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

33281

Vol. 63, No. 117

Thursday, June 18, 1998

1See 63 FR 20191 (April 23, 1998).

FARM CREDIT ADMINISTRATION

12 CFR Part 615

RIN 3052–AB76

Funding and Fiscal Affairs, Loan

Policies and Operations, and Funding

Operations; Investment Management

AGENCY: Farm Credit Administration.

ACTION: Proposed rule.

SUMMARY: The Farm Credit

Administration (FCA), by the FCA

Board (Board), proposes to amend the

investment regulations to provide Farm

Credit System (Farm Credit, FCS, or

System) banks with a broader array of

eligible investments. Under the

proposed regulations, Farm Credit banks

are expected to hold only high-quality

and liquid investments to maintain a

liquidity reserve, invest surplus funds,

and manage interest rate risk. The

proposal provides System banks with

guidance on sound practices for

managing risks associated with

investment activities and grants System

banks greater flexibility to manage risk

on an institutional, portfolio, or

individual instrument level. These

amendments are also designed to better

enable FCS banks to adjust to the rapid

and continual changes in the financial

markets.

DATES: Written comments should be

received on or before August 17, 1998.

ADDRESSES: Comments may be

submitted by email to FCA at ‘‘regcomm@fca.gov.’’ Comments may also be

mailed or delivered to Patricia W.

DiMuzio, Director, Regulation and

Policy Division, Office of Policy and

Analysis, Farm Credit Administration,

1501 Farm Credit Drive, McLean,

Virginia 22102–5090 or sent by

facsimile transmission to (703) 734–

5784. Copies of all communications

received will be available for review by

interested parties in the Office of Policy

and Analysis, Farm Credit

Administration.

FOR FURTHER INFORMATION CONTACT:

Laurie A. Rea, Senior Policy Analyst,

Office of Policy Analysis, Farm Credit

Administration, McLean, VA 22102–

5090, (703) 883–4498;

or

Richard Katz, Senior Attorney, Office of

General Counsel, Farm Credit

Administration, McLean, VA 22102–

5090, (703) 883–4020, TDD (703) 883–

4444.

SUPPLEMENTARY INFORMATION:

I. Background

Petitions by System banks, various

developments and innovations in the

securities markets, and improvements in

risk management technologies have all

led the FCA to reexamine its investment

management regulations in subpart E of

part 615. The FCA aims to develop a

regulatory framework that establishes

certain fundamental practices each

Farm Credit bank should follow to fully

understand and effectively manage the

risks inherent in its investment

portfolio. Although non-agricultural

investments are a relatively small

percentage of the assets of Farm Credit

banks, proper investment management

enables System banks to control risks

stemming from their operations as

monoline providers of agricultural

credit. The FCA’s proposal is

specifically designed to enhance

investment management practices at

Farm Credit banks, and many aspects of

this proposal are consistent with the

policies that the Federal Financial

Institutions Examination Council

(FFIEC) recently adopted in a document

entitled ‘‘Supervisory Policy Statement

on Investment Securities and End-User

Derivatives Activities.’’ 1

The proposed amendments enable

FCA to relax or repeal many of the

detailed criteria that the existing

regulations prescribe for specific types

of investments. As a result, § 615.5140

will provide broader parameters for

various classes of investments while

retaining essential safety and soundness

controls, such as credit ratings and

diversification standards.

II. Investment Portfolio Management

Board and senior management should

develop and implement comprehensive

risk management processes to

effectively identify, measure, monitor,

and control risks associated with

investment activities. Although risk

management programs will differ among

System banks, certain elements are

fundamental to all sound risk

management programs. Safe and sound

banking practices require System banks

to have programs to manage the market,

credit, liquidity, operational, legal, and

other risks associated with investment

activities. Effective risk management

also addresses risks in individual

instruments, the investment portfolio,

and the entire institution.

Proposed § 615.5133 sets forth the

fundamental criteria for developing

sound investment management

practices at Farm Credit banks. Senior

management, under the oversight of the

board of directors, should adhere to

investment practices that are

appropriate for the bank’s individual

circumstances and consistent with these

regulations. The failure to understand

and manage the risks associated with

investment activities will generally be

considered an unsafe and unsound

banking practice.

A. Investment Policy Requirements

Many aspects of the current

investment management regulations are

retained in this proposal. However, the

complexity of many financial products,

both on- and off-balance sheet, compels

the FCA and other Federal financial

institution regulators to advocate a more

comprehensive and institution-wide

approach to risk management. Thus, the

FCA is proposing to strengthen,

redesign, and reorganize this section.

1. Board and Senior Management

Oversight

The introductory paragraph to

proposed § 615.5133 outlines the basic

responsibilities of the board of directors

regarding the investment activities of its

bank. The proposed rule requires the

board to adopt written policies that

specifically identify the purposes and

objectives, risk parameters, delegations

of authority, and reporting requirements

for managing the bank’s investment

portfolio. The investment policy should

also address how investment activities

affect the institution’s capital and

earnings. For this reason, a Farm Credit

bank board may include its investment

policy in a broader asset-liability

management (ALM) or risk management

policy. Oversight by both the board of

directors and senior management of

each Farm Credit bank is an integral
33282 Federal Register / Vol. 63, No. 117 /Thursday, June 18, 1998 / Proposed Rules

2See 58 FR 63034, 63040 (November 30, 1993).

3 In general, whether a given agreement is termed

a ‘‘repurchase agreement’’ or a ‘‘reverse repurchase

agreement’’ depends largely on which party

initiated the transaction. Market participants

typically view the transaction from the dealer’s

perspective. In this preamble and the proposed

regulation, the FCA uses the term ‘‘repurchase

agreement’’ regardless of the perspective from

which the transaction is viewed.

4For a more detailed discussion on managing

risks associated with repurchase agreements, Farm

Credit banks should review the FFIEC’s modified

policy statement on repurchase agreements with

securities dealers and others. See 63 FR 6935

(February, 11, 1998).

5The FCA’s proposed capital regulations provide

more detailed discussions of FCS institution

responsibilities as they relate to interest rate risk

management. See 62 FR 49623 (September, 23,

1997).

part of an effective risk management

program. The board of directors is

responsible for ensuring that

management and operational personnel

have the requisite skills and resources to

manage the risks associated with

investment activities in accordance with

the board’s policies. Annually, the

board of directors of each Farm Credit

bank must review its investment

policies to determine whether objectives

and risk exposure limits continue to be

appropriate for the bank. Senior

management discharges its

responsibility by adhering to the board’s

policies, providing advice to the board,

and safely and soundly conducting

investment activities on both a strategic

and operational basis.

2. Risk Limits

Proposed § 615.5133(a) requires the

board’s policies to define the risk

parameters for the bank’s investment

activities. Foremost, risk parameters are

to be based on the strength of each Farm

Credit bank’s capital position and its

ability to measure and manage risk. The

risk parameters should be consistent

with the bank’s broader business

strategies and institutional objectives.

The bank’s investment policies should

identify the risk characteristics of

permissible investments and establish

risk limits and diversification

requirements for the various classes of

eligible investments and the investment

portfolio. The policies of each Farm

Credit bank should control credit,

market, liquidity, and operational risks

associated with investment activities.

B. Credit Risk

A System bank should not acquire

investments without assessing the

creditworthiness of issuers, obligors, or

other counterparties. Credit risk

generally refers to the risk that an issuer,

obligor, or other counterparty will

default on its obligation to pay the

investor under the terms of the security

or instrument.

Proposed § 615.5133(a)(1) requires

each System bank to establish

comprehensive policies to control credit

risk in its investment portfolio. Each

Farm Credit institution must maintain a

well-diversified investment portfolio.

As a result, every Farm Credit bank

should limit concentrations relating to

single or related counterparties,

geographical areas, industries, or

obligations with similar characteristics.

The FCA proposes to delete current

§ 615.5133(i) relating to specific credit

risk controls on investments in

collateralized mortgage obligations

(CMOs), real estate investment conduits

(REMICs), and asset-backed securities

(ABS), in favor of the broader language

proposed in § 615.5133(a)(1)(i).

Nevertheless, the FCA continues to

expect banks to address concentration

risks associated with CMOs, REMICs,

mortgage-backed securities (MBS), and

ABS by establishing appropriate

portfolio limits on each of these

investments. More specifically, the

policy of each Farm Credit bank should

address minimum pool size, the

minimum number of loans in a pool,

geographic diversification of a pool, and

maximum allowable premiums.

As part of its efforts to control credit

risks, Farm Credit banks should

consider the ability of counterparties to

honor their obligations and

commitments. The selection of dealers,

brokers, and investment bankers

(collectively, securities firms) is an

important aspect of effective

management of counterparty credit risk.

Proposed § 615.5133(a)(1)(ii) requires

bank boards of directors to identify the

criteria for selecting securities firms. A

satisfactory approval process includes a

review of each firm’s financial

statements and an evaluation of its

ability to honor its commitments,

including an inquiry into the general

reputation of the securities firm. In

some situations, it is also prudent for

System banks to review information

from Federal or State securities

regulators and industry self-regulatory

organizations such as the National

Association of Securities Dealers

concerning any formal enforcement

actions against the dealer, its affiliates,

or associated personnel. Proposed

§ 615.5133(a)(1)(ii) also requires the

board of directors to set limits on the

amounts and types of transactions that

the bank can execute with authorized

securities firms. The board of directors

must annually review management’s

selection of securities firms and

limitations on transactions with such

firms.

Proposed § 615.5133(a)(1)(ii) responds

to requests by System banks for

modifications in the FCA’s policy

concerning the board’s role in selecting

securities firms, financial institutions,

and other counterparties. The proposed

rule would no longer require the board

of directors to approve specific

depository institutions where the bank

holds certificates of deposits and

Federal funds. The FCA originally

imposed this requirement on System

banks at a time when small, isolated,

and financially weak commercial banks

were offering brokered deposits with

high rates of return.2 Reforms in the

commercial banking industry and a

widespread awareness of the risks

inherent in such instruments have

lessened FCA’s regulatory concern.

Furthermore, proposed

§ 615.5140(a)(4)(i) sets minimum credit

and maturity limits for investments in

certificates of deposits, Federal funds,

and bankers acceptances.

