[Federal Register Volume 61, Number 131 (Monday, July 8, 1996)]
[Rules and Regulations]
[Pages 35607-35623]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-17120]


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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

12 CFR Part 1750

RIN 2550-AA03


Office of Federal Housing Enterprise Oversight; Minimum Capital

AGENCY: Office of Federal Housing Enterprise Oversight, HUD.

ACTION: Final regulation.

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SUMMARY: The Office of Federal Housing Enterprise Oversight (OFHEO) is 
issuing a final regulation that sets forth the methodology for 
computing the minimum capital requirement for the Federal National 
Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage 
Corporation (Freddie Mac) (collectively, the Enterprises). The final 
regulation also establishes procedures for the filing of quarterly 
minimum capital reports by each Enterprise. In addition, the final 
regulation establishes procedures under which OFHEO will determine the 
capital classification of each Enterprise on a quarterly basis.

EFFECTIVE DATE: August 7, 1996.

FOR FURTHER INFORMATION CONTACT: Gary L. Norton, Deputy General Counsel 
(202/414-3800); Isabella W. Sammons, Associate General Counsel (202/
414-3800); Michael P. Scott, Assistant Director, Office of Research, 
Analysis and Capital Standards (202/414-3800), 1700 G Street, N.W., 4th 
Floor, Washington, D.C. 20552.

SUPPLEMENTARY INFORMATION:

I. Background

    Title XIII of the Housing and Community Development Act of 1992, 
Pub. L. No. 102-550, known as the Federal Housing Enterprises Financial 
Safety and Soundness Act of 1992 (1992 Act), established OFHEO as an 
independent office within the Department of Housing and Urban 
Development. OFHEO is responsible for ensuring that the Enterprises are 
adequately capitalized and operating in a safe and sound manner. 
Included among the express statutory authorities of the Director of 
OFHEO is the authority to issue regulations establishing minimum and 
risk-based capital standards.<SUP>1
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    \1\ 1992 Act, section 1313(b)(1) (12 U.S.C. 4513(b)(1)).
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    As a separate rulemaking procedure, OFHEO published an Advance 
Notice of Proposed Rulemaking (ANPR) <SUP>2 as the first step toward 
developing the risk-based capital regulation required by section 1361 
of the 1992 Act.<SUP>3 The risk-based capital regulation will specify a 
stress test that will determine the amount of capital that an 
Enterprise must hold to maintain positive capital throughout a 10-year 
period of economic stress. That amount, plus an additional 30 percent 
to cover management and operations risk, will constitute the risk-based 
capital requirement of the Enterprise.
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    \2\ 60 FR 7468, Feb. 8, 1995.
    \3\ 12 U.S.C. 4611.
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    The ANPR solicited public comment on a variety of issues concerning 
the development of the risk-based capital regulation. In light of the 
complex issues, OFHEO decided to issue the proposed risk-based capital 
regulation in two Notices of Proposed Rulemaking (NPRs).
    The first NPR addresses two key components of the stress test--the 
``benchmark loss experience'' (the basis for determining the extent of 
Enterprise credit losses during the stress test) and the use of the 
OFHEO House Price Index (HPI) in the stress test to estimate changes 
over time in the values of single-family properties securing Enterprise 
mortgages.<SUP>4 A second NPR, currently being developed, will address 
the remaining aspects of the risk-based capital stress test and how the 
stress test will be used to determine the Enterprises' risk-based 
capital requirements.
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    \4\ 61 FR 29592, Jun. 11, 1996.
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    In addition to the risk-based capital standard, the 1992 Act 
prescribes a minimum capital standard for the Enterprises.<SUP>5 This 
final regulation implements the minimum capital standard of the 1992 
Act. Unlike the risk-based capital requirement that is computed by 
applying the stress test, the minimum capital requirement is computed 
on the basis of capital ratios that are applied to certain defined on-
balance sheet assets and off-balance sheet obligations of the 
Enterprises.
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    \5\ Section 1362 (12 U.S.C. 4612).
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    OFHEO issued a proposed Minimum Capital regulation on June 8, 
1995.<SUP>6 As discussed in the preamble to the proposed regulation, 
the proposed regulation contained the interim administrative procedures 
with respect to the methodology for computing the minimum capital 
requirement for on- and off-balance sheet items, except for interest 
rate and foreign exchange rate contracts for which the methodology was 
modified. The proposed regulation also established procedures for the 
filing of minimum capital reports by the Enterprises each quarter, or 
at other times as required by the Director. The proposed regulation 
further required OFHEO to provide each Enterprise with notice and 
opportunity to comment on its proposed capital classification.
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    \6\ 60 FR 30201.
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    OFHEO received five comments in response to the proposed 
regulation. Comments were received from a federal government agency 
(Office of Thrift Supervision), both Enterprises, and two trade 
associations (America's Community Bankers and Mortgage Bankers 
Association of America). OFHEO has carefully considered the comments in 
developing the final regulation. A discussion of the comments received 
follows.

II. Comments on the Proposed Minimum Capital Regulation

General Comments

    Freddie Mac commented generally on OFHEO's role with respect to the

[[Page 35608]]

minimum capital standard of the 1992 Act. First, Freddie Mac noted that 
the 1992 Act details what the capital standard is, unlike the statutes 
governing the capital standards for banks and thrifts. Therefore, 
Freddie Mac concluded that the Minimum Capital regulation should 
reflect Congress' intent that OFHEO act as the implementor, rather than 
the creator, of the minimum capital standard.
    OFHEO agrees that its role is to implement the minimum capital 
standard set forth in the 1992 Act. Nevertheless, Congress specifically 
authorized OFHEO to adjust the capital ratios that are applied to 
certain off-balance sheet obligations, the credit risk of which differs 
from that of mortgage-backed securities (MBS). Additionally, in 
implementing the 1992 Act, OFHEO must define those terms not defined 
therein. OFHEO believes that the final regulation effectively 
implements the minimum capital standard in a manner completely 
consistent with the specific provisions and overall intent of the 1992 
Act.
    Secondly, Freddie Mac stated that Congress recognized that the 
minimum capital standard would create marginal capital requirements and 
that marginal capital requirements tend to induce changes in the 
Enterprises' behavior.<SUP>7 Therefore, Freddie Mac explained, Congress 
cautioned OFHEO against creating ``perverse incentives'' that may 
induce Freddie Mac to make inappropriate changes in the conduct of its 
businesses.<SUP>8 Freddie Mac further noted that, in the context of 
OFHEO's risk-based capital standard, ``OFHEO has expressed a policy of 
designing the [risk-based] capital regulation to reflect closely the 
relative risks inherent in the Enterprises' different activities, 
rather than setting out to encourage or discourage particular 
activities by means of a [risk-based] capital regulation that rewards 
or punishes an Enterprise that engages in such activities.' Freddie Mac 
urged OFHEO to apply this policy to its design of the Minimum Capital 
regulation.
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    \7\ Marginal capital requirements are incremental capital 
requirements for each additional dollar of business.
    \8\ Freddie Mac cites S. Rep. No. 282, 102d Cong., 2d Sess. 24 
(1992).
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    As recognized by Freddie Mac, congressional concern regarding the 
creation of perverse incentives was expressed in the context of the 
discussion of risk-based capital and the appropriate level of detail of 
the stress test.<SUP>9 OFHEO has stated that, where feasible, it will 
endeavor to avoid the creation of perverse incentives in its risk-based 
capital regulation for the Enterprises. However, this concept has 
little relevance to the minimum capital standard. The minimum capital 
requirement is computed on the basis of simple leverage ratios.
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    \9\ The Senate report accompanying the legislation states: ``A 
more detailed [stress test] model will be more likely to create the 
right incentives and less likely to create perverse incentives.'' S. 
Rep. No. 282, 102d Cong., 2d Sess. 24 (1992).
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    The proposed regulation deviates from the specific statutory ratios 
in only one area--by adjusting the statutory ratio of 0.45 percent for 
certain off-balance sheet obligations relative to the credit risk of 
MBS. The proposed regulation establishes different minimum capital 
ratios for collateralized and uncollateralized exposure for interest 
rate and foreign exchange rate contracts. Although OFHEO considered 
using a single capital ratio applied to all interest rate and foreign 
exchange rate contracts, thus treating contracts as one broad risk 
category, OFHEO believes that making a distinction between 
collateralized and uncollateralized exposure provides the Enterprises 
with better risk management incentives.

Section 1750.1  General

    Section 1750.1 of the proposed Minimum Capital regulation provides 
in part that:

    The board of directors of each Enterprise is responsible for 
ensuring that the Enterprise maintains capital at a level that is 
sufficient to ensure the continued financial viability of the 
Enterprise and in excess of the minimum capital level contained in 
this Subpart A.

    Freddie Mac recommended that the phrase ``is sufficient to ensure 
the continued financial viability of the Enterprise'' be deleted from 
section 1750.1 because it appears to establish a new or additional 
capital standard not provided for in the 1992 Act. Freddie Mac stated 
that, in light of the comprehensive guidance in the 1992 Act as to how 
to determine the levels of capital that the Enterprises are required to 
hold, it would be inappropriate for OFHEO, by regulation, to amend the 
minimum capital standard of the 1992 Act by adding a financial 
viability standard.
    OFHEO disagrees with Freddie Mac's view because OFHEO has the duty 
and authority to ensure the safe and sound financial operation of the 
Enterprises, and none of the capital levels specified in the 1992 Act 
represent the amount needed by an Enterprise to operate safely and 
soundly under all circumstances. The language in proposed section 
1750.1 is consistent with OFHEO's authority under section 1313(a) of 
the 1992 Act,<SUP>10 which provides that the duty of the Director is to 
ensure that the Enterprises are adequately capitalized and operating 
safely. OFHEO's specific authority to issue the Minimum Capital 
regulation is derived from section 1313(b) of the 1992 Act,<SUP>11 
which provides the Director with the authority to issue regulations to 
carry out (a) part 1 of subtitle A of the 1992 Act (which establishes 
OFHEO and sets forth OFHEO's authorities), (b) subtitle B (which sets 
forth the required capital levels for the Enterprises and OFHEO's 
special enforcement powers with respect to capital levels), (c) 
subtitle C (which sets forth OFHEO's enforcement provisions), and (d) 
``other matters relating to safety and soundness.'' As explained in 
section 1302 of the 1992 Act,<SUP>12 Congress finds that--
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    \10\ 12 U.S.C. 4513(a).
    \11\ 12 U.S.C. 4513(b).
    \12\ 12 U.S.C. 4501.

* * * an entity regulating such enterprises should have the 
authority to establish capital standards, require financial 
disclosure, prescribe adequate standards for books and records and 
other internal controls, conduct examinations when necessary, and 
enforce compliance with the standards and rules that it establishes 
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* * *.

    Section 1750.1 is also consistent with the manner in which the 
capitalization provisions of the 1992 Act are designed to operate. The 
capitalization provisions in the 1992 Act are structured in the 
following way. The 1992 Act provides for both ``mandatory'' and 
``discretionary'' capital classifications.<SUP>13 The 1992 Act also 
sets forth certain supervisory actions that are specific to each 
capital classification.<SUP>14
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    \13\ Section 1364 (12 U.S.C. 4614).
    \14\ Sections 1365-1367 (12 U.S.C. 4615-4617).
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    Under the discretionary capital classification criteria, the 
Director may reclassify an Enterprise at a lower capital level than it 
would be classified under the mandatory classification criteria. The 
Director may do so if the Enterprise is engaging in conduct that could 
result in a rapid depletion of core capital or the value of the 
property subject to mortgages held or securitized by the Enterprise has 
decreased significantly.<SUP>15
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    \15\ Section 1364(b) (12 U.S.C. 4614(b)).
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    When the Enterprise is placed in a lower capital classification as 
a result of either a mandatory or discretionary classification, it is 
required to increase its capital pursuant to a mandatory capital 
restoration plan.<SUP>16 The Director's discretionary classification 
authority thus could have the effect of requiring

[[Page 35609]]

an Enterprise that is engaging in certain types of risky activities to 
increase the amount of capital it holds, pursuant to a mandatory 
capital restoration plan, even though it meets or exceeds the minimum 
capital or risk-based capital requirement.<SUP>17
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    \16\ Sections 1365(a)(1) and 1369C (12 U.S.C. 4615(a)(1) and 
4622).
    \17\ Section 1365 (12 U.S.C. 4615).
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    The discretionary classification authority reflects the statutory 
scheme that the minimum capital ratios in the 1992 Act establishes a 
``floor'' on capital, not a ``ceiling.'' The legislative history of the 
1992 Act indicates that there was some confusion regarding this issue 
that was resolved in favor of the ``floor'' approach. For example, 
during Senate consideration of the bill, Senator Metzenbaum stated to 
the Chairman of the Committee:

    [You] said on this floor that the Director [of OFHEO] did indeed 
have the authority to set the required ratios above the minimum 
levels * * * if necessary to protect the health and security of an 
enterprise and that it is important that the Director act in those 
circumstances. Since that time, I have learned that some Senators 
may have a different view about the Director's authority. I would 
like to be assured by the chairman of the committee and the manager 
of this bill that the director has authority to raise capital 
standards, if necessary.

