[Federal Register Volume 62, Number 184 (Tuesday, September 23, 1997)]
[Proposed Rules]
[Pages 49623-49634]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-25107]
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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. 62, No. 184 / Tuesday, September 23, 1997 /
Proposed Rules
[[Page 49623]]
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FARM CREDIT ADMINISTRATION
12 CFR Parts 611, 615, 620 and 627
RIN 3052-AB58
Organization; Funding and Fiscal Affairs, Loan Policies and
Operations, and Funding Operations; Disclosure to Shareholders; Title V
Conservators and Receivers; Capital Provisions
AGENCY: Farm Credit Administration.
ACTION: Proposed rule.
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SUMMARY: The Farm Credit Administration (FCA or Agency), through the
FCA Board (Board), issues a proposed rule to amend its capital adequacy
and related regulations to address interest rate risk as it pertains to
Farm Credit System (System) institutions, the definition of insolvency
for the purpose of appointing a receiver, the establishment of capital
and bylaw requirements for System service corporations, and changes to
risk-weighting categories. In addition, the proposed regulations
address the retirement of other allocated equities included in core
surplus, deferred-tax assets, the treatment of intra-System investments
for capital computation purposes, various other computational issues,
and other technical issues. The rule is intended to add safety and
soundness requirements deferred from prior rulemakings, provide more
consistency with capital requirements of other financial regulators,
and make technical corrections.
DATES: Written comments should be received on or before November 24,
1997.
ADDRESSES: Comments may be mailed or delivered to Patricia W. DiMuzio,
Director, Regulation Development Division, Office of Policy Development
and Risk Control, Farm Credit Administration, 1501 Farm Credit Drive,
McLean, Virginia 22102-5090 or sent by facsimile transmission to (703)
734-5784. Comments may also be submitted via electronic mail to ``comm@fca.gov.'' Copies of all communications received will be available
for review by interested parties in the Office of Policy Development
and Risk Control, Farm Credit Administration.
FOR FURTHER INFORMATION CONTACT:
Dennis K. Carpenter, Senior Policy Analyst, Office of Policy
Development and Risk Control, Farm Credit Administration, McLean, VA
22102-5090, (703) 883-4498, TDD (703) 883-4444,
or
Rebecca S. Orlich, Senior Attorney, Office of General Counsel, Farm
Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TDD (703)
883-4444.
SUPPLEMENTARY INFORMATION:
I. General
Capital adequacy and customer eligibility regulations, adopted in
January and effective in March 1997, added surplus and net collateral
ratios for System institutions and established procedures for setting
individual institution capital ratios and issuing capital directives.
See 62 FR 4429, January 30, 1997. The purpose of these proposed
regulations is to build on previous regulatory efforts by addressing
discrete issues related to capital that were deferred during the FCA's
consideration of its newly effective capital adequacy regulations. The
issues in this proposed rulemaking include: (1) Interest rate risk; (2)
the definition of insolvency for the purpose of appointing a
conservator or receiver; (3) the establishment of capital and bylaw
requirements for service corporations; and (4) various computational
issues, and other issues involving the capital regulations. The
objectives of these proposed amendments are:
1. To add provisions where the FCA believes significant capital
issues have not been previously addressed in the regulations. Expressly
addressing such issues in the regulations accords more certainty to
both the Agency and System institutions regarding supervisory
expectations and standards for enforcement.
2. To achieve consistency with the capital requirements of other
Federal banking regulatory agencies (the Office of the Comptroller of
the Currency, the Federal Deposit Insurance Corporation, the Federal
Reserve Board, and the Office of Thrift Supervision) in areas of
similar risk, such as risk-weighting of assets. In proposing changes,
the FCA is cognizant that circumstances unique or special to System
institutions may appropriately be addressed in a manner that differs
from the treatment of commercial banks and thrifts by the other Federal
banking regulators.
3. To make revisions and clarifications in the regulations that
address concerns raised by FCA examiners and System institutions.
4. To make technical corrections including removing some
inconsistencies in the computations of the core surplus and total
surplus ratios.
II. Interest Rate Risk
For the past several years, the FCA has studied the feasibility of
modifying the capital adequacy regulations to include a specific
interest rate risk exposure component. The current regulations take a
risk-based approach that addresses credit risk exposures but does not
specifically address other potential exposures. Of particular concern
to the FCA is the potentially adverse effect interest rate risk may
have on net interest income and the market value of an institution's
equity. Specifically, it is the risk of loss of net interest income or
the market value of on- and off-balance sheet positions caused by a
change in market interest rates. Similar actions to address interest
rate risk have been undertaken by the other Federal banking agencies,
which were required by section 305 of the Federal Deposit Insurance
Corporation Improvement Act of 1991 (FDICIA) (Pub. L. 102-242, 105
Stat. 2236, 2354 (12 U.S.C. 1828 note)) to revise their risk-based
capital guidelines to take adequate account of interest rate risk.
The FCA suspended development of the interest rate risk component
until completion of higher priority capital adequacy regulations. The
FCA is now proposing to add new Secs. 615.5180 and 615.5181 to require
banks to establish an interest rate risk management program and to
provide that the banks' boards of directors and senior management are
responsible for maintaining effective oversight. In addition, proposed
Sec. 615.5182 would require any other System institution (excluding the
Federal Agricultural
[[Page 49624]]
Mortgage Corporation 1) with significant interest rate risk
to establish a risk management program.
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\1\ Regulations affecting the Federal Agricultural Mortgage
Corporation will be issued separately.
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The proposed rule reflects the FCA's belief that an institution's
board and senior management are responsible for ensuring that risks are
adequately identified, measured, monitored and controlled.
Additionally, proposed Secs. 615.5350(b)(7) and 615.5355(a)(4) provide
that the FCA may take action against an institution for failure to
maintain sufficient capital for interest rate risk exposures.
Institutions found to have high levels of exposure or weak management
practices may be directed by the FCA to take corrective action,
including raising additional capital, strengthening management
expertise, improving management information and measurement systems,
reducing levels of exposure, or a combination thereof.
The requirements of the proposed rule are similar to interest rate
risk management requirements in Sec. 615.5135 of the investment
regulations. The existing regulation provides more specific criteria
regarding the interest rate risk management process. The proposed rule
is general in nature and sets forth the FCA's expectations regarding
board and management oversight, particularly maintaining adequate
capital for interest rate risk exposures. As a result, the proposed
rule provides a flexible regulatory approach to interest rate risk that
encourages innovations in risk management practices while ensuring that
the FCA can respond to emerging risks in an increasingly complex
financial marketplace.
The FCA intends to provide additional guidance on specific criteria
and guidelines in the form of a Board Policy Statement or Bookletter in
the future. The guidelines will establish a risk assessment approach
for the evaluation of capital adequacy specifically addressing interest
rate risk, similar to the approach taken by the other Federal banking
agencies, and would set forth the FCA's expectations for certain
aspects of the institution's ongoing internal control process. These
guidelines will address fundamental management practices for
identifying, managing, controlling, monitoring, and reporting interest
rate risk exposures. The guidelines will reflect the FCA's belief that
all institutions should establish a risk management program appropriate
for the level of an institution's overall interest rate risk exposure
and complexity of its holdings and activities.
