[Federal Register Volume 60, Number 110 (Thursday, June 8, 1995)]
[Proposed Rules]
[Pages 30201-30208]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-13913]
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Proposed Rules
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.
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Federal Register / Vol. 60, No. 110 / Thursday, June 8, 1995 /
Proposed Rules
[[Page 30201]]
DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
Office of Federal Housing Enterprise Oversight
12 CFR Part 1750
RIN 2550-AA03
Minimum Capital
AGENCY: Office of Federal Housing Enterprise Oversight, HUD.
ACTION: Proposed rule.
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SUMMARY: The Office of Federal Housing Enterprise Oversight (OFHEO)
proposes to issue a regulation for determining the minimum capital
requirement for the Federal National Mortgage Association and the
Federal Home Loan Mortgage Corporation (collectively, the Enterprises).
The proposed regulation defines the necessary terms and sets forth the
methodology for computing the minimum capital level. The proposed
regulation also establishes procedures for the filing of quarterly
minimum capital reports by each Enterprise. In addition, the proposed
regulation establishes procedures under which OFHEO will determine the
capital classification of each Enterprise on a quarterly basis.
DATES: Written comments on the proposed regulation must be received by
August 7, 1995.
ADDRESSES: All comments concerning the proposed regulation should be
addressed to Anne E. Dewey, General Counsel, Office of Federal Housing
Enterprise Oversight, 1700 G Street NW., 4th Floor, Washington, D.C.
20552. Copies of all communications received will be available for
examination by interested parties at the Office of Federal Housing
Enterprise Oversight.
FOR FURTHER INFORMATION CONTACT: Gary L. Norton, Deputy General Counsel
(202/414-3800); or Michael P. Scott, Assistant Director, Office of
Research, Analysis and Capital Standards (202/414-3800), 1700 G Street
NW., 4th Floor, Washington, D.C. 20552.
SUPPLEMENTARY INFORMATION:
I. Background
Title XIII of the Housing and Community Development Act of 1992,
Pub. L. No. 102-550, known as the Federal Housing Enterprises Financial
Safety and Soundness Act of 1992, 12 U.S.C. 4501 et seq. (Act),
established the Office of Federal Housing Enterprise Oversight (OFHEO).
OFHEO is an independent office within the Department of Housing and
Urban Development with responsibility for ensuring that the Federal
National Mortgage Association (Fannie Mae) and the Federal Home Loan
Mortgage Corporation (Freddie Mac) (collectively, the Enterprises) are
adequately capitalized and operating in a safe and sound manner.
Included among the express statutory authorities of the Director of
OFHEO is the authority to issue regulations establishing the capital
level requirements.1
\1\ Act, section 1313(b)(1) (12 U.S.C. 4513(b)(1)).
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On February 8, 1995, OFHEO published an Advance Notice of Proposed
Rulemaking 2 as the first step toward developing the risk-based
capital regulation required by section 1361 of the Act.3 The risk-
based capital requirements will be based on a stress test to be
developed by OFHEO. The stress test will determine the amount of
capital that an Enterprise must hold to absorb the projected losses
associated with credit and interest rate risks during a ten-year period
of economic stress. That amount plus an additional 30 percent to cover
management and operations risks will constitute the risk-based capital
level of the Enterprise.
\2\ 60 FR 7468, Feb. 8, 1995.
\3\ 12 U.S.C. 4611.
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Separate from the risk-based capital requirements, section 1362 of
the Act prescribes the minimum capital requirement for the
Enterprises.4 Unlike the risk-based capital requirements, which
are based on the stress test, the minimum capital level is computed
largely on the basis of statutorily established ratios that are applied
to certain defined on- and off-balance sheet items of the Enterprises.
\4\ 12 U.S.C. 4612.
An Enterprise's capital serves as a cushion to absorb financial
losses, thereby reducing the risk of failure. As specified by the Act,
the minimum capital level of an Enterprise represents an essential
amount of capital needed as protection against the broad categories of
risk in its businesses. The minimum capital level is not designed to
address the risks of specific exposures within these categories. In
addition, none of the capital levels specified in the Act represents
the amount needed by an Enterprise to operate safely and soundly under
all circumstances.
Section 1364 of the Act 5 requires the Director of OFHEO to
determine the capital classification of each Enterprise not less than
quarterly. The proposed minimum capital regulation provides procedures
for each Enterprise to file a minimum capital level report each quarter
and at other times, as required by the Director. In addition, it
implements the provisions of section 1368 of the Act,6 which
require OFHEO to provide each Enterprise with notice and an opportunity
to comment on its capital classification.
\5\ 12 U.S.C. 4614.
\6\ 12 U.S.C. 4618.
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II. Interim Procedures
As discussed below, the Act specifies the minimum capital ratios
applicable to on-balance sheet assets and to certain off-balance sheet
obligations, e.g., mortgage-backed securities (MBS), but requires
adjustment of the minimum capital ratio applicable to other off-balance
sheet obligations. Following the appointment of the Director of OFHEO,
OFHEO implemented the statutory minimum capital and capital
classification provisions by establishing, through administrative
action, interim procedures for computing the minimum capital level.
These interim procedures will continue to be used until the effective
date of the final minimum capital regulation.
On-Balance Sheet Assets
The interim procedures apply the minimum capital ratio applicable
to on-balance sheet assets as specified in section 1362(a)(1) of the
Act.7 That section establishes a minimum capital ratio of 2.50
percent of the aggregate on-balance sheet assets of the Enterprises
determined in accordance with generally accepted accounting principles
(GAAP).
\7\ 12 U.S.C. 4612(a)(1). [[Page 30202]]
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Mortgage-Backed Securities 8
\8\ Mortgage-backed securities are defined in the proposed
regulation as securities, investments, or substantially equivalent
instruments that represent an interest in a pool of loans secured by
mortgages or deeds of trust where the principal or interest payments
to the investor in the security or substantially equivalent
instrument are guaranteed or effectively guaranteed by an
Enterprise.
