Source: https://www.federalregister.gov/documents/2005/11/17/05-22730/federal-agricultural-mortgage-corporation-funding-and-fiscal-affairs-federal-agricultural-mortgage
Timestamp: 2017-08-24 01:45:00
Document Index: 396580317

Matched Legal Cases: ['art 652', '§\u2009652', 'art 1750', '§\u2009652', '§\u2009655', 'arts 652', 'art 652']

A Proposed Rule by the Farm Credit Administration on 11/17/2005
You may send us comments by February 15, 2006.
70 FR 69692
69692-69709 (18 pages)
05-22730
V. Issues, Options Considered, and Proposed Revisions
1. Treatment of Loans for Which Origination Data Are Not Collected by Farmer Mac
2. Revise the Treatment of Standby Loans
3. Revise the Treatment of Miscellaneous Income
4. Revise the Treatment of Gain on Sale of AMBS
5. Revise the Operating Expense Regression Equation
6. Improve Estimates of Carrying Costs of Troubled Loans by Revising Assumptions Regarding Loan Loss Resolution Timing
7. Add a Component To Reflect Counterparty Risk
8. Provide Public Notice of Technical Changes to the RBCST
9. Stressed-Based Cost of Funds Increment
10. Recognition of Risk on AgVantage Bonds
11. Impact of Proposed Changes on Required Capital
12. Change to Disclosure Regulations
https://www.federalregister.gov/d/05-22730 https://www.federalregister.gov/d/05-22730
The Farm Credit Administration (FCA, Agency, us, or we) is proposing to amend regulations governing the Federal Agricultural Mortgage Corporation (Farmer Mac or the Corporation). Analysis of the Farmer Mac risk-based capital stress test (RBCST or the model) in the 3 years since its first official submission as of June 30, 2002, has identified several opportunities to update the model in response to changing financial markets, new business practices and the evolution of the loan portfolio at Farmer Mac, as well as continued development of best-industry practices among leading financial institutions. The proposed rule focuses on improvements to the RBSCT by modifying regulations found at 12 CFR part 652, subpart B. The effect of the proposed rule is intended to be a more accurate reflection of risk in the model in order to improve the model's output—Farmer Mac's regulatory minimum capital level. The proposed rule also makes one clarification relating to Farmer Mac's reporting requirements at 12 CFR 655.50(c).
Send us your comments by electronic mail to reg-comm@fca.gov, through the Pending Regulations section of our Web site at http://www.fca.gov, or through the Government-wide Web site http://www.regulations.gov. You may also submit your comments in writing to Robert Coleman, Director, Office of Secondary Market Oversight, Farm Credit Administration, 1501 Farm Credit Drive, McLean, VA 22102-5090, or by facsimile transmission to (703) 883-4477.
Joy Strickland, Senior Counsel, Office of the General Counsel, Farm Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703) 883-4020.
The purpose of this proposed rule is to revise the risk-based capital (RBC) regulations that apply to Farmer Mac. The substantive issues addressed in this Start Printed Page 69693proposed rule are: Miscellaneous income estimates, operating expense estimates, counterparty risk on non-program investments, the resolution timing for troubled loans and associated carrying costs, the treatment for income related to gain on sale of agricultural mortgage-backed securities (AMBS), the treatment of certain loan data for modeling purposes,[1] and the estimation of credit risk in the Long-Term Standby Purchase Commitment (Standby) portfolio.
The RBC rule contains language that anticipates the need for continuing changes to the model over time in an effort to adapt the model to Farmer Mac's actual operations on an on-going basis to the extent practicable. The Office of Secondary Market Oversight (OSMO) is also interested in updating the model in future rulemakings to respond to opportunities created by the continued evolution in techniques available for modeling risk-based capital requirements.
Further, consistent with the FCA Chairman and Chief Executive Officer's (CEO) letter to Congress on actions taken or to be taken in response to the Government Accountability Office (GAO) report entitled, “Farmer Mac: Some Progress Made, but Greater Attention to Risk Management, Mission, and Corporate Governance Is Needed” (Report),[2] the regulatory development process also included consideration of all comments and recommendations in the Report pertaining to the RBCST.
Analysis of the Farmer Mac RBCST since its first official submission as of June 30, 2002, has identified several opportunities to update the model in response to changing financial markets, new business practices and from the evolution of the loan portfolio at Farmer Mac, as well as continued development of best-industry practices among leading financial institutions. We have divided the changes into two broad categories that we label “technical” and “substantive.” Technical changes are those we may implement without rulemaking and that do not require FCA Board action. We incorporated several such technical changes in December 2002, June 2004, and August 2005, and implemented them as Versions 1.1, 1.2, and 1.25 of the RBCST, respectively. These technical changes, and other Call Report-related changes, are detailed later in this preamble. This proposed rule makes substantive changes that require formal rulemaking procedures and FCA Board approval to implement.
The FCA, through this proposed rule, seeks to update and refine the RBCST. Our goal is to ensure that the RBCST reflects changes in the Corporation's business structure and loan portfolio that have occurred since the model was originally developed by FCA, while complying with the statutory requirements and constraints on the model's design.
A. Modify the RBCST's treatment of loans for which Farmer Mac does not collect certain loan origination data required by the model because of the loan product type and related underwriting requirements (e.g., seasoned and fast-track loans). The proposed revision would use loan proxy data to estimate loan level losses rather than applying state-level average loss rates to such loans. The proposed revision also includes the use of data proxies when certain data anomalies are identified or other ambiguous data conditions are present.
B. Revise the treatment of Standby loans for which loan origination data needed by the model are available. Currently, the model treats all Standby loans as if they are seasoned loans for which the loan origination data needed for RBCST purposes are not available. Average loss rates by-state estimated from other loans are applied to Standby loans located in the same state. The proposed rule would improve the loss estimation method applied to Standby loans by applying an approach similar to that applied to the rest of the loan portfolio.
C. Change the method used to estimate future years' miscellaneous income from a fixed rate of 2 basis points of total assets to the 3-year average of the annualized actual miscellaneous income for each quarter as a percent of the sum of: Cash, investments, guaranteed securities, and loans held for investment. This change is consistent with the regulation's goal to reflect Farmer Mac's actual operations, as much as practicable.
D. Revise the variables in the regression formula used to calculate operating expense coefficients to more completely reflect Farmer Mac's cost. Operating expense coefficients are used to estimate future years' operating expenses.
