Source: https://www.federalregister.gov/documents/2005/06/17/05-11801/assessment-and-apportionment-of-administrative-expenses-loan-policies-and-operations-funding-and
Timestamp: 2017-10-21 05:08:04
Document Index: 383289833

Matched Legal Cases: ['art 615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009613', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009613', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', 'arts 607', 'art 607', '§\u2009607', '§\u2009607', '§\u2009615', '§\u2009615', '§\u2009614', '§\u2009615', '§\u2009615', 'art 615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009613', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', 'art 620', '§\u2009620', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', 'art 325', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615', '§\u2009615']

Federal Register :: Assessment and Apportionment of Administrative Expenses; Loan Policies and Operations; Funding and Fiscal Affairs, Loan Policies and Operations, and Funding Operations; Disclosure to Shareholders; Capital Adequacy Risk-Weighting Revisions
A Rule by the Farm Credit Administration on 06/17/2005
70 FR 35335
35335-35357 (23 pages)
12 CFR 607
3052-AC09
05-11801
B. Basis of Risk-Based Capital Rules
C. Subsequent Capital Developments
D. Scope of FCA's Rulemaking
IV. The Ratings-Based Approach for Government-Sponsored Agencies and OECD Banks
V. Section-by-Section Analysis of Rule
A. Section 615.5201—Definitions
3. Credit-Enhancing Representations and Warranties
8. Government-Sponsored Agency
10. Non-OECD Bank
15. Rural Business Investment Company
B. Sections 615.5210 and 615.5211—Ratings-Based Approach for Positions in Securitizations
1. Sections 615.5210 and 615.5211—General
2. Section 615.5210(b)—Positions that Qualify for the Ratings-Based Approach
3. Section 615.5210(b)—Application of the Ratings-Based Approach
C. Section 615.5210(c)—Treatment of Positions in Securitizations That Do Not Qualify for the Ratings-Based Approach
1. Section 615.5210(c)(1), (c)(2), and (c)(3)—Positions Subject to Dollar-for-Dollar Capital Treatment
2. Section 615.5210(c)(4)—Unrated Recourse Obligations and Direct Credit Substitutes
3. Sections 615.5210(c)(5) and 615.5211(d)(7)—Stripped Mortgage-Backed Securities (SMBS)
4. Section 615.5211(d)(12)—Unrated Positions in Asset-Backed Securities and Mortgage-Backed Securities
D. Section 615.5210(d)—Senior Positions Not Externally Rated
E. Section 615.5210(e)—Low-Level Exposure Rule
F. Section 615.5211—Risk Categories—Balance Sheet Assets
1. Section 615.5211(b)(6)—Securities and Other Claims on, and Portions of Claims Guaranteed by, Government-Sponsored Agencies
2. Section 615.5211(a)(5), (b)(14), and (b)(15)—Treatment of Claims on Qualifying Securities Firms
3. Section 615.5211(c)(2)—Treatment of Qualified Residential Loans
4. Section 615.5211(d)(8)—Treatment of Investments in Rural Business Investment Companies
G. Section 615.5212(b)(4)(i)—Computation of Credit-Equivalent Amounts for Direct Credit Substitutes and Recourse Obligations
H. Section 615.5210(f)—Reservation of Authority
A. Section 615.5211—Changes to Listing of Balance Sheet Assets
1. Section 615.5211(a)— 0-Percent Category
2. Section 615.5211(b)—20-Percent Category
3. Section 615.5211(c)— 50-Percent Category
4. Section 615.5211(d)—100-Percent Category
B. Other Nonsubstantive Changes
https://www.federalregister.gov/d/05-11801 https://www.federalregister.gov/d/05-11801
Start Preamble Start Printed Page 35336
The Farm Credit Administration (FCA, we, our) issues this final rule changing our regulatory capital standards on recourse obligations, direct credit substitutes, residual interests, asset- and mortgage-backed securities, claims on securities firms, and certain residential loans. We are modifying our risk-based capital requirements to more closely match a Farm Credit System (FCS or System) institution's relative risk of loss on these credit exposures to its capital requirements. In doing so, our rule risk-weights recourse obligations, direct credit substitutes, residual interests, asset- and mortgage-backed securities, and claims on securities firms based on external credit ratings from nationally recognized statistical rating organizations (NRSROs). In addition, our rule will make our regulatory capital treatment more consistent with that of the other financial regulatory agencies for transactions and assets involving similar risk and address financial structures and transactions developed by the market since our last update. We also make a number of nonsubstantive changes to our regulations to make them easier to use.
Robert Donnelly, Senior Accountant, Office of Policy and Analysis, Farm Credit Administration, McLean, VA 22102-5090, (703) 883-4498; TTY (703) 883-4434; or Jennifer A. Cohn, Senior Attorney, Office of General Counsel, Farm Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703) 883-4020.
Help achieve a more consistent regulatory capital treatment with the other financial regulatory agencies [1] for transactions involving similar risk; and
The FCA published a proposed rule implementing a ratings-based approach for risk-weighting certain FCS assets on August 6, 2004.[2] The proposal incorporated an interim final rule the FCA published on March 28, 2003 that had implemented a ratings-based approach for investments in non-agency asset-backed securities (ABS) and mortgage-backed securities (MBS).[3] The proposal also incorporated a final rule the FCA published on May 26, 2004, that implemented a ratings-based approach for loans to other financing institutions (OFIs).[4]
We received 12 letters commenting on this proposal. Ten of these letters were from individual FCS institutions (including the Federal Agricultural Mortgage Corporation (Farmer Mac)) and one was from the Farm Credit Council, trade association for the System banks and associations. The final letter was from a commercial bank. All commenters generally applauded our overall effort to implement capital treatment that is more consistent with that of the other financial regulatory agencies but opposed one or more specific provisions of the proposed regulation. We discuss these comments, and our responses, later in this preamble.[5]
Since the late 1980s, the regulatory capital requirements applicable to federally regulated financial institutions, including FCS institutions, have been based, in part, on the risk-based capital framework developed by the Basel Committee on Banking Supervision (Basel Committee).[6] We first adopted risk-weighting categories for System assets as part of the 1988 regulatory capital revisions [7] required by the Agricultural Credit Act of 1987 [8] and made minor revisions to these categories in 1998.[9] Risk-weighting is used to assign appropriate capital requirements to on- and off-balance sheet positions and to compute the risk-adjusted asset base for FCS banks' and associations' permanent capital, core surplus, and total surplus ratios. These previous risk-weighting categories were similar to those outlined in the Accord on International Convergence of Capital Measurement and Capital Standards (1988, as amended in 1998) (Basel Accord) and were also adopted by the other financial regulatory agencies. Our risk-based capital requirements are contained in subparts H and K of part 615 of our regulations.
Since the FCA adopted its previous risk-weighting regulations, much has occurred in the area of capital and credit risk. The Basel Committee has for a number of years been developing a new accord to reflect advances in risk management practices, technology, and banking markets. In June 2004, the Basel Committee released its document “International Convergence of Capital Measurement and Capital Standards: A Revised Framework.” The Basel Committee intends for its new framework (known as Basel II) to be available for implementation as of year-end 2006, with the most advanced approaches to risk measurement available for implementation as of year-end 2007.[10]
In January 2005, the other financial regulatory agencies announced that they planned to publish a proposed rule and guidance implementing Basel II in mid-Start Printed Page 35337year 2005 and that their final regulations would be effective in January 2008.[11] However, on April 29, 2005, these agencies announced that additional analysis was needed before they could publish a proposed rule.[12] The agencies emphasized that, although they are delaying their timeline, they remain committed to implementing Basel II.[13]
Basel II is very complex. In the United States, only a very small number of large, internationally active banking organizations will be subject to the entire, advanced Basel II framework, but some of the principles of Basel II will apply to all banking organizations. One such principle is a reliance on external credit ratings by NRSROs as a basis for determining counterparty risk. The other financial regulatory agencies have stated that they also expect to consider possible changes to their risk-based capital regulations for banking organizations not subject to the advanced Basel II framework. They expect that these changes would become effective at the same time as the framework-based regulations.[14]
Since 2001, even before Basel II was finalized, the other financial regulatory agencies have amended their risk-based capital regulations consistent with the ratings-based approach of Basel II. Most relevant to our final rule, in November 2001 the other financial regulatory agencies published a rule [15] that bases the capital requirements for positions that banking organizations [16] hold in recourse obligations, direct credit substitutes, residual interests, and asset- and mortgage-backed securities [17] on the relative credit exposure of these positions, as measured by external credit ratings received from an NRSRO.[18] Similarly, in April 2002, the other financial regulatory agencies published a rule [19] that bases the capital requirements for claims on or guaranteed by securities firms on their relative risk exposure as measured by external credit ratings from NRSROs. The other financial regulatory agencies have also applied the ratings-based approach to other credit exposures, consistent with the approach of Basel II.