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For MBS, the interim procedures apply the minimum capital ratio
specified in section 1362(a)(2) of the Act.9 That section
establishes a minimum capital ratio of 0.45 percent of the unpaid
principal balance of outstanding MBS and substantially equivalent off-
balance sheet instruments 10 that the Enterprises issue or
guarantee. It only applies to MBS and substantially equivalent
instruments that are not included among the on-balance sheet items of
the Enterprises.
\9\ 12 U.S.C. 4612(a)(2).
\10\ An off-balance sheet obligation is defined in the proposed
regulation to mean a binding agreement, contract, or similar
arrangement that requires or may require future payment(s) in money
or kind by another party to an Enterprise or that effectively
guarantees all or part of such payment(s) to third parties, where
such agreement or contract is a source of credit risk for an
Enterprise not included on its balance sheet.
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Other Off-Balance Sheet Obligations
Section 1362(a)(3) of the Act 11 requires OFHEO to adjust the
minimum capital ratios for off-balance sheet obligations other than
MBS. That adjustment must reflect the differences between the credit
risk of such obligations and the credit risk of MBS. That section
further provides that commitments in excess of 50 percent of the
average dollar amount of the commitments outstanding each quarter over
the preceding four quarters are to be excluded from minimum capital
level computations. The following discussion describes the interim
procedures for determining minimum capital requirements for off-balance
sheet obligations other than MBS.
\11\ 12 U.S.C. 4612(a)(3).
Commitments \12\
\12\ A commitment is defined in the proposed regulation to mean
any contractual, legally binding arrangement that obligates an
Enterprise to purchase mortgages for portfolio or securitization.
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OFHEO determined that there is no significant difference between
the credit risk of commitments and the credit risk of MBS. Therefore,
the interim procedures set a minimum capital ratio for commitments of
0.45 percent, which is applied to 50 percent of the average of the
dollar amounts of commitments outstanding on the date for which the
minimum capital level is being computed and the dates of the three
preceding quarter-ends.
Multifamily Credit Enhancements
Multifamily credit enhancements (MFCEs) are guarantees by an
Enterprise of payments on multifamily mortgage revenue bonds issued by
state and local housing finance agencies. The guarantees permit state
and local agencies to obtain a lower cost of funds. The bonds are
collateralized by multifamily mortgages to which the Enterprise has
recourse in the event of a default. OFHEO concluded that the risk of
MFCEs is most analogous to the risk of multifamily MBS. Therefore, the
interim procedures apply the minimum capital ratio for MBS (0.45
percent) to the outstanding principal amount of bonds with MFCEs.
Sold Portfolio Remittances Pending
Sold portfolio remittances pending are funds held in custodial
accounts awaiting collection by one of the Enterprises for disbursement
to the holders of MBS. The obligations associated with these funds
arise from the MBS accounting cycle in the accounting system of one of
the Enterprises. Once payments of mortgage principal are received by a
seller-servicer and placed in custodial accounts, the Enterprise
reduces the reported amount of the MBS, or sold portfolio. The
Enterprise eventually passes the mortgage principal payments to MBS
investors.
OFHEO concluded that the sold portfolio remittances pending are
essentially part of MBS. Sold portfolio remittances pending are
reflected separately only as a result of the accounting treatment used
by one Enterprise. Therefore, the interim procedures apply the same
minimum capital ratio for MBS (0.45 percent) to the dollar amount of
sold portfolio remittances pending.
Interest Rate and Foreign Exchange Rate Contracts
The Enterprises use interest rate contracts \13\ to obtain more
desirable financing terms and hedge interest rate risk exposure. Fannie
Mae uses foreign exchange rate contracts \14\ to fix the United States
dollar costs of debt issued in foreign currencies. The credit risk
associated with interest rate and foreign exchange rate contracts is
the risk of loss that may result when a counterparty defaults.
\13\ Interest rate contracts include single currency interest
rate swaps, basis swaps, forward rate agreements, interest rate
options purchased (including caps, collars, and floors), and other
instruments that give rise to similar credit risks (including when-
issued securities and forward deposits accepted).
\14\ Foreign exchange rate contracts include cross-currency
interest rate swaps, forward foreign exchange contracts, currency
options purchased, and other instruments that give rise to similar
credit risks.
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Because the credit risk of interest rate and foreign exchange rate
contracts is not fundamentally different than the risk of those
contracts to banks and bank holding companies, the interim procedures
apply substantially the same requirements as the risk-based
requirements that are applicable to banks and bank holding companies.
Those bank-related requirements are contained in guidelines that have
been adopted by the Board of Governors of the Federal Reserve System at
12 C.F.R. Part 208, Appendix A, for state member banks, and at 12
C.F.R. Part 225, Appendix A, for bank holding companies; by the
Comptroller of the Currency at 12 C.F.R. Part 3, Appendix A, for
national banks; and by the Federal Deposit Insurance Corporation at 12
C.F.R. Part 325, Appendix A, for federally insured state nonmember
banks (hereinafter referred to as the Guidelines).\15\
\15\ The Guidelines are based upon a framework developed jointly
by supervisory authorities from the countries that are represented
on the Basle Committee on Banking Regulations and Supervisory
Practices.
The Guidelines convert off-balance sheet items into balance sheet
equivalents by determining a credit equivalent amount (CEA) for each
item. Risk-weights are applied to the CEA based on the type of
counterparty and on the extent to which qualifying collateral has been
posted.
The CEA for interest rate and foreign exchange rate contracts is an
estimate of the overall credit exposure associated with such contracts.
