12 CFR Part 702 — Capital Adequacy

PART 702—CAPITAL ADEQUACY Authority: 12 U.S.C. 1757(9), 1766(a), 1784(a), 1786(e), 1790d. Source: 65 FR 8584, Feb. 18, 2000, unless otherwise noted. Editorial Note: Nomenclature changes to part 702 appear at 84 FR 1606, Feb. 5, 2019. § 702.1 Authority, purpose, scope, and other supervisory authority. (a) Authority. (b) Purpose. (c) Scope. (d) Other supervisory authority. [80 FR 66706, Oct. 29, 2015; 85 FR 62210, Oct. 2, 2020, as amended at 86 FR 15401, Mar. 23, 2021] § 702.2 Definitions. Unless otherwise provided in this part, the terms used in this part have the same meanings as set forth in FCUA sections 101 and 216, 12 U.S.C. 1752, 1790d. All accounting terms not otherwise defined in this section have meanings consistent with the commonly-accepted meanings under United States generally accepted accounting principles (U.S. GAAP). The following definitions apply to this part: Allowances for loan and lease losses (ALLL) Amortized cost Appropriate state official Call Report Carrying value CCULR Central counterparty (CCP) Charitable donation account Commercial loan Commitment Consumer loan Contractual compensating balance Credit conversion factor (CCF) Credit derivative Credit union Current CUSO Custodian Depository institution Derivative contract Derivatives Clearing Organization Equity investment Equity investment in CUSOs Exchange Excluded goodwill Excluded other intangible assets Exposure amount (1) The amortized cost for investments classified as held-to-maturity and available-for-sale, and the fair value for trading securities. (2) The outstanding balance for Federal Reserve Bank Stock, Central Liquidity Facility Stock, Federal Home Loan Bank Stock, nonperpetual capital and perpetual contributed capital at corporate credit unions, and equity investments in CUSOs. (3) The carrying value for non-CUSO equity investments, and investment funds. (4) The carrying value for the credit union's holdings of general account permanent insurance, and separate account insurance. (5) The amount calculated under § 702.105 of this part for derivative contracts. Fair value Financial collateral First-lien residential real estate loan (1) The credit union made a reasonable and good faith determination at or before consummation of the loan that the member will have a reasonable ability to repay the loan according to its terms; and (2) In transactions where the credit union holds the first-lien and junior lien(s), and no other party holds an intervening lien, for purposes of this part the combined balance will be treated as a single first-lien residential real estate loan. Forward agreement GAAP General account permanent insurance General obligation Goodwill Government guarantee Government-sponsored enterprise (GSE) Grandfathered Secondary Capital Guarantee Identified losses Industrial development bond Intangible assets Investment fund Junior-lien residential real estate loan Loan secured by real estate Loan to a CUSO Loans transferred with limited recourse i.e., Mortgage-backed security (MBS) Mortgage partnership finance program Mortgage servicing assets Multilateral development bank NCUSIF Net worth (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 § 702.407, and the outstanding principal amount of Grandfathered Secondary Capital treated as Regulatory Capital in accordance with § 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. (3) For a credit union that acquires another credit union in a mutual combination, net worth also includes the retained earnings of the acquired credit union, or of an integrated set of activities and assets, less any bargain purchase gain recognized in either case to the extent the difference between the two is greater than zero. The acquired retained earnings must be determined at the point of acquisition under GAAP. A mutual combination, including a supervisory combination, is a transaction in which a credit union acquires another credit union or acquires an integrated set of activities and assets that is capable of being conducted and managed as a credit union. (4) The term “net worth” also includes loans to and accounts in an insured credit union, established pursuant to section 208 of the Act [12 U.S.C. 1788], provided such loans and accounts: (i) Have a remaining maturity of more than 5 years; (ii) Are subordinate to all other claims including those of shareholders, creditors, and the NCUSIF; (iii) Are not pledged as security on a loan to, or other obligation of, any party; (iv) Are not insured by the NCUSIF; (v) Have non-cumulative dividends; (vi) Are transferable; and (vii) Are available to cover operating losses realized by the insured credit union that exceed its available retained earnings. Net worth ratio New credit union Nonperpetual capital Non-security beneficial interest Off-balance sheet exposure (1) For unfunded commitments, excluding unconditionally cancellable commitments, the remaining unfunded portion of the contractual agreement. (2) For loans transferred with limited recourse, or other seller-provided credit enhancements, and that qualify for true sales accounting, the maximum contractual amount the credit union is exposed to according to the agreement, net of any related valuation allowance. (3) For loans transferred under the Federal Home Loan Bank (FHLB) mortgage partnership finance program, the outstanding loan balance as of the reporting date, net of any related valuation allowance. (4) For financial standby letters of credit, the total potential exposure of the credit union under the contractual agreement. (5) For forward agreements that are not derivative contracts, the future contractual obligation amount. (6) For sold credit protection through guarantees and credit derivatives, the total potential exposure of the credit union under the contractual agreement. (7) For off-balance sheet securitization exposures, the notional amount of the off-balance sheet credit exposure (including any credit enhancements, representations, or warranties that obligate a credit union to protect another party from losses arising from the credit risk of the underlying exposures) that arises from a securitization. (8) For securities borrowing or lending transactions, the amount of all securities borrowed or lent against collateral or on an uncollateralized basis. Off-balance sheet items On-balance sheet Other intangible assets Over-the-counter (OTC) interest rate derivative contract Part 703 compliant investment fund Perpetual contributed capital Public sector entity (PSE) Qualifying master netting agreement (1) The agreement creates a single legal obligation for all individual transactions covered by the agreement upon an event of default, including upon an event of conservatorship, receivership, insolvency, liquidation, or similar proceeding, of the counterparty; (2) The agreement provides the credit union the right to accelerate, terminate, and close out on a net basis all transactions under the agreement and to liquidate or set off collateral promptly upon an event of default, including upon an event of conservatorship, receivership, insolvency, liquidation, or similar proceeding, of the counterparty, provided that, in any such case, any exercise of rights under the agreement will not be stayed or avoided under applicable law in the relevant jurisdictions, other than in receivership, conservatorship, resolution under the Federal Deposit Insurance Act, Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act, or under any similar insolvency law applicable to GSEs; (3) The agreement does not contain a walkaway clause (that is, a provision that permits a non-defaulting counterparty to make a lower payment than it otherwise would make under the agreement, or no payment at all, to a defaulter or the estate of a defaulter, even if the defaulter or the estate is a net creditor under the agreement); and (4) In order to recognize an agreement as a qualifying master netting agreement for purposes of this part, a credit union must conduct sufficient legal review, at origination and in response to any changes in applicable law, to conclude with a well-founded basis (and maintain sufficient written documentation of that legal review) that: (i) The agreement meets the requirements of paragraph (2) of this definition; and (ii) In the event of a legal challenge (including one resulting from default or from conservatorship, receivership, insolvency, liquidation, or similar proceeding), the relevant court and administrative authorities would find the agreement to be legal, valid, binding, and enforceable under the law of relevant jurisdictions. Recourse pro rata Repurchase transactions Residential mortgage-backed security Residential property Restructured Revenue obligation Risk-based capital ratio Risk-weighted assets Secured consumer loan Senior executive officer Separate account insurance Share-secured loan Shares STRIPS Structured product Subordinated Subordinated Debt Supervisory merger or combination (1) An assisted merger or purchase and assumption where funds from the NCUSIF were provided to the continuing credit union; (2) A merger or purchase and assumption classified by NCUA as an “emergency merger” where the acquired credit union is either insolvent or “in danger of insolvency” as defined under appendix B to Part 701 of this chapter; or (3) A merger or purchase and assumption that included NCUA's or the appropriate state official's identification and selection of the continuing credit union. Swap Dealer Total assets (1)(i) Average quarterly balance. The credit union's total assets measured by the average of quarter-end balances of the current and three preceding calendar quarters; (ii) Average monthly balance. The credit union's total assets measured by the average of month-end balances over the three calendar