E. Revise the model's estimate of gain on sale of AMBS from a fixed rate of 0.75 percent of new Farmer Mac I program volume to a rolling 3-year weighted average of actual gain levels experienced by Farmer Mac.
F. Change the model's assumption concerning loan loss resolution timing. The proposed revision reflects the stress associated with carrying costs on non-performing loans based on Farmer Mac's actual experience resolving troubled loans.
G. Adjust the model's estimate of income on non-program investments to reflect counterparty risk. We propose the application of discounts or “haircuts” to the yields on individual investments, scaled according to their credit ratings. FCA's consideration of such an adjustment was suggested in the October 2003 GAO Report.
H. Publish all prior technical changes, including those implemented in December 2002 (RBCST Version 1.1), June 2004 (RBCST Version 1.2), and August 2005 (RBCST Version 1.25).
I. Make other technical changes including improved formatting and clarity of labeling in certain cells of the RBCST worksheets and deletion of § 652.100 which is no longer relevant as it dealt with the date the original final rule on the RBCST became effective.
We have identified several items that require regulatory attention to amend or clarify the final rule published on April 12, 2001 (66 FR 19048). Below is a detailed explanation of all changes considered and proposed.
There is a significant portion of Farmer Mac's portfolio for which loan origination data required by the model are not collected by Farmer Mac under its underwriting requirements. The RBCST was designed to use loan data at origination. While not always necessary for underwriting purposes, loan origination data is important to the functioning of the model.
The RBCST uses a predictive equation to estimate the probability of default (PD) for each loan held or securitized by Farmer Mac as well as those underlying Standby contracts. The predictive equation is based on variables representing data at loan origination for each loan's debt-to-asset ratio, current ratio, loan-to-value ratio (LTV), and debt service coverage ratio, as well as Start Printed Page 69694inflation-adjusted loan size and worst-case rates of decline in farmland values. The PD estimated for each loan is combined with a loss-given-default estimate and loan size to determine expected loss. The loan loss is then adjusted for seasoning to account for a decline in PD as a loan ages. The RBCST then processes losses, together with other factors, to determine Farmer Mac's risk-based capital requirement. This approach to estimating PDs requires data at loan origination for the financial variables associated with each loan.
Currently, the RBCST separates Farmer Mac's portfolio into two groups referred to as “Cash Window” loans and Standby loans. Cash Window loans are loans held for investment and loans that underlie guaranteed securities, and Standby loans are loans that underlie Standby contracts. This segmentation was originally made to reflect Farmer Mac's business and loan underwriting practices when FCA developed the RBCST. At that time, Cash Window loans were newly originated full-time farm loans on which origination underwriting data were consistently available. Standby loans, on the other hand, were primarily highly seasoned Farm Credit System loans for which origination underwriting data were not available. Similarly, the business processes that pertain to Cash Window and Standby loans differed. Cash Window loans were generally processed by Farmer Mac on a loan-by-loan basis and held in a loan pool until sufficient volume was attained to permit securitization as an AMBS. Standby loans were largely underwritten on a pool basis and subject to a due diligence review. Therefore, the RBCST's portfolio segmentation was designed to treat Cash Window loans and Standby loans differently to reflect their operational differences. In versions 1.25 and earlier, the RBCST directly applies the estimated loss rates to individual Cash Window loans. For Standby loans, the RBCST indirectly applies these rates to individual loans following the specialized treatment discussed below.
During initial development of the RBCST in 1998, origination financial data were available on a majority (approximately 88 percent) of Farmer Mac's Cash Window loans, excluding pre-1996 loans. Since then, Farmer Mac's loan portfolio has evolved such that several of its loan products do not require collection of origination financial data. For instance, Farmer Mac has established specialized underwriting standards for Fast Track (i.e., reduced documentation loans), seasoned, and part-time farm loans that exclude the collection of certain origination loan data used for RBCST purposes in recognition of acceptable alternative underwriting criteria. Total growth in these loan types, especially seasoned loans, has outpaced other types in the years since the model was first designed. Due to this growth, the proportion of loans with incomplete underwriting data has increased. As a result, the current treatment of applying average state-level loss rates estimated from other loans within the portfolio is applied to a significant proportion of the total loan portfolio. We recognize that collecting origination financial data used for RBCST purposes on all loan products may be impractical. Therefore, we propose modifying the current treatment of such loans to apply loan data proxies that conservatively reflect Farmer Mac's underwriting criteria and practices.
In describing the revisions, we will first discuss revisions for Cash Window loans and address Standby loans in the following section of this preamble as a separate improvement to the RBCST.
Under this proposed rule, the RBCST would substitute conservative proxies when the necessary loan origination data is unavailable. The conservative proxies reflect the higher end of the range of acceptable LTV and debt-to-asset ratios, and the lower end of the range of acceptable debt service coverage (DSC) ratios according to Farmer Mac's underwriting criteria. The proxy values to be applied are as follows: Debt-to-asset ratio of 0.60, LTV ratio of 0.70, and DSC ratio of 1.20.
The conservative proxies relate directly to Farmer Mac's underwriting standards thereby serving as another aspect of the proposed rule that draws on Farmer Mac's actual operations to enhance the RBCST. Using conservative proxy data preserves the theoretical and structural integrity of the RBCST and maintains consistency with statutory requirements for a stressful, worst-case scenario.
In addition, we propose application of the proxy data to data anomalies that occasionally occur in large sets of loan level data. Several conditions under which an anomaly would be identified are described in section 4.1, paragraph d.(3)(A) of the Technical Appendix to this proposed rule along with the proxy data that would be applied in each case.
Other loan data adjustments would be made in response to certain unique situations. These deal with rare instances where an origination date field might be blank, purchase or commitment date fields are blank, or the original loan balance is less than the current scheduled loan balance. For example, if the original loan balance field is blank or is less than the scheduled loan balance, the RBCST will use the scheduled (current) loan balance for modeling purposes. In such cases, when alternative loan balance data are used, the RBCST will substitute the “cut-off” date (i.e., the date the loan was guaranteed or placed under a Standby agreement) for the origination date for that loan for purposes of the seasoning adjustment. In addition, the model uses the cut-off date when the loan origination date field is blank for lack of any other data to use in the model's seasoning adjustment. Because it would not be possible to compile an exhaustive list of data anomalies, the proposed rule reserves FCA's authority to require an explanation from Farmer Mac on other data anomalies and to apply the proxy data to such data until the anomaly is addressed by Farmer Mac.