Proposed § 615.5133(a)(1)(iii) requires

Farm Credit banks to establish

appropriate collateral margin

requirements for repurchase

agreements.3 The FCA is proposing this

amendment, in part, because proposed

§ 615.5140(a)(4)(iv) would expand the

types of securities that Farm Credit

banks may accept as collateral in

repurchase transactions. As a means of

managing potential counterparty credit

risk, it is prudent for System banks to

establish appropriate collateral margin

requirements based on the quality of the

collateral and the terms of the

agreement. Farm Credit banks should

also manage their exposure to loss on

repurchase agreements by regularly

marking the collateral to market and

maintaining control of the collateral.4

C. Market Risk

From a safety and soundness

perspective, it is crucial for the

management of a Farm Credit bank to

fully understand the market risks

associated with investment securities

prior to acquisition and on an ongoing

basis. Market risk is the risk to a bank’s

financial condition resulting from

adverse changes in value of its holdings

arising from movements in interest rates

or prices. The most significant market

risk of investment activities is interest

rate risk. Proposed § 615.5133(a)(2)

would require bank boards to establish

limits on market risk exposure at the

institutional, portfolio, or individual

instrument level. This change

corresponds with pending changes in

other parts of the FCA regulations that

address interest rate risk management.5

To manage market risk exposure,

System banks should evaluate how
Federal Register / Vol. 63, No. 117 /Thursday, June 18, 1998 / Proposed Rules 33283

6The minimum liquidity reserve that System

banks maintain under § 615.5134 must be sufficient

to fund their operations for approximately 15 days

in the event that System access to the capital

markets becomes impeded.

7Two provisions of this regulation,

§ 615.5133(d)(1) and (d)(2) are new, while existing

Continued

individual instruments and the

investment portfolio as a whole affect

the bank’s overall interest rate risk

profile. Bank’s should monitor the price

sensitivity of its investment portfolio

and specify institution-wide interest

rate risk limits. In addition, banks may

find it useful to establish interest rate

risk limits on the investment portfolio

or on certain types of securities. Risk

parameters should be commensurate

with the bank’s ability to measure,

manage, and absorb risk. Boards should

consider the bank’s level of capital and

earnings and its tolerance for market

risk exposure when setting risk

parameters. Market risk limits should be

established in a manner that is

consistent with all relevant regulations,

policies, and guidance issued by the

FCA.

D. Liquidity Risk

The FCA expects Farm Credit banks

to manage liquidity risk at both the

investment and the institutional levels.

System banks may encounter liquidity

risk stemming from market conditions

surrounding individual investment

activities. In this context, liquidity risk

is the risk that a bank would not be able

to easily sell or liquidate an investment

quickly at a fair price. This inability

may be due to inadequate market depth

or market disruption. At the

institutional level, liquidity risk is the

risk that System banks could encounter

a liquidity crisis if they are unable to

fund operations at reasonable rates

because access to the capital markets is

impeded. This impediment may result

from a market disruption or real or

perceived credit problems.

The FCA proposes to repeal a

provision in existing § 615.5134(b)

which requires System banks to

segregate investments held in the

liquidity reserve from investments that

are maintained for the other purposes

permitted by existing § 615.5132. As a

result of this amendment, System banks

will have greater flexibility to decide

how best to use their investments to

manage exposure to risk.6 Since the

liquidity characteristics of an

investment influence whether it is

suitable for meeting particular

institutional objectives, the FCA also

proposes a conforming change to

§ 615.5133(a)(3). Pursuant to this

amendment, the bank’s policies must

specify the desired liquidity

characteristics of investments that it

will use for maintaining a liquidity

reserve and accomplishing other

institutional objectives.

The bank’s investment policies must

also require the bank to maintain

sufficient quantities of liquid

investments to comply with the

liquidity reserve requirements of

§ 615.5134. Pursuant to § 615.5132, each

Farm Credit bank’s total investments,

including its liquidity reserve, cannot

exceed 30 percent of its total

outstanding loans. The FCA expects the

policies of each Farm Credit bank to

strike an appropriate balance between

the need for a liquidity reserve, the

management of interest rate risk, and

the investment of surplus funds as it

strives to accomplish its institutional

objectives.

E. Operational Risk

Operational risk occurs when

deficiencies in internal controls or

information systems result in

unexpected loss to a financial

institution. Operational risk may arise

from inadequate procedures, human

error, information system failure, or

fraud. Internal controls that effectively

detect and prevent operating risks are an

integral part of prudent investment

management. The ability of management

to accurately assess and control

operating risks is often one of the

greatest challenges that financial

institutions face from investment

activities. Therefore, proposed

§ 615.5133(a)(4) would require the board

of directors of each Farm Credit bank to

address operating risks by establishing

policies that foster effective internal

controls.

Organizational structure and reporting

lines should clearly delineate

responsibility and accountability for all

investment management functions,

including risk measurement, risk

management, and oversight.

Organizational structure should

periodically be reviewed to reveal

conflicts of interest or inadequate

checks and balances. Proposed

§ 615.5133(b) specifically requires

System banks to identify who has

delegated authority to conduct

investment transactions and the extent

of that authority. In addition, the

proposed rule requires a separation of

duties and supervision between

personnel executing investment

transactions and those responsible for

approving, revaluating, and overseeing

the bank’s investments. Separation of

duties promotes integrity, accuracy, and

reasonable business practices that

reduce the risk of loss. Senior

management must ensure that bank

investment practices and risk exposure

are regularly reviewed and evaluated by

personnel who are independent from

those responsible for executing

investment transactions.

Existing § 615.5133(h), which the FCA

proposes to modify and redesignate as

§ 615.5133(c), requires Farm Credit

banks to establish appropriate internal

controls to monitor their investment

activities and prevent loss, fraud,

embezzlement, conflicts of interest, and

unauthorized investment practices.

Redesignated § 615.5133(c)(1) adds

conflicts of interest as an issue that

every System bank must specifically

address in its investment policies. The

policies of each Farm Credit bank

should provide guidelines to prevent or

resolve conflicts of interest that may

arise from employees who are directly

involved in purchasing and selling

securities. Furthermore, the bank’s

policies should ensure that all directors,

officers, and employees act in the best

interest of the institution.

Due to the increasingly complex

nature of investment instruments, Farm

Credit banks must maintain information

systems that are capable of monitoring,

measuring, and evaluating the risks

inherent in their investment activities.

Proposed § 615.5133(c)(3) would require

banks to maintain management

information systems that are

commensurate with the nature, scope,

and complexity of the bank’s investment

activities. Internal quantitative models

and management expertise must be

adequate to analyze individual

investment instruments, the investment

portfolio, and the effect investments

have on the bank’s cashflows, earnings,

and capital.

Farm Credit banks may also be

exposed to other sources of operating

risks, such as legal risk that may result

from contracts that are not legally

enforceable. The FCA expects each bank

to adequately assess and control other

operational risks relating to investment

activities. Accordingly, Farm Credit

banks should clearly define

documentation requirements for

securities transactions, retention and

safekeeping of documents, as well as

possession and control of purchased

instruments.

F. Securities Valuation

Accurate and frequent securities

valuation is essential to measuring risk

and monitoring compliance with the

bank’s objectives and risk parameters.

Proposed § 615.5133(d) establishes the

basic requirements for securities

valuations by Farm Credit banks.7
33284 Federal Register / Vol. 63, No. 117 /Thursday, June 18, 1998 / Proposed Rules

§ 615.5140(d) has been modified and redesignated

as proposed § 615.5133(d)(3).

System banks must understand the

value and price sensitivity of their

investments prior to purchase and on an

ongoing basis. System banks should rely

on valuation methodologies that take

into account all the risk elements in a

security to determine its price.

Appropriate securities valuation

practices enable managers to fully

understand the risks and cashflow

characteristics of the investments.

A critical step in sound investment

management is the independent

verification of securities prices.

Accordingly, proposed § 615.5133(d)(1)

requires each Farm Credit bank, at the

time of purchase or sale, to verify the

value of the security (except new issues)

with a source that is independent of the

broker, dealer, counterparty, or other

intermediary in the specific transaction.

Under the proposed rule, independent

verification of price can be as simple as

obtaining a price from an industryrecognized information provider.

Although price quotes from information

providers are not actual market prices,

they confirm whether the broker’s price

is reasonable. In the event that a bank

is unable to obtain a second price quote

on a particular security, a price quote

may be obtained on a security with

substantially similar characteristics.

Proposed § 615.5133(d)(2) requires

Farm Credit banks to determine, at least

monthly, the fair value of each security

in their portfolio and the fair value of

the investment portfolio as a whole.

This provision is added to the

regulations to ensure that management

has the necessary information to assess

the performance of the bank’s

investment portfolio. Additionally, this

requirement enables management to

provide accurate and timely reports to

the board of directors in accordance

with proposed § 615.5133(e).

Existing § 615.5140(c) has been

modified and redesignated as proposed

§ 615.5133(d)(3). Currently,

§ 615.5140(c) requires each Farm Credit

bank to perform ongoing evaluations of

all eligible investments in its portfolio

and to support its evaluation with the

most recent credit rating by at least one

nationally recognized statistical rating

organization (NRSRO). As amended,

proposed § 615.5133(d)(3) specifically

requires Farm Credit banks to perform

evaluations of the credit quality and

price sensitivity to changes in market

interest rates of all investments held in

its portfolio prior to purchase and on an

ongoing basis. This change emphasizes

that effective credit and interest rate risk

management is vital to successful FCS

bank operations.

The substance and form of the

evaluations are likely to vary depending

on the type of instrument. Relatively

simple or standardized instruments

with readily identifiable risks require

significantly less analysis than more

volatile or complex instruments.

Proposed § 615.5141 contains specific

stress testing guidance for evaluating the

price sensitivity of mortgage securities.

Other eligible investments that have

uncertain cashflows as a result of

embedded options (such as call options,

caps or floors) may require similar

analytical techniques to appropriately

evaluate the instruments. For example,

prior to investing in ABS, the FCA

expects a bank to conduct or obtain an

evaluation of the collateral (including

type, aging of the assets, and the credit

quality of the underlying loans) and an

analysis of the securities’ structure and

cashflows.