III. Definition of Insolvency
The FCA proposes several changes to Sec. 627.2710, which sets forth
the grounds for appointing a conservator or receiver for a System
institution. First, the FCA proposes to amend the definition of
``insolvency'' as a ground for appointing a conservator or receiver in
paragraph (b)(1) to clarify that any stock or allocated equities held
by current or former borrowers are not ``obligations to members.'' The
FCA believes that this approach for determining insolvency is
consistent with financial statements based on generally accepted
accounting principles (GAAP) 2 and more appropriately
reflects the at-risk character of borrower stock and allocated
equities. There would be no change in the treatment of obligations to
members such as investment bonds and uninsured accounts. Second, the
FCA would revise paragraph (b)(3), which currently provides that a
conservator or receiver may be appointed if ``[t]he institution is in
an unsafe or unsound condition to transact business.'' The revision
would add that ``having insufficient capital or otherwise'' is a
circumstance that the FCA could consider to be an unsafe or unsound
condition. The proposed addition also identifies capital and collateral
benchmarks below which an institution could be considered to be
operating unsafely, as well as other conditions. The benchmarks and
conditions are:
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\2\ GAAP does not define insolvency. However, for the purposes
of this regulation, insolvency means total liabilities greater than
total assets based upon GAAP financial statements.
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1. For banks, a net collateral ratio (as defined by
Sec. 615.5301(d)) of 102 percent.
2. For associations, collateral insufficient to meet the
requirements of the association's general financing agreement with its
affiliated bank.
3. For all institutions, permanent capital (as defined in
Sec. 615.5201) of less than one-half the minimum required level for the
institution.
4. For all institutions, a relevant total surplus ratio (as defined
by Sec. 615.5301(i)) of less than 2 percent.
5. For associations, stock impairment.
The first two benchmarks address situations where an institution's
continued liquidity is in doubt. In setting the proposed net collateral
ratio benchmark at 102 percent, the FCA reviewed the requirements of
the System's Market Access Agreement (MAA), as well as the collateral
positions of the banks. The FCA also considered a 101-percent standard
because the MAA has a 101-percent eligible collateral benchmark below
which a bank's market access is restricted.3 After
deliberations, the FCA decided to propose a higher 102-percent
benchmark to allow time to appoint a conservator or receiver before a
bank is effectively unable to maintain normal funding activities. The
Agency requests comment on the appropriateness of the 102-percent
benchmark.
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\3\ The regulation's net collateral ratio is calculated net of
any association investments counted as permanent capital by
associations and determined using total liabilities, whereas
eligible collateral is determined by dividing available collateral
by obligations requiring collateralization.
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The third and fourth benchmarks identify situations where an
institution is substantially undercapitalized. The last condition
addresses a situation where an association could be exposed to
significant customer and marketing uncertainties that may have a
significant impact on financial viability or may affect other System
institutions.
These benchmarks and conditions are intended to be examples of what
the FCA would consider to be an unsafe or unsound condition to transact
business but are not exclusive. The Agency would continue to have the
discretion to deem an institution to be in an unsafe or unsound
condition to transact business based on other activities or
circumstances that are not enumerated in the regulation. The FCA notes
that, under this proposal, it also retains the discretion not to
appoint a conservator or receiver in the event that any of the
enumerated circumstances exist. The Agency would evaluate the totality
of circumstances before deciding what action, if any, to take.
In developing the proposed revision to this ground for appointing a
conservator or receiver, the FCA reviewed the prompt corrective action
benchmarks and tripwires used by the other Federal banking regulators
with respect to commercial banks and thrifts. The other agencies'
prompt corrective action regulations implement provisions of the FDICIA
requiring such agencies to take certain supervisory actions, including
the appointment of a conservator or receiver, well before insolvency is
reached, if an institution's capital declines to unacceptable levels.
Although the FCA is not subject to the FDICIA and continues to have
supervisory discretion when System institutions are in troubled
circumstances, the FCA supports the underlying philosophy of the FDICIA
to take supervisory action before an institution is insolvent. It has
been the experience of the FCA and the other Federal banking regulators
that the longer a failing institution is allowed to remain open, the
more difficult it will
[[Page 49625]]
ultimately be to resolve the affairs of the institution. Early
intervention is even more important in the Farm Credit System where
joint and several liability exists and where the financial health of
one institution can affect the public image of other System
institutions. The FCA notes that, for this reason, it is very likely
that the Agency would appoint a conservator or receiver well before
GAAP-based insolvency is reached.
IV. Service Corporations
A. Capital Requirements for Service Corporations
Section 4.25 of the Farm Credit Act of 1971, as amended (Act),
requires System institutions to submit proposals to form service
corporations to the FCA for issuance of a charter. Current regulations
require the submission of bylaws and proposed amounts and sources of
capitalization pursuant to Sec. 611.1135(b)(3)(vii), (4), and (5).
However, current regulations do not set standard capital requirements
for all service corporations. The FCA proposes to amend
Sec. 611.1135(c) to address the establishment of capital requirements
for service corporations.
Service corporations vary widely in their purpose and structure and
present different types of risks to their parent banks or associations.
The capital requirements for banks and associations would have little
relevance for most service corporations because most service
corporations have a small asset base and entirely different risks. Nor
does the FCA believe that any single minimum capital adequacy standard
is appropriate for all service corporations. The FCA instead proposes
to set minimum capital adequacy requirements in the corporate charter
approval process as a condition of approval. The FCA would monitor
compliance through the examination process.
B. Application of Bylaw Regulations to Service Corporations
The capitalization bylaw provisions in Sec. 615.5220 currently do
not apply to service corporations, including the Farm Credit Services
Leasing Corporation (FCL or Leasing Corporation). The FCA believes that
all institutions, including service corporations, should have capital
bylaws that meet the relevant requirements of that provision. The FCA,
therefore, proposes to amend Sec. 615.5220 by adding a new paragraph
(b) requiring all service corporations to have relevant capitalization
provisions in their bylaws. A conforming amendment to
Sec. 611.1135(b)(4) is also proposed.
V. Deferred-Tax Assets
A. The Proposed Rule
The FCA proposes to amend Sec. 615.5201 to add new paragraph (d) to
define deferred-tax assets that are dependent on future income or
future events. The FCA also proposes to amend Sec. 615.5210 to add a
new paragraph (e)(11) establishing a requirement to exclude certain
deferred-tax assets in capital calculations. Under the proposed rule,
deferred-tax assets that can be realized through carrybacks to taxes
paid on income earned in prior periods will not be excluded for
regulatory capital purposes. However, deferred-tax assets that can be
realized only if an institution earns sufficient taxable income in the
future or that are dependent on the occurrence of other future events
for realization will be partly excluded for regulatory capital
purposes. The proposed exclusion is the amount in excess of the amount
that the institution is expected to realize within 1 year of the most
recent calendar quarter-end date, based on the institution's financial
projections of taxable income and other events for that year, or the
amount in excess of 10 percent of core surplus capital existing before
the deduction of any disallowed tax assets, whichever is greater.
Excluded deferred-tax assets will be deducted from capital and from
assets for purposes of calculating capital ratios. This proposed
exclusion is consistent with requirements of the other Federal banking
agencies in response to the issuance by the Financial Accounting
Standards Board (FASB) of the Statement of Financial Accounting
Standards (SFAS) No. 109, ``Accounting for Income Taxes,'' in February
1992.
B. Discussion
Deferred-tax assets are assets that reflect, for financial
reporting purposes, amounts that will be realized as reductions of
future taxes or as refunds from a taxing authority. Deferred-tax assets
may arise because of limitations under tax laws that provide that
certain net operating losses or tax credits be carried forward if they
cannot be used to recover taxes previously paid. These ``tax
carryforwards'' are realized only if the institution generates
sufficient future taxable income during the carryforward period.
Deferred-tax assets may also arise from deductible temporary
differences in the tax and financial reporting of certain events. For
example, institutions may report higher income to taxing authorities
than they reflect in their financial records because their loan loss
provisions are expensed for reporting purposes but are not deducted for
tax purposes until the loans are charged off.