months of the applicable calendar quarter; (iii) Average daily balance. The credit union's total assets measured by the average daily balance over the applicable calendar quarter; or (iv) Quarter-end balance. The credit union's total assets measured by the quarter-end balance of the applicable calendar quarter as reported on the credit union's Call Report. (2) For each quarter, a credit union must elect one of the measures of total assets listed in paragraph (1) of this definition to apply for all purposes under this part except §§ 702.103 through 702.105 (risk-based capital requirement). (3) Notwithstanding paragraph (1) of this definition, a credit union may exclude loans pledged as collateral for a non-recourse loan that is provided as part of the Paycheck Protection Program Lending Facility, announced by the Federal Reserve Board on April 7, 2020, from the calculation of total assets for the purpose of calculating its net worth ratio. For the purpose of this provision, a credit union's liability under the Facility must be reduced by the principal amount of the loans pledged as collateral for funds advanced under the Facility. Trading assets Trading liabilities Tranche Unconditionally cancelable Unsecured consumer loan U.S. Government agency [80 FR 66706, Oct. 29, 2015, as amended at 86 FR 11073, Feb. 23, 2021; 86 FR 72803, Dec. 23, 2021; 86 FR 72809, Dec. 23, 2021] Editorial Note: At 86 FR 72809, Dec. 23, 2021, § 702.2 was amended by revising the definition of “Regulatory Capital”; however, the definition did not exist. The amendment could not be incorporated due to inaccurate amendatory instruction. Subpart A—Prompt Corrective Action Source: 80 FR 66706, Oct. 29, 2015, unless otherwise noted. § 702.101 Capital measures, capital adequacy, effective date of classification, and notice to NCUA. (a) Capital measures. (1) The net worth ratio; and (2) If determined to be applicable under § 702.103, either the risk-based capital ratio under § 702.104(a) through (c) or the CCULR framework under § 702.104(d). (b) Capital adequacy. (2) A credit union defined as complex must have a process for assessing its overall capital adequacy in relation to its risk profile and a comprehensive written strategy for maintaining an appropriate level of capital. (c) Effective date of capital classification. (1) Quarter-end effective date. (2) Corrected capital classification. (3) Reclassification to lower category. (d) Notice to NCUA by filing Call Report. (2) Failure to timely file a Call Report as required under this section in no way alters the effective date of a change in capital classification under paragraph (b) of this section, or the affected credit union's corresponding legal obligations under this part. [80 FR 66706, Oct. 29, 2015, as amended at 86 FR 72804, Dec. 23, 2021] § 702.102 Capital classification. (a) Capital categories. (1) Well capitalized (i)(A) Net worth ratio. (B) Risk-based capital ratio. (ii) Complex credit union leverage ratio. (B) The complex credit union is a qualifying complex credit union that has opted into the CCULR framework under § 702.104(d), is in the grace period, as defined in § 702.104(d)(7), and has a CCULR of 7.0 percent or greater. (2) Adequately capitalized (i) Net worth ratio. (ii) Risk-based capital ratio. (iii) Does not meet the definition of a well capitalized credit union. (3) Undercapitalized (i) Net worth ratio. (ii) Risk-based capital ratio. (4) Significantly undercapitalized (i) The credit union has a net worth ratio of 2.0 percent or more but less than 4.0 percent; or (ii) The credit union has a net worth ratio of 4.0 percent or more but less than 5.0 percent, and either— (A) Fails to submit an acceptable net worth restoration plan within the time prescribed in § 702.110; (B) Materially fails to implement a net worth restoration plan approved by the NCUA Board; or (C) Receives notice that a submitted net worth restoration plan has not been approved. (5) Critically undercapitalized Table 1 to § 702.102—Capital Categories Capital classification Net worth ratio Risk-based capital CCULR, if And subject to following Well Capitalized 7% or greater And 10% or greater Or 9% or greater * Adequately Capitalized 6% or greater And 8% or greater Or N/A And does not meet the criteria to be classified as well capitalized. Undercapitalized 4% to 5.99% Or Less than 8% Or N/A Significantly Undercapitalized 2% to 3.99% N/A N/A Or if “undercapitalized at <5% net worth and (a) fails to timely submit, (b) fails to materially implement, or (c) receives notice of the rejection of a net worth restoration plan. Critically Undercapitalized Less than 2% N/A N/A * (b) Reclassification based on supervisory criteria other than net worth. (1) Unsafe or unsound condition. (2) Unsafe or unsound practice. (c) Non-delegation. (d) Consultation with state officials. [80 FR 66706, Oct. 29, 2015, as amended at 86 FR 72804, Dec. 23, 2021] § 702.103 Applicability of risk-based capital measures. For purposes of § 702.102, a credit union is defined as “complex” and a risk-based capital measure is applicable only if the credit union's quarter-end total assets exceed five hundred million dollars ($500,000,000), as reflected in its most recent Call Report. A complex credit union may calculate its risk-based capital measure either by using the risk-based capital ratio under § 702.104(a) through (c), or, for a qualifying complex credit union opting into the CCULR framework, by using the CCULR framework under § 702.104(d). [86 FR 72805, Dec. 23, 2021] § 702.104 Risk-based capital ratio. A complex credit union must calculate its risk-based capital measure in accordance with this section. A complex credit union may calculate its risk-based capital measure either by using the risk-based capital ratio under paragraphs (a) through (c) of this section, or, for a qualifying complex credit union opting into the CCULR framework, by using the CCULR framework under paragraph (d) of this section. (a) Calculation of the risk-based capital ratio. (b) Risk-based capital ratio numerator. (1) Capital elements of the risk-based capital ratio numerator. (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 GAAP; (vii) The outstanding principal amount of Subordinated Debt treated as Regulatory Capital in accordance with § 702.407 and the outstanding principal amount of Grandfathered Secondary Capital treated as Regulatory Capital in accordance with § 702.414; and (viii) Section 208 assistance included in net worth (as defined in § 702.2). (2) Risk-based capital ratio numerator deductions. (i) NCUSIF Capitalization Deposit; (ii) Goodwill; (iii) Other intangible assets; (iv) Identified losses not reflected in the risk-based capital ratio numerator; and (v) Mortgage servicing assets that exceed 25 percent of the sum of the capital elements in paragraph (b)(1) of this section, less deductions required under paragraphs (b)(2)(i) thorough (iv) of this section. (c) Risk-weighted assets General. (2) Risk weights for on-balance sheet assets. (i) Category 1—zero percent risk weight. (A) The balance of: ( 1 ( 2 (B) The exposure amount of: ( 1 ( 2 ( 3 (C) Insured balances due from FDIC-insured depositories or federally insured credit unions. (D) Covered loans issued under the Small Business Administration's Paycheck Protection Program, 15 U.S.C. 636(a)(36). (ii) Category 2—20 percent risk weight. (A) The uninsured balances due from FDIC-insured depositories, federally insured credit unions, and all balances due from privately-insured credit unions. (B) The exposure amount of: ( 1 ( 2 ( 3 ( 4 ( 5 (C) The balances due from Federal Home Loan Banks. (D) The balance of share-secured loans, where the shares securing the loan are on deposit with another depository institution. (E) The portions of outstanding loans with a government guarantee. (F) The portions of commercial loans secured with contractual compensating balances. (iii) Category 3—50 percent risk weight. (A) The outstanding balance (net of government guarantees), including loans held for sale, of current first-lien residential real estate loans less than or equal to 35 percent of assets. (B) The exposure amount of: ( 1 ( 2 (iv) Category 4—75 percent risk weight. (A) Current first-lien residential real estate loans greater than 35 percent of assets. (B) Current secured consumer loans. (v) Category 5—100 percent risk weight. (A) The outstanding balance (net of government guarantees), including loans held for sale, of: ( 1 ( 2 ( 3 ( 4 ( 5 (B) The exposure amount of: ( 1 ( 2 ( 3 ( 4 ( 5 ( 6 ( 7 ( 8 ( 9 (C) All other assets listed on the statement of financial condition not specifically assigned a different risk weight under this subpart. (vi) Category 6—150 percent risk weight. (A) The outstanding balance, net of government guarantees and including loans held for sale, of: ( 1 ( 2 ( 3 ( 4 ( 5 (B) The exposure amount of: ( 1 ( 2 (vii) Category 7—250 percent risk weight. A credit union must assign a 250 percent risk weight to the carrying value of mortgage servicing assets not deducted from the risk-based capital numerator pursuant to § 702.104(b). (viii) Category 8—300 percent risk weight. (A) Publicly traded equity investments, other than a CUSO investment. (B) Investment funds that do not meet the requirements under § 703.14(c) of this chapter, with the option to use the look-through approaches in paragraph (c)(3)(iii)(B) of this section. (C) Separate account insurance, with the option to use the look-through approaches in paragraph (c)(3)(iii)(B) of this section. (ix) Category 9 (x) Category 10—1,250 percent risk weight. (3) Alternative risk weights for certain on-balance sheet assets Non-significant equity exposures General. (B) Determination of non-significant equity exposures. (C) Determination of the aggregate amount of equity exposures. ( 1 ( 2 ( 3 ( 4 (ii) Charitable donation accounts. (iii) Alternative approaches. (A) Gross-up approach. (B) Look-through approaches. (4) Risk weights for off-balance sheet items. (i) For the outstanding balance of loans transferred to a Federal Home Loan Bank under the mortgage partnership finance program, a 20 percent CCF and a 50 percent risk weight. (ii) For other loans transferred with limited recourse, a 100 percent CCF applied to the off-balance sheet exposure and: (A) For commercial loans, a 100 percent risk weight. (B) For first-lien residential real estate loans, a 50 percent risk weight. (C) For junior-lien residential real estate loans, a 100 percent risk weight. (D) For all secured consumer loans, a 75 percent risk weight. (E) For all unsecured consumer loans, a 100 percent risk weight. (iii) For unfunded commitments: (A) For a commitment that is unconditionally cancelable, a 0 percent CCF. (B) For commercial loans, a 50 percent CCF with a 100 percent risk weight. (C) For first-lien residential real estate loans, a 10 percent CCF with a 50 percent risk weight. (D) For junior-lien residential real estate loans, a 10 percent CCF with a 100 percent risk weight. (E) For all secured consumer loans, a 10 percent CCF with a 75 percent risk weight. (F) For all unsecured consumer loans, a 10 percent CCF with a 100 percent risk weight. (iv) For financial standby letter of credits, a 100 percent CCF and a 100 percent risk weight. (v) For forward agreements that are not derivative contracts, a 100 percent CCF and a 100 percent risk weight. (vi) For sold credit protection through guarantees and credit derivatives, a 100 percent CCF and a 100 percent risk weight for guarantees; for credit derivatives the risk weight is determined by the applicable provisions of 12 CFR 324.34 or 324.35. (vii) For off-balance sheet securitization exposures, a 100 percent CCF, and the risk weight is determined as if the exposure is an on-balance sheet securitization exposure. (viii) For securities borrowing or lending transactions, a 100 percent CCF and a 100 percent risk weight. A credit union may recognize the credit risk mitigation benefits of financial collateral, as defined under 12 CFR 324.2, by risk weighting the collateralized portion of the exposure under the applicable provisions of 12 CFR 324.35 or 324.37. (ix) For the off-balance sheet portion of repurchase transactions, a 100 percent CCF and a 100 percent risk weight. A credit union may recognize the credit risk mitigation benefits of financial collateral, as defined by 12 CFR 324.2, by risk weighting the collateralized portion of the exposure under the applicable provisions of 12 CFR 324.35 or 324.37. (x) For all other off-balance sheet exposures not explicitly provided a CCF or risk weight in this paragraph (c) that meet the definition of a commitment, a 100 percent CCF and a 100 percent risk weight. (5) Derivative contracts. (6) Asset Securitizations Issued by Complex Credit Unions. A credit union must follow the requirements of the applicable provisions of 12 CFR 324.41 when it transfers exposures in connection with a securitization. A credit union may only exclude the transferred exposures from the calculation of its risk-weighted assets if each condition in 12 CFR 324.41 is satisfied. A credit union that meets these conditions, but retains any credit risk for the transferred exposures, must hold risk-based capital against the credit risk it retains in connection with the securitization. (d) Complex Credit Union Leverage Ratio (CCULR) Framework General. (2) Qualifying Complex Credit Union. (i) Has a CCULR of 9.0 percent or greater; (ii) Has total off-balance sheet exposures of 25 percent or less of its total assets; (iii) Has the sum of total trading assets and total trading liabilities of 5 percent or less of its total assets; and (iv) Has the sum of total goodwill and total other intangible assets of 2 percent or less of its total assets. (3) Calculation of Qualifying Criteria. (4) Calculation of the CCULR. (5) Opting into the CCULR Framework. (ii) A qualifying complex credit union can opt into the CCULR framework at the end of each calendar quarter. (6) Opting Out of the CCULR Framework. (ii) [Reserved] (7) Treatment when ceasing to meet the qualifying complex credit union requirements. (ii) The grace period begins at the end of the calendar quarter in which the credit union no longer satisfies the criteria to be a qualifying complex credit union. The grace period ends on the last day of the second consecutive calendar quarter following the beginning of the grace period. (iii) During the grace period, the credit union continues to be treated as a qualifying complex credit union for the purpose of this part and must continue calculating and reporting its CCULR, unless the qualifying complex credit union has opted out of using the CCULR framework under paragraph (d)(6) of this section. The qualifying complex credit union also continues to be considered to have met the capital ratio requirements for the well capitalized capital category under § 702.102(a)(1). However, if the qualifying complex credit union has a CCULR of less than seven percent, it will not be considered to have met the capital ratio requirements for the well capitalized capital category under § 702.102(a)(1) and its capital classification is determined by its net worth ratio. (iv) [Reserved] (v) A qualifying complex credit union that ceases to meet the qualifying criteria in paragraph (d)(2) of this section as a result of a merger or acquisition that is not a supervisory merger or combination has no grace period and must comply with the risk-based capital ratio under paragraphs (a) through (c) of this section in the quarter it ceases to be a qualifying complex credit union. (e) Reservation of authority. [80 FR 66706, Oct. 29, 2015, as amended at 86 FR 11073, Feb. 23, 2021; 86 FR 72805, Dec. 23, 2021] § 702.105 Derivative contracts. (a) OTC interest rate derivative contracts Exposure amount Single OTC interest rate derivative contract. (A) Current credit exposure. (B) PFE. 1 ( 2) Table 1 to § 702.105—Conversion Factor Matrix for Interest Rate Derivative Contracts 2 Remaining maturity Conversion One year or less 0.00 Greater than one year and less than or equal to five years 0.005 Greater than five years 0.015 2 (ii) Multiple OTC interest rate derivative contracts subject to a qualifying master netting agreement. (A) Net current credit exposure. (B) Adjusted sum of the PFE amounts (Anet). ( 1 ( 2 (2) Recognition of credit risk mitigation of collateralized OTC derivative contracts. (b) Cleared transactions for interest rate derivatives General requirements. (2) Risk-weighted assets for cleared transactions. (ii) A credit union's total risk-weighted assets for cleared transactions is the sum of the risk-weighted asset amounts for all its cleared transactions. (3) Trade exposure amount. (i) The exposure amount for the derivative contract or netting set of derivative contracts, calculated using the methodology used to calculate exposure amount for OTC interest rate derivative contracts under paragraph (a) of this section; plus (ii) The fair value of the collateral posted by the credit union and held by the, clearing member, or custodian. (4) Cleared transaction risk weights. (i) Two percent if the collateral posted by the credit union to the DCO or clearing member is subject to an arrangement that prevents any losses to the credit union due to the joint default or a concurrent insolvency, liquidation, or receivership proceeding of the clearing member and any other clearing member clients of the clearing member; and the clearing member credit union has conducted sufficient legal review to conclude with a well-founded basis (and maintains sufficient written documentation of that legal review) that in the event of a legal challenge (including one resulting from an event of default or from liquidation, insolvency, or receivership proceedings) the relevant court and administrative authorities would find the arrangements to be legal, valid, binding and enforceable under the law of the relevant jurisdictions; or (ii) Four percent if the requirements of paragraph (b)(4)(i) are not met. (5) Recognition of credit risk mitigation of collateralized OTC derivative contracts. (c) Recognition of credit risk mitigation of collateralized interest rate derivative contracts. (2) As an alternative to the simple approach, a credit union may recognize the credit risk mitigation benefits of financial collateral that secures such a contract or netting set if the financial collateral is marked-to-fair value on a daily basis and subject to a daily margin maintenance requirement by applying a risk weight to the exposure as if it were uncollateralized and adjusting the exposure amount calculated under paragraph (a) or (b) of this section using the collateral approach in paragraph (c)(3) of this section. The credit union must substitute the exposure amount calculated under paragraphs (b) or (c) of this section in the equation in paragraph (c)(3) of this section. (3) Collateralized transactions General. (ii) Simple collateralized derivatives approach. (A) The collateral must be subject to a collateral agreement for at least the life of the exposure; (B) The collateral must be revalued at least every six months; and (C) The collateral and the exposure must be denominated in the same currency. (iii) Risk weight substitution. (B) A credit union must apply a risk weight to the unsecured portion of the exposure based on the risk weight applicable to the exposure under this subpart. (iv) Exceptions to the 20 percent risk weight floor and other requirements. (A) A credit union may assign a zero percent risk weight to an exposure to a derivatives contract that is marked-to-market on a daily basis and subject to