    Senator Riegle, in replying, explained that:

    [T]he Director is given the duty to ensure that the enterprises 
are adequately capitalized and operating safely in accordance with 
this act and the Charter Acts. Under section 103(a)(1) of the bill, 
the Director is authorized to issue regulations concerning the 
financial health and security of the enterprises, including the 
establishment of capital standards. There is no way the Director can 
discharge these responsibilities unless he or she has the authority 
to prescribe capital standards to be met by the enterprises.
* * * * *
    Unless the legislation specifically and affirmatively prohibits 
the Director from establishing required capital ratios, it must be 
assumed that the Director has that authority in order to discharge 
his or her duties assigned under section 102 * * *. The only 
constraint on the Director's authority is that the required capital 
ratios cannot be set below the minimum levels contained in section 
202.
* * * * *
    If the Director believed that the minimum statutory ratios * * * 
should be raised, he or she would obviously have to seek a change in 
the law. A Director might believe an increase in the statutory 
minimum ratios * * * to be necessary if he or she concluded that 
they were clearly inadequate under all foreseeable circumstances. If 
the Congress were to so raise the statutory minimum ratios * * * it 
would establish a new and higher floor applicable to the Director's 
discretionary authority to prescribe capital ratios. However, there 
is nothing in the legislation that would preclude the Director from 
setting the required rated * * * without further legislation. If the 
circumstances that gave rise to the need for higher ratios changed, 
the Director could then reduce the required capital ratios, but not 
lower than the minimum ratios * * *.<SUP>18
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    \18\ 138 Cong. Rec. S9353-54 (July 1, 1992). This colloquy was 
with respect to section 202, Minimum Capital Levels, of S. 2733. 
Although the 1992 Act was a compromise between S. 2733 and H.R. 
2900, section 202 of S. 2733 is substantially similar to section 
1362 of the 1992 Act. Therefore, the colloquy with respect to 
section 202, cited above, is relevant to the discussion of section 
1362 of the 1992 Act.

    In the House of Representatives, the issue of whether the minimum 
capital ratios constituted a floor or a ceiling was raised during the 
consideration of the conference report. In a discussion between the 
Chairman and Ranking Member of the Committee, the two members agreed 
that the duty of the Director to ensure that the Enterprises are 
adequately capitalized and operating safely in accordance with the 1992 
Act authorizes the Director to require a higher ratio than the minimum 
ratio specified in the statute.<SUP>19
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    \19\ 138 Cong. Rec. H11,102 (Oct. 3, 1992) (discussion by Mr. 
Gonzalez, Mr. Frank, and Mr. Leach). In response to Mr. Gonzalez' 
explanation, Mr. Leach stated that ``I fully share with you the 
interpretation that would imply that the Director could go above the 
2.5-percent requirement that is currently in statute [sic] * * *.'' 
Id.
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    Freddie Mac further questioned why the board of directors of each 
Enterprise is held responsible for maintaining capital at a level that 
is sufficient to ensure the continued viability of the Enterprise. 
Freddie Mac stated that the board of directors has a fiduciary duty to 
protect the interests of the Enterprise's shareholders, and that 
maintaining an adequate level of capital under varying circumstances 
would be one aspect of the overall set of responsibilities represented 
within that duty. Furthermore, Freddie Mac stated that the fiduciary 
duties of corporate directors are derived principally from state common 
law, so the adoption of a viability standard and corresponding 
responsibility could interfere with the subtleties and complexities of 
that law.
    OFHEO believes that to the extent there is any conflict between 
state law and the 1992 Act, the conflict would be resolved in favor of 
the 1992 Act and implementing regulations. The Enterprises are 
federally-chartered entities subject to federal statutory and 
regulatory requirements. The 1992 Act imposes capital requirements on 
the Enterprises and makes clear that the board of directors of each 
Enterprise is responsible for the financial safety and soundness of the 
Enterprise. Specifically, the Director is authorized to take 
enforcement actions, e.g., cease and desist orders and civil money 
penalties, against directors of an Enterprise for actions that deplete 
the core capital of the Enterprise, cause a loss to the Enterprise, or 
violate an order or regulation of OFHEO.<SUP>20 In exercising its 
enforcement powers, OFHEO will be cognizant of all of the relevant 
federal and, if applicable, state requirements. However, to the extent 
there are any applicable state law requirements relating to the 
fiduciary responsibilities of the directors, they would not override 
the obligations created by the 1992 Act or the Minimum Capital 
regulation.
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    \20\ See sections 1371, 1372, and 1376 (12 U.S.C. 4631, 4632, 
and 4636).
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    Freddie Mac also recommended that the phrase ``in excess of the 
minimum capital level'' be replaced by ``is equal to or exceeds the 
minimum capital level'' in order to reflect accurately the minimum 
capital standard set forth in the 1992 Act. OFHEO agrees and has 
revised section 1750.1 accordingly. OFHEO has also substituted, where 
appropriate, the word ``requirement'' for ``level'' to ensure 
consistency of terms throughout the Minimum Capital regulation.
    Section 1750.1 of the proposed regulation also contains a sentence 
that reads: ``The regulation contained in this Subpart A establishes 
the minimum capital requirements for each Enterprise.'' Freddie Mac 
recommended an editorial change that would clarify that the regulation 
sets forth the ``methodology'' for computing the minimum capital 
requirement for each Enterprise. OFHEO agrees with the need for this 
change and the final regulation has been revised accordingly.

Section 1750.2  Definitions

    Proposed Section 1750.2 defines various terms used in the Minimum 
Capital regulation. OFHEO received comments on the definitions of the 
following terms: commitment, core capital, foreign exchange rate 
contract, interest rate contract, multifamily credit enhancement, off-
balance sheet obligation, other off-balance sheet obligations, and 
qualifying collateral. The comments are discussed below.
Commitment
    Freddie Mac recommended that, for the purpose of the minimum 
capital requirement computation, the term ``commitment'' should be 
defined as a legally binding agreement that obligates an Enterprise to 
purchase mortgages that

[[Page 35610]]

specify all the terms of the transaction, including price, volume, and 
fees.
    Freddie Mac referenced its comments to OFHEO's ANPR on risk-based 
capital.<SUP>21 In those comments, Freddie Mac stated that, as a matter 
of general contract law, an agreement is legally binding only if all of 
its key terms are included and agreed upon. Therefore, any definition 
of a contractual commitment should include a requirement that it be a 
binding contractual obligation of the Enterprise to purchase mortgages 
and specify price, volume, and fees.
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    \21\ ``Comments of the Federal Home Loan Mortgage Corporation on 
the Advance Notice of Proposed Rulemaking on Risk-Based Capital of 
the Office of Federal Housing Enterprise Oversight,'' 139-146 (May 
9, 1995) (available at OFHEO).
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    OFHEO agrees that for purposes of the Minimum Capital regulation 
the term ``commitment'' should mean any legally binding agreement that 
obligates an Enterprise to purchase or securitize mortgages, and has 
defined the term as such. However, OFHEO does not believe it necessary 
or appropriate to restrict the definition of the term ``commitment'' by 
reference to price, volume, and fees because agreements may be legally 
binding even when there is a lack of specificity on all terms.<SUP>22 
It would not be possible for OFHEO to reflect the complexities of this 
area of contract law in a regulatory definition. Moreover, to do so 
would be inadvisable in light of Congress' specific concerns regarding 
the need for capital to support commitments and other off-balance sheet 
obligations.
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    \22\ See Restatement (Second) of Contracts section 204 (1981).
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    For example, in discussing the need for the capital requirements of 
the 1992 Act, Congress expressed the concern that off-balance sheet 
obligations had not been previously captured under prior capital 
standards:

    The capital provisions of the GSEs' charter Acts limit their 
debt to 15 times their capital unless HUD sets a higher ratio * * * 
This is unsatisfactory because no capital need be held against the 
GSEs' $750 billion of off balance sheet guarantees * * *. <SUP>23
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    \23\ S. Rep. No. 282, 102d Cong., 2d Sess. 11 (1992).

Recognizing this concern, it would be inappropriate for OFHEO to 
promulgate a narrow definition that could exempt certain legally 
binding commitments from the minimum capital calculation.
    OFHEO has made editorial revisions to the definition of the term 
``commitment'' by substituting the word ``agreement'' for 
``arrangement'' and by deleting the phrase ``for portfolio.''
Core Capital
    In drafting the definition of core capital in the proposed 
regulation, OFHEO made minor changes to the statutory language that 
were intended to improve the clarity of the provision. Freddie Mac 
commented that since Congress expressly defined core capital in section 
1303(4) of the 1992 Act,<SUP>24 the regulation should use the same 
statutory language to avoid confusion. In light of the comment 
received, OFHEO wants to ensure that the regulation does not create any 
confusion and has revised the definition of core capital in the final 
regulation to mirror the statutory definition.
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    \24\ 12 U.S.C. 4502(4).
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Foreign Exchange Rate Contracts and Interest Rate Contracts
    OFHEO received a comment from Freddie Mac on the definitions of the 
terms ``foreign exchange rate contracts'' and ``interest rate 
contracts.'' Freddie Mac stated that the definitions of these terms as 
they appear in section 1750.2 and Appendix A of the proposed regulation 
are not identical. To avoid any implication that the differences are 
intentional, Freddie Mac recommended that OFHEO define the terms only 
in one location, or that OFHEO conform the language of the two sets of 
definitions.
    The different ways these terms are used in the regulation and 
Appendix A make it is necessary to include a definition in the main 
body of the regulation as well as a separate discussion in Appendix A. 
However, in light of the comment, OFHEO has made editorial changes to 
conform the definitions of the terms ``foreign exchange rate 
contracts'' and ``interest rate contracts'' in section 1750.2 to the 
discussion of such terms in Appendix A.
Multifamily Credit Enhancement
    Section 1750.2 of the proposed regulation defines the term 
multifamily credit enhancement to mean ``a guarantee by an Enterprise 
of the payments on a multifamily mortgage revenue bond issued by a 
state or local housing finance agency.''
    Fannie Mae recommended that OFHEO revise the definition to describe 
more fully the routine types of transactions in which an Enterprise 
engages ``to support multifamily bond issues.'' Fannie Mae stated that 
it normally provides credit enhancement through a collateral pledge, 
purchase agreement, or other contractual obligation by which the 
mortgage loan risk is borne by the Enterprise during a period in which 
the bonds are credit enhanced by a letter of credit or surety 
obligation of another party.
    Fannie Mae also commented that under many state laws, other state 
and local governmental units or instrumentalities may issue mortgage 
revenue bonds, not only state and local housing finance agencies. 
Therefore, Fannie Mae recommended that the definition should be 
expanded to include any state and local governmental issuers authorized 
to issue such revenue bonds secured by mortgages.
    OFHEO agrees with the comment and has revised the definition of the 
term ``multifamily credit enhancement'' to describe more fully the 
routine types of transactions in which an Enterprise engages to support 
multifamily bond issues.
Off-balance Sheet Obligation and Other Off-Balance Sheet Obligations
    OFHEO received comments from Freddie Mac on the definitions of the 
terms ``off-balance sheet obligation'' and ``other off-balance sheet 
obligations.'' The term ``off-balance sheet obligation'' is defined in 
proposed section 1750.2 to mean--

* * * a binding agreement, contract, or similar arrangement that 
requires or may require future payment(s) in money or kind by 
another party to an Enterprise or that effectively guarantees all or 
part of such payment(s) to third parties, where such agreement or 
contract is a source of credit risk that is not included on its 
balance sheet.

The term ``other off-balance sheet obligations'' is defined in proposed 
section 1750.2 to mean--

* * * all off-balance sheet obligations of an Enterprise that are 
not mortgage-backed securities or substantially equivalent 
instruments.

