Subordinated Debt

 
CONTENT
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).
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 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.
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 \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\
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 \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).
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[[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\
---------------------------------------------------------------------------
 \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.
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[[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\
---------------------------------------------------------------------------
 \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).
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 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.
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 \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)).
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 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.
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 \119\ 12 CFR 701.34(b)(1)(ii).
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 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;
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 \120\ For the purposes of this letter, ``leverage'' refers to
funding activity outside a credit union's customary deposit base.
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 (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\
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 \121\ 12 CFR 701.34(b)(1).
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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.
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 \122\ Id. 701.34(b)(2)).
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 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.
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 \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.
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[[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\
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 \124\ 12 CFR part 746, subpart A.
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 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.
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 \125\ IRC 501(c)(14).
 \126\ 12 U.S.C. 1768.
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 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.
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 \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.
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 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).
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 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\
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 \131\ 12 CFR 5.47(f)(2)); (g)(1)(ii).
 \132\ Id. 7022.34(d)(1).
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 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.
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 \133\ Id. 34(b)(9).
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 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).
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 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).
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 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;
* * * * *
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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