System banks must continue to

support their credit evaluations by the

most recent credit rating with a NRSRO.

However, Farm Credit banks should not

rely exclusively on NRSRO ratings prior

to purchasing investments because there

may be a lag before an adverse event is

reflected in the credit rating.

G. Reports to the Bank’s Board

Adequate reporting enables bank

boards to properly discharge their

fiduciary responsibilities. The

investment policy should define routine

reporting requirements and the means

for reporting exceptions to policy.

Management reports need to

communicate effectively to the board of

directors the nature of the risks inherent

in the bank’s investment activities.

Reporting should occur frequently so

that the board has timely, accurate, and

sufficient information to understand

how changes in the investment portfolio

affect the balance sheet and the bank’s

risk profile. The FCA proposes to

modify the second sentence of existing

§ 615.5133(h) to emphasize these points

and to redesignate it as § 615.5133(e).

Proposed § 615.5133(e) requires

quarterly reports on the performance

(i.e., gains or losses) and risk of

individual investments and the

investment portfolio. Key risks should

be specifically identified and discussed

in the report. More specifically, reports

should relate potential risk exposure to

changes in market interest rates and any

other factors (such as credit

deterioration) that may affect the value

of the bank’s investment holdings. In

addition, proposed § 615.5133(e)

requires management reports to discuss

how investments affect the bank’s

overall financial condition and to

evaluate whether the performance of the

investment portfolio effectively achieves

the objectives established by the board

of directors. Reports should specifically

identify any deviations from the board’s

policies.

III. Eligible Investments

A. Overview

Section 615.5140 lists the eligible

investments that System banks may

purchase and hold to maintain a

liquidity reserve, manage interest rate

risk, and invest surplus short-term

funds. Associations are also authorized

to hold eligible investments listed in

§ 615.5140 to invest surplus funds and

reduce interest rate risk pursuant to

existing § 615.5141 (redesignated as

§ 615.5142). Only investments that can

be promptly converted into cash

without significant loss are suitable for

achieving these objectives. For this

reason, the eligible investments listed in

both existing and proposed § 615.5140

generally have short maturities and

maintain a high investment grade credit

rating by an NRSRO. Furthermore, all

eligible investments are either traded in

active secondary markets or are valuable

as collateral.

The proposed rule provides System

institutions with a broad array of highquality and liquid investments. The

FCA proposes to expand the list of

eligible investments and to relax or

repeal certain restrictions in existing

§ 615.5140. These revisions reflect

changes in the financial markets as well

as the FCA’s desire to develop a

regulatory framework that can more

readily accommodate innovations in

financial products and analytical tools.

The FCA Board proposes to

restructure the format of § 615.5140 to

accommodate eligible investments that

are newly authorized by the FCA and to

provide an organizational structure that

is easy to understand. Similar classes of

investments, such as full faith and

credit obligations of Federal and State

governments and short-term money

market instruments are now grouped

together in proposed § 615.5140(a). The

FCA proposes to reduce the number of

portfolio caps and repeal existing

regulatory restrictions on the amount

that each FCS institution can invest in

negotiable certificates of deposit,

Federal funds, bankers acceptances, and

prime commercial paper.

Requirements that apply to several

categories of eligible investments have

been relocated to § 615.5140(b). For

example, the requirement that an

investment must be marketable will

now be covered by a single provision in
Federal Register / Vol. 63, No. 117 /Thursday, June 18, 1998 / Proposed Rules 33285

8See FCA BL–038, ‘‘Guidance Relating to

Investment Activities,’’ (November 26, 1997).

proposed § 615.5140(b)(1). Additionally,

the sovereign rating for political and

economic stability of foreign countries,

which is currently repeated several

times in the existing regulation, is

relocated to proposed § 615.5140(b)(2).

The FCA is proposing to revise its

regulatory terminology for credit ratings.

References to the credit ratings of

specific NRSROs are omitted from the

proposed rule so it more accurately

encompasses the broad universe of

market ratings. Instead, the proposed

regulation requires each eligible

investment listed in § 615.5140(a) to

maintain a specified long-term or shortterm credit rating by an NRSRO that is

recognized by the Securities and

Exchange Commission (SEC). Whereas

the existing regulation refers, for

example, to a Standards and Poor’s

(S&P) Corporation rating of ‘‘AA’’ or its

equivalent, the proposed regulation

refers to ‘‘the highest two credit ratings

by an NRSRO.’’ The following table

provides a comparative illustration of

S&P’s investment grades for both longterm and short-term issue credit ratings.

Investment grade

S&P ratings

LongtermShortterm

First ................................ AAA A–1

Second ........................... AA A–2

Third ............................... A A–3

Fourth ............................. BBB

The ratings in the table are often

modified by either plus or minus signs

to show relative standing within a major

rating category. Specific investment

credit ratings in the proposed rule refer

to the generic rating categories, not

modifiers within the generic group.

Thus, for example, a long-term rating of

‘‘AA¥’’ by S&P would be, for the

purposes of FCA’s regulations, within

the ‘‘two highest credit ratings by an

NRSRO.’’

The following section provides a

category-by-category discussion of the

FCA’s proposed regulatory framework

for eligible investments.

B. U.S. Treasury and Agency Securities

The FCA retains § 615.5140(a)(1)

without revision. This provision

authorizes each FCS institution to invest

in obligations that are backed by the full

faith and credit of the United States, its

agencies, instrumentalities, and

corporations. In response to frequent

questions about the scope of this

provision, the FCA confirms that

§ 615.5140(a)(1) permits the purchase of

debt obligations of other Governmentsponsored enterprises (GSEs). Private

obligations that are fully insured or

guaranteed as to both principal and

interest by the United States, its

agencies, instrumentalities, or

corporations are also covered by this

regulation. Thus, for example, a System

institution may hold federally insured

deposits, loans that are guaranteed by

either the Export-Import Bank of the

United States or the Overseas Private

Investment Corporation, and certain

obligations of the Small Business

Administration.

C. Municipal Securities

The FCA proposes to redesignate

§ 615.5140(a)(10), which authorizes the

investment in the general obligations of

State and municipal governments, as

§ 615.5140(a)(2), without significant

change. The FCA proposes to add a

definition of ‘‘general obligation of a

State or political subdivision’’ to

§ 615.5131 to codify its recent guidance

on which bonds are deemed to be

backed by the full faith and credit of a

State or local government.8 Under this

definition, general obligation bonds are

those that are: (1) Full faith and credit

obligations of a State or local

government that possesses powers of

general taxation; or (2) obligations of a

governmental unit that lacks powers of

general taxation if an obligor possessing

general powers of taxation

unconditionally guarantees to make all

payments on these obligations.

System banks have requested

authority to invest in municipal revenue

bonds. These bonds are not supported

by the taxation powers of the obligor

and are repayable from fee income and

other sources of revenue. Although

many municipal revenue bonds are

highly rated by NRSROs and are

actively traded in secondary markets,

others are not. The universe of

municipal revenue bonds is also

diverse, and effective regulation of

System investment in these securities

could be difficult. For these reasons, the

FCA requests comments on how it could

permit these investments while limiting

risks to System institutions.

Specifically, the FCA solicits comments

on how the regulation could establish:

(1) Criteria for determining which

revenue bonds are suitable for meeting

the investment purposes in § 615.5132;

and (2) an appropriate limit on the

amount of these investments.

D. International and Multilateral

Development Banks

Obligations of the International Bank

for Reconstruction and Development

(World Bank) are eligible investments

under existing § 615.5140(a)(3). The

FCA’s proposal expands the scope of

this provision to include the obligations

of other international and multilateral

development banks (such as the InterAmerican Development Bank and the

North American Development Bank) in

which the United States is a voting

shareholder. This amendment

recognizes other highly rated banks that

work in concert with the World Bank to

promote development in various

countries.

E. Money Market Instruments

Several provisions of existing

§ 615.5140(a) authorize investments in

negotiable certificates of deposit,

Federal funds, bankers acceptances,

prime commercial paper, and

repurchase agreements. These money

market instruments have high credit

quality and short maturities.

Additionally, they can be sold on active

secondary markets prior to maturity.

These qualities make them highly liquid

and valuable as collateral. Accordingly,

the FCA proposes to group all money

market instruments together into a

single regulatory provision,

§ 615.5140(a)(4). Since these money

market instruments pose limited risks to

investors, the FCA believes that this

regulation should no longer impose

specific limitations on the amounts of

negotiable certificates of deposit,

Federal funds, bankers acceptances, and

prime commercial paper that each FCS

institution could hold in its investment

portfolio. However, § 615.5140(b)(3)

continues to restrict the amount that an

FCS institution could invest with a

single obligor or institution to 20

percent of its total capital. The FCA is

also proposing to omit the definitions of

negotiable certificates of deposit,

Federal funds, and Term Federal funds

from existing § 615.5131 because the

meanings of these instruments are

commonly understood by participants

in the money markets. Additionally, the

FCA has relocated the definitions of

prime commercial paper and repurchase

agreements from existing § 615.5131 to

proposed § 615.5140(a)(4) so these

regulations are easier to read.

The FCA proposes to omit specific

references to Eurodollar and Yankee

certificates of deposits from § 615.5131

and § 615.5140 because proposed

§ 615.5140 (a)(4)(i) is sufficiently broad

to permit investment in both of these

instruments. The provision in existing

§ 615.5140(a)(5) regarding deposit

insurance for domestic and Yankee

certificates of deposit became redundant

in 1996 when the FCA amended

§ 615.5140(a)(1) to specifically cover

Federal insurance of private debt
33286 Federal Register / Vol. 63, No. 117 /Thursday, June 18, 1998 / Proposed Rules

9See 61 FR 67187 (December 20, 1996).

10Master Notes are interest-bearing unsecured

promissory notes that are issued by institutions to

investors under a master note agreement. The most

common type of master note agreement is a

variable-amount note which is a type of open-ended

commercial paper that allows the investment and

withdrawal of funds on a daily basis and pays a

daily interest rate tied to the commercial paper rate.