Under the Guidelines, the CEA is the sum of two components: (1) the
current exposure and (2) the potential future exposure. The current
exposure (often referred to as ``replacement cost'') of a contract is
equal to the contract's market value or zero, if its market value is
negative. The potential future exposure of an interest rate or foreign
exchange rate contract (often referred to as the ``add-on'') is
calculated for each contract, regardless of its current market
value.\16\ Potential future exposure is calculated by multiplying the
notional amount of the contract by a credit conversion factor, which is
determined by the remaining maturity and by the type of the contract
(0.0 percent for interest rate contracts expiring in less than one year
and 0.5 percent for those expiring in more than [[Page 30203]] one
year; 1.0 percent for foreign exchange contracts expiring in less than
one year and 5.0 percent for those expiring in more than a year).
\16\ Because the floating rates associated with basis swaps are
highly correlated, potential future exposure is not material; the
credit exposure for these contracts is evaluated solely on the basis
of the mark-to-market values.
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Once the CEA of an interest rate or foreign exchange rate contract
has been determined, the amount of the contract is assigned a risk-
weight (20 or 50 percent) appropriate to the counterparty or, if
relevant, the nature of any collateral or guarantees. Total risk-
weighted assets are then multiplied by 8.0 percent \17\ to determine
the amounts included in the Enterprise's minimum capital level.
\17\ Eight percent represents the required ratio of total
capital to risk-weighted assets contained in the Guidelines.
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The interim procedures allow the Enterprises to recognize the risk-
reducing benefits of qualifying bilateral netting contracts as outlined
in the Federal Reserve Board's final rule amending the risk-based
capital guidelines (59 FR 62987, Dec. 7, 1994). Thus, the Enterprises
may net positive and negative mark-to-market values of interest rate
and foreign exchange rate contracts in the determination of the current
exposure portion of the CEA.
The interim procedures supplement the Guidelines in the area of
foreign exchange rate contracts. Fannie Mae includes items associated
with foreign exchange rate contracts on its balance sheet. With respect
to such contracts, OFHEO determines the amount that would be required
under the Guidelines and compares it to the amount that would result
from applying the 2.50 percent ratio for on-balance sheet assets
contained in the Act, and applies the higher amount.
III. Basis for the Proposed Minimum Capital Regulation 18
\18\ In the course of developing this proposed regulation, OFHEO
solicited and received comments and recommendations from the
Enterprises regarding alternative approaches. One Enterprise
asserted that a low minimum capital ratio for interest rate and
foreign exchange rate contracts is justified because these contracts
are not used for speculative purposes; credit losses on these
contracts have not been experienced; the contracts are mostly
executed under master netting agreements with counterparties that
are investment-grade; and, depending on counterparty credit quality,
require the posting of collateral or other credit enhancements. The
Enterprise suggested that OFHEO continue to apply the Guidelines to
calculate the CEA to measure the credit exposure of interest rate
and foreign exchange rate contracts, but that OFHEO apply a fixed
ratio of 0.45 percent to the CEA, rather than apply the 8.00 percent
ratio and various risk-weights, as required by the Guidelines. The
Enterprise suggested the elimination of risk-weights because it
believes they do not measure credit quality. The Enterprise
suggested that the enforcement of strict credit and performance
standards for its counterparties, coupled with aggressive collateral
requirements for credit exposure, eliminates the need for credit
differentiation among counterparties and the corresponding risk-
weights. The Enterprise also recommended that OFHEO's regulations
reflect, without amendment, the proposed and final changes to the
Guidelines related to the calculation of current and potential
future exposure. These changes would incorporate the impact of
bilateral netting in the calculation of credit exposure, extend the
capital treatment under the Guidelines to activities other than
interest rate and currency contracts, and add higher credit
conversion factors for longer-term contracts.
The other Enterprise supported the application of the Guidelines
to calculate the CEA and recommended that OFHEO apply, as a starting
point, a capital ratio of 0.45 percent to that amount. It made
further recommendations that would collectively have the effect of
lowering the capital requirements, namely, that OFHEO consider: (1)
easing the requirements under which bilateral netting contracts
become ``qualifying,'' enabling an institution to ``net'' and thus
reduce its current and potential future exposure; (2) increasing the
benefit of netting over what proposed amendments to the Guidelines
provide by applying the ``net-to-gross ratio'' (the current net
positive market value of swaps divided by their current gross
positive market value) on a portfolio-wide basis rather than
counterparty-by-counterparty, and applying it to 100 percent of the
notional amount rather than 50 percent; and (3) adjusting the 0.45
percent capital ratio applied to the CEA of interest rate and
foreign exchange rate contracts downward based on the credit ratings
of the counterparties, collateral arrangements, and other credit
enhancements.
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The proposed regulation continues the interim approach with respect
to on-balance sheet items, MBS, commitments, multifamily credit
enhancements, and sold portfolio remittances pending. However, the
proposed regulation modifies the interim approach with respect to
interest rate and foreign exchange rate contracts. A discussion of how
OFHEO arrived at the approach adopted by the proposed regulation
follows.
The Act requires OFHEO to adjust the statutory minimum capital
ratio applicable to any class of off-balance sheet obligations if the
credit risk of that class of obligations differs from the credit risk
of MBS. OFHEO believes that the credit risk of interest rate and
foreign exchange rate contracts, as measured by their CEAs, is
significantly greater than that of MBS. Accordingly, the proposed
regulation contains a minimum capital ratio for interest rate and
foreign exchange rate contracts that is higher than the ratio
applicable to MBS. Under the proposed regulation, this ratio will be
applied to the CEAs of these contracts. The proposed regulation
provides a relatively lower ratio for exposures that are collateralized
than for those that are not collateralized. However, the proposed
regulation does not distinguish between different types of
counterparties. The minimum capital amount associated with interest
rate and foreign exchange rate contracts under the proposed regulation
is not expected to be substantially different than it is under the
interim procedures.
Risk of MBS
In developing the proposed regulation, OFHEO analyzed the relative
risk of interest rate and foreign exchange rate contracts as compared
with MBS. The source of credit risk of MBS to the Enterprises is the
risk of defaults and losses on the underlying mortgages. Guarantee fees
provide a continuing source of income to offset these losses.