Just as the other financial regulatory agencies have adopted risk-based rules, consistent with the approach of Basel II, that are relevant for the banking organizations that they regulate, the FCA has proposed and adopted rules tailored to activities of the FCS. Our intention is to align our risk-based capital framework with the rules of the other financial regulatory agencies where appropriate, but also to recognize areas where differences are warranted. For example, this rule places emphasis on capital treatment of investments in ABS and MBS held for liquidity. In contrast, the rules of the other financial regulatory agencies focus on traditional securitization activities, where a banking organization sells assets or credit exposures to increase its liquidity and manage credit risk.
These revisions to our capital rules implement a ratings-based approach for risk-weighting positions in recourse obligations, residual interests (other than credit-enhancing interest-only strips), direct credit substitutes, and asset- and mortgage-backed securities. Highly rated positions will receive a favorable (less than 100-percent) risk weighting. Positions that are rated below investment grade [20] will receive a less favorable risk weighting. The FCA will apply this approach to positions based on their inherent risks rather than how they might be characterized or labeled.
As noted, this ratings-based approach provides risk weightings for a variety of assets that have a wide range of credit ratings. We provide risk weightings for investments that are rated below investment grade, although they are not eligible investments under our current investment regulations.[21] This rule does not, however, expand the scope of eligible investments. It merely explains how to risk weight an investment that was eligible when purchased if its credit rating subsequently deteriorates. Such investments must still be disposed of in accordance with § 615.5143.[22]
Securitizations typically carve up the risk of credit losses from the underlying assets and distribute it to different parties. The “first dollar,” or most subordinate, loss position is first to absorb credit losses; the most “senior” investor position is last to absorb losses; and there may be one or more loss positions in between (“second dollar” loss positions). Each loss position functions as a credit enhancement for the more senior positions in the structure.
Recourse, in connection with sales of whole loans or loan participations, is now frequently associated with asset securitizations. Depending on the type of securitization, the sponsor of a securitization may provide a portion of the total credit enhancement internally, as part of the securitization structure, through the use of excess spread accounts, overcollateralization, retained subordinated interests, or other similar on-balance sheet assets. When these or other on-balance sheet internal enhancements are provided, the enhancements are “residual interests” for regulatory capital purposes.
A seller may also arrange for a third party to provide credit enhancement [23] in an asset securitization. If another financial institution provides the third-party enhancement, then that institution assumes some portion of the assets' credit risk. In this proposed rule, all Start Printed Page 35338forms of third-party enhancements, i.e., all arrangements in which an FCS institution assumes credit risk from third-party assets or other claims that it has not transferred, are referred to as “direct credit substitutes.”
Many asset securitizations use a combination of recourse and third-party enhancements to protect investors from credit risk. When third-party enhancements are not provided, the institution ordinarily retains virtually all of the credit risk on the assets.
Similar to the other financial regulatory agencies, the FCA expects FCS institutions to identify, measure, monitor, and control securitization risks and explicitly incorporate the full range of those risks into their risk management systems. The board and management are responsible for adequate policies and procedures that address the economic substance of their activities and fully recognize and ensure appropriate management of related risks. Additionally, FCS institutions must be able to measure and manage their risk exposure from securitized positions, either retained or acquired. The formality and sophistication with which the risks of these activities are incorporated into an institution's risk management system should be commensurate with the nature and volume of its securitization activities.[24]
Under our proposal, beginning 18 months after the effective date of the final rule, the ratings-based approach would have applied to assets covered by credit protection provided by Government-sponsored agencies and OECD banks, including credit derivatives (e.g., credit default swaps), loss purchase commitments, guarantees and other similar arrangements. In addition, the ratings-based approach would have applied to unrated positions in recourse obligations, direct credit substitutes, residual interests (other than credit-enhancing interest-only strips) and asset- or mortgage-backed securities that are guaranteed by Government-sponsored agencies beginning 18 months after the final rule's effective date.
As we noted in the preamble to our proposed rule, the other financial regulatory agencies have not yet implemented the ratings-based approach for assets covered by credit protection provided by Government-sponsored agencies or OECD banks or for positions in securitizations guaranteed by Government-sponsored agencies. However, we proposed these provisions as a limited implementation of the Basel II framework. Further, we cited because of our concern that claims of this nature on any counterparties that are not highly rated or are unrated, including Government-sponsored agencies and OECD banks, may pose significant risks to FCS institutions. In particular, we expressed our concern about the unique structural and operational risks that these types of claims may present.
In addition, we noted in the preamble to the proposed rule that the United States General Accounting Office (GAO) [25] recently recommended that the FCA “[c]reate a plan to implement actions currently under consideration to reduce potential safety and soundness issues that may arise from capital arbitrage activities of Farmer Mac and FCS institutions.” [26] Our proposal stated that the rule would help ensure that FCS institutions could not alter their capital requirements simply by using different structures, arrangements, or counterparties without changing the nature of the risks they assume or retain.
The proposed regulation, which would permit a 20-percent risk weighting for a claim of this nature on a Government-sponsored agency or OECD bank counterparty only if the agency or bank has an AAA or AA issuer credit rating, is inconsistent with other FCA regulations, including its rule governing other financing institutions (OFIs) and its proposed rule governing Investments in Farmers' Notes.[27] In addition, under the proposed rule, investments in debt obligations of a Government-sponsored agency would be risk weighted at 20 percent regardless of issuer credit rating, even though these investments are not backed by mortgages, unlike the investments that would be subject to the ratings-based approach.
We have removed these provisions related to Government-sponsored agencies and OECD banks from the final rule. We believe it is prudent to wait for the other financial regulatory agencies to announce the approach they plan to take so that any competitive disadvantage due to inconsistent risk-weighting requirements can be avoided. We are continuing to evaluate the progress of the other financial regulatory agencies toward implementing Basel II and to determine the appropriate Start Printed Page 35339implementation for the System. As Basel II is implemented throughout the banking world, we expect to revisit our approach to risk weighting. Thus, System institutions should anticipate additional regulatory capital amendments, consistent with Basel II, over the next few years.
Because this rule implements a new risk-weighting approach for recourse obligations, residual interests, direct credit substitutes, and other securitization arrangements, we are amending § 615.5201 to add a number of new definitions relating to these activities. We are updating certain other definitions as warranted. For the most part, to achieve consistency with the other financial regulatory agencies, we are adopting the same definitions as the other agencies.
We define “credit derivative” as a contract that allows one party (the protection purchaser) to transfer the credit risk of an asset or off-balance sheet credit exposure to another party (the protection provider). The value of a credit derivative is dependent, at least in part, on the credit performance of a “reference asset.”
The definitions of “recourse” and “direct credit substitute” cover credit derivatives to the extent that an institution's credit risk exposure exceeds its pro rata interest in the underlying obligation. The ratings-based approach therefore applies to rated instruments such as credit-linked notes issued as part of a synthetic securitization.
Credit derivatives can have a variety of structures. Therefore, we will continue to evaluate the risk weighting of credit derivatives on a case-by-case basis. Furthermore, we will continue to use the November 1999 and December 1999 guidance on synthetic securitizations issued by the Federal Reserve Board and the OCC as a guide for determining appropriate capital requirements for FCS institutions and continue to apply the structural and risk management requirements outlined in the 1999 guidance.[28]
We define the term “credit-enhancing interest-only strip” as an on-balance sheet asset that, in form or in substance, (1) Represents the contractual right to receive some or all of the interest due on transferred assets; and (2) exposes the institution to credit risk directly or indirectly associated with the transferred assets that exceeds its pro rata claim on the assets, whether through subordination provisions or other credit enhancement techniques. FCA reserves the right to identify other cash flows or related interests as credit-enhancing interest-only strips based on the economic substance of the transaction.
