[Federal Register: August 6, 2004 (Volume 69, Number 151)]
[Proposed Rules]
[Page 47983-48006]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr06au04-29]
[[Page 47983]]
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Part II
Farm Credit Administration
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12 CFR Parts 607, 614, 615, and 620
Assessment and Apportionment of Administrative Expenses; Loan Policies
and Operations; Funding and Fiscal Affairs, Loan Policies and
Operations, and Funding Operations; Disclosure to Shareholders; Capital
Adequacy Risk-Weighting Revisions; Proposed Rule
[[Page 47984]]
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FARM CREDIT ADMINISTRATION
12 CFR Parts 607, 614, 615, and 620
RIN 3052-AC09
Assessment and Apportionment of Administrative Expenses; Loan
Policies and Operations; Funding and Fiscal Affairs, Loan Policies and
Operations, and Funding Operations; Disclosure to Shareholders; Capital
Adequacy Risk-Weighting Revisions
AGENCY: Farm Credit Administration.
ACTION: Proposed rule.
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SUMMARY: The Farm Credit Administration (FCA) proposes to change its
regulatory capital standards on recourse obligations, direct credit
substitutes, residual interests, asset- and mortgage-backed securities,
guarantee arrangements, claims on securities firms, and certain
qualified residential loans. We are modifying our risk-based capital
requirements to more closely match a Farm Credit System (FCS or System)
institution's relative risk of loss on these credit exposures to its
capital requirements. In doing so, we propose to risk-weight recourse
obligations, direct credit substitutes, residual interests, and asset-
and mortgage-backed securities based on external credit ratings from
nationally recognized statistical rating organizations (NRSROs). In
addition, our proposal will make our regulatory capital treatment more
consistent with that of the other financial regulatory agencies for
transactions and assets involving similar risk and address financial
structures and transactions developed by the market since our last
update. We also propose to make a number of nonsubstantive changes to
our regulations to make them easier to use.
DATES: Please send your comments to us by November 4, 2004.
ADDRESSES: You may send comments by electronic mail to ``
reg-comm@fca.gov,'' through the Pending Regulations section of FCA's Web
site, ``http://www.fca.gov,'' or through the governmentwide ``http://www.regulations.gov
'' Web site. You may also send comments to S. Robert
Coleman, Director, Regulation and Policy Division, Office of Policy and
Analysis, Farm Credit Administration, 1501 Farm Credit Drive, McLean,
VA 22102-5090 or by fax to (703) 734-5784. You may review copies of all
comments we receive at our office in McLean, Virginia.
FOR FURTHER INFORMATION CONTACT:
Laurie A. Rea, Senior Policy Analyst, Office of Policy and Analysis,
Farm Credit Administration, McLean, VA 22102-5090, (703) 883-4479; TTY
(703) 883-4434;
or
Jennifer A. Cohn, Senior Attorney, Office of General Counsel, Farm
Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703)
883-2020.
SUPPLEMENTARY INFORMATION:
I. Objectives
The objectives of this proposed rule are to:
Ensure FCS institutions maintain capital levels
commensurate with their relative exposure to credit risk;
Help achieve a more consistent regulatory capital
treatment with the other financial regulatory agencies \1\ for
transactions involving similar risk;
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\1\ We refer collectively to the Office of the Comptroller of
the Currency (OCC), the Board of Governors of the Federal Reserve
System (Federal Reserve Board), the Federal Deposit Insurance
Corporation (FDIC), and the Office of Thrift Supervision (OTS) as
the ``other financial regulatory agencies.''
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Address a recent recommendation by the United States
General Accounting Office (GAO) to take appropriate measures to reduce
potential safety and soundness issues that may arise from capital
arbitrage; and
Allow FCS institutions' capital to be used more
efficiently in serving agriculture and rural America and supporting
other System mission activities.
II. Background
A. Basis of Current Risk-Based Capital Rules
Since the late 1980s, the regulatory capital requirements
applicable to federally regulated financial institutions, including FCS
institutions, have been based, in part, on the risk-based capital
framework developed under the guidance of the Basel Committee on
Banking Supervision (Basel Committee).\2\ We first adopted risk-
weighting categories for System assets as part of the 1988 regulatory
capital revisions \3\ required by the Agricultural Credit Act of 1987
\4\ and made minor revisions to these categories in 1998.\5\ Risk-
weighting is used to assign on- and off-balance sheet positions
appropriate capital requirements and to compute the risk-adjusted asset
base for FCS banks' and associations' permanent capital, core surplus,
and total surplus ratios. The current risk-weighting categories are
similar to those outlined in the Accord on International Convergence of
Capital Measurement and Capital Standards (1988, as amended in 1998)
(Basel Accord), which were also adopted by the other financial
regulatory agencies. Our risk-based capital requirements are contained
in subparts H and K of part 615 of our regulations.
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\2\ The Basel Committee is a committee of central banks and bank
supervisors/regulators from the major industrialized countries that
formulate standards and guidelines related to banking and recommend
them for adoption by member countries and others. All Basel
Committee documents mentioned in this preamble are available on the
Committee's Web site at http://www.bis.org/bcbs/.
\3\ See 53 FR 39229 (October 6, 1988).
\4\ Agricultural Credit Act of 1987, Pub. L. 100-233 (January 6,
1988).
\5\ See 63 FR 39219 (July 22, 1998).
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B. Implications of the New Basel Capital Accord
In April 2003, the Basel Committee issued a consultative document
on the proposed New Basel Capital Accord (Basel II). Basel II discusses
potential modifications to the current Basel Accord, including the
capital treatment of securitizations. The standards established by our
proposal enhance risk sensitivity in a manner consistent with the
standardized approach to credit risk under Basel II. The standardized
approach establishes fixed risk weights corresponding to each
supervisory risk weight category and makes use of external credit
assessments to enhance risk sensitivity compared with the current Basel
Accord. Similarly, under our proposal we use external credit ratings
assigned by NRSROs as a basis for determining the credit quality and
the resulting capital treatment for credit exposures.\6\ According to
their most recent press release (May 11, 2004), the Basel Committee has
achieved consensus on the remaining issues regarding the proposals for
the new international capital standard. The Basel Committee also
confirmed that the standardized and foundation approaches will be
implemented from year-end 2006. However, the Committee indicated that
another year of impact analysis will be needed to evaluate the most
advanced approaches, and therefore these will not be implemented until
year-end 2007. As we continue to review Basel II and assess its
implications and appropriateness for FCS institutions, we may make
further revisions to our capital regulations. In the interim, we
welcome comments on the proposed
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new framework and its applicability to FCS institutions.
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\6\ An NRSRO is a rating organization that the Securities and
Exchange Commission recognizes as an NRSRO. See 12 CFR 615.5131(j).
See also 66 FR 59632, 59639, 59655, 59662 (November 29, 2001).
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C. Rules Recently Adopted by the Other Financial Regulatory Agencies
In developing these proposed changes, we also took into
consideration recent changes the other financial regulatory agencies
made to their capital rules. These changes are briefly described below.
In November 2001, the other financial regulatory agencies issued a
final rule that amended their risk-based capital regulations for
positions that banking organizations \7\ hold in recourse obligations,
direct credit substitutes, residual interests, and asset- and mortgage-
backed securities.\8\ The other financial regulatory agencies intended
for these changes to produce more consistent capital treatment for
credit risks associated with exposures arising from these positions.
More specifically, the new risk-based standards tie capital
requirements for these transactions to their relative risk exposure, as
measured by credit ratings received from an NRSRO.
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\7\ Banking organizations include banks, bank holding companies,
and thrifts. See 66 FR 59614 (November 29, 2001).
\8\ See 66 FR 59614 (November 29, 2001).
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Similarly, in April 2002, the other financial regulatory agencies,
consistent with the proposed changes to the Basel Accord, issued a rule
that amended their risk-based capital standards for banking
organizations with regard to the risk weighting of claims on, and
claims guaranteed by, qualifying securities firms.\9\ The capital
requirements for these claims are also tied in a similar manner to
their relative risk exposure as measured by NRSRO credit ratings.
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\9\ See 67 FR 16971 (April 9, 2002).
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In January 2002, the other financial regulatory agencies (except
the OTS) adopted a joint final rule governing the regulatory capital
treatment of equity investments in nonfinancial companies held by
banking organizations under various legal authorities.\10\ Among other
changes in regulatory capital treatment, this joint final rule
addresses the risk weighting of investments in small business
investment companies (SBICs).
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\10\ See 67 FR 3784 (January 25, 2002).
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In August 2003, the other financial regulatory agencies issued for
comment their views on the proposed framework for implementing the
Basel II in the United States.\11\ The advance notice of proposed
rulemaking (ANPRM) describes significant elements of the Advanced
Internal Ratings-Based approach for credit risk (including credit
exposures from securitizations) and the Advanced Measurement Approaches
for operational risk. The ANPRM also specifies the criteria that would
be used to determine banking organizations that would be required to
use the advanced approaches.\12\
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\11\ See 68 FR 45900 (August 4, 2003).
\12\ Internationally active banking organizations with total
assets of $250 billion or more or total on-balance sheet foreign
exposures of $10 billion or more would be required to adopt the
advanced approaches. All other banks would continue to apply the
general risk-based capital rules, unless they opt-in.
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Our proposal does not address the advanced approach for positions
in securitizations (or any other credit exposures). The focus of this
proposed rule is on improving the risk sensitivity of the current risk-
based capital through the use of external credit ratings.
D. FCA Rulemakings
On February 19, 2003, the FCA Board adopted an interim final rule
that amended our capital rules to allow System institutions to use a
lower risk weighting for highly rated investments in non-agency \13\
asset-backed securities (ABS) and mortgage-backed securities (MBS),
which have reduced exposure to credit risk.\14\ This was one of the
changes the other financial regulatory agencies made in November 2001.
Because this change was narrow and noncontroversial, relieved a
regulatory burden, and immediately furthered the mission of the System,
we adopted it without prepromulgation comment. This change became
effective on May 13, 2003. We issued the interim final rule with a
request for comments but received none.
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\13\ Non-agency securities are securities not issued or
guaranteed by the United States Government, a Government agency (as
defined in Sec. 615.5201(f)), or a Government-sponsored agency (as
defined in Sec. 615.5201(g)).
\14\ See 68 FR 15045 (March 28, 2003).
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Additionally, on April 22, 2004, FCA adopted changes to the risk-
based capital treatment for other financing institutions (OFIs).\15\
Those amendments also aimed to enhance the risk sensitivity of FCA's
risk-based capital rules through changes in risk weightings. This
proposed rule incorporates the changes made to our risk weightings
through the OFI rulemaking.
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\15\ See 69 FR 29852 (May 26, 2004).
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E. GAO Recommendation on Capital Arbitrage
In a recent report, the GAO recommended that the FCA ``[c]reate a
plan to implement actions currently under consideration to reduce
potential safety and soundness issues that may arise from capital
arbitrage activities of Farmer Mac and FCS institutions.'' \16\ This
proposed rulemaking takes important steps to reduce potential safety
and soundness issues that may result from securitization and guarantee/
credit protection arrangements that FCS institutions engage in with the
Federal Agricultural Mortgage Corporation (Farmer Mac), domestic banks,
and securities firms. In particular, we take measures to ensure that
FCS institutions cannot alter their capital requirements simply by
using different structures, arrangements or counterparties without
changing the nature of the risks they assume or retain.
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\16\ United States General Accounting Office, Farmer Mac: Some
Progress Made, but Greater Attention to Risk Management, Mission,
and Corporate Governance Is Needed, GAO-04-116, at page 59 (2003).
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III. Scope of Our Proposal
Our proposal embraces many of the Basel Committee's objectives for
improving risk sensitivity in regulatory capital rules and aligns our
risk-based capital framework closely with the rules of the other
financial regulatory agencies. However, because the scope of the FCS
institutions' activities differs from the activities of banking
organizations, our proposal is not identical to their rules. Their
rules focus on traditional securitization activities, where a banking
organization sells assets or credit exposures to increase its liquidity
and manage credit risk. Our proposal places more emphasis on capital
treatment of investments in ABS and MBS held for liquidity and other
types of structured financial transactions and arrangements where an
FCS institution transfers, retains, or assumes credit risk to manage
its credit risk profile. Examples of these other types of transactions
and arrangements are synthetic securitizations, financial guarantee
arrangements, long-term standby purchase commitments, and credit
derivatives.
Like the other financial regulatory agencies, we are also proposing
a ratings-based approach for claims on securities firms. Additionally,
similar to the rules that the other financial regulatory agencies have
adopted, our proposal also addresses risk weighting for authorized
investments in nonfinancial companies. Subtitle H of the Consolidated
Farm and Rural Development Act,\17\ as amended by section 6029 of the
Farm Security and Rural Investment Act of 2002,\18\ authorizes System
institutions to invest in rural business investment companies (RBICs).
RBICs are similar to SBICs, in
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which banking organizations are allowed to invest.
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\17\ Pub. L. 87-128 (August 8, 1961).
\18\ Pub. L. 107-171 (May 3, 2002).
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Furthermore, as the other financial regulatory agencies have done,
we are making explicit our authority to modify a stated risk weight or
credit conversion factor, if warranted, on a case-by-case basis.
We invite comments on whether we should make any additional
modifications to our risk-based capital rules to more closely align
capital requirements for FCS institutions with their relative risk
exposure and requirements for other banking organizations. We also
invite comments on whether FCA should delay or accelerate
implementation of any aspects of this proposal.
IV. Overview
A. General Approach
We propose revisions to our capital rules that would implement a
ratings-based approach for risk-weighting positions in recourse
obligations, residual interests (other than credit-enhancing interest-
only strips), direct credit substitutes, and asset- and mortgage-backed
securities. Highly rated positions will receive a favorable (less than
100-percent) risk weighting. Positions that are rated below investment
grade \19\ will receive a less favorable risk weighting (generally
greater than 100-percent risk weight). The FCA proposes to apply this
approach to positions based on their inherent risks rather than how
they might be characterized or labeled.
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\19\ Investment grade means a credit rating of AAA, AA, A or BBB
or equivalent by an NRSRO.
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As noted, our proposed ratings-based approach provides risk
weightings for a variety of assets that have a wide range of credit
ratings. We provide risk weightings for investments that are rated
below investment grade, although they are not eligible investments
under our current investment regulations.\20\ This proposed rule does
not, however, expand the scope of eligible investments. It merely
explains how to risk weight an investment that was eligible when
purchased if its credit rating subsequently deteriorates. Such
investments must still be disposed of in accordance with Sec.
615.5143.\21\
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\20\ See Sec. 615.5140.
\21\ Section 615.5143 provides that an institution must dispose
of an ineligible investment within 6 months unless FCA approves, in
writing, a plan that authorizes divestiture over a longer period of
time. An institution must dispose of an ineligible investment as
quickly as possible without substantial financial loss.
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B. Asset Securitization
This proposal necessitates an understanding of asset securitization
and other structured transactions that are used as tools to manage and
transfer credit risk. Therefore, we have included the following
background explanation to aid our readers.
Asset securitization is the process by which loans or other credit
exposures are pooled and reconstituted into securities, with one or
more classes or positions that may then be sold. Securitization
provides an efficient mechanism for institutions to sell loan assets or
credit exposures and thereby to increase the institution's liquidity.
For purposes of this preamble, references to ``securitizations'' also
include structured financial transactions or arrangements and synthetic
transactions \22\ that generally create stratified credit risk
positions, which may or may not be in the form of a security, whose
performance is dependent upon a pool of loans or other credit
exposures. For example, in a synthetic securitization, loans are not
sold or transferred, but rather the performance of securities is tied
to a reference pool of loan assets or other credit exposures.\23\
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\22\ For examples of synthetic securitization structures, see
Banking Bulletin 99-43, December 1999 (OCC); Supervision and
Regulation Letter 99-32, Capital Treatment for Synthetic
Collateralized Loan Obligations, November 15, 1999 (Federal Reserve
Board).
\23\ Synthetic transactions bundle credit risks associated with
on-balance sheet assets or off-balance sheet items and sell them
into the market.
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Securitizations typically carve up the risk of credit losses from
the underlying assets and distribute it to different parties. The
``first dollar,'' or most subordinate, loss position is first to absorb
credit losses; the most ``senior'' investor position is last to absorb
losses; and there may be one or more loss positions in between
(``second dollar'' loss positions). Each loss position functions as a
credit enhancement for the more senior positions in the structure.