    Freddie Mac noted that section 1362(a)(3) of the 1992 Act <SUP>25 
requires the Enterprises to hold 0.45 percent core capital against 
other off-balance sheet obligations (excluding commitments in excess of 
50 percent of the average dollar amount of commitments outstanding each 
quarter over the preceding four quarters), except as the Director 
adjusts the 0.45 percent ratio to reflect differences between the 
credit risk of such obligations and MBS. Freddie Mac stated that an 
obligation of an Enterprise does not subject the Enterprise directly to 
credit risk: ``it is the party holding the obligation that bears the 
credit risk of an Enterprise obligation.'' However, while the 
obligations of an Enterprise create no

[[Page 35611]]

direct credit risk for the Enterprise, certain obligations, such as MBS 
or commitments to purchase mortgages, involve identifiable credit risk 
that is related in one way or another to those obligations (the risk of 
the default on the associated mortgages). Freddie Mac believes that 
this related credit risk is what Congress intended to capture when it 
enacted the minimum capital requirement applicable to other off-balance 
sheet obligations. Therefore, Freddie Mac believes that a definition of 
``other off-balance sheet obligations'' will not capture the related 
credit risk that is apparently the focus of the 1992 Act.
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    \25\ 12 U.S.C. 4612(a)(3).
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    To resolve this concern, Freddie Mac recommended that OFHEO delete 
the definition of the term ``off-balance sheet obligation'' and take a 
targeted approach in the definition of the term ``other off-balance 
sheet obligations'' by identifying only those items that OFHEO intends 
to include within the scope of the term, i.e., commitments, multifamily 
credit enhancements, sold portfolio remittances pending, and interest 
rate and foreign exchange rate contracts. Freddie Mac believes that 
because OFHEO has considered no other items to be other off-balance 
sheet obligations, such a definition would fully implement section 
1362(a)(3) of the 1992 Act.<SUP>26 Freddie Mac stated that, to the 
extent that the Director determines in the future that other items 
should be considered to be other off-balance sheet obligations, the 
Director should address such items in a future rulemaking proceeding to 
amend the Minimum Capital regulation. In connection with this 
recommendation, Freddie Mac also recommended that section 1750.4(a)(7) 
be deleted. That section provides for other off-balance sheet 
obligations to be included in the computation of the minimum capital 
requirement.
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    \26\ Id.
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    After considering Freddie Mac's comments, OFHEO has determined not 
to adopt the recommendations with respect to the definition of the 
terms ``off-balance sheet obligation'' and ``other off-balance sheet 
obligations.'' The capital provisions of the 1992 Act require the 
Enterprises to hold sufficient capital to ensure against risks of both 
on- and off-balance sheet items. For off-balance sheet obligations, the 
1992 Act specifies the ratio of 0.45 percent of the unpaid principal 
balance of MBS and substantially equivalent instruments issued or 
guaranteed by the Enterprise. The Act also specifies a ratio of 0.45 
percent of other off-balance sheet obligations (excluding commitments 
in excess of 50 percent of the average dollar amount of the commitments 
outstanding each quarter over the preceding four quarters), except that 
the Director must adjust the 0.45 percent ratio to reflect differences 
between the credit risk of such obligations and MBS.
    OFHEO believes that it is appropriate to provide for a definition 
of other off-balance sheet obligations, which ensures that capital will 
be held against all off-balance sheet obligations whether or not they 
are now used by the Enterprises or at any time in the future. The 1992 
Act requires that OFHEO apply a ratio of 0.45 percent to other off-
balance sheet obligations until OFHEO determines whether an adjustment 
is necessary. OFHEO has determined the appropriate ratios for 
commitments, multifamily credit enhancements, sold portfolio 
remittances pending, interest rate contracts, and foreign exchange rate 
contracts. When an Enterprise begins to use a new type of obligation, 
OFHEO will apply the statutory ratio of 0.45 percent. OFHEO will then 
analyze the obligation to determine whether an adjustment to the 0.45 
percent ratio is necessary, and will amend the Minimum Capital 
regulation, as appropriate.
    Freddie Mac believes that the proposed definitions could create 
confusion because they appear to conflict with how the term 
``obligation'' is used elsewhere in the 1992 Act and in the 
Enterprises' Charter Acts. The proposed regulation defines the term 
``off-balance sheet obligation'' as a binding agreement or contract 
that requires another party to make future payments in money or in kind 
to an Enterprise (or guarantees of such payments to a third party). In 
contrast, Freddie Mac stated that the term ``obligation'' used 
elsewhere in the 1992 Act and the Enterprises' Charter Acts applies 
only to future payments from an Enterprise to a third party--and not to 
future payments from another party to the Enterprise (or guarantees of 
such payments to a third party).
    Freddie Mac also stated that the proposed definition of the term 
``other off-balance sheet obligations'' could create confusion as to 
whether resecuritizations of MBS, such as real estate mortgage 
investment conduits and other multi-class MBS, are included in that 
definition. Freddie Mac believes that it was the intent of Congress 
that such resecuritizations should not be included and that OFHEO's 
interim procedures do not include resecuritizations. Also, Freddie Mac 
believes that the definition of the term ``other off-balance sheet 
obligations'' is too narrow because commitments, which Congress 
expressly considered to be other off-balance sheet obligations, would 
not fall within the proposed definition of that term.
    OFHEO believes that because the term ``obligation'' may be used 
differently in the 1992 Act and the Enterprises' Charter Acts, it more 
important to include a definition of the terms ``off-balance sheet 
obligation'' and ``other off-balance sheet obligations'' for purposes 
of the computation of the minimum capital requirement. However, to 
eliminate any confusion regarding the treatment of commitments, the 
definition of the term ``off-balance sheet obligation'' has been 
revised to include an express reference to commitments. Also, the 
definition of the term ``other off-balance sheet obligations'' has been 
revised to clarify that resecuritizations of MBS are not included in 
the definition.
Qualifying Collateral
    Freddie Mac noted that the definition of the term ``qualifying 
collateral'' in section 1750.2 differs from the discussion of what 
constitutes qualifying collateral in paragraph 5 of Appendix A. 
Consistent with this comment, OFHEO has made conforming editorial 
changes to both the definition in section 1750.2 and the discussion in 
Appendix A.
    OFHEO has also revised the footnote in connection with the 
definition of the term ``qualifying collateral'' by defining the term 
``OECD-based group of counties'' to conform with the Joint Final Rule 
published by the Federal Reserve System, the Office of the Comptroller 
of the Currency, and the Federal Deposit Insurance Corporation.<SUP>27 
This final rule was promulgated after the publication of the proposed 
Minimum Capital regulation.
---------------------------------------------------------------------------

    \27\ 60 FR 66042, Dec. 20, 1995.
---------------------------------------------------------------------------

Section 1750.4  Minimum Capital Requirement Computation

    Section 1750.4(a) of the proposed regulation provides that the 
minimum capital requirement for each Enterprise is the sum of the 
following amounts--

--2.50 percent times the aggregate on-balance sheet assets of the 
Enterprise;
--0.45 percent times the unpaid principal balance of mortgage-backed 
securities and substantially equivalent instruments that were issued or 
guaranteed by the Enterprise;
--0.45 percent of 50 percent of the average dollar amount of 
commitments outstanding each quarter over the preceding four quarters;

[[Page 35612]]

--0.45 percent of the outstanding principal amount of bonds with 
multifamily credit enhancements;
--0.45 percent of the dollar amount of sold portfolio remittances 
pending;
--3.00 percent of the credit equivalent amount of interest rate and 
foreign exchange rate contracts except to the extent of the current 
market value of posted qualifying collateral;
--1.50 percent of the credit equivalent amount of interest rate and 
foreign exchange rate contracts equal to the market value of posted 
qualifying collateral; and
--0.45 percent of the outstanding amount of other off-balance sheet 
obligations, excluding commitments, multifamily credit enhancements, 
sold portfolio remittances pending, and interest rate and foreign 
exchange rate contracts, except as adjusted by the Director to reflect 
differences in the credit risk of such obligations in relation to MBS.

    Section 1750.4(b) provides that any asset or financial obligation 
that can be properly classified in more than one of the enumerated 
categories shall be classified in the category that yields the highest 
minimum capital amount.
    OFHEO received comments with respect to section 1750.4, as 
explained below.

Section 1750.4(a)(6)  Ratios With Respect to Interest Rate and Foreign 
Exchange Rate Contracts

Notice of Adjustment
    Freddie Mac asserted that OFHEO has not provided adequate notice to 
the Enterprises of the basis, in quantifiable terms, for the proposed 
upward adjustment it makes to the 0.45 percent ratio with respect to 
interest rate and foreign exchange rate contracts.
    OFHEO believes that it provided adequate notice of the basis of the 
proposed adjustment in the preamble of the proposed Minimum Capital 
regulation. The preamble explained how OFHEO analyzed the relative 
credit risk of interest rate and foreign exchange rate contracts as 
compared with the credit risk of MBS. However, in light of this 
comment, OFHEO believes it appropriate to summarize its reasons for 
adjusting the 0.45 percent ratio.
    The source of credit risk of MBS to the Enterprises is the risk of 
defaults and losses on the mortgages underlying the MBS. The aggregate 
credit risk associated with the underlying mortgages is low because the 
Enterprises require very broad geographic diversification; strict and 
consistent mortgage underwriting standards; minimum initial 
collateralization of 125 percent (i.e., maximum 80 percent loan-to-
value ratio) or supplemental mortgage insurance; and increasing levels 
of collateralization as loans amortize and property values increase. 
Moreover, the credit risk of MBS is offset by the continuing source of 
income provided by guarantee fees.
    Neither Enterprise has experienced a net credit loss on its MBS. 
Annual losses to date have ranged from two basis points to ten basis 
points (expressed as a percentage of the outstanding portfolio), and 
have been easily covered by guarantee fee income, which has ranged from 
20 to 25 basis points.
    The source of credit risk of interest rate and foreign exchange 
rate contracts is the risk of counterparty default. The credit risk of 
interest rate and foreign exchange rate contracts is greater than that 
of MBS, even though the Enterprises attempt to limit the credit risk of 
the contracts by restricting their business to high quality 
counterparties and adjusting collateral requirements on the basis of 
the counterparty credit quality and the current replacement cost of the 
contracts. The credit risk associated with interest rate and foreign 
exchange rate contracts is a result of the following characteristics:
    <bullet> Large swings in market rates, on which interest rate and 
foreign exchange rate contracts are based, may simultaneously increase 
exposure to and risk of default by one or more counterparties, which 
are typically financial firms.
    <bullet> While losses may be infrequent, the high level of 
interdependence of the world's major financial institutions, many of 
which are important interest rate and foreign exchange rate contract 
counterparties, could cause disproportionately high losses when they do 
occur. This phenomenon is often referred to as ``systemic risk.''
    <bullet> Counterparty risk is concentrated. The loss resulting from 
the default of a single counterparty could be many times larger than 
the amount of capital that would be associated with the application of 
a 0.45 percent capital ratio.
    <bullet> Interest rate and foreign exchange rate contract exposures 
are not as fully collateralized as are the mortgages underlying the 
Enterprises' MBS.
    <bullet> The interest rate and foreign exchange rate contracts 
markets are comparatively new; therefore, the functioning of these 
markets is less predictable in terms of operational and legal risk.
    <bullet> There is no current stream of fee income to offset losses 
on interest rate and foreign exchange rate contracts associated with 
counterparty failures.
    OFHEO recognizes that, although the credit risk characteristics of 
interest rate and foreign exchange rate contracts can be identified, 
they are difficult to quantify. However, the 1992 Act does not require 
such quantification. Rather, it requires a reasonable analysis, based 
on available information, of the credit risk of interest rate and 
foreign exchange rate contracts relative to that of MBS.
    The fact that the Enterprises have not experienced a net credit 
loss on their MBS does not mean that there are no risks associated with 
these instruments. Similarly, the fact that the Enterprises have not 
experienced losses associated with interest rate and foreign exchange 
rate contracts does not mean that there are no risks associated with 
these contracts. In these circumstances, it is appropriate for OFHEO to 
analyze the relative risks of these instruments by comparing their 
respective credit risk characteristics. Based on an analysis of these 
relative credit risk characteristics, OFHEO adjusted the 0.45 percent 
ratio applicable to MBS upward to reflect the greater risk of interest 
rate and foreign exchange rate contracts. As OFHEO and the Enterprises 
accumulate data on the risk of, and gain experience with the 
application of the ratios for, interest rate and foreign exchange rate 
contracts, OFHEO may make adjustments to the ratios, as appropriate.
    Freddie Mac also commented on the upward adjustment of ratios for 
interest rate and foreign exchange rate contracts in light of OFHEO's 
statement in the Annual Report to Congress that the credit risk of the 
Enterprises' derivatives (interest rate and foreign exchange rate) 
contracts ``is very small relative to the credit risk the Enterprises 
face with regard to mortgages they hold or guarantee.'' <SUP>28 This 
statement was in the context of the notional values of the contracts. 
As the Annual Report to Congress notes two sentences later, the 
replacement cost (current credit exposure) of the contracts is 
relatively small. In other words, the replacement cost, which together 
with an amount for potential future credit exposure constitutes the 
credit equivalent amount, is very small in comparison with the notional 
amount. We note that the credit equivalent amount represents the 
overall credit risk of interest rate and foreign exchange rate 
contracts.
---------------------------------------------------------------------------

    \28\ OFHEO, Annual Report to Congress, 9 (June 15, 1995).
---------------------------------------------------------------------------

Lowering the Proposed Ratios
    Fannie Mae recommended lowering the proposed ratios from 3.0 
percent of