Deferred-tax assets arising from deductible temporary differences
may be ``carried back'' and recovered from taxes previously paid.
However, when deferred-tax assets arising from deductible temporary
differences exceed such previously paid tax amounts, they will be
realized only if there is sufficient future taxable income during the
carryforward period.
Another type of deferred-tax assets arises from deductible
temporary differences that are dependent on the occurrence of other
future events.4 These deferred-tax assets are not generally
available for ``carried back or carry forward'' treatment, but rather
are realized in the year the event occurs.
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\4\ The regulations of the other Federal banking agencies do not
address this type of deferred-tax assets because it is not
applicable to the operations of commercial banks or thrifts, but
SFAS No. 109 does encompass all types of such assets.
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As with the other Federal banking agencies, the FCA has certain
concerns about including in capital deferred-tax assets that are
dependent upon future taxable income. Realization of such assets
depends on whether a System institution that is subject to income tax
has sufficient future taxable income during the carryforward period.
Since an institution that is in a net operating loss carryforward
position is often experiencing financial difficulties, its prospects
for generating sufficient taxable income in the future are uncertain.
In addition, the future prospects for a financial services organization
can change rapidly. This raises concerns about the realization of
deferred-tax assets that are dependent upon future taxable income, even
when an institution appears to be sound and well managed. Thus, there
is considerable uncertainty in determining whether deferred-tax assets
will be realized. Many institutions are able to make reasonably
accurate projections of future taxable income for relatively short
periods of time, but beyond these short time periods, the reliability
of the projections tends to decrease significantly.
Certain deferred-tax assets are realized upon the occurrence of
certain future events other than taxable income. The same supervisory
concerns exist regarding these tax assets as regarding tax assets
dependent on future income. Several System institutions have
significant amounts of deferred-tax assets that represent the expected
refund of income taxes previously paid on earnings distributed in the
form of nonqualified allocations of patronage to
[[Page 49626]]
their stockholders. The realization of these deferred-tax assets is
dependent not on future taxable income but rather on actions of the
institutions to retire stock or allocated surplus associated with the
nonqualified distributions. However, an institution might be unable to
retire this stock and allocated equities during periods of financial
difficulties when conversion of these deferred-tax assets to cash would
be needed.
In addition, as it becomes less likely that deferred-tax assets
will be realized, an institution is required under SFAS 109 to reduce
its deferred-tax assets through increases to the asset's valuation
allowance. Additions to this allowance would reduce an institution's
regulatory capital at precisely the time it likely needs additional
capital support.
C. Determination of the Deferred-Tax Exclusion
The FCA proposes to require the exclusion of the greater of the
amount of deferred-tax assets dependent on future income or events that
are not expected to be realized within 1 year, or the amount by which
the deferred-tax assets exceed 10 percent of core surplus capital
before the exclusion. To determine the deferred-tax exclusion, an
institution would assume that all temporary differences fully reverse
as of the calculation date. The amount of deferred-tax assets that are
dependent upon future taxable income that is expected to be realized
within 1 year means the amount of such deferred-tax assets that could
be absorbed by the amount of income taxes that are expected to be
payable based upon the institution's projected future taxable income
for the next 12 months. Estimates of taxable income for the next year
should include the effect of tax-planning strategies that the
institution intends to implement to realize tax carryforwards that will
otherwise expire during the year. Consistent with the other banking
agencies and SFAS No. 109, the FCA believes that tax planning
strategies are often carried out to prevent the expiration of such
carryforwards. Deferred taxes that are dependent on other future events
(other than future taxable income) and that are not expected to be
realized within 1 year are to be deducted in the determination of the
institution's capital measurements.
The FCA believes that institutions will not have significant
difficulty in implementing these proposed limits. System institutions
routinely make financial projections as part of their annual business
planning process. Both the 1-year and 10-percent computations are
straightforward and relatively simple. The Agency also believes that
most System institutions would not be negatively affected by the
implementation of this exclusion of deferred-tax assets. A small number
of institutions that have significant tax-deferred assets may be
initially unable to satisfy the core surplus ratio but should be able
to comply within a relatively short time frame.
The proposed partial exclusion is intended to balance the continued
concerns of the Agency about deferred-tax assets that are dependent
upon future taxable income and other future events against the fact
that such assets will, in many cases, be realized. The exclusion based
on 10 percent of core surplus also would ensure that System
institutions could not place excessive reliance on deferred-tax assets
to satisfy the minimum capital standards.
D. Additional Guidance
The following additional guidance is provided to assist System
institutions' understanding of how the FCA proposes to implement the
deferred-tax exclusion.
1. Projecting Future Taxable Income and Other Events
Institutions may use the financial projections for planning the
current fiscal year (adjusted for any significant changes that have
occurred or are expected to occur) when applying the exclusion at an
interim date within each fiscal year. In addition, while the proposed
rule does not specify how originating temporary differences should be
treated for purposes of projecting taxable income and other events for
the next year, each institution should decide whether to adjust its
financial projections for originating temporary differences and should
follow a reasonable and consistent approach.
2. Tax Jurisdictions
Under this proposed rule, an institution would not be required to
determine its exclusion of deferred-tax assets on a jurisdiction-by-
jurisdiction basis. While an approach that looks at each jurisdiction
separately may be more accurate from a theoretical standpoint, the FCA
is in agreement with the other Federal banking agencies that the
greater precision achieved by mandating such an approach would not
outweigh the complexities involved and the inherent cost to
institutions. Therefore, to limit regulatory burden, an institution
would have the option to calculate one overall exclusion of deferred-
tax assets that covers all tax jurisdictions in which it operates.
3. Available-for-Sale Securities
Under SFAS No. 115, ``Accounting for Certain Investments in Debt
and Equity Securities'' (SFAS No. 115), available-for-sale securities
are reported at fair value, with unrealized holding gains and losses on
such securities, net of tax effects, included in a separate component
of stockholders' equity. The Agency's current regulations exclude from
regulatory capital the amount of net unrealized holding gains and
losses on available-for-sale securities. It would be consistent to
exclude the deferred tax effects relating to unrealized holding gains
and losses on these available-for-sale securities from the calculation
of the allowable amount of deferred-tax assets for regulatory capital
purposes. However, requiring the exclusion of such deferred tax effects
may add significant complexity to the regulatory capital standards and
in most cases would not have a significant impact on regulatory capital
ratios.
The FCA proposes to permit, but not require, institutions to adjust
the amount of deferred-tax assets and liabilities arising from marking-
to-market available-for-sale debt securities. This choice should reduce
the implementation burden for institutions not wanting to contend with
the complexity arising from such adjustments, while permitting those
institutions that want to achieve greater precision to make such
adjustments. However, institutions must follow a consistent approach
with respect to such adjustments.
VI. Computational Issues
Following the implementation of the new capital adequacy
provisions, various System institution representatives and FCA
examiners have identified certain capital computational concerns and
interpretive issues. Such issues primarily involved the computation of
the total surplus and core surplus capital requirements. These issues
are addressed below as technical corrections to the existing capital
adequacy regulations.
A. Average Daily Balance Requirement
The FCA has received comments from System institutions voicing
concern with the requirement to calculate the total and core surplus
ratios using month-end balances. Institutions have commented that using
month-end balances results in significant variability in the ratios due
simply to seasonal lending trends. They recommended that
[[Page 49627]]
the total and core surplus ratios be calculated using the same basis as
permanent capital. The permanent capital ratio is computed using
average daily balances for the most recent 3-month period.