a daily margin maintenance requirement, to the extent the contract is collateralized by cash on deposit. (B) A credit union may assign a 10 percent risk weight to an exposure to a derivatives contract that is marked-to-market daily and subject to a daily margin maintenance requirement, to the extent that the contract is collateralized by an exposure that qualifies for a zero percent risk weight under § 702.104(c)(2)(i). (v) A credit union may assign a zero percent risk weight to the collateralized portion of an exposure where: (A) The financial collateral is cash on deposit; or (B) The financial collateral is an exposure that qualifies for a zero percent risk weight under § 702.104(c)(2)(i), and the credit union has discounted the fair value of the collateral by 20 percent. (4) Collateral haircut approach. (ii) The collateral haircut approach applies to both OTC and cleared interest rate derivatives contracts discussed in this section. (iii) A credit union must determine the exposure amount for a collateralized derivative contracts by setting the exposure amount equal to the max {0,[(exposure amount − value of collateral) + (sum of current fair value of collateral instruments * market price volatility haircut of the collateral instruments)]}, where: (A) The value of the exposure equals the exposure amount for OTC interest rate derivative contracts (or netting set) calculated under paragraphs (a)(1)(i) and (ii) of this section. (B) The value of the exposure equals the exposure amount for cleared interest rate derivative contracts (or netting set) calculated under paragraph (b)(3) of this section. (C) The value of the collateral is the sum of cash and all instruments under the transaction (or netting set). (D) The sum of current fair value of collateral instruments as of the measurement date. (E) A credit union must use the standard supervisory haircuts for market price volatility in Table 2 to this section. Table 2 to § 702.105—Standard Supervisory Market Price Volatility Haircuts [Based on a 10 business-day holding period] Residual maturity Haircut (in percent) assigned based on: Collateral risk weight Zero 20 or 50 Less than or equal to 1 year 0.5 1.0 Greater than 1 year and less than or equal to 5 years 2.0 3.0 Greater than 5 years 4.0 6.0 Cash collateral held Zero Other exposure types 25.0 (d) All other derivative contracts and transactions. § 702.106 Prompt corrective action for adequately capitalized credit unions. (a) Earnings retention. (b) Decrease in retention. (1)(i) Is necessary to avoid a significant redemption of shares; and (ii) Would further the purpose of this part. (2) Notwithstanding paragraph (a) of this section, from February 28, 2022, until March 31, 2023, for a credit union that is adequately capitalized: (i) The NCUA Board may issue an administrative order specifying temporary revisions to the earnings retention requirement, to the extent the NCUA Board determines that such lesser amount— (A) Is necessary to avoid a significant redemption of shares; and (B) Would further the purpose of this part. (ii) Despite the issuance of an administrative order under paragraph (b)(2) of the section, the Regional Director may require a credit union to submit an earnings retention waiver under paragraph (b)(1) if the credit union poses an undue risk the National Credit Union Share Insurance Fund or exhibits material safety and soundness concerns. (c) Decrease by FISCU. (d) Periodic review. [80 FR 66706, Oct. 29, 2015, as amended at 87 FR 10950, Feb. 28, 2022] § 702.107 Prompt corrective action for undercapitalized credit unions. (a) Mandatory supervisory actions by credit union. (1) Earnings retention. (2) Submit net worth restoration plan. provided however, (3) Restrict increase in assets. (i) Plan approved. (A) The assets of the credit union are increasing consistent with the approved plan; and (B) The credit union is implementing steps to increase the net worth ratio consistent with the approved plan; (ii) Plan not approved. (A) Total accounts receivable and accrued income on loans and investments; or (B) Total cash and cash equivalents; or (C) Total loans outstanding, not to exceed the sum of total assets plus the quarter-end balance of unused commitments to lend and unused lines of credit provided however that a credit union which increases a balance as permitted under paragraphs (a)(3)(ii)(A), (B) or (C) of this section cannot offer rates on shares in excess of prevailing rates on shares in its relevant market area, and cannot open new branches; (4) Restrict member business loans. (b) Second tier discretionary supervisory actions by NCUA. (1) Requiring prior approval for acquisitions, branching, new lines of business. (2) Restricting transactions with and ownership of a CUSO. (3) Restricting dividends paid. (4) Prohibiting or reducing asset growth. (5) Alter, reduce or terminate activity. (6) Prohibiting nonmember deposits. (7) Dismissing director or senior executive officer. provided however, (8) Employing qualified senior executive officer. (9) Other action to carry out prompt corrective action. (c) First tier application of discretionary supervisory actions. § 702.108 Prompt corrective action for significantly undercapitalized credit unions. (a) Mandatory supervisory actions by credit union. (1) Earnings retention. (2) Submit net worth restoration plan. (3) Restrict increase in assets. (4) Restrict member business loans. (b) Discretionary supervisory actions by NCUA. (1) Requiring prior approval for acquisitions, branching, new lines of business. (2) Restricting transactions with and ownership of CUSO. (3) Restricting dividends paid. (4) Prohibiting or reducing asset growth. (5) Alter, reduce or terminate activity. (6) Prohibiting nonmember deposits. (7) New election of directors. (8) Dismissing director or senior executive officer. provided however, (9) Employing qualified senior executive officer. (10) Restricting senior executive officers' compensation. (11) Other actions to carry out prompt corrective action. (12) Requiring merger. (c) Discretionary conservatorship or liquidation if no prospect of becoming adequately capitalized. § 702.109 Prompt corrective action for critically undercapitalized credit unions. (a) Mandatory supervisory actions by credit union. (1) Earnings retention. (2) Submit net worth restoration plan. (3) Restrictions on payments on Subordinated Debt. (4) Restrict increase in assets. (5) Restrict member business loans. (b) Discretionary supervisory actions by NCUA. (1) Requiring prior approval for acquisitions, branching, new lines of business. (2) Restricting transactions with and ownership of CUSO. (3) Restricting dividends paid. (4) Prohibiting or reducing asset growth. (5) Alter, reduce or terminate activity. (6) Prohibiting nonmember deposits. (7) New election of directors. (8) Dismissing director or senior executive officer. provided however, (9) Employing qualified senior executive officer. (10) Restricting senior executive officers' compensation. (11) Restrictions on payments on Grandfathered Secondary Capital. (12) Requiring prior approval. (i) Entering into any material transaction not within the scope of an approved net worth restoration plan (or approved revised business plan under subpart C of this part); (ii) Extending credit for transactions deemed highly leveraged by the NCUA Board or, if state-chartered, by the appropriate state official; (iii) Amending the credit union's charter or bylaws, except to the extent necessary to comply with any law, regulation, or order; (iv) Making any material change in accounting methods; and (v) Paying dividends or interest on new share accounts at a rate exceeding the prevailing rates of interest on insured deposits in its relevant market area; (13) Other action to carry out prompt corrective action. (14) Requiring merger. (c) Mandatory conservatorship, liquidation or action in lieu thereof Action within 90 days. (i) Conservatorship. (ii) Liquidation. (iii) Other corrective action. provided however, (2) Renewal of other corrective action. (3) Mandatory liquidation after 18 months Generally. (ii) Exception. (A) Has been in substantial compliance with an approved net worth restoration plan requiring consistent improvement in net worth since the date the net worth restoration plan was approved; (B) Has positive net income or has an upward trend in earnings that the NCUA Board projects as sustainable; and (C) Is viable and not expected to fail. (iii) Review of exception. (A) Recertify the credit union if it continues to satisfy the criteria of paragraph (c)(3)(ii) of this section; or (B) Promptly place the credit union into liquidation, pursuant to 12 U.S.C. 1787(a)(3)(A)(ii), if it fails to satisfy the criteria of paragraph (c)(3)(ii) of this section. (4) Nondelegation. (d) Mandatory liquidation of insolvent federal credit union. [80 FR 66706, Oct. 29, 2015, as amended at 86 FR 11073, Feb. 23, 2021] § 702.110 Consultation with state officials on proposed prompt corrective action. (a) Consultation on proposed conservatorship or liquidation. (1) The NCUA Board shall seek the views of the appropriate state official (as defined in § 702.2), and give him or her an opportunity to take the proposed action; (2) The NCUA Board shall, upon timely request of the appropriate state official, promptly provide him or her with a written statement of the reasons for the proposed conservatorship or liquidation, and reasonable time to respond to that statement; and (3) If the appropriate state official makes a timely written response that disagrees with the proposed conservatorship or liquidation and gives reasons for that disagreement, the NCUA Board shall not place the credit union into conservatorship or liquidation unless it first considers the views of the appropriate state official and