[[Page 35613]]

the credit equivalent amount of uncollateralized interest rate and 
foreign exchange rate contracts and 1.5 percent of the credit 
equivalent amount of collateralized contracts to 2.0 percent and 0.5 
percent respectively. Fannie Mae believes that the proposed ratios are 
unreasonably high in relation to the historical loss experience for 
similar obligations.
    Fannie Mae stated that the factors that determine an adequate 
amount of required capital for interest rate and foreign exchange rate 
contracts include the probability of default and the severity of 
possible loss. To determine the probability of default of 
collateralized interest rate and foreign exchange rate contracts, 
Fannie Mae analyzed historical default statistics from Moody's 
Investors Service over the past 25 years for unsecured, 5- to 9-year 
term senior debt of corporations with debt ratings from Aaa to Baa. 
Fannie Mae stated that it uses historical data for unsecured senior 
debt because data on interest rate and foreign exchange rate contracts 
is limited due to the relative newness of the market in such contracts. 
Fannie Mae believes that their default rates are functionally 
equivalent because interest rate and foreign exchange rate contracts 
and unsecured senior debt represent general corporate obligations.
    Fannie Mae stated that the average rating of its interest rate and 
foreign exchange rate counterparties is Aa or A. Using the Moody's 
Investors Service historical data, the default rates for unsecured 
senior debt in those categories ranges from 0.3 percent to 1.5 percent. 
Thus, Fannie Mae suggested that an appropriate estimate of default 
incidence for its interest rate and foreign exchange rate contracts is 
between 0.3 and 1.5 percent.
    Fannie Mae then stated that the historical data demonstrates that 
the average loss severity from 1974 through 1994 is 51.1 percent for 
all corporate unsecured senior debt, and 28.4 percent for Baa or better 
corporate unsecured senior debt. Multiplying the default incidence by 
the loss severity yields a ``capital ratio.'' Thus, according to Fannie 
Mae, a default incidence in the range of 0.3 to 1.5 percent and a 
severity level in the range of 28.4 to 51.1 percent produces a 
``capital ratio'' for uncollateralized interest rate and foreign 
exchange rate contracts in the range of 0.1 to 0.75 percent. The ratio 
that Fannie Mae recommended--2.0 percent for uncollateralized interest 
rate and foreign exchange rate contracts--is 2\2/3\ times its estimated 
``worst case'' ratio of 0.75 percent. Consequently, Fannie Mae believes 
the recommended ratio to be an adequate and suitable minimum capital 
ratio for uncollateralized interest rate and foreign exchange rate 
contracts.
    Fannie Mae further believes that the use of collateral 
significantly reduces the severity of loss associated with interest 
rate and foreign exchange rate contracts. Fannie Mae asserted that 10 
percent is a reasonable estimate of expected loss severity for 
collateralized interest rate and foreign exchange rate contracts, 
because Fannie Mae evaluates the market value of collateral and 
exposures at least monthly, Fannie Mae requires over-collateralization 
if credit quality deteriorates below a specific level, and the loss 
severity of uncollateralized exposures is best represented by the 28.4 
percent historical loss severity experience for unsecured senior debt. 
By multiplying the 10 percent loss severity by the 0.3 to 1.5 percent 
historical average default rates, Fannie Mae estimated a ``capital 
ratio range'' of 0.03 percent to 0.15 percent. Thus, Fannie Mae's 
recommendation of a 0.5 percent ratio for collateralized interest rate 
and foreign exchange rate contracts is 3\1/3\ times its estimated 
``worst case.''
    After carefully considering Fannie Mae's arguments, OFHEO has 
decided not to reduce the proposed ratio for interest rate and foreign 
exchange rate contracts. Fannie Mae's analysis assumes that the default 
rate for interest rate and foreign exchange rate contracts will conform 
with the historical default rates for corporate unsecured senior debt. 
As Fannie Mae noted, interest rate and foreign exchange rate contracts 
are relatively new instruments and historical default rates are 
lacking. Therefore, OFHEO cannot assume that the default rates of 
unsecured senior debt and interest rate and foreign exchange rate 
contracts will prove to be comparable.
    Even assuming the default rates would be comparable, Fannie Mae's 
proposal does not provide an adequate capital cushion. Fannie Mae 
derives what it calls ``capital ratios'' based on more than twenty 
years' experience of a national sample of corporate credits. These 
``capital ratios'' are in fact average national loss rates for a period 
not marked by extreme economic stress. For minimum capital purposes, 
Fannie Mae proposes to apply rates to both uncollateralized and 
collateralized counterparty exposure that are roughly three times as 
high as these capital ratios. The 1992 Act requires that any adjustment 
to the 0.45 percent ratio reflect the credit risk relative to MBS. 
Fannie Mae's proposed multiples are not consistent with this 
requirement. As the above discussion notes, neither Enterprise has 
experienced any net credit loss on its MBS. However, ignoring guarantee 
fee income, annual losses to date have ranged from two basis points to 
ten basis points. Thus the 0.45 percent statutory capital ratio for MBS 
ranges from 4.5 to 22.5 times the historical loss experience for MBS--
higher than the 2\2/3\ and 3\1/3\ times the estimated ``worst case'' 
loss proposed by Fannie Mae.
    Fannie Mae's analysis also ignores a number of factors which 
increase the potential loss associated with the credit exposure of 
interest rate and foreign exchange rate contracts that are not present 
with MBS. The credit exposures of interest rate and foreign exchange 
rate contracts are highly concentrated, large swings of interest rates 
may simultaneously increase both the credit exposure and the default 
risk, and systemic problems could cause disproportionately high losses 
when they do occur.
    Furthermore, Fannie Mae predicates its proposal on its current risk 
management practices, with respect to counterparty creditworthiness and 
collateral requirements and their enforcement. OFHEO believes that a 
minimum capital requirement establishes an essential amount of capital 
that an Enterprise with given levels of business must hold to address 
broad categories of risk, not specific exposures. Accordingly, it 
should not attempt to reflect the quality of current risk management 
practices. For example, Fannie Mae's analysis assumes that it will 
continue to manage credit risk by doing business with counterparties 
with Aa and A ratings and that such counterparties are not subject to 
sudden declines in ratings. Fannie Mae also assumes that, if ratings 
decline, it will require and be able to obtain more collateral.
    Even if these assumptions were valid, OFHEO believes that they 
cannot be the basis of a minimum capital requirement. The minimum 
capital requirement is not intended to be a risk-based capital 
requirement. The 1992 Act separately provides for a risk-based capital 
requirement in which credit, interest, and operational and management 
risk are calculated using a stress test. The 1992 Act requires that the 
0.45 percent ratio for other off-balance sheet obligations be adjusted 
to reflect differences in the credit risk of the obligation and MBS. 
OFHEO believes that the adjustment should be for differences in risk 
associated with the inherent risk characteristics of different 
instruments, not the risk characteristics of counterparties to these 
obligations or

[[Page 35614]]

current risk management practices for these obligations.
Right to Raise the Ratio
    America's Community Bankers recommended that OFHEO explicitly 
reserve the right to raise the ratio for uncollateralized interest rate 
and foreign exchange rate contracts to 4.0 percent depending on the 
specific counterparty risks involved. As discussed above, OFHEO 
believes that counterparty credit ratings are not the appropriate focus 
of minimum capital ratios and that it has required an adequate amount 
of capital for uncollateralized interest rate and foreign exchange rate 
contracts. If OFHEO's experience with the application of the ratio for 
interest rate and foreign exchange rate contracts proves otherwise, 
OFHEO will raise the ratio. In addition, as discussed in connection 
with the comments on section 1750.1, if the business practices of an 
Enterprise were to endanger the capital adequacy of the Enterprise, 
OFHEO would take any actions necessary to ensure the financial safety 
and soundness of the Enterprise's operations.
Avoid Changing the Capital Calculation
    Mortgage Bankers Association of America (MBA) stated that the 
proposed change from the interim guidelines in the calculation of the 
capital ratio for interest rate and foreign exchange rate contracts 
does not appear to be so significant as to cause the Enterprises to 
increase current guarantee fees, which would ultimately harm consumers 
in the form of higher interest rates or fees. MBA understands that the 
Enterprises currently have sufficient capital to meet the higher 
capital ratios that would result from the proposal. Nevertheless, MBA 
urged OFHEO to remain cautious and avoid changing the capital 
calculation of interest rate and foreign exchange rate contracts if the 
calculation influences the Enterprises' selection of funding and 
hedging instruments in a way that affects their ability to manage 
risks, is detrimental to their housing mission, or increases the cost 
of credit to consumers.
    MBA recognizes that OFHEO does not wish to jeopardize the 
Enterprises' ability to meet their housing mission and goals, but must 
ensure the safety and soundness of the Enterprises. MBA believes that 
OFHEO should strive to strike a balance and avoid imposing inefficient 
capital requirements that inhibit the management of risk.
    OFHEO agrees that the capital requirements should ensure the safety 
and soundness of the Enterprises while not jeopardizing the 
Enterprises' ability to meet their housing mission and goals. 
Consistent with that approach, OFHEO does not believe that the change 
in the calculation of the capital ratio for interest rate and foreign 
exchange rate contracts will adversely affect the Enterprises' ability 
to manage risk or increase the cost of mortgage credit to consumers. 
Furthermore, mindful of the need to strike a balance among competing 
interests, OFHEO believes that it is in the best long-term interests of 
consumers and the Enterprises that the Enterprises have an adequate 
cushion of minimum capital to ensure against loss. While a decrease in 
capital requirements could result in a reduction in mortgage credit 
costs for consumers in the short-term, the decrease would not be 
beneficial in the long-term if it jeopardized the financial viability 
of the Enterprises.
    This view is consistent with the congressional findings set forth 
in the 1992 Act that recognize the Enterprises' important housing 
mission and the need to provide long-term safeguards in the form of 
capital requirements to reduce the risk of failure.\29\ The 
congressional findings also recognize the Enterprises' obligation to 
facilitate the financing of affordable housing while maintaining a 
strong financial condition and a reasonable economic return.\30\
---------------------------------------------------------------------------

    \29\ See section 1302 (12 U.S.C. 4501).
    \30\ Section 1302(7) (12 U.S.C. 4501(7)).
---------------------------------------------------------------------------

``Pro Rata'' Capital Charge
    The Office of Thrift Supervision asked whether the proposed 
regulation would provide a reduced ``pro rata'' capital charge for 
partially collateralized interest rate and foreign exchange rate 
contracts. In response to this comment, OFHEO notes that section 
1750.4(a)(6) provides a ratio of 3.00 percent of the credit equivalent 
amount of interest rate and foreign exchange rate contracts, except to 
the extent of the current market value of posted qualifying collateral; 
and 1.50 percent of the market value of qualifying collateral posted to 
secure interest rate and foreign exchange rate contracts, not to exceed 
the credit equivalent amount of such contracts. Thus, an interest rate 
or foreign exchange rate contract partially collateralized with 
qualifying collateral will have a reduced capital charge to the extent 
of the qualifying collateral.
Enterprises' Right to Require Collateral
    Fannie Mae and Freddie Mac both stated that the market widely 
perceives an agreement with a Aaa rated counterparty that agrees to 
post collateral if it is downgraded to be as safe as, or safer than, a 
comparable agreement with a lesser-rated counterparty that posts 
collateral. They claimed that the proposed regulation would run counter 
to well-established market practices by rewarding an Enterprise with a 
lower capital requirement if its Aaa rated counterparties are 
downgraded and post collateral under their collateral agreements, or if 
the Enterprise avoids Aaa rated counterparties in favor of lesser-rated 
counterparties.
    Freddie Mac recommended the following standard: The same minimum 
capital ratio would apply for collateralized agreements and for 
uncollateralized agreements where the counterparty holds the highest 
credit rating of any entity effectively recognized by the Division of 
Market Regulation of the Securities and Exchange Commission as a 
nationally recognized statistical rating organization for the purposes 
of capital rules for broker-dealers, and has entered into a binding 
agreement to post qualifying collateral if and when the counterparty no 
longer holds the highest rating of such an entity. As an alternative, 
Freddie Mac recommended treating the contract as fully collateralized 
for purposes of computing the minimum capital requirement where a Aaa 
rated counterparty has agreed to post collateral when it is downgraded.
    OFHEO has considered Fannie Mae's and Freddie Mac's 
recommendations, but has decided not to adopt them. The Enterprises' 
recommendations rely heavily on the credit ratings of counterparties 
and current Enterprise practice. In fact, Freddie Mac has noted 
elsewhere that credit enhancements in which the counterparty is 
required to post collateral only when its credit rating or capital 
begins to deteriorate ``present some management-and-operations risk 
because the arrangements need to be monitored and the collateral needs 
to be posted in a timely fashion.'' \31\
---------------------------------------------------------------------------

    \31\ ``Comments of the Federal Home Loan Mortgage Corporation on 
the Advance Notice of Proposed Rulemaking on Risk-Based Capital of 
the Office of Federal Housing Enterprise Oversight,'' 72 (May 9, 
1995)(available at OFHEO).
---------------------------------------------------------------------------

    OFHEO believes that reliance on the credit ratings of 
counterparties and current Enterprise practice should not be the basis 
for establishing minimum capital ratios. Even though the 1992 Act 
requires that credit risk be taken into account when adjusting the 
ratio for certain off-balance sheet obligations, the minimum capital 
requirement essentially is computed on the basis of simple leverage 
ratios. Categories of obligations that are assigned a specific ratio 
include obligations with a mixture

[[Page 35615]]

of greater and lesser risk, depending on borrower or counterparty 
characteristics.
    Consistent with the concepts underlying ``minimum'' as opposed to 
``risk-based'' capital, when developing the proposed regulation, OFHEO 
considered whether the minimum capital ratio should be the same for 
interest rate and foreign exchange rate contracts regardless of whether 
collateral was posted. In adopting the proposed regulation, OFHEO 
determined that a lower minimum capital ratio for the collateralized 
portion of an obligation was appropriate. This determination was made 
based on the recognition that a collateralized position affords the 
Enterprises greater certainty of collection than an uncollateralized 
position in the event of a decline in the financial condition of a 
counterparty. In contrast, the value of a promise by a counterparty to 
post collateral in the event that it is downgraded is subject to the 
diminished capacity of a counterparty during times of financial stress 
to identify and pledge adequate liquid assets to secure its contractual 
obligations.
    OFHEO also recognizes that the value of a promise by a counterparty 
to post collateral when it is downgraded is influenced by the speed of 
the rating agency's ability to recognize changes in credit conditions. 
Recent incidents, such as the default of Barings from trading losses, 
illustrate how rapidly the financial health of a well-respected entity 
can deteriorate. When a decline occurs very rapidly, a promise to post 
collateral to secure counterparty obligations may be of little value. 
Finally, as a point of comparison, OFHEO notes that the risk-based 
capital standards for banks and thrifts do not treat agreements to post 
collateral as the equivalent of collateral and do not incorporate 
counterparty credit ratings into the determination of risk weights 
assigned to different counterparties.