The FCA proposes to amend Sec. 615.5330(c) to require computation
of the total surplus, core surplus, and risk-adjusted asset base using
average daily balances for the most recent 3 months in the same way
they are used for the calculation of permanent capital. The FCA is
proposing this change for the following reasons:
1. The change will smooth out seasonal fluctuations in month-end
balances that may result in undue volatility of the total and core
surplus ratios;
2. The requirement is not a burden on System institutions because
they already have the information-processing capability to compute the
3-month average of daily balances for various balance sheet accounts;
3. The change achieves consistency in the calculation methodology
with regulatory permanent capital requirements; and
4. The 3-month average daily balance methodology is less
susceptible to adjustment by delaying or advancing the recognition of
various business activities compared to the month-end balances
methodology.
Existing Sec. 615.5205 requires institutions to maintain at all
times a permanent capital ratio of at least the minimum required level.
The FCA proposes to amend Sec. 615.5330(a) and (b) to extend this
requirement to the total and core surplus ratios as well. In each case
the ratios would be calculated as described above. This change would
also ensure ongoing compliance with the requirements of
Sec. 615.5240(c), which allows an institution's board of directors to
delegate borrower stock retirements to management under certain
conditions, including the maintenance of capital ratios at or above the
minimum requirements.
The FCA is not proposing to change the requirement in
Sec. 615.5335(b) to compute the net collateral ratio using month-end
balances at a specific point in time. However, the FCA proposes that
banks expressly be required to achieve and maintain at all times a net
collateral ratio at or above the regulatory minimum. In addition, banks
must have the capability to calculate the net collateral ratio at any
time using the balances outstanding at the computation date. Having
this capability is important to banks to support daily issuances of
debt securities to meet their funding needs.
B. Treatment of Intra-System Investments and Other Adjustments
1. Reciprocal Investments
The FCA proposes to clarify Sec. 615.5210(e)(1) of the capital
adequacy regulations that addresses the treatment of reciprocal
holdings between two System institutions. The current regulation has
not consistently been interpreted by institutions to require that the
cross-elimination of reciprocal holdings be made before making the
other required adjustments relating to intra-System investments. The
FCA intended that elimination of investments between two System
institutions be applied on a net basis after adjusting for reciprocal
holdings (see 53 FR 16956, May 12, 1988). As an example, if institution
A has a $100 equity investment in institution B, and institution B has
a $25 equity investment in institution A, the net investment after
offsetting reciprocal holdings is $75 (i.e., $100--$25). The regulatory
offsetting requirement results in the elimination of $25 from the
capital and assets of both institutions. This ``netting effect''
ensures that double-counted cross-capital investments made by System
institutions are eliminated prior to other adjustments required by the
capital regulations. In the example above, the remaining $75 net
investment is then the amount used when applying the other intra-System
investment-related provisions of the regulations to the computation of
permanent capital, total surplus, and core surplus. The FCA believes
this clarification is necessary to avoid possible misinterpretations
that may result in incorrect deductions.
2. Computation of Total and Core Surplus
The FCA proposes to clarify the treatment of intra-System equity
investments and other deductions for the computation of total and core
surplus. For the calculation of total surplus, the FCA proposes to
amend Sec. 615.5301(i)(7) to more clearly require the same deductions
made in the computation of permanent capital. When calculating total
surplus, System institutions should eliminate intra-System investments
and other deductions from total surplus in a manner consistent with the
elimination of such investments when an institution calculates its
permanent capital. These eliminations are necessary to ensure that the
investing institution does not include certain intra-System investments
when computing total surplus and makes similar deductions such as
elimination of certain tax-deferred assets. The FCA views most intra-
System investments as a commitment of capital between related entities.
From a regulatory capital adequacy perspective, elimination of most
intra-System investments by the investing institution appropriately
reflects that the capital commitment is in the related issuing
institution. 5
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\5\ Only the issuing institution may include such equities in
its total surplus, and only to the extent such equities qualify
pursuant to Sec. 615.5301(i).
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The FCA also proposes to eliminate Sec. 615.5330(a)(2) and (a)(3)
because these paragraphs are no longer necessary. As previously
discussed, the FCA is proposing to amend Sec. 615.5301(i)(7) to require
the same deductions to be made in computing total surplus as are
required for the calculation of permanent capital. With this revision
to Sec. 615.5301(i)(7), the existing requirements of Sec. 615.5330
(a)(2) and (a)(3) are redundant.
With respect to core surplus, some institutions have interpreted
the existing regulation as not requiring the elimination of an
investment in another System institution (except for associations'
investments in their affiliated banks), as is required in the
calculation of other regulatory capital measurements. The FCA believes
that the elimination of most intra-System investments from core surplus
is also appropriate. For this reason, the FCA is proposing to amend
Sec. 615.5301(b)(4) to require the elimination of most intra-System
investments from the computation of the core surplus of both the
investing and the issuing institutions. However, investments to
capitalize loan participations would not be eliminated from the
investing institution's core surplus. The FCA views investments between
System institutions resulting from loan participations as a pass-
through of member-purchased or allocated equity. Because the issuing
institution does not count such equities as core surplus, the FCA
believes that elimination of such pass-through investments from the
investing institution's core surplus would be unnecessary. The FCA
invites comment on this approach and the alternative approach of
eliminating intra-System investments relating to loan participations
from the core surplus of the investing institution.
For the core surplus computation, existing Sec. 615.5301(b)(3)
requires institutions to make the deductions set forth in
Sec. 615.5210(e)(6) and (e)(7) for investments in the Leasing
Corporation and for goodwill. The Agency intended for other relevant
adjustments required for permanent capital to be made in the
[[Page 49628]]
core surplus ratio as well. Therefore, the FCA proposes to amend the
core surplus computation also to require adjustments for loss-sharing
agreements and for deferred-tax assets.
3. Investments in Service Corporations
Existing Sec. 615.5210(e)(6) requires an institution to deduct its
investment in the FCL from total capital for purposes of computing its
permanent capital. The FCA proposes to require institutions to deduct
their investments in all other service corporations as well. This
change would be in conformity with the FCA's view that the capital is
committed to support risks at the service corporation level and would
clarify that such capital would be available to meet any capital
requirements imposed by the Agency on service corporations. The
required deductions would also be made in the investing institution's
core and total surplus computations.
C. Counting Farm Credit System Financial Assistance Corporation (FAC)
Obligations as a Liability on an Institution's Balance Sheet
Section 615.5210(a) of the existing regulations provides that no
FAC obligations shall be included in the balance sheets of any Farm
Credit institution. The FCA proposes to restrict this treatment to only
those FAC obligations that were issued to pay capital preservation and
loss-sharing agreements.
System institutions are obligated under the Act to: (1) Repay
Treasury-paid interest from direct assistance and general Systemwide
FAC debt; (2) pay interest on direct assistance FAC obligations; and
(3) pay principal and interest on capital preservation-related FAC
debt. Section 6.9(e)(3)(E) of the Act provides that certain obligations
of the FAC issued in connection with the capital preservation and loss-
sharing agreements not be included in the obligations of any
institution for reporting purposes. In 1988, when the FCA determined
that this exception to GAAP should also be included in the capital
regulations, it made the exception broader than the statute by applying
it to all FAC obligations. Since the relevant provision of the Act
refers only to the obligations of the FAC that were issued in
connection with the repayment of capital preservation agreements, the
FCA proposes to conform the language of the regulation to the statute.
D. Changes in Risk-Weighting Categories and Credit Conversion Factors
for Calculating Risk-Adjusted Assets
The FCA proposes modifications to the risk-weighting categories for
on-and off-balance-sheet assets in Sec. 615.5210(f). The purposes of
the modifications are to provide a more accurate weighting of assets
relative to their risk and to incorporate recent changes to the Basle
Accord, 6 as well as to provide consistency with the
requirements of the other Federal banking agencies. The following
changes are proposed:
---------------------------------------------------------------------------
\6\ Agreed to by the Committee on Banking Regulations and
Supervisory Practices, under the auspices of the Bank for
International Settlements in Basle, Switzerland (Basle Committee).
