[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 ``<a href="/cdn-cgi/l/email-protection#0b796e6c2601686466664b6d686a256c647d">reg-
<span class="__cf_email__" data-cfemail="73101c1e1e331510125d141c05">[email protected]</span></a>.'' 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 <SUP>1</SUP>) 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) <SUP>2</SUP> 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.<SUP>3</SUP> 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.<SUP>4</SUP> 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. <SUP>5</SUP>
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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, <SUP>6</SUP> 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 <SUP>7</SUP> 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.<SUP>8</SUP> 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 A<INF>net</INF> = (0.4 x 
A<INF>gross</INF>)+ 0.6(NGR x A<INF>gross</INF>) where:
    a. A<INF>net</INF> is the adjusted potential future credit 
exposure;
    b. A<INF>gross</INF> 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 
A<INF>net</INF>=(0.4  x  A<INF>gross</INF>)+0.6 (NGR  x  
A<INF>gross</INF>) where:
    (1) A<INF>net</INF> is the adjusted potential future credit 
exposure;
    (2) A<INF>gross</INF> 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


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