As discussed in the previous section, loans underlying a Standby agreement receive specialized treatment by the RBCST Versions 1.25 and earlier. Rather than modeling loan-specific data, the average state-level loss rates determined from the Cash Window loan portfolio are applied to Standby loans based on the state in which the property is located. The loans are then seasoned based on their age from origination date. We adopted this treatment in response to the characteristics of Standby loans at the time the RBCST was developed. At that time, nearly all Standby loans were seasoned and origination financial data were not readily or consistently available from the originating FCS institution. Because the volume of the Standby program was not high at the time we developed the RBCST, and because the Standby loans were generally highly seasoned, it was deemed appropriate to establish a separate treatment for Standby loans that based losses on loans estimated using the Cash Window portfolio. However, given the availability of the newly proposed data proxies described above, it is now deemed more appropriate to treat Standby loans in a similar manner to Cash Window loans when estimating credit risk. In addition, Farmer Mac's Standby portfolio now includes more unseasoned loans for which loan origination data are available but are not currently used to estimate losses under the model's current treatment of Standby loans.
We propose to remove the specialized treatment of Standby loans and treat these loans in the same manner as Cash Window loans with the exception of seasoned Standby loans. Loans for Start Printed Page 69695which origination data are available would be processed using those data. Standby loans for which origination data are not available or where data anomalies are identified would receive the same proxy data used for Cash Window loans. Seasoned Standby loans where data are available will receive the proxy data in light of Farmer Mac's practice of populating origination data fields with “cut off” data for such loans. “Cut off” data are data as of the date the loan was taken into Farmer Mac's portfolio. As a result, the RBCST would apply the loss-frequency model and loss-severity factor to all loans both Standby and Cash Window. This change would yield a more complete measure of credit risk of unseasoned Standby loans and compensate for the uncertainty associated with missing data on Standby loans.
Currently, the RBCST estimates Farmer Mac's miscellaneous income over the 10 years of the model's time horizon as 2 basis points of total assets. This estimate was considered adequate because it approximated the historical average over the years prior to the model's development. Moreover, the amounts estimated were not significant. We propose to change the estimate of future years' miscellaneous income to the 3-year weighted average of actual miscellaneous income in each quarter divided by that quarter's actual sum of: Cash, investments, guaranteed securities, and loans held for investment. This change is consistent with the goal to reflect, as much as practicable, Farmer Mac's actual operations on an on-going basis, as it will be updated quarterly with Farmer Mac's most recent actual miscellaneous income experience.
The benefits of this proposed change are that it will:
(1) Build in an on-going adjustment to the estimate based on recent experience;
(2) Be easily understood;
(3) Add transparency to the miscellaneous income estimate; and
(4) Be consistent with the current rule's intent to simulate Farmer Mac's operations to the maximum extent practicable.
The proposed rule revises the methodology used to estimate future years' gains on the sale of AMBS, thus improving the model's ability to reflect Farmer Mac's current operations on an on-going basis. Previously, the model credited Farmer Mac with income of 0.75 percent of new Farmer Mac I program volume as estimated by the backfilling of loan volume in accordance with the steady-state scenario. However, recent trends in Farmer Mac's operations demonstrate that AMBS sales are more sporadic. The revised approach reflects the gain rates most recently experienced in Farmer Mac's operations by establishing a new input in the Data Inputs worksheet for “Gain Rate on AMBS Sales” and applying that gain rate factor (expressed as the actual gain as a percentage of the par value of the AMBS sold) to the dollar amount of AMBS sold during the most recent 4 quarters. Applying the 3-year gain rate factor to the most recent 4 quarters of activity appropriately smoothes the variability in Farmer Mac's sales of AMBS for RBCST purposes.
The RBCST currently uses a regression equation to estimate operating expenses in future years that relates historic Farmer Mac operating expenses to a constructed variable reflecting loan and investment volumes. The goal is to accurately reflect costs associated with operating Farmer Mac as its program balances and investment levels change without being overly influenced by random variations that can reasonably occur in any given quarter. The structural model for estimating operating expenses was developed soon after the 1996 legislation that resulted in Farmer Mac's current business structure. As a result, the historic data can be divided into two time periods—with one time period representing activity prior to their ability to pool whole loans and hold loans on their balance sheet, and a second period with their business activities focused more directly and actively on loan-based activities. The data from the latter period had much higher cost structures than the former. To accommodate the data structure while retaining the longest sample period possible, a specification was adopted that included pre-1996 data with a dummy variable that permitted an intercept shift or, equivalently, as two segments of the regression with a “jump” in the fitted line at the point of the changes in cost structure related to the 1996 legislation. Additionally, it seemed reasonable to consider a structure that recognized economies of scale, assuming incremental business additions could be underwritten at lower marginal costs. As a result, a structure was adopted relating the logarithm of the sum of loans and investments to actual operating expenses with a dummy variable separating the pre- and post-1996 data periods.
Considerable data have accumulated since the operating expense regression was developed. Therefore, it is appropriate to develop a more complete representation of Farmer Mac's business activities at this point. We have considered: (a) The appropriate historic data period, (b) specific business segments and activities to include as explanatory variables, (c) the potential for seasonality in the expense structure, (d) the potential automation of the estimation of the coefficients within the RBCST, and (e) the need to utilize existing data structures and accounting conventions to the degree reasonable (i.e., the potential difficulty with reconstructing some historic data series related to changed business segments).
The Agency believes that a more complete characterization of the expense structure of Farmer Mac can be specified by separating the business activities that contribute to variation in annualized expenses into:
(i) On-balance sheet investments,
(ii) On-balance sheet guaranteed securities,
(iii) The sum of off-balance sheet loans in the Farmer Mac I and Farmer Mac II programs, and
(iv) Gross real estate owned (REO).
The use of the multiple regressors obviates the need for the dummy variable. The inclusion of REO captures a possible high-cost segment of their business and provides a direct linkage between problem loans and higher operating costs. To reflect economies of scale, the independent variables are expressed on a logarithmic scale. The proposed specification and attendant revision in the RBCST utilize the following expression:
Expensest = α + β1 ln(OnFt) + β2 ln(OnGSt) + β3 ln(OnIt + OffIIt) + β4 ln(OnREOt)
Where “t” indicates time period in the model, “OnF” represents on-balance sheet investments, “OnGS” represents on-balance sheet guaranteed securities, “OffI” and “OffII” represent off-balance sheet Farmer Mac I and II program loans, respectively, and “REO” represents gross real-estate owned. The in-sample fit is improved with this specification relative to the previously required approach for comparable data periods. Tests of the appropriate sample period for estimation are roughly comparable when using either complete available sample period data or data from quarters after the 1996 legislation and the establishment of the RBC Start Printed Page 69696requirement. As under the current RBCST, Farmer Mac must re-estimate the coefficients quarterly and supply the coefficients and worksheet as part of its quarterly submission.