Under this agreement the other Federal banking agencies that are
signatories to the Accord are bound to consider such direction and
revise their regulations accordingly. The FCA, for consistency
purposes, also chooses to consider and revise its regulations, as
appropriate to the System.
---------------------------------------------------------------------------
1. Elimination of the 10-Percent Category
The FCA proposes to eliminate this risk-weight category as set
forth in existing Sec. 615.5210(f)(2)(ii). The assets in this category
would be reassigned to other categories that more accurately reflect
their credit risks, consistent with the risk-weighting treatment by the
other Federal banking agencies. Securities issued by the U.S.
Government or its agencies and portions of loans and other assets
guaranteed by the full faith and credit of the U.S. Government or its
agencies would be risk-weighted at 0 percent in Sec. 615.5210(f)(2)(i).
Cash items in the process of collection and portions of loans and other
assets collateralized by securities of the U.S. Government or its
agencies would be risk-weighted at 20 percent in new
Sec. 615.5210(f)(2)(ii). These changes would make the FCA's risk-
weighting of these items consistent with that of the other financial
regulators.
2. Risk-Weighting of Assets That Are Conditionally Guaranteed by the
U.S. Government or Its Agencies at 20 Percent
Such assets are not specifically distinguished from unconditional
guarantees in the FCA's current weighting scheme. However, the FCA is
now proposing to differentiate between unconditional guarantees, which
have a risk-weighting of 0 percent, and conditional guarantees, which
are proposed to be risk-weighted at 20 percent, in new
Sec. 615.5210(f)(2)(ii)(B). Government-sponsored agency securities not
backed by the full faith and credit of the U.S. Government would also
be risk-weighted at 20 percent. In developing the proposed revisions,
the FCA believes that such guarantees pose some risk and that 20
percent is the appropriate risk-weighting for the general credit risk
and would conform to the treatment of such assets by the other
financial regulators.
3. Modification of the Definitions of Two Items Involving Foreign Banks
Claims on foreign banks with an original maturity of 1 year or less
are now risk-weighted at 20 percent, and those with an original
maturity of more than 1 year are weighted at 100 percent. For risk-
weighting purposes, the FCA proposes to make a distinction between the
Organization for Economic Cooperation and Development (OECD)-based
group of countries 7 and non-OECD-based countries in the
same fashion as the other Federal banking agencies. Generally,
membership in the OECD indicates that such member countries have lower
levels of sovereign risk and, therefore, justifies a lower risk-
weighting. The FCA proposes to risk-weight all claims on OECD banks at
20 percent in new Sec. 615.5210(f)(2)(ii), regardless of maturity, and
claims on non-OECD banks at 20 percent when the remaining maturity is 1
year or less. Claims on non-OECD banks with a remaining maturity of
more than 1 year would be risk-weighted at 100 percent in new
Sec. 615.5210(f)(2)(iv). The FCA has added a definition of OECD in
Sec. 615.5201(j).
---------------------------------------------------------------------------
\7\ OECD means countries that are full members of the
Organization for Economic Cooperation and Development. As of August
1997, the OECD includes the following countries: Australia, Austria,
Belgium, Canada, the Czech Replublic, Denmark, Finland, France,
Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, South
Korea, Luxembourg, Mexico, the Netherlands, New Zealand, Norway,
Poland, Portugal, Spain, Sweden, Switzerland, Turkey, the United
Kingdom, and the United States. Saudia Arabia has concluded special
lending arrangements with the International Monetary Fund (IMF)
associated with the IMF's General Arrangements to Borrow which,
together with the aforementioned countries that are full members of
the OECD, comprise the OECD-based group of countries.
---------------------------------------------------------------------------
4. Risk-Weighting of Unused Commitments With an Original Maturity of
Less Than 14 Months at 0 Percent
Unused commitments with an original maturity of more than 1 year
now have a 50-percent credit conversion factor, which means that 50
percent of the face amount of such commitments must be added to the
appropriate risk-weighting category, usually 100 percent. Many loans
made by Farm Credit institutions are on annual renewal cycles. It is
the established practice of
[[Page 49629]]
many of these institutions that, in order to have loan commitments in
place at the beginning of each annual cycle, the credit review and
subsequent commitment are typically done 30 to 60 days prior to the end
of the current loan commitment. Consequently, such ``advance''
commitments have been classified in the 50-percent credit conversion
category. The FCA has concluded that these annual advance commitments
do not differ substantially from commitments made with an original
maturity of 1 year or less.
The FCA proposes in Sec. 615.5210(f)(3)(ii) to classify in the 0-
percent credit conversion category those binding commitments with an
original maturity of 14 months or less. This change is intended to
recognize that the timing of the issuance of binding commitments is
appropriately related to the annual operating cycle of borrowers, so
that institutions can continue current practices and be able to risk-
weight such loans at 0 percent.
5. Revision of Credit Conversion Factors for Derivative Transactions
In September 1995, the other Federal banking agencies adopted final
amendments to their risk-based capital regulations relating to
derivative transactions based on the Basle Committee's recommendations.
See 60 FR 46171, September 5, 1995.8 Their final rule
amended the matrix of conversion factors used to calculate potential
future exposure and permitted institutions to recognize the effects of
qualifying bilateral netting arrangements in the calculation of
potential future exposure. The matrix of conversion factors used to
calculate potential future exposure was expanded to take into account
innovations in the derivatives markets. Specifically, the matrix was
modified by adding higher conversion factors to address long-dated
transactions (e.g., contracts with remaining maturities over 5 years),
and new conversion factors were added to cover certain types of
derivative transactions not previously covered.
---------------------------------------------------------------------------
\8\ In July 1994 the Basle Accord was revised to permit
institutions to net positive and negative mark-to-market values of
rate contracts entered into with a single counterparty subject to a
qualifying, legally enforceable, bilateral netting agreement. Based
upon this revision to the Basle Accord, the other Federal banking
agencies revised their risk-based capital regulations accordingly.
---------------------------------------------------------------------------
In conformity with the other Federal banking agencies, the FCA
proposes to amend Sec. 615.5210(f)(3)(iii) to permit institutions to
net positive and negative mark-to-market values of derivatives
contracts entered into with a single counterparty subject to a
qualifying, legally enforceable bilateral netting arrangement for
purposes of determining credit equivalent amounts. The FCA is adding a
definition of ``qualifying bilateral netting contract'' in new
Sec. 615.5201(m). The FCA also proposes to adopt the formula used by
the other Federal banking agencies for current and potential future
exposure for contracts subject to qualifying bilateral netting
agreements. The formula is expressed as Anet = (0.4 x
Agross)+ 0.6(NGR x Agross) where:
a. Anet is the adjusted potential future credit
exposure;
b. Agross is the sum of potential future credit
exposures determined by multiplying the notional principal amount by
the appropriate credit conversion factor; and
c. 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.
In addition, the FCA proposes to amend the conversion factor matrix
as set forth in the following table:
Conversion Factor Matrix
[In percent]
------------------------------------------------------------------------
Interest Exchange
Remaining maturity rate 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
------------------------------------------------------------------------
The FCA would further require that, for any derivative contracts
that do not fall into one of the categories above, the potential future
credit exposure must be determined using the commodity conversion
factors.