determines that— (i) The NCUSIF faces a significant risk of loss if the credit union is not placed into conservatorship or liquidation; and (ii) Conservatorship or liquidation is necessary either to reduce the risk of loss, or to reduce the expected loss, to the NCUSIF with respect to the credit union. (b) Nondelegation. (c) Consultation on proposed discretionary action. § 702.111 Net worth restoration plans (NWRP). (a) Schedule for filing Generally. (2) Exception. (3) Filing of additional plan. (4) Failure to timely file plan. (b) Assistance to small credit unions. (c) Contents of NWRP. (1) Specify— (i) A quarterly timetable of steps the credit union will take to increase its net worth ratio, and risk-based capital measure if applicable, so that it becomes adequately capitalized by the end of the term of the NWRP, and to remain so for four (4) consecutive calendar quarters; (ii) The projected amount of net worth increases in each quarter of the term of the NWRP as required under § 702.106(a), or as permitted under § 702.106(b); (iii) How the credit union will comply with the mandatory and any discretionary supervisory actions imposed on it by the NCUA Board under this subpart; (iv) The types and levels of activities in which the credit union will engage; and (v) If reclassified to a lower category under § 702.102(b), the steps the credit union will take to correct the unsafe or unsound practice(s) or condition(s); (2) Include pro forma financial statements, including any off-balance sheet items, covering a minimum of the next two years; and (3) Contain such other information as the NCUA Board has required. (4) Notwithstanding paragraphs (c)(1), (2), and (3) of this section, the Board may permit a credit union that is undercapitalized to submit to the Regional Director a streamlined NWRP attesting that its reduction in capital was caused by share growth and that such share growth is a temporary condition due to the COVID-19 pandemic. A streamlined NWRP plan may be accepted from February 28, 2022, until March 31, 2023. (d) Criteria for approval of NWRP. (1) Complies with paragraph (c) of this section; (2) Is based on realistic assumptions, and is likely to succeed in restoring the credit union's net worth; and (3) Would not unreasonably increase the credit union's exposure to risk (including credit risk, interest-rate risk, and other types of risk). (e) Consideration of regulatory capital. (f) Review of NWRP Notice of decision. (2) Delayed decision. (3) Consultation with state officials. (g) NWRP not approved Submission of revised NWRP. (2) Notice of decision on revised NWRP. (3) Disapproval of reclassified credit union's NWRP. (4) Submission of multiple unapproved NWRPs. (h) Amendment of NWRP. (i) Publication. (j) Termination of NWRP. [80 FR 66706, Oct. 29, 2015, as amended at 86 FR 72806, Dec. 23, 2021; 87 FR 10950, Feb. 28, 2022] § 702.112 Reserves. Each credit union shall establish and maintain such reserves as may be required by the FCUA, by state law, by regulation, or in special cases by the NCUA Board or appropriate state official. § 702.113 Full and fair disclosure of financial condition. (a) Full and fair disclosure defined. (b) Full and fair disclosure implemented. (c) Declaration of officials. (d) Charges for loan and lease losses. (1) Charges for loan and lease losses shall be made timely and in accordance with GAAP; (2) The ALLL must be maintained in accordance with GAAP; and (3) At a minimum, adjustments to the ALLL shall be made prior to the distribution or posting of any dividend to the accounts of members. § 702.114 Payment of dividends. (a) Restriction on dividends. (b) Payment of dividends and interest refunds. Subpart B—Alternative Prompt Corrective Action for New Credit Unions Source: 80 FR 66706, Oct. 29, 2015, unless otherwise noted. § 702.201 Scope and definition. (a) Scope. (b) New credit union defined. (c) Effect of spin-offs. (d) Actions to evade prompt corrective action. § 702.202 Net worth categories for new credit unions. (a) Net worth measures. (b) Effective date of net worth classification of new credit union. (c) Net worth categories. (1) Well capitalized (2) Adequately capitalized (3) Moderately capitalized (4) Marginally capitalized (5) Minimally capitalized (6) Uncapitalized Table 1 to § 702.202—Capital Categories for New Credit Unions A new credit union's capital classification is If it's net worth ratio is Well Capitalized 7% or above. Adequately Capitalized 6 to 7%. Moderately Capitalized 3.5% to 5.99%. Marginally Capitalized 2% to 3.49%. Minimally Capitalized 0% to 1.99%. Uncapitalized Less than 0%. (d) Reclassification based on supervisory criteria other than net worth. (e) Consultation with state officials. § 702.203 Prompt corrective action for adequately capitalized new credit unions. Beginning on the effective date of classification, an adequately capitalized new credit union must increase the dollar amount of its net worth by the amount reflected in its approved initial or revised business plan in accordance with § 702.204(a)(2), or in the absence of such a plan, in accordance with § 702.106 until it is well capitalized. § 702.204 Prompt corrective action for moderately capitalized, marginally capitalized, or minimally capitalized new credit unions. (a) Mandatory supervisory actions by new credit union. (1) Earnings retention. (2) Submit revised business plan. (i) Has not increased its net worth ratio consistent with its then-present approved business plan; (ii) Has no then-present approved business plan; or (iii) Has failed to comply with paragraph (a)(3) of this section; and (3) Restrict member business loans. (b) Discretionary supervisory actions by NCUA. (c) Discretionary conservatorship or liquidation. § 702.205 Prompt corrective action for uncapitalized new credit unions. (a) Mandatory supervisory actions by new credit union. (1) Earnings retention. (2) Submit revised business plan. (i) Has not increased its net worth ratio consistent with its then-present approved business plan; (ii) Has no then-present approved business plan; or (iii) Has failed to comply with paragraph (a)(3) of this section; and (3) Restrict member business loans. (b) Discretionary supervisory actions by NCUA. (c) Mandatory liquidation or conservatorship. (1) Plan not submitted. (2) Plan rejected, approved, implemented. (i) The effective date of classification as uncapitalized; or (ii) The last day of the calendar month following expiration of the time period provided in the credit union's initial business plan (approved at the time its charter was granted) to remain uncapitalized, regardless whether a revised business plan was rejected, approved or implemented. (3) Exception. (d) Discretionary liquidation of an uncapitalized new credit union. [80 FR 66706, Oct. 29, 2015, as amended at 86 FR 11073, Feb. 23, 2021] § 702.206 Revised business plans (RBP) for new credit unions. (a) Schedule for filing Generally. (i) The last of the calendar month following the end of the calendar quarter that the credit union's net worth ratio has not increased consistent with the-present approved business plan; (ii) The effective date of classification as less than adequately capitalized if the credit union has no then-present approved business plan; or (iii) The effective date of classification as less than adequately capitalized if the credit union has increased the total amount of member business loans in violation of § 702.204(a)(3). (2) Exception. (3) Failure to timely file plan. (b) Contents of revised business plan. (1) Address changes, since the new credit union's current business plan was approved, in any of the business plan elements required for charter approval under chapter 1, section IV.D. of appendix B to part 701 of this chapter, or for state-chartered credit unions under applicable state law; (2) Establish a timetable of quarterly targets for net worth during each year in which the RBP is in effect so that the credit union becomes adequately capitalized by the time it no longer qualifies as “new” per § 702.201; (3) Specify the projected amount of earnings of net worth increases as provided under § 702.204(a)(1) or 702.205(a)(1); (4) Explain how the new credit union will comply with the mandatory and discretionary supervisory actions imposed on it by the NCUA Board under this subpart; (5) Specify the types and levels of activities in which the new credit union will engage; (6) In the case of a new credit union reclassified to a lower category under § 702.202(d), specify the steps the credit union will take to correct the unsafe or unsound condition or practice; and (7) Include such other information as the NCUA Board may require. (c) Criteria for approval. (1) Addresses the items enumerated in paragraph (b) of this section; (2) Is based on realistic assumptions, and is likely to succeed in building the credit union's net worth; and (3) Would not unreasonably increase the credit union's exposure to risk (including credit risk, interest-rate risk, and other types of risk). (d) Review of revised business plan Notice of decision. (2) Delayed decision. (3) Consultation with state officials. (e) Plan not approved Submission of new revised plan. (2) Notice of decision on revised plan. (3) Submission of multiple unapproved RBPs. (f) Amendment of plan. (g) Publication. [80 FR 66706, Oct. 29, 2015, as amended at 86 FR 11073, Feb. 23, 2021] § 702.207 Consideration of Subordinated Debt and Grandfathered Secondary Capital for new credit unions. (a) Exception from prompt corrective action for new credit unions. (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. (c) Prompt corrective action based on other supervisory criteria Application of prompt corrective action to an exempt new credit union. (i) Unsafe or unsound condition. (ii) Unsafe or unsound