The RBCST was developed with a loss-severity estimate that assumes it would take Farmer Mac 1 year to work through problem loans from the point of default through final disposition. At the time of development of the RBCST, historical problem loan resolution timing data from Farmer Mac were not available. Farmer Mac data now indicate that problem loans may take longer to resolve than the 1 year assumed in the model's loss-severity rate.[3] If the time interval is longer than the current model's assumption, the capital needs for carrying non-performing assets in the model are likely understated in the current model. Therefore, we propose to reflect costs associated with any additional loan loss resolution time (LLRT) period (i.e., the period beyond the 1-year period assumed in the loss-severity rate) in the model.[4]
With the exception of the 1-year period assumed in the loss-severity rate, the current RBCST under a steady-state scenario requires backfilling of problem loan volume with like assets, without recognizing any additional cost associated with carrying loans as non-earning, but funded, assets. Under the proposed rule, the RBCST will now reflect costs associated with the LLRT period. The change would be incorporated into the RBCST as follows. Off-balance sheet loans associated with losses are assumed to be purchased from the Standby portfolio and fully funded at the short-term cost of funds rate used in the model, and no associated guarantee fee is generated. The short-term cost of funds (adjusted to incorporate interest rate shock effects) is used to estimate this additional funding cost in recognition of Farmer Mac's actual business practices. On-balance sheet loans generating losses are also removed from the interest earnings calculations and continue to generate interest expense at the blended cost of long- and short-term funds (again adjusted to incorporate interest rate shock effects) for the LLRT period. The model would continue to backfill new loans at the point of loan resolution to retain its steady-state specification.
The proposed revisions involve two principal changes from the current RBCST. First, the date of backfill would be moved to a point in time that more accurately reflects Farmer Mac's actual experience. The model would then capture the additional costs of carrying loans in a non-interest earning category on the balance sheet. Second, the guarantee fee income would only be generated on performing loan guarantees and commitments. The LLRT becomes a line item in the Data Inputs worksheet. The initial LLRT will be set by FCA based on Farmer Mac historical data. The Corporation has not had a significant number of problem loans that have gone through the full resolution process from which to determine the LLRT for RBCST purpose. Nevertheless, the Agency has consistently designed the RBCST to reflect Farmer Mac data and its actual experience when available. The proposed treatment reflects the data currently available from Farmer Mac on the resolution of troubled loans. If Farmer Mac establishes a pattern of faster or slower resolution of troubled loans in the future, we will consider adjustments to the LLRT at that time.
The proposed LLRT revisions are forward-looking only. In other words, actual loans that defaulted in year zero and are in their second year of non-performing status in year 1 of the model's 10-year time horizon are not included in the proposed LLRT revision, and therefore no adjustment to restate current balance sheet amounts is required. An approach involving such a restatement was considered but deemed to add an unnecessary degree of complexity to the model. We note that the revision to more accurately reflect the carrying cost of non-performing loans results in less additional stress under a down-rate interest rate shock than under an up-rate shock. This result is logical as it would be less costly to fund non-performing loans when interest rates are relatively low.
One further calculation is necessary to complete the proposed LLRT revision. Implementation of the LLRT revision requires an estimate of loan amortization to estimate the additional carrying cost associated with the LLRT period by applying the appropriate cost of funds to a loan's remaining balance at the time of default. We use the portfolio average principal amortization to make this adjustment (i.e., total portfolio current scheduled principal balance divided by total origination balance). The LLRT scaling factor is calculated in the Credit Loss Module as the ratio of total portfolio current scheduled principal balance divided by total origination balance divided by the loss-severity factor (0.209). This approach results in the calculation of a stressed level of nonperforming loan volume based on the credit losses estimated by the RBCST.
Currently, the RBCST does not include a component to reflect counterparty risk on Farmer Mac's portfolio of investment securities, and derivatives. We propose adopting a system of haircuts to the yields on investment securities, scaled according to credit ratings—with greater haircuts applied to lower credit ratings. The risk-based capital regulations of the Office of Federal Housing Enterprise Oversight (OFHEO) (12 CFR part 1750) established a precedent for the levels of such haircuts. OFHEO defines five levels of credit ratings from “AAA” to “below BBB and unrated.” They assign each of the nationally recognized statistical rating organizations' (NRSRO) rating categories to one of the four OFHEO general rating categories. With these definitions specified, rate haircuts are applied by OFHEO to the securities in the investment and derivatives portfolios of its regulated enterprises.
In assessing the counterparty risk associated with non-program investments, OFHEO examined Depression-era default rates (1929 to 1931) [5] and a study completed for the National Bureau of Economic Research (NBER) in the 1950's.[6] OFHEO's haircut levels recognize recoveries on defaulted instruments, an adjustment that was also based on Depression-era data. Thus, haircut levels were derived based on default rates multiplied by severity rates. For all counterparties, the default rates used were 5 percent for AAA, 12.5 percent for AA, 20 percent for A, 40 percent for BBB and 100 percent for below BBB or unrated. Severity rates used were 70 percent for nonderivative securities, yielding net haircuts of 3.5 percent, 8.75 percent, 14.0 percent, and 28.0 percent for ratings AAA through Start Printed Page 69697BBB, respectively. One hundred percent haircuts are applied to the “BBB or unrated” category. The haircuts are applied on a weighted-average basis as reductions in the weighted-average yields of non-program investment categories.
We also considered OFHEO's phase-in of the haircuts and believe such a phase-in is appropriate for the RBCST as well. The rationale for the phase-in is based on the assumption that defaults on investments in response to a general downturn in the economy would not be instantaneous but on a more random basis through time. Therefore, the Agency proposes to phase-in the haircuts on a linear basis over the RBCST's 10-year time horizon. Further, we elected not to assign the rating of a parent company to its unrated subsidiary. This treatment is consistent with the OFHEO rule, which defends this policy on the basis that (a) NRSROs will not impute a corporate parent's rating to a derivative or credit enhancement counterparty in the context of a securities transaction, and (b) to extend that rating to the unrated subsidiary would be tantamount to the regulator rating the subsidiary.