Credit-enhancing interest-only strips include any balance sheet asset that represents the contractual right to receive some or all of the remaining interest cash flow generated from assets that have been transferred into a trust (or other special purpose entity), after taking into account trustee and other administrative expenses, interest payments to investors, servicing fees, and reimbursements to investors for losses attributable to the beneficial interests they hold, as well as reinvestment income and ancillary revenues [29] on the transferred assets.
Credit-enhancing interest-only strips are generally carried on the balance sheet at the present value of the reasonably expected net cash flow, adjusted for some level of prepayments if relevant, and discounted at an appropriate market interest rate. As mentioned earlier, FCA will look to the economic substance of the transaction and reserves the right to identify other cash flows or spread-related assets as credit-enhancing interest-only strips on a case-by-case basis. For example, including some principal payments with interest and fee cash flows will not otherwise negate the regulatory capital treatment of that asset as a credit-enhancing interest-only strip. Credit-enhancing interest-only strips include both purchased and retained interest-only strips that serve in a credit-enhancing capacity, even though purchased interest-only strips generally do not result in the creation of capital on the purchaser's balance sheet.
More specifically, “credit-enhancing representations and warranties” are defined as representations and warranties that: (1) Are made or assumed in connection with a transfer of assets (including loan-servicing assets); and (2) obligate an institution to protect investors from losses arising Start Printed Page 35340from credit risk in the assets transferred or loans serviced. The term includes promises to protect a party from losses resulting from the default or nonperformance of another party or from an insufficiency in the value of collateral.
Similarly, a loan-servicing arrangement is considered as recourse or a direct credit substitute if the institution, as servicer, is responsible for credit losses associated with the serviced loans. However, a cash advance made by a servicer to ensure an uninterrupted flow of payments to investors or the timely collection of the loans is specifically excluded from the definitions of recourse and direct credit substitute, provided that the servicer is entitled to reimbursement for any significant advances and this reimbursement is not subordinate to other claims. To be excluded from recourse and direct credit substitute treatment, an independent credit assessment of the likelihood of repayment of the servicer's cash advance should be made prior to advancing funds, and the institution should only make such an advance if prudent lending standards are met.
The definition of “direct credit substitute” complements the definition of “recourse.” The term “direct credit substitute” refers to an arrangement in which an institution assumes, in form or in substance, credit risk directly or indirectly associated with an on- or off-balance sheet asset or exposure that was not previously owned by the institution (third-party asset) and the risk assumed by the institution exceeds the pro rata share of the institution's interest in the third-party asset. If the institution has no claim on the third-party asset, then the institution's assumption of any credit risk is a direct credit substitute. The term explicitly includes items such as the following:
Clean-up calls on third-party assets. However, clean-up calls that are 10 percent or less of the original pool balance and that are exercisable at the option of the institution are not direct credit substitutes.
The rule defines “externally rated” to mean that an instrument or obligation has received a credit rating from at least one NRSRO. The use of external credit ratings provides a way to determine credit quality relied upon by investors and other market participants to differentiate the regulatory capital treatment for loss positions representing different gradations of risk. This use permits more equitable treatment of transactions and structures in administering the risk-based capital requirements.
Section 615.5201(o) of our regulations previously defined the term “standby letter of credit.” We are changing the term to “financial standby letter of credit” to conform our term to that used by the other financial regulatory agencies. We are making no substantive changes to the definition.
The term “Government agency” was defined in two places in our previous capital regulations: § 615.5201(f), the definitions section, and § 615.5210(f)(2)(i)(D), which was the section on computing the permanent capital ratio. We have modified the previous § 615.5201(f) definition by replacing it with the definition of Government agency previously in § 615.5210(f)(2)(i)(D) and have deleted the definition in previous § 615.5210(f)(2)(i)(D). We believe these changes streamline the regulation. We do not intend to change the meaning of this term.
The term “Government-sponsored agency” was also defined in two places in our previous capital regulations (§ 615.5201(g), the definitions section, Start Printed Page 35341and § 615.5210(f)(2)(ii)(A), the former section on computing the permanent capital ratio). We have modified the previous definition in § 615.5201(g) by replacing it with the previous § 615.5210(f)(2)(ii)(A) definition of Government-sponsored agency (amended slightly for clarity, as discussed below) and have deleted the redundant definition in previous § 615.5210(f)(2)(ii)(A). This change simply streamlines our regulations and does not change the meaning of the term.
“Government-sponsored agency” is defined as an agency, instrumentality, or corporation chartered or established to serve public purposes specified by the United States Congress but whose obligations are not explicitly guaranteed by the full faith and credit of the United States Government, including but not limited to any Government-sponsored enterprise (GSE). This definition includes GSEs such as Fannie Mae and Farmer Mac, as well as Federal agencies, such as the Tennessee Valley Authority, that issue obligations that are not explicitly guaranteed by the United States' full faith and credit. This definition is slightly different from that in our proposal, although the meaning is the same; we have clarified that the term includes corporations, as well as agencies or instrumentalities, that are chartered or established to serve public purposes specified by Congress, and also that the term includes GSEs. This information was provided in the preamble to the proposed rule but was not explicitly stated in the rule itself.
We define “nationally recognized statistical rating organization” (NRSRO) as a rating organization that the Securities and Exchange Commission (SEC) recognizes as an NRSRO. This definition is identical to the definition in § 615.5131(j) of our regulations.
We define “non-OECD bank” as a bank and its branches (foreign and domestic) organized under the laws of a country that does not belong to the OECD group of countries.[30]
We define “OECD bank” as a bank and its branches (foreign and domestic) organized under the laws of a country that belongs to the OECD group of countries. For purposes of our capital regulations, this term includes U.S. depository institutions.
We add language to clarify that permanent capital is subject to adjustments such as dollar-for-dollar reduction of capital for residual interests or other high-risk assets as described in new § 615.5207. We made no other changes.
The rule defines the term “recourse” to mean an arrangement in which an institution retains, in form or in substance, any credit risk directly or indirectly associated with an asset it has sold (in accordance with generally accepted accounting principles (GAAP)) that exceeds a pro rata share of the institution's claim on the asset. If an institution has no claim on an asset it has sold, then the retention of any credit risk is recourse. A recourse obligation typically arises when an institution transfers assets in a sale and retains an explicit obligation to repurchase assets or to absorb losses due to a default on the payment of principal or interest or any other deficiency in the performance of the underlying obligor or some other party. Recourse may also exist implicitly if an institution provides credit enhancement beyond any contractual obligation to support assets it has sold.
Our definition of recourse is consistent with the other regulators' long-standing use of this term and incorporates existing practices regarding retention of risk in asset sales. The other financial regulatory agencies have noted that third-party enhancements, such as insurance protection, purchased by the originator of a securitization for the benefit of investors, do not constitute recourse. The purchase of enhancements for a securitization or other structured transaction where the institution is completely removed from any credit risk will not, in most instances, constitute recourse. However, if the purchase or premium price is paid over time and the size of the payment is a function of the third party's loss experience on the portfolio, such an arrangement indicates an assumption of credit risk and would be considered recourse.
The rule defines “residual interest” as any on-balance sheet asset that: (1) Represents an interest (including a beneficial interest) created by a transfer that qualifies as a sale (in accordance with GAAP) of financial assets, whether through a securitization or otherwise; and (2) exposes an institution to credit risk directly or indirectly associated with the transferred asset that exceeds a pro rata share of that institution's claim on the asset, whether through subordination provisions or other credit enhancement techniques.
This functional definition reflects the fact that financial structures vary in the way they use certain assets as credit enhancements. Therefore, residual interests include any retained on-balance sheet asset that functions as a credit enhancement in a securitization or other structured transaction, regardless of its characterization in financial or regulatory reports.