The aggregate risk associated with the Enterprises' underlying
mortgages is low because the Enterprises have--
Very broad geographic diversification;
Strict and consistent mortgage underwriting standards; and
Requirements for minimum initial collateralization of 125
percent (i.e., maximum 80 percent loan-to-value ratio) or supplemental
mortgage insurance, as well as increasing levels of collateralization
as loans amortize and property values increase.
Neither Enterprise has experienced a net credit loss on its MBS.
Annual losses to date have ranged from two basis points to ten basis
points (expressed as a percentage of the outstanding portfolio) and
have been easily covered by guarantee fee income, which has ranged from
20 to 25 basis points.
Risks of Interest Rate and Foreign Exchange Rate Contracts
The Enterprises limit the credit risk of interest rate and foreign
exchange rate contracts by restricting their business to high quality
counterparties and adjusting collateral requirements on the basis of
the current replacement cost and counterparty credit quality of
interest rate and foreign exchange rate contracts. Notwithstanding
these limitations of risk, interest rate and foreign exchange rate
contracts entail the following risks beyond those of MBS:
Large swings in market rates, on which interest rate and
foreign exchange rate contracts are based, may simultaneously increase
exposure to, and risk of default by, one or more counterparties, which
are typically financial firms.
While losses may be infrequent, systemic problems could
cause disproportionately high losses when they do occur.
Counterparty risk is concentrated. The loss resulting from
the default of a single counterparty could be many times larger than
the amount of capital that would be associated with the application of
a 0.45 percent capital ratio.
The interest rate and foreign exchange rate contracts
market is [[Page 30204]] comparatively new; therefore, the functioning
of this market is less predictable in terms of operational and legal
risk.
Interest rate and foreign exchange rate contract exposures
are not as fully-collateralized as are the mortgages underlying the
Enterprises' MBS.
There is no current stream of fee income to offset losses
on interest rate and foreign exchange rate contracts associated with
counterparty failures.
The effect of these differences is difficult to quantify.
Derivative markets are relatively new. While the Enterprises have not
experienced any losses on interest rate or foreign exchange rate
contracts, recent losses by major participants make clear that the
unexpected, sudden failure of a financial firm that is a counterparty
is a risk that must be seriously considered.
Based on a weighing of these factors, the proposed regulation
applies a higher ratio to the CEAs of interest rate and foreign
exchange rate contracts than to MBS. The proposed regulation applies a
ratio of 3.00 percent to uncollateralized exposure and a ratio of 1.50
percent to collateralized exposure. OFHEO believes that the proposed
regulation will encourage prudent management of counterparty risk by
reducing the capital requirement by half to the extent a counterparty
posts collateral that qualifies under the Guidelines. This approach is
consistent with a minimum capital level that focuses on the general
risk characteristics of instruments rather than the credit quality of
third parties.
The proposed regulation continues to allow the Enterprises to
recognize the risk-reducing benefits of qualifying bilateral netting
contracts. As under the interim procedures, the Enterprises are allowed
to net positive and negative mark-to-market values of interest rate and
foreign exchange rate contracts in the determination of the current
exposure portion of the CEA.\19\
\19\ Proposals by the Comptroller of the Currency (59 FR 45243,
Sept. 1, 1994) and the Board of Governors of the Federal Reserve
System (59 FR 43508, Aug. 24, 1994) would make other changes to the
Guidelines. First, they would increase the number of credit
conversion factors that are used to measure the potential future
exposure, subjecting contracts with longer maturities to higher
factors. Second, they would set new credit conversion factors for
contracts related to equities, precious metals, and other
commodities. (These are not currently relevant to the Enterprises.)
Finally, they would change the way that potential future exposure is
calculated when the contracts are subject to a qualifying bilateral
netting agreement, resulting in a reduction in the amount of capital
required for the netted interest rate and foreign exchange rate
contracts.
OFHEO will continue to review the progress of the banking agency
proposals which permit similar risk-reducing benefits of netting in
the calculation of potential future exposure and which address other
issues identified in this proposal. OFHEO will make a determination
of the appropriateness of the inclusion of these changes in the
minimum capital regulation if and when these banking agency
proposals become effective.
In developing this proposal, OFHEO compared the results of the
application of the interim procedures and the proposed regulation with
respect to interest rate and foreign exchange rate contracts. For each
of the past five quarters, OFHEO determined the weighted average
capital ratio that resulted from the application of the interim
procedures for all interest rate and foreign exchange rate contracts.
The weighted average capital ratio for each Enterprise over this period
ranged between 2.24 percent and 3.41 percent. Had the ratios in the
proposed regulation been used, the average ratio for each Enterprise
would have ranged from 2.32 percent to 3.00 percent. Thus, the
application of the ratios in the proposed regulation will result in a
minimum capital level roughly consistent with the minimum capital level
under the interim procedures.
OFHEO considered the argument that because MBS are accorded a much
lower capital ratio by the Act than MBS under the Guidelines,
consistency requires that interest rate and foreign exchange rate
contracts be accorded a similarly lower ratio. Unlike the Enterprises,
institutions subject to the Guidelines do not issue MBS that are fully
guaranteed by the institutions. The Guidelines would apply the same
capital ratio to MBS backed by the issuers' guarantees as is applied to
mortgages held in portfolio. Banks' mortgage loans held in portfolio
are considerably more risky than the mortgages underlying the
Enterprises' MBS because they are not as well-diversified, on average
have experienced higher loss rates, are not required to be as well-
collateralized, and are not protected by a stream of guarantee fee
income.
OFHEO has also considered the argument that OFHEO should establish
a low minimum capital ratio for interest rate and foreign exchange rate
contracts in recognition of the steps the Enterprises take to manage
that risk. Further, OFHEO has considered the argument that OFHEO should
apply different minimum capital ratios for interest rate and foreign
exchange rate contracts based on the specific counterparty risk of the
contract. OFHEO believes that these arguments are inconsistent with the
purpose of minimum capital requirements. The proposed minimum capital
regulation is designed to establish an essential amount of capital that
an Enterprise, with given levels of outstanding business, must hold to
address broad categories of risks. The minimum capital ratios should
reflect risk inherent in types of instruments, not the Enterprises'
current practices.