We propose to apply these haircuts on a weighted-average basis by investment categories established in the “Data Inputs” worksheet of the RBCST, e.g., commercial paper, corporate debt and asset-backed securities, agency mortgaged-backed securities and collateralized mortgage obligations. This proposal requires the Corporation to calculate the weighted-average haircut by investment category to be applied to the weighted-average yields for each investment category and input the haircuts into the “Data Inputs” worksheet. The proposed haircuts are set forth in the Table in paragraph e. of section 4.1 in the Technical Appendix.
Stress that impacts Farmer Mac would reasonably be expected to affect its terms of access to the swap market. Therefore, we considered adopting a similar haircut on derivative securities.[7] However, while the OFHEO regulation applies haircuts to derivatives, we do not propose to do so at this time. Our reasoning is based on our preference for a different approach to haircutting derivatives that reflects lost payments from derivative securities in a net-receive position, as well as the additional expense associated with the replacement of derivative positions when the counterparty has defaulted and the market value of the derivative has increased since the date the defaulted derivative contract was executed. Such an increased market value would be to Farmer Mac's benefit when the counterparty does not default, but to its detriment when it does. The Agency will address this risk in future revisions of the RBCST and specifically requests comment on the most appropriate approach to incorporate such “replacement cost” risk into the RBCST.
In December 2002, the Agency modified the RBCST with four technical changes. The changes resulted in the release of FARMER MAC RBCST Version 1.1.xls, which was uploaded for public access on the FCA Web site in the same month and first used by Farmer Mac for its December 31, 2002, submission. FARMER MAC RBCST Version 1.2 incorporates an individual change to the calculation of regulatory capital held by Farmer Mac and was implemented in June 2004. FARMER MAC RBCST Version 1.25 completed the changes in Version 1.2 to fully accommodate the format of Farmer Mac's balance sheet after its adoption of FASB Financial Interpretation 45 (FIN 45) in August 2005. The changes are summarized below.
(i) Added two line items in the Data Inputs worksheet for Real Estate Owned (REO), one for “gross” REO and the other “net” of allowances for losses on REO assets. This change in the RBCST balance sheet was made to adapt the model to the new balance sheet reporting format in Farmer Mac's financial statements. The change also corrects the amount of REO that is captured in assets-subject-to-loss on the Loan and Cashflows worksheet. Gross REO, not net REO, is now added into assets-subject-to-loss.
(ii) Corrected the “base-case” interest rate used in measuring interest rate risk on the Risk Measures worksheet. The Act requires that the model apply “shocks” to current interest rates at the lesser of 600 basis points or 50 percent of average interest rates on Treasury obligations in order to gauge Farmer Mac's sensitivity to interest rate risk. Previously, the model's base-case was calculated applying the shock to the 12-month average Constant Maturity Treasury rate (CMT) instead of the 3-month average CMT as required by the regulation. The change makes the model more consistent with the language in the original regulation.
(iii) Added the line item for “Gain/Loss on Available for Sale Assets” in the balance sheet. The RBCST ignores these gains and losses for purposes of calculating income because they do not represent actual cash flows. However, they must be presented in the balance sheet to maintain balanced financial statements and for accuracy of disclosure. This changes only the presentation of the model's balance sheet and has no impact on the regulatory capital requirement.
(iv) Corrected the method of distributing credit losses over time. The formula to distribute losses on new loan volume previously allocated the impact of those losses over all 10 years of the model's projected time horizon. For example, a small portion of losses on new loan volume in year 5 was recognized in years 1, 2, 3, and 4 of Version 1.0. The change correctly associates losses on each year's estimated new loan originations across the remaining years in the 10-year period.
(v) Recently, Farmer Mac changed the reporting format of its balance sheet in order to adopt the Financial Accounting Standards Board Interpretation No. 45 (FIN 45). The change resulted in the RBCST misstating Farmer Mac's regulatory capital held. To correct this, we inserted a new data element for Farmer Mac to submit in the Data Inputs worksheet of the RBCST, “Contingent obligation for probable losses under FIN 45.” The new data input, combined with a new line item in the balance sheet for the contra-asset account “Allowance for Loan Losses,” will permit the RBCST to correctly gross up Farmer Mac's generally accepted accounting principles (GAAP) equity to calculate its regulatory capital held as follows:
RCapital = EquityGAAP − OCI + R + ALL + C
RCapital = Regulatory Capital Held
EquityGAAP = Equity according to GAAP
R = Reserves for Loan Losses
ALL = Allowance for Loan Losses
C = Contingent obligation for Probable Losses under FIN45
This change was implemented in June 2004 as FARMER MAC RBCST Version 1.2.
(vi) FARMER MAC RBCST Version 1.25 was implemented to complete the modifications necessary as a result of Farmer Mac's reporting format changes after the adoption of FIN 45. It ensures that the income generator references the appropriate fractions of all relevant balance sheet accounts for purposes of projecting income over the model's 10-year time horizon. Start Printed Page 69698
(vii) Currently § 652.85(d) requires the RBCST to be submitted quarterly not later than the last business day of April for the quarter ended March 31, July for the quarter ended June 30, October for the quarter ended September 30, and January for the quarter ended December 31. OSMO recently formally incorporated the RBCST submission into the Farmer Mac Call Report, which is due by the date of Farmer Mac's filing of its quarterly Form 10-Q, or annual Form 10-K, with the Securities and Exchange Commission. Therefore, we propose to revise the rule by changing the RBCST submission deadline as follows. The RBCST submission will be due on the date of the filing of Farmer Mac's SEC Form 10-Q or 10-K, but no later than the 40th day after the quarter's ending March 31, June 30, and September 30, and the 60th day after the quarter ending on December 30. This technical change was implemented in the Call Report submitted for the first quarter of 2004.
It is reasonable to assume that a crisis in the agriculture sector that generates worst-case historical loan loss levels would have an impact on Farmer Mac's cost of funds. We considered alternative approaches to reflect the possible impact on funding spreads of significant stress to FAMC. For example, the cost of funds data used in the RBCST could be adjusted to correspond to the maximum spreads over U.S. Treasury securities of comparable maturity that were experienced by the Farm Credit System during the worst-case credit risk conditions of the 1980s. According to findings of Duncan and Singer, the worst-case historical stressful spreads over treasuries for comparable maturity Farm Credit System issuances were 138 basis points for 6-month securities, 130 basis points for 1-year securities, 115 basis points for 3-year securities, and 95 basis points for 5-year securities.[8]
The spreads in the RBCST could reflect these increased levels with an adjustment to account for Farmer Mac's current holdings of non-program investments relative to those held by the FCS institutions at the time of maximum stress.