VII. Other Issues
A. Retirement of Other Allocated Equities Included in Core Surplus
The FCA's recently adopted capital adequacy regulations permit
associations to include, subject to limitations, both nonqualified and
qualified allocated equities in core surplus. The regulations permit
the inclusion of nonqualified allocated equities that are not
distributed according to an established plan or practice. The
regulations further allow associations to include in core surplus other
allocated equities (i.e., qualified or nonqualified notices of
allocation) with an original maturity of at least 5 years and not
scheduled for revolvement during the next 3 years. The preamble to the
Capital Adequacy and Customer Eligibility final rule (62 FR 4429,
January 30, 1997) discussed disallowing a series or class of allocated
equities from treatment as core surplus in the event of partial
retirements. The preamble also described exceptions to the disallowance
requirement if an institution retires allocated equities in the event
of loan default or the death of the equityholder. However, in the
regulation the disallowance for partial retirements, as well as the
exceptions, appeared to apply only to the nonqualified allocated
equities without a plan or practice of revolvement.
Several System associations have asked the FCA whether the other
allocated equities includible in core surplus would also be disallowed
in the event of partial retirement. The remaining equities would be
disallowed, and the related exceptions would apply in such
circumstances. The FCA is now proposing to amend
Sec. 615.5310(b)(2)(ii) in order to ensure consistent treatment of all
allocated equities counted as core surplus in the event of partial
retirements.
[[Page 49630]]
B. Ensuring Two Nominees for Each Bank Director's Position and Ensuring
Representation on the Board of all Types of Agriculture in the District
Section 4.15 of the Act requires associations to ``endeavor to
assure'' that, when directors are elected, there are at least two
nominees for each position and that representation of all types of
agriculture practiced in the territory is achieved to the extent
possible. The statute goes on to say that ``[r]egulations of the Farm
Credit Administration governing the election of bank directors shall
similarly assure a choice of two nominees for each elective office to
be filled and that the bank board represent as nearly as possible all
types of agriculture in the district.'' The FCA interprets the
provision to require banks to make a good faith effort to locate at
least two nominees and to try to assure representation on the board
that is reflective of the bank's territory. The Agency proposes to add
a new paragraph (5) to Sec. 615.5230(b) to require documentation of
that effort. In the event that a bank is unable to find at least two
nominees for each position, the bank would be required to keep written
documentation of its efforts to do so. The bank would also be required
to keep a record of the type of agriculture engaged in by each director
on its board.
In addition, the FCA proposes to add Sec. 611.350 to add a
reference in the subpart on director elections to the cooperative
principles set forth in Sec. 615.5230 that apply to such elections.
C. Statement of SFAS No. 130, Reporting Comprehensive Income
The FASB recently issued SFAS No. 130, Reporting Comprehensive
Income (Statement). This Statement sets forth standards for reporting
and display of comprehensive income in a full set of financial
statements. For fiscal years beginning after December 15, 1997, this
Statement will require financial statements to display a balance
representing the accumulation of other comprehensive income. This new
balance will be displayed separately from retained earnings and
additional paid-in capital in the equity (capital) section of the
statement of financial position. For the most part, the FCA believes
that the Statement represents only a change in display of existing
financial transactions and, therefore, does not introduce any new
issues that have an effect on the Agency's current regulatory capital
standards. The FCA believes that current standards in the capital
regulations already address the transactional items that comprise the
newly separated component of equity. Accordingly, the FCA has
determined that there are no compelling reasons to change the capital
standards to take into account the changes in the display of financial
transactions resulting from this Statement. The Agency invites any
parties with an interest in this issue to submit comments.
E. Conforming Amendments
The FCA proposes to amend Sec. 620.5 to require institutions to
disclose information on their surplus and collateral ratios in the
annual report to shareholders. Conforming, nonsubstantive changes are
also proposed in Sec. 615.5201(h) to replace ``allocation'' with
``allotment'' and in Secs. 615.5210(b) and 615.5260(a)(3)(ii) to remove
obsolete language.
List of Subjects
12 CFR Part 611
Agriculture, Banks, banking, 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.
12 CFR Part 627
Agriculture, Banks, banking, Claims, Rural areas.
For the reasons stated in the preamble, parts 611, 615, 620, and
627 of chapter VI, title 12 of the Code of Federal Regulations are
proposed to be amended to read as follows:
PART 611--ORGANIZATION
1. The authority citation for part 611 continues to read as
follows:
Authority: Secs. 1.3, 1.13, 2.0, 2.10, 3.0, 3.21, 4.12, 4.15,
4.21, 5.9, 5.10, 5.17, 7.0--7.13, 8.5(e) of the Farm Credit Act (12
U.S.C. 2011, 2021, 2071, 2091, 2121, 2142, 2183, 2203, 2209, 2243,
2244, 2252, 2279a--2279f-1, 2279aa-5(e)); secs. 411 and 412 of Pub.
L. 100-233, 101 Stat. 1568, 1638; secs. 409 and 414 of Pub. L. 100-
399, 102 Stat. 989, 1003, and 1004.
Subpart C--Election of Directors
2. Section 611.350 is added to read as follows:
Sec. 611.350 Application of cooperative principles to the election of
directors.
In the election of directors, each System institution shall comply
with the applicable cooperative principles set forth in Sec. 615.5230
of this chapter.
Subpart I--Service Organizations
3. Section 611.1135 is amended by revising paragraphs (b)(4) and
(c) to read as follows:
Sec. 611.1135 Incorporation of service organizations.
* * * * *
(b) * * *
(4) The proposed bylaws, which shall include the provisions
required by Sec. 615.5220(b) of this chapter.
* * * * *
(c) Approval. The Farm Credit Administration may condition the
issuance of a charter, including imposing minimum capital requirements,
as it deems appropriate. For good cause, the Farm Credit Administration
may deny the application. Upon approval by the Farm Credit
Administration of a completed application, which shall be kept on file
at the Farm Credit Administration, the Agency shall issue a charter for
the service corporation which shall thereupon become a corporate body
and a Federal instrumentality.
* * * * *
PART 615--FUNDING AND FISCAL AFFAIRS, LOAN POLICIES AND OPERATIONS,
AND FUNDING OPERATIONS
4. 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 E--Investment Management
5. Section 615.5135 is amended by revising the introductory
paragraph to read as follows:
Sec. 615.5135 Management of interest rate risk.
The board of directors of each Farm Credit Bank, bank for
cooperatives, and agricultural credit bank shall develop and implement
an interest rate risk management program as set forth in subpart G of
this part. The board of directors shall adopt an interest rate risk
management section of an asset/liability management policy which
establishes
[[Page 49631]]
interest rate risk exposure limits as well as the criteria to determine
compliance with these limits. At a minimum, the interest rate risk
management section shall establish policies and procedures for the bank
to:
* * * * *
6. A new subpart G is added to read as follows:
Subpart G--Risk Assessment and Management
Sec.
615.5180 Interest rate risk management by banks--general.
615.5181 Bank interest rate risk management program.
615.5182 Interest rate risk management by associations and other
Farm Credit System institutions other than banks.
Subpart G--Risk Assessment and Management
Sec. 615.5180 Interest rate risk management by banks--general.
The board of directors of each Farm Credit Bank, bank for
cooperatives, and agricultural credit bank shall develop and implement
an interest rate risk management program tailored to the needs of the
institution and consistent with the requirements set forth in
Sec. 615.5135 of this part. The program shall establish a risk
management process that effectively identifies, measures, monitors, and
controls interest rate risk.
Sec. 615.5181 Bank interest rate risk management program.
(a) The board of directors of each Farm Credit Bank, bank for
cooperatives, and agricultural credit bank is responsible for providing
effective oversight to the interest rate risk management program and
must be knowledgeable of the nature and level of interest rate risk
taken by the institution.
(b) Senior management is responsible for ensuring that interest
rate risk is properly managed on both a long-range and a day-to-day
basis.