Recourse, in connection with sales of whole loans or loan
participations, is now frequently associated with asset
securitizations. Depending on the type of securitization, the sponsor
of a securitization may provide a portion of the total credit
enhancement internally, as part of the securitization structure,
through the use of excess spread accounts, overcollateralization,
retained subordinated interests, or other similar on-balance sheet
assets. When these or other on-balance sheet internal enhancements are
provided, the enhancements are ``residual interests'' for regulatory
capital purposes.
A seller may also arrange for a third party to provide credit
enhancement \24\ in an asset securitization. If another financial
institution provides the third-party enhancement, then that institution
assumes some portion of the assets' credit risk. In this proposed rule,
all forms of third-party enhancements, i.e., all arrangements in which
an FCS institution assumes credit risk from third-party assets or other
claims that it has not transferred, are referred to as ``direct credit
substitutes.''
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\24\ The terms ``credit enhancement'' and ``enhancement'' refer
to both recourse arrangements (including residual interests) and
direct credit substitutes.
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Many asset securitizations use a combination of recourse and third-
party enhancements to protect investors from credit risk. When third-
party enhancements are not provided, the institution ordinarily retains
virtually all of the credit risk on the assets.
C. Risk Management
While asset securitization can enhance both credit availability and
profitability, managing the risks associated with this activity poses
significant challenges. While not new to FCS institutions, these risks
may be less obvious and more complex than traditional lending
activities. Specifically, securitization can involve credit, liquidity,
operational, legal, and reputation risks that may not be fully
recognized by management or adequately incorporated into risk
management systems. The capital treatment required by this proposed
rule addresses credit risk presented in securitizations and other
credit risk mitigation techniques. Therefore, it is essential that an
institution's compliance with capital standards be complemented by
effective risk management practices and strategies.
Similar to the other financial regulatory agencies, the FCA expects
FCS institutions to identify, measure, monitor, and control
securitization risks and explicitly incorporate the full range of those
risks into their risk management systems. The board and management are
responsible for adequate policies and procedures that address the
economic substance of their activities and fully recognize and ensure
appropriate management of related risks. Additionally, FCS institutions
must be able to measure and manage their risk exposure from securitized
positions, either retained or acquired. The formality and
sophistication with which the risks of these activities are
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incorporated into an institution's risk management system should be
commensurate with the nature and volume of its securitization
activities.\25\
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\25\ This proposal would not grant any new authorities to System
institutions. It merely provides risk weightings for investments and
transactions that are otherwise authorized.
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V. Section-by-Section Analysis of Proposed Changes
The following discussion provides explanations, where necessary, of
the more complex changes we propose. Most of the changes are necessary
to more closely align our rules with those of the other financial
regulatory agencies and to recognize relative risk exposure. As
mentioned above, we have also made a number of organizational and plain
language changes to make our rules easier to follow. These changes are
discussed later in this preamble.
A. Section 615.5201--Definitions
Because this rule would implement a new risk-weighting approach for
recourse obligations, residual interests, direct credit substitutes,
and other securitization and guarantee arrangements, we are proposing
to amend Sec. 615.5201 to add a number of new definitions relating to
these activities. We are also proposing to update certain other
definitions as warranted. For the most part, to achieve consistency
with the other financial regulatory agencies, we are proposing to adopt
the same definitions as the other agencies.
1. Credit Derivative
We propose to define credit derivative as a contract that allows
one party (the protection purchaser) to transfer the credit risk of an
asset or off-balance sheet credit exposure to another party (the
protection provider). The value of a credit derivative is dependent, at
least in part, on the credit performance of a ``reference asset.''
The proposed definitions of ``recourse'' and ``direct credit
substitute'' cover credit derivatives to the extent that an
institution's credit risk exposure exceeds its pro rata interest in the
underlying obligation. The ratings-based approach therefore applies to
rated instruments such as credit-linked notes issued as part of a
synthetic securitization.
Credit derivatives can have a variety of structures. Therefore, we
will continue to evaluate credit derivatives on a case-by-case basis.
Furthermore, we will continue to use the December 1999 guidance on
synthetic securitizations issued by the Federal Reserve Board and the
OCC as a guide for determining appropriate capital requirements for FCS
institutions and continue to apply the structural and risk management
requirements outline in the 1999 guidance.\26\
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\26\ See Banking Bulletin 99-43, December 1999 (OCC);
Supervision and Regulation Letter 99-32, Capital Treatment for
Synthetic Collateralized Loan Obligations, November 15, 1999
(Federal Reserve Board).
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2. Credit-Enhancing Interest-Only Strip
We propose to define the term ``credit-enhancing interest-only
strip'' as an on-balance sheet asset that, in form or in substance, (1)
Represents the contractual right to receive some or all of the interest
due on transferred assets; and (2) exposes the institution to credit
risk directly or indirectly associated with the transferred assets that
exceeds its pro rata claim on the assets, whether through subordination
provisions or other credit enhancement techniques. FCA proposes to
reserve the right to identify other cash flows or related interests as
credit-enhancing interest-only strips based on the economic substance
of the transaction.
Credit-enhancing interest-only strips include any balance sheet
asset that represents the contractual right to receive some or all of
the remaining interest cash flow generated from assets that have been
transferred into a trust (or other special purpose entity), after
taking into account trustee and other administrative expenses, interest
payments to investors, servicing fees, and reimbursements to investors
for losses attributable to the beneficial interests they hold, as well
as reinvestment income and ancillary revenues \27\ on the transferred
assets.
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\27\ According to the Statement of Financial Accounting
Standards No. 140, ancillary revenues include late charges on
transferred assets.
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Credit-enhancing interest-only strips are generally carried on the
balance sheet at the present value of the reasonably expected net cash
flow, adjusted for some level of prepayments if relevant, and
discounted at an appropriate market interest rate. Typically, transfers
of assets accounted for as a sale under generally accepted accounting
principles (GAAP) result in the seller recording a gain on the portion
of the transferred assets that has been sold. This gain is recognized
as income, thus increasing the institution's capital position.
Under the proposed rule, FCA would look to the economic substance
of the transaction and reserve the right to identify other cash flows
or spread-related assets as credit-enhancing interest-only strips on a
case-by-case basis. For example, including some principal payments with
interest and fee cash flows will not otherwise negate the regulatory
capital treatment of that asset as a credit-enhancing interest-only
strip. Credit-enhancing interest-only strips include both purchased and
retained interest-only strips that serve in a credit-enhancing
capacity, even though purchased interest-only strips generally do not
result in the creation of capital on the purchaser's balance sheet.
3. Credit-Enhancing Representations and Warranties
When an institution transfers or purchases assets, including
servicing rights, it customarily makes or receives representations and
warranties concerning those assets. These representations and
warranties give certain rights to other parties and impose obligations
upon the seller or servicer of those assets. To the extent such
representations and warranties function as credit enhancements to
protect asset purchasers or investors from credit risk, the proposed
rule treats them as recourse or direct credit substitutes.
More specifically, credit-enhancing representations and warranties
are defined in the proposal as representations and warranties that: (1)
Are made or assumed in connection with a transfer of assets (including
loan-servicing assets); and (2) obligate an institution to protect
investors from losses arising from credit risk in the assets
transferred or loans serviced. As proposed, the term includes promises
to protect a party from losses resulting from the default or
nonperformance of another party or from an insufficiency in the value
of collateral.
The proposed definition is consistent with the other financial
regulatory agencies' long-standing recourse treatment of
representations and warranties that effectively guarantee performance
or credit quality of transferred loans. However, a number of factual
warranties unrelated to ongoing performance or credit quality are
typically made. These warranties entail operational risk, as opposed to
credit risk inherent in a financial guaranty, and are excluded from the
definitions of recourse and direct credit substitute. Warranties that
create operational risk include warranties that assets have been
underwritten or collateral appraised in conformity with identified
standards and warranties that permit the return of assets in instances
of incomplete documentation, misrepresentation, or fraud. FCA expects
FCS institutions to be able to demonstrate effective management of
operational risks created by warranties.
[[Page 47988]]
Warranties or assurances that are treated as recourse or direct
credit substitutes include warranties on the actual value of asset
collateral or that ensure the market value corresponds to appraised
value or the appraised value will be realized in the event of
foreclosure and sale. Also, premium refund clauses, which can be
triggered by defaults, are generally credit enhancements. A premium
refund clause is a warranty that obligates the seller who has sold a
loan at a price in excess of par, i.e., at a premium, to refund the
premium, either in whole or in part, if the loan defaults or is prepaid
within a certain period of time. However, certain premium refund
clauses are not considered credit enhancements, including:
(1) Premium refund clauses covering loans for a period not to
exceed 120 days from the date of transfer. These warranties may cover
only those loans that were originated within 1 year of the date of the
transfer; and
(2) Premium refund clauses covering assets guaranteed, in whole or
in part, by the United States Government, a United States Government
agency, or a United States Government-sponsored agency, provided the
premium refund clause is for a period not to exceed 120 days from the
date of transfer.
Clean-up calls, an option that permits a servicer or its affiliate
to take investors out of their positions prior to repayment of all
loans, are also generally treated as credit enhancements. A clean-up
call is not recourse or a direct credit substitute only if the
agreement to repurchase is limited to 10 percent or less of the
original pool balance. Repurchase of any loans 30 days or more past due
would invalidate this exemption.
Similarly, a loan-servicing arrangement is considered as recourse
or a direct credit substitute if the institution, as servicer, is
responsible for credit losses associated with the serviced loans.
However, a cash advance made by a servicer to ensure an uninterrupted
flow of payments to investors or the timely collection of the loans is
specifically excluded from the definitions of recourse and direct
credit substitute, provided that the servicer is entitled to
reimbursement for any significant advances and this reimbursement is
not subordinate to other claims. To be excluded from recourse and
direct credit substitute treatment, an independent credit assessment of
the likelihood of repayment of the servicer's cash advance should be
made prior to advancing funds, and the institution should only make
such an advance if prudent lending standards are met.
4. Direct Credit Substitute
The proposed definition of direct credit substitute complements the
definition of recourse. We propose the term ``direct credit
substitute'' to refer to an arrangement in which an institution
assumes, in form or in substance, credit risk directly or indirectly
associated with an on- or off-balance sheet asset or exposure that was
not previously owned by the institution (third-party asset) and the
risk assumed by the institution exceeds the pro rata share of the
institution's interest in the third-party asset. If the institution has
no claim on the third-party asset, then the institution's assumption of
any credit risk is a direct credit substitute. The term explicitly
includes items such as the following:
Financial standby letters of credit that support financial
claims on a third party that exceed an institution's pro rata share in
the financial claim;
Guarantees, surety arrangements, credit derivatives, and
similar instruments backing financial claims that exceed an
institution's pro rata share in the financial claim;
Purchased subordinated interests that absorb more than
their pro rata share of losses from the underlying assets;
Credit derivative contracts under which the institution
assumes more than its pro rata share of credit risk on a third-party
asset or exposure;
Loans or lines of credit that provide credit enhancement
for the financial obligations of a third party;
Purchased loan-servicing assets if the servicer is
responsible for credit losses or if the servicer makes or assumes
credit-enhancing representations and warranties with respect to the
loans serviced (servicer cash advances are not direct credit
substitutes); and
Clean-up calls on third-party assets. However, clean-up
calls that are 10 percent or less of the original pool balance and that
are exercisable at the option of the institution are not direct credit
substitutes.
5. Externally Rated
The proposal defines externally rated to mean that an instrument or
obligation has received a credit rating from at least one NRSRO. The
use of external credit ratings provides a way to determine credit
quality relied upon by investors and other market participants to
differentiate the regulatory capital treatment for loss positions
representing different gradations of risk. This use permits more
equitable treatment of transactions and structures in administering the
risk-based capital requirements.
6. Financial Standby Letter of Credit
Section 615.5201(o) of our regulations currently defines the term
``standby letter of credit.'' We propose to change the term to
financial standby letter of credit, but propose no substantive changes
to the definition.
7. Government Agency
This term is currently defined in two places in our capital
regulations: Sec. 615.5201(f), which is our definitions section, and
Sec. 615.5210(f)(2)(i)(D), which is our section on computing the
permanent capital ratio. We propose to modify the Sec. 615.5201(f)
definition by replacing it with the definition of Government agency
currently in Sec. 615.5210(f)(2)(i)(D), and then delete the definition
in Sec. 615.5210(f)(2)(i)(D). We believe these changes would
streamline the regulation. We do not intend to change the meaning of
this term.
8. Government-Sponsored Agency
The term Government-sponsored agency is also currently defined in
two places in our capital regulations (Sec. 615.5201(g), which is in
the definitions section, and Sec. 615.5210(f)(2)(ii)(A), which is in
the section on computing the permanent capital ratio). We propose to
modify the definition in Sec. 615.5201(g) by replacing it with the
Sec. 615.5210(f)(2)(ii)(A) definition of Government-sponsored agency,
and then delete the redundant definition in Sec.
615.5210(f)(2)(ii)(A). This proposed change simply streamlines our
regulations and does not change the meaning of the term Government-
sponsored agency.
Under this proposal, the term ``Government-sponsored agency'' would
be defined as an agency or instrumentality chartered or established to
serve public purposes specified by the United States Congress but whose
obligations are not explicitly guaranteed by the full faith and credit
of the United States Government. This definition includes Government-
sponsored enterprises, such as Fannie Mae and Farmer Mac, as well as
Federal agencies, such as the Tennessee Valley Authority, that issue
obligations that are not explicitly guaranteed by the United States'
full faith and credit.
9. Nationally Recognized Statistical Rating Organization
We propose to define NRSRO as a rating organization that the
Securities and Exchange Commission (SEC) recognizes as an NRSRO. This
definition
[[Page 47989]]
is identical to the existing definition in Sec. 615.5131(j) of our
regulations.
10. Non-OECD Bank
We propose to define non-OECD bank as a bank and its branches
(foreign and domestic) organized under the laws of a country that does
not belong to the OECD group of countries.\28\
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\28\ OECD stands for the Organization for Economic Cooperation
and Development. The OECD is an international organization of
countries that are committed to democratic government and the market
economy. For purposes of our capital regulations, as well as those
of the other financial regulatory agencies and the Basel Accord,
OECD countries are those countries that are full members of the OECD
or that have concluded special lending arrangements associated with
the International Monetary Fund's General Arrangements to Borrow,
excluding any country that has rescheduled its external sovereign
debt within the previous 5 years. The OECD currently has 30 member
countries. An up-to-date listing of member countries is available at
http://www.oecd.org or www.oecdwash.org.
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11. OECD Bank
We propose to define OECD bank as a bank and its branches (foreign
and domestic) organized under the laws of a country that belongs to the
OECD group of countries. For purposes of our capital regulations, this
term would include U.S. depository institutions.
12. Permanent Capital
We propose to add language to clarify that permanent capital is
subject to adjustments such as dollar-for-dollar reduction of capital
for residual interests or other high-risk assets as described in
proposed Sec. 615.5207. We do not propose any other changes.
13. Recourse
The proposed rule defines the term ``recourse'' to mean an
arrangement in which an institution retains, in form or in substance,
any credit risk directly or indirectly associated with an asset it has
sold (in accordance with GAAP) that exceeds a pro rata share of the
institution's claim on the asset. If an institution has no claim on an
asset it has sold, then the retention of any credit risk is recourse. A
recourse obligation typically arises when an institution transfers
assets in a sale and retains an explicit obligation to repurchase
assets or to absorb losses due to a default on the payment of principal
or interest or any other deficiency in the performance of the
underlying obligor or some other party. Recourse may also exist
implicitly if an institution provides credit enhancement beyond any
contractual obligation to support assets it has sold.
Our proposed definition of recourse is consistent with the other
regulators' long-standing use of this term and incorporates existing
practices regarding retention of risk in asset sales. The other
financial regulatory agencies noted that third-party enhancements,
e.g., insurance protection, purchased by the originator of a
securitization for the benefit of investors, do not constitute
recourse. The purchase of enhancements for a securitization or other
structured transaction where the institution is completely removed from
any credit risk will not, in most instances, constitute recourse.
However, if the purchase or premium price is paid over time and the
size of the payment is a function of the third party's loss experience
on the portfolio, such an arrangement indicates an assumption of credit
risk and would be considered recourse.
14. Residual Interest
The proposed rule defines residual interest as any on-balance sheet
asset that: (1) Represents an interest (including a beneficial
interest) created by a transfer that qualifies as a sale (in accordance
with GAAP) of financial assets, whether through a securitization or
otherwise; and (2) exposes an institution to credit risk directly or
indirectly associated with the transferred asset that exceeds a pro
rata share of that institution's claim on the asset, whether through
subordination provisions or other credit enhancement techniques.