IV. Proposed Minimum Capital Regulation: Section-by-Section Summary
The proposed regulation sets forth the minimum capital requirements
that will replace the interim procedures currently in use. The proposed
minimum capital regulation also establishes procedures for the filing
of minimum capital reports by the Enterprises each quarter, or at other
times as required by the Director. The proposed minimum capital
regulation also requires OFHEO to provide each Enterprise with notice
and opportunity to comment on its capital classification. A summary of
the treatment of the on- and off-balance sheet items, the filing
procedures, and the notice of capital classification follows.
On-Balance Sheet Assets
The minimum capital ratio for on-balance sheet assets is specified
in section 1362(a)(1) of the Act.\20\ That section establishes a
minimum capital ratio equal to 2.50 percent of the aggregate on-balance
sheet assets of the Enterprises determined in accordance with GAAP. The
proposed regulation adopts that ratio.
\20\ 12 U.S.C. 4612(a)(1).
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Mortgage-Backed Securities
Section 1362(a)(2) of the Act \21\ establishes a minimum capital
ratio of 0.45 percent of the unpaid principal balance of outstanding
MBS and substantially equivalent instruments issued or guaranteed by
the Enterprises that are not included in the on-balance sheet assets of
the Enterprises. The proposed regulation adopts that ratio.
\21\ 12 U.S.C. 4612(a)(2).
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Other Off-Balance Sheet Obligations
Section 1362(a)(3) of the Act \22\ also establishes a minimum
capital ratio of 0.45 percent for all other off-balance sheet
obligations, except as adjusted by the Director to reflect the
differences in the credit risk of those off-balance sheet obligations
in relation to MBS and substantially equivalent instruments. The
proposed regulation continues the interim treatment for three of the
four major categories of off-balance sheet obligations: (1) commitments
will require capital equal to 0.45 percent of 50 percent of the average
dollar amount [[Page 30205]] of commitments outstanding each quarter
over the preceding four quarters, (2) multifamily credit enhancements
will require capital equal to 0.45 percent of the unpaid principal
balance, and (3) sold portfolio remittances pending will require
capital equal to 0.45 percent of the dollar amount.\23\ Any individual
interest rate and foreign exchange rate contract or group of contracts
subject to a recognized netting agreement will require capital equal to
3.00 percent of the CEA, except to the extent that the Enterprises hold
qualifying collateral. The portion of the CEA equal to the market value
of the collateral for that contract or group of contracts will equal
1.50 percent.
\22\ 12 U.S.C. 4612(a)(3).
\23\ Freddie Mac accounts for these funds held by seller-
servicers in custodial accounts separately from MBS until principal
payments are passed on to MBS investors. Fannie Mae includes these
custodial accounts in its MBS accounts.
Minimum Capital Report
The proposed regulation requires that each Enterprise file with the
Director of OFHEO a minimum capital report each quarter or at other
times, as required by the Director. The report will contain the
information required by OFHEO in written instructions to the
Enterprise, including, but not limited to, an estimate of the minimum
capital level and an estimate of core capital overage or shortfall
relative to the estimated minimum capital level. The proposed
regulation provides the Director flexibility to determine the specific
items to be included in the minimum capital report. The proposed
regulation also addresses the timing, certification, and amendment of
the report. The information provided by each Enterprise in the minimum
capital report will be used by OFHEO in determining the capital
classification of the Enterprise.
Notice of Capital Classification
Section 1368 of the Act 24 requires OFHEO to provide the
Enterprises with notice of, and an opportunity to comment on, the
proposed minimum capital classification. This proposed regulation
provides that before OFHEO determines the capital classification of an
Enterprise, OFHEO will provide the Enterprise with written notice of
the proposed classification and a 30-day period during which each
Enterprise may submit its views regarding the classification. The
proposed regulation provides that OFHEO may extend the period for up to
30 days and may shorten the period to less than 30 days if the Director
determines that the condition of an Enterprise so warrants. Following
the expiration of the response period, OFHEO will take into
consideration any comments received from an Enterprise prior to issuing
the final notice of capital classification.
\24\ 12 U.S.C. 4618.
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Regulatory Impact
Executive Order 12606, The Family
This proposed regulation does not have potential for significant
impact on family formulation, maintenance, and general well-being, and
thus, is not subject to review under Executive Order 12606.
Executive Order 12612, Federalism
This proposed regulation has no federalism implications that
warrant the preparation of a Federalism Assessment in accordance with
Executive Order 12612.
Executive Order 12866, Regulatory Planning and Review
This proposed regulation has been reviewed by the Office of
Management and Budget pursuant to Executive Order 12866.
Unfunded Mandates Reform Act of 1995
This proposed regulation does not include a federal mandate that
may result in the expenditure by State, local, and tribal governments,
in the aggregate, or by the private sector, of $100,000,000 or more
(adjusted annually for inflation) in any one year. As a result, this
proposed regulation does not warrant the preparation of an assessment
statement in accordance with the Unfunded Mandates Reform Act of 1995.
Regulatory Flexibility Act
This proposed regulation will not have significant economic impact
on a substantial number of small entities.
Paperwork Reduction Act
This proposed regulation contains no information collection
requirements that require the approval of the Office of Management and
Budget pursuant to the Paperwork Reduction Act of 1980, 44 U.S.C. 3501
et seq.
List of Subjects in 12 CFR Part 1750
Minimum capital, capital classifications.
Accordingly, for the reasons set forth in the preamble, OFHEO
proposes to amend Chapter XVII of Title 12 of the Code of Federal
Regulations by adding Part 1750 to read as follows:
PART 1750--CAPITAL
Subpart A--Minimum Capital
Sec.
