 p.m. Eastern Standard or Daylight Savings
                Time, whichever is then currently in effect, would be deemed received
                by the NCUA on the same business day. An electronic filing that is
                submitted by direct transmission commencing after 5:30 p.m. Eastern
                Standard or Daylight Savings Time, whichever is then currently in
                effect, or on a Saturday, Sunday, or Federal holiday, would be deemed
                received by the NCUA on the next business day. If an electronic filer
                in good faith attempts to file a document
                [[Page 14030]]
                with the NCUA in a timely manner, but the filing is delayed due to
                technical difficulties beyond the electronic filer's control, the
                electronic filer may request that the NCUA adjust the filing date of
                such document. The NCUA may grant the request if it appears that such
                adjustment is appropriate and consistent with the public interest and
                the protection of investors.
                 (3) If an Issuing Credit Union experiences unanticipated technical
                difficulties preventing the timely preparation and submission of an
                electronic filing, the Issuing Credit Union may, upon notice to the
                Appropriate Supervision Office, file the subject filing in paper format
                no later than one business day after the date on which the filing was
                to be made.
                 (4) Any filing of amendments or supplements to an Offering Document
                must include two copies, one of which must be marked to indicate
                clearly and precisely, by underlining or in some other conspicuous
                manner, the changes made from the previously filed Offering Document.
                 (m) Filing fees. (1) The NCUA may require filing fees to accompany
                certain filings made under this subpart before it will accept those
                filings. The NCUA provides an applicable fee schedule on its website at
                www.NCUA.gov.
                 (2) Filing fees must be paid to the NCUA by electronic transfer.
                Sec. 702.409 Preapproval for federally insured, state-chartered
                credit unions to issue Subordinated Debt.
                 (a) A federally insured, state-chartered credit union is required
                to submit the information required under Sec. 702.408 and, if
                applicable, paragraph (b) of this section to both the Appropriate
                Supervision Office and its state supervisory authority. The Appropriate
                Supervision Office will issue decisions approving a federally insured,
                state-chartered credit union's application only after obtaining the
                concurrence of the federally insured, state-chartered credit union's
                state supervisory authority. The NCUA will notify a federally insured,
                state-chartered credit union's state supervisory authority before
                issuing a decision to ``approve for use'' a federally insured, state-
                chartered credit union's Offering Document and any amendments thereto,
                under Sec. 702.408, if applicable.
                 (b) If the Appropriate Supervision Office has reason to believe
                that an issuance by a federally insured, state-chartered credit union
                under this subpart could subject that federally insured, state-
                chartered credit union to federal income taxation, the Appropriate
                Supervision Office may require the federally insured, state-chartered
                credit union to provide:
                 (1) A written legal opinion, satisfactory to the NCUA, from
                nationally recognized tax counsel or letter from the Internal Revenue
                Service indicating whether the proposed Subordinated Debt would be
                classified as capital stock for federal income tax purposes and, if so,
                describing any material impact of federal income taxes on the federally
                insured, state-chartered credit union's financial condition; or
                 (2) A Pro Forma Financial Statement (balance sheet, income
                statement, and statement of cash flows), covering a minimum of five
                years, that shows the impact of the federally insured, state-chartered
                credit union being subject to federal income tax.
                 (c) If the Appropriate Supervision Office requires additional
                information from a federally insured, state-chartered credit union
                under paragraph (b) of this section, the federally insured, state-
                chartered credit union may determine, in its sole discretion, whether
                the information it provides is in the form described in paragraph
                (b)(1) or (2) of this section.
                Sec. 702.410 Interest payments on Subordinated Debt.
                 (a) Requirements for interest payments. An Issuing Credit Union is
                prohibited from paying interest on Subordinated Debt in accordance with
                Sec. 702.109.
                 (b) Accrual of interest. Notwithstanding nonpayment pursuant to
                paragraph (a) of this section, interest on the Subordinated Debt may
                continue to accrue according to terms provided for in the Subordinated
                Debt Note and as otherwise permitted in this subpart.
                 (c) Interest safe harbor. Except as otherwise provided in this
                section, the NCUA shall not impose a discretionary supervisory action
                that requires the Issuing Credit Union to suspend interest with respect
                to the Subordinated Debt if:
                 (1) The issuance and sale of the Subordinated Debt complies with
                all requirements of this subpart;
                 (2) The Subordinated Debt is issued and sold in an arms-length,
                bona fide transaction;
                 (3) The Subordinated Debt was issued and sold in the ordinary
                course of business, with no intent to hinder, delay or defraud the
                Issuing Credit Union or its creditors; and
                 (4) The Subordinated Debt was issued and sold for adequate
                consideration in U.S. dollars.
