The Dodd-Frank Act requires the federal banking agencies and NCUA to remove all references to credit ratings in their regulations and substitute “other standards of creditworthiness” the agencies deem appropriate.
NCUA finalized amendments to its investment regulation (Section 703) last December, and the changes are effective June 11, 2013. NCUA believes about 750 federal credit unions must develop or augment their systems to evaluate the creditworthiness of their investments.
CUNA expects NCUA to issue (near press time) additional guidance on how to comply with its new investment rules. The agency says it will provide more information about ways credit unions can evaluate a possible investment and what examiners will expect.
As a refresher, NCUA’s investment regulation is already quite comprehensive in its requirements. It addresses required investment policies, recordkeeping and documentation requirements, control over investments and advisers, credit analysis, noncompliant investments, broker-dealers’ qualifications, safekeeping, valuing securities, monitoring securities and nonsecurity investments, permissible and prohibited investments, grandfathered investments, conflicts of interest, and investment pilot programs. The new rules address aspects of the existing regulations that rely on references to credit ratings.
Which CUs must follow the rules
Section 703 applies only to investments by federal credit unions. But if a federally insured state-chartered credit union (FISCU) holds an investment that isn’t permissible for a federal credit union, it might be subject to special reserving on that investment.
During the comment period on the proposed regulation, someone wrote that if a FISCU holds a ratings-based investment that’s permissible under state law that tracks the old regulation, then NCUA shouldn’t consider that investment “nonconforming” and subject to special reserves.
NCUA answered by including this amendment to Section 741 that’s applicable to state-chartered credit unions:
“[I]f a state-chartered credit union conducts and documents an analysis that reasonably concludes an investment is at least investment grade, as defined in Section 703.2 of this chapter, and the investment is otherwise permissible for federal credit unions, that investment is not considered to be beyond those authorized by the Act of the NCUA Rules and Regulations.”
So state-chartered credit unions also should review the new investment rules applicable to federal credit unions to determine what changes they might need to make in their investment programs.
The new 'investment grade' standard
If NCUA must eliminate all references to credit ratings—such as “AAA” or “AA”—and credit rating agencies in its regulations to define permissible investments, what does it consider “an appropriate standard”?
Section 703.2 says:
“Investment grade means the issuer of a security has an adequate capacity to meet the financial commitments under the security for the projected life of the asset or exposure, even under adverse economic conditions. An issuer has an adequate capacity to meet financial commitments if the risk of default by the obligor is low and the full and timely repayment of principal and interest on the security is expected.”
The regulation lists eight factors a credit union can use to evaluate the creditworthiness of a security; a credit union might consider any of them as appropriate. The supplemental information that accompanies the final regulation issued last December elaborates a little on what these eight factors mean, and NCUA is expected to provide more details in its coming guidance.
These are the factors a credit union might consider (and the list isn’t intended to be exhaustive):
► Credit spreads;
► Securities-related research;
► Internal or external credit risk assessments;
► Default statistics;
► Inclusion on an index;
► Priorities and enhancements;
► Price, yield, and/or volume; and
► Asset class-specific factors.
Keep in mind that although NCUA can’t reference credit ratings in its regulation, nothing prohibits credit unions from using credit ratings as an element of the required credit analysis under the agency’s new regulation, which explains the third factor.
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