The rule adds a definition for “Rural Business Investment Company” (RBIC). Section 6029 of the Farm Security and Rural Investment Act of 2002 [31] amended the Consolidated Farm and Rural Development Act, as amended (7 U.S.C. 1921 et seq.) by adding a new subtitle H, establishing a new “Rural Business Investment Program.” The new subtitle permits FCS institutions to establish or invest in RBICs, subject to specified limitations. We define RBICs by referring to the statutory definition codified in 7 U.S.C. 2009cc(14). That provision defines RBIC as “a company that (A) has been granted final approval by the Secretary [of Agriculture] * * * and; (B) has entered into a participation agreement with the Secretary [of Agriculture].”
The rule defines “securitization” as the pooling and repackaging by a special Start Printed Page 35342purpose entity or trust of assets or other credit exposures that can be sold to investors. Securitization includes transactions that create stratified credit risk positions whose performance is dependent upon an underlying pool of credit exposures, including loans and commitments.
Additionally, new § 615.5210(f) of the regulation makes explicit FCA's authority to override the use of certain ratings or the ratings on certain instruments, either on a case-by-case basis or through broader supervisory policy, if necessary or appropriate to address the risk that an instrument poses to FCS institutions.
Under new § 615.5210(b) of our rule, certain positions in securitizations qualify for the ratings-based approach. These positions in securitizations are eligible for the ratings-based approach, provided the positions have favorable external ratings (as explained below) by at least one NRSRO.
Residual interests (other than credit-enhancing interest-only strips);[32] and
Asset- and mortgage-backed securities.
Under new § 615.5210, the capital requirement for a position that qualifies for the ratings-based approach is computed by multiplying the face amount of the position by the appropriate risk weight as determined by the position's external credit rating.
Under new § 615.5210(b), a position that is traded and externally rated qualifies for the ratings-based approach if its long-term external rating is one grade below investment grade or better (e.g., BB or better) or its short-term external rating is investment grade or better (e.g., A-3, P-3).[33] If the position receives more than one external rating, the lowest rating would apply. This requirement eliminates the potential for rating shopping.
Under the ratings-based approach, the capital requirement for a position that qualifies for the ratings-based approach is computed by multiplying the face amount of the position by the appropriate risk weight determined in accordance with the following tables: [34]
Rating examples 35
Highest or second highest investment grade AAA or AA 20
More than one category below investment grade, or unrated B or below or Unrated Not eligible for the ratings-based approach.
Below investment grade, or unrated B or lower (Not Prime) Not eligible for the ratings-based approach.
These amendments do not change the risk-weight requirement that FCA adopted in its interim final rule for non-agency asset- and mortgage-backed securities that are highly rated.[36] These amendments simply make our rule language more consistent with that used by the other financial regulatory agencies for these types of transactions.
Positions that have long-term external ratings that are two grades below investment grade or lower (e.g., B or lower) or short-term external ratings that are one grade below investment grade or lower (e.g., B or lower, Not Prime).
We adopt the dollar-for-dollar treatment for the credit-enhancing and highly subordinated positions listed above because these positions raise a number of supervisory concerns that the other financial regulatory agencies also share.[37] The level of credit risk exposure associated with deeply subordinated assets, particularly subinvestment grade and unrated residual interests, is extremely high. They are generally subordinated to all other positions, and these assets are subject to valuation concerns that might lead to loss as explained further below. Additionally, the lack of an active market makes these assets difficult to independently value and relatively illiquid.
In particular, there are a number of concerns regarding residual interests. A banking organization can inappropriately generate “paper profits” (or mask actual losses) through incorrect cash flow modeling, flawed loss assumptions, inaccurate prepayment estimates, and inappropriate discount rates. Such practices often lead to an inflation of capital, falsely making the banking organization appear more financially sound. Also, embedded within residual interests, including credit-enhancing interest-only strips, is a significant level of credit and prepayment risk that make their valuation extremely sensitive to changes in underlying assumptions. For these reasons we, like the other financial regulatory agencies, concluded that a higher capital requirement is warranted for unrated residual interests and all credit-enhancing interest-only strips. Furthermore, the “low-level exposure rule,” discussed below, does not apply to these positions in securitizations. For example, if an FCS institution holds a non-externally rated 10-percent residual interest in $100 million of loans sold into a securitization, the institution's capital charge would be $10 million. If an FCS institution purchases a $25 million position in an ABS that is subsequently downgraded to B or lower, its capital charge would be $25 million, the full amount of the position.
We note that the final rules adopted by the other financial regulatory agencies impose both a dollar-for-dollar risk weighting for residual interests that do not qualify for the ratings-based approach and a concentration limit on a subset of those residual interests—credit-enhancing interest-only strips—for the purpose of calculating a bank's leverage ratio. Under their combined approach, credit-enhancing interest-only strips are limited to 25 percent of a banking organization's Tier 1 capital. Everything above that amount is deducted from Tier 1 capital. Generally, under the other financial regulatory agencies' rules, all other residual interests that do not qualify for the ratings-based approach (including any credit-enhancing interest-only strips that were not deducted from Tier 1 capital) are subject to a dollar-for-dollar risk weighting. The combined capital charge is limited to the face amount of a banking organization's residual interests.
As indicated previously, we are adopting a one-step approach for these positions in securitizations. This requires FCS institutions to deduct from capital and assets the face amount of their position. The resulting total capital charge is virtually the same under both approaches. However, we found that the one-step approach is easier to apply to FCS institutions because the way they compute their regulatory capital standards differs from the way other banking organizations compute their standards.
As discussed in the definitions section, the contractual retention of credit risk by an FCS institution associated with assets it has sold generally constitutes recourse.[38] The definitions of recourse and direct credit substitute complement each other, and there are many types of recourse arrangements and direct credit substitutes that can be assumed through either on- or off-balance sheet credit exposures that are not externally rated. Start Printed Page 35344Under new § 615.5210(c)(4), FCS institutions are required to hold capital against the entire outstanding amount of assets supported (e.g., all more senior positions) by an on-balance sheet recourse obligation or direct credit substitute that is unrated. This treatment parallels our approach for off-balance sheet recourse obligations and direct credit substitutes, as discussed later under the computation of credit equivalent amounts. For example, if an FCS institution retains an on-balance sheet first-loss position through a recourse arrangement or direct credit substitute in a pool of rural housing loans that qualify for a 50-percent risk weight, the FCS institution would include the full amount of the assets in the pool, risk weighted at 50 percent, in its risk-weighted assets for purposes of determining its risk-based capital ratios. The low-level exposure rule [39] provides that the dollar amount of risk-based capital required for assets transferred with recourse should not exceed the maximum dollar amount for which an FCS institution is contractually liable.
The other financial regulatory agencies currently permit their banking organizations to use three alternative approaches (i.e., internal ratings, program ratings, and computer programs) for determining the capital requirements for certain unrated direct credit substitutes and recourse obligations in asset-backed commercial paper programs. As discussed in the preamble to our proposed rule, the FCA has decided not to address the capital requirements for asset-backed commercial paper programs at this time due to the limited involvement FCS institutions presently have in these programs. FCA will continue to determine the capital requirements for such programs on a case-by-case basis.
Under new §§ 615.5210(c)(5) and 615.5211(d)(7), SMBS and similar instruments, such as interest-only strips that are not credit-enhancing or principal-only strips (including such instruments guaranteed by Government-sponsored agencies), are assigned to the 100-percent risk-weight category. Even if highly rated, these securities do not receive the more favorable capital treatment available to other mortgage securities because of their higher market risk profile. Typically, SMBS contain a higher degree of price volatility associated with mortgage prepayments.[40]
For senior positions not externally rated, the following capital treatment applies under new § 615.5210(d). If an FCS institution retains an unrated position that is senior or preferred in all respects (including collateral and maturity) to a rated position that is traded, the position is treated as if it had the same rating assigned to the rated position. These senior unrated positions qualify for the risk weighting of the subordinated rated positions as long as the subordinate rated position is traded and remains outstanding for the entire life of the unrated position, thus providing full credit support for the term of the unrated position.
Under new § 615.5211(b)(6), securities and other claims on, and portions of claims guaranteed by, Government-sponsored agencies are assigned to the 20-percent risk-weight category. This category includes, for example, debt securities and asset- or mortgage-backed securities [41] guaranteed by Government-sponsored agencies. The category also includes assets covered by credit protection provided by Government-sponsored agencies through credit derivatives (e.g., credit default swaps), loss purchase commitments, guarantees, and other similar arrangements.