11See 58 FR 63035, (November 30, 1993). Private

label mortgage securities are issued by commercial

banks, thrifts, and private conduits. Unlike agency

securities, private label mortgage securities must be

registered with the SEC.

12Section 615.5174 permits Farm Credit banks

and associations to invest in mortgage-related

securities that are guaranteed by the Federal

Agricultural Mortgage Corporation (Farmer Mac).

obligations.9 Deposit insurance usually

is not a consideration when an FCS

institution purchases negotiable

Eurodollar certificates of deposit

because only a small portion of its

investment is typically insured.

System banks requested authority to

invest in Eurodollar time deposits. A

Eurodollar time deposit is a nonnegotiable deposit denominated in

United States dollars that is issued by

an overseas branch of a United States

bank or by a foreign bank outside the

United States. The riskiness of

Eurodollar time deposits depends on

both the creditworthiness of the issuing

bank and the foreign country where the

deposit is located. Financial institutions

generally use Eurodollar time deposits

as an alternative to Federal funds. Most

Eurodollar time deposits mature within

180 days.

The FCA agrees that Eurodollar time

deposits are suitable for investing shortterm surplus funds and interest rate risk

management. However, the FCA

proposes several safety and soundness

constraints for Eurodollar time deposits

because these instruments are not

negotiable and they are held at

depository institutions outside of the

United States. Specifically, proposed

§ 615.5140(a)(4)(ii) allows each FCS

institution to invest in Eurodollar time

deposits that mature within 90 days and

that are issued by depository

institutions that maintain the highest

short-term issuer credit rating by an

NRSRO. In addition, proposed

§ 615.5140(b)(2) further requires

Eurodollar time deposits to be held at

depository institutions located in

foreign countries that maintain the

highest sovereign rating for political and

economic stability. The FCA also

proposes to limit investments in

Eurodollar time deposits to 20 percent

of an FCS institution’s total investment

portfolio to control concentration risk in

these non-negotiable instruments.

System banks also requested authority

to invest in certificates of deposits that

mature within 3 years but contain a put

option that enables the investor to

require the depository institution to

repurchase the instrument. The FCA’s

research reveals that the market for

certificates of deposits with embedded

put options is almost nonexistent, and

no commercial banks have issued these

instruments in several years. These

instruments are neither liquid nor

traded in active secondary markets.

Commercial banks have engineered the

few existing certificates of deposits with

put options for specific customers.

Therefore, the FCA has not added these

instruments to the list of eligible

investments in the proposed rule.

Prime commercial paper remains an

eligible investment under the proposed

regulations. The FCA has redesignated

§ 615.5140(a)(7) as § 615.5140(a)(4)(iii).

The FCA proposes to expand the

types of collateral that support eligible

repurchase agreements. System banks

have asserted that the FCA’s investment

eligibility criteria limit their ability to

participate in the repurchase agreement

market because market participants are

often unwilling to post collateral that

specifically complies with the

investment criteria in existing

§ 615.5140. The FCA acknowledges that

repurchase transactions can be a

valuable tool for investing short-term

surplus funds, and they are relatively

safe due to short maturities, high quality

of collateral, and collateral margin

requirements. For this reason, the FCA

proposes to amend this regulation. The

proposed regulatory approach will

allow more latitude to participate in this

market, while maintaining essential

safety and soundness controls.

Redesignated § 615.5140(a)(4)(iv)

permits each FCS institution to invest in

repurchase agreements where the FCS

institution agrees to purchase

marketable securities subject to a legal

agreement that requires the counterparty

to repurchase the same or identical

securities at a specific price within 100

days or less. Any securities held as

collateral in connection with repurchase

agreements must be either eligible

investments authorized by this section

or other marketable securities that are

rated in the highest credit rating

category by an NRSRO. In the event that

the counterparty defaults on the

agreement and the FCS institution takes

possession of the collateral, the

divestiture requirements in existing

§ 615.5142 (redesignated as proposed

§ 615.5143) apply to any collateral that

fails to qualify as an eligible investment

under § 615.5140(a).

In 1995, the FCA approved a System

request to invest in Master Notes

pursuant to existing § 615.5140(a)(11),

which permits the FCA to authorize

additional investments on a case-bycase basis. As requested, the FCA

proposes § 615.5140(a)(4)(v) to codify

System institutions’ authority to invest

in Master Notes.10 The proposed

regulation authorizes investments in

Master Notes that: (1) Are executed with

a domestic counterparty that maintains

the highest issuer short-term credit

rating by an NRSRO; and (2) mature

overnight or within 270 days under a

callable contract. The FCA also

proposes to increase the portfolio limit

on Master Notes from 15 to 20 percent

of the FCS institution’s investment

portfolio.

F. Mortgage Securities

1. Overview

Currently, § 615.5140(a)(2) authorizes

investment in mortgage securities that

are issued or guaranteed by the

Government National Mortgage

Association (Ginnie Mae or GNMA), the

Federal National Mortgage Association

(Fannie Mae or FNMA), and the Federal

Home Loan Mortgage Corporation

(Freddie Mac or FHLMC). CMOs that are

collateralized by mortgage securities of

GNMA, FNMA and FHLMC are also

expressly authorized under the current

regulations, even though they are

packaged, issued, and sold under a

private label.11 Under the existing

regulation, eligible mortgage securities

must either reprice within 1 year or

comply with the stress tests specified in

§ 615.5140(a)(2)(iii).12 System banks

may hold mortgage securities that are

issued or fully guaranteed by Ginnie

Mae without restriction as to amount.

However, the existing regulation

restricts mortgage securities that are

issued or fully guaranteed by Fannie

Mae and Freddie Mac to 50 percent of

each bank’s total investments.

System banks seek further

opportunities to invest in the mortgage

securities market because of the high

credit quality and liquidity of these

securities. In particular, Farm Credit

banks have requested authority to invest

in mortgage securities that are

collateralized by loans that do not

comply with the FNMA and FHLMC

underwriting standards and certain

stripped mortgage-backed securities

(SMBS). Recently, System banks

petitioned the FCA to repeal the

portfolio limit on Fannie Mae and

Freddie Mac mortgage securities. This

request also suggested that the revised

regulation authorize FCS institutions to

invest in mortgage securities that are

rated within the two highest investment

credit grades by an NRSRO. The
Federal Register / Vol. 63, No. 117 /Thursday, June 18, 1998 / Proposed Rules 33287

13Several other asset classes in the non-agency

MBS market exist, including: (1) Housing and

Urban Development paper; (2) high loan-to-value

loans; (3) Community Reinvestment Act loans; and

(4) loans to borrowers with conforming loan

balances with other features that prevent agency

securitization, such as low documentation, selfemployment, and unique property features.

14The proposed rule allows investments in

mortgage securities that are offered and sold

pursuant to section 4 (5) of the Securities Act of

1933, 15 U.S.C. 77d(5), or are residential mortgage

related securities within the meaning of section 3

(a) (41) of the Securities Exchange Act of 1934, 15

U.S.C. 78c(a) (41). SMMEA amended several

statutes to encourage private sector investment in

certain mortgage-related securities. See Pub. L. 98–

440, 98 Stat. 1689, October 3, 1984.

15A recent FCA bookletter explains the authority

of System banks to invest in fixed-rate mortgage

securities that convert to adjustable rate securities.

See BL–038, ‘‘Guidance Relating to Investment

Activities,’’ (November 26, 1997).

16Under existing § 615.5140(a)(2)(ii), each fixedrate mortgage security must have a weighted

average life (WAL) of 5 years or less, and changes

in its WAL and price cannot exceed specified

percentages, assuming parallel and sustained shift

in interest rates of 300 basis points.

17Existing § 615.5131(r) defines SMBS as

‘‘securities created by segregating the cashflows

from the underlying mortgages or mortgage

securities to create two or more new securities, each

with a specified percentage of the underlying

security’s principal payments, interest payments, or

combination of the two.’’ Furthermore, existing

§ 615.5140(a)(2)(v)(A) and 615.5174(c) specifically

prohibit System banks from acquiring SMBS that

are issued by GNMA, FNMA, FHLMC, and the

Farmer Mac. When the existing regulations were

adopted, the FCA reasoned that SMBS exhibit

extreme price volatility to shifting interest rates,

and therefore, these instruments were not suitable

for maintaining a liquidity reserve or managing

interest rate risk. See 56 FR 65091, 65096

(December 18, 1991); 58 FR 63034, 63046

(November 30, 1993).

proposed rule permits investment in a

greater variety of mortgage securities,

subject to essential safety and

soundness constraints.

2. Limits on FNMA and FHLMC

Mortgage Securities

As previously noted, System banks

requested that the FCA repeal the 50-

percent investment portfolio limit on

mortgage securities that are issued or

guaranteed as to principle and interest

by FNMA and FHLMC. System banks

commented that no other financial

institution regulatory agency places

restrictions on the credit exposure to

GSEs and that exposure limits on these

securities should be left to the

discretion of each bank.

At this time, the FCA does not

propose to repeal the existing portfolio

limits for FNMA and FHLMC mortgage

securities. As explained in greater detail

below, the proposed regulation

significantly expands the authority of

System institutions to purchase and

hold mortgage securities. The FCA’s

proposal will permit System institutions

to invest, for the first time, in nonagency mortgage securities. Under

certain circumstances, System banks

would also be able to hold mortgage

derivative products, such as SMBS, for

interest rate risk management.

Additionally, the new regulations will

enable System institutions to rely on

alternate stress tests for measuring the

price sensitivity of mortgage securities.

The FCA agrees with System

commenters that the board and

management of each FCS institution

should establish risk exposure limits for

all mortgage securities. A regulatory

portfolio limit on FNMA and FHLMC

mortgage securities does not absolve an

institution’s board or management of its

responsibility to establish risk

parameters that are based on the

institution’s unique risk-bearing

capacity. The FCA also expects each

FCS institution to maintain a welldiversified investment portfolio,

regardless of whether these regulations

impose a portfolio cap on particular

classes of investments.

Regulatory portfolio limits enhance

safety and soundness by limiting credit

exposure, promoting diversification of

System investment portfolios, and

curtailing investments in securities that

may exhibit considerable interest rate or

liquidity risks. The FCA invites further

comment about this issue.