Sec. 615.5182 Interest rate risk management by associations and other
Farm Credit System institutions other than banks.
Associations and other Farm Credit System institutions other than
banks, excluding the Federal Agricultural Mortgage Corporation, with
interest rate risk that could lead to significant declines in net
income or in the market value of capital shall comply with the
requirements of Secs. 615.5180 and 615.5181. The interest rate risk
program shall be commensurate with the level of direct interest rate
exposure under the management control of the institution.
Subpart H--Capital Adequacy
7. Section 615.5201 is amended by removing the word ``allocation''
and adding in its place, the word ``allotment'' in paragraph (h);
redesignating paragraphs (d), (e), (f), (g), (h), (i), (j), (k), (l),
(m), and (n) as paragraphs (e), (f), (g), (h), (i), (k), (l), (n), (o),
(p), and (q) respectively; and adding new paragraphs (d), (j), and (m)
to read as follows:
Sec. 615.5201 Definitions.
* * * * *
(d) 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; or
(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.
* * * * *
(j) 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.
* * * * *
(m) 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;
(3) The contract creates a single obligation either to pay or to
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.
* * * * *
6. Section 615.5210 is amended by adding new paragraph (e)(11);
removing paragraph (f)(2)(v); and revising paragraphs (a), (b), (e)
introductory text, (e)(1), (e)(6), (f)(2)(i), (f)(2)(ii), heading of
(f)(2)(iii), (f)(2)(iv), (f)(3) introductory text, (f)(3)(ii)(A), and
(f)(3)(iii) to read as follows:
Sec. 615.5210 Computation of the permanent capital ratio.
(a) The institution's permanent capital ratio shall be 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 shall be
computed using average daily balances for the most recent 3 months.
* * * * *
(e) For the purpose of computing the institution's permanent
capital ratio, the following adjustments shall be made prior to
assigning assets to risk-weight categories and computing the ratio:
(1) Where two Farm Credit System institutions have stock
investments in each other, such reciprocal holdings shall be eliminated
to the extent of the offset. If the investments are equal in amount,
each institution shall deduct from its assets and its total capital an
amount equal to the investment. If the investments are not equal in
amount, each institution shall deduct from its total capital and its
assets an amount equal to the smaller investment. The elimination of
reciprocal holdings required by this paragraph shall be made prior to
making the other adjustments required by this subsection.
* * * * *
(6) The double-counting of capital between a service corporation
chartered
[[Page 49632]]
under section 4.25 of the Act and its owner institutions shall be
eliminated by deducting an amount equal to their investment in the
service corporation from their total capital.
* * * * *
(11) For purposes of calculating capital ratios under this part,
deferred-tax assets are subject to the conditions, limitations, and
restrictions described in this paragraph.
(i) Each institution shall 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:
(A) The amount of deferred-tax assets that are 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
(B) The amount of deferred-tax assets that are dependent on future
income or future events in excess of ten (10) percent of the amount of
core surplus that exists before the deduction of any deferred-tax
assets.
(ii) For purposes of this calculation:
(A) 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 shall not be deducted from assets and
from equity capital.
(B) All existing temporary differences should be assumed to fully
reverse at the calculation date.
(C) 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.
(D) Financial projections shall 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.
(E) 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.
(f) * * *
(2) * * *
(i) Category 1: 0 Percent.
(A) Cash on hand and demand balances held in domestic or foreign
banks.
(B) Claims on Federal Reserve Banks.
(C) Goodwill.
(D) Direct claims on and portions of claims unconditionally
guaranteed by the United States Treasury, United States Government
agencies, or central governments in other OECD countries. A United
States Government agency is defined as an 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.
(ii) Category 2: 20 Percent.
(A) Portions of loans and other assets collateralized by United
States Government-sponsored agency securities. A United States
Government-sponsored agency is defined as an agency originally
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.
(B) Portions of loans and other assets conditionally guaranteed by
the United States Government or its agencies.
(C) Portions of loans and other assets collateralized by securities
issued or guaranteed (fully or partially) by the United States
Government or its agencies (but only to the extent guaranteed).
(D) Claims on domestic banks (exclusive of demand balances).
(E) Claims on, or guarantees by, OECD banks.
(F) Claims on non-OECD banks with a remaining maturity of 1 year or
less.
(G) Investments in State and local government obligations backed by
the ``full faith and credit of State or local government.'' Other
claims (including loans) and portions of claims guaranteed by the full
faith and credit of a State government (but only to the extent
guaranteed).
(H) Claims on official multinational lending institutions or
regional development institutions in which the United States Government
is a shareholder or contributor.
(I) Loans and other obligations of and investments in Farm Credit
institutions.
(J) Local currency claims on foreign central governments to the
extent that the Farm Credit institution has local liabilities in that
country.
(K) Cash items in the process of collection.
(iii) Category 3: 50 Percent.
* * * * *
(iv) Category 4: 100 Percent.
(A) All other claims on private obligors.
(B) Claims on non-OECD banks with a remaining maturity greater than
1 year.
(C) All other assets not specified above, including but not limited
to, leases, fixed assets, and receivables.
(D) All non-local currency claims on foreign central governments,
as well as local currency claims on foreign central governments that
are not included in Category 2(J).
* * * * *
(3) * * *
(i) * * *
(ii) Credit conversion factors shall be applied to off-balance-
sheet items as follows:
(A) 0 Percent.
(1) Unused commitments with an original maturity of 14 months or
less; or
(2) Unused commitments with an original maturity of greater than 14
months if:
* * * * *
(iii) Credit equivalents of interest rate contracts and foreign
exchange contracts.
(A) Credit equivalents of interest rate contracts and foreign
exchange contracts (except single currency floating/floating interest
rate swaps) shall be 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.
Conversion Factor Matrix
[In Percent]
------------------------------------------------------------------------
Interest Exchange
Remaining maturity rate rate Commodity
------------------------------------------------------------------------
One year or less................. 0.0 1.0 10.0
[[Page 49633]]
Over 1 to 5 years................ 0.5 5.0 12.0
Over 5 years..................... 1.5 7.5 15.0
------------------------------------------------------------------------
(B) For any derivative contract that does not fall within one of
the categories in the above table, the potential future credit exposure
shall 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
shall be the net sum of all positive and negative mark-to-market values
for each derivative contract. The positive sum of the net current
exposure shall be added to the adjusted potential future credit
exposure for the same multiple contracts with a single counterparty.
The adjusted potential future credit exposure shall be computed as
Anet=(0.4 x Agross)+0.6 (NGR x
Agross) where:
(1) Anet is the adjusted potential future credit
exposure;
(2) Agross is the sum of potential future credit
exposures determined by multiplying the notional principal amount by
the appropriate credit conversion factor; and
(3) 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.
* * * * *
Subpart I--Issuance of Equities
9. Section 615.5220 is amended by redesignating paragraphs (a)
through (h) as new paragraphs (1) through (8) consecutively; by adding
the paragraph designation ``(a)'' to the introductory text; and by
adding a new paragraph (b) to read as follows:
Sec. 615.5220 Capitalization bylaws.
* * * * *
(b) The board of directors of each service corporation (including
the Leasing Corporation) shall adopt capitalization bylaws, subject to
the approval of its voting shareholders, that set forth the
requirements of paragraphs (a)(1), (a)(2), and (a)(3) of this section
to the extent applicable. Such bylaws shall also set forth the manner
in which equities will be retired and the manner in which earnings will
be distributed.
10. Section 615.5230 is amended by adding a new paragraph (b)(5) to
read as follows:
Sec. 615.5230 Implementation of cooperative principles.