We are adding claims on qualifying securities firms to the current risk-based capital requirements.[42]
Specifically, we are adopting a 0-percent risk weight for claims on, or guaranteed by, qualifying securities firms that are collateralized by cash held Start Printed Page 35345by the institution or by securities issued or guaranteed by the United States or OECD central governments, provided that a positive margin of collateral is required to be maintained on such a claim on a daily basis, taking into account any change in the institution's exposure to the obligor or counterparty under the claim in relation to the market value of the collateral held in support of the claim.[43]
We are also reducing from 100 percent to 20 percent the risk weighting applied to all other claims on and claims guaranteed by qualifying securities firms that satisfy specified external rating requirements.[44] Specifically, we are adopting a 20-percent risk weighting for all claims on and claims guaranteed by a qualifying securities firm that has a long-term issuer credit rating in one of the two highest investment-grade rating categories from an NRSRO, or if the claim is guaranteed by the qualifying securities firm's parent company with such a rating.[45]
Can be liquidated, terminated, or accelerated immediately in bankruptcy or similar proceeding, and the security or collateral agreement will not be stayed or voided, under applicable law of the relevant country.[46]
Existing § 613.3030 authorizes System institutions to provide financing to rural homeowners for the purpose of buying, remodeling, improving, and repairing rural homes. “Rural homeowner” is defined as an individual who resides in a rural area and is not a bona fide farmer, rancher, or producer or harvester of aquatic products. “Rural home” means a single-family moderately priced dwelling located in a rural area that will be owned and occupied as the rural homeowner's principal residence. “Rural area” means open country within a state or the Commonwealth of Puerto Rico, which may include a town or village that has a population of not more than 2,500 persons.
Previous § 615.5210(f)(2)(iii)(B) assigned these rural home loans, provided they were secured by first lien mortgages or deeds of trust, to the 50-percent risk-weight category.[47] However, residential loans to bona fide farmers, ranchers, and producers and harvesters of aquatic products have formerly been considered to be agricultural loans and have been risk weighted at 100 percent under previous § 615.5210(f)(2)(iv).
New § 615.5211(c)(2) assigns a 50-percent risk weight to all qualified residential loans, as defined in revised § 615.5201. To be a qualified residential loan, a loan must be either: (i) A rural home loan, as authorized by § 613.3030,[48] or (ii) a single-family residential loan to a bona fide farmer, rancher, or producer or harvester of aquatic products.[49] A qualified residential loan must be secured by a first lien mortgage or deed of trust on the residential property only (not on any adjoining agricultural property or any other nonresidential property), must have been approved in accordance with prudent underwriting standards, must not be past due 90 days or more or carried in nonaccrual status, and must have a monthly amortization schedule. In addition, the mortgage or deed of trust securing the residential property must be written and recorded in accordance with all state and local requirements governing its enforceability as a first lien. Finally, the secured residential property must have a permanent right-of-way access.
This view is consistent with that of the other financial regulatory agencies. Under their rules, a loan that is fully secured by a first lien on a one- to four-family residential property is assigned to the 50-percent risk-weight category as long as the loan has been approved in accordance with prudent underwriting standards and is not past due 90 days or more or carried in nonaccrual status.[50] The other financial regulatory agencies do not distinguish among types of borrowers.
Consistent with the position of the other financial regulatory agencies, any residential loan that does not meet the definition of a qualified residential loan must be assigned to the 100-percent risk-weight category.
The other financial regulatory agencies have issued guidance that addresses their concerns about the appropriate risk weighting for residential loans with high loan-to-value (LTV) ratios. Unlike the lenders that these other agencies regulate, however, System institutions are limited by statute, except in limited circumstances, to an 85-percent LTV ratio on real estate (including residential real estate).[51] Therefore, this regulation does not contain specific LTV requirements. Assigning risk weighting based on specific risk factors with greater granularity (including LTV) is consistent with the underlying framework of Basel II. We expect to review these risk factors as we consider future rulemakings regarding Basel II.
We made one non-substantive change to the final rule. We added language to clarify that the first lien mortgage or deed of trust must be on the residential property only, not on any other property.[52]
The Farm Credit Council and six System institutions commented on this proposal. All commenters appreciated FCA's proposed reduction of the risk weighting for residential loans to farmers. Six of the seven commenters, however, stated that the proposed rule's requirement for a separate residential deed would be burdensome for the institution and costly for the borrower and that a separate survey or legal description could be used instead. One commenter stated that competitors make loans on residential property using legal descriptions but not recorded deeds and that the deed requirement is an additional cost and time requirement that would prevent it from competing Start Printed Page 35346for these loans. Another commenter stated that the requirement for a separate residential deed penalizes farmers who own existing sites that were acquired as part of larger parcels from obtaining loans with 50-percent risk weighting to remodel or repair their homes. All of these commenters requested that we delete the requirement for a separate deed. Another commenter suggested, if the deed requirement could not be eliminated, that the regulation set a maximum acreage limitation, such as 50 or 100 acres, that could be included in the residential site.
We chose not to set a specific acreage limitation because size does not necessarily determine the residential nature of property. Rather, we expect each institution to adopt underwriting standards that would ensure the collateral is characteristic of comparable residential property. If FCA examiners find that the collateral is not characteristic of residential property or that any loan was inappropriately classified as a qualified residential loan, the Agency will require the loan to be risk weighted at 100 percent.
As previously discussed, the Farm Security and Rural Investment Act (Pub. L. 107-171) amended the Consolidated Farm and Rural Development Act, 7 U.S.C. 1921 et seq., to permit FCS institutions to establish or invest in RBICs subject to certain limitations. A RBIC has a similar mission and objectives to serve rural entrepreneurs as a Small Business Investment Company (SBIC) does to serve qualifying small businesses. Currently, the other financial regulatory agencies risk weight investments in SBICs at 100 percent and deduct from capital an escalating percentage of SBIC investments that exceed 15 percent of capital.[53] In this rule, FCA risk weights investments in RBICs at 100 percent.[54] FCA is not limiting the amount of RBIC investments that can receive the 100-percent risk weight because a System institution is precluded by statute from making an investment in a RBIC in excess of 5 percent of the capital and surplus of the institution.[55] This statutory limitation imposes adequate controls on risk from these investments.
The final rule modifies our methodology for determining the credit equivalent amount of off-balance sheet direct credit substitutes and adds a similar provision for recourse obligations. Under the new rule, the credit equivalent amount for a direct credit substitute or recourse obligation is the full amount of the credit-enhanced assets for which an institution directly or indirectly retains or assumes credit risk multiplied by a 100-percent conversion factor.[56] To determine the institution's risk-weighted assets for an off-balance sheet recourse obligation or a direct credit substitute, the credit equivalent amount is assigned to the risk-weight category appropriate to the obligor in the underlying transaction, after considering any associated guarantees or collateral.
Financial institutions are developing novel transactions that do not fit into the conventional risk-weight categories or credit conversion factors in the current standards. Financial institutions are also devising novel instruments that nominally fit into a particular category but impose levels of risk on the financial institutions that are not commensurate with the risk-weight category for the asset, exposure, or instrument. Accordingly, new § 615.5210(f) of the rule more explicitly Start Printed Page 35347indicates that FCA, on a case-by-case basis, may determine the appropriate risk weight for any asset or credit equivalent amount and the appropriate credit conversion factor for any off-balance sheet item in these circumstances. Exercise of this authority may result in a higher or lower risk weight or credit equivalent amount for these assets or off-balance sheet items. This reservation of authority explicitly recognizes the retention of sufficient discretion to ensure that novel financial assets, exposures, and instruments will be treated appropriately under the regulatory capital standards.
We clarify the listing of balance sheet assets identified in each risk-weight category in new § 615.5211 to more closely align the regulatory language with our long-standing policy positions. This new regulatory language also mirrors the language used by the other financial regulatory agencies to the extent applicable to System institutions. Over the years, we have generally interpreted our risk-weighting categories consistently with the other financial regulatory agencies. In some instances, however, the listing of assets included in each category is not as specific or clear as that of the other financial regulatory agencies. We make these amendments for the purpose of clarity and consistency with the other financial regulatory agencies.