FCA requests specific comments on an appropriate methodology to add stress to funding spreads in the RBCST. In particular, we request suggestions on how best to incorporate differences in the relative risk in the portfolios of the FCS and Farmer Mac as it relates to expected cost of funds differences between the two entities, including how one might scale the on-going changes in the risk of Farmer Mac's portfolio to moderate or amplify the stressful cost of funds spread.
We considered applying the haircuts on non-program investments to AgVantage bonds because, despite their status as program assets, they exhibit many characteristics of investment securities. The model does not currently recognize risk associated with these assets or the loan collateral associated with them. We rejected that approach because AgVantage bonds are securities representing an interest in a pool of qualified loans. The statute requires losses on such loans to be estimated in a manner similar to the credit risk on other program assets.
AgVantage bonds are secured by either a general pledge of collateral that constitutes a representation and warranty of the availability of unencumbered qualified loan assets, or a specific pledge of qualified loans which, however, may be freely substituted at any time. Submitting loan-level data on AgVantage loan collateral for loss estimation is either not possible for lack of specifically identified loans, or subject to inaccuracy due to specific loans being replaced at any time, or simply impractical in terms of cost. The AgVantage program accounts for a very small portion of total program loan volume, and the proposed rule makes no change to the treatment of AgVantage assets. However, we specifically request comment on the question of how best to modify the RBCST in future rulemakings to consider the risk of AgVantage bonds.
We evaluated the impact of the proposed changes to the currently active version of the model, Version 1.25. Our tests indicated that changes related to the data proxies, the treatment of Standby loan portfolio, and the LLRT would have the most significant impact on minimum regulatory capital calculated by the model. The table below provides an indication of the impact of the revisions in the quarter ended June 30, 2005. Lines 1 through 6 present the impacts if only that revision were made to the current version and the column labeled “Difference” calculates the impact of that individual change for the quarter ended June 30, 2005, compared to the minimum requirement calculated using the currently active Version 1.25. Line 7 presents the impact of all proposed revisions in Version 2.0. As the table shows, the individual change impacts do not have an additive relationship to the total impact on the model output. This is due to the interrelationship of the changes with one another when they are combined in Version 2.0.
Calculated Regulatory Minimum Capital 6/30/2005 Difference
RBCST Version 1.25 (calculated as of 6/30/2005) 49,605
RBCST 2.0 Individual Change Impacts:
(1) CLM Changes: Data Proxies and Standby Treatment 75,665 26,060
(2) Miscellaneous Income Treatment 45,468 (4,137)
(3) Gain on Sale of AMBS 49,605
(4) Investment Haircuts 51,737 2,131
(5) Loan Loss Resolution Timing (LLRT) 76,956 27,350
(6) Operating Expenses 59,063 9,458
(7) Total RBCST Version 2.0 Impact 123,529 73,924
As shown in the table, implementation of the LLRT carrying costs and application of the data proxies result in the greatest impact on the calculated risk-based capital requirements. The impact of using loan data proxies reflects the conservative nature of the proxies and to the modeling of all loans in the portfolio Start Printed Page 69699compared to the current approach of applying state-level loss estimated from certain loans to loan where loan origination data are unavailable. The table also indicates that increases in the LLRT period result in greater capital needs to offset the income and expense effects of carrying nonperforming loan volume. The other proposed changes create a more comprehensive representation of Farmer Mac operations for RBCST purposes, though they are not as significant in their impact.
We are also proposing one change to the disclosure regulations in § 655.50(c). We propose to remove the word “should” and replace it with “must” to clarify that Farmer Mac must provide FCA with a copy of substantive correspondence it files with the Securities and Exchange Commission.
For the reasons stated in the preamble, parts 652 and 655 of chapter VI, title 12 of the Code of Federal Regulations are proposed to be amended as follows:
2. Add subpart B to part 652 to read as follows:
(4) Forecasted income, expense, and balance sheet statements for each year of the plan; and
(1) You will use Corporation loan-level data to implement the credit risk component of the risk-based capital stress test.Start Printed Page 69700
(c) If you anticipate entering into any new business activity that could have a significant effect on capital, you must determine a pro forma risk-based capital level, which must include the new business activity, and report this pro forma determination to the Director, Start Printed Page 69701Office of Secondary Market Oversight, at least 10-business days prior to implementation of the new business program.
Loss-Frequency and Loss-Severity Models.
Loan-Seasoning Adjustment.
Example Calculation of Dollar Loss on One Loan.
Calculation of Loss Rates for Use in the Stress Test.
Process for Calculating the Interest Rate Movement.
Elements Used in Generating Cashflows.
Assumptions and Relationships.
Loan and Cashflow Accounts.
a. Appendix A provides details about the risk-based capital stress test (stress test) for Farmer Mac. The stress test calculates the risk-based capital level required by statute under stipulated conditions of credit risk and interest rate risk. The stress test uses loan-level data from Farmer Mac's agricultural mortgage portfolio or proxy data as described in section 4.1d.(3) below, as well as quarterly Call Report and related information to generate pro forma financial statements and calculate a risk-based capital requirement. The stress test also uses historic agricultural real estate mortgage performance data, relevant economic variables, and other inputs in its calculations of Farmer Mac's capital needs over a 10-year period.
a. Credit risks are modeled in the stress test using historical time series loan-level data to measure the frequency and severity of losses on agricultural mortgage loans. The model relates loss frequency and severity to loan-level characteristics and economic conditions through appropriately specified regression equations to account explicitly for the effects of these characteristics on loan losses. Loan losses for Farmer Mac are estimated from the resulting loss-frequency equation combined with the loss-severity factor by substituting the respective values of Farmer Mac's loan-level data or proxy data as described in section 4.1d.(3) below, and applying stressful economic inputs.