Residual interests generally include credit-enhancing interest-only
strips, spread accounts, cash collateral accounts, retained
subordinated interests (and other forms of overcollateralization), and
similar assets that function as a credit enhancement. Residual
interests generally do not include interests purchased from a third
party. However, a purchased credit-enhancing interest-only strip is a
residual interest because of its similar risk profile.
This functional based definition reflects the fact that financial
structures vary in the way they use certain assets as credit
enhancements. Therefore, residual interests include any retained on-
balance sheet asset that functions as a credit enhancement in a
securitization or other structured transaction, regardless of its
characterization in financial or regulatory reports.
15. Rural Business Investment Companies
The proposed rule adds a definition for RBICs. Section 6029 of the
Farm Security and Rural Investment Act of 2002 \29\ amended the
Consolidated Farm and Rural Development Act, as amended (7 U.S.C. 1921
et seq.) by adding a new subtitle H, establishing a new ``Rural
Business Investment Program.'' The new subtitle permits FCS
institutions to establish or invest in RBICs, subject to specified
limitations. While the Secretary of Agriculture is responsible for
promulgating regulations governing RBICs, the FCA continues to be
responsible for addressing any issues pertaining to FCS institutions'
investments in RBICs, including risk-weighting those investments. We
define RBICs by referring to the statutory definition as codified in 7
U.S.C. 2009cc(14). That provision defines RBIC as ``a company that (A)
has been granted final approval by the Secretary [of Agriculture] * * *
and; (B) has entered into a participation agreement with the Secretary
[of Agriculture].''
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\29\ Pub. L. 107-171.
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16. Securitization
The proposed rule defines securitization as the pooling and
repackaging by a special purpose entity or trust of assets or other
credit exposures that can be sold to investors. Securitization includes
transactions that create stratified credit risk positions whose
performance is dependent upon an underlying pool of credit exposures,
including loans and commitments.
17. Other Terms
We also propose to add definitions for the following terms:
Bank
Face Amount
Financial Asset
Qualified Residential Loan
Qualifying Securities Firm
Risk Participation
Servicer Cash Advance
Traded Position
U.S. Depository Institution
Finally, we propose to carry over the remaining existing definitions
without substantive change.
B. Sections 615.5210 and 615.5211--Ratings-Based Approach for Positions
in Securitizations
1. Sections 615.5210 and 615.5211--General
As described in the overview section of this preamble, each loss
position in an asset securitization structure functions as a credit
enhancement for the more senior loss positions in the structure.
Historically, neither our risk-based capital standards nor those of the
other financial regulatory agencies varied the capital requirements for
different credit enhancements or loss positions to reflect differences
in the relative credit risks represented by the
[[Page 47990]]
positions. To address this issue, the other financial regulatory
agencies implemented a multilevel, ratings-based approach to assess
capital requirements on recourse obligations, residual interests
(except credit-enhancing interest-only strips), direct credit
substitutes, and senior and subordinated positions in asset-backed
securities and mortgage-backed securities based on their relative
exposure to credit risk. The approach uses credit ratings from NRSROs
to measure relative exposure to credit risk and determine the
associated risk-based capital requirement.
Under this rulemaking, we are proposing to adopt similar
requirements. These changes would bring our regulations into close
alignment with those of the other financial regulatory agencies for
externally rated positions in securitizations with similar risks. We
are also proposing to apply a ratings-based approach to unrated
positions in Government-sponsored agency securitizations based on the
issuer's credit rating beginning 18 months after the effective date of
a final rule.
Currently, the other financial regulatory agencies do not apply a
ratings-based approach to securities issued by Government-sponsored
agencies; these securities are generally risk-weighted at 20 percent.
The other financial regulatory agencies do, however, apply the ratings-
based approach to rated positions in privately issued mortgage
securities (e.g. collateralized mortgage obligations and real estate
investment conduits) that are backed by agency mortgage pass-through
securities. Further, the other financial regulatory agencies uniformly
risk-weight stripped mortgage backed securities issued by Government-
sponsored agencies at 100 percent because of their higher risk
assessment. Additionally, the other financial regulatory agencies
reserve the authority to require a higher risk weighting on any
position (including positions in Government-sponsored agency
securitizations) based on the underlying risks of the position.
The market has historically regarded securities issued by
Government-sponsored agencies as posing minimal credit risk. However,
we are concerned that subordinated positions, residual interests, or
exposures to counterparties (including Government-sponsored agencies)
that are not highly rated or are unrated may pose significant risks to
FCS institutions. We are also concerned about the unique structural and
operational risks that securitizations may present. Therefore, we
believe it is appropriate to apply the ratings-based approach to all
positions in securitizations that are not guaranteed by the full faith
and credit of the United States.
Furthermore, the use of credit ratings would provide an objective
basis for determining credit quality as relied upon by investors or
other market participants. These ratings would then be used to
differentiate the regulatory capital treatment for loss positions based
on different gradations of risk. This approach would enable us to apply
the risk-based capital treatment to a wide variety of transactions and
structures in a more equitable manner.
Additionally, Sec. 615.5210(f) of the proposed regulation would
grant FCA the authority to override the use of certain ratings or the
ratings on certain instruments, either on a case-by-case basis or
through broader supervisory policy, if necessary or appropriate to
address the risk that an instrument poses to FCS institutions.
2. Section 615.5210(b)--Positions that Qualify for the Ratings-Based
Approach
Under Sec. 615.5210(b) of our proposed rule, certain positions in
securitizations qualify for the ratings-based approach. These positions
in securitizations are eligible for the ratings-based approach,
provided the positions have favorable external ratings (as explained
below) by at least one NRSRO. Eighteen months after the effective date
of the final rule, the ratings based approach will be implemented for
unrated positions in securitizations that are guaranteed by Government-
sponsored agencies based on the issuer credit rating of the agency.
During the transition period before this provision is effective, FCS
institutions may continue to risk-weight their unrated positions in
securitizations that are guaranteed by Government-sponsored agencies at
20-percent, regardless of whether the agency maintains an issuer rating
by an NRSRO.
More specifically, the following positions in securitizations
qualify for the ratings-based approach if they satisfy the criteria set
forth below:
Recourse obligations;
Direct credit substitutes;
Residual interests (other than credit-enhancing interest-
only strips);\30\ and
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\30\ We propose to exclude credit-enhancing interest-only strips
from the ratings-based approach because of their high-risk profile,
as discussed under section V.C.1. of this preamble.
---------------------------------------------------------------------------
Asset- and mortgage-backed securities.
3. Section 615.5210(b)--Application of the Ratings-Based Approach
Under proposed Sec. 615.5210, the capital requirement for a
position that qualifies for the ratings-based approach is computed by
multiplying the face amount of the position by the appropriate risk
weight as determined by the position's external credit rating. In the
case of unrated positions in securitizations guaranteed by Government-
sponsored agencies beginning 18 months after the effective date of the
final rule, the issuer's credit rating will be used to determine the
appropriate risk-weight for the position.
A position that is traded and externally rated qualifies for the
ratings-based approach if its long-term external rating is one grade
below investment grade or better (e.g., BB or better) or its short-term
external rating is investment grade or better (e.g., A-3, P-3).\31\ If
the position receives more than one external rating, the lowest rating
would apply. This requirement eliminates the potential for rating
shopping. Currently, individual securities issued and guaranteed by
Government-sponsored agencies generally do not have external ratings
from NRSROs. If, however, a position in an agency securitization does
have an external rating, that rating must be used to determine the
appropriate risk-weighting for the position.
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\31\ These ratings are examples only. Different NRSROs may have
different ratings for the same grade.
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A position that is externally rated but not traded qualifies for
the ratings-based approach if it satisfies the following criteria:
It must be externally rated by more than one NRSRO;
Its long-term external rating must be one grade below
investment grade or better (e.g., BB or better) or its short-term
external rating must be investment grade or better (e.g., A-3, P-3). If
the position receives more than one external rating, the lowest rating
would apply;
The ratings must be publicly available; and
The ratings must be based on the same criteria used to
rate traded positions.
The proposed rule also specifically provides that an unrated
position that is guaranteed by a Government-sponsored agency would
qualify for the ratings-based approach based on the Government-
sponsored agency's issuer credit rating beginning 18 months after the
effective date of the final rule.
Under the ratings-based approach, the capital requirement for a
position that qualifies for the ratings-based approach
[[Page 47991]]
is computed by multiplying the face amount of the position by the
appropriate risk weight determined in accordance with the following
tables: \32\
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\32\ See paragraphs (b)(14), (c)(3), (d)(6), and (e) of proposed
Sec. 615.5211.
Risk-Based Capital Requirements for Long-Term Issue or Issuer Ratings
----------------------------------------------------------------------------------------------------------------
Rating category Rating examples \33\ Risk weight (in percent)
----------------------------------------------------------------------------------------------------------------
Highest or second highest investment AAA or AA.............. 20.
grade.
Third highest investment grade...... A...................... 50.
Lowest investment grade............. BBB.................... 100.
One category below investment grade. BB..................... 200.
More than one category below B or below or Unrated.. Not eligible for the ratings-based approach.
investment grade, or unrated.
----------------------------------------------------------------------------------------------------------------
Risk-Based Capital Requirements for Short-Term Issue Ratings
----------------------------------------------------------------------------------------------------------------
Short-term rating category Rating examples Risk weight (in percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade............ A-1, P-1............... 20.
Second highest investment grade..... A-2, P-2............... 50.
Lowest investment grade............. A-3, P-3............... 100.
Below investment grade, or unrated.. B or lower (Not Prime). Not eligible for the ratings--based approach.
----------------------------------------------------------------------------------------------------------------
The charts for long-term and short-term ratings are not identical
because rating agencies use different methodologies. Each short-term
rating category covers a range of longer-term rating categories. For
example, a P-1 rating could map to a long-term rating as high as Aaa or
as low as A3.
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\33\ These ratings are examples only. Different NRSROs may have
different ratings for the same grade. Further, ratings are often
modified by either a plus or minus sign to show relative standing
within a major rating category. Under the proposed rule, ratings
refer to the major rating category without regard to modifiers. For
example, an investment with a long-term rating of ``A-'' would be
risk weighted at 50 percent.
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These proposed amendments would not change the risk-weight
requirement that FCA recently adopted for eligible asset- and mortgage-
backed securities that continue to be highly rated.\34\ These
amendments simply make our rule language more consistent with that used
by the other financial regulatory agencies for these types of
transactions.
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\34\ See 68 FR 15045, March 24, 2003.
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C. Section 615.5210(c)--Treatment of Positions in Securitizations That
Do Not Qualify for the Ratings-Based Approach
1. Section 615.5210(c)(1), (c)(2), and (c)(3)--Positions Subject to
Dollar-for-Dollar Capital Treatment
We propose to subject certain positions in asset securitizations
that do not qualify for the ratings-based approach to dollar-for-dollar
capital treatment. These positions include:
Residual interests that are not externally rated;
Credit-enhancing interest-only strips; and
Positions that have long-term external ratings that are
two grades below investment grade or lower (e.g., B or lower) or short-
term external ratings that are one grade below investment grade or
lower (e.g., B or lower, Not Prime).\35\
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\35\ See paragraphs (c)(1), (c)(2), and (c)(3) of proposed Sec.
615.5210.
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We emphasize that credit-enhancing positions in securitizations of
Government-sponsored agencies are subject to the same capital treatment
as positions in non-agency securitizations with similar risk profiles.
For example, if an FCS institution retains or purchases an unrated
subordinated interest in a Government-sponsored agency securitization
that provides a credit enhancement for the entire pool of loans in the
securitization, then the FCS institution must hold capital dollar-for-
dollar for the amount of that position.
Under the dollar-for-dollar treatment, an FCS institution must
deduct from capital and assets the face amount of the position. This
means, in effect, one dollar in total capital must be held against
every dollar held in these positions, even if this capital requirement
exceeds the full risk-based capital charge.
We propose the dollar-for-dollar treatment for the credit-enhancing
and highly subordinated positions listed above because these positions
raise a number of supervisory concerns that the other financial
regulatory agencies also share.\36\ The level of credit risk exposure
associated with deeply subordinated assets, particularly subinvestment
grade and unrated residual interests, is extremely high. They are
generally subordinated to all other positions, and these assets are
subject to valuation concerns that might lead to loss as explained
further below. Additionally, the lack of an active market makes these
assets difficult to independently value and relatively illiquid.
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\36\ See 66 FR 59614 (November 29, 2001).
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In particular, there are a number of concerns regarding residual
interests. A banking organization can inappropriately generate ``paper
profits'' (or mask actual losses) through incorrect cash flow modeling,
flawed loss assumptions, inaccurate prepayment estimates, and
inappropriate discount rates. Such practices often lead to an inflation
of capital, falsely making the banking organization appear more
financially sound. Also, embedded within residual interests, including
credit-enhancing interest-only strips, is a significant level of credit
and prepayment risk that make their valuation extremely sensitive to
changes in underlying assumptions. For these reasons we, like the other
financial regulatory agencies, concluded that a higher capital
requirement is warranted for unrated residual interests and all credit-
enhancing interest-only strips. Furthermore, the ``low-level exposure
rule,'' discussed below, does not apply to these positions in
securitizations. For example, if an FCS institution holds a 10-percent
residual interest that is not externally rated in a $100 million
[[Page 47992]]
securitization, its capital charge would be $10 million. If an FCS
institution purchases a $25 million position in an ABS that is
subsequently downgraded to B or lower, its capital charge would be $25
million, the full amount of the position.
We note that the final rules adopted by the other financial
regulatory agencies impose both a dollar-for-dollar risk weighting for
residual interests that do not qualify for the ratings-based approach
and a concentration limit on a subset of those residual interests--
credit-enhancing interest-only strips--for the purpose of calculating a
bank's leverage ratio. Under their combined approach, credit-enhancing
interest-only strips are limited to 25 percent of a banking
organization's Tier 1 capital. Everything above that amount is deducted
from Tier 1 capital. Generally, under the other financial regulatory
agencies' rules, all other residual interests that do not qualify for
the ratings-based approach (including any credit-enhancing interest-
only strips that were not deducted from Tier 1 capital) are subject to
a dollar-for-dollar risk weighting. The combined capital charge is
limited to the face amount of a banking organization's residual
interests.
As indicated previously, we are proposing a one-step approach for
these positions in securitizations. This would require FCS institutions
to deduct from capital and assets the face amount of their position.
The resulting total capital charge is virtually the same under both
approaches. However, we found that the one-step approach is easier to
apply to FCS institutions because the way they compute their regulatory
capital standards differs from the way other banking organizations
compute their standards.
2. Section 615.5210(c)(4)--Unrated Recourse Obligations and Direct
Credit Substitutes
As discussed in the definitions section, the contractual retention
of credit risk by an FCS institution associated with assets it has sold
generally constitutes recourse.\37\ The definitions of recourse and
direct credit substitute complement each other, and there are many
types of recourse arrangements and direct credit substitutes that can
be assumed through either on- or off-balance sheet credit exposures
that are not externally rated. Under Sec. 615.5210(c)(4) of this
proposal, FCS institutions would be required to hold capital against
the entire outstanding amount of assets supported (e.g., all more
senior positions) by an on-balance recourse obligation or direct credit
substitute that is unrated. This treatment parallels our approach for
off-balance sheet recourse obligations and direct credit substitutes,
as discussed later under the computation of credit equivalent amounts.
For example, if an FCS institution retains an on-balance sheet first-
loss position through a recourse arrangement or direct credit
substitute in a pool of rural housing loans that qualify for a 50-
percent risk weight, the FCS institution would include the full amount
of the assets in the pool, risk-weighted at 50 percent, in its risk-
weighted assets for purposes of determining its risk-based capital
ratios. The low-level exposure rule \38\ provides that the dollar
amount of risk-based capital required for assets transferred with
recourse should not exceed the maximum dollar amount for which an FCS
institution is contractually liable.
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\37\ As previously discussed, the proposed rule defines the term
``recourse'' to mean an arrangement in which an institution retains,
in form or in substance, any credit risk directly or indirectly
associated with an asset it has sold, if the credit risk exceeds a
pro rata share of the institution's claim on the asset. If an
institution has no claim on an asset that it has sold, then the
retention of any credit risk is recourse.
\38\ See proposed Sec. 615.5210(e).