3. Non-agency Mortgage Securities

The size and liquidity of the nonagency mortgage securities market has

increased markedly since the

implementation of the current

regulations in 1993. The largest sector of

the non-agency market is comprised of

securities that are collateralized by

‘‘jumbo’’ mortgages with principal

amounts that exceed the maximum

limits for FNMA and FHLMC

programs.13

The credit quality and liquidity of any

particular non-agency mortgage security

are dependent upon a myriad of factors,

including the type of collateral and the

structure, term, and originator of the

issue. Non-agency mortgage securities

are not explicitly or implicitly

guaranteed by the United States, so

these instruments typically require

credit enhancements to receive a high

rating. Credit enhancement is usually

provided by some combination of issuer

or third-party guarantee, letter of credit,

over-collateralization, pool insurance, or

subordination. As a result of these credit

enhancements, highly rated non-agency

mortgage securities enjoy low default

rates.

The FCA determines that non-agency

mortgage securities that maintain the

highest credit rating by an NRSRO have

sufficient protections against default

risk. Proposed § 615.5140(a)(5)(ii)

permits each System institution to

invest in mortgage securities that are

offered by private sector entities. Under

this proposal, privately issued mortgage

securities are eligible investments for

System institutions if they are rated in

the highest rating category by an NRSRO

and they are collateralized by qualifying

residential mortgages, meeting the

requirements of the Secondary Mortgage

Market Enhancement Act of 1984

(SMMEA).14 Prior to investing in such

securities, every System bank must

subject each non-agency mortgage

security to stress testing in accordance

with § 615.5141. Non-agency mortgage

securities cannot exceed 15 percent of

each institution’s total investments.

Furthermore, mortgage securities that

are issued by any party other than

Ginnie Mae cannot exceed 50 percent of

each institutions’ total investments.

This amendment balances the System’s

request for a broader selection of

mortgage securities with appropriate

safety and soundness restraints.

4. Fixed-rate Mortgage Pass-through

Securities

Currently, fixed-rate mortgage

securities are eligible investments for

System institutions if they satisfy the

three-pronged stress test in existing

§ 615.5140(a)(2)(ii).15 This stress test

provides a basic method for measuring

the price sensitivity of a mortgage

security to changes in interest rates.16

System banks requested that the FCA

repeal the requirement in existing

§ 615.5140(a)(2) that subjects mortgage

pass-through securities to the stress test.

The Farm Credit banks asserted that

interest rate risk in mortgage passthrough securities is easier to model and

analyze and other federally regulated

financial institutions are not subject to

similar requirements.

The FCA believes that stress testing of

all mortgage securities is a necessary

discipline that enables each System

institution to better understand and

manage the risks inherent in these

instruments. Therefore, the FCA does

not incorporate the System’s suggestion

in this proposal. However, as discussed

below, the FCA proposes significant

changes to the stress-testing

requirements for mortgage securities.

5. Other Mortgage-derivative Products

The FCA also plans to repeal existing

§§ 615.5131(r) and (s), 615.5140(a)(2)(v),

and certain provisions in § 615.5174(c)

that explicitly ban investments in SMBS

and inverse floating-rate debt classes.17

System banks claim that the explicit ban

on SMBS is overly broad and, as a
33288 Federal Register / Vol. 63, No. 117 /Thursday, June 18, 1998 / Proposed Rules

18See 63 FR 20191 (April 23, 1998).

result, it excludes securities with

limited interest rate risk. The FCA

concludes that the explicit regulatory

ban on certain mortgage-derivative

products is unnecessary because all

mortgage securities are subject to stresstesting requirements under both the

current and proposed rules. The degree

of price sensitivity that a mortgage

security exhibits to changes in market

interest rates is influenced by its unique

characteristics. A System institution

should determine whether a particular

mortgage security meets its risk

management objectives by using

analytical techniques and

methodologies that effectively evaluate

how interest rate changes will affect

prepayments and cashflows of the

instrument.

Repeal of these regulatory restrictions

will afford each System institution

greater latitude to manage interest rate

risks in the investment portfolio and its

balance sheet. Although certain

mortgage derivative products are risky

because their prices may be subject to

substantial fluctuations, the FCA

recognizes that they can also be useful

tools for reducing interest rate risk.

Successful risk management of these

instruments requires a thorough

understanding of the principles that

govern the pricing of these instruments.

In general, FCA would view it as an

unsafe and unsound practice to hold

SMBS and inverse floaters for any

purpose other than to reduce specific

interest rate risks. Management must

document, prior to purchase and each

quarter thereafter, that the mortgage

derivative product is reducing the

interest rate risk of a designated group

of assets or liabilities and the interest

rate risk of the institution. However, if

such an instrument exhibits only

minimal price sensitivity under the

stress test in proposed § 615.5141, a

System institution would be allowed to

purchase and hold the instrument for

other purposes permitted by existing

§ 615.5132.

6. Stress-testing Requirements

Although credit risk on highly rated

mortgage securities is minimal, these

securities may expose investors to

significant interest rate risk. Since

borrowers may prepay their mortgages,

investors may not receive the expected

cashflows and returns on these

securities. Numerous factors influence

the cashflow pattern and price

sensitivity of mortgage securities.

Prepayments on these securities are

affected by the spread between market

rates and the actual interest rates of

mortgages in the pool, the path of

interest rates, and the unpaid balances

and remaining terms to maturity on the

mortgage collateral. The price behavior

of a mortgage security also depends on

whether the security was purchased at

a premium or at a discount. Therefore,

each System institution needs to employ

appropriate analytical techniques and

methodologies to measure and evaluate

interest rate risk inherent in mortgage

securities. More specifically, prudent

risk management practices require every

System institution to examine the

performance of each mortgage security

under a wide array of possible interest

rate scenarios. For these reasons, the

FCA continues to believe that

appropriate stress testing of all mortgage

securities is necessary to gain a full

understanding of the risks inherent in

the instruments.

Originally, FCS banks requested

technical modifications to FCA’s

existing regulatory stress test. System

banks subsequently requested that the

FCA repeal the regulatory stress test

after the FFIEC rescinded a policy

statement that required depository

institutions to stress test mortgage

derivative products.18 The System

banks commented that the FCA should

make its regulatory approach consistent

with the FFIEC’s new policy.

In response, the FCA proposes

significant changes to existing

requirements for evaluating the price

sensitivity of mortgage securities and

determining their suitability. The FCA’s

revised regulatory approach reflects

improvements in prepayment models

and methodologies for evaluating and

measuring the price sensitivity of a

security. Specifically, this proposal

would enable each FCS institution to

choose between two alternative

approaches for measuring and

evaluating the price sensitivity of

mortgage securities to interest rate

fluctuations.

Under the first option, an FCS

institution may continue to use a

modified version of the existing threepronged stress test. The FCA proposes

to modify the third prong of the stress

test, which establishes a price

sensitivity limit for mortgage securities.

Under proposed § 615.5141(a)(3), the

estimated change in the price of the

security cannot exceed 13 percent due

to an immediate and sustained parallel

shift in the yield curve of plus or minus

300 basis points. This revision, which

was originally requested by System

banks, corrects an inconsistency in the

test that may arise under certain interest

rate scenarios. This change affords more

latitude for investment in mortgage

securities.

Proposed § 615.5141(b) allows the use

of alternative stress tests to evaluate the

price sensitivity of investments in

mortgage securities. The FCA is

permitting alternative stress tests

because new risk management

technologies better enable investors to

measure interest rate risks in complex

mortgage securities. Alternative stress

tests must be able to measure the price

sensitivity of mortgage instruments over

different interest rate/yield curve

scenarios prior to purchase and each

quarter thereafter. The methodology that

an FCS institution uses to analyze

mortgage securities must be

commensurate with the complexity of

the instrument’s structure and

cashflows. For example, a pre-purchase

analysis may show the effect of an

immediate and parallel shift in the yield

curve of plus and minus 100, 200, and

300 basis points. Depending on the

instrument’s complexity, such analysis

may encompass a wider range of

scenarios, including non-parallel

changes in the yield curve. A

comprehensive analysis may also take

into consideration other relevant factors,

such as interest rate volatility and

changes in credit spreads. The

methodology used to evaluate an

instrument’s price sensitivity should

enable management to determine that

the particular mortgage security: (1) Is

compatible with the objectives and risk

limits in the institution’s investment

policies; and (2) does not expose capital

and earnings to excessive risk.

An FCS institution employing

internal models for valuation and risk

measurement of mortgage securities

should have adequate procedures to

validate the models and periodically

review all elements of the modeling

process, including assumptions and risk

measurement methodologies and

techniques. Any FCS institution that

relies on third parties for valuation and

risk measurement must understand the

assumptions and techniques used. All

analysis must be available for review by

the Office of Examination of the FCA.

7. Other Technical Changes

The FCA proposes to replace the

definitions of ‘‘CMOs,’’ ‘‘mortgagebacked securities,’’ and ‘‘REMICs’’ in

existing § 615.5131(e), (l), and (p) with

a single definition of ‘‘mortgage

securities’’ in proposed § 615.5131(i),

which encompasses mortgage passthrough securities and all mortgage

derivative products. Although proposed

§ 615.5131(i) continues to refer to CMOs

and REMICS, the FCA has omitted

specific regulatory definitions for these

securities from the regulation because
Federal Register / Vol. 63, No. 117 /Thursday, June 18, 1998 / Proposed Rules 33289

19See 58 FR 63034, 63050 (November 30, 1993).

20Although the System’s recommendation did

not address the credit rating for ABS, the FCA

proposes to retain the requirement in the existing

regulation that all eligible ABS maintain the highest

credit rating by an NRSRO.

their meanings are commonly

understood in the financial markets.

The FCA proposes to relocate the

applicable regulatory provision

governing ARM securities from

§ 615.5140(a)(2)(ii) to § 615.5141 and to

delete the definition of ‘‘adjustable-rate

mortgage’’ in existing § 615.5131(b)

because it is redundant.