* * * * *
(b) * * *
(5) Each bank shall endeavor to assure that there is a choice of at
least two nominees for each elective office to be filled and that the
board represent as nearly as possible all types of agriculture in the
district. If fewer than two nominees for each position are named, the
efforts of the bank to locate two willing nominees shall be documented
in the books and records of the bank. The bank shall also maintain a
list of the type or types of agriculture engaged in by each director on
its board.
Subpart J--Retirement of Equities
11. Section 615.5260 is amended by revising paragraph (a)(3)(ii) to
read as follows:
Sec. 615.5260 Retirement of eligible borrower stock.
(a) * * *
(3) * * *
(ii) In the case of participation certificates and other equities,
face or equivalent value; or
* * * * *
Subpart K--Surplus and Collateral Requirements
12. Section 615.5301 is amended by revising paragraphs (a),
(b)(2)(ii), (b)(3), (b)(4), and (i)(7) to read as follows:
Sec. 615.5301 Definitions.
* * * * *
(a) The terms deferred-tax assets that are dependent on future
income or future events, institution, permanent capital, and total
capital shall have the meanings set forth in Sec. 615.5201.
* * * * *
(b) * * *
(2) * * *
(ii) The allocated equities, if subject to revolvement, are not
scheduled for revolvement during the next 3 years, provided that, in
the event that such allocated equities included in core surplus are
retired, other than as required by section 4.14B of the Act, or in
connection with a loan default or the death of an equityholder whose
loan has been repaid (to the extent provided for in the institution's
capital adequacy plan), any remaining such allocated equities that were
allocated in the same year will be excluded from core surplus.
(3) The deductions required to be made by an institution in the
computation of its permanent capital pursuant to Sec. 615.5210(e)(6),
(7), (9), and (11) shall also be made in the computation of its core
surplus. Deductions required by Sec. 615.5210(e)(1) 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).
(4) Equities issued by System institutions and held by other System
institutions shall not be included in the core surplus of the issuing
institution or of the holder, unless approved pursuant to paragraph
(b)(1)(iv) of this section, except that equities held in connection
with a loan participation shall not be excluded by the holder. This
paragraph shall not apply to investments by an association in its
affiliated bank, which are governed by Sec. 615.5301(b)(1)(i).
* * * * *
(i) * * *
(7) Any deductions made by an institution in the computation of its
permanent capital pursuant to Sec. 615.5210(e) shall also be made in
the computation of its total surplus.
13. Section 615.5330 is revised to read as follows:
Sec. 615.5330 Minimum surplus ratios.
(a) Total surplus.
(1) Each institution shall achieve and at all times maintain a
ratio of at least 7 percent of total surplus to the risk-adjusted asset
base.
(2) The risk-adjusted asset base is the total dollar amount of the
institution's assets adjusted in accordance with Sec. 615.5301(i)(7)
and weighted on the basis of risk in accordance with Sec. 615.5210(f).
(b) Core surplus.
(1) Each institution shall achieve and at all times maintain a
ratio of core surplus to the risk-adjusted asset base of at least 3.5
percent, of which no more than 2 percentage points may consist of
[[Page 49634]]
allocated equities otherwise includible pursuant to Sec. 615.5301(b).
(2) Each association shall compute its core surplus ratio by
deducting an amount equal to the net investment in the bank from its
core surplus.
(3) The risk-adjusted asset base is the total dollar amount of the
institution's assets adjusted in accordance with Secs. 615.5301(b)(3)
and 615.5330(b)(2), and weighted on the basis of risk in accordance
with Sec. 615.5210(f).
(c) An institution shall compute its risk-adjusted asset base,
total surplus, and core surplus ratios using average daily balances for
the most recent 3 months.
14. Section 615.5335 is revised to read as follows:
Sec. 615.5335 Bank net collateral ratio.
(a) Each bank shall achieve and at all times maintain a net
collateral ratio of at least 103 percent.
(b) At a minimum, a bank shall compute its net collateral ratio as
of the end of each month. A bank shall have the capability to compute
its net collateral ratio a day after the close of a business day using
the daily balances outstanding for assets and liabilities for that
date.
Subpart L--Establishment of Minimum Capital Ratios for an
Individual Institution
15. Section 615.5350 is amended by adding a new paragraph (b)(7) to
read as follows:
Sec. 615.5350 General--Applicability.
* * * * *
(b) * * *
(7) An institution with significant exposures to declines in net
income or in the market value of its capital due to a change in
interest rates and/or the exercising of embedded or explicit options.
Subpart M--Issuance of a Capital Directive
16. Section 615.5355 is amended by revising paragraph (a)(4) to
read as follows:
Sec. 615.5355 Purpose and scope.
(a) * * *
(4) Take other action, such as reduction of assets or the rate of
growth of assets, restrictions on the payment of dividends or
patronage, or restrictions on the retirement of stock, to achieve the
applicable capital ratios, or reduce levels of interest rate and other
risk exposures, or strengthen management expertise, or improve
management information and measurement systems; or
* * * * *
PART 620--DISCLOSURE TO SHAREHOLDERS
17. 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); sec. 424 of Pub. L. 100-233, 101
Stat. 1568, 1656.
Subpart A--General
Sec. 620.1 [Amended]
18. Section 620.1 is amended by removing the reference
``Sec. 615.5201(j)'' and adding in its place, the reference
``Sec. 615.5201(l)'' in paragraph (j).
Subpart B--Annual Report to Shareholders
Sec. 620.5 [Amended]
19. Section 620.5 is amended by removing the word ``permanent''
from paragraphs (d)(2), (g)(4)(v), and (g)(4)(vi); by revising
paragraph (f)(3); and by adding paragraph (f)(4) to read as follows:
Sec. 620.5 Contents of the annual report to shareholders.
* * * * * *
(f) * * *
(3) For all banks (on a bank-only basis):
(i) Permanent capital ratio.
(ii) Total surplus ratio.
(iii) Core surplus ratio.
(iv) Net collateral ratio.
(4) For all associations:
(i) Permanent capital ratio.
(ii) Total surplus ratio.
(iii) Core surplus ratio.
* * * * *
PART 627--TITLE V CONSERVATORS AND RECEIVERS
20. The authority citation for part 627 continues to read as
follows:
Authority: Secs. 4.2, 5.9, 5.10, 5.17, 5.51, 5.58 of the Farm
Credit Act (12 U.S.C. 2183, 2243, 2244, 2252, 2277a, 2277a-7).
Subpart A--General
21. Section 627.2710 is amended by revising paragraphs (b)(1) and
(b)(3) to read as follows:
Sec. 627.2710 Grounds for appointment of conservators and receivers.
* * * * *
(b) * * *
(1) The institution is insolvent, in that the assets of the
institution are less that its obligations to creditors and others,
including its members. For purposes of determining insolvency,
``obligations to members'' shall not include stock or allocated
equities held by current or former borrowers.
* * * * *
(3) The institution is in an unsafe and unsound condition to
transact business, including having insufficient capital or otherwise.
For purposes of this regulation, ``unsafe or unsound condition'' shall
include, but shall not be limited to, the following conditions:
(i) For banks, a net collateral ratio of 102 percent.
(ii) For associations, collateral insufficient to meet the
requirements of the association's general financing agreement with its
affiliated bank.
(iii) For all institutions, permanent capital of less than one-half
the minimum required level for the institution.
(iv) For all institutions, a relevant total surplus ratio of less
than 2 percent.
(v) For associations, stock impairment.
* * * * *
Dated: September 17, 1997.
Floyd Fithian,
Secretary, Farm Credit Administration Board.
[FR Doc. 97-25107 Filed 9-22-97; 8:45 am]
BILLING CODE 6705-01-P