                 (d) Authority, rights, and powers of the NCUA and the NCUA Board.
                This section does not waive, limit, or otherwise affect the authority,
                rights, or powers of the NCUA or the NCUA Board in any capacity,
                including the NCUA Board as conservator or liquidating agent, to take
                any action or to exercise any power not specifically mentioned,
                including but not limited to any rights, powers or remedies of the NCUA
                Board as conservator or liquidating agent regarding transfers or other
                conveyances taken in contemplation of the Issuing Credit Union's
                insolvency or with the intent to hinder, delay or defraud the Issuing
                Credit Union or the creditors of such Issuing Credit Union, or that is
                fraudulent under applicable law.
                Sec. 702.411 Prior written approval to prepay Subordinated Debt.
                 (a) Prepayment option. An Issuing Credit Union may include in the
                terms of its Subordinated Debt an option that allows the Issuing Credit
                Union to prepay the Subordinated Debt in whole or in part prior to
                maturity, provided, however, that the Issuing Credit Union is required
                to:
                 (1) Clearly disclose the requirements of this section in the
                Subordinated Debt Note; and
                 (2) Obtain approval under paragraph (b) of this section before
                exercising a prepayment option.
                 (b) Prepayment application. Before an Issuing Credit Union can, in
                whole or in part, prepay Subordinated Debt prior to maturity, the
                Issuing Credit Union must first submit to the Appropriate Supervision
                Office an application that must include, at a minimum, the information
                required in paragraph (d) of this section.
                 (c) Federally insured, state-chartered credit union prepayment
                applications. Before a federally insured, state-chartered credit union
                may submit an application for prepayment to the Appropriate Supervision
                Office, it must obtain written approval from its state supervisory
                authority to prepay the Subordinated Debt it is proposing to prepay. A
                federally insured, state-chartered credit union must provide evidence
                of such approval as part of its application to the Appropriate
                Supervision Office.
                 (d) Application contents. An Issuing Credit Union's application to
                prepay Subordinated Debt must include, at a minimum, the following:
                 (1) A copy of the Subordinated Debt Note and any agreement(s)
                reflecting the terms and conditions of the Subordinated Debt the
                Issuing Credit Union is proposing to prepay;
                 (2) An explanation why the Issuing Credit Union believes it still
                would hold an amount of capital commensurate with its risk exposure
                notwithstanding
                [[Page 14031]]
                the proposed prepayment or a description of the replacement
                Subordinated Debt, including the amount of such instrument, and the
                time frame for issuance, the Issuing Credit Union is proposing to use
                to replace the prepaid Subordinated Debt; and
                 (3) Any additional information the Appropriate Supervision Office
                requests.
                 (e) Decision on application to prepay. (1) Within 45 calendar days
                (which may be extended by the Appropriate Supervision Office) after the
                date of receipt of a complete application, the Appropriate Supervision
                Office will provide the Issuing Credit Union with a written
                determination on its application. In the case of a full or partial
                denial, including a conditional approval under paragraph (e)(2) of this
                section, the written decision will state the reasons for the denial or
                conditional approval.
                 (2) The written determination from the Appropriate Supervision
                Office may approve the Issuing Credit Union's request, approve the
                Issuing Credit Union's request with conditions, or deny the Issuing
                Credit Union's request. In the case of a denial or conditional
                approval, the Appropriate Supervision Office will provide the Issuing
                Credit Union with a description of why it denied the Issuing Credit
                Union's request or imposed conditions on the approval of such request.
                 (3) If the Issuing Credit Union proposes or the NCUA requires the
                Issuing Credit Union to replace the Subordinated Debt, the Issuing
                Credit Union must receive affirmative approval under this subpart and
                must issue and sell the replacement instrument prior to or concurrently
                with prepaying the Subordinated Debt.
                 (f) Resubmissions. An Issuing Credit Union that receives an adverse
                written determination on its application to prepay, in whole or in
                part, may cure any deficiencies noted in the Appropriate Supervision
                Office's written determination and reapply under the requirements of
                this section. This subsection does not prohibit an Issuing Credit Union
                from appealing the Appropriate Supervision Office's adverse decision
                under subpart A of part 746 of this chapter.
                Sec. 702.412 Effect of a merger or dissolution on the treatment of
                Subordinated Debt as Regulatory Capital.
