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.

Proposed Rules Federal Register

49623

Vol. 62, No. 184

Tuesday, September 23, 1997

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.

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 riskweighting 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 ‘‘regcomm@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 §§ 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 § 615.5182 would

require any other System institution

(excluding the Federal Agricultural
49624 Federal Register / Vol. 62, No. 184 / Tuesday, September 23, 1997 / Proposed Rules

1Regulations affecting the Federal Agricultural

Mortgage Corporation will be issued separately.

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.

3The 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.

Mortgage Corporation 1) with significant

interest rate risk to establish a risk

management program.

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

§§ 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 § 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

§ 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:

1. For banks, a net collateral ratio (as

defined by § 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 § 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

§ 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.

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
Federal Register / Vol. 62, No. 184 / Tuesday, September 23, 1997 / Proposed Rules 49625

4The 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.

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

§ 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 § 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 § 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

§ 615.5220 by adding a new paragraph

(b) requiring all service corporations to

have relevant capitalization provisions

in their bylaws. A conforming

amendment to § 611.1135(b)(4) is also

proposed.

V. Deferred-Tax Assets

A. The Proposed Rule

The FCA proposes to amend

§ 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

§ 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.

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
49626 Federal Register / Vol. 62, No. 184 / Tuesday, September 23, 1997 / Proposed Rules

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 taxplanning 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 taxdeferred 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 deferredtax 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), availablefor-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-forsale 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-tomarket 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
Federal Register / Vol. 62, No. 184 / Tuesday, September 23, 1997 / Proposed Rules 49627

5Only the issuing institution may include such

equities in its total surplus, and only to the extent

such equities qualify pursuant to § 615.5301(i).

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

§ 615.5330(c) to require computation of

the total surplus, core surplus, and riskadjusted 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 § 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 § 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 § 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 § 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

§ 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

§ 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 intraSystem 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 taxdeferred 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

The FCA also proposes to eliminate

§ 615.5330(a)(2) and (a)(3) because these

paragraphs are no longer necessary. As

previously discussed, the FCA is

proposing to amend § 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

§ 615.5301(i)(7), the existing

requirements of § 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 § 615.5301(b)(4) to

require the elimination of most intraSystem 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 § 615.5301(b)(3) requires

institutions to make the deductions set

forth in § 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
49628 Federal Register / Vol. 62, No. 184 / Tuesday, September 23, 1997 / Proposed Rules

6Agreed 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.

7OECD 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.

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 § 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 Treasurypaid 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 § 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:

1. Elimination of the 10-Percent

Category

The FCA proposes to eliminate this

risk-weight category as set forth in

existing § 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

§ 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 § 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 § 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 riskweighting 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 nonOECD-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 riskweighting. The FCA proposes to riskweight all claims on OECD banks at 20

percent in new § 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 § 615.5210(f)(2)(iv). The FCA has

added a definition of OECD in

§ 615.5201(j).

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 riskweighting category, usually 100 percent.

Many loans made by Farm Credit

institutions are on annual renewal

cycles. It is the established practice of
Federal Register / Vol. 62, No. 184 / Tuesday, September 23, 1997 / Proposed Rules 49629

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 riskbased capital regulations accordingly.

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

§ 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.

In conformity with the other Federal

banking agencies, the FCA proposes to

amend § 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 § 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-tomarkets 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]

Remaining maturity Interest rate Exchange

rate Commodity

1 year or less ........................................................................................................................................... 0.0 1.0 10.0

Over 1 to 5 years ..................................................................................................................................... 0.5 5.0 12.0

Over 5 years ............................................................................................................................................. 1.5 7.5 15.0

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

§ 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.
49630 Federal Register / Vol. 62, No. 184 / Tuesday, September 23, 1997 / Proposed Rules

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 § 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

§ 611.350 to add a reference in the

subpart on director elections to the

cooperative principles set forth in

§ 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 § 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 § 615.5201(h) to replace

‘‘allocation’’ with ‘‘allotment’’ and in

§§ 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:

§ 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 § 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:

§ 611.1135 Incorporation of service

organizations.

* * * * *

(b) * * *

(4) The proposed bylaws, which shall

include the provisions required by

§ 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:

§ 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
Federal Register / Vol. 62, No. 184 / Tuesday, September 23, 1997 / Proposed Rules 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

§ 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

§ 615.5135 of this part. The program

shall establish a risk management

process that effectively identifies,

measures, monitors, and controls

interest rate risk.

§ 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.

§ 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 §§ 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:

§ 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:

§ 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
49632 Federal Register / Vol. 62, No. 184 / Tuesday, September 23, 1997 / Proposed Rules

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, deferredtax 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 Governmentsponsored 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 (markto-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]

Remaining maturity Interest rate Exchange

rate Commodity

One year or less ....................................................................................................................................... 0.0 1.0 10.0
Federal Register / Vol. 62, No. 184 / Tuesday, September 23, 1997 / Proposed Rules 49633

CONVERSION FACTOR MATRIX—Continued

[In Percent]

Remaining maturity Interest rate Exchange

rate Commodity

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 markto-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

× Agross)+0.6 (NGR × 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-tomarkets 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:

§ 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:

§ 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:

§ 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:

§ 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 § 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 § 615.5210(e)(6), (7), (9), and

(11) shall also be made in the

computation of its core surplus.

Deductions required by § 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 § 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 § 615.5301(b)(1)(i).

* * * * *

(i) * * *

(7) Any deductions made by an

institution in the computation of its

permanent capital pursuant to

§ 615.5210(e) shall also be made in the

computation of its total surplus.

13. Section 615.5330 is revised to read

as follows:

§ 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 riskadjusted asset base.

(2) The risk-adjusted asset base is the

total dollar amount of the institution’s

assets adjusted in accordance with

§ 615.5301(i)(7) and weighted on the

basis of risk in accordance with

§ 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
49634 Federal Register / Vol. 62, No. 184 / Tuesday, September 23, 1997 / Proposed Rules

allocated equities otherwise includible

pursuant to § 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

§§ 615.5301(b)(3) and 615.5330(b)(2),

and weighted on the basis of risk in

accordance with § 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:

§ 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:

§ 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:

§ 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

§ 620.1 [Amended]

18. Section 620.1 is amended by

removing the reference ‘‘§ 615.5201(j)’’

and adding in its place, the reference

‘‘§ 615.5201(l)’’ in paragraph (j).

Subpart B—Annual Report to

Shareholders

§ 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:

§ 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:

§ 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

DEPARTMENT OF TRANSPORTATION

Federal Aviation Administration

14 CFR Part 39

[Docket No. 97–NM–126–AD]

RIN 2120–AA64

Airworthiness Directives; Saab Model

SAAB 2000 Series Airplanes

AGENCY: Federal Aviation

Administration, DOT.

ACTION: Notice of proposed rulemaking

(NPRM).

SUMMARY: This document proposes the

adoption of a new airworthiness

directive (AD) that is applicable to

certain Saab Model SAAB 2000 series

airplanes. This proposal would require

inspection of the two-way check valve

on the engine fire extinguishing system

for discrepancies, and corrective action,

if necessary. This proposal is prompted

by issuance of mandatory continued

airworthiness information by a foreign

civil airworthiness authority. The

actions specified by the proposed AD

are intended to prevent discrepancies of

the check valve, which could result in

improper functioning of the engine fire

extinguishing system.