Section 1750.4(a)(7)  Ratio With Respect to Other Off-Balance Sheet 
Obligations

    Section 1750.4(a)(7) of the proposed regulation provides the amount 
of other off-balance sheet obligations that is to be included in the 
computation of the minimum capital requirement. The amount is--
    0.45 percent of the outstanding amount of other off-balance sheet 
obligations, excluding commitments, multifamily credit enhancements, 
sold portfolio remittances pending, and interest rate contracts and 
foreign exchange rate contracts except as adjusted by the Director to 
reflect differences in the credit risk of such obligations in relation 
to mortgage-backed securities.
    Freddie Mac recommended that proposed section 1750.4(a)(7) be 
deleted in connection with its comments that (1) the definition of the 
term ``off-balance sheet obligation'' be deleted and (2) the definition 
of the term ``other off-balance sheet obligations'' be defined in terms 
of commitments, multifamily credit enhancements, sold portfolio 
remittances pending, and interest rate and foreign exchange rate 
contracts. (See the full discussion under section 1750.2, above.) If 
section 1750.4(a)(7) is retained, Freddie Mac recommended that OFHEO 
delete the phrase ``the outstanding amount.'' Freddie Mac believes that 
the phrase could create confusion if, in the future, OFHEO determines 
that an item should be treated as an ``other off-balance sheet 
obligation,'' and OFHEO also determines that the appropriate measure of 
credit risk should be something other than an ``outstanding amount.''
    OFHEO agrees with Freddie Mac; however, rather than deleting the 
phrase ``outstanding amount,'' OFHEO has substituted the phrase 
``credit equivalent amount, or other appropriate measure, as determined 
by the Director.'' This revision will clarify that, depending on the 
specific characteristics of the obligation, the computation of the 
minimum capital requirement may be based on the credit equivalent 
amount or other measures that the Director determines are appropriate.
    OFHEO also has made a clarifying editorial revision to proposed 
section 1750.4(a)(6)(ii) with respect to the computation of the minimum 
capital amount for interest rate and exchange rate contracts.

Section 1750.4(b)  Capital Treatment of On-Balance Sheet and Off-
Balance Sheet Items

    Section 1750.4(b) of the proposed regulation provides that, for 
purposes of the minimum capital requirement computation, any asset or 
financial obligation that is properly classifiable in more than one 
category of items must be classified in the category that yields the 
highest requirement.
    Freddie Mac expressed the concern that the proposed regulation 
would require capital charges for foreign exchange rate contracts to be 
computed as if such contracts were reflected on the balance sheet, even 
if they are not. Freddie Mac also recommended that OFHEO clarify that 
the regulation will not require an Enterprise to make adjustments to a 
balance sheet that has been prepared in accordance with generally 
accepted accounting principles (GAAP).
    As noted by Freddie Mac, the Enterprises are required to prepare 
their balance sheets in accordance with GAAP. Consistent with that 
requirement, the Minimum Capital regulation does not require an 
Enterprise to adjust its balance sheet prepared in accordance with 
GAAP. The requirements of the Minimum Capital regulation relate only to 
the computation of the minimum capital requirement.
    Under GAAP, it is possible that some assets or obligations may 
properly be reflected either on or off the balance sheet. OFHEO 
believes that, for minimum capital purposes, it is appropriate to 
classify any asset or obligation that may be properly reflected either 
on or off the balance sheet in the category that yields the highest 
minimum capital requirement. The purpose of capital is to serve as a 
cushion to absorb losses and thereby reduce the risk of failure of the 
Enterprise. The minimum capital requirement represents a level of 
capital for an Enterprise which, if not met, will result in the 
institution being classified as 'significantly undercapitalized.'' 
Consequently, it would be inappropriate for the Minimum Capital 
regulation to permit an Enterprise to determine its minimum capital 
requirement by favoring one accounting treatment over another. The 
purpose of section 1750.4(b) is to avoid such a circumstance.
    In addition, Freddie Mac commented on the relationship between 
section 1750.4(b) and paragraph 4 of Appendix A, suggesting that they 
articulated inconsistent requirements with respect to interest rate and 
foreign exchange rate contracts. In that regard, Freddie Mac 
recommended that OFHEO treat all foreign exchange rate contracts as 
other off-balance sheet obligations, and then subtract from the 
computed minimum capital requirement the amount, if any, that is 
attributable to the contracts as on-balance sheet assets.
    OFHEO does not believe there is any inconsistency between section 
1750.4(b) and paragraph 4 of Appendix A. The scope of the two 
provisions is different and, to the extent they deal with the same 
issue, they address different aspects of the issue. As explained above, 
section 1750.4(b) provides that an Enterprise's assets or obligations 
that may be properly classified in more than one of the on- or off-
balance sheet categories will be classified according to the category 
that yields the highest

[[Page 35616]]

minimum capital requirement. The scope of section 1750.4(b) encompasses 
not only interest rate and foreign exchange rate contracts, but also 
any other assets or obligations that could be classified in more than 
one category.
    In contrast, paragraph 4 of Appendix A, Avoidance of Double 
Counting, is restricted in scope to interest rate and foreign exchange 
rate contracts and only addresses the issue of double counting. The 
purpose of paragraph 4 is to ensure that the capital amount for such 
contracts is not double counted if the proper accounting treatment 
results in a portion of the credit exposure of the contract(s) being 
reflected on and off the balance sheet. To that end, paragraph 4 
provides that the amount of credit exposure arising from interest rate 
and foreign exchange rate contracts may need to be excluded from on-
balance sheet assets in calculating the minimum capital requirement.

Section 1750.5  Notice of Capital Classification

    Section 1750.5 outlines the procedures that OFHEO will follow when 
notifying each Enterprise of its capital classification.
    Freddie Mac noted that while the proposed regulation sets forth a 
process that could result in a final capital classification not being 
issued until a full 150 days after the end of a quarter, it hopes that 
a process of less than 90 days would continue to be the norm.
    Section 1750.3 provides that an Enterprise has 30 days after the 
end of each quarter to file a minimum capital report. Section 1750.5 
provides that within 60 days of receiving the minimum capital report, 
OFHEO will provide each Enterprise with a notice of proposed capital 
classification. The Enterprise has 30 days in which to respond to the 
proposed capital classification. The Enterprise's response period may 
be extended up to 30 additional calendar days, or shortened, at the 
sole discretion of the Director. The Director, after taking into 
consideration the Enterprise's response, has up to 30 calendar days 
following the end of the response period in which to issue a final 
notice of capital classification.
    The time periods specified in the regulation are designed to 
establish the longest possible timeframes for actions by the 
Enterprises and OFHEO in the capital classification process. OFHEO 
would expect that under most circumstances the total elapsed time for a 
capital classification will be substantially less than the maximum 
period contemplated in the regulation. In that regard, the timing of 
the submission of the Enterprise's minimum capital report and its 
response to the proposed classification will have a significant impact 
on the time period for receipt of the final capital classification.

Appendix A

    Appendix A provides the methodology for computing the minimum 
capital component for interest rate and foreign exchange rate 
contracts.
    The Office of Thrift Supervision questioned whether OFHEO had 
considered whether the proposed treatment of interest rate and foreign 
exchange rate contracts, including the bilateral netting provisions, 
adds unnecessary complexity to the minimum capital standard in light of 
the sophisticated risk-based capital regulation that OFHEO is 
developing.
    Although the minimum capital standard is a minimum leverage ratio 
standard, Congress has required that OFHEO consider the credit risk of 
off-balance sheet obligations and adjust the 0.45 percent ratio to 
reflect the difference between the credit risk of interest rate and 
foreign exchange rate contracts and MBS. Thus, OFHEO believes that the 
adjusted ratios should be applied to the credit equivalent amount of 
interest rate and foreign exchange rate contracts because the credit 
equivalent amount best represents the dollar amount at risk. OFHEO also 
believes that bilateral netting, that is, the offsetting of positive 
and negative mark-to-market values in the determination of a current 
credit exposure used in the calculation of a credit equivalent amount, 
provides a more accurate representation of the dollar amount at risk. 
Consequently, OFHEO believes that the more complex treatment with 
respect to interest rate and foreign exchange rate contracts is 
appropriate.
Paragraph 5.  Collateral
    Freddie Mac noted that the definition of the term ``qualifying 
collateral'' in section 1750.2 differs from the discussion of what 
constitutes qualifying collateral in paragraph 5 of Appendix A. OFHEO 
does not intend that there be any difference and has revised the 
discussion in Appendix A to conform with the definition set forth in 
section 1750.2. (See the full discussion of this comment under section 
1750.2, Qualifying collateral, above.)
    Additionally, OFHEO has renumbered paragraphs 1 and 2 of Appendix A 
of the proposed regulation to ensure ease of reading and reference.

IV. Section-by-Section Analysis

Section 1750.1  General

    This section states that the regulation sets forth the methodology 
for computing the minimum capital requirement for each Enterprise. It 
further states that the board of directors of each Enterprise is 
responsible for ensuring that the Enterprise maintains capital at a 
level that is sufficient to ensure the continued financial viability of 
the Enterprise and that equals or exceeds the minimum capital 
requirement.

Section 1750.2  Definitions

    Section 1750.2 provides definitions for the terms used in the 
regulation.
    The term ``affiliate'' is defined as to mean any entity that 
controls, is controlled by, or is under common control with, an 
Enterprise, except as otherwise provided by the Director.
    The term ``commitment'' is defined to mean any contractual, legally 
binding agreement that obligates an Enterprise to purchase or to 
securitize mortgages.
    The term ``core capital'' is defined to mean the sum of (as 
determined in accordance with generally accepted accounting principles) 
the par or stated value of outstanding common stock; the par or stated 
value of outstanding perpetual, noncumulative preferred stock; paid-in 
capital; and retained earnings. This definition does not include debt 
instruments or any amounts an Enterprise could be required to pay at 
the option of an investor to retire capital instruments. The amount of 
retained earnings includable in the calculation of core capital is the 
net of the carrying value of Treasury stock. Treasury stock is stock 
that an Enterprise has issued and subsequently acquired, but has not 
retired or resold. Carrying value is typically the amount the 
Enterprise paid for the Treasury stock.
    The term ``Director'' is defined to mean the Director of OFHEO.
    The term ``Enterprise'' is defined to mean the Federal National 
Mortgage Association and any affiliate thereof or the Federal Home Loan 
Mortgage Corporation and any affiliate thereof.
    The term ``foreign exchange rate contracts'' is defined to mean 
cross-currency interest rate swaps, forward foreign exchange contracts, 
currency options purchased (including currency options purchased over-
the-counter), and any other instrument that gives rise to similar 
credit risks. The definition clarifies that the term ``foreign exchange 
rate contracts'' does not mean foreign exchange rate contracts with an 
original maturity of 14 calendar days or less and