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The other financial regulatory agencies currently permit their
banking organizations to use three alternative approaches (i.e.,
internal ratings, program ratings, and computer programs) for
determining the capital requirements for certain unrated direct credit
substitutes and recourse obligations in asset-backed commercial paper
programs. The other financial regulatory agencies also recently issued
an interim final rule and a proposed rule on the capital treatment for
asset-backed commercial paper programs that are consolidated onto the
balance sheets of the sponsoring banks. This change is the result of a
recently issued accounting interpretation, Financial Accounting
Standards Board Interpretation No. 46, Consolidation of Variable
Interest Entities.\39\ At this time, the FCA has decided not to address
the capital requirements for asset-backed commercial paper programs due
to the limited involvement FCS institutions presently have in these
programs. FCA will continue to determine the capital requirements for
such programs on a case-by-case basis, but does request further comment
on the appropriate capital treatment for these activities.
---------------------------------------------------------------------------
\39\ See 68 FR 56530 (October 1, 2003).
---------------------------------------------------------------------------
3. Sections 615.5210(c)(5) and 615.5211(d)(7)--Stripped Mortgage-Backed
Securities (SMBS)
Under proposed Sec. Sec. 615.5210(c)(5) and 615.5211(d)(7), SMBS
and similar instruments, such as interest-only strips that are not
credit-enhancing or principal-only strips (including such instruments
guaranteed by Government-sponsored agencies), are assigned to the 100-
percent risk-weight category. Even if highly rated, these securities do
not receive the more favorable capital treatment available to other
mortgage securities because of their higher market risk profile.
Typically, SMBS contain a higher degree of price volatility associated
with mortgage prepayments. As indicated previously, credit-enhancing
positions in securitization are subject to dollar-for-dollar capital
treatment.
4. Section 615.5211(d)--Unrated Positions in Asset-Backed Securities
and Mortgage-Backed Securities
Unrated positions in mortgage- and asset-backed securities that do
not qualify for the ratings-based approach would generally be assigned
to the 100-percent risk-weight category under the proposal. This would
include unrated positions in securitizations guaranteed by Government-
sponsored agencies without issuer credit ratings beginning 18 months
after the effective date of the final rule.
The FCA recognizes that the proposed risk-based capital
requirements can provide a more favorable treatment for certain unrated
positions in securitizations than those rated below investment grade.
For this reason, FCA will look to the substance of the transaction to
determine whether a higher capital requirement is warranted based on
the risk characteristics of the position. Additionally, because of the
many advantages, including pricing, liquidity, and favorable capital
treatment on highly rated positions in asset securitizations, we
believe this overall regulatory approach provides ample incentives for
all participants to obtain external ratings.
D. Section 615.5210(d)--Senior Positions Not Externally Rated
For senior positions not externally rated, the following capital
treatment applies under proposed Sec. 615.5210(d). If an FCS
institution retains an unrated position that is senior or preferred in
all respects (including collateral and maturity) to a rated position
that is traded, the position is treated as if it had the same rating
assigned to the rated position. These senior unrated positions
[[Page 47993]]
qualify for the risk weighting of the subordinated rated positions as
long as the subordinate rated position is: (1) Traded; and (2) remains
outstanding for the entire life of the unrated position, thus providing
full credit support for the term of the unrated position.
E. Section 615.5210(e)--Low-Level Exposure Rule
Section 615.5210(e) of the proposed rule limits the maximum risk-
based capital requirement to the lesser of the maximum contractual
exposure or the full capital charge against the outstanding amount of
assets transferred with recourse. When the proposed low-level exposure
rule applies, an institution would generally hold capital dollar-for-
dollar against the amount of its maximum contractual exposure. Thus, if
the maximum contractual exposure to loss retained or assumed in
connection with recourse obligation or a direct credit substitute is
less than the full risk-based capital requirement for the assets
enhanced, the risk-based capital requirement is limited to the maximum
contractual exposure.
In the absence of any other recourse provisions, the on-balance
sheet amount of assets retained or assumed in connection with a
recourse obligation or direct credit substitute represents the maximum
contractual exposure. For example, assume that $100 million of loans is
sold and securitized and an FCS institution provides a $5 million
credit enhancement through a recourse obligation. Instead of holding 7
percent or $7 million of capital, the low-level exposure limits the
risk-based requirement to the $5 million maximum contractual loss
exposure, with $5 million held dollar-for-dollar against capital.
F. Section 615.5211--Risk Categories--Balance Sheet Assets
1. Section 615.5211(b)(6)--Securities and Other Claims on, and Portions
of Claims, Guaranteed by Government-Sponsored Agencies
Under proposed Sec. 615.5211(b)(6), securities and other claims
on, and portions of claims guaranteed by, Government-sponsored agencies
are generally assigned to the 20-percent risk-weight category.\40\ For
example, this risk-based capital treatment applies to investments in
debt securities or other similar obligations issued by agencies.
Beginning eighteen months after the effective date of the final rule,
this provision would exclude, positions in securitizations guaranteed
by Government-sponsored agencies, such as asset- and mortgage-backed
securities, which we have already discussed, and claims on Government-
sponsored agencies that are described in the next section of this
preamble.
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\40\ Assets in this category include, for example, asset- or
mortgage-backed securities that are issued or guaranteed by
Government-sponsored agencies.
---------------------------------------------------------------------------
2. Sections 615.5211(b)(7), (c)(4) and (d)(11)--Treatment of Assets
Covered by Credit Protection Provided by Government-Sponsored Agencies
and OECD Banks
This proposal addresses the risk-based capital treatment for assets
covered by credit protection provided by Government-sponsored agencies
and OECD banks.
FCS institutions use a variety of credit risk mitigation strategies
to alter their risk profiles. Credit protection may be obtained through
credit default swaps, loss purchase commitments, guarantees, and other
similar arrangements. These transactions or arrangements often contain
a number of structural complexities and may impose additional
operational and counterparty risk on FCS institutions that use these
arrangements. In an Informational Memorandum dated October 23, 2003,
the agency specifically informed FCS institutions of its concerns
regarding excessive risk exposure to single counterparties and
suggested that FCS institution boards consider engaging in business
transactions only with counterparties rated in one of the two highest
rating categories by an NRSRO.
We believe FCS institutions should enter into these types of
financial arrangements only with sophisticated entities that are
financially strong and well capitalized. We believe a ratings-based
approach coupled with a close examination of the unique features of
these transactions will help create the appropriate incentives for FCS
institutions to carefully select their counterparties and fully
understand the risks transferred, retained, or assumed through these
arrangements. FCS institutions should also take appropriate measures to
manage additional operational risks that may be created by these
arrangements. FCS institutions should thoroughly review and understand
all the legal definitions and parameters of these instruments,
including credit events that constitute default, as well as
representations and warranties, to determine how well the contract will
perform under a variety of economic conditions.
We believe it is appropriate to differentiate the capital
requirements for these types of arrangements based on an assessment of
the risks retained, transferred to investors or other third parties, or
assumed in the form of counterparty risk. Thus, we are proposing to
implement a ratings-based approach for assigning capital requirements
to assets covered by credit protection arrangements, including credit
derivatives (e.g., credit default swaps), loss purchase commitments,
guarantees and other similar arrangements.\41\
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\41\ As under our existing regulations, all other claims on OECD
banks will continue to be risk-weighted at 20 percent regardless of
the OECD bank's rating or lack thereof. See proposed Sec.
615.5211(b)(6).
---------------------------------------------------------------------------
The implementation of this provision beginning 18 months after the
effective date of the final rule will allow FCS institutions to assess
their current risk mitigation techniques, counterparty risk exposures,
and long-term capital adequacy objectives and make any adjustments that
are necessary.
The following table indicates the risk weightings for assets
covered by credit protection or guarantees based on the provider's
credit rating when this provision becomes effective.
----------------------------------------------------------------------------------------------------------------
BBB or below or
Credit Protection Provider Credit Rating \42\ AAA to AA A unrated
----------------------------------------------------------------------------------------------------------------
Risk weight of assets covered (in percent)................... 20 50 100
----------------------------------------------------------------------------------------------------------------
During the transition period, FCS institutions may continue to risk
weight
[[Page 47994]]
assets covered by credit protection contracts with OECD banks and
Government-sponsored agencies at 20 percent. After the transition
period ends, FCS institutions may only risk-weight loan assets (or
portions of assets) covered by these arrangements at 20 percent
provided the Government-sponsored agency or OECD bank providing the
credit protection maintains an issuer credit rating in one of the two
highest investment grade ratings from at least one NRSRO (if the credit
protection provider is rated by more than one NRSRO the lowest rating
applies).\43\ If the credit protection provider is rated in the third
investment grade category (e.g., ``A'') by an NRSRO, a 50-percent risk
weight will apply to the assets covered by the contract. If the credit
protection provider is rated in the lowest investment grade category or
below, or is not rated, a 100-percent risk weight will apply to the
assets covered by the contract.\44\
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\42\ These ratings are examples only. Different NRSROs may have
different ratings for the same grade. Further, ratings are often
modified by either a plus or minus sign to show relative standing
within a major rating category. Under the proposed rule, ratings
refer to the major rating category without regard to modifiers. For
example, an investment with a long-term rating of ``A-'' would be
risk weighted at 50 percent.
\43\ See proposed Sec. 615.5211(b)(7).
\44\ See proposed Sec. 615.5211(c)(4).
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Additionally, FCS institutions may recognize the credit protection
in calculating their capital requirements only if the guarantee, credit
derivative, or agreement represents a direct claim on the protection
provider and it explicitly references specific assets. The agreement
must also have legal certainty and be irrevocable and unconditional
(there should be no clause in the contract that allows the protection
provider to unilaterally cancel the credit coverage, and there should
be no clause that prevents the protection provider from being obligated
to pay out in a timely manner). FCS institutions must also satisfy the
FCA that they have established appropriate controls to manage any
additional operational risks that might be associated with such
arrangements.
In situations where an FCS institution assumes a first loss
position on loan assets covered by credit protection contracts, the FCS
institution must hold capital on a dollar-for-dollar basis to support
its first loss position. The remaining balance covered by the contract
may be risk weighted based on the guarantor's or counterparty's credit
rating as explained above. Under the proposal, an FCS institution's
risk-based capital requirement is limited to the maximum dollar amount
for which an FCS institution is contractually liable on the first loss
position plus the capital charge for the remaining assets or the full
capital charge (e.g., 7 percent) for all the assets covered by the
arrangement. For example, if an FCS institution retains a 2-percent
first loss position in $100 of loan assets covered by a guarantee from
an OECD bank rated ``A,'' the FCS institution's combined capital charge
for all the assets would be $2 for the first loss position plus $98
risk weighted at 50 percent multiplied by 7 percent, or $5.43.
As noted previously, we believe the use of credit ratings provides
an objective basis for determining credit risk as relied upon by
investors or other market participants. We believe this approach
results in a more equitable treatment for all types of credit
protection providers under our capital rules. Furthermore, this allows
FCA to differentiate capital requirements based on an FCS institution's
relative exposure to risk. Because the nature and structure of such
arrangements may vary significantly, FCA reserves the authority to
evaluate each arrangement individually and to make an appropriate
capital determination as circumstances may warrant.
The other financial regulatory agencies have not yet implemented
the ratings-based approach suggested under the Basel II proposal for
claims on, or guarantees by, OECD banks or Government-sponsored
agencies. The methodology that we propose to apply to certain
guarantee/credit derivative arrangements is a limited application of
the ratings-based approach proposed under Basel II for individual
claims on and guarantees by banks (i.e., Standardized Approach).\45\ As
previously noted, at this time we are continuing to evaluate Basel II
and may propose additional amendments to more fully implement a
ratings-based approach for other types of claims on or guarantees by
financial institutions through a future rulemaking.
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\45\ See The New Basel Capital Accord Consultative Document,
Basel Committee on Banking Supervision, April 2003.
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3. Section 615.5211(a)(5), (b)(15), and (b)(16)--Treatment of Claims on
Qualifying Securities Firms
We are adding claims on qualifying securities firms to the current
risk-based capital requirements.\46\ In doing so, our proposal aims to
level the playing field among OECD banks, Government-sponsored agencies
and securities firms (that meet certain qualifying standards) that
provide guarantees.
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\46\ Under proposed Sec. 615.5201, ``qualifying securities
firm'' means: (1) A securities firm incorporated in the United
States that is a broker-dealer that is registered with the SEC and
that complies with the SEC's net capital regulations; and (2) a
securities firm incorporated in any other OECD-based country, if the
institution is subject to supervision and regulation comparable to
that imposed on depository institutions in OECD countries.
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Specifically, we propose to adopt a 0-percent risk weight for
claims on, or guaranteed by, qualifying securities firms that are
collateralized by cash on deposit in the institution or by securities
issued or guaranteed by the United States or OECD central governments,
provided that a positive margin of collateral is required to be
maintained on such a claim on a daily basis, taking into account any
change in the institution's exposure to the obligor or counterparty
under the claim in relation to the market value of the collateral held
in support of the claim.\47\
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\47\ Proposed Sec. 615.5211(a)(5).
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We also propose to reduce from 100 percent to 20 percent the risk
weighting applied to all other claims on and claims guaranteed by
qualifying securities firms that satisfy specified external rating
requirements.\48\ Specifically, we propose to adopt a 20-percent risk
weighting for all claims on and claims guaranteed by a qualifying
securities firm that has a long-term issuer credit rating in one of the
two highest investment-grade rating categories from an NRSRO, or if the
claim is guaranteed by the qualifying securities firm's parent company
with such a rating.\49\
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\48\ Proposed Sec. 615.5211(b)(15).
\49\ If ratings are available from more than one NRSRO, the
lowest rating will be used to determine whether the rating standard
has been met.
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We note that this ratings criteria is consistent with our proposed
criteria for obtaining a 20-percent risk weight on assets covered by
certain credit protection arrangements with Government-sponsored
agencies and OECD banks described above. This proposal applies a higher
rating standard to securities firms than the other financial regulatory
agencies adopted to ensure consistency throughout our rules. Otherwise,
the potential for capital arbitrage would exist when securities firms
provide guarantees or credit protection through structured transactions
and agreements. If we did not apply the higher standard to securities
firms, an institution could receive a more favorable capital treatment
by obtaining credit protection from a securities firm than a
Government-sponsored agency or OECD bank, even when the underlying risk
was the same. To avoid this result, we have crafted the regulations so
that the
[[Page 47995]]
capital treatment is commensurate with the underlying risks.
Finally, we propose a 20-percent risk weight for certain
collateralized claims on qualifying securities firms without regard to
satisfaction of the rating standard, provided the claim arises under a
contract that:
Is a reverse repurchase/repurchase agreement or securities
lending/borrowing transaction executed under standard industry
documentation;
Is collateralized by liquid and readily marketable debt or
equity securities;
Is marked-to-market daily;
Is subject to a daily margin maintenance requirement under
the standard documentation; and
Can be liquidated, terminated, or accelerated immediately
in bankruptcy or similar proceeding, and the security or collateral
agreement will not be stayed or voided, under applicable law of the
relevant country.\50\
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\50\ See proposed Sec. 615.5211(b)(16).
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4. Section 615.5211(c)(2)--Treatment of Qualified Residential Loans
Existing Sec. 613.3030 authorizes System institutions to provide
financing to rural homeowners for the purpose of buying, remodeling,
improving, and repairing rural homes. ``Rural homeowner'' is defined as
an individual who resides in a rural area and is not a bona fide
farmer, rancher, or producer or harvester of aquatic products. ``Rural
home'' means a single-family moderately priced dwelling located in a
rural area that will be owned and occupied as the rural homeowner's
principal residence. ``Rural area'' means open country within a state
or the Commonwealth of Puerto Rico, which may include a town or village
that has a population of not more than 2,500 persons. Existing Sec.
615.5210(f)(2)(iii)(B) assigns these rural home loans, provided they
are secured by first lien mortgages or deeds of trust, to the 50-
percent risk-weight category. However, residential loans to bona fide
farmers, ranchers, and producers and harvesters of aquatic products are
currently considered to be agricultural loans and are risk-weighted at
100 percent under Sec. 615.5210(f)(2)(iv).
Proposed Sec. 615.5211(c)(2) would assign a 50-percent risk weight
to all qualified residential loans, as defined in proposed Sec.
615.5201. To be a qualified residential loan, a loan must be either:
(i) A rural home loan, as authorized by Sec. 613.3030,\51\ or (ii) a
single-family residential loan to a bona fide farmer, rancher, or
producer or harvester of aquatic products.\52\ A qualified residential
loan must be secured by a first lien mortgage or deed of trust, must
have been approved in accordance with prudent underwriting standards,
must not be past due 90 days or more or carried in nonaccrual status,
and must have a monthly amortization schedule. In addition, the secured
residence and residential site must have a deed separate from other
adjoining land and a permanent right-of-way access.
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\51\ As discussed above, these loans are currently included in
the 50-percent risk-weight category.
\52\ As discussed above, these loans currently receive a 100-
percent risk weighting.