1750.1 General.
1750.2 Definition.
1750.3 Procedure and timing.
1750.4 Minimum capital level computation.
1750.5 Notice of capital classification.
Appendix A to Subpart A of Part 1750--Minimum Capital Level
Components for Interest Rate and Foreign Exchange Rate Contracts
Subpart B--[Reserved]
Authority: 12 U.S.C. 4513, 4514, 4612, 4614, 4618.
Subpart A--Minimum Capital
Sec. 1750.1 General.
The regulation contained in this Subpart A establishes the minimum
capital requirements for each Enterprise. The board of directors of
each Enterprise is responsible for ensuring that the Enterprise
maintains capital at a level that is sufficient to ensure the continued
financial viability of the Enterprise and in excess of the minimum
capital level contained in this Subpart A.
Sec. 1750.2 Definitions.
For purposes of this Subpart A, the following definitions shall
apply.
Act means the Federal Housing Enterprises Financial Safety and
Soundness Act of 1992, found at Title XIII of the Housing and Community
Development Act of 1992, Pub. L. No. 102-550, 12 U.S.C. 4501 et seq.
Affiliate means any entity that controls, is controlled by, or is
under common control with, an Enterprise, except as otherwise provided
by the Director.
Commitment means any contractual, legally binding arrangement that
obligates an Enterprise to purchase mortgages for portfolio or
securitization.
Core Capital (1) means the sum of--
(i) the par or stated value of outstanding common stock,
(ii) the par or stated value of perpetual, noncumulative preferred
stock,
(iii) paid-in capital, and
(iv) retained earnings; and
(2) Does not include any amounts the Enterprise could be required
to pay at the option of an investor to retire capital or debt
instruments.
Director means the Director of OFHEO.
Enterprise means the Federal National Mortgage Association and any
affiliate thereof or the Federal Home Loan [[Page 30206]] Mortgage
Corporation and any affiliate thereof.
Foreign exchange rate contracts means cross-currency interest rate
swaps, forward foreign exchange contracts, currency options purchased,
and any other instruments that give rise to similar credit risks.
Interest rate contracts means single currency interest rate swaps,
basis swaps, forward rate agreements, interest rate options purchased
(including caps, collars and floors purchased), and any other
instruments that give rise to similar credit risks (including when-
issued securities and forward deposits accepted).
Mortgage-backed security means a security, investment, or
substantially equivalent instrument that represents an interest in a
pool of loans secured by mortgages or deeds of trust where the
principal or interest payments to the investor in the security or
substantially equivalent instrument are guaranteed or effectively
guaranteed by an Enterprise.
Multifamily credit enhancement means a guarantee by an Enterprise
of the payments on a multifamily mortgage revenue bond issued by a
state or local housing finance agency.
Notional amount means the face value of the underlying financial
instrument(s) on which an interest rate or foreign exchange rate
contract is based.
Off-balance sheet obligation means a binding agreement, contract,
or similar arrangement that requires or may require future payment(s)
in money or kind by another party to an Enterprise or that effectively
guarantees all or part of such payment(s) to third parties, where such
agreement or contract is a source of credit risk that is not included
on its balance sheet.
OFHEO means the Office of Federal Housing Enterprise Oversight.
Other off-balance sheet obligations means all off-balance sheet
obligations of an Enterprise that are not mortgage-backed securities or
substantially equivalent instruments.
Perpetual, noncumulative preferred stock means preferred stock that
(1) does not have a maturity date, (2) provides the issuer the ability
and the legal right to eliminate dividends and does not permit the
accruing or payment of impaired dividends, (3) cannot be redeemed at
the option of the holder, and (4) has no other provisions that will
require future redemption of the issue, in whole or in part, or that
will reset the dividend periodically based, in whole or in part, on the
Enterprise's current credit standing, such as auction rate, money
market, or remarketable preferred stock, or that may cause the dividend
to increase to a level that could create an incentive for the issuer to
redeem the instrument, such as exploding rate stock.
Qualifying collateral means cash on deposit, securities issued or
guaranteed by the central governments of the OECD-based group of
countries,1 United States Government agencies, or United States
Government-sponsored agencies, and securities issued or guaranteed by
multilateral lending institutions or regional development banks.
\1\ The OECD-based group of countries is comprised of all full
members of the Organization for Economic Cooperation and Development
(OECD), as well as countries that have concluded special lending
arrangements with the International Monetary Fund (IMF) associated
with the Fund's General Arrangements to Borrow. The OECD includes
the following countries: Australia, Austria, Belgium, Canada,
Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy,
Japan, Luxembourg, the Netherlands, New Zealand, Norway, Portugal,
Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the
United States. Saudi Arabia has concluded special lending
arrangements with the IMF associated with the IMF's General
Arrangements to Borrow.
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Sec. 1750.3 Procedures and timing.
(a) Each Enterprise shall file with the Director a minimum capital
report each quarter or at such other times as the Director requires, in
his or her sole discretion. The report shall contain the information
that responds to all of the items required by OFHEO in written
instructions to the Enterprise, including, but not limited to:
(1) estimate of the minimum capital level;
(2) estimate of core capital coverage or shortfall relative to the
estimated minimum capital level;
(3) such other information as may be required by the Director.
(b) The quarterly minimum capital report shall be submitted not
later than April 30, July 30, October 30, and January 30 of each year.
(c) Each minimum capital report shall be submitted in writing and
in such other format as may be required by the Director.
(d) In the event an Enterprise makes an adjustment to its financial
statements for a quarter or a date for which the information was
requested, which would cause an adjustment to a minimum capital report,
the Enterprise shall file with the Director an amended minimum capital
report not later than 3 business days after the date of such
adjustment.
(e) Each minimum capital report or any amended minimum capital
report shall contain a declaration by an officer authorized by the
board of directors of the Enterprise to make such a declaration,
including, but not limited to a president, vice president, or
treasurer, that the report is true and correct to the best of such
officer's knowledge and belief.