[[Page 35617]]

foreign exchange rate contracts traded on exchanges that require daily 
payment of variation margins.
    The term ``interest rate contracts'' is defined to mean single 
currency interest rate swaps, basis swaps, forward rate agreements, 
interest rate options purchased (including caps, collars, and floors 
purchased), over-the-counter options purchased, and any other 
instrument that gives rise to similar credit risks (including when-
issued securities and forward deposits accepted). The definition of the 
term ``interest rate contracts'' does not include instruments traded on 
exchanges that require daily payment of variation margins.
    The term ``mortgage-backed security'' is defined to mean a 
security, investment, or substantially equivalent instrument that 
represents an interest in a pool of loans secured by mortgages or deeds 
of trust where the principal or interest payments to the investor in 
the security or substantially equivalent instrument are guaranteed or 
effectively guaranteed by an Enterprise.
    The term ``multifamily credit enhancement'' is defined to mean any 
guarantee, pledge, purchase arrangement, or other obligation or 
commitment provided or entered into by an Enterprise with respect to 
multifamily mortgages to provide credit enhancement, liquidity, 
interest rate support, and other guarantees and enhancements for 
revenue bonds issued by a state or local governmental unit (including a 
housing finance agency) or other bond issuer.
    The term ``1992 Act'' is defined to mean the Federal Housing 
Enterprises Financial Safety and Soundness Act of 1992, found at Title 
XIII of the Housing and Community Development Act of 1992, Pub. L. No. 
102-550.
    The term ``notional amount'' is defined to mean the face value of 
the underlying financial instrument(s) on which an interest rate or 
foreign exchange rate contract is based.
    The term ``off-balance sheet obligation'' is defined to mean a 
binding agreement, contract, or similar arrangement that requires or 
may require future payment(s) in money or kind by another party to an 
Enterprise, or that effectively guarantees all or part of such 
payment(s) to third parties (including commitments), where such 
agreement or contract is a source of credit risk that is not included 
on its balance sheet.
    The term ``OFHEO'' is defined to mean the Office of Federal Housing 
Enterprise Oversight.
    The term ``other off-balance sheet obligations'' is defined to mean 
all off-balance sheet obligations of an Enterprise that are not 
mortgage-backed securities or substantially equivalent instruments and 
that are not resecuritized MBS such as real estate mortgage investment 
conduits or similar resecuritized instruments.
    The term ``perpetual, noncumulative preferred stock'' is defined to 
mean preferred stock that does not have a maturity date, provides the 
issuer the ability and the legal right to eliminate dividends and does 
not permit the accruing or payment of impaired dividends, and that 
cannot be redeemed at the option of the holder. It is further defined 
as preferred stock that has no other provisions that will require 
future redemption of the issue, in whole or in part, or that will reset 
the dividend periodically based, in whole or in part, on the 
Enterprise's current credit standing, such as auction rate, money 
market, or remarketable preferred stock, or that may cause the dividend 
to increase to a level that could create an incentive for the issuer to 
redeem the instrument, such as exploding rate stock. For purposes of 
minimum capital, perpetual, noncumulative preferred stock must provide 
capital that is available to absorb losses of the Enterprise from any 
source.
    The term ``qualifying collateral'' is defined to mean cash on 
deposit; securities issued or guaranteed by the central governments of 
the OECD-based group of countries,<SUP>32 United States Government 
agencies, or United States Government-sponsored agencies; and 
securities issued by multilateral lending institutions or regional 
development banks.
---------------------------------------------------------------------------

    \32\ The OECD-based group of countries comprises full members of 
the Organization for Economic Cooperation and Development (OECD) 
regardless of entry date, as well as countries that have concluded 
special lending arrangements with the International Monetary Fund 
(IMF) associated with the IMF's General Arrangements to Borrow, but 
excludes any country that has rescheduled its external sovereign 
debt within the previous 5 years. A rescheduling of external 
sovereign debt generally would include any renegotiation of terms 
arising from a country's mobility or unwillingness to meet its 
external debt service obligations, but generally not include any 
renegotiation to allow the borrower to take advantage of a decline 
in interest rate or other change in market conditions.
    As of November 1995, the OECD countries included the following 
countries: Australia, Austria, Belgium, Canada, Denmark, Finland, 
France, Germany, Greece, Iceland, Ireland, Italy, Japan, Luxembourg, 
Mexico, the Netherlands, New Zealand, Norway, Portugal, Spain, 
Sweden, Switzerland, Turkey, the United Kingdom, and the United 
States; and Saudi Arabia has concluded special lending arrangements 
with the IMF associated with the IMF's General Arrangements to 
Borrow.
---------------------------------------------------------------------------

Section 1750.3  Procedures and Timing

    Section 1750.3 provides that each Enterprise must file with the 
Director a minimum capital report each quarter, or at such other times 
as the Director requires, in his or her sole discretion. The report 
must contain the information that responds to all of the items required 
by OFHEO in written instructions to the Enterprise, including, but not 
limited to an estimate of the minimum capital requirement; an estimate 
of core capital overage or shortfall relative to the estimated minimum 
capital requirement; and such other information as may be required by 
the Director.
    This section further provides that the report must be submitted not 
later than April 30, July 30, October 30, and January 30 of each year, 
and that it must be in writing and in such other format as may be 
required by the Director.
    In the event an Enterprise makes an adjustment to its financial 
statements for a quarter or a date for which the information was 
requested which would cause an adjustment to a minimum capital report, 
section 1750.3 requires that the Enterprise file an amended minimum 
capital report not later than 3 business days after the date of such 
adjustment.
    Finally, section 1750.3 provides that each minimum capital report 
or any amended minimum capital report must contain a declaration by an 
officer authorized by the board of directors of the Enterprise to make 
such a declaration, including, but not limited to, a president, vice 
president, or treasurer, that the report is true and correct to the 
best of such officer's knowledge and belief.

Section 1750.4  Minimum Capital Requirement Computation

    Section 1750.4 sets forth the methodology for computing the minimum 
capital requirement. The minimum capital requirement is the sum of the 
following amounts:

--2.50 percent times the aggregate on-balance sheet assets of the 
Enterprise;
--0.45 percent times the unpaid principal balance of mortgage-backed 
securities and substantially equivalent instruments that were issued or 
guaranteed by the Enterprise;
--0.45 percent of 50 percent of the average dollar amount of 
commitments outstanding each quarter over the preceding four quarters;
--0.45 percent of the outstanding principal amount of bonds with 
multifamily credit enhancements;
--0.45 percent of the dollar amount of sold portfolio remittances 
pending;

[[Page 35618]]

--3.00 percent of the credit equivalent amount of interest rate 
contracts and foreign exchange rate contracts, except to the extent of 
the current market value of posted qualifying collateral, computed in 
accordance with Appendix A; 1.50 percent of the market value of 
qualifying collateral posted to secure interest rate and foreign 
exchange rate contracts, not to exceed the credit equivalent amount of 
such contracts, computed in accordance with Appendix A; and
--0.45 percent of the outstanding amount, credit equivalent amount, or 
other measure determined appropriate by the Director, of other off-
balance sheet obligations (excluding commitments, multifamily credit 
enhancements, sold portfolio remittances pending, and interest rate 
contracts and foreign exchange rate contracts), except as adjusted by 
the Director to reflect differences in the credit risk of such 
obligations in relation to mortgage-backed securities.

    In the event that any asset or financial obligation is properly 
classifiable in more than one of the above categories, section 1750.4 
provides that, for minimum capital purposes, the asset or financial 
obligation must be classified in the category that yields the highest 
minimum capital requirement.
    The section further explains that the term ``preceding four 
quarters'' means the last day of the quarter just ended (or the date 
for which the minimum capital report is filed, if different), and the 
three preceding quarter-ends.

Section 1750.5  Notice of Capital Classification

    Section 1750.5 states that not later than 60 calendar days after 
the date for which the minimum capital report is filed, OFHEO will 
provide each Enterprise with a notice of proposed capital 
classification in accordance with section 1368 of the 1992 Act.<SUP>33 
The notice of proposed capital classification includes the proposed 
minimum capital requirement and the summary computation of the proposed 
minimum capital requirement.
---------------------------------------------------------------------------

    \33\ 12 U.S.C. 4618.
---------------------------------------------------------------------------

    Each Enterprise has a period of 30 calendar days following receipt 
of a notice of proposed capital classification to submit a response. 
The response period may be extended for up to 30 additional calendar 
days at the sole discretion of the Director. The Director may shorten 
the response period with the consent of the Enterprise or without such 
consent if the Director determines that the condition of the Enterprise 
requires a shorter response period.
    Section 1750.5 further provides that the Director must take into 
consideration any response to the notice of proposed capital 
classification received from the Enterprise and must issue a notice of 
final capital classification for each Enterprise not later than 30 
calendar days following the end of the response period.

Appendix A to Subpart A of Part 1750--Minimum Capital Components for 
Interest Rate and Foreign Exchange Rate Contracts

Calculation of Credit Equivalent Amounts
    Appendix A provides that the minimum capital components for 
interest rate and foreign exchange rate contracts are computed on the 
basis of the credit equivalent amounts of such contracts. The credit 
equivalent amount of an off-balance sheet interest rate or foreign 
exchange rate contract that is not subject to a qualifying bilateral 
netting contract in accordance with Appendix A is equal to the sum of 
the current exposure (sometimes referred to as the replacement cost) of 
the contract and an estimate of the potential future credit exposure 
over the remaining life of the contract.
    The current exposure is determined by the mark-to-market value of 
the contract. If the mark-to-market value is positive, then the current 
exposure is the mark-to-market value. If the mark-to-market value is 
zero or negative, then the current exposure is zero. Mark-to-market 
values are measured in United States dollars, regardless of the 
currency or currencies specified in the contract, and should reflect 
changes in the relevant rates as well as counterparty credit quality.
    The potential future credit exposure of a contract, including a 
contract with a negative mark-to-market value, is estimated by 
multiplying the notional principal amount of the contract by a credit 
conversion factor. The effective rather than the apparent or stated 
notional amount must be used in this calculation. The credit conversion 
factors for interest rate contracts are 0.0 percent for interest rate 
contracts with a remaining maturity of 1 year or less; 0.5 percent for 
interest rate contracts with a remaining maturity of over 1 year; 1.0 
percent for foreign exchange rate contracts with a remaining maturity 
of 1 year or less; and 5.0 percent for foreign exchange rate contracts 
with a remaining maturity of over 1 year.
    Because foreign exchange rate contracts involve an exchange of 
principal upon maturity, and foreign exchange rates are generally more 
volatile than interest rates, higher conversion factors have been 
established for foreign exchange rate contracts than for interest rate 
contracts.
    No potential future credit exposure is calculated for single 
currency interest rate swaps in which payments are made based upon two 
floating rate indexes, so-called floating/floating or basis swaps. The 
credit exposure on these contracts is evaluated solely on the basis of 
their mark-to-market values.
Avoidance of Double Counting
    Appendix A provides that, in certain cases, credit exposures 
arising from the interest rate and foreign exchange rate contracts 
covered by this Appendix A may already be reflected, in part, on the 
balance sheet. To avoid double counting such exposures in the 
assessment of capital adequacy, counterparty credit exposures arising 
from the types of instruments covered by this Appendix A may need to be 
excluded from balance sheet assets in calculating the minimum capital 
requirement.
Collateral
    Appendix A provides that the sufficiency of collateral for off-
balance sheet items is determined by the market value of the collateral 
in relation to the credit equivalent amount. Collateral held against a 
netting contract is not recognized for minimum capital standard 
purposes unless it is legally available to support the single legal 
obligation created by the netting contract. Excess collateral held 
against one contract or a group of contracts for which a recognized 
netting agreement exists may not be considered.
    The only forms of collateral that are formally recognized by the 
minimum capital standard framework are cash on deposit; securities 
issued or guaranteed by the central governments of the OECD-based group 
of countries, United States Government agencies, or United States 
Government-sponsored agencies; and securities issued by multilateral 
lending institutions or regional development banks.
Netting
    For purposes of Appendix A, netting refers to the offsetting of 
positive and negative mark-to-market values in the determination of a 
current exposure to be used in the calculation of a credit equivalent 
amount. Any legally enforceable form of bilateral netting (that is, 
netting with a single counterparty) of interest rate and foreign 
exchange rate contracts is recognized for purposes of calculating the 
credit equivalent amount if it meets the following requirements. 
Netting is

[[Page 35619]]

accomplished under a written netting contract that creates a single 
legal obligation, covering all included individual contracts, with the 
effect that the Enterprise would have a claim to receive, or obligation 
to pay, only the net amount of the sum of the positive and negative 
mark-to-market values on included individual contracts in the event 
that a counterparty, or a counterparty to whom the contract has been 
validly assigned, fails to perform due to default, insolvency, 
liquidation, or similar circumstances.
    The Enterprise must obtain a written and reasoned legal opinion(s) 
representing that in the event of a legal challenge--including one 
resulting from default, insolvency, liquidation, or similar 
circumstances--the relevant court and administrative authorities would 
find the Enterprise's exposure to be such a net amount under--

--the law of the jurisdiction in which the counterparty is chartered or 
the equivalent location in the case of noncorporate entities, and if a 
branch of the counterparty is involved, then also under the law of the 
jurisdiction in which the branch is located;
--the law that governs the individual contracts covered by the netting 
contract; and
--the law that governs the netting contract.