                 (a) In the event of a merger of an Issuing Credit Union into or the
                assumption of its Subordinated Debt by another federally insured credit
                union, the Subordinated Debt will be treated as Regulatory Capital only
                to the extent that the resulting credit union is either a LICU, a
                Complex Credit Union, and/or a New Credit Union.
                 (b) In the event the resulting credit union is not a LICU, a
                Complex Credit Union, or a New Credit Union, the Subordinated Debt of
                the merging credit union can either be:
                 (1) If permitted by the terms of the Subordinated Debt Note, repaid
                by the resulting credit union upon approval by the NCUA under Sec.
                702.411; or
                 (2) Continue to be held by the resulting credit union as
                Subordinated Debt, but will not be classified as Regulatory Capital
                under this subpart, unless the resulting credit union meets the
                eligibility requirements of Sec. 702.403.
                 (c) Voluntary liquidation. In the event of a voluntary dissolution
                of an Issuing Credit Union that has outstanding Subordinated Debt, the
                Subordinated Debt may be repaid in full according to 12 CFR part 710,
                subject to the requirements in Sec. 702.411.
                Sec. 702.413 Repudiation safe harbor.
                 (a) The NCUA Board as conservator for a federally insured credit
                union, or its lawfully appointed designee, shall not exercise its
                repudiation authorities under 12 U.S.C. 1787(c) with respect to
                Subordinated Debt if:
                 (1) The issuance and sale of the Subordinated Debt complies with
                all requirements of this subpart;
                 (2) The Subordinated Debt was issued and sold in an arms-length,
                bona fide transaction;
                 (3) The Subordinated Debt was issued and sold in the ordinary
                course of business, with no intent to hinder, delay or defraud the
                Issuing Credit Union or its creditors; and
                 (4) The Subordinated Debt was issued and sold for adequate
                consideration in U.S. dollars.
                 (b) This section does not authorize the attachment of any
                involuntary lien upon the property of either the NCUA Board as
                conservator or liquidating agent or its lawfully appointed designee.
                Nor does this section waive, limit, or otherwise affect the authority,
                rights, or powers of the NCUA or the NCUA Board in any capacity to take
                any action or to exercise any power not specifically mentioned,
                including but not limited to any rights, powers or remedies of the NCUA
                Board as conservator or liquidating agent (or its lawfully appointed
                designee) regarding transfers or other conveyances taken in
                contemplation of the Issuing Credit Union's insolvency or with the
                intent to hinder, delay or defraud the Issuing Credit Union or the
                creditors of such Issuing Credit Union, or that is fraudulent under
                applicable law.
                Sec. 702.414 Regulations governing Grandfathered Secondary Capital.
                 This section codifies the requirements of Sec. Sec. 701.34(b),
                (c), and (d) of this chapter in subpart D, with minor modifications, in
                effect before [EFFECTIVE DATE OF THE FINAL RULE]. The terminology used
                in this section is specific to this section. All secondary capital
                issued before the effective date of this rule that was issued in
                accordance with Sec. Sec. 701.34(b), (c), and (d) of this chapter in
                subpart D or, in the case of a federally insured, state-chartered
                credit union, Sec. 741.204(c) of this chapter, that is referred to
                elsewhere in this subpart as ``Grandfathered Secondary Capital,'' is
                subject to the requirements set forth in this section.
                 (a) Secondary capital is subject to the following conditions:
                 (1) Secondary capital plan. A credit union that has Grandfathered
                Secondary Capital under this section must have a written, NCUA-approved
                ``Secondary Capital Plan'' that, at a minimum:
                 (i) States the maximum aggregate amount of uninsured secondary
                capital the LICU plans to accept;
                 (ii) Identifies the purpose for which the aggregate secondary
                capital will be used, and how it will be repaid;
                 (iii) Explains how the LICU will provide for liquidity to repay
                secondary capital upon maturity of the accounts;
                 (iv) Demonstrates that the planned uses of secondary capital
                conform to the LICU's strategic plan, business plan and budget; and
                 (v) Includes supporting pro forma financial statements, including
                any off-balance sheet items, covering a minimum of the next two years.
                 (2) Issuances not completed before [EFFECTIVE DATE OF THE FINAL
                RULE]. Any issuances of secondary capital not completed by the
                effective date of this subpart are, as of the effective date of this
                subpart, subject to the requirements applicable to Subordinated Debt
                discussed elsewhere in this subpart.
                 (3) Nonshare account. The secondary capital account is established
                as an uninsured secondary capital account or other form of non-share
                account.