Sec. 1750.4 Minimum capital level computation.
(a) The minimum capital level for each Enterprise shall be computed
by adding the following amounts:
(1) 2.50 percent times the aggregate on-balance sheet assets of the
Enterprise;
(2) 0.45 percent times the unpaid principal balance of mortgage-
backed securities and substantially equivalent instruments that were
issued or guaranteed by the Enterprise;
(3) 0.45 percent of 50 percent of the average dollar amount of
commitments outstanding each quarter over the preceding four quarters;
(4) 0.45 percent of the outstanding principal amount of bonds with
multifamily credit enhancements;
(5) 0.45 percent of the dollar amount of sold portfolio remittances
pending;
(6) (i) 3.00 percent of the credit equivalent amount of interest
rate and foreign exchange rate contracts except to the extent of the
current market value of posted qualifying collateral, computed in
accordance with Appendix A to this subpart;
(ii) 1.50 percent of the credit equivalent amount of interest rate
and foreign exchange rate contracts equal to the market value of posted
qualifying collateral, computed in accordance with Appendix A to this
subpart; and
(7) 0.45 percent of the outstanding amount of other off-balance
sheet obligations, excluding commitments, multifamily credit
enhancements, sold portfolio remittances pending, and interest rate
contracts and foreign exchange rate contracts, except as adjusted by
the Director to reflect differences in the credit risk of such
obligations in relation to mortgage-backed securities.
(b) Any asset or financial obligation that can be properly
classified in more than one of the categories enumerated in paragraphs
(a)(1) through (7) of this section shall be classified in the category
that yields the highest minimum capital level.
(c) As used in this section, the term ``preceding four quarters''
means the last day of the quarter just ended (or the date for which the
minimum capital report is filed, if different), and the three preceding
quarter-ends.
Sec. 1750.5 Notice of capital classification.
(a) Pursuant to section 1364 of the Act (12 U.S.C. 4614), OFHEO is
required to determine the capital classification of [[Page 30207]] each
Enterprise on a not less than quarterly basis.
(b) The determination of the capital classification shall be made
following a notice to, and opportunity to respond by, the Enterprise.
(1) Not later than 60 calendar days after the date for which the
minimum capital report is filed, OFHEO will provide each Enterprise
with a proposed notice of classification in accordance with section
1368 of the Act (12 U.S.C. 4618). The proposed notice shall contain the
following information:
(i) the proposed classification;
(ii) the proposed minimum capital level; and
(iii) the summary computation of the proposed minimum capital
level.
(2) Each Enterprise shall have a period of 30 calendar days
following receipt of a proposed notice of classification to submit a
response regarding the proposed classification. The response period may
be extended for up to 30 additional calendar days at the sole
discretion of the Director. The Director may shorten the response
period with the consent of the Enterprise or without such consent if
the Director determines that the condition of the Enterprise requires a
shorter period.
(3) The Director shall take into consideration any response to the
proposed notice received from the Enterprise and shall issue a final
notice of capital classification for each Enterprise not later than 30
calendar days following the end of the response period in accordance
with section 1368 of the Act (12 U.S.C. 4618).
Appendix A to Subpart A of Part 1750--Minimum Capital Level Components
for Interest Rate and Foreign Exchange Rate Contracts
The minimum capital level components for interest rate and
foreign exchange rate contracts are computed on the basis of the
credit equivalent amounts of such contracts. Credit equivalent
amounts are computed for each of the following off-balance sheet
interest rate and foreign exchange rate instruments:
1. Interest Rate Contracts
a. Single currency interest rate swaps.
b. Basis swaps.
c. Forward rate agreements.
d. Interest rate options purchased (including caps, collars, and
floors).
e. Any other instrument that gives rise to similar credit risks
(including when-issued securities and forward deposits accepted).
2. Foreign Exchange Rate Contracts
a. Cross-currency interest rate swaps.
b. Forward foreign exchange rate contracts.
c. Currency options purchased.
d. Any other instrument that gives rise to similar credit risks.
Foreign exchange rate contracts with an original maturity of 14
calendar days or less and instruments traded on exchanges that
require daily payment of variation margins are excluded from the
minimum capital level computation. Over-the-counter options
purchased, however, are included and treated in the same way as the
other interest rate and foreign exchange rate contracts.
3. Calculation of Credit Equivalent Amounts
a. The credit equivalent amount of an off-balance sheet rate
contract that is not subject to a qualifying bilateral netting
contract in accordance with this Appendix A is equal to the sum of
the current exposure (sometimes referred to as the replacement cost)
of the contract and an estimate of the potential future credit
exposure over the remaining life of the contract.
b. The current exposure is determined by the mark-to-market
value of the contract. If the mark-to-market value is positive, then
the current exposure is the mark-to-market value. If the mark-to-
market value is zero or negative, then the current exposure is zero.
Mark-to-market values are measured in United States dollars,
regardless of the currency or currencies specified in the contract,
and should reflect changes in the relevant rates, as well as
counterparty credit quality.
c. The potential future credit exposure of a contract, including
a contract with a negative mark-to-market value, is estimated by
multiplying the notional principal amount of the contract by a
credit conversion factor. The Enterprises shall use the effective
rather than the apparent or stated notional amount in this
calculation. The credit conversion factors are:
------------------------------------------------------------------------
Foreign
Interest exchange
Remaining maturity rate rate
contracts contracts
(percent) (percent)
------------------------------------------------------------------------
One year or less.................................. 0.0 1.0
Over one year..................................... 0.5 5.0
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d. Because foreign exchange rate contracts involve an exchange
of principal upon maturity, and foreign exchange rates are generally
more volatile than interest rates, higher conversion factors have
been established for foreign exchange rate contracts than for
interest rate contracts.
e. No potential future credit exposure is calculated for single
currency interest rate swaps in which payments are made based upon
two floating rate indexes, so-called floating/floating or basis
swaps. The credit exposure on these contracts is evaluated solely on
the basis of their mark-to-market values.