We have reorganized the order of the assets listed in the 0-percent risk-weight category.[57] We have added a listing for portions of local currency claims on, or unconditionally guaranteed by, non-OECD central governments (including non-OECD central banks), to the extent the institution has liabilities booked in that currency (§ 615.5211(a)(4)). We have also revised the language in § 615.5211(a)(1), (a)(2), and (a)(3).[58] Finally, we have deleted previous § 615.5210(f)(2)(i)(C), which put goodwill in the 0-percent category. New § 615.5207(g) (which carried over without substantive change from previous § 615.5210(e)(7)) provides that an institution must deduct from total capital an amount equal to all goodwill before it assigns assets to the risk-weighting categories. Thus, it is unnecessary to assign goodwill to a risk-weighting category.
We have reorganized the order of the assets listed in the 20-percent risk-weight category.[59] We have added the following assets in addition to the changes previously discussed:
Portions of loans and other claims collateralized by cash on deposit (§ 615.5211(b)(8));
Portions of claims collateralized by securities issued by official multinational lending institutions or regional development institutions in which the United States Government is a shareholder or contributing member (§ 615.5211(b)(11)); and
Investments in shares of mutual funds whose portfolios are permitted to hold only assets that qualify for the zero or 20-percent risk-weight categories (§ 615.5211(b)(12)).
We have revised the language in § 615.5211(b)(3),[60] (b)(4),[61] (b)(5),[62] (b)(7),[63] (b)(9),[64] and (b)(10) [65] to make these provisions easier to read. In addition, we added the language in § 615.5211(b)(6) to clarify our policy position and to conform to the language used by for the other financial regulatory agencies.
In the 50-percent risk-weight category, we added a listing for revenue bonds or similar obligations, including loans and leases, that are obligations of a state or political subdivisions of the United States or other OECD countries but for which the government entity is committed to repay the debt only out of revenue from the specific projects financed.[66] We are making these revisions to further distinguish the varying degrees of risk associated with investments in different types of revenue bonds. This change also parallels the rules of the other financial regulatory agencies. We also made plain language changes to § 615.5211(c)(1).[67]
Claims on, or portions of claims guaranteed by, non-OECD central governments (except such claims that are included in other risk-weighting categories), and all claims on non-OECD state and local governments (§ 615.5211(d)(3));
Industrial development bonds and similar obligations issued under the auspices of states or political subdivisions of the OECD-based group of countries for the benefit of a private party or enterprise where that party or enterprise, not the government entity, is obligated to pay the principal and interest (§ 615.5211(d)(4));
Premises, plant, and equipment; other fixed assets; and other real estate owned (§ 615.5211(d)(5));
If they have not already been deducted from capital, investments in unconsolidated companies, joint ventures, or associated companies; deferred-tax assets; and servicing assets (§ 615.5211(d)(9)); and
All other assets not specified, including, but not limited to, leases and receivables (§ 615.5211(d)(12)).
We have changed the heading of § 615.5200 from “General” to “Capital planning” to better reflect the content of this section. We have made no other changes to this section.
We have broken up previous § 615.5210, which was cumbersome to use because of its length, into seven separate regulatory sections. The newly redesignated sections are:
§ 615.5206—Permanent capital ratio computation.
§ 615.5207—Capital adjustments and associated reductions to assets.
§ 615.5208—Allotment of allocated investments.
§ 615.5209—Deferred-tax assets.
§ 615.5210—Risk-adjusted assets.
§ 615.5211—Risk categories—balance sheet assets. Start Printed Page 35348
§ 615.5212—Credit conversion factors—off-balance sheet items.
We have deleted an obsolete reference to the Farm Credit System Financial Assistance Corporation in § 615.5201.
We have added paragraph (k) to newly redesignated § 615.5207 for clarity.
Pursuant to section 605(b) of the Regulatory Flexibility Act (5 U.S.C. 601 et seq.), the FCA hereby certifies that the final rule will not have a significant impact on a substantial number of small entities. Each of the banks in the System, considered together with its affiliated associations, has assets and annual income in excess of the amounts that would qualify them as small entities. Therefore, System institutions are not “small entities” as defined in the Regulatory Flexibility Act.
For the reasons stated in the preamble, we amend parts 607, 614, 615, and 620 of chapter VI, title 12 of the Code of Federal Regulations as follows:
1. The authority citation for part 607 continues to read as follows:
§ 607.2
2. Amend § 607.2(b) introductory text by removing the reference “§ 615.5210(f)” and adding in its place “§ 615.5210.”
4. Revise § 614.4351 (a) introductory text to read as follows:
Computation of lending and leasing limit base
(a) Lending and leasing limit base. An institution's lending and leasing limit base is composed of the permanent capital of the institution, as defined in § 615.5201 of this chapter, with adjustments applicable to the institution provided for in § 615.5207 of this chapter, and with the following further adjustments:
5. The authority citation for part 615 continues to read as follows:
6. Revise the heading of § 615.5200 to read as follows:
7. Revise § 615.5201 to read as follows:
Credit derivative means a contract that allows one party (the protection purchaser) to transfer the credit risk of an asset or off-balance sheet credit exposure to another party (the protection provider). The value of a credit derivative is dependent, at least in part, on the credit performance of a “reference asset.”
Credit-enhancing interest-only strip—
(2) FCA reserves the right to identify other cash flows or related interests as credit-enhancing interest-only strips. In determining whether a particular Start Printed Page 35349interest cash flow functions as a credit-enhancing interest-only strip, FCA will consider the economic substance of the transaction.
Credit-enhancing representations and warranties—
Nonagreeing association means an association that does not have an allotment agreement in effect with a Farm Credit Bank or agricultural credit bank pursuant to § 615.5207(b)(2).
OECD means the group of countries that are full members of the Organization for Economic Cooperation and Development, regardless of entry date, as well as countries that have concluded special lending arrangements with the International Monetary Fund's General Arrangement to Borrow, excluding any country that has Start Printed Page 35350rescheduled its external sovereign debt within the previous 5 years.
Permanent capital, subject to adjustments as described in § 615.5207, includes:
Qualified residential loan—
(i) A rural home loan, as authorized by § 613.3030, and
(3) The contract creates a single obligation either to pay or receive the net amount of the sum of positive and negative mark-to-market values for all derivative contracts subject to the qualifying bilateral netting contract;
(2) Loan-servicing assets retained pursuant to an agreement under which the institution will be responsible for Start Printed Page 35351losses associated with the loans serviced. Servicer cash advances as defined in this section are not recourse obligations;
Residual interest—
(2) Residual interests generally include credit-enhancing interest-only strips, spread accounts, cash collateral accounts, retained subordinated interests (and other forms of overcollateralization), and similar assets that function as a credit enhancement.
Risk-adjusted asset base means the total dollar amount of the institution's assets adjusted in accordance with § 615.5207 and weighted on the basis of risk in accordance with §§ 615.5211 and 615.5212.
§ 615.5210
8. Remove existing § 615.5210.
9. Add new §§ 615.5206 through 615.5212 to read as follows:
§ 615.5206
Permanent capital ratio computation.
(c) The institution's permanent capital ratio is calculated by dividing the institution's permanent capital, adjusted in accordance with § 615.5207 (the numerator), by the risk-adjusted asset base (the denominator) as determined in § 615.5210, to derive a ratio expressed as a percentage.
Start Printed Page 35352
§ 615.5207
Capital adjustments and associated reductions to assets.
(j) The permanent capital of an institution must exclude the net effect of all transactions covered by the definition of “accumulated other comprehensive income” contained in the Statement of Financial Accounting Standards No. 130, as promulgated by the Financial Accounting Standards Board.
(k) For purposes of calculating capital ratios under this part, deferred-tax assets are subject to the conditions, limitations, and restrictions described in § 615.5209.
(l) Capital may also need to be reduced for potential loss exposure on any recourse obligations, direct credit substitutes, residual interests, and credit-enhancing interest-only-strips in accordance with § 615.5210.
§ 615.5208
Allotment of allocated investments.