                 (4) Minimum maturity. The maturity of the secondary capital account
                is a minimum of five years.
                 (5) Uninsured account. The secondary capital account is not insured
                by the National Credit Union Share Insurance Fund or any governmental
                or private entity.
                 (6) Subordination of claim. The secondary capital account
                investor's claim against the LICU is subordinate to all other claims
                including those of
                [[Page 14032]]
                shareholders, creditors and the National Credit Union Share Insurance
                Fund.
                 (7) Availability to cover losses. Funds deposited into a secondary
                capital account, including interest accrued and paid into the secondary
                capital account, are available to cover operating losses realized by
                the LICU that exceed its net available reserves (exclusive of secondary
                capital and allowance accounts for loan and lease losses), and to the
                extent funds are so used, the LICU must not restore or replenish the
                account under any circumstances. The LICU may, in lieu of paying
                interest into the secondary capital account, pay accrued interest
                directly to the investor or into a separate account from which the
                secondary capital investor may make withdrawals. Losses must be
                distributed pro-rata among all secondary capital accounts held by the
                LICU at the time the losses are realized. In instances where a LICU
                accepted secondary capital from the United States Government or any of
                its subdivisions under the Community Development Capital Initiative of
                2010 (``CDCI secondary capital'') and matching funds were required
                under the Initiative and are on deposit in the form of secondary
                capital at the time a loss is realized, a LICU must apply either of the
                following pro-rata loss distribution procedures to its secondary
                capital accounts with respect to the loss:
                 (i) If not inconsistent with any agreements governing other
                secondary capital on deposit at the time a loss is realized, the CDCI
                secondary capital may be excluded from the calculation of the pro-rata
                loss distribution until all of its matching secondary capital has been
                depleted, thereby causing the CDCI secondary capital to be held as
                senior to all other secondary capital until its matching secondary
                capital is exhausted. The CDCI secondary capital should be included in
                the calculation of the pro-rata loss distribution and is available to
                cover the loss only after all of its matching secondary capital has
                been depleted.
                 (ii) Regardless of any agreements applicable to other secondary
                capital, the CDCI secondary capital and its matching secondary capital
                may be considered a single account for purposes of determining a pro-
                rata share of the loss and the amount determined as the pro-rata share
                for the combined account must first be applied to the matching
                secondary capital account, thereby causing the CDCI secondary capital
                to be held as senior to its matching secondary capital. The CDCI
                secondary capital is available to cover the loss only after all of its
                matching secondary capital has been depleted.
                 (8) Security. The secondary capital account may not be pledged or
                provided by the account investor as security on a loan or other
                obligation with the LICU or any other party.
                 (9) Merger or dissolution. In the event of merger or other
                voluntary dissolution of the LICU, other than merger into another LICU,
                the secondary capital accounts will be closed and paid out to the
                account investor to the extent they are not needed to cover losses at
                the time of merger or dissolution.
                 (10) Contract agreement. A secondary capital account contract
                agreement must have been executed by an authorized representative of
                the account investor and of the LICU reflecting the terms and
                conditions mandated by this section and any other terms and conditions
                not inconsistent with this section.
                 (11) Disclosure and acknowledgement. An authorized representative
                of the LICU and of the secondary capital account investor each must
                have executed a ``Disclosure and Acknowledgment'' as set forth in the
                appendix to this section at the time of entering into the account
                agreement. The LICU must retain an original of the account agreement
                and the ``Disclosure and Acknowledgment'' for the term of the
                agreement, and a copy must be provided to the account investor.
                 (12) Prompt corrective action. As provided in this part, the NCUA
                may prohibit a LICU as classified ``critically undercapitalized'' or,
                if ``new,'' as ``moderately capitalized'', ``marginally capitalized'',
                ``minimally capitalized'' or ``uncapitalized,'' as the case may be,
                from paying principal, dividends or interest on its uninsured secondary
                capital accounts established after August 7, 2000, `except that unpaid
                dividends or interest will continue to accrue under the terms of the
                account to the extent permitted by law.
                 (b) Accounting treatment; Recognition of net worth value of
                accounts--(1) Debt. A LICU that issued secondary capital accounts
                pursuant to paragraph (a) of this section must record the funds on its
                balance sheet as a debt titled ``uninsured secondary capital account.''