G. Corporate Debt Obligations and ABS

Currently, corporate debt obligations

and ABS are subject to a single

regulatory provision, existing

§ 615.5140(a)(8). Under the existing

regulation, corporate bonds and ABS,

combined, cannot exceed 15 percent of

the total investments of each FCS

institution. Under this proposal,

corporate bonds and ABS would be

governed by separate regulatory

provisions, and the portfolio cap for

each category would be 20 percent of

total outstanding investments. The

FCA’s proposal to expand the portfolio

limits for these two investments

provides every FCS institution with

greater flexibility to invest in these

securities within reasonable risk

diversification parameters.

Existing § 615.5140(a)(8)(ii) authorizes

each FCS institution to invest in ABS

that mature in 5 years, are collateralized

by loans on new automobiles (CARs) or

credit card receivables (CARDs), and

maintain the highest investment grade

credit rating by an NRSRO. The FCA

adopted § 615.5140(a)(8)(ii) in 1993

when CARs and CARDs comprised

approximately 80 percent of the ABS

market and other types of ABS were not

actively traded in the secondary

markets.19

The scope and depth of the ABS

market has expanded rapidly since

1993. As a result, System banks have

requested authority to invest in ABS

that are collateralized by other types of

assets. Originally, System banks

petitioned the FCA for authority to

purchase and hold ABS that are secured

by home equity loans, manufactured

housing loans, agricultural equipment

loans, student loans, and wholesale

dealer automobile loans. Subsequently,

System banks requested that the FCA

amend the regulation so it places no

restrictions on the types of collateral

that securitize ABS. System banks assert

that a high credit rating is more

indicative of an ABS’s liquidity than its

underlying collateral. Farm Credit banks

also suggested that the FCA revise the

maturity limits on ABS to permit fixedrate ABS that have both a final maturity

of 7 years or less and a WAL of 5 years

or less, and floating-rate ABS that have

both a final maturity of 10 years or less

and a WAL of 7 years or less.

This proposal adopts a modified

version of the System’s original

recommendation.20 Proposed

§ 615.5140(a)(6) would authorize

investment in ABS that are

collateralized by CARs, CARDs, home

equity loans, manufactured housing

loans, equipment loans, student loans,

and wholesale dealer automobile loans.

The FCA emphasizes that securities

collateralized by home equity loans are

ABS, not mortgage securities, under this

proposal. The FCA finds that the market

for these types of ABS is sufficiently

developed and that these securities are

suitable for meeting the objectives of

§ 615.5132. This broad array of ABS

should provide FCS institutions with an

ample selection of highly rated, fixedincome investments that have relatively

stable cashflows.

Under proposed § 615.5140(a)(6), FCA

specifies that the WAL for all eligible

ABS cannot exceed 5 years and the final

maturity cannot exceed 7 years. The

FCA proposes to extend the final

maturity from 5 to 7 years in recognition

that ABS with final maturities of 7 years

typically have much shorter WALs. This

approach has the added advantage of

facilitating comparisons between

amortizing ABS and other fixed-income

securities. The FCA does not adopt the

System’s suggestion regarding the

maturity of adjustable-rate ABS for two

reasons. Most ABS have final maturities

that are shorter than the timeframe

recommended by Farm Credit banks.

Other factors, such as the frequency of

repricing, periodic and life-time interest

rate caps and the index to which the

instrument is tied are important

determinants of how the instrument will

perform. Therefore, the FCA requests

comments on how the regulations could

address maturity limits for adjustable

ABS.

The FCA anticipates that there will be

further growth in the ABS market and

active secondary markets will ultimately

develop for ABS that are backed by

other types of collateral. Thus, the FCA

also requests comments on how it could

develop a more flexible final regulation

that would enable the regulator to

establish criteria for determining the

suitability of new types of ABS that

financial markets may create.

The FCA proposes no substantive

changes to the regulatory provisions that

govern investments in corporate debt

obligations. Under this proposal,

existing § 615.5140(a)(8)(i) will be

redesignated as § 615.5140(a)(7).

H. Shares in Investment Companies

The FCA believes that investment

companies provide System institutions

with another convenient method to

diversify and manage risks. Therefore,

the FCA proposes to authorize

investment in shares of any investment

company that is registered under section

8 of the Investment Company Act of

1940, 15 U.S.C. 80a–8, as long as the

investment company’s portfolio consists

exclusively of securities that are

authorized by § 615.5140. Prior to

investing in a particular investment

company, an FCS institution would be

required by proposed § 615.5140(a)(8) to

evaluate the investment company’s risk

and return objectives. As part of this

evaluation, the FCS institution should

determine whether the investment

company’s use of financial derivatives is

consistent with its investment policies.

For instance, the FCA would generally

view it an unsafe and unsound practice

for an FCS institution to invest in an

investment company that uses financial

derivatives for speculative purposes

rather than as a risk management tool.

Every System institution should

maintain appropriate documentation on

each investment, including a prospectus

and analysis, so its investment and

selection process can be audited and

examined.

Proposed § 615.5140(b)(5) addresses

how the obligor and portfolio

limitations in § 615.5140(b)(3) and (b)(4)

apply to an FCS institution’s interest in

an investment company. Generally,

proposed § 615.5140(b)(5)(i) requires

combining the institution’s direct

holdings of an eligible investment with

its pro rata interest in the same type of

instrument in the portfolio of an

investment company for the purpose of

complying with § 615.5140(b)(3),

(b)(4)(i), and (b)(4)(ii). The FCA notes

that aggregation is required only if this

regulation subjects a particular

investment to an obligor or portfolio

limit. For example, prime commercial

paper is subject to an obligor limit, but

not a portfolio limit. As a result, the

regulation requires aggregation to ensure

that no more than 20 percent of an FCS

institution’s total capital is invested in

the prime commercial paper of any

single obligor. However, no regulatory

restriction applies to the amount of

prime commercial paper that an FCS

institution may hold in its investment

portfolio, either directly or through an

investment company.

Proposed § 615.5140(b)(5)(ii) carves

out two exceptions to this aggregation

rule. The first exception applies to the
33290 Federal Register / Vol. 63, No. 117 /Thursday, June 18, 1998 / Proposed Rules

obligor limit, while the second

exemption covers portfolio restrictions.

Under § 615.5140(b)(5)(ii)(A), an FCS

institution may elect not to combine its

pro rata interest in a particular security

in an investment company with its

direct holdings of securities that are

issued by the same obligor if the

investment company’s holdings of the

securities of any one issuer do not

exceed 5 percent of its total portfolio.

Pursuant to § 615.5140(b)(5)(ii)(B), an

FCS institution may elect not to

combine its pro rata interest in a type

of security in an investment company

with its direct holding of a class of

securities that are subject to the

portfolio limits if its shares in a

particular investment company do not

exceed 10 percent of its total

investments.

I. Other Eligible Investments

The FCA proposes to redesignate

existing § 615.5140(a)(11) as

§ 615.5140(a)(9). This proposal contains

no substantive amendments to this

provision, which allows the purchase of

other short-term investments, as

authorized by the FCA that are

marketable and highly rated by an

NRSRO. Whenever possible, the FCA

seeks to repeal regulatory prior-approval

requirements that are not mandated by

the Act. The FCA requests comments on

how the final regulation could permit

FCS institutions, under certain

circumstances, to invest in short-term,

highly rated, marketable securities that

are not expressly authorized by

§ 615.5140 without requiring Agency

approval.

IV. Technical Amendments

The FCA proposes several conforming

amendments to § 615.5174 relating to

investments in securities issued by

Farmer Mac. The terminology for

mortgage securities has been revised so

that it is consistent with proposed

amendments to § 615.5131.

The FCA proposes to repeal the

definitions of ‘‘asset-liability

management,’’ ‘‘Federal funds,’’

‘‘interest rate risk,’’ ‘‘market value of

equity,’’ ‘‘net interest income,’’ ‘‘total

capital,’’ and ‘‘weighted average

maturity’’ in § 615.5131 because the

meanings of these terms are commonly

understood in financial markets.

Separately, the FCA has redefined

‘‘absolute final maturity’’ in

§ 615.5131(a) as ‘‘final maturity’’ in

proposed § 615.5131(c).

The FCA also proposes to repeal

§ 615.5142(a) and remove the

designation from paragraph (b) because

this provision is obsolete. Existing

§ 615.5142(a) pertains to the divestiture

of investments that were rendered

ineligible when the FCA originally

adopted these regulations in 1993.

List of Subjects in 12 CFR Part 615

Accounting, Agriculture, Banks,

banking, Government securities,

Investments, Rural areas.

For the reasons stated in the

preamble, part 615 of chapter VI, title 12

of the Code of Federal Regulations is

proposed to be amended to read as

follows:

PART 615—FUNDING AND FISCAL

AFFAIRS, LOAN POLICIES AND

OPERATIONS, AND FUNDING

OPERATIONS

1. 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.

2. Subpart E is amended by revising

the heading to read as follows:

Subpart E—Investment Portfolio

Management

3. Section 615.5131 is revised to read

as follows:

§ 615.5131 Definitions.

For purposes of this subpart, the

following definitions shall apply:

(a) Asset-backed securities (ABS)

mean investment securities that provide

for ownership of a fractional undivided

interest or collateral interests in specific

assets of a trust that are sold and traded

in the capital markets. For the purposes

of this subpart, ABS exclude mortgage

securities that are defined in

§ 615.5131(i).

(b) Eurodollar time deposit means a

non-negotiable deposit denominated in

United States dollars and issued by an

overseas branch of a United States bank

or by a foreign bank outside the United

States.

(c) Final maturity means the last date

on which the remaining principal

amount of a security is due and payable

(matures) to the registered owner. It

shall not mean the call date, the

expected average life, the duration, or

the weighted average maturity.

(d) General obligations of a State or

political subdivision means:

(1) The full faith and credit

obligations of a State, the District of

Columbia, the Commonwealth of Puerto

Rico, a territory or possession of the

United States, or a political subdivision

thereof that possesses general powers of

taxation, including property taxation; or

(2) An obligation payable from a

special fund or by an obligor not

possessing general powers of taxation

when an obligor possessing general

powers of taxation, including property

taxation, has unconditionally promised

to make payments into the fund or

otherwise provide funds to cover all

required payments on the obligation.

(e) Liquid investments are assets that

can be promptly converted into cash

without significant loss to the investor.