e. The FCBT data used for estimation also included as performing loans, those loans that were re-amortized, paid in full, or merged with a new loan. Including these loans may lead to an understatement of loss-frequency probabilities if some of the re-amortized, paid, or merged loans experience default or incur losses. In contrast, when the Start Printed Page 69702loans that are re-amortized, paid in full, or merged are excluded from the analysis, the loss-frequency rates are overstated if a higher proportion of loans that are re-amortized, paid in full, or combined (merged) into a new loan are non-default loans compared to live loans.[1]
p = 1/(1 + exp (−(BX))
BX = (−12.62738) + 1.91259 · X1 + (−0.33830)
· X2/ (1 + 0.0413299)Periods + (−0.19596) · X3 + 4.55390
· (1−exp ((−0.00538178) · X4) + 2.49482 · X5
p is the probability that a loan defaults and has positive losses (Pr (Y=1 | x));
X3 is the DSCR at loan origination
X 5: D/A ratio 2.49482 <0.0000
Hosmer and Lemeshow goodness-of-fit p-value—0.1718
Max-rescaled R 2—0.2015
Concordant—85.2%
Disconcordant—12.0%
Tied—2.8%
m. Loss severity was not found to vary systematically and was considered constant across the tested loan characteristics and lending conditions. Thus, the simple weighted average by loss volume of 20.9 percent is used in the stress test.[9] You must Start Printed Page 69703multiply loss severity with the probability estimate computed from the loss-frequency equation to determine the loss rate for a loan.
Here is an example of the calculation of the dollar losses for an individual loan with the following characteristics and input values:[11]
0.998972 = 1 − exp((−.00538178) · $1,278,500 / 1000)
Z1 = (−12.62738) + 1.91259 · LTV5.3914596 − 0.33830 · (−16.6439443) − 0.19596 · DSCR + 4.55390 · 0.998972 + 2.49482 · DA = (−1.428509)
Default Loss Frequency at (−16.64%) = 1 / 1 + exp − (−1.428509) = 0.19333111
Loss Frequency Probability at (−16.74%) = 1 / 1 + exp−(−1.394679) = 0.19866189
Step 3: Calculate the slope adjustment. You must calculate slope by subtracting the difference between “Loss-Frequency Probability at −16.64 percent” and “Loss-Frequency Probability at −16.74 percent” and dividing by −0.1 (the difference between −16.64 percent and 16.74 percent as follows:
0.05330776 = (0.19333111 − 0.19866189) / −0.1
Z1 = (−12.62738) + (1.91259) (LTV5.3914596) −(0.33830) (−16.6939443) − (0.19596) (DSCR) + (4.55390) (0.998972) + (2.49482) (DA) = −1.411594
1 / 1 + exp(−1.411594) = 0.19598279
Dampened Maximum Land Price Decline = (−20.00248544) = (−23.52) (1.0413299)−4
Slope Adjustment = 0.17637092 = 0.053312247 · (−16.6939443 − (−20.00248544))
$81,987 = $97,277 − $97,277 · (0.157178762) [14]
a. You must compute the loss rates by state as the dollar weighted average seasoned loss rates from the Cash Window and Standby loan portfolios by state. The spreadsheet entitled, “Credit Loss Module.XLS” can be used for these calculations. This spreadsheet is available for download on our Web site, http://www.fca.gov, or will be provided upon request. The blended loss rates for each state are copied from the “Credit Loss Module” to the stress test spreadsheet for determining Farmer Mac's regulatory capital requirement.
Shock in basis points equals: 255
Ending Scheduled Balance.
Pre/Post Act.
Loan Cutoff Date.
Original Scheduled P&I.
Original Appraised Value.
Gross Farm Revenue.
Interest on Capital Debt.
Income & FICA Taxes.
Net Off-Farm Income.
Guarantee/Commitment Fee.
Seasoned Loan Flag.
(2) From the loan-level data, you must identify the geographic distribution by state of Farmer Mac's loan portfolio and enter the Start Printed Page 69705current loan balance for each state in the “Data Inputs” worksheet. The lifetime age-adjustment of origination year loss rates was discussed in section 2.0, “Credit Risk.” The lifetime age-adjusted loss rates are entered in the “Risk Measures” worksheet of the stress test. The stress test application of the loss rates is discussed in section 4.3, “Risk Measures.”
(3) Under certain circumstances, described below, you must substitute the following data proxies for the variables LTV, DSCR, and D/A: LTV = 0.70, DSCR = 1.20, and D/A = 0.60. The substitution must be done whenever any of these data are missing, i.e., cells are blank, or one or more of the conditions in the following table is true.
12. Calculated LTV (original loan amount divided by original appraised value) does not equal the submitted greater of LTV ratio The greater of the two LTV ratios.
13. Any of the fields referenced in “1.” through “12.” above are blank or contain spaces, periods, zeros, negative amounts, or fonts formatted to any setting ratios other than numbers Proxy all realted ratios.
Seasoned Standby loans that include loan data Proxy data applied.16
e. Weighted Haircuts for Non-Program Investments. For non-program investments, the stress test adjusts the weighted average yield data referenced in section 4.1b. to reflect counterparty risk. Non-program investments are defined in 12 CFR 652.5. The haircuts are applied by credit rating category. For this purpose, FCA credit rating categories are mapped to the Nationally Recognized Statistical Rating Organizations (NRSRO) ratings categories as set forth in the following table.
Rating Agencies Mappings to FCA Ratings Categories
Moody's Short-Term 17 Prime-1 MIG1 VMIG1 Prime-2 MIG2 VMIG2 Prime-3 MIG3 VMIG3 Not Prime, SG and Unrated.
Fitch Individual Bank Ratings A B A/B C B/C D C/D E D/E
The Corporation must calculate the haircut to be applied to each investment based on the lowest credit rating the investment received from NRSRO using the haircuts levels in the following table.
FARMER MAC RBCST Maximum Haircut by FCA Ratings Category
FCA ratings category
Non-derivative contract counterparties or instruments (percent)
AAA 3.50
BBB 28.00
Below BBB and Unrated 100.00
Individual investment haircuts must then be aggregated into weighted average haircuts by investment category and provided in the “Data Inputs” worksheet. The spreadsheet uses this information to account for counterparty insolvency through reduced interest earnings on these categories of investment according to a 10-year linear phase-in. Each asset account category identified in this data requirement is discussed in section 4.2, “Assumptions and Relationships.”
f. Other Data Requirements. Other data elements are taxes paid over the previous 2 years, the corporate tax schedule, selected line items from Schedule RS-C of the Call Report, and 10-year CMT information as discussed in section 3.1 entitled, “Process for Calculating the Interest Rate Movement.” The stress test uses the corporate tax schedule and previous taxes paid to determine the appropriate amount of taxes, including available loss carry-backs and loss carry-forwards. Three line items found in sections Part II.2.a. and 2.b. of Call Report Schedule RS-C Capital Calculation must also be entered in the “Data Inputs” sheet. The two line items found in Part II.2.a. contain the dollar volume off-balance sheet assets relating to the Farmer Mac I and II programs. The off-balance sheet program asset dollar volumes are used to calculate the operating expense regression on a quarterly basis. The single-line item found in Part II.2.b. provides the amount of other off-balance sheet obligations and is presented in the balance sheet section of the stress test for purposes of completeness. The 10-year CMT quarterly average of the monthly series and the 12-month average of the monthly series must be entered in the “Data Inputs” sheet. These two data elements are used to determine the starting interest rate and the level of the interest rate shock applied in the stress test.