4. Avoidance of Double Counting
In certain cases, credit exposures arising from the interest
rate and foreign exchange instruments covered by this Appendix A may
already be reflected, in part, on the balance sheet. To avoid double
counting such exposures in the assessment of capital adequacy,
counterparty credit exposures arising from the types of instruments
covered by this Appendix A may need to be excluded from balance
sheet assets in calculating the minimum capital level.
5. Collateral
The sufficiency of collateral and guarantees for off-balance
sheet items is determined by the market value of the collateral in
relation to the credit equivalent amount. Collateral held against a
netting contract is not recognized for minimum capital level
purposes unless it is legally available to support the single legal
obligation credit by the netting contract. The only forms of
collateral that are formally recognized by the minimum capital level
framework are cash on deposit in the bank; securities issued or
guaranteed by the central governments of the OECD-based group of
countries,1 United States Government agencies, or United States
Government-sponsored agencies; and securities issued by multilateral
lending institutions or regional development banks. Excess
collateral held against one contract or a group of contracts for
which a recognized netting agreement exists may not be considered.
\1\ The OECD-based group of countries is comprised of all full
members of the Organization for Economic Cooperation and Development
(OECD), as well as countries that have concluded special lending
arrangements with the International Monetary Fund (IMF) associated
with the Fund's General Arrangements to Borrow. The OECD includes
the following countries: Australia, Austria, Belgium, Canada,
Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy,
Japan, Luxembourg, the Netherlands, New Zealand, Norway, Portugal,
Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the
United States. Saudi Arabia has concluded special lending
arrangements with the IMF associated with the IMF's General
Arrangements to Borrow.
6. Netting
a. For purposes of this Appendix A, netting refers to the
offsetting of positive and negative mark-to-market values in the
determination of a current exposure to be used in the calculation of
a credit equivalent amount. Any legally enforceable form of
bilateral netting (that is, netting with a single counterparty) of
interest rate contracts and foreign exchange rate contracts is
recognized for purposes of calculating the credit equivalent amount
provided that:
i. The netting is accomplished under a written netting contract
that creates a single legal obligation, covering all included
individual contracts, with the effect that the Enterprise would have
a claim to receive, or obligation to pay, only the net amount of the
sum of the positive and negative mark-to-market values on included
individual contracts in the event that a counterparty, or a
counterparty to whom the contract has been validly assigned, fails
to perform due to default, insolvency, liquidation, or similar
circumstances.
ii. The Enterprise obtains a written and reasoned legal
opinion(s) representing that in the event of a legal challenge--
including one resulting from default, insolvency, liquidation, or
similar circumstances--the relevant court and administrative
authorities would find the Enterprise's exposure to be such a net
amount under:
[[Page 30208]] --The law of the jurisdiction in which the
counterparty is chartered or the equivalent location in the case of
noncorporate entities, and if a branch of the counterparty is
involved, then also under the law of the jurisdiction in which the
branch is located;
--The law that governs the individual contracts covered by the
netting contract; and
--The law that governs the netting contract.
iii. The Enterprise establishes and maintains procedures to
ensure that the legal characteristics of netting contracts are kept
under review in the event of possible changes in relevant law.
iv. The Enterprise maintains in its files documentation adequate
to support the netting of rate contracts, including a copy of the
bilateral netting contract and necessary legal opinions.
b. A contract containing a walkaway clause is not eligible for
netting for purposes of calculating the credit equivalent
amount.2
\2\ A walkaway clause is a provision in a netting contract 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.
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c. By netting individual contracts for the purpose of
calculating its credit equivalent amount, the Enterprise represents
that it has met the requirements of this Appendix A and all the
appropriate documents are in the Enterprise's files and available
for inspection by OFHEO. OFHEO may determine that an Enterprise's
files are inadequate or that a netting contract, or any of its
underlying individual contracts, may not be legally enforceable
under any one of the bodies of law described in this Appendix A. If
such a determination is made, the netting contract may be
disqualified from recognition for minimum capital level purposes or
underlying individual contracts may be treated as though they are
not subject to the netting contract.
d. The credit equivalent amount of rate contracts that are
subject to a qualifying bilateral netting contract is calculated by
adding the current exposure of the netting contract and the sum of
the estimates of the potential future credit exposures on all
individual contracts subject to the netting contract, estimated in
accordance with section 3 of this Appendix A. Offsetting contracts
in the same currency maturing on the same date will have lower
potential future exposure as well as lower current exposure.
Therefore, for purposes of calculating potential future credit
exposure to a netting counterparty for foreign exchange rate
contracts and other similar contracts in which notional principal is
equivalent to cash flows, total notional principal is defined as the
net receipts falling due on each value date in each currency.
e. The current exposure of the netting contract is determined by
summing all positive and negative mark-to-market values of the
individual contracts included in the netting contract. If the net
sum of the mark-to-market values is positive, then the current
exposure of the netting contract is equal to that sum. If the net
sum of the mark-to-market values is zero or negative, then the
current exposure of the netting contract is zero. OFHEO may
determine that a netting contract qualifies for minimum capital
level netting treatment even though certain individual contracts may
not qualify. In such instances, the nonqualifying contracts should
be treated as individual contracts that are not subject to the
netting contract.
f. In the event a netting contract covers contracts that are
normally excluded from the minimum capital level computation--for
example, foreign exchange rate contracts with an original maturity
of fourteen calendar days or less, or instruments traded on
exchanges that require daily payment of variation margin--an
Enterprise may elect consistently either to include or exclude all
mark-to-market values of such contracts when determining net current
exposure.
Subpart B--[Reserved]
Dated: June 1, 1995.
Aida Alvarez,
Director, Office of Federal Housing Enterprise Oversight.
[FR Doc. 95-13913 Filed 6-7-95; 8:45 am]
BILLING CODE 4220-01-P