In the money market, a security is liquid

if the spread between bid and ask prices

is narrow and a reasonable amount can

be sold at those prices.

(f) Loans are defined by § 621.2(f) of

this chapter and are calculated quarterly

(as of the last day of March, June,

September, and December) by using the

average daily balance of loans for the

quarter then ended.

(g) Market risk means the risk to the

bank’s financial condition resulting

from a decline in value of its holdings

arising from changes in interest rates or

market prices. A bank’s exposure to

market risk can be measured by

assessing the effect of changing rates

and prices on either earnings or

economic value of an individual

instrument, a portfolio, or the entire

institution.

(h) Marketable investment means an

asset that can be sold with reasonable

promptness at a price that reasonably

reflects its fair value in an active and

universally recognized secondary

market.

(i) Mortgage securities means

securities that are either:

(1) Collateralized with residential

mortgage loans (excluding home equity

loans) that represent ownership of a

fractional undivided interest in a

specific pool of mortgages (commonly

known as pass-through securities or

participation certificates), or

(2) A multi-class, pay-through bond

backed by a pool of residential mortgage

pass-through securities or residential

mortgage loans (including securities

commonly known as collateralized

mortgage obligations and real estate

mortgage investment conduits).

(j) Nationally Recognized Statistical

Rating Organization (NRSRO) means a

rating organization that the Securities

and Exchange Commission has

recognized as an NRSRO.

(k) Weighted average life (WAL)

means the average time to receipt of

principal, weighted by the size of each

principal payment. Weighted average
Federal Register / Vol. 63, No. 117 /Thursday, June 18, 1998 / Proposed Rules 33291

life for mortgage and asset-backed

securities is calculated under specific

prepayment assumptions.

4. Section 615.5133 is revised to read

as follows:

§ 615.5133 Investment portfolio

management.

The board of directors of each Farm

Credit bank is responsible for adopting

written policies for managing the bank’s

investment activities. The board of

directors shall also ensure that the

bank’s investments are safely and

soundly managed in accordance with

the written policies and that appropriate

internal controls are in place to

preclude investment actions that

undermine the solvency and liquidity of

the bank. Written investment policies

must address the purposes and

objectives of investments, risk

parameters, delegations of authority,

and reporting requirements. Annually,

the board of directors of each Farm

Credit bank shall review its investment

policies to determine whether objectives

and risk exposure limits continue to be

appropriate for the bank.

(a) Risk parameters. The investment

policies shall establish risk limits and

diversification requirements for the

various classes of eligible investments

and the entire investment portfolio. Risk

parameters shall be based on the Farm

Credit bank’s institutional objectives,

capital position, and its tolerance for

risk. The policies must identify the

types and quantity of investments that

the bank will hold to achieve its

objectives and control credit, market

liquidity, and operational risks.

(1) Credit risk. The bank’s investment

policies shall establish:

(i) Credit quality standards, limits on

counterparty risk, and risk

diversification requirements that limit

concentrations based on a single or

related counterparties, a geographical

area, industries or obligations with

similar characteristics.

(ii) Criteria for selecting brokers,

dealers, and investment bankers

(collectively, securities firms). The

policy shall also set limits on the

amounts and types of transactions that

the bank shall execute with authorized

securities firms. The board of directors

shall annually review management’s

selection of securities firms and

limitations on transactions with such

securities firms.

(iii) Collateral margin requirements on

repurchase agreements.

(2) Market risk. The bank’s investment

policies shall set market risk limits for

the institution, the investment portfolio

or specific types of investments

pursuant to the regulations in this

chapter and guidance by the Farm

Credit Administration.

(3) Liquidity risk. The bank’s policies

shall describe the liquidity

characteristics of investments used to

accomplish institutional objectives and

its liquidity needs sufficient to comply

with the requirements of § 615.5134.

(4) Operational risk. The bank’s

policy shall address operational risks,

including delegations of authority and

internal controls in accordance with

paragraphs (b) and (c) of this section.

(b) Delegations of authorities. All

delegations of the management of the

bank’s investments to specific personnel

or committees shall state the extent of

management’s authority and

responsibilities.

(c) Internal controls. Each Farm Credit

bank shall:

(1) Establish appropriate internal

controls to detect and prevent loss,

fraud, embezzlement, conflicts of

interest, and unauthorized investments

and ensure compliance with policies

established by the board.

(2) Ensure that a separation of duties

and supervision exists between

personnel executing investment

transactions and those responsible for

approving, revaluating, and overseeing

the bank’s investments.

(3) Maintain management information

systems that are commensurate with the

level and complexity of the bank’s

investment activities.

(d) Securities valuation. Each Farm

Credit bank shall:

(1) Verify the value of any security

(except new issues) that it purchases or

sells from a source that is independent

of the broker, dealer, counterparty, or

other intermediary in the specific

transaction.

(2) Determine, at least monthly, the

fair value of each security in its

portfolio and the fair value of the

portfolio as a whole.

(3) Perform evaluations of the credit

quality and price sensitivity to changes

in market interest rates of all

investments held in its portfolio prior to

purchase and on an ongoing basis.

(e) Reports to the board. Reports on

the performance and risk of each

investment and the investment portfolio

shall be made to the board of directors

or a committee thereof each quarter.

Reports shall identify potential risk

exposure to changes in market interest

rates and other factors that may affect

the value of the bank’s investment

holdings. Each report shall discuss how

investments affect the bank’s overall

financial condition and evaluate

whether the performance of the

investment portfolio effectively achieves

the objectives established by the board

of directors. Any deviations from the

board’s policies shall be specifically

identified in the report.

5. Section 615.5134 is amended by

revising paragraph (b) to read as follows:

§ 615.5134 Liquidity reserve requirement.

* * * * *

(b) All investments held for the

purpose of meeting the liquidity reserve

requirement under this section shall be

free of lien.

* * * * *

6. Section 615.5140 is revised to read

as follows:

§ 615.5140 Eligible investments.

(a) Farm Credit banks are authorized

to hold the following types of eligible

investments, denominated in United

States dollars, to comply with the

requirements of §§ 615.5132, 615.5134,

and 615.5135 of this subpart:

(1) Treasury and agency securities.

Obligations of the United States; fullrecourse obligations, other than

mortgage securities, of agencies,

instrumentalities or corporations of the

United States, or debt obligations of

other obligors that are fully insured or

guaranteed as to both principal and

interest by the United States, its

agencies, instrumentalities, or

corporations.

(2) General obligations of a State or

political subdivision that mature within

10 years and are rated in one of the

three highest credit rating categories by

an NRSRO.

(3) Obligations of international and

multilateral development banks in

which the United States is a voting

shareholder.

(4) Money market instruments: (i)

Negotiable certificates of deposit that

mature within 1 year or less, Federal

funds, term Federal funds that have a

callable contract with a term to maturity

of 100 days or less, and bankers

acceptances that are issued by

depository institutions. All issuers of

money market instruments listed in

paragraph (a)(4)(i) of this section shall

maintain a rating in one of the two

highest short-term credit rating

categories by an NRSRO.

(ii) Eurodollar time deposits that

mature within 90 days and are held at

depository institutions that maintain a

rating in the highest short-term credit

rating category by an NRSRO.

(iii) Prime commercial paper that has

a maturity of 270 days or less and is

rated in the highest short-term credit

rating category by an NRSRO.

(iv) Repurchase agreements where a

Farm Credit bank agrees to purchase

marketable securities subject to an

agreement that requires a counterparty
33292 Federal Register / Vol. 63, No. 117 /Thursday, June 18, 1998 / Proposed Rules

to repurchase the same or identical

securities at a specific time within 100

days or less. The collateral for

repurchase agreements shall be either

eligible investments authorized by this

section or other marketable securities

that are rated in the highest credit rating

category by an NRSRO.

(v) Master notes that mature

overnight, or have a callable feature and

mature within 270 days, and are

executed with domestic counterparties

that maintain a rating in the highest

short-term credit rating category by an

NRSRO.

(5) Mortgage securities that are rated

in the highest credit rating category by

an NRSRO and are either:

(i) Agency mortgage securities that are

issued or guaranteed as to principal and

interest by the Government National

Mortgage Association, the Federal

National Mortgage Association, Federal

Home Loan Mortgage Corporation, or

(ii) Non-agency mortgage securities

that are offered and sold pursuant to

section 4(5) of the Securities Act of

1933, 15 U.S.C. 77d(5) or are residential

mortgage-related securities within the

meaning of section 3(a)(41) of the

Securities Exchange Act of 1934, 15

U.S.C. 78c(a)(41).

(iii) Mortgage securities shall not be

consider eligible investments, unless

they comply with the requirements of

§ 615.5141 of this subpart.

(6) Asset-backed securities that are

collateralized by credit card receivables,

automobile loans, home equity loans,

manufactured housing loans, equipment

loans, student loans, or wholesale dealer

automobile loans that are rated in the

highest credit rating category by an

NRSRO. The expected WAL on eligible

ABS shall not exceed 5 years and the

final maturity shall not exceed 7 years.

(7) Corporate debt securities that are

rated within the two highest credit

rating categories by an NRSRO, mature

within 5 years and are not convertible

into equity securities.

(8) Investment companies. Shares of

an investment company registered

under section 8 of the Investment

Company Act of 1940, 15 U.S.C. 80a–8

(including mutual funds, unit

investment trusts, and collective

investment funds maintained by a

national bank under 12 CFR part 9),

provided that the portfolio of the

investment company consists

exclusively of eligible investments that

are authorized by this section or

§ 615.5174 of this part. In addition,

Farm Credit banks must evaluate the

investment company’s risk and return

objectives and use of derivatives to

ensure that the investment company’s

objectives and strategies for achieving

its objectives are consistent with the

bank’s investment policies and the

requirements of this subpart.

(9) Other investments, as authorized

by the Farm Credit Administration, that

have a short maturity and are rated

investment grade by an NRSRO. A Farm

Credit bank seeking approval of an

investment under this paragraph should

provide the Farm Credit Administration

with documentation that describes the

risk characteristics of the investment

and explains the bank’s purpose and

objectives for making the investment.