    The Enterprise must establish and maintain procedures to ensure 
that the legal characteristics of netting contracts are kept under 
review in the event of possible changes in relevant law. Furthermore, 
the Enterprise must maintain in its files documentation adequate to 
support the netting of rate contracts, including a copy of the 
bilateral netting contract and necessary legal opinions.
    A contract containing a walkaway clause is not eligible for netting 
for purposes of calculating the credit equivalent amount. A walkaway 
clause is a provision in a netting contract that permits a non-
defaulting counterparty to make lower payments than it would make 
otherwise under the contract, or no payment at all, to a defaulter or 
to the estate of a defaulter, even if the defaulter or the estate of 
the defaulter is a net creditor under the contract.
    By netting individual contracts for the purpose of calculating its 
credit equivalent amount, the Enterprise represents that it has met the 
requirements of Appendix A, and that all the appropriate documents are 
in the Enterprise's files and available for inspection by OFHEO. OFHEO 
may determine that an Enterprise's files are inadequate or that a 
netting contract, or any of its underlying individual contracts, may 
not be legally enforceable under any one of the bodies of law described 
in Appendix A. If such a determination is made, the netting contract 
may be disqualified from recognition for minimum capital standard 
purposes or underlying individual contracts may be treated as though 
they are not subject to the netting contract.
    The credit equivalent amount of interest rate and foreign exchange 
rate contracts that are subject to a qualifying bilateral netting 
contract is calculated by adding the current exposure of the netting 
contract and the sum of the estimates of the potential future credit 
exposures on all individual contracts subject to the netting contract, 
estimated in accordance with Appendix A. Offsetting contracts in the 
same currency maturing on the same date will have lower potential 
future exposure as well as lower current exposure. Therefore, for 
purposes of calculating potential future credit exposure to a netting 
counterparty for foreign exchange rate contracts, and other similar 
contracts in which notional principal is equivalent to cash flows, 
total notional principal is defined as the net receipts falling due on 
each value date in each currency.
    The current exposure of the netting contract is determined by 
summing all positive and negative mark-to-market values of the 
individual contracts included in the netting contract. If the net sum 
of the mark-to-market values is positive, then the current exposure of 
the netting contract is equal to that sum. If the net sum of the mark-
to-market values is zero or negative, then the current exposure of the 
netting contract is zero. OFHEO may determine that a netting contract 
qualifies for netting treatment even though certain individual 
contracts may not qualify. In such instances, the nonqualifying 
contracts should be treated as individual contracts that are not 
subject to the netting contract.
    In the event a netting contract covers contracts that are normally 
excluded from the minimum capital requirement computation--for example, 
foreign exchange rate contracts with an original maturity of 14 
calendar days or less, or instruments traded on exchanges that require 
daily payment of variation margin--an Enterprise may elect consistently 
either to include or exclude all mark-to-market values of such 
contracts when determining net current exposure.
    As stated in the preamble to the proposed regulation, in developing 
Appendix A, OFHEO considered provisions of the regulations of the 
federal banking agencies with respect to the calculation of the credit 
equivalent amount for interest rate and foreign exchange rate 
contracts. Subsequent to the publication of the proposed Minimum 
Capital regulation, the federal banking agencies amended their 
regulations with respect to interest rate and foreign exchange rate 
contracts.<SUP>34 The amendments increase the number of credit 
conversion factors that are used to measure the potential future credit 
exposure of interest rate and foreign exchange rate contracts. They 
also change the way the potential future credit exposure is calculated 
when the interest rate and foreign exchange rate contracts are subject 
to a qualifying bilateral netting agreement, resulting in a reduction 
in the amount of capital required for the netted interest rate and 
foreign exchange rate contracts.
---------------------------------------------------------------------------

    \34\ 60 FR 46170 (Sept. 5, 1995).
---------------------------------------------------------------------------

    OFHEO is analyzing those amendments and considering whether to 
conform Appendix A to the final regulations of the federal banking 
agencies. Based on the results of that analysis, OFHEO will publish a 
proposal, as appropriate.

Regulatory Impact

Executive Order 12606, The Family

    This regulation does not have potential for significant impact on 
family formulation, maintenance, and general well-being, and thus is 
not subject to review under Executive Order 12606.

Executive Order 12612, Federalism

    This regulation has no federalism implications that warrant the 
preparation of a Federalism Assessment in accordance with Executive 
Order 12612.

Executive Order 12866, Regulatory Planning and Review

    This regulation has been reviewed by the Office of Management and 
Budget pursuant to Executive Order 12866.

Executive Order 12988, Civil Justice Reform

    This proposed regulation meets the applicable standards of sections 
3(a) and (b) of Executive Order 12988.

Unfunded Mandates Reform Act of 1995

    The regulation does not require the preparation of an assessment 
statement in accordance with the Unfunded Mandates Reform Act of 1995. 
Assessment statements are not required for regulations that incorporate 
requirements specifically set forth in

[[Page 35620]]

law. As explained in the preamble, this regulation implements the 
minimum capital standard contained in the 1992 Act. In addition, this 
regulation does not include a federal mandate that may result in the 
expenditure by State, local, and tribal governments, in the aggregate, 
or by the private sector, of $100,000,000 or more (adjusted annually 
for inflation) in any 1 year.

Regulatory Flexibility Act

    This regulation is applicable only to the Enterprises, which are 
not small entities for purposes of the Regulatory Flexibility Act, and 
does not have a significant effect on a substantial number of small 
entities. Therefore, the General Counsel of OFHEO has certified that 
the final regulation will not have significant economic impact on a 
substantial number of small entities.

Paperwork Reduction Act

    This regulation contains no information collection requirements 
that require the approval of the Office of Management and Budget 
pursuant to the Paperwork Reduction Act of 1980, 44 U.S.C. 3501 et seq.

List of Subjects in 12 CFR Part 1750

    Banks, banking, Federal Home Loan Mortgage Corporation, Federal 
National Mortgage Association, Mortgages, Securities.

    Accordingly, for the reasons set forth in the preamble, OFHEO 
amends Chapter XVII of Title 12 of the Code of Federal Regulations by 
adding Part 1750 to read as follows:

PART 1750--CAPITAL

Subpart A--Minimum Capital

Sec.
1750.1  General.
1750.2  Definitions.
1750.3  Procedure and timing.
1750.4  Minimum capital requirement computation.
1750.5  Notice of capital classification.

Appendix A to Subpart A of Part 1750--Minimum Capital Components for 
Interest Rate and Foreign Exchange Rate Contracts

Subpart B--[Reserved]

    Authority: 12 U.S.C. 4513, 4514, 4612, 4614, 4618.

Subpart A--Minimum Capital


Sec. 1750.1  General.

    The regulation contained in this subpart A sets forth the 
methodology for computing the minimum capital requirement for each 
Enterprise. The board of directors of each Enterprise is responsible 
for ensuring that the Enterprise maintains capital at a level that is 
sufficient to ensure the continued financial viability of the 
Enterprise and that equals or exceeds the minimum capital requirement 
contained in this subpart A.


Sec. 1750.2  Definitions.

    For purposes of this subpart A, the following definitions shall 
apply:
    Affiliate means any entity that controls, is controlled by, or is 
under common control with, an Enterprise, except as otherwise provided 
by the Director.
    Commitment means any contractual, legally binding agreement that 
obligates an Enterprise to purchase or to securitize mortgages.
    Core Capital--(1) Means the sum of (as determined in accordance 
with generally accepted accounting principles)--
    (i) The par or stated value of outstanding common stock;
    (ii) The par or stated value of outstanding perpetual, 
noncumulative preferred stock;
    (iii) Paid-in capital; and
    (iv) Retained earnings; and
    (2) Does not include debt instruments or any amounts the Enterprise 
could be required to pay at the option of an investor to retire capital 
instruments.
    Director means the Director of OFHEO.
    Enterprise means the Federal National Mortgage Association and any 
affiliate thereof or the Federal Home Loan Mortgage Corporation and any 
affiliate thereof.
    Foreign exchange rate contracts--
    (1) Means cross-currency interest rate swaps, forward foreign 
exchange contracts, currency options purchased (including currency 
options purchased over-the-counter), and any other instrument that 
gives rise to similar credit risks; and
    (2) Does not mean foreign exchange rate contracts with an original 
maturity of 14 calendar days or less and foreign exchange rate 
contracts traded on exchanges that require daily payment of variation 
margins.
    Interest rate contracts--
    (1) Means single currency interest rate swaps, basis swaps, forward 
rate agreements, interest rate options purchased (including caps, 
collars, and floors purchased), over-the-counter options purchased, and 
any other instrument that gives rise to similar credit risks (including 
when-issued securities and forward deposits accepted); and
    (2) Does not mean such instruments traded on exchanges that require 
daily payment of variation margins.
    Mortgage-backed security means a security, investment, or 
substantially equivalent instrument that represents an interest in a 
pool of loans secured by mortgages or deeds of trust where the 
principal or interest payments to the investor in the security or 
substantially equivalent instrument are guaranteed or effectively 
guaranteed by an Enterprise.
    Multifamily credit enhancement means any guarantee, pledge, 
purchase arrangement, or other obligation or commitment provided or 
entered into by an Enterprise with respect to multifamily mortgages to 
provide credit enhancement, liquidity, interest rate support, and other 
guarantees and enhancements for revenue bonds issued by a state or 
local governmental unit (including a housing finance agency) or other 
bond issuer.
    1992 Act means the Federal Housing Enterprises Financial Safety and 
Soundness Act of 1992, found at Title XIII of the Housing and Community 
Development Act of 1992, Pub. L. 102-550, 12 U.S.C. 4501 et seq.
    Notional amount means the face value of the underlying financial 
instrument(s) on which an interest rate or foreign exchange rate 
contract is based.
    Off-balance sheet obligation means a binding agreement, contract, 
or similar arrangement that requires or may require future payment(s) 
in money or kind by another party to an Enterprise, or that effectively 
guarantees all or part of such payment(s) to third parties (including 
commitments), where such agreement or contract is a source of credit 
risk that is not included on its balance sheet.
    OFHEO means the Office of Federal Housing Enterprise Oversight.
    Other off-balance sheet obligations means all off-balance sheet 
obligations of an Enterprise that are not mortgage-backed securities or 
substantially equivalent instruments and that are not resecuritized 
mortgage-backed securities, such as real estate mortgage investment 
conduits or similar resecuritized instruments.
    Perpetual, noncumulative preferred stock means preferred stock 
that--
    (1) Does not have a maturity date;
    (2) Provides the issuer the ability and the legal right to 
eliminate dividends and does not permit the accruing or payment of 
impaired dividends;
    (3) Cannot be redeemed at the option of the holder; and
    (4) Has no other provisions that will require future redemption of 
the issue, in whole or in part, or that will reset the dividend 
periodically based, in whole or in part, on the Enterprise's current 
credit standing, such as auction rate,

[[Page 35621]]

money market, or remarketable preferred stock, or that may cause the 
dividend to increase to a level that could create an incentive for the 
issuer to redeem the instrument, such as exploding rate stock.
    Qualifying collateral means cash on deposit; securities issued or 
guaranteed by the central governments of the OECD-based group of 
countries,<SUP>1 United States Government agencies, or United States 
Government-sponsored agencies; and securities issued by multilateral 
lending institutions or regional development banks.
---------------------------------------------------------------------------

    \1\ The OECD-based group of countries comprises full members of 
the Organization for Economic Cooperation and Development (OECD) 
regardless of entry date, as well as countries that have concluded 
special lending arrangements with the International Monetary Fund 
(IMF) associated with the IMF's General Arrangements to Borrow, but 
excludes any country that has rescheduled its external sovereign 
debt within the previous 5 years. A rescheduling of external 
sovereign debt generally would include any renegotiation of terms 
arising from a country's mobility or unwillingness to meet its 
external debt service obligations, but generally not include any 
renegotiation to allow the borrower to take advantage of a decline 
in interest rate or other change in market conditions. As of 
November 1995, the OECD countries included the following countries: 
Australia, Austria, Belgium, Canada, Denmark, Finland, France, 
Germany, Greece, Iceland, Ireland, Italy, Japan, Luxembourg, Mexico, 
the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, 
Switzerland, Turkey, the United Kingdom, and the United States; and 
Saudi Arabia has concluded special lending arrangements with the IMF 
associated with the IMF's General Arrangements to Borrow.
---------------------------------------------------------------------------


Sec. 1750.3  Procedure and timing.