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We propose this change because we believe that all residential
loans that meet the standards set forth in the definition of qualified
residential loan, whether made to farmers, ranchers, or aquatic
producers or harvesters or not, pose the same level of risk. This view
is consistent with that of the other financial regulatory agencies.
Under their rules, a loan that is fully secured by a first lien on a
one- to four-family residential property is assigned to the 50-percent
risk-weight category as long as the loan has been approved in
accordance with prudent underwriting standards and is not past due 90
days or more or carried in nonaccrual status.\53\ The other financial
regulatory agencies do not distinguish whether such a loan is made to a
farmer or a non-farmer.
---------------------------------------------------------------------------
\53\ See, e.g., FDIC regulations at 12 CFR Part 325, Appendix A,
II.C., Category 3.
---------------------------------------------------------------------------
Consistent with the position of the other financial regulatory
agencies, any residential loan that does not meet the definition of a
qualified residential loan would be assigned to the 100-percent risk-
weight category.
5. Section 615.5211(d)(8)--Treatment of Investments in Rural Business
Investment Companies
As previously discussed, the Farm Security and Rural Investment Act
(Pub. L. 107-171) recently amended the Consolidated Farm and Rural
Development Act, 7 U.S.C. 1921 et seq., to permit FCS institutions to
establish or invest in RBICs subject to certain limitations. A RBIC has
a similar mission and objectives to serve rural entrepreneurs as a SBIC
does to serve qualifying small businesses. Currently, the other
financial regulatory agencies risk-weight investments in SBICs at 100
percent and deduct from capital an escalating percentage of SBIC
investments that exceed 15 percent of capital.\54\ FCA proposes to
risk-weight RBICs at 100 percent.\55\ FCA is not proposing to limit the
amount of RBIC investments that can receive the 100-percent risk weight
because a System institution is precluded by statute from making an
investment in a RBIC in excess of 5 percent of the capital and surplus
of the institution.\56\ This statutory limitation imposes adequate
controls on risk from these investments.
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\54\ See 67 FR 3784, January 25, 2002.
\55\ See proposed Sec. 615.5211(d)(8).
\56\ 7 U.S.C. 2009cc-9(b).
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G. Section 615.5212(b)(4)(i)--Computation of Credit-Equivalent Amounts
for Direct Credit Substitutes and Recourse Obligations
We propose to modify our current methodology for determining the
credit equivalent amount of off-balance sheet direct credit substitutes
and propose to add a similar provision for recourse obligations. Under
the proposal, the credit equivalent amount for a direct credit
substitute or recourse obligation is the full amount of the credit-
enhanced assets for which an institution directly or indirectly retains
or assumes credit risk multiplied by a 100-percent conversion
factor.\57\ To determine the institution's risk-weighted assets for an
off-balance sheet recourse obligation or a direct credit substitute,
the credit equivalent amount is assigned to the risk weight category
appropriate to the obligor in the underlying transaction, after
considering any associated guarantees or collateral.
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\57\ See proposed Sec. 615.5212(b)(4)(i).
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The proposal eliminates the current anomalies between direct credit
substitutes and recourse arrangements that expose an institution to the
same amount of risk but different capital requirements. These changes
would also provide consistent risk-based capital treatment for
positions with similar risk exposures regardless of whether they are
structured as on- or off-balance sheet transactions. For example, as
noted previously, for a direct credit substitute that is an on-balance
sheet asset, e.g., a purchased subordinated security, an institution
must also calculate risk-weighted assets using the amount of the direct
credit substitute and the full amount of the assets it supports,
meaning all the more senior positions in the structure. This is another
change necessary to make our rules consistent with the current rules
established by the other financial regulatory agencies.
H. Section 615.5210(f)--Reservation of Authority
Financial institutions are developing novel transactions that do
not fit into conventional risk-weight categories or credit conversion
factors in the current standards. Financial institutions are also
devising novel instruments that
[[Page 47996]]
nominally fit into a particular category, but impose levels of risk on
the financial institutions that are not commensurate with the risk-
weight category for the asset, exposure or instrument. Accordingly,
Sec. 615.5210(f) of the proposed rule more explicitly indicates that
FCA, on a case-by-case basis, may determine the appropriate risk weight
for any asset or credit equivalent amount and the appropriate credit
conversion factor for any off-balance sheet item in these
circumstances. Exercise of this authority may result in a higher or
lower risk weight or credit equivalent amount for these assets or off-
balance sheet items. This reservation of authority explicitly
recognizes the retention of sufficient discretion to ensure that novel
financial assets, exposures, and instruments will be treated
appropriately under the regulatory capital standards.
VI. Other Changes
In addition to the changes detailed above, we also propose to make
a number of other changes. We propose most of these changes for clarity
or plain language purposes or to eliminate obsolete references. These
changes are described below.
A. Section 615.5211--Changes to Listing of Balance Sheet Assets
We propose to clarify the listing of balance sheet assets
identified in each risk-weight category in proposed Sec. 615.5211 to
more closely align the regulatory language with our long-standing
policy positions. This new regulatory language also mirrors the
language used by the other financial regulatory agencies to the extent
applicable to System institutions. Over the years, we have interpreted
our risk-weighting categories consistently with the other financial
regulatory agencies. In some instances, however, the listing of assets
included in each category is not as specific or clear as that of the
other financial regulatory agencies. We propose these amendments for
the purpose of clarity and consistency with the other financial
regulatory agencies.
1. Section 615.5211(a)--0-Percent Category
We propose to reorganize the order of the assets listed in the 0-
percent risk-weight category.\58\ We propose to add a listing for
portions of local currency claims on, or unconditionally guaranteed by,
non-OECD central governments (including non-OECD central banks), to the
extent the institution has liabilities booked in that currency (Sec.
615.5211(a)(4)). We also propose to revise the language in Sec. Sec.
615.5211(a)(1), 615.5211(a)(2), and 615.5211(a)(3).\59\ Finally, we
propose to delete existing Sec. 615.5210(f)(2)(i)(C), which puts
goodwill in the 0-percent category. Proposed Sec. 615.5207(g) (which
we propose to carry over without substantive change from existing Sec.
615.5210(e)(7)) provides that an institution must deduct from total
capital an amount equal to all goodwill before it assigns assets to the
risk-weighting categories. Thus, it is unnecessary to assign goodwill
to a risk-weighting category.
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\58\ Except where otherwise indicated, all references are to the
proposed regulation.
\59\ See existing Sec. 615.5210(f)(2)(i)(A), (f)(2)(i)(B), and
(f)(2)(i)(C).
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2. Section 615.5211(b)--20-Percent Category
We propose to reorganize the order of the assets listed in the 20-
percent risk-weight category.\60\ We propose to add the following
assets in addition to the changes previously discussed:
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\60\ Except where otherwise indicated, all references are to the
proposed regulation.
---------------------------------------------------------------------------
Portions of loans and other claims collateralized by cash
on deposit (Sec. 615.5211(b)(9));
Portions of claims collateralized by securities issued by
official multinational lending institutions or regional development
institutions in which the United States Government is a shareholder or
contributing member (Sec. 615.5211(b)(12)); and
Investments in shares of mutual funds whose portfolios are
permitted to hold only assets that qualify for the zero or 20-percent
risk-weight categories (Sec. 615.5211(b)(13)).
We propose to revise the language in Sec. 615.5211(b)(3),\61\
(b)(4),\62\ (b)(5),\63\ (b)(6),\64\ (b)(8),\65\ (b)(10),\66\ and
(b)(11)\67\ to make them easier to read.
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\61\ Consolidated from existing Sec. 615.5210(f)(2)(ii)(D) and
(f)(2)(ii)(E).
\62\ Existing Sec. 615.5210(f)(2)(ii)(F).
\63\ Consolidated from existing Sec. 615.4210(f)(2)(ii)(B) and
(f)(2)(ii)(J).
\64\ This provision is not contained in current FCA regulations.
\65\ Consolidated from existing Sec. 615.5210(f)(2)(ii)(A) and
(f)(2)(ii)(C).
\66\ See existing Sec. 615.5210(f)(2)(ii)(G).
\67\ See existing Sec. 615.5210(f)(2)(ii)(H).
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3. Section 615.5211(c)--50-Percent Category
In the 50-percent risk-weight category, we propose to add a listing
for revenue bonds or similar obligations, including loans and leases,
that are obligations of a state or political subdivisions of the United
States or other OECD countries but for which the government entity is
committed to repay the debt only out of revenue from the specific
projects financed.\68\ We are making these revisions to further
distinguish the varying degrees of risk associated with investments in
different types of revenue bonds. This change also parallels the rules
of the other financial regulatory agencies. We also propose to make
plain language changes to Sec. 615.5211(c)(1).\69\
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\68\ Proposed Sec. 615.5211(c)(5). This provision is not
contained in current FCA regulations.
\69\ See existing Sec. 615.5210(f)(2)(iii)(A).
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4. Section 615.5211(d)--100-Percent Category
The existing 100-percent risk-weight category lists only four
assets, including a catch-all: All other assets not specified in the
other risk-weight categories, including, but not limited to, leases,
fixed assets, and receivables. Consistent with the other financial
regulatory agencies, and to provide clearer guidance, we propose to
itemize many of the assets that are currently included within the
catch-all, including:
Claims on, or portions of claims guaranteed by, non-OECD
central governments (except such claims that are included in other
risk-weighting categories), and all claims on non-OECD state and local
governments (Sec. 615.5211(d)(3));
Industrial development bonds and similar obligations
issued under the auspices of states or political subdivisions of the
OECD-based group of countries for the benefit of a private party or
enterprise where that party or enterprise, not the government entity,
is obligated to pay the principal and interest (Sec. 615.5211(d)(4));
Premises, plant, and equipment; other fixed assets; and
other real estate owned (Sec. 615.5211(d)(5)).
If they have not already been deducted from capital,
investments in unconsolidated companies, joint ventures, or associated
companies; deferred-tax assets; and servicing assets (Sec.
615.5211(d)(9)); and
All other assets not specified, including, but not limited
to, leases and receivables (Sec. 615.5211(d)(12)).
B. Other Nonsubstantive Changes
We propose to change the heading of Sec. 615.5200 from ``General''
to ``Capital planning'' to better reflect the content of this section.
We do not propose any other changes to this section.
We propose to break up Sec. 615.5210, which is cumbersome to use
because of its length, into seven separate regulatory sections. The
newly redesignated sections are:
[[Page 47997]]
Sec. 615.5206--Permanent capital ratio computation
Sec. 615.5207--Capital adjustments and associated
reductions to assets
Sec. 615.5208--Allotment of allocated investments
Sec. 615.5209--Deferred-tax assets
Sec. 615.5210--Risk-adjusted assets
Sec. 615.5211--Risk categories--balance sheet assets
Sec. 615.5212--Credit conversion factors--off-balance
sheet items
This reorganization should make these provisions easier to use. We do
not intend any substantive changes with this reorganization.
We propose to delete an obsolete reference to the Farm Credit
System Financial Assistance Corporation in Sec. 615.5201.
We propose to add paragraph (k) to newly redesignated Sec.
615.5207 for clarity.
We propose to make minor, nonsubstantive, plain language, and
organizational changes throughout the revised regulation.
Because we propose to reorganize this regulation, references to the
regulation in other FCA regulations need to be updated. Accordingly, we
propose to make conforming reference updates in parts 607, 614, and 620
of this chapter.
VII. Regulatory Flexibility Act
Pursuant to section 605(b) of the Regulatory Flexibility Act (5
U.S.C. 601 et seq.), the FCA hereby certifies that the proposed rule
will not have a significant impact on a substantial number of small
entities. Each of the banks in the System, considered together with its
affiliated associations, has assets and annual income in excess of the
amounts that would qualify them as small entities. Therefore, System
institutions are not ``small entities'' as defined in the Regulatory
Flexibility Act.
List of Subjects
12 CFR Part 607
Accounting, Agriculture, Banks, banking, Reporting and
recordkeeping requirements, Rural areas.
12 CFR Part 614
Agriculture, Banks, banking, Flood insurance, Foreign trade,
Reporting and recordkeeping requirements, Rural areas.
12 CFR Part 615
Accounting, Agriculture, Banks, banking, Government securities,
Investments, Rural areas.
12 CFR Part 620
Accounting, Agriculture, Banks, banking, Reporting and
recordkeeping requirements, Rural areas.
For the reasons stated in the preamble, we propose to amend parts
607, 614, 615, and 620 of chapter VI, title 12 of the Code of Federal
Regulations as follows:
PART 607--ASSESSMENT AND APPORTIONMENT OF ADMINISTRATIVE EXPENSES
1. The authority citation for part 607 continues to read as
follows:
Authority: Secs. 5.15, 5.17 of the Farm Credit Act (12 U.S.C.
2250, 2252) and 12 U.S.C. 3025.
Sec. 607.2 [Amended]
2. Amend Sec. 607.2(b) introductory text by removing the reference
``Sec. 615.5210(f)'' and adding in its place ``Sec. 615.5210.''
PART 614--LOAN POLICIES AND OPERATIONS
3. The authority citation for part 614 continues to read as
follows:
Authority: 42 U.S.C. 4012a, 4104a, 4104b, 4106, and 4128; secs.
1.3, 1.5, 1.6, 1.7, 1.9, 1.10, 1.11, 2.0, 2.2, 2.3, 2.4, 2.10, 2.12,
2.13, 2.15, 3.0, 3.1, 3.3, 3.7, 3.8, 3.10, 3.20, 3.28, 4.12, 4.12A,
4.13B, 4.14, 4.14A, 4.14C, 4.14D, 4.14E, 4.18, 4.18A, 4.19, 4.25,
4.26, 4.27, 4.28, 4.36, 4.37, 5.9, 5.10, 5.17, 7.0, 7.2, 7.6, 7.8,
7.12, 7.13, 8.0, 8.5, of the Farm Credit Act (12 U.S.C. 2011, 2013,
2014, 2015, 2017, 2018, 2019, 2071, 2073, 2074, 2075, 2091, 2093,
2094, 2097, 2121, 2122, 2124, 2128, 2129, 2131, 2141, 2149, 2183,
2184, 2201, 2202, 2202a, 2202c, 2202d, 2202e, 2206, 2206a, 2207,
2211, 2212, 2213, 2214, 2219a, 2219b, 2243, 2244, 2252, 2279a,
2279a-2, 2279b, 2279c-1, 2279f, 2279f-1, 2279aa, 2279aa-5); sec. 413
of Pub. L. 100-233, 101 Stat. 1568, 1639.
Subpart J--Lending and Leasing Limits
4. Revise Sec. 614.4351(a) introductory text to read as follows:
Sec. 614.4351 Computation of lending and leasing limit base
(a) Lending and leasing limit base. An institution's lending and
leasing limit base is composed of the permanent capital of the
institution, as defined in Sec. 615.5201 of this chapter, with
adjustments applicable to the institution provided for in Sec.
615.5207 of this chapter, and with the following further adjustments:
* * * * *
PART 615--FUNDING AND FISCAL AFFAIRS, LOAN POLICIES AND OPERATIONS,
AND FUNDING OPERATIONS
5. The authority citation for part 615 continues to read as
follows:
Authority: Secs. 1.5, 1.7, 1.10, 1.11, 1.12, 2.2, 2.3, 2.4, 2.5,
2.12, 3.1, 3.7, 3.11, 3.25, 4.3, 4.3A, 4.9, 4.14B, 4.25, 5.9, 5.17,
6.20, 6.26, 8.0, 8.3, 8.4, 8.6, 8.7, 8.8, 8.10, 8.12 of the Farm
Credit Act (12 U.S.C. 2013, 2015, 2018, 2019, 2020, 2073, 2074,
2075, 2076, 2093, 2122, 2128, 2132, 2146, 2154, 2154a, 2160, 2202b,
2211, 2243, 2252, 2278b, 2278b-6, 2279aa, 2279aa-3, 2279aa-4,
2279aa-6, 2279aa-7, 2279aa-8, 2279aa-10, 2279aa-12); sec. 301(a) of
Pub. L. 100-233, 101 Stat. 1568, 1608.
Subpart H--Capital Adequacy
6. Revise the heading of Sec. 615.5200 to read as follows:
Sec. 615.5200 Capital planning.
* * * * *
7. Revise Sec. 615.5201 to read as follows:
Sec. 615.5201 Definitions.
For the purpose of this subpart, the following definitions apply:
Allocated investment means earnings allocated but not paid in cash
by a System bank to an association or other recipient.