                 (2) Schedule for recognizing net worth value. The LICU's reflection
                of the net worth value of the accounts in its financial statement may
                never exceed the full balance of the secondary capital on deposit after
                any early redemptions and losses. For accounts with remaining
                maturities of less than five years, the LICU must reflect the net worth
                value of the accounts in its financial statement in accordance with the
                lesser of:
                 (i) The remaining balance of the accounts after any redemptions and
                losses; or
                 (ii) The amounts calculated based on the following schedule:
                ------------------------------------------------------------------------
                 Net worth
                 value of
                 Remaining maturity original
                 balance
                 (percent)
                ------------------------------------------------------------------------
                Four to less than five years............................... 80
                Three to less than four years.............................. 60
                Two to less than three years............................... 40
                One to less than two years................................. 20
                Less than one year......................................... 0
                ------------------------------------------------------------------------
                 (3) Financial statement. The LICU must reflect the full amount of
                the secondary capital on deposit in a footnote to its financial
                statement.
                 (c) Redemption of secondary capital. With the written approval of
                NCUA, secondary capital that is not recognized as net worth under
                paragraph (b)(2) of this section (``discounted secondary capital'' re-
                categorized as Subordinated Debt) may be redeemed according to the
                remaining maturity schedule in paragraph (c)(3) of this section.
                 (1) Request to redeem secondary capital. A request for approval to
                redeem discounted secondary capital may be submitted in writing at any
                time, must specify the increment(s) to be redeemed and the schedule for
                redeeming all or any part of each eligible increment, and must
                demonstrate to the satisfaction of NCUA that:
                 (i) The LICU will have a post-redemption net worth classification
                of at least ``adequately capitalized'' under this part;
                 (ii) The discounted secondary capital has been on deposit at least
                two years;
                 (iii) The discounted secondary capital will not be needed to cover
                losses prior to final maturity of the account;
                 (iv) The LICU's books and records are current and reconciled;
                 (v) The proposed redemption will not jeopardize other current
                sources of funding, if any, to the LICU; and
                 (vi) The request to redeem is authorized by resolution of the
                LICU's board of directors.
                 (2) Decision on request. A request to redeem discounted secondary
                capital may be granted in whole or in part. If a LICU is not notified
                within 45 days of receipt of a request for approval to redeem secondary
                capital that its request is either granted or denied, the LICU may
                proceed to redeem secondary capital accounts as proposed.
                 (3) Schedule for redeeming secondary capital.
                [[Page 14033]]
                ------------------------------------------------------------------------
                 Redemption
                 limit as
                 Remaining maturity percent of
                 original
                 balance
                ------------------------------------------------------------------------
                Four to less than five years............................... 20
                Three to less than four years.............................. 40
                Two to less than three years............................... 60
                One to less than two years................................. 80
                ------------------------------------------------------------------------
                 (4) Early redemption exception. Subject to the written approval of
                NCUA obtained pursuant to the requirements of paragraphs (c)(1) and (2)
                of this section, a LICU can redeem all or part of secondary capital
                accepted from the United States Government or any of its subdivisions
                at any time after the secondary capital has been on deposit for two
                years. If the secondary capital was accepted under conditions that
                required matching secondary capital from a source other than the
                Federal Government, the matching secondary capital may also be redeemed
                in the manner set forth in the preceding sentence. For purposes of
                obtaining NCUA's approval, all secondary capital a LICU accepts from
                the United States Government or any of its subdivisions, as well as its
                matching secondary capital, if any, is eligible for early redemption
                regardless of whether any part of the secondary capital has been
                discounted pursuant to paragraph (b)(2) of this section.
                Appendix A to Subpart D of Part 702--Disclosure and Acknowledgement
                Form
                 A LICU that is authorized to accept uninsured secondary capital
                accounts and each investor in such an account must have executed and
                dated the following ``Disclosure and Acknowledgment'' form, a signed
                original of which must be retained by the credit union:
                Disclosure and Acknowledgment
                 [Name of CU] and [Name of investor] hereby acknowledge and agree
                that [Name of investor] has committed [amount of funds] to a
                secondary capital account with [name of credit union] under the
                following terms and conditions:
                 1. Term. The funds committed to the secondary capital account
                are committed for a period of _ years.
                 2. Redemption prior to maturity. Subject to the conditions set
                forth in 12 CFR 702.414, the funds committed to the secondary
                capital account are redeemable prior to maturity only at the option
                of the LICU and only with the prior written approval of NCUA.
                 3. Uninsured, non-share account. The secondary capital account
                is not a share account and the funds committed to the secondary
                capital account are not insured by the National Credit Union Share
                Insurance Fund or any other governmental or private entity.