    (a) Each Enterprise shall file with the Director a minimum capital 
report each quarter or at such other times as the Director requires, in 
his or her sole discretion. The report shall contain the information 
that responds to all of the items required by OFHEO in written 
instructions to the Enterprise, including, but not limited to:
    (1) Estimate of the minimum capital requirement;
    (2) Estimate of core capital overage or shortfall relative to the 
estimated minimum capital requirement;
    (3) Such other information as may be required by the Director.
    (b) The quarterly minimum capital report shall be submitted not 
later than April 30, July 30, October 30, and January 30 of each year.
    (c) Each minimum capital report shall be submitted in writing and 
in such other format as may be required by the Director.
    (d) In the event an Enterprise makes an adjustment to its financial 
statements for a quarter or a date for which the information was 
requested, which would cause an adjustment to a minimum capital report, 
the Enterprise shall file with the Director an amended minimum capital 
report not later than 3 business days after the date of such 
adjustment.
    (e) Each minimum capital report or any amended minimum capital 
report shall contain a declaration by an officer authorized by the 
board of directors of the Enterprise to make such a declaration, 
including, but not limited to a president, vice president, or 
treasurer, that the report is true and correct to the best of such 
officer's knowledge and belief.


Sec. 1750.4  Minimum capital requirement computation.

    (a) The minimum capital requirement for each Enterprise shall be 
computed by adding the following amounts:
    (1) 2.50 percent times the aggregate on-balance sheet assets of the 
Enterprise;
    (2) 0.45 percent times the unpaid principal balance of mortgage-
backed securities and substantially equivalent instruments that were 
issued or guaranteed by the Enterprise;
    (3) 0.45 percent of 50 percent of the average dollar amount of 
commitments outstanding each quarter over the preceding four quarters;
    (4) 0.45 percent of the outstanding principal amount of bonds with 
multifamily credit enhancements;
    (5) 0.45 percent of the dollar amount of sold portfolio remittances 
pending;
    (6)(i) 3.00 percent of the credit equivalent amount of interest 
rate contracts and foreign exchange rate contracts, except to the 
extent of the current market value of posted qualifying collateral, 
computed in accordance with appendix A to this subpart;
    (ii) 1.50 percent of the market value of qualifying collateral 
posted to secure interest rate and foreign exchange rate contracts, not 
to exceed the credit equivalent amount of such contracts, computed in 
accordance with appendix A to this subpart; and
    (7) 0.45 percent of the outstanding amount, credit equivalent 
amount, or other measure determined appropriate by the Director, of 
other off-balance sheet obligations (excluding commitments, multifamily 
credit enhancements, sold portfolio remittances pending, and interest 
rate contracts and foreign exchange rate contracts), except as adjusted 
by the Director to reflect differences in the credit risk of such 
obligations in relation to mortgage-backed securities.
    (b) Any asset or financial obligation that is properly classifiable 
in more than one of the categories enumerated in paragraphs (a) (1) 
through (7) of this section shall be classified in the category that 
yields the highest minimum capital requirement.
    (c) As used in this section, the term ``preceding four quarters'' 
means the last day of the quarter just ended (or the date for which the 
minimum capital report is filed, if different), and the three preceding 
quarter-ends.


Sec. 1750.5  Notice of capital classification.

    (a) Pursuant to section 1364 of the 1992 Act (12 U.S.C. 4614), 
OFHEO is required to determine the capital classification of each 
Enterprise on a not less than quarterly basis.
    (b) The determination of the capital classification shall be made 
following a notice to, and opportunity to respond by, the Enterprise.
    (1) Not later than 60 calendar days after the date for which the 
minimum capital report is filed, OFHEO will provide each Enterprise 
with a notice of proposed capital classification in accordance with 
section 1368 of the 1992 Act (12 U.S.C. 4618). The notice shall contain 
the following information--
    (i) The proposed capital classification;
    (ii) The proposed minimum capital requirement; and
    (iii) The summary computation of the proposed minimum capital 
requirement.
    (2) Each Enterprise shall have a period of 30 calendar days 
following receipt of a notice of proposed capital classification to 
submit a response regarding the proposed capital classification. The 
response period may be extended for up to 30 additional calendar days 
at the sole discretion of the Director. The Director may shorten the 
response period with the consent of the Enterprise, or without such 
consent if the Director determines that the condition of the Enterprise 
requires a shorter period.
    (3) The Director shall take into consideration any response to the 
notice of proposed capital classification received from the Enterprise 
and shall issue a notice of final capital classification for each 
Enterprise not later than 30 calendar days following the end of the 
response period in accordance with section 1368 of the 1992 Act (12 
U.S.C. 4618).

Appendix A to Subpart A of Part 1750--Minimum Capital Components for 
Interest Rate and Foreign Exchange Rate Contracts

    1. The minimum capital components for interest rate and foreign 
exchange rate contracts are computed on the basis of the credit 
equivalent amounts of such contracts. Credit equivalent amounts are 
computed for each of the following off-balance sheet

[[Page 35622]]

interest rate and foreign exchange rate contracts:

a. Interest Rate Contracts

    i. Single currency interest rate swaps.
    ii. Basis swaps.
    iii. Forward rate agreements.
    iv. Interest rate options purchased (including caps, collars, 
and floors purchased).
    v. Any other instrument that gives rise to similar credit risks 
(including when-issued securities and forward deposits accepted).

b. Foreign Exchange Rate Contracts

    i. Cross-currency interest rate swaps.
    ii. Forward foreign exchange rate contracts.
    iii. Currency options purchased.
    iv. Any other instrument that gives rise to similar credit 
risks.
    2. Foreign exchange rate contracts with an original maturity of 
14 calendar days or less and foreign exchange rate contracts traded 
on exchanges that require daily payment of variation margins are 
excluded from the minimum capital requirement computation. Over-the-
counter options purchased, however, are included and treated in the 
same way as the other interest rate and foreign exchange rate 
contracts.

3. Calculation of Credit Equivalent Amounts

    a. The minimum capital components for interest rate and foreign 
exchange rate contracts are computed on the basis of the credit 
equivalent amounts of such contracts. The credit equivalent amount 
of an off-balance sheet interest rate and foreign exchange rate 
contract that is not subject to a qualifying bilateral netting 
contract in accordance with this appendix A is equal to the sum of 
the current exposure (sometimes referred to as the replacement cost) 
of the contract and an estimate of the potential future credit 
exposure over the remaining life of the contract.
    b. The current exposure is determined by the mark-to-market 
value of the contract. If the mark-to-market value is positive, then 
the current exposure is the mark-to-market value. If the mark-to-
market value is zero or negative, then the current exposure is zero. 
Mark-to-market values are measured in United States dollars, 
regardless of the currency or currencies specified in the contract, 
and should reflect changes in the relevant rates, as well as 
counterparty credit quality.
    c. The potential future credit exposure of a contract, including 
a contract with a negative mark-to-market value, is estimated by 
multiplying the notional principal amount of the contract by a 
credit conversion factor. The effective rather than the apparent or 
stated notional amount must be used in this calculation. The credit 
conversion factors are:

------------------------------------------------------------------------
                                                              Foreign   
                                            Interest rate  exchange rate
            Remaining maturity                 contracts     contracts  
                                              (percent)      (percent)  
------------------------------------------------------------------------
1 year or less............................            0.0            1.0
Over 1 year...............................            0.5            5.0
------------------------------------------------------------------------

    d. Because foreign exchange rate contracts involve an exchange 
of principal upon maturity, and foreign exchange rates are generally 
more volatile than interest rates, higher conversion factors have 
been established for foreign exchange rate contracts than for 
interest rate contracts.
    e. No potential future credit exposure is calculated for single 
currency interest rate swaps in which payments are made based upon 
two floating rate indexes, so-called floating/floating or basis 
swaps. The credit exposure on these contracts is evaluated solely on 
the basis of their mark-to-market values.

4. Avoidance of Double Counting

    In certain cases, credit exposures arising from the interest 
rate and foreign exchange instruments covered by this appendix A may 
already be reflected, in part, on the balance sheet. To avoid double 
counting such exposures in the assessment of capital adequacy, 
counterparty credit exposures arising from the types of instruments 
covered by this appendix A may need to be excluded from balance 
sheet assets in calculating the minimum capital requirement.

5. Collateral

    a. The sufficiency of collateral for off-balance sheet items is 
determined by the market value of the collateral in relation to the 
credit equivalent amount. Collateral held against a netting contract 
is not recognized for minimum capital standard purposes unless it is 
legally available to support the single legal obligation created by 
the netting contract. Excess collateral held against one contract or 
a group of contracts for which a recognized netting agreement exists 
may not be considered.
    b. The only forms of collateral that are formally recognized by 
the minimum capital standard framework are cash on deposit; 
securities issued or guaranteed by the central governments of the 
OECD-based group of countries, United States Government agencies, or 
United States Government-sponsored agencies; and securities issued 
by multilateral lending institutions or regional development banks.

6. Netting

    a. For purposes of this appendix A, netting refers to the 
offsetting of positive and negative mark-to-market values in the 
determination of a current exposure to be used in the calculation of 
a credit equivalent amount. Any legally enforceable form of 
bilateral netting (that is, netting with a single counterparty) of 
interest rate and foreign exchange rate contracts is recognized for 
purposes of calculating the credit equivalent amount provided that 
the following criteria are met:
    i. Netting must be accomplished under a written netting contract 
that creates a single legal obligation, covering all included 
individual contracts, with the effect that the Enterprise would have 
a claim to receive, or obligation to pay, only the net amount of the 
sum of the positive and negative mark-to-market values on included 
individual contracts in the event that a counterparty, or a 
counterparty to whom the contract has been validly assigned, fails 
to perform due to default, insolvency, liquidation, or similar 
circumstances.
    ii. The Enterprise must obtain a written and reasoned legal 
opinion(s) representing that in the event of a legal challenge--
including one resulting from default, insolvency, liquidation, or 
similar circumstances--the relevant court and administrative 
authorities would find the Enterprise's exposure to be such a net 
amount under--
    A. The law of the jurisdiction in which the counterparty is 
chartered or the equivalent location in the case of noncorporate 
entities, and if a branch of the counterparty is involved, then also 
under the law of the jurisdiction in which the branch is located;
    B. The law that governs the individual contracts covered by the 
netting contract; and
    C. The law that governs the netting contract.
    iii. The Enterprise must establish and maintain procedures to 
ensure that the legal characteristics of netting contracts are kept 
under review in the event of possible changes in relevant law.
    iv. The Enterprise must maintain in its files documentation 
adequate to support the netting of rate contracts, including a copy 
of the bilateral netting contract and necessary legal opinions.
    b. A contract containing a walkaway clause is not eligible for 
netting for purposes of calculating the credit equivalent 
amount.<SUP>1
---------------------------------------------------------------------------

    \1\ A walkaway clause is a provision in a netting contract that 
permits a non-defaulting counterparty to make lower payments than it 
would make otherwise under the contract, or no payment at all, to a 
defaulter or to the estate of a defaulter, even if the defaulter or 
the estate of the defaulter is a net creditor under the contract.
---------------------------------------------------------------------------

    c. By netting individual contracts for the purpose of 
calculating its credit equivalent amount, the Enterprise represents 
that it has met the requirements of this appendix A and all the 
appropriate documents are in the Enterprise's files and available 
for inspection by OFHEO. OFHEO may determine that an Enterprise's 
files are inadequate or that a netting contract, or any of its 
underlying individual contracts, may not be legally enforceable 
under any one of the bodies of law described in this appendix A. If 
such a determination is made, the netting contract may be 
disqualified from recognition for minimum capital standard purposes 
or underlying individual contracts may be treated as though they are 
not subject to the netting contract.
    d. The credit equivalent amount of interest rate and foreign 
exchange rate contracts that are subject to a qualifying bilateral 
netting contract is calculated by adding the current exposure of the 
netting contract and the sum of the estimates of the potential 
future credit exposures on all individual contracts subject to the 
netting contract, estimated in accordance with paragraph 3 of this 
appendix A. Offsetting contracts in the same currency maturing on 
the same date will have lower potential future exposure as well as 
lower current exposure. Therefore, for purposes of calculating 
potential future credit exposure to a netting counterparty for 
foreign exchange rate contracts and other similar contracts in which 
notional principal

[[Page 35623]]

is equivalent to cash flows, total notional principal is defined as 
the net receipts falling due on each value date in each currency.
    e. The current exposure of the netting contract is determined by 
summing all positive and negative mark-to-market values of the 
individual contracts included in the netting contract. If the net 
sum of the mark-to-market values is positive, then the current 
exposure of the netting contract is equal to that sum. If the net 
sum of the mark-to-market values is zero or negative, then the 
current exposure of the netting contract is zero. OFHEO may 
determine that a netting contract qualifies for minimum capital 
standard netting treatment even though certain individual contracts 
may not qualify. In such instances, the nonqualifying contracts 
should be treated as individual contracts that are not subject to 
the netting contract.
    f. In the event a netting contract covers contracts that are 
normally excluded from the minimum capital requirement computation--
for example, foreign exchange rate contracts with an original 
maturity of 14 calendar days or less, or instruments traded on 
exchanges that require daily payment of variation margin--an 
Enterprise may elect consistently either to include or exclude all 
mark-to-market values of such contracts when determining net current 
exposure.

Subpart B--[Reserved]

Aida Alvarez,
Director, Office of Federal Housing Enterprise Oversight.
[FR Doc. 96-17120 Filed 7-5-96; 8:45 am]
BILLING CODE 4220-01-P