Bank means an institution that:
(1) Engages in the business of banking;
(2) Is recognized as a bank by the bank supervisory or monetary
authority of the country of its organization or principal banking
operations;
(3) Receives deposits to a substantial extent in the regular course
of business; and
(4) Has the power to accept demand deposits.
Commitment means any arrangement that legally obligates an
institution to:
(1) Purchase loans or securities;
(2) Participate in loans or leases;
(3) Extend credit in the form of loans or leases;
(4) Pay the obligation of another;
(5) Provide overdraft, revolving credit, or underwriting
facilities; or
(6) Participate in similar transactions.
Credit conversion factor means that number by which an off-balance
sheet item is multiplied to obtain a credit equivalent before placing
the item in a risk-weight category.
Credit derivative means a contract that allows one party (the
protection purchaser) to transfer the credit risk of an asset or off-
balance sheet credit exposure to another party (the protection
provider). The value of a credit derivative is dependent, at least
[[Page 47998]]
in part, on the credit performance of a ``reference asset.''
Credit-enhancing interest-only strip
(1) The term credit-enhancing interest-only strip means an on-
balance sheet asset that, in form or in substance:
(i) Represents the contractual right to receive some or all of the
interest due on transferred assets; and
(ii) Exposes the institution to credit risk directly or indirectly
associated with the transferred assets that exceeds its pro rata claim
on the assets, whether through subordination provisions or other credit
enhancement techniques.
(2) FCA reserves the right to identify other cash flows or related
interests as credit-enhancing interest-only strips. In determining
whether a particular interest cash flow functions as a credit-enhancing
interest-only strip, FCA will consider the economic substance of the
transaction.
Credit-enhancing representations and warranties
(1) The term credit-enhancing representations and warranties means
representations and warranties that:
(i) Are made or assumed in connection with a transfer of assets
(including loan-servicing assets), and
(ii) Obligate an institution to protect investors from losses
arising from credit risk in the assets transferred or loans serviced.
(2) Credit-enhancing representations and warranties include
promises to protect a party from losses resulting from the default or
nonperformance of another party or from an insufficiency in the value
of the collateral.
(3) Credit-enhancing representations and warranties do not include:
(i) Early-default clauses and similar warranties that permit the
return of, or premium refund clauses covering, loans for a period not
to exceed 120 days from the date of transfer. These warranties may
cover only those loans that were originated within 1 year of the date
of the transfer;
(ii) Premium refund clauses covering assets guaranteed, in whole or
in part, by the United States Government, a United States Government
agency, or a United States Government-sponsored agency, provided the
premium refund clause is for a period not to exceed 120 days from the
date of transfer;
(iii) Warranties that permit the return of assets in instances of
fraud, misrepresentation, or incomplete documentation; or
(iv) Clean-up calls if the agreements to repurchase are limited to
10 percent or less of the original pool balance (except where loans 30
days or more past due are repurchased).
Deferred-tax assets that are dependent on future income or future
events means:
(1) Deferred-tax assets arising from deductible temporary
differences dependent upon future income that exceed the amount of
taxes previously paid that could be recovered through loss carrybacks
if existing temporary differences (both deductible and taxable and
regardless of where the related tax-deferred effects are recorded on
the institution's balance sheet) fully reverse;
(2) Deferred-tax assets dependent upon future income arising from
operating loss and tax carryforwards;
(3) Deferred-tax assets arising from temporary differences that
could be recovered if existing temporary differences that are dependent
upon other future events (both deductible and taxable and regardless of
where the related tax-deferred effects are recorded on the
institution's balance sheet) fully reverse.
Direct credit substitute means an arrangement in which an
institution assumes, in form or in substance, credit risk directly or
indirectly associated with an on- or off-balance sheet asset or
exposure that was not previously owned by the institution (third-party
asset) and the risk assumed by the institution exceeds the pro rata
share of the institution's interest in the third-party asset. If the
institution has no claim on the third-party asset, then the
institution's assumption of any credit risk is a direct credit
substitute. Direct credit substitutes include, but are not limited to:
(1) Financial standby letters of credit that support financial
claims on a third party that exceed an institution's pro rata share in
the financial claim;
(2) Guarantees, surety arrangements, credit derivatives, and
similar instruments backing financial claims that exceed an
institution's pro rata share in the financial claim;
(3) Purchased subordinated interests that absorb more than their
pro rata share of losses from the underlying assets;
(4) Credit derivative contracts under which the institution assumes
more than its pro rata share of credit risk on a third-party asset or
exposure;
(5) Loans or lines of credit that provide credit enhancement for
the financial obligations of a third party;
(6) Purchased loan-servicing assets if the servicer is responsible
for credit losses or if the servicer makes or assumes credit-enhancing
representations and warranties with respect to the loans serviced.
Servicer cash advances as defined in this section are not direct credit
substitutes; and,
(7) Clean-up calls on third-party assets. However, clean-up calls
that are 10 percent or less of the original pool balance and that are
exercisable at the option of the institution are not direct credit
substitutes.
Direct lender institution means an institution that extends credit
in the form of loans or leases to eligible borrowers in its own right
and carries such loan or lease assets on its books.
Externally rated means that an instrument or obligation has
received a credit rating from at least one NRSRO.
Face amount means:
(1) The notional principal, or face value, amount of an off-balance
sheet item;
(2) The amortized cost of an asset not held for trading purposes;
and
(3) The fair value of a trading asset.
Financial asset means cash or other monetary instrument, evidence
of debt, evidence of an ownership interest in an entity, or a contract
that conveys a right to receive from or exchange cash or another
financial instrument with another party.
Financial standby letter of credit means a letter of credit or
similar arrangement that represents an irrevocable obligation to a
third-party beneficiary:
(1) To repay money borrowed by, or advanced to, or for the account
of, a second party (the account party); or
(2) To make payment on behalf of the account party, in the event
that the account party fails to fulfill its obligation to the
beneficiary.
Government agency means an agency or instrumentality of the United
States Government whose obligations are fully and explicitly guaranteed
as to the timely repayment of principal and interest by the full faith
and credit of the United States Government.
Government-sponsored agency means an agency or instrumentality
chartered or established to serve public purposes specified by the
United States Congress but whose obligations are not explicitly
guaranteed by the full faith and credit of the United States
Government.
Institution means a Farm Credit Bank, Federal land bank
association, Federal land credit association, production credit
association, agricultural credit association, Farm Credit Leasing
Services Corporation, bank for cooperatives, agricultural credit bank,
and their successors.
Nationally recognized statistical rating organization (NRSRO) means
a rating organization that the Securities and Exchange Commission
recognizes as an NRSRO.
Non-OECD bank means a bank and its branches (foreign and domestic)
[[Page 47999]]
organized under the laws of a country that does not belong to the OECD
group of countries.
Nonagreeing association means an association that does not have an
allotment agreement in effect with a Farm Credit Bank or agricultural
credit bank pursuant to Sec. 615.5207(b)(2).
OECD means the group of countries that are full members of the
Organization for Economic Cooperation and Development, regardless of
entry date, as well as countries that have concluded special lending
arrangements with the International Monetary Fund's General Arrangement
to Borrow, excluding any country that has rescheduled its external
sovereign debt within the previous 5 years.
OECD bank means a bank and its branches (foreign and domestic)
organized under the laws of a country that belongs to the OECD group of
countries. For purposes of this subpart, this term includes U.S.
depository institutions.
Performance-based standby letter of credit means any letter of
credit, or similar arrangement, however named or described, that
represents an irrevocable obligation to the beneficiary on the part of
the issuer to make payment as a result of any default by a third party
in the performance of a nonfinancial or commercial obligation.
Permanent capital, subject to adjustments as described in Sec.
615.5207, includes:
(1) Current year retained earnings;
(2) Allocated and unallocated earnings (which, in the case of
earnings allocated in any form by a System bank to any association or
other recipient and retained by the bank, must be considered, in whole
or in part, permanent capital of the bank or of any such association or
other recipient as provided under an agreement between the bank and
each such association or other recipient);
(3) All surplus;
(4) Stock issued by a System institution, except:
(i) Stock that may be retired by the holder of the stock on
repayment of the holder's loan, or otherwise at the option or request
of the holder;
(ii) Stock that is protected under section 4.9A of the Act or is
otherwise not at risk;
(iii) Farm Credit Bank equities required to be purchased by Federal
land bank associations in connection with stock issued to borrowers
that is protected under section 4.9A of the Act;
(iv) Capital subject to revolvement, unless:
(A) The bylaws of the institution clearly provide that there is no
express or implied right for such capital to be retired at the end of
the revolvement cycle or at any other time; and
(B) The institution clearly states in the notice of allocation that
such capital may only be retired at the sole discretion of the board of
directors in accordance with statutory and regulatory requirements and
that no express or implied right to have such capital retired at the
end of the revolvement cycle or at any other time is thereby granted;
(5) Term preferred stock with an original maturity of at least 5
years and on which, if cumulative, the board of directors has the
option to defer dividends, provided that, at the beginning of each of
the last 5 years of the term of the stock, the amount that is eligible
to be counted as permanent capital is reduced by 20 percent of the
original amount of the stock (net of redemptions);
(6) Financial assistance provided by the Farm Credit System
Insurance Corporation that the FCA determines appropriate to be
considered permanent capital; and
(7) Any other debt or equity instruments or other accounts the FCA
has determined are appropriate to be considered permanent capital. The
FCA may permit one or more institutions to include all or a portion of
such instrument, entry, or account as permanent capital, permanently or
on a temporary basis, for purposes of this part.
Qualified residential loan:
(1) The term qualified residential loan means:
(i) A rural home loan, as authorized by Sec. 613.3030, and
(ii) A single-family residential loan to a bona fide farmer,
rancher, or producer or harvester of aquatic products.
(2) A qualified residential loan must be secured by a first lien
mortgage or deed of trust, must have been approved in accordance with
prudent underwriting standards, must not be past due 90 days or more or
carried in nonaccrual status, and must have a monthly amortization
schedule. In addition, the secured residence and residential site must
have a deed separate from other adjoining land and a permanent right-
of-way access.
Qualifying bilateral netting contract means a bilateral netting
contract that meets at least the following conditions:
(1) The contract is in writing;
(2) The contract is not subject to a walkaway clause, defined as a
provision that permits a non-defaulting counterparty to make lower
payments than it would make otherwise under the contract, or no payment
at all, to a defaulter or to the estate of a defaulter, even if the
defaulter or the estate of the defaulter is a net creditor under the
contract;
(3) The contract creates a single obligation either to pay or
receive the net amount of the sum of positive and negative mark-to-
market values for all derivative contracts subject to the qualifying
bilateral netting contract;
(4) The institution receives a legal opinion that represents, to a
high degree of certainty, that in the event of legal challenge the
relevant court and administrative authorities would find the
institution's exposure to be the net amount;
(5) The institution establishes a procedure to monitor relevant law
and to ensure that the contracts continue to satisfy the requirements
of this section; and
(6) The institution maintains in its files adequate documentation
to support the netting of a derivatives contract.
Qualifying securities firm means:
(1) A securities firm incorporated in the United States that is a
broker-dealer that is registered with the Securities and Exchange
Commission (SEC) and that complies with the SEC's net capital
regulations (17 CFR 240.15c3-1); and
(2) A securities firm incorporated in any other OECD-based country,
if the institution is able to demonstrate that the securities firm is
subject to supervision and regulation (covering its direct and indirect
subsidiaries, but not necessarily its parent organizations) comparable
to that imposed on depository institutions in OECD countries. Such
regulation must include risk-based capital requirements comparable to
those imposed on depository institutions under the Accord on
International Convergence of Capital Measurement and Capital Standards
(1988, as amended in 1998) (Basel Accord).
Recourse means an institution's retention, in form or in substance,
of any credit risk directly or indirectly associated with an asset it
has sold (in accordance with generally accepted accounting principles)
that exceeds a pro rata share of the institution's claim on the asset.
If an institution has no claim on an asset it has sold, then the
retention of any credit risk is recourse. A recourse obligation
typically arises when an institution transfers assets in a sale and
retains an explicit obligation to repurchase assets or to absorb losses
due to a default on the payment of principal or interest or any other
deficiency in the performance of the underlying obligor or some other
party. Recourse may also exist implicitly if an institution provides
credit enhancement beyond
[[Page 48000]]
any contractual obligation to support assets it has sold. Recourse
obligations include, but are not limited to:
(1) Credit-enhancing representations and warranties made on
transferred assets;
(2) Loan-servicing assets retained pursuant to an agreement under
which the institution will be responsible for losses associated with
the loans serviced. Servicer cash advances as defined in this section
are not recourse obligations;
(3) Retained subordinated interests that absorb more than their pro
rata share of losses from the underlying assets;
(4) Assets sold under an agreement to repurchase, if the assets are
not already included on the balance sheet;
(5) Loan strips sold without contractual recourse where the
maturity of the transferred portion of the loan is shorter than the
maturity of the commitment under which the loan is drawn;
(6) Credit derivatives issued that absorb more than the
institution's pro rata share of losses from the transferred assets; and
(7) Clean-up call on assets the institution has sold. However,
clean-up calls that are 10 percent or less of the original pool balance
and that are exercisable at the option of the institution are not
recourse arrangements.
Residual interest:
(1) The term residual interest means any on-balance sheet asset
that:
(i) Represents an interest (including a beneficial interest)
created by a transfer that qualifies as a sale (in accordance with
generally accepted accounting principles) of financial assets, whether
through a securitization or otherwise; and
(ii) Exposes an institution to credit risk directly or indirectly
associated with the transferred asset that exceeds a pro rata share of
the institution's claim on the asset, whether through subordination
provisions or other credit enhancement techniques.
(2) Residual interests generally include credit-enhancing interest-
only strips, spread accounts, cash collateral accounts, retained
subordinated interests (and other forms of overcollateralization), and
similar assets that function as a credit enhancement.
(3) Residual interests further include those exposures that, in
substance, cause the institution to retain the credit risk of an asset
or exposure that had qualified as a residual interest before it was
sold.
(4) Residual interests generally do not include interests purchased
from a third party. However, purchased credit-enhancing interest-only
strips are residual interests.
Risk-adjusted asset base means the total dollar amount of the
institution's assets adjusted in accordance with Sec. 615.5207 and
weighted on the basis of risk in accordance with Sec. Sec. 615.5211
and 615.5212.
Risk participation means a participation in which the originating
party remains liable to the beneficiary for the full amount of an
obligation (e.g., a direct credit substitute) notwithstanding that
another party has acquired a participation in that obligation.
Rural Business Investment Company has the definition given in 7
U.S.C. 2009cc(14).
Securitization means the pooling and repackaging by a special
purpose entity or trust of assets or other credit exposures that can be
sold to investors. Securitization includes transactions that create
stratified credit risk positions whose performance is dependent upon an
underlying pool of credit exposures, including loans and commitments.
Servicer cash advance means funds that a mortgage servicer advances
to ensure an uninterrupted flow of payments, including advances made to
cover foreclosure costs or other expenses to facilitate the timely
collection of the loan. A servicer cash advance is not a recourse
obligation or a direct credit substitute if:
(1) The servicer is entitled to full reimbursement and this right
is not subordinated to other claims on the cash flows from the
underlying asset pool; or
(2) For any one loan, the servicer's obligation to make
nonreimbursable advances is contractually limited to an insignificant
amount of the outstanding principal amount on that loan.
Stock means stock and participation certificates.
Total capital means assets minus liabilities, valued in accordance
with generally accepted accounting principles (GAAP), except that
liabilities do not include obligations to retire stock protected under
section 4.9A of the Act.
Traded position means a position retained, assumed, or issued that
is externally rated, where there is a reasonable expectation that, in
the near future, the rating will be relied upon by:
(1) Unaffiliated investors to purchase the position; or
(2) An unaffiliated third party to enter into a transaction
involving the position, such as a purchase, loan, or repurchase
agreement.
U.S. depository institution means branches (foreign and domestic)
of federally insured banks and depository institutions chartered and
headquartered in the 50 states of the United States, the District of
Columbia, Puerto Rico, and United States territories and possessions.
The definition encompasses banks, mutual or stock savings banks,
savings or building and loan associations, cooperative banks, credit
unions, international banking facilities of domestic depository
institutions, and U.S.-chartered depository institutions owned by
foreigners. The definition excludes branches and agencies of foreign
banks located in the U.S. and bank holding companies.
Sec. 615.5210 [Removed]
8. Remove existing Sec. 615.5210.
9. Add new Sec. Sec. 615.5206 through 615.5212 to read as follows:
Sec. 615.5206 Permanent capital ratio computation.