(a) The following conditions apply to agreements that a Farm Credit Bank or agricultural credit bank enters into with an affiliated association pursuant to § 615.5207(b)(2):
(2) The permanent capital ratio of the Farm Credit Bank or agricultural credit bank must be computed as of the date that the existing agreement terminates, using a 3-month average daily balance, excluding the allocated investment from nonagreeing associations but including any allocated investments of agreeing associations that are allotted to the bank under applicable allocation agreements. The permanent capital ratio of each nonagreeing association must be computed as of the same date using a 3-month average daily balance, and must be computed excluding its allocated investment in the bank. Start Printed Page 35353
(3) If the permanent capital ratio for the Farm Credit Bank or agricultural credit bank calculated in accordance with § 615.5208(b)(2) is 7 percent or above, the allocated investment of each nonagreeing association whose permanent capital ratio calculated in accordance with § 615.5208(b)(2) is 7 percent or above must be allotted 50 percent to the bank and 50 percent to the association.
(4) If the permanent capital ratio of the Farm Credit Bank or agricultural credit bank calculated in accordance with § 615.5208(b)(2) is 7 percent or above, the allocated investment of each nonagreeing association whose capital ratio is below 7 percent must be allotted to the association until the association's capital ratio reaches 7 percent or until all of the investment is allotted to the association, whichever occurs first. Any remaining unallotted allocated investment must be allotted 50 percent to the bank and 50 percent to the association.
(5) If the permanent capital ratio of the Farm Credit Bank or agricultural credit bank calculated in accordance with § 615.5208(b)(2) is less than 7 percent, the amount of additional capital needed by the bank to reach a permanent capital ratio of 7 percent must be determined, and an amount of the allocated investment of each nonagreeing association must be allotted to the Farm Credit Bank or agricultural credit bank, as follows:
§ 615.5209
Deferred-tax assets.
(4) Financial projections must include the estimated effect of tax-planning strategies that are expected to be implemented to minimize tax liabilities and realize tax benefits. Financial projections for the current fiscal year (adjusted for any significant changes that have occurred or are expected to occur) may be used when applying the capital limit at an interim date within the fiscal year.
Risk-adjusted assets.
(a) Computation. Each asset on the institution's balance sheet and each off-balance-sheet item, adjusted by the appropriate credit conversion factor in § 615.5212, is assigned to one of the risk categories specified in § 615.5211. The aggregate dollar value of the assets in each category is multiplied by the percentage weight assigned to that category. The sum of the weighted dollar values from each of the risk categories comprises “risk-adjusted assets,” the denominator for computation of the permanent capital ratio.
(i) If the position is traded and externally rated, its long-term external Start Printed Page 35354rating must be one grade below investment grade or better (e.g., BB or better) or its short-term external rating must be investment grade or better (e.g., A-3, P-3). If the position receives more than one external rating, the lowest rating applies.
(c) Positions in securitizations that do not qualify for a ratings-based approach.
(5) Any stripped mortgage-backed security or similar instrument, such as an interest-only strip that is not credit-enhancing or a principal-only strip (including such instruments guaranteed by Government-sponsored agencies), is assigned to the 100-percent risk-weight category described in § 615.5211(d)(7).
(f) Reservation of authority. The FCA may, on a case-by-case basis, determine the appropriate risk weight for any asset or credit equivalent amount that does not fit wholly within one of the risk categories set forth in § 615.5211 or that imposes risks that are not commensurate with the risk weight otherwise specified in § 615.5211 for the asset or credit equivalent. In addition, the FCA may, on a case-by-case basis, determine the appropriate credit conversion factor for any off-balance sheet item that does not fit wholly within one of the credit conversion factors set forth in § 615.5212 or that imposes risks that are not commensurate with the credit conversion factor otherwise specified in § 615.5212 for the item. In making this determination, the FCA will consider the similarity of the asset or off-balance sheet item to assets or off-balance sheet items explicitly treated in §§ 615.5211 or 615.5212, as well as other relevant factors.
§ 615.5211
Risk categories—balance sheet assets.
(9) General obligation claims on, and portions of claims guaranteed by, the full faith and credit of states or other political subdivisions or OECD Start Printed Page 35355countries, including U.S. state and local governments.
(13) Recourse obligations, direct credit substitutes, residual interests (other than credit-enhancing interest-only strips) and asset-or mortgage-backed securities that are externally rated in the highest or second highest investment grade category, e.g., AAA, AA, in the case of long-term ratings, or the highest rating category, e.g., A-1, P-1, in the case of short-term ratings.
(3) Recourse obligations, direct credit substitutes, residual interests (other than credit-enhancing interest-only strips) and asset-or mortgage-backed securities that are rated in the third highest investment grade category, e.g., A, in the case of long-term ratings, or the second highest rating category, e.g., A-2, P-2, in the case of short-term ratings.
(d) Category 4: 100 Percent. This category includes all assets not specified in the categories above or below nor deducted dollar-for-dollar from capital and assets as discussed in § 615.5210(c). This category comprises standard risk assets such as those typically found in a loan or lease portfolio and includes:
(4) Industrial-development bonds and similar obligations issued under the auspices of states or political subdivisions of the OECD-based group of countries for the benefit of a private party or enterprise where that party or enterprise, not the government entity, is obligated to pay the principal and interest.
(6) Recourse obligations, direct credit substitutes, residual interests (other than credit-enhancing interest-only strips) and asset-or mortgage-backed securities that are rated in the lowest investment grade category, e.g., BBB, in the case of long-term ratings, or the third highest rating category, e.g., A-3, P-3, in the case of short-term ratings.
(e) Category 5: 200 Percent. Recourse obligations, direct credit substitutes, residual interests (other than credit-enhancing interest-only strips) and asset-or mortgage-backed securities that are rated one category below the lowest investment grade category, e.g., BB.
§ 615.5212
Credit conversion factors—off-balance sheet items.
(a) The face amount of an off-balance sheet item is generally incorporated into risk-weighted assets in two steps. For most off-balance sheet items, the face amount is first multiplied by a credit conversion factor. (In the case of direct credit substitutes and recourse obligations the full amount of the assets enhanced are multiplied by a credit conversion factor). The resultant credit equivalent amount is assigned to the Start Printed Page 35356appropriate risk-weight category described in § 615.5211 according to the obligor or, if relevant, the guarantor or the collateral.
(c) Credit equivalents of interest rate contracts and foreign exchange contracts. (1) Credit equivalents of interest rate contracts and foreign exchange contracts (except single-currency floating/floating interest rate swaps) are determined by adding the replacement cost (mark-to-market value, if positive) to the potential future credit exposure, determined by multiplying the notional principal amount by the following credit conversion factors as appropriate.
1 year or less 0.0 1.0 10.0
Over 1 to 5 years 0.5 5.0 12.0
Over 5 years 1.5 7.5 15.0
(2) For any derivative contract that does not fall within one of the categories in the above table, the potential future credit exposure is to be calculated using the commodity conversion factors. The net current exposure for multiple derivative contracts with a single counterparty and subject to a qualifying bilateral netting contract is the net sum of all positive and negative mark-to-market values for each derivative contract. The positive sum of the net current exposure is added to the adjusted potential future credit exposure for the same multiple contracts with a single counterparty. The adjusted potential future credit exposure is computed as Anet = (0.4 × Agross) + 0.6 (NGR × Agross) where:
(i) Anet is the adjusted potential future credit exposure;
(ii) Agross is the sum of potential future credit exposures determined by multiplying the notional principal amount by the appropriate credit conversion factor; and
(3) Credit equivalents of single-currency floating/floating interest rate swaps are determined by their replacement cost (mark-to-market).
10. Amend § 615.5301 by revising paragraphs (b)(3), (i)(2), and (i)(8) to read as follows:
§ 615.5301
(3) The deductions that must be made by an institution in the computation of its permanent capital pursuant to § 615.5207(f), (g), (i), and (k) shall also be made in the computation of its core surplus. Deductions required by § 615.5207(a) shall also be made to the extent that they do not duplicate deductions calculated pursuant to this section and required by § 615.5330(b)(2).