(b) The authority of Farm Credit banks

to hold the investments listed in

paragraph (a) of this section is subject to

the following requirements:

(1) Marketable securities. Except for

the money market instruments listed in

paragraph (a)(4) of this section, all other

eligible investments shall be marketable

within the meaning of § 615.5131(h).

(2) Rating of foreign countries.

Whenever the obligor or issuer of an

eligible investment is located outside of

the United States, the host country shall

maintain the highest sovereign rating for

political and economic stability by an

NRSRO.

(3) Obligor limits. Except for eligible

investments covered by paragraph (a)(1)

of this section and mortgage securities

that are issued by or guaranteed as to

principal and interest by the

Government National Mortgage

Association, Federal National Mortgage

Association, or the Federal Home Loan

Mortgage Corporation under paragraph

(a)(5)(i) of this section, each Farm Credit

bank shall not invest more than twenty

(20) percent of its total capital in eligible

investments issued by any single

institution, issuer, or obligor.

(4) Portfolio limits. Subject to

§ 615.5132, each Farm Credit System

bank is authorized to hold eligible

investments listed in paragraph (a) of

this section without limitation as to

amount except:

(i) Mortgage securities shall not

exceed fifty (50) percent of the bank’s

total investments authorized under this

section provided that mortgage

securities that are issued under

paragraph (a)(5)(ii) of this section shall

not exceed fifteen (15) percent of the

bank’s total investments. Mortgage

securities that are issued by the

Government National Mortgage

Association shall not be subject to any

restriction on amount.

(ii) Each of the following types of

investments shall not exceed twenty

(20) percent of the bank’s total

investments authorized under this

section:

(A) Eurodollar time deposits;

(B) Master notes;

(C) Asset-backed securities; and

(D) Corporate bonds.

(5) Limit on investment company

holdings. (i) General. A Farm Credit

bank shall combine its direct holdings

of eligible investments with its pro rata

interest in the same type of instrument

or obligor in the portfolio of an

investment company for the purpose of

complying with the obligor and

portfolio limitations of paragraphs

(b)(3), (b)(4)(i), and (b)(4)(ii) of this

section.

(ii) Alternate diversification

requirements for investment companies.

(A) Exemption from the obligor limit. A

Farm Credit bank may elect not to

combine its pro rata interest in a

particular security in an investment

company with the bank’s direct

holdings of securities that are subject to

the obligor limit in paragraph (b)(3) of

this section if the investment company’s

holdings of the securities of any one

issuer do not exceed five (5) percent of

its total portfolio.

(B) Exemption from the portfolio

limits. A Farm Credit bank may elect not

to combine its pro rata interest in a type

of security in an investment company

with the bank’s direct holding of a class

of securities that are subject to the

portfolio limits in paragraphs (b)(4)(i)

and (b)(4)(ii) of this section if the bank’s

shares in an investment company do not

exceed ten (10) percent of its total

investments.

§ 615.5141 through 615.5143

[Redesignated]

7. Sections 615.5141, 615.5142, and

615.5143 are redesignated as

§§ 615.5142, 615.5143, and 615.5144,

respectively, and a new § 615.5141 is

added to read as follows:

§ 615.5141 Stress tests for mortgage

securities.

Each Farm Credit bank shall perform

stress tests to determine how interest

rate fluctuations will affect the

cashflows and price of all mortgage

securities that it purchases and holds

under § 615.5140(a)(5), as well as their

overall affect on the earnings and capital

of the bank. Adjustable mortgage

securities that have a repricing

mechanism of 12 months or less and

tied to an index are not subject to stress

testing. Farm Credit banks may conduct

the stress tests in accordance with either

paragraph (a) or (b) of this section.

(a) Mortgage securities shall comply

with the following three tests at the time

of purchase and each quarter thereafter:

(1) Average Life Test. The expected

WAL of the instrument does not exceed

5 years.

(2) Average Life Sensitivity Test. The

expected WAL does not extend for more
Federal Register / Vol. 63, No. 117 /Thursday, June 18, 1998 / Proposed Rules 33293

than 2 years, assuming an immediate

and sustained parallel shift in the yield

curve of plus 300 basis points, nor

shorten for more than 3 years, assuming

an immediate and sustained parallel

shift in the yield curve of minus 300

basis points.

(3) Price Sensitivity Test. The

estimated change in price is not more

than thirteen (13) percent due to an

immediate and sustained parallel shift

in the yield curve of plus or minus 300

basis points.

(4) Exemption. A floating-rate

mortgage security shall not be subject to

paragraphs (a)(1) and (2) of this section

if at the time of purchase, and each

subsequent quarter, it bears a rate of

interest that is below the contractual cap

on the instrument.

(b) A Farm Credit bank may use

alternative stress tests to evaluate the

price sensitivity of its investments in

mortgage securities. Alternative stress

tests must be able to measure the price

sensitivity of mortgage instruments over

different interest rate/yield curve

scenarios prior to purchase and each

quarter thereafter. The methodology

used to analyze mortgage securities

shall be commensurate with the

complexity of the instrument’s structure

and cashflows. Prior to purchase and

quarterly thereafter, the stress test

should determine that the mortgage

security’s risk is compatible with the

bank’s investment policies and the

investment does not expose the bank’s

capital and earnings to excessive risks.

(c) In applying the stress tests in

either paragraphs (a) or (b) of this

section, each Farm Credit bank shall

rely on verifiable information to support

all of its assumptions, including

prepayment and interest-rate volatility

assumptions. All assumptions that form

the basis of the bank’s evaluation of the

security and its underlying collateral

shall be available for review by the

Office of Examination of the Farm

Credit Administration. Subsequent

changes in the bank’s assumptions shall

be documented. If at any time after

purchase, a mortgage security no longer

complies with requirements in this

section, the bank shall divest the

security in accordance with § 615.5143

of this part.

§ 615.5143 [Amended]

8. Newly designated § 615.5143 is

amended by removing paragraph (a) and

the paragraph designation from

paragraph (b).

Subpart F—Property and Other

Investments

§ 615.5174 [Amended]

9. Section 615.5174 is amended by

removing the words ‘‘mortgage-backed

securities (MBSs), as defined by

§ 615.5131(l), collateralized mortgage

obligations (CMOs), as defined by

§ 615.5131(e), and Real Estate Mortgage

Investment Conduits (REMICs), as

defined by § 615.5131(p)’’ in paragraph

(a), and adding in their place, the words

‘‘mortgage securities as defined by

§ 615.5131(l);’’ by removing the words,

‘‘as defined by § 615.5131(b),’’ from

paragraph (b)(1); by removing paragraph

(c); and redesignating paragraphs (d)

and (e) as paragraphs (c) and (d),

respectively.

Dated: June 15, 1998.

Floyd Fithian,

Secretary, Farm Credit Administration Board.

[FR Doc. 98–16208 Filed 6–17–98; 8:45 am]

BILLING CODE 6705–01–P

DEPARTMENT OF TRANSPORTATION

Federal Aviation Administration

14 CFR Part 39

[Docket No. 98–CE–51–AD]

RIN 2120–AA64

Airworthiness Directives; SchemppHirth K.G. Model Cirrus Sailplanes

AGENCY: Federal Aviation

Administration, DOT.

ACTION: Notice of proposed rulemaking

(NPRM).

SUMMARY: This document proposes to

adopt a new airworthiness directive

(AD) that would apply to certain

Schempp-Hirth K.G. (Schemmp-Hirth)

Model Cirrus sailplanes. The proposed

AD would require modifying or

replacing the connecting rod between

the airbrake bellcranks, and replacing

the existing 6 millimeter (mm) bolt with

an 8 mm bolt. The proposed AD is the

result of mandatory continuing

airworthiness information (MCAI)

issued by the airworthiness authority for

Germany. The actions specified by the

proposed AD are intended to prevent

the threaded bolt that is welded to the

connecting rod between the airbrake

bellcranks from breaking, which could

result in loss of airbrake control with a

possible reduction/loss of sailplane

control.

DATES: Comments must be received on

or before July 21, 1998.

ADDRESSES: Submit comments in

triplicate to the Federal Aviation

Administration (FAA), Central Region,

Office of the Regional Counsel,

Attention: Rules Docket No. 98–CE–51–

AD, Room 1558, 601 E. 12th Street,

Kansas City, Missouri 64106. Comments

may be inspected at this location

between 8 a.m. and 4 p.m., Monday

through Friday, holidays excepted.

Service information that applies to the

proposed AD may be obtained from

Schempp-Hirth Flugzeugbau GmbH,

Krebenstrasse 25, Postfach 1443, D–

73230 Kircheim/Teck, Germany. This

information also may be examined at

the Rules Docket at the address above.

FOR FURTHER INFORMATION CONTACT: Mr.

Mike Kiesov, Aerospace Engineer, FAA,

Small Airplane Directorate, 1201

Walnut, suite 900, Kansas City, Missouri

64106; telephone: (816) 426–6934;

facsimile: (816) 426–2169.

SUPPLEMENTARY INFORMATION:

Comments Invited

Interested persons are invited to

participate in the making of the

proposed rule by submitting such

written data, views, or arguments as

they may desire. Communications

should identify the Rules Docket

number and be submitted in triplicate to

the address specified above. All

communications received on or before

the closing date for comments, specified

above, will be considered before taking

action on the proposed rule. The

proposals contained in this notice may

be changed in light of the comments

received.

Comments are specifically invited on

the overall regulatory, economic,

environmental, and energy aspects of

the proposed rule. All comments

submitted will be available, both before

and after the closing date for comments,

in the Rules Docket for examination by

interested persons. A report that

summarizes each FAA-public contact

concerned with the substance of this

proposal will be filed in the Rules

Docket.

Commenters wishing the FAA to

acknowledge receipt of their comments

submitted in response to this notice

must submit a self-addressed, stamped

postcard on which the following

statement is made: ‘‘Comments to

Docket No. 98–CE–51–AD.’’ The

postcard will be date stamped and

returned to the commenter.

Availability of NPRMs

Any person may obtain a copy of this

NPRM by submitting a request to the

FAA, Central Region, Office of the

Regional Counsel, Attention: Rules

Docket No. 98–CE–51–AD, Room 1558,

601 E. 12th Street, Kansas City, Missouri

64106.