(a) The institution's permanent capital ratio is determined on the
basis of the financial statements of the institution prepared in
accordance with generally accepted accounting principles except that
the obligations of the Farm Credit System Financial Assistance
Corporation issued to repay banks in connection with the capital
preservation and loss-sharing agreements described in section 6.9(e)(1)
of the Act shall not be considered obligations of any institution
subject to this regulation prior to their maturity.
(b) The institution's asset base and permanent capital are computed
using average daily balances for the most recent 3 months.
(c) The institution's permanent capital ratio is calculated by
dividing the institution's permanent capital, adjusted in accordance
with Sec. 615.5207 (the numerator), by the risk-adjusted asset base
(the denominator) as determined in Sec. 615.5210, to derive a ratio
expressed as a percentage.
(d) Until September 27, 2002, payments of assessments to the Farm
Credit System Financial Assistance Corporation, and any part of the
obligation to pay future assessments to the Farm Credit System
Financial Assistance Corporation that is recognized as an expense on
the books of a bank or association, shall be included in the capital of
such bank or association for the purpose of determining its compliance
with regulatory capital requirements, to the extent allowed by section
6.26(c)(5)(G) of the Act. If the bank directly or indirectly passes on
all or part of the payments to its affiliated associations pursuant to
section 6.26(c)(5)(D) of the
[[Page 48001]]
Act, such amounts shall be included in the capital of the associations
and shall not be included in the capital of the bank. After September
27, 2002, no payments of assessments or obligations to pay future
assessments may be included in the capital of the bank or association.
Sec. 615.5207 Capital adjustments and associated reductions to
assets.
For the purpose of computing the institution's permanent capital
ratio, the following adjustments must be made prior to assigning assets
to risk-weight categories and computing the ratio:
(a) Where two Farm Credit System institutions have stock
investments in each other, such reciprocal holdings must be eliminated
to the extent of the offset. If the investments are equal in amount,
each institution must deduct from its assets and its total capital an
amount equal to the investment. If the investments are not equal in
amount, each institution must deduct from its total capital and its
assets an amount equal to the smaller investment. The elimination of
reciprocal holdings required by this paragraph must be made prior to
making the other adjustments required by this section.
(b) Where a Farm Credit Bank or an agricultural credit bank is
owned by one or more Farm Credit System institutions, the double
counting of capital is eliminated in the following manner:
(1) All equities of a Farm Credit Bank or agricultural credit bank
that have been purchased by other Farm Credit institutions are
considered to be permanent capital of the Farm Credit Bank or
agricultural credit bank.
(2) Each Farm Credit Bank or agricultural credit bank and each of
its affiliated associations may enter into an agreement that specifies,
for the purpose of computing permanent capital only, a dollar amount
and/or percentage allotment of the association's allocated investment
between the bank and the association. Section 615.5208 provides
conditions for allotment agreements or defines allotments in the
absence of such agreements.
(c) A Farm Credit Bank or agricultural credit bank and a recipient,
other than an association, of allocated earnings from such bank may
enter into an agreement specifying a dollar amount and/or percentage
allotment of the recipient's allocated earnings in the bank between the
bank and the recipient. Such agreement must comply with the provisions
of paragraph (b) of this section, except that, in the absence of an
agreement, the allocated investment must be allotted 100 percent to the
allocating bank and 0 percent to the recipient. All equities of the
bank that are purchased by a recipient are considered as permanent
capital of the issuing bank.
(d) A bank for cooperatives and a recipient of allocated earnings
from such bank may enter into an agreement specifying a dollar amount
and/or percentage allotment of the recipient's allocated earnings in
the bank between the bank and the recipient. Such agreement must comply
with the provisions of paragraph (b) of this section, except that, in
the absence of an agreement, the allocated investment must be allotted
100 percent to the allocating bank and 0 percent to the recipient. All
equities of a bank that are purchased by a recipient shall be
considered as permanent capital of the issuing bank.
(e) Where a bank or association invests in an association to
capitalize a loan participation interest, the investing institution
must deduct from its total capital an amount equal to its investment in
the participating institution.
(f) The double-counting of capital by a service corporation
chartered under section 4.25 of the Act and its stockholder
institutions must be eliminated by deducting an amount equal to the
institution's investment in the service corporation from its total
capital.
(g) Each institution must deduct from its total capital an amount
equal to all goodwill, whenever acquired.
(h) To the extent an institution has deducted its investment in
another Farm Credit institution from its total capital, the investment
may be eliminated from its asset base.
(i) Where a Farm Credit Bank and an association have an enforceable
written agreement to share losses on specifically identified assets on
a predetermined quantifiable basis, such assets must be counted in each
institution's risk-adjusted asset base in the same proportion as the
institutions have agreed to share the loss.
(j) The permanent capital of an institution must exclude the net
effect of all transactions covered by the definition of ``accumulated
other comprehensive income'' contained in the Statement of Financial
Accounting Standards No. 130, as promulgated by the Financial
Accounting Standards Board.
(k) For purposes of calculating capital ratios under this part,
deferred-tax assets are subject to the conditions, limitations, and
restrictions described in Sec. 615.5209.
(l) Capital may also need to be reduced for potential loss exposure
on any recourse obligations, direct credit substitutes, residual
interests, and credit-enhancing interest-only-strips in accordance with
Sec. 615.5210.
Sec. 615.5208 Allotment of allocated investments.
(a) The following conditions apply to agreements that a Farm Credit
Bank or agricultural credit bank enters into with an affiliated
association pursuant to Sec. 615.5207(b)(2):
(1) The agreement must be for a term of 1 year or longer.
(2) The agreement must be entered into on or before its effective
date.
(3) The agreement may be amended according to its terms, but no
more frequently than annually except in the event that a party to the
agreement is merged or reorganized.
(4) On or before the effective date of the agreement, a certified
copy of the agreement, and any amendments thereto, must be sent to the
field office of the Farm Credit Administration responsible for
examining the institution. A copy must also be sent within 30 calendar
days of adoption to the bank's other affiliated associations.
(5) Unless the parties otherwise agree, if the bank and the
association have not entered into a new agreement on or before the
expiration of an existing agreement, the existing agreement will
automatically be extended for another 12 months, unless either party
notifies the Farm Credit Administration in writing of its objection to
the extension prior to the expiration of the existing agreement.
(b) In the absence of an agreement between a Farm Credit Bank or an
agricultural credit bank and one or more associations, or in the event
that an agreement expires and at least one party has timely objected to
the continuation of the terms of its agreement, the following formula
applies with respect to the allocated investments held by those
associations with which there is no agreement (nonagreeing
associations), and does not apply to the allocated investments held by
those associations with which the bank has an agreement (agreeing
associations):
(1) The allotment formula must be calculated annually.
(2) The permanent capital ratio of the Farm Credit Bank or
agricultural credit bank must be computed as of the date that the
existing agreement terminates, using a 3-month average daily balance,
excluding the allocated investment from nonagreeing associations but
including any allocated investments of agreeing associations that are
allotted to the bank
[[Page 48002]]
under applicable allocation agreements. The permanent capital ratio of
each nonagreeing association must be computed as of the same date using
a 3-month average daily balance, and must be computed excluding its
allocated investment in the bank.
(3) If the permanent capital ratio for the Farm Credit Bank or
agricultural credit bank calculated in accordance with Sec. 615.5211
is 7 percent or above, the allocated investment of each nonagreeing
association whose permanent capital ratio calculated in accordance with
Sec. 615.5211 is 7 percent or above must be allotted 50 percent to the
bank and 50 percent to the association.
(4) If the permanent capital ratio of the Farm Credit Bank or
agricultural credit bank calculated in accordance with Sec. 615.5211
is 7 percent or above, the allocated investment of each nonagreeing
association whose capital ratio is below 7 percent must be allotted to
the association until the association's capital ratio reaches 7 percent
or until all of the investment is allotted to the association,
whichever occurs first. Any remaining unallotted allocated investment
must be allotted 50 percent to the bank and 50 percent to the
association.
(5) If the permanent capital ratio of the Farm Credit Bank or
agricultural credit bank calculated in accordance with Sec. 615.5211
is less than 7 percent, the amount of additional capital needed by the
bank to reach a permanent capital ratio of 7 percent must be
determined, and an amount of the allocated investment of each
nonagreeing association must be allotted to the Farm Credit Bank or
agricultural credit bank, as follows:
(i) If the total of the allocated investments of all nonagreeing
associations is greater than the additional capital needed by the bank,
the allocated investment of each nonagreeing association must be
multiplied by a fraction whose numerator is the amount of capital
needed by the bank and whose denominator is the total amount of
allocated investments of the nonagreeing associations, and such amount
must be allotted to the bank. Next, if the permanent capital ratio of
any nonagreeing association is less than 7 percent, a sufficient amount
of unallotted allocated investment must then be allotted to each
nonagreeing association, as necessary, to increase its permanent
capital ratio to 7 percent, or until all such remaining investment is
allotted to the association, whichever occurs first. Any unallotted
allocated investment still remaining must be allotted 50 percent to the
bank and 50 percent to the nonagreeing association.
(ii) If the additional capital needed by the bank is greater than
the total of the allocated investments of the nonagreeing associations,
all of the remaining allocated investments of the nonagreeing
associations must be allotted to the bank.
(c) If a payment or part of a payment to the Farm Credit System
Financial Assistance Corporation pursuant to section 6.9(e)(3)(D)(ii)
of the Act would cause a bank to fall below its minimum permanent
capital requirement, the bank and one or more association shall amend
their allocation agreements to increase the allotment of the allocated
investment to the bank sufficiently to enable the bank to make the
payment to the Farm Credit System Financial Assistance Corporation,
provided that the associations would continue to meet their minimum
permanent capital requirement. In the case of a nonagreeing
association, the Farm Credit Administration may require a revision of
the allotment sufficient to enable the bank to make the payment to the
Farm Credit System Financial Assistance Corporation, provided that the
association would continue to meet its minimum permanent capital
requirement. The Farm Credit Administration Board may, at the request
of one or more of the institutions affected, waive the requirements of
this paragraph if the Board deems it is in the overall best interest of
the institutions affected.
Sec. 615.5209 Deferred-tax assets.
For purposes of calculating capital ratios under this part,
deferred-tax assets are subject to the conditions, limitations, and
restrictions described in this section.
(a) Each institution must deduct an amount of deferred-tax assets,
net of any valuation allowance, from its assets and its total capital
that is equal to the greater of:
(1) The amount of deferred-tax assets that is dependent on future
income or future events in excess of the amount that is reasonably
expected to be realized within 1 year of the most recent calendar
quarter-end date, based on financial projections for that year, or
(2) The amount of deferred-tax assets that is dependent on future
income or future events in excess of 10 percent of the amount of core
surplus that exists before the deduction of any deferred-tax assets.
(b) For purposes of this calculation:
(1) The amount of deferred-tax assets that can be realized from
taxes paid in prior carryback years and from the reversal of existing
taxable temporary differences may not be deducted from assets and from
equity capital.
(2) All existing temporary differences should be assumed to fully
reverse at the calculation date.
(3) Projected future taxable income should not include net
operating loss carryforwards to be used within 1 year or the amount of
existing temporary differences expected to reverse within that year.
(4) Financial projections must include the estimated effect of tax-
planning strategies that are expected to be implemented to minimize tax
liabilities and realize tax benefits. Financial projections for the
current fiscal year (adjusted for any significant changes that have
occurred or are expected to occur) may be used when applying the
capital limit at an interim date within the fiscal year.
(5) The deferred tax effects of any unrealized holding gains and
losses on available-for-sale debt securities may be excluded from the
determination of the amount of deferred-tax assets that are dependent
upon future taxable income and the calculation of the maximum allowable
amount of such assets. If these deferred-tax effects are excluded, this
treatment must be followed consistently over time.
Sec. 615.5210 Risk-adjusted assets.
(a) Computation. Each asset on the institution's balance sheet and
each off-balance-sheet item, adjusted by the appropriate credit
conversion factor in Sec. 615.5212, is assigned to one of the risk
categories specified in Sec. 615.5211. The aggregate dollar value of
the assets in each category is multiplied by the percentage weight
assigned to that category. The sum of the weighted dollar values from
each of the risk categories comprises ``risk-adjusted assets,'' the
denominator for computation of the permanent capital ratio.
(b) Ratings-based approach. (1) Under the ratings-based approach:
(i) Beginning 18 months after the effective date of this section, a
position in a securitization that is unrated and guaranteed by a
Government-sponsored agency is assigned to the appropriate risk-weight
category based on the issuer credit rating of the agency.
(ii) A rated position in a securitization (provided it satisfies
the criteria specified in paragraph (b)(3) of this section) is assigned
to the appropriate risk-weight category based on its external rating.
(2) Provided they satisfy the criteria specified in paragraph
(b)(3) of this
[[Page 48003]]
section, the following positions qualify for the ratings-based
approach:
(i) Recourse obligations;
(ii) Direct credit substitutes;
(iii) Residual interests (other than credit-enhancing interest-only
strips); and
(iv) Asset-or mortgage-backed securities.
(3) A position specified in paragraph (b)(2) of this section
qualifies for a ratings-based approach provided it satisfies the
following criteria:
(i) If the position is traded and externally rated, its long-term
external rating must be one grade below investment grade or better
(e.g., BB or better) or its short-term external rating must be
investment grade or better (e.g., A-3, P-3). If the position receives
more than one external rating, the lowest rating applies.
(ii) If the position is not traded and is externally rated,
(A) It must be externally rated by more than one NRSRO;
(B) Its long-term external rating must be one grade below
investment grade or better (e.g., BB or better) or its short-term
external rating must be investment grade or better (e.g., A-3, P-3 or
better). If the ratings are different, the lowest rating applies;
(C) The ratings must be publicly available; and
(D) The ratings must be based on the same criteria used to rate
traded positions.
(iii) Beginning 18 months after the effective date of this section,
the position is unrated and is guaranteed by a Government-sponsored
agency.
(c) Positions in securitizations that do not qualify for a ratings-
based approach. The following positions in securitizations do not
qualify for a ratings-based approach, whether or not they are
guaranteed by Government-sponsored agencies. They are treated as
indicated.
(1) For any residual interest that is not externally rated, the
institution must deduct from capital and assets the face amount of the
position (dollar-for-dollar reduction).
(2) For any credit-enhancing interest-only strip, the institution
must deduct from capital and assets the face amount of the position
(dollar-for-dollar reduction).
(3) For any position that has a long-term external rating that is
two grades below investment grade or lower (e.g., B or lower) or a
short-term external rating that is one grade below investment grade or
lower (e.g., B or lower, Not Prime), the institution must deduct from
capital and assets the face amount of the position (dollar-for-dollar
reduction).
(4) Any recourse obligation or direct credit substitute (e.g., a
purchased subordinated security) that is not externally rated is risk
weighted using the amount of the recourse obligation or direct credit
substitute and the full amount of the assets it supports, i.e., all the
more senior positions in the structure. This treatment is subject to
the low-level exposure rule set forth in paragraph (e) of this section.
This amount is then placed into a risk-weight category according to the
obligor or, if relevant, the guarantor or the nature of the collateral.
(5) Any stripped mortgage-backed security or similar instrument,
such as an interest-only strip that is not credit-enhancing or a
principal-only strip, is assigned to the 100-percent risk-weight
category described in Sec. 615.5211(d)(7).
(d) Senior positions not externally rated. For a position in a
securitization that is not externally rated but is senior in all
features to a traded position (including collateralization and
maturity), an institution may apply a risk weight to the face amount of
the senior position based on the traded position's external rating.
This section will apply only if the traded position provides
substantial credit support for the entire life of the unrated position.
(e) Low-level exposure rule. If the maximum contractual exposure to
loss retained or assumed by an institution in connection with a
recourse obligation or a direct credit substitute is less than the
effective risk-based capital requirement for the credit-enhanced
assets, the risk-based capital required under paragraph (c)(4) of this
section is limited to the institution's maximum contractual exposure,
less any recourse liability account established in accordance with
generally accepted accounting principles. This limitation does not
apply when an institution provides credit enhancement beyond any
contractual obligation to support assets it has sold.
(f) Reservation of authority. The FCA may, on a case-by-case basis,
determine the appropriate risk weight for any asset or credit
equivalent amount that does not fit wholly within one of the risk
categories set forth in Sec. 615.5211 or that imposes risks that are
not commensurate with the risk weight otherwise specified in Sec.
615.5211 for the asset or credit equivalent. In addition, the FCA may,
on a case-by-case basis, determine the appropriate credit conversion
factor for any off-balance sheet item that does not fit wholly within
one of the credit conversion factors set forth in Sec. 615.5212 or
that imposes risks that are not commensurate with the credit conversion
factor otherwise specified in Sec. 615.5212 for the item. In making
this determination, the FCA will consider the similarity of the asset
or off-balance sheet item to assets or off-balance sheet items
explicitly treated in Sec. Sec. 615.5211 or 615.5212, as well as other
relevant factors.