practice. (2) Non-delegation. (3) Consultation with state officials. (d) Discretionary liquidation. (e) Restrictions on payments on Subordinated Debt. [86 FR 11073, Feb. 23, 2021] § 702.208 Incentives for new credit unions. (a) Assistance in revising business plans. (b) Assistance. (c) Small credit union program. [80 FR 66706, Oct. 29, 2015. Redesignated at 86 FR 11073, Feb. 23, 2021] § 702.209 Reserves. Each new credit union shall establish and maintain such reserves as may be required by the FCUA, by state law, by regulation, or in special cases by the NCUA Board or appropriate state official. [80 FR 66706, Oct. 29, 2015. Redesignated at 86 FR 11073, Feb. 23, 2021] § 702.210 Full and fair disclosure of financial condition. (a) Full and fair disclosure defined. (b) Full and fair disclosure implemented. (c) Declaration of officials. (d) Charges for loan and lease losses. (1) Charges for loan and lease losses shall be made timely in accordance with generally accepted accounting principles (GAAP); (2) The ALLL must be maintained in accordance with GAAP; and (3) At a minimum, adjustments to the ALLL shall be made prior to the distribution or posting of any dividend to the accounts of members. [80 FR 66706, Oct. 29, 2015. Redesignated at 86 FR 11073, Feb. 23, 2021] § 702.211 Payment of dividends. (a) Restriction on dividends. (b) Payment of dividends and interest refunds. [80 FR 66706, Oct. 29, 2015. Redesignated at 86 FR 11073, Feb. 23, 2021] Subpart C—Capital Planning and Stress Testing Source: 79 FR 24315, Apr. 30, 2014, unless otherwise noted. Redesignated at 80 FR 66722, Oct. 29, 2015. § 702.301 Authority, purpose, and reservation of authority. (a) Authority. (b) Purpose. (c) Reservation of authority. § 702.302 Definitions. For purposes of this subpart— Baseline scenario Capital plan Capital planning process Covered credit union (1) Timing. (2) Regulatory relief for 2021 and 2022. Planning horizon Pre-provision net revenue Provision for loan and lease losses Reverse stress test Scenarios Sensitivity testing Stress scenario Stress test Stress test capital Stress test capital ratio Tier I credit union Tier II credit union Tier III credit union [79 FR 24315, Apr. 30, 2014, as amended at 80 FR 48012, Aug. 11, 2015; 83 FR 17909, Apr. 25, 2018; 86 FR 15401, Mar. 23, 2021] § 702.303 Capital policy. (a) General requirements. (b) Mandatory elements. (1) State goals and limits for capital levels and risk exposure. (2) Establish requirements for reviewing and reporting capital levels and breaches of capital limits, with contingency plans for remedying any breaches. (3) State the governance over the capital analysis process, including all the activities that contribute to the analysis; (4) Specify capital analysis roles and responsibilities, including controls over external resources used for any part of capital analysis (such as vendors and data providers); (5) Specify the internal controls that govern capital planning, including review by internal audit, control of changes in capital planning procedures, and required documentation; (6) Describe the frequency with which capital analyses will be conducted; (7) State how capital analysis results are used and by whom; and (8) Be reviewed at least annually and updated as necessary to ensure that it remains current with changes in market conditions, credit union products and strategies, credit union risk exposures and activities, the credit union's established risk appetite, and industry practices. § 702.304 Capital planning. (a) Annual capital planning. (2) A covered credit union's board of directors (or a designated committee of the board) must at least annually, and for tier III credit unions, prior to the submission of the capital plan under paragraph (a)(1) of this section: (i) Review the credit union's process for assessing capital adequacy; (ii) Ensure that any deficiencies in the credit union's process for assessing capital adequacy are appropriately remedied; and (iii) Approve the credit union's capital plan. (b) Mandatory elements. (1) A quarterly assessment of the expected sources and levels of stress test capital over the planning horizon that reflects the covered credit union's financial state, size, complexity, risk profile, scope of operations, and existing level of capital, assuming both expected and unfavorable conditions, including: (i) Estimates of projected revenues, losses, reserves, and pro forma capital levels, over each quarter of the planning horizon under expected and unfavorable conditions; and (ii) A detailed description of the credit union's process for assessing capital adequacy; (2) A discussion of how the credit union will, under expected and unfavorable conditions, maintain stress test capital commensurate with all of its risks, including strategic, legal, and compliance risks; (3) A discussion of how the credit union will, under expected and unfavorable conditions, maintain ready access to funding, meet its obligations to all creditors and other counterparties, and continue to serve as an intermediary for its members; (4) A discussion of any expected changes to the credit union's business plan that are likely to have a material impact on the credit union's capital adequacy and liquidity; and (5) A program to: (i) Conduct sensitivity testing to analyze the effect on the credit union's stress test capital of changes in variables, parameters, and inputs used by the credit union in preparing its capital plan; (ii) Conduct reverse stress testing to identify events and circumstances that cause severely unfavorable outcomes for the credit union; and (iii) Analyze the impact of credit risk and interest rate risk to capital under unfavorable economic conditions, both separately and in combination with each other. [79 FR 24315, Apr. 30, 2014, as amended at 80 FR 48012, Aug. 11, 2015; 81 FR 7198, Feb. 11, 2016; 83 FR 17910, Apr. 25, 2018; 91 FR 38274, June 25, 2026] Editorial Note: At 84 FR 1606, Feb. 5, 2019, § 702.504 (prior to redesignation as § 702.304) was amended in paragraph (b)(4) by revising the citation “§ 702.306(c)” to read “§ 702.506(c)”; however, that citation did not exist in the section and the amendment could not be incorporated due to inaccurate amendatory instruction. § 702.305 NCUA action on capital plans. (a) Timing Tier I & tier II credit unions. (2) Tier III credit unions. (b) Grounds for rejection of capital plan. (1) The covered credit union has material unresolved supervisory issues associated with its capital planning process; (2) The capital analysis underlying the covered credit union's capital plan, or the covered credit union's methodologies for reviewing the robustness of its capital adequacy, are not reasonable or appropriate; (3) Data utilized for the capital analysis is insufficiently detailed to capture the risks of the covered credit union, or the data lacks integrity; (4) The plan does not meet all of the requirements of § 702.304; (5) Unacceptable weakness in the capital plan or policy, the capital planning analysis, or any critical system or process supporting capital analysis; (6) The covered credit union's capital planning process constitutes an unsafe or unsound practice, or would violate any law, regulation, NCUA order, directive, or any condition imposed by, or written agreement with, NCUA. In determining whether a capital plan would constitute an unsafe or unsound practice, NCUA considers whether the covered credit union is and would remain in sound financial condition after giving effect to the capital plan. (c) Notification in writing. (d) Resubmission of a capital plan. (1) NCUA-noted deficiencies in the credit union's original capital plan or policy; and (2) Remediation plans for unresolved supervisory issues contributing to the rejection of the credit union's original capital plan. (e) Supervisory actions. (f) Consultation on proposed action. [79 FR 24315, Apr. 30, 2014, as amended at 80 FR 48012, Aug. 11, 2015; 83 FR 17910, Apr. 25, 2018; 80 FR 66722, Oct. 29, 2015] § 702.306 Annual supervisory stress testing. (a) General requirements. (b) Credit union-run supervisory stress tests General. (2) Tier III credit unions. (3) NCUA tests. (c) Potential impact on capital. (1) Losses, pre-provision net revenues, loan and lease loss provisions, and net income; and (2) The potential impact on the stress test capital ratio, incorporating the effects of any capital action over the planning horizon and maintenance of an allowance for loan losses appropriate for credit exposures throughout the horizon. The credit union, or the NCUA if it elects to conduct the stress test under paragraph (b)(3) of this section, will conduct the stress tests without assuming any risk mitigation actions on the part of the credit union, except those existing and identified as part of the credit union's balance sheet, or off-balance sheet positions, such as derivative positions, on the date of the stress test. (d) Information collection. (e) Stress test results. (f) Supervisory actions. (2) If an NCUA-run stress test shows that a tier III credit union does not have the ability to maintain a stress test capital ratio of 5 percent or more under expected and stressed conditions in each quarter of the planning horizon, the credit union must provide NCUA, by November 30 of the calendar year in which NCUA conducted the tests, a stress test capital enhancement plan showing how it will meet that target. (3) A tier III credit union operating without an NCUA approved stress test capital enhancement plan required under this section may be subject to supervisory actions. (g) Consultation on proposed action. [83 FR 17910, Apr. 25, 2018, as amended at 87 FR 45009, July 27, 2022] Subpart D—Subordinated Debt, Grandfathered Secondary Capital, and Regulatory Capital Source: 86 FR 11074, Feb. 23, 2021, unless otherwise noted. § 