                 4. Prepayment risk. Redemption of U.S.C. prior to the account's
                original maturity date may expose the account investor to the risk
                of being unable to reinvest the repaid funds at the same rate of
                interest for the balance of the period remaining until the original
                maturity date. The investor acknowledges that it understands and
                assumes responsibility for prepayment risk associated with the [name
                of credit union]'s redemption of the investor's U.S.C. account prior
                to the original maturity date.
                 5. Availability to cover losses. The funds committed to the
                secondary capital account and any interest paid into the account may
                be used by [name of credit union] to cover any and all operating
                losses that exceed the credit union's net worth exclusive of
                allowance accounts for loan losses, and in the event the funds are
                so used, (name of credit union) will under no circumstances restore
                or replenish those funds to [name of institutional investor].
                Dividends are not considered operating losses and are not eligible
                to be paid out of secondary capital.
                 6. Accrued interest. By initialing below, [name of credit union]
                and [name of institutional investor] agree that accrued interest
                will be:
                __Paid into and become part of the secondary capital account;
                __Paid directly to the investor;
                __Paid into a separate account from which the investor may make
                withdrawals; or
                __Any combination of the above provided the details are specified
                and agreed to in writing.
                 7. Subordination of claims. In the event of liquidation of [name
                of credit union], the funds committed to the secondary capital
                account will be subordinate to all other claims on the assets of the
                credit union, including claims of member shareholders, creditors and
                the National Credit Union Share Insurance Fund.
                 8. Prompt Corrective Action. Under certain net worth
                classifications (see 12 CFR 702.204(b)(11), 702.304(b) and
                702.305(b), as the case may be), the NCUA may prohibit [name of
                credit union] from paying principal, dividends or interest on its
                uninsured secondary capital accounts established after August 7,
                2000, except that unpaid dividends or interest will continue to
                accrue under the terms of the account to the extent permitted by
                law.
                ACKNOWLEDGED AND AGREED TO this _day of [month and year] by:
                -----------------------------------------------------------------------
                [name of investor's official]
                [title of official]
                [name of investor]
                [address and phone number of investor]
                [investor's tax identification number]
                -----------------------------------------------------------------------
                [name of credit union official]
                [title of official]
                PART 709--INVOLUNTARY LIQUIDATION OF FEDERAL CREDIT UNIONS AND
                ADJUDICATION OF CREDITOR CLAIMS INVOLVING FEDERALLY INSURED CREDIT
                UNIONS IN LIQUIDATION
                0
                14. The authority citation for part 709 continues to read as follows:
                 Authority: 12 U.S.C. 1757, 1766, 1767, 1786(h), 1786(t), and
                1787(b)(4), 1788, 1789, 1789a.
                0
                15. Amend Sec. 709.5 by revising paragraph (b)(8) to read as follows:
                Sec. 709.5 Payout priorities in involuntary liquidation.
                * * * * *
                 (b) * * *
                 (8) Outstanding Subordinated Debt (as defined in part 702 of this
                chapter) or outstanding Grandfathered Secondary Capital (as defined in
                part 702 of this chapter); and
                * * * * *
                PART 741--REQUIREMENTS OF INSURANCE
                0
                16. The authority citation for part 741 continues to read as follows:
                 Authority: 12 U.S.C. 1757, 1766(a), 1781-1790, and 1790d; 31
                U.S.C. 3717.
                0
                17. Amend Sec. 741.204 by revising paragraph (c) and removing
                paragraph (d) to read as follows:
                Sec. 741.204 Maximum public unit and nonmember accounts, and low-
                income designation.
                * * * * *
                 (c) Follow the requirements of Sec. 702.414 for any Grandfathered
                Secondary Capital (as defined in part 702 of this chapter) issued
                before [EFFECTIVE DATE OF THE FINAL REGULATION].
                0
                18. Add Sec. Sec. 741.226 and 741.227 to read as follows:
                Sec. 741.226 Subordinated Debt.
                 Any credit union that is insured, or that makes application for
                insurance, pursuant to title II of the Act must follow the requirements
                of subpart D of part 702 of this chapter before it may issue
                Subordinated Debt, as that term is defined in Sec. 702.402 of this
                chapter, and to the extent not inconsistent with applicable state law
                and regulation; and
                Sec. 741.227 Loans to credit unions.
                 Any credit union that is insured pursuant to Title II of the Act
                must adhere to the requirements in Sec. 701.25 of this chapter.
                [FR Doc. 2020-01537 Filed 3-9-20; 8:45 am]
                 BILLING CODE 7535-01-P