Sec. 615.5211 Risk categories--balance sheet assets.
Section 615.5210(c) specifies certain balance sheet assets that are
not assigned to the risk categories set forth below. All other balance
sheet assets are assigned to the percentage risk categories as follows:
(a) Category 1: 0 Percent
(1) Cash (domestic and foreign).
(2) Balances due from Federal Reserve Banks and central banks in
other OECD countries.
(3) Direct claims on, and portions of claims unconditionally
guaranteed by, the U.S. Treasury, government agencies, or central
governments in other OECD countries.
(4) Portions of local currency claims on, or unconditionally
guaranteed by, non-OECD central governments (including non-OECD central
banks), to the extent the institution has liabilities booked in that
currency.
(5) Claims on, or guaranteed by, qualifying securities firms that
are collateralized by cash on deposit in the institution or by
securities issued or guaranteed by the United States (including U.S.
Government agencies) or OECD central governments, provided that a
positive margin of collateral is required to be maintained on such a
claim on a daily basis, taking into account any change in the
institution's exposure to the obligor or counterparty under the claim
in relation to the market value of the collateral held in support of
the claim.
(b) Category 2: 20 Percent
(1) Cash items in the process of collection.
(2) Loans and other obligations of and investments in Farm Credit
institutions.
(3) All claims (long- and short-term) on, and portions of claims
(long- and short-term) guaranteed by, OECD banks (excluding claims
described in paragraphs (b)(7), (c)(4) or (d)(11) of this section).
(4) Short-term (remaining maturity of 1 year or less) claims on,
and portions of short-term claims guaranteed by, non-OECD banks.
(5) Portions of loans and other claims conditionally guaranteed by
the U.S. Treasury, government agencies, or central governments in other
OECD countries and portions of local currency claims conditionally
guaranteed by non-
[[Page 48004]]
OECD central governments to the extent that the institution has
liabilities booked in that currency.
(6) Securities and other claims on, and portions of claims
guaranteed by, Government-sponsored agencies (excluding positions in
securitizations described in Sec. 615.5210 and claims that are
described in (b)(7), (c)(4) or (d)(11) of this section), without regard
to issuer credit rating.
(7)(i) Until 18 months after this rule's effective date, assets or
portions of assets covered by credit protection provided by Government-
sponsored agencies and OECD banks through credit derivatives (e.g.,
credit default swaps), loss purchase commitments, guarantees, and other
similar arrangements;
(ii) Beginning 18 months after the effective date of this section,
assets or portions of assets covered by credit protection provided by
Government-sponsored agencies and OECD banks through credit derivatives
(e.g., credit default swaps), loss purchase commitments, guarantees,
and other similar arrangements, provided the Government-sponsored
agencies and OECD banks have an issuer credit rating in one of the two
highest investment grade ratings from at least one NRSRO (if the credit
protection provider is rated by more than one NRSRO the lowest rating
applies).
(8) Portions of loans and other claims (including repurchase
agreements) collateralized by securities issued or guaranteed by the
U.S. Treasury, government agencies, Government-sponsored agencies or
central governments in other OECD countries.
(9) Portions of loans and other claims collateralized by cash held
by the institution or its funding bank.
(10) General obligation claims on, and portions of claims
guaranteed by, the full faith and credit of states or other political
subdivisions or OECD countries, including U.S. state and local
governments.
(11) Claims on, and portions of claims guaranteed by, official
multinational lending institutions or regional development institutions
in which the U.S. Government is a shareholder or a contributing member.
(12) Portions of claims collateralized by securities issued by
official multilateral lending institutions or regional development
institutions in which the U.S. Government is a shareholder or
contributing member.
(13) Investments in shares of mutual funds whose portfolios are
permitted to hold only assets that qualify for the zero or 20-percent
risk categories.
(14) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips) and asset-
or mortgage-backed securities that:
(i) Are externally rated in the highest or second highest
investment grade category, e.g., AAA, AA, in the case of long-term
ratings, or the highest rating category, e.g., A-1, P-1, in the case of
short-term ratings; or
(ii)(A) Until 18 months after the effective date of this section,
are unrated and are guaranteed by a Government-sponsored agency;
(B) Beginning 18 months after the effective date of this section,
are unrated and are guaranteed by a Government-sponsored agency with an
issuer credit rating in the highest or second highest investment grade
category, e.g., AAA or AA.
(15) Claims on, and claims guaranteed by, qualifying securities
firms provided that:
(i) The qualifying securities firm, or at least one issue of its
long-term debt, has a rating in one of the highest two investment grade
rating categories from an NRSRO (if the securities firm or debt has
more than one NRSRO rating the lowest rating applies); or
(ii) The claim is guaranteed by a qualifying securities firm's
parent company with such a rating.
(16) Certain collateralized claims on qualifying securities firms
without regard to satisfaction of the rating standard, provided that
the claim arises under a contract that:
(i) Is a reverse repurchase/repurchase agreement or securities
lending/borrowing transaction executed under standard industry
documentation;
(ii) Is collateralized by liquid and readily marketable debt or
equity securities;
(iii) Is marked-to-market daily;
(iv) Is subject to a daily margin maintenance requirement under the
standard documentation; and
(v) Can be liquidated, terminated, or accelerated immediately in
bankruptcy or similar proceeding, and the security or collateral
agreement will not be stayed or avoided, under applicable law of the
relevant country.
(17) Claims on other financing institutions provided that:
(i) The other financing institution qualifies as an OECD bank or it
is owned and controlled by an OECD bank that guarantees the claim, or
(ii) The other financing institution has a rating in one of the
highest three investment-grade rating categories from a NRSRO or the
claim is guaranteed by a parent company with such a rating, and
(iii) The other financing institution has endorsed all obligations
it pledges to its funding Farm Credit bank with full recourse.
(c) Category 3: 50 Percent
(1) All other investment securities with remaining maturities under
1 year, if the securities are not eligible for the ratings-based
approach or subject to the dollar-for-dollar capital treatment.
(2) Qualified residential loans.
(3) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips) and asset-
or mortgage-backed securities that:
(i) Are rated in the third highest investment grade category, e.g.,
A, in the case of long-term ratings, or the second highest rating
category, e.g., A-2, P-2, in the case of short-term ratings; or
(ii) Beginning 18 months after the effective date of this section,
are unrated and are guaranteed by a Government-sponsored agency with an
issuer credit rating in the third highest investment grade category,
e.g., A.
(4) Beginning 18 months after the effective date of this section,
assets or portions of assets covered by credit protection provided by
Government-sponsored agencies and OECD banks through credit derivatives
(e.g., credit default swaps), loss purchase commitments, guarantees,
and other similar arrangements, provided the Government-sponsored
agencies and OECD banks have an issuer credit rating in the third
highest investment grade category, e.g., A, from at least one NRSRO (if
they are rated by more than one NRSRO the lowest rating applies).
(5) Revenue bonds or similar obligations, including loans and
leases, that are obligations of state or political subdivisions of the
United States or other OECD countries but for which the government
entity is committed to repay the debt only out of revenue from the
specific projects financed.
(6) Claims on other financing institutions that:
(i) Are not covered by the provisions of paragraph (b)(17) of this
section, but otherwise meet similar capital, risk identification and
control, and operational standards, or
(ii) Carry an investment-grade or higher NRSRO rating or the claim
is guaranteed by a parent company with such a rating, and
(iii) The other financing institution has endorsed all obligations
it pledges to its funding Farm Credit bank with full recourse.
(d) Category 4: 100 Percent. This category includes all assets not
specified in the categories above or below nor deducted dollar-for-
dollar from capital
[[Page 48005]]
and assets as discussed in Sec. 615.5210(c). This category comprises
standard risk assets such as those typically found in a loan or lease
portfolio and includes:
(1) All other claims on private obligors;
(2) Claims on, or portions of claims guaranteed by, non-OECD banks
with a remaining maturity exceeding 1 year; and
(3) Claims on, or portions of claims guaranteed by, non-OECD
central governments that are not included in paragraphs (a)(4) or
(b)(4) of this section, and all claims on non-OECD state and local
governments.
(4) Industrial-development bonds and similar obligations issued
under the auspices of states or political subdivisions of the OECD-
based group of countries for the benefit of a private party or
enterprise where that party or enterprise, not the government entity,
is obligated to pay the principal and interest.
(5) Premises, plant, and equipment; other fixed assets; and other
real estate owned.
(6) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips) and asset-
or mortgage-backed securities that:
(i) Are rated in the lowest investment grade category, e.g., BBB,
in the case of long-term ratings, or the third highest rating category,
e.g., A-3, P-3, in the case of short-term ratings; or
(ii) Beginning 18 months after the effective date of this section,
are unrated and are guaranteed by a Government-sponsored agency that
has an issuer credit rating in or below the lowest investment grade
category, e.g., BBB, or that is unrated.
(7) Stripped mortgage-backed securities and similar instruments,
such as interest-only strips that are not credit-enhancing and
principal-only strips (including such instruments guaranteed by
Government-sponsored agencies).
(8) Investments in Rural Business Investment Companies.
(9) If they have not already been deducted from capital:
(i) Investments in unconsolidated companies, joint ventures, or
associated companies.
(ii) Deferred-tax assets.
(iii) Servicing assets.
(10) All non-local currency claims on foreign central governments,
as well as local currency claims on foreign central governments that
are not included in any other category;
(11) Beginning 18 months after the effective date of this section,
assets or portions of assets covered by credit protection provided by
Government-sponsored agencies and OECD banks through credit derivatives
(e.g., credit default swaps), loss purchase commitments, guarantees,
and other similar arrangements, provided the Government-sponsored
agencies and OECD banks have an issuer credit rating in the lowest
investment grade category, e.g., BBB, or below from at least one NRSRO
(if they are rated by more than one NRSRO the lowest rating applies) or
are unrated;
(12) Claims on other financing institutions that do not otherwise
qualify for a lower risk-weight category under this section; and
(13) All other assets not specified above, including but not
limited to leases and receivables.
(e) Category 5: 200 Percent. Recourse obligations, direct credit
substitutes, residual interests (other than credit-enhancing interest-
only strips) and asset- or mortgage-backed securities that are rated
one category below the lowest investment grade category, e.g., BB.
Sec. 615.5212 Credit conversion factors--off-balance sheet items.
(a) The face amount of an off-balance sheet item is generally
incorporated into risk-weighted assets in two steps. For most off-
balance sheet items, the face amount is first multiplied by a credit
conversion factor. (In the case of direct credit substitutes and
recourse obligations the full amount of the assets enhanced are
multiplied by a credit conversion factor). The resultant credit
equivalent amount is assigned to the appropriate risk-weight category
described in Sec. 615.5211 according to the obligor or, if relevant,
the guarantor or the collateral.
(b) Conversion factors for various types of off-balance sheet items
are as follows:
(1) 0 Percent
(i) Unused commitments with an original maturity of 14 months or
less;
(ii) Unused commitments with an original maturity greater than 14
months if:
(A) They are unconditionally cancellable by the institution; and
(B) The institution has the contractual right to, and in fact does,
make a separate credit decision based upon the borrower's current
financial condition before each drawing under the lending arrangement.
(2) 20 Percent. Short-term, self-liquidating, trade-related
contingencies, including but not limited to commercial letters of
credit.
(3) 50 Percent
(i) Transaction-related contingencies (e.g., bid bonds, performance
bonds, warranties, and performance-based standby letters of credit
related to a particular transaction).
(ii) Unused loan commitments with an original maturity greater than
14 months, including underwriting commitments and commercial credit
lines.
(iii) Revolving underwriting facilities (RUFs), note issuance
facilities (NIFs) and other similar arrangements pursuant to which the
institution's customer can issue short-term debt obligations in its own
name, but for which the institution has a legally binding commitment to
either:
(A) Purchase the obligations its customer is unable to sell by a
stated date; or
(B) Advance funds to its customer if the obligations cannot be
sold.
(4) 100 Percent
(i) The full amount of the assets supported by direct credit
substitutes and recourse obligations for which an institution directly
or indirectly retains or assumes credit risk. For risk participations
in such arrangements acquired by the institution, the full amount of
assets supported by the main obligation multiplied by the acquiring
institution's percentage share of the risk participation. The capital
requirement under this paragraph is limited to the institution's
maximum contractual exposure, less any recourse liability account
established under generally accepted accounting principles.
(ii) Acquisitions of risk participations in bankers acceptances.
(iii) Sale and repurchase agreements, if not already included on
the balance sheet.
(iv) Forward agreements (i.e., contractual obligations) to purchase
assets, including financing facilities with certain drawdown.
(c) Credit equivalents of interest rate contracts and foreign
exchange contracts. (1) Credit equivalents of interest rate contracts
and foreign exchange contracts (except single-currency floating/
floating interest rate swaps) are determined by adding the replacement
cost (mark-to-market value, if positive) to the potential future credit
exposure, determined by multiplying the notional principal amount by
the following credit conversion factors as appropriate.
[[Page 48006]]
Conversion Factor Matrix
[In Percent]
----------------------------------------------------------------------------------------------------------------
Remaining maturity Interest rate Exchange rate Commodity
----------------------------------------------------------------------------------------------------------------
1 year or less.................................................. 0.0 1.0 10.0
Over 1 to 5 years............................................... 0.5 5.0 12.0
Over 5 years.................................................... 1.5 7.5 15.0
----------------------------------------------------------------------------------------------------------------
(2) For any derivative contract that does not fall within one of
the categories in the above table, the potential future credit exposure
is be calculated using the commodity conversion factors. The net
current exposure for multiple derivative contracts with a single
counterparty and subject to a qualifying bilateral netting contract is
the net sum of all positive and negative mark-to-market values for each
derivative contract. The positive sum of the net current exposure is
added to the adjusted potential future credit exposure for the same
multiple contracts with a single counterparty. The adjusted potential
future credit exposure is computed as Anet = (0.4 x
Agross) + 0.6 (NGR x Agross) where:
(i) Anet is the adjusted potential future credit
exposure;
(ii) Agross is the sum of potential future credit
exposures determined by multiplying the notional principal amount by
the appropriate credit conversion factor; and
(iii) NGR is the ratio of the net current credit exposure divided
by the gross current credit exposure determined as the sum of only the
positive mark-to-markets for each derivative contract with the single
counterparty.
(3) Credit equivalents of single-currency floating/floating
interest rate swaps are determined by their replacement cost (mark-to-
market).
Subpart K--Surplus and Collateral Requirements
10. Amend Sec. 615.5301 by revising paragraphs (b)(3), (i)(2), and
(i)(8) to read as follows:
Sec. 615.5301 Definitions.
(b) * * *
(3) The deductions that must be made by an institution in the
computation of its permanent capital pursuant to Sec. 615.5207(e),
(f), (h), and (j) shall also be made in the computation of its core
surplus. Deductions required by Sec. 615.5207(a) shall also be made to
the extent that they do not duplicate deductions calculated pursuant to
this section and required by Sec. 615.5330(b)(2).
* * * * *
(i) * * *
(2) Allocated equities, including allocated surplus and stock, that
are not subject to a plan or practice of revolvement or retirement of 5
years or less and are eligible to be included in permanent capital
pursuant to Sec. 615.5201; and
* * * * *
(8) Any deductions made by an institution in the computation of its
permanent capital pursuant to Sec. 615.5207 shall also be made in the
computation of its total surplus.
* * * * *
Sec. 615.5330 [Amended]
11. Amend Sec. 615.5330 by removing the reference ``Sec.
615.5210(f)'' and adding in its place ``Sec. 615.5210'' in paragraphs
(a)(2) and (b)(3).
PART 620--DISCLOSURE TO SHAREHOLDERS
12. The authority citation for part 620 continues to read as
follows:
Authority: Secs. 5.17, 5.19, 8.11 of the Farm Credit Act (12
U.S.C. 2252, 2254, 2279aa-11); secs. 424 of Pub. L. 100-233, 101
Stat. 1568, 1656.
Subpart A--General
Sec. 620.1 [Amended]
13. Amend Sec. 620.1(j) by removing the reference ``Sec.
615.5201(l)'' and adding in its place ``Sec. 615.5201.''
Dated: July 30, 2004.
Jeanette C. Brinkley,
Secretary, Farm Credit Administration Board.
[FR Doc. 04-17570 Filed 8-5-04; 8:45 am]
BILLING CODE 6705-01-P