702.401 Purpose and scope. (a) Subordinated Debt. (b) Grandfathered Secondary Capital. [86 FR 72809, Dec. 23, 2021, as amended at 88 FR 18010, Mar. 27, 2023] § 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 § 702.414.) All other terms in this subpart and not expressly defined in this section have the meanings assigned to them elsewhere in this part. For ease of use, certain key terms are included in this section using cross citations to other sections of this part where those terms are defined. Accredited Investor Appropriate Supervision Office Complex credit union Entity Accredited Investor Grandfathered Secondary Capital Immediate Family Member Issuing Credit Union Low-income designated credit union (LICU) Natural Person Accredited Investor provided Net worth Net worth ratio New credit union Offering Document Pro Forma Financial Statements Qualified Counsel Regulatory Capital (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 the later of 30 years from the date of issuance or January 1, 2052, 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, if applicable; (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 the later of 30 years from the date of issuance or January 1, 2052, Grandfathered Secondary Capital that is included in its net worth ratio and in its RBC ratio, if applicable; and (4) With respect to a new credit union, the aggregate outstanding principal amount of Subordinated Debt and, until the later of 30 years from the date of issuance or January 1, 2052, Grandfathered Secondary Capital that is considered pursuant to § 702.207. Retained Earnings Risk-based capital (RBC) ratio Senior Executive Officer e.g., Subordinated Debt Subordinated Debt Note [86 FR 11074, Feb. 23, 2021, as amended at 86 FR 72809, Dec. 23, 2021; 88 FR 18010, Mar. 27, 2023] § 702.403 Eligibility. (a) Subject to receiving approval under § 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 § 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 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. § 702.404 Requirements of the Subordinated Debt Note. (a) Requirements. (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. The stated maturity of the Subordinated Debt Note may not reset and may not contain an option to extend the maturity. A credit union seeking to issue Subordinated Debt Notes with maturities longer than 20 years from the date of issuance must provide the information required in § 702.408(b)(14) as part of its application for preapproval to issue Subordinated Debt; (3) Be subordinate to all other claims in liquidation under § 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 §§ 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 § 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. (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 § 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. (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; and (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 § 712.1(d) of this chapter. (d) Default covenants. (e) Minimum denominations of issuances to Natural Person Accredited Investors. [86 FR 11074, Feb. 23, 2021, as amended at 88 FR 18011, Mar. 27, 2023] § 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 WITH 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 § 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; and (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; and (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. § 702.406 Requirements related to the offer, sale, and issuance of Subordinated Debt Notes. (a) Offering Document. (b) Territorial limitations. (c) Accredited Investors. 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 [ ] Any 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; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any investment adviser registered pursuant to section 203 of the Investment Advisers Act of 1940 or registered pursuant to the laws of a state; any investment adviser relying on the exemption from registering with the Securities and Exchange Commission under section 203(l) or (m) of the Investment Advisers Act of 1940; any insurance company as defined in section 2(a)(13) of the Act; any 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; any 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; any Rural Business Investment Company as defined in section 384A of the Consolidated Farm and Rural Development Act; any 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; any 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; [ ] Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, partnership, or limited liability company, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000; [ ] Any natural person whose individual net worth, or joint net worth with that person's spouse or spousal equivalent, exceeds $1,000,000; (excluding the value of the person's primary residence). For the purposes of calculating joint net worth in this paragraph: joint net worth can be the aggregate net worth of the investor and spouse or spousal equivalent; assets need not be held jointly to be included in the calculation; [ ] Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse or spousal equivalent 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; [ ] An entity in which all of the equity holders are accredited investors by virtue of their meeting one or more of the above standards; [ ] Any entity, of a type not listed in paragraph (a)(1), (2), (3), (7), or (8) of 17 CFR 230.501(a), not formed for the specific purpose of acquiring the securities offered, owning investments in excess of $5,000,000; [ ] Any natural person holding in good standing one or more professional certifications or designations or credentials from an accredited educational institution that the Securities and Exchange Commission has designated as qualifying an individual for accredited investor status; [ ] Any natural person who is a “knowledgeable employee,” as defined in rule 3c5(a)(4) under the Investment Company Act of 1940 (17 CFR 270.3c-5(a)(4)), of the issuer of the securities being offered or sold where the issuer would be an investment company, as defined in section 3 of such act, but for the exclusion provided by either section 3(c)(1) or section 3(c)(7) of such act; [ ] Any “family office,” as defined in rule 202(a)(11)(G)-1 under the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)-1): (i) With assets under management in excess of $5,000,000, (ii) That is not formed for the specific purpose of acquiring the securities offered, and (iii) Whose prospective investment is directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment; and [ ] Any “family client,” as defined in rule 202(a)(11)(G)-1 under the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)-1)), of a family office meeting the requirements in paragraph (a)(12) of § 275.202(a)(11)(G)-1 and whose prospective investment in the issuer is directed by such family office pursuant to paragraph (a)(12)(iii) of § 275.202(a)(11)(G)-1. 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. (e) Offers, issuances, and sales of Subordinated Debt Notes. (1) Application to offer, issue, and sell at offices of Issuing Credit Union. (2) Decision on application. (3) Commissions, bonuses, or comparable payments. (4) Issuances by tellers. (5) Permissible issuing personnel. (6) Issuance practices, advertisements, and other literature used in connection with the offer and sale of Subordinated Debt Notes. (7) Office of an Issuing Credit Union. (f) Securities laws. (g) Resales. § 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 § 702.404(a)(6)), as required by the following schedule: Table 1 to § 720.407 Remaining maturity Balance treated as 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 § 702.408 Preapproval to issue Subordinated Debt. (a) Scope. (b) Initial application to issue Subordinated Debt. (1) A statement indicating how the credit union qualifies to issue Subordinated Debt given the eligibility requirements of § 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 and income statement) and cash flow projections, including any off-balance sheet items, covering at least two 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 § 701.34 of this chapter, 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 § 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) In the case of a credit union applying to issue Subordinated Debt Notes with maturities longer than 20 years, an analysis demonstrating that the proposed Subordinated Debt Notes would be properly characterized as debt in accordance with U.S. GAAP. The Appropriate Supervision Office may require that such analysis include one or more of the following: (i) A written legal opinion from a Qualified Counsel; (ii) A written opinion from a licensed certified public accountant (CPA); and (iii) An analysis conducted by the credit union or independent third party; (15) 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 (16) Any additional information requested in writing by the Appropriate Supervision Office. (c) Decision on initial application. (1) Written determination. (2) Conditions of approval. (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. (e) Requirements for all Offering Documents Minimum information required in an Offering Document. (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 § 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. (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 Filing of a Draft Offering Document. (i) Request for additional information, clarifications, or amendments. (ii) Written determination. (2) Filing of a final Offering Document. (g) Filing of an Offering Document for offerings of Subordinated Debt exclusively to Entity Accredited Investors. (h) Material changes to any initial