(2) Allocated equities, including allocated surplus and stock, that are not subject to a plan or practice of revolvement or retirement of 5 years or less and are eligible to be included in permanent capital pursuant to paragraph(4)(iv) of the definition of permanent capital in § 615.5201; and
(8) Any deductions made by an institution in the computation of its permanent capital pursuant to § 615.5207 shall also be made in the computation of its total surplus.
§ 615.5330
11. Amend § 615.5330 by removing the reference “§ 615.5210(f)” and adding in its place “§ 615.5210” in paragraphs (a)(2) and (b)(3).
End Amendment Part Start Part Start Printed Page 35357
12. The authority citation for part 620 continues to read as follows:
13. Amend § 620.1(j) by removing the reference “§ 615.5201(l)” and adding in its place “§ 615.5201.”
1. We refer collectively to the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Federal Reserve Board), the Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision (OTS) as the “other financial regulatory agencies.”
2. 69 FR 47984.
3. 68 FR 15045.
4. 69 FR 29852.
5. We also received a letter from CoBank. That letter did not comment on the proposed regulation. Rather, it suggested a coordinated System/FCA effort to jointly explore further implications and appropriateness of Basel II and volunteered CoBank as a testing bank for a possible “Quantitative Impact Study.” We note that, separately from this regulation, FCA staff is currently evaluating the implementation of Basel II and will assess CoBank's suggestions as part of that evaluation.
6. The Basel Committee is a committee reporting to the central banks and bank supervisors/regulators from the major industrialized countries that formulates standards and guidelines related to banking and recommends them for adoption by member countries and others. The Basel Committee has no formal supranational supervisory authority and its recommendations have no legal force.
7. See 53 FR 39229 (October 6, 1988).
8. Pub. L. 100-233 (January 6, 1988).
9. See 63 FR 39219 (July 22, 1998).
10. See the Basel Committee's Web site at http://www.bis.org for extensive information about Basel II.
11. See Interagency Statement—U.S. Implementation of Basel II Framework: Qualification Process—IRB and AMA (Jan. 27, 2005).
12. See Joint Press Release, Banking Agencies to Perform Additional Analysis Before Issuing Notice of Proposed Rulemaking Related to Basel II (April 29, 2005).
14. See Interagency Statement—U.S. Implementation of Basel II Framework: Qualification Process—IRB and AMA (January 27, 2005).
15. 66 FR 59614 (November 29, 2001).
16. Banking organizations include banks, bank holding companies, and thrifts. See 66 FR 59614 (November 29, 2001).
17. See 66 FR 59614 (November 29, 2001.)
18. An NRSRO is a rating organization that the Securities and Exchange Commission recognizes as an NRSRO. See new FCA regulation 12 CFR 615.5201.
19. 67 FR 16971 (April 9, 2002).
20. Investment grade means a credit rating of AAA, AA, A or BBB or equivalent by an NRSRO.
21. See § 615.5140.
22. Section 615.5143 provides that an institution must dispose of an ineligible investment within 6 months unless FCA approves, in writing, a plan that authorizes divestiture over a longer period of time. An institution must dispose of an ineligible investment as quickly as possible without substantial financial loss.
23. The terms “credit enhancement” and “enhancement” refer to both recourse arrangements (including residual interests) and direct credit substitutes.
24. This rule does not grant any new authorities to System institutions. It merely provides risk weightings for investments and transactions that are otherwise authorized.
25. This agency has been renamed the Government Accountability Office.
26. United States General Accounting Office, Farmer Mac: Some Progress Made, but Greater Attention to Risk Management, Mission, and Corporate Governance Is Needed, GAO-04-116, at page 59 (2003).
27. Both the OFI rule and the proposed Farmers' Notes rule permit a 20-percent risk weighting if the counterparty is an OECD bank, regardless of issuer credit rating, or if the counterparty has at least an A credit rating. See 69 FR 29852 (May 26, 2004); 69 FR 55362 (Sept. 14, 2004).
28. See Banking Bulletin 99-43, December 1999 (OCC); Supervision and Regulation Letter 99-32, Capital Treatment for Synthetic Collateralized Loan Obligations, November 15, 1999 (Federal Reserve Board).
29. Under Statement of Financial Accounting Standards No. 140, ancillary revenues include late charges on transferred assets.
30. OECD stands for the Organization for Economic Cooperation and Development. The OECD is an international organization of countries that are committed to democratic government and the market economy. For purposes of our capital regulations, as well as those of the other financial regulatory agencies and the Basel Accord, OECD countries are those countries that are full members of the OECD or that have concluded special lending arrangements associated with the International Monetary Fund's General Arrangements to Borrow, excluding any country that has rescheduled its external sovereign debt within the previous 5 years. The OECD currently has 30 member countries. An up-to-date listing of member countries is available at http://www.oecd.org or www.oecdwash.org..
31. Pub. L. 107-171.
32. We exclude credit-enhancing interest-only strips from the ratings-based approach because of their high-risk profile, as discussed under section V.C.1. of this preamble.
33. These ratings are examples only. Different NRSROs may have different ratings for the same grade.
34. See paragraphs (b)(13), (c)(3), (d)(6), and (e) of new § 615.5211.
35. These ratings are examples only. Different NRSROs may have different ratings for the same grade. Further, ratings are often modified by either a plus or minus sign to show relative standing within a major rating category. Under the proposed rule, ratings refer to the major rating category without regard to modifiers. For example, an investment with a long-term rating of “A−” would be risk weighted at 50 percent.
36. See 68 FR 15045 (March 28, 2003).
37. See 66 FR 59614 (November 29, 2001).
38. As previously discussed, this rule defines the term “recourse” to mean an arrangement in which an institution retains, in form or in substance, any credit risk directly or indirectly associated with an asset it has sold, if the credit risk exceeds a pro rata share of the institution's claim on the asset. If an institution has no claim on an asset that it has sold, then the retention of any credit risk is recourse.
39. See new § 615.5210(e).
40. As indicated previously, credit-enhancing positions in securitizations are subject to dollar-for-dollar capital treatment.
41. Stripped mortgage-backed securities, as discussed above, are assigned to the 100-percent risk-weighting category.
42. Under revised § 615.201, “qualifying securities firm” means: (1) A securities firm incorporated in the United States that is a broker-dealer that is registered with the SEC and that complies with the SEC's net capital regulatiions; and (2) a securities firm incorporated in any other OECD-based country, if the institution is subject to supervision and regulation comparable to that imposed on depository institutions in OECD countries.
43. Proposed § 615.5211(a)(5).
44. Proposed § 615.5211(b)(15).
45. If ratings are available from more than one NRSRO, the lowest rating will be used to determine whether the rating standard has been met.
46. See new § 615.5211(b)(16).
47. This risk weighting has been retained in the new rule. See §§ 615.5201 and 615.5211(c)(2).
48. As discussed above, these loans have previously been included in the 50-percent risk-weight category.
49. As discussed above, these loans have previously received a 100-percent risk weighting.
50. See, e.g., FDIC regualtions at 12 CFR Part 325, Appendix A, II.C., Category 3.
51. Section 1.10 of the Act.
52. This requirement does not preclude an institution, in an abundance of caution, from taking other property as additional collateral.
53. See 67 FR 3784, January 25, 2002.
54. See new § 615.5211(d)(8).
55. 7 U.S.C. 2009cc-9(b).
56. See new § 615.5212(b)(4)(i).
57. Except where otherwise indicated, all references are to the new regulation.
58. See previous § 615.5210(f)(2)(i)(A), (f)(2)(i)(B), and (f)(2)(i)(C).
59. Except where otherwise indicated, all references are to the new regulation.
60. Consolidated from previous § 615.5210(f)(2)(ii)(D) and (f)(2)(ii)(E).
61. Previous § 615.5210(f)(2)(ii)(F).
62. Consolidated from previous § 615.4210(f)(2)(ii)(B) and (f)(2)(ii)(J).
63. Consolidated from previous § 615.5210(f)(2)(ii)(A) and (f)(2)(ii)(C).
64. See previous § 615.5210(f)(2)(ii)(G).
65. See previous § 615.5210(f)(2)(ii)(H).
66. New § 615.5211(c)(4). This provision was not contained in previous FCA regulations.
67. See previous § 615.5210(f)(2)(iii)(A).