application or Offering Document Reapproval of initial application. (2) Reapproval of Offering Document. (3) Failure to request reapproval. (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. (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 § 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. (k) Expiration of authority to issue Subordinated Debt. (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. (2) Provided the Issuing Credit Union filing the document has complied with all requirements regarding the filing in this section, 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 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. http://www.NCUA.gov. (2) Filing fees must be paid to the NCUA by electronic transfer. [86 FR 11074, Feb. 23, 2021, as amended at 88 FR 18011, Mar. 27, 2023] § 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 § 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 § 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) Pro Forma Financial Statements (balance sheet and income statement) and cash flow projections, including any off-balance sheet items, covering at least two 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. (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. [86 FR 11074, Feb. 23, 2021, as amended at 88 FR 18011, Mar. 27, 2023] § 702.410 Interest payments on Subordinated Debt. (a) Requirements for interest payments. (b) Accrual of interest. (c) Interest safe harbor. (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. § 702.411 Prior written approval to prepay Subordinated Debt. (a) Prepayment option. (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. (c) Federally insured, state-chartered credit union prepayment applications. (d) Application contents. (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 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. (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. § 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 § 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 § 702.403. (c) 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 § 702.411. § 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. § 702.414 Regulations governing Grandfathered Secondary Capital. This section recodifies the requirements from 12 CFR 701.34(b), (c), and (d) that were in effect as of December 31, 2021, with minor modifications. The terminology used in this section is specific to this section. Except as provided in the next sentence, all secondary capital issued under § 701.34 of this chapter before January 1, 2022, or, in the case of a federally insured, state-chartered credit union, § 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. Issuances of secondary capital to the U.S. Government or any of its subdivisions, under applications approved before January 1, 2022, pursuant to § 701.34 or § 741.204(c) of this chapter, are also considered “Grandfathered Secondary Capital” irrespective of the date of issuance. (a) Secondary capital is subject to the following conditions: (1) Secondary capital plan. (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 January 1, 2022. (3) Nonshare account. (4) Minimum maturity. (5) Uninsured account. (6) Subordination of claim. (7) Availability to cover losses. (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. (9) Merger or dissolution. (10) Contract agreement. (11) Disclosure and acknowledgement. (12) Prompt corrective action. (b) Accounting treatment; Recognition of net worth value of accounts Debt. (2) Schedule for recognizing net worth value. (i) The remaining balance of the accounts after any redemptions and losses; or (ii) The amounts calculated based on the following schedule: Table 1 to Paragraph (b)(2)(ii) Remaining maturity Net worth value of 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. (c) Redemption of secondary capital. (1) Request to redeem secondary capital. (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. (3) Schedule for redeeming secondary capital. Table 2 to Paragraph (c)(3) Remaining maturity Redemption limit as 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. [86 FR 11074, Feb. 23, 2021, as amended at 86 FR 72809, Dec. 23, 2021; 88 FR 18011, Mar. 27, 2023] 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. 2. Redemption prior to maturity. 3. Uninsured, non-share account. 4. Prepayment risk. 5. Availability to cover losses. 6. Accrued interest. ____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. 8. Prompt Corrective Action. 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] Subparts E-F [Reserved] Subpart G—CECL Transition Provisions Source: 86 FR 34932, July 1, 2021, unless otherwise noted. § 702.701 Authority, purpose, and scope. (a) Authority. (b) Purpose. (c) Scope. (i) Generally accepted accounting principles (GAAP) under § 702.402(d)(1)(i); or (ii) In the case of Federally-insured, State-chartered credit unions, any other applicable standard under State law or regulation under § 702.402(d)(1)(ii)(B). (2) The transition provisions of this subpart do not apply to Federally-insured credit unions, whether Federally or State-chartered, including credit unions defined as “new” pursuant to section 1790d(b)(2), that make charges for loan losses using a reasonable reserve methodology under § 702.402(d)(1)(ii)(A). § 702.702 Definitions. In addition to the definitions set forth in § 702.2, the following definitions apply to this subpart: CECL transitional amount Current Expected Credit Losses (CECL) Transition period § 702.703 CECL transition provisions. (a) Eligibility. (1) The credit union has not adopted CECL before its first fiscal year beginning after December 15, 2022; and (2) The credit union records a reduction in retained earnings due to the adoption of CECL. (b) Determination of CECL transition amount. (2) For purposes of calculating the fourth through twelfth quarters of the transition period, as described in paragraphs (c)(2) and (c)(3) of this section, the CECL transitional amount is equal to the difference between the credit union's retained earnings as of the end of the fiscal year in which the credit union adopts CECL and the credit union's retained earnings as of the beginning of its next fiscal year. (c) Calculation of CECL transition provision. (1) Increase retained earnings and total assets as reported on the Call Report for purposes of the net worth ratio by 100 percent of its CECL transitional amount during the first three quarters of the transition period (first three reporting quarters of the fiscal year in which the credit union adopts CECL); (2) Increase retained earnings and total assets as reported on the Call Report for purposes of the net worth ratio by sixty-seven percent of its CECL transitional amount during the second four quarters of the transition period (fourth reporting quarter of the fiscal year in which the credit union adopts CECL and first three reporting quarters of the next fiscal year); and (3) Increase retained earnings and total assets as reported on the Call Report for purposes of the net worth ratio by thirty-three percent of its CECL transitional amount during the final four quarters of the transition period. Appendix A to Part 702—Gross-Up Approach, and Look-Through Approaches Instead of using the risk weights assigned in § 702.104(c)(2) a credit union may determine the risk weight of certain investment funds, and the risk weight of a non-subordinated or subordinated tranche of any investment as follows: (a) Gross-up approach Applicability. (2) Calculation. (i) Pro rata share, which is the par value of the credit union's exposure as a percent of the par value of the tranche in which the securitization exposure resides; (ii) Enhanced amount, which is the par value of tranches that are more senior to the tranche in which the credit union's securitization resides; (iii) Exposure amount, which is the amortized cost for investments classified as held-to-maturity and available-for-sale, and the fair value for trading securities; and (iv) Risk weight, which is the weighted-average risk weight of underlying exposures of the securitization as calculated under this appendix. (3) Credit equivalent amount. (i) The exposure amount of the credit union's exposure; and (ii) The pro rata share multiplied by the enhanced amount, each calculated in accordance with paragraph (a)(2) of this appendix. (4) Risk-weighted assets. (5) Securitization exposure defined. (i) A credit exposure that arises from a securitization; or (ii) An exposure that directly or indirectly references a securitization exposure described in paragraph (a)(5)(i) of this appendix. (6) Securitization defined. (i) The credit risk associated with the underlying exposures has been separated into at least two tranches reflecting different levels of seniority; (ii) Performance of the securitization exposures depends upon the performance of the underlying exposures; and (iii) All or substantially all of the underlying exposures are financial exposures (such as loans, receivables, asset-backed securities, mortgage-backed securities, or other debt securities). (b) Look-through approaches. Applicability. (2) Full look-through approach. General. (A) The aggregate risk-weighted asset amounts of the exposures held by the fund as if they were held directly by the credit union; and (B) The credit union's proportional ownership share of the fund. (ii) Holding report. (A) Use the most recently issued investment fund holding report; and (B) Use an investment fund holding report that reflects holding that are not older than 6-months from the quarter-end effective date (as defined in § 702.101(c)(1). (3) Simple modified look-through approach. (4) Alternative modified look-through approach. [80 FR 66722, Oct. 29, 2015]

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