(3) Elements related to income and expense assumptions. Several other parameters that are required to generate pro forma financial statements may not be easily captured from historic data or may have characteristics that suggest that they be individually supplied. These parameters are the gain on agricultural mortgage-backed securities (AMBS) sales, miscellaneous income, operating expenses, reserve requirement, guarantee fees and loan loss resolution timing.
(C) The stress test assumes that short-term cost of funds is incurred in relation to the amount of defaulting loans purchased from off-balance sheet pools. The remaining UPB on this loan volume is the origination amount reduced by the proportion of the total portfolio that has amortized as of the end of the most recent quarter. This volume is assumed to be funded at the short-term cost of funds and this expense continues for a period equal to the loan loss resolution timing period (LLRT) period minus 1. We will calculate the LLRT period from Farmer Mac data. In addition, during the LLRT period, all guarantee income associated with the loan volume ceases.
(E) The Agency will consider revising the LLRT period in response to changes in the Corporation's actual experience.
(F) Operating costs are determined in the model through application of the revised Start Printed Page 69707operating expense equation which may be restated as:
Expenses = α + β1 ln(OnFt) + β2 ln(OnGSt) + β3 ln(OffIt + OffIIt) + β4 ln(REOt)
Where t indicates time period in the model, OnF represents on-balance sheet investments, OnGS represents on-balance sheet guaranteed securities, OffI and OffII represent off balance sheet Farmer Mac I and II program loans, respectively, REO represents gross real-estate owned and the βi coefficients are taken from the operating expense regression equation which is to be re-estimated quarterly by Farmer Mac, and the resulting coefficients entered into the “Assumptions and Relationships” worksheet. As additional data accumulate, the specification will be re-examined and modified if we deem changing the specification results in a more appropriate representation of operating expenses.
(G) To run the stress test, the operating expense regression equation must be re-estimated using data from Farmer Mac's inception to the most recent quarterly financial information and the resulting coefficient entered into the “Assumptions and Relationships”worksheet.
(H) The reserve requirement as a fraction of loan assets can also be specified. However, the stress test is run with the reserve requirement set to zero. Setting the parameter to zero causes the stress test to calculate a risk-based capital level that is comparable to regulatory capital, which includes reserves. Thus, the risk-based capital requirement contains the regulatory capital required, including reserves. The amount of total capital that is allocated to the reserve account is determined by GAAP. The guarantee rates applied in the stress test are: post-1996 Farmer Mac I assets (50 basis points, current weighted average of 42 basis points); pre-1996 Farmer Mac I assets (25 basis points); and Farmer Mac II assets (25 basis points).
0.014 = 0.0694 − 0.0554
(5) Elements related to interest rate shock test. As described earlier, the interest rate shock test is implemented as a single set of forward interest rates. The stress test applies the up-rate scenario and down-rate scenario separately. The stress test also uses the results of Farmer Mac's shock test, as described in paragraph c. of section 4.1, “Data Inputs,” to calculate the impact on equity from a stressful change in interest rates as discussed in section 3.0 titled, “Interest Rate Risk.” The stress test uses a schedule relating a change in interest rates to a change in the market value of equity. For instance, if interest rates are shocked upward so that the percentage change is 262 basis points, the linearly interpolated effective estimated duration of equity is −6.7405 years given Farmer Mac's interest rate measurement results at 250 and 300 basis points of −6.7316 and −6.7688 years, respectively found on the effective duration schedule. The stress test uses the linearly interpolated estimated effective duration for equity to calculate the market value change by multiplying duration by the base value of equity before any rate change from Farmer Mac's interest rate risk measurement results with the percentage change in interest rates.
The worksheet labeled “Loan and Cashflow Data” contains the categorized loan data and cashflow accounting relationships that are used in the stress test to generate projections of Farmer Mac's performance and condition. As can be seen in the worksheet, the steady-state formulation results in account balances that remain constant except for the effects of discontinued programs and the LLRT adjustment. For assets with maturities under 1 year, the results are reported for convenience as though they matured only one time per year with the additional convention that the earnings/cost rates are annualized. For the pre-1996 Act assets, maturing balances are added back to post-1996 Act account balances. The liability accounts are used to satisfy the accounting identity, which requires assets to equal liabilities plus owner equity. In addition to the replacement of maturities under a steady state, liabilities are increased to reflect net losses or decreased to reflect resulting net gains. Adjustments must be made to the long- and short-term debt accounts to maintain the same relative proportions as existed at the beginning period from which the stress test is run with the exception of changes associated with the funding of defaulted loans during the LLRT period. The primary receivable and payable accounts are also maintained on this worksheet, as is a summary balance of the volume of loans subject to credit losses.
a. Information related to income performance through time is contained on the worksheet named “Income Statements.” Information from the first period balance sheet is used in conjunction with the earnings and cost-spread relationships from Farmer Mac supplied data to generate the first period's income statement. The same set of accounts is maintained in this worksheet as “Loan and Cashflow Accounts” for consistency in reporting each annual period of the 10-year stress period of the test with the exception of the line item labeled “Interest reversals to carry loan losses” which incorporates the LLRT adjustment to earnings from the “Risk Measures” worksheet. Loans that defaulted do not earn interest or guarantee and commitment fees during LLRT period. The income from each interest-bearing account is calculated, as are costs of interest-bearing liabilities. In each case, these entries are the associated interest rate for that period multiplied by the account balances. Start Printed Page 69708
b. The credit losses described in section 2.0, “Credit Risk,” are transmitted through the provision account as is any change needed to re-establish the target reserve balance. For determining risk-based capital, the reserve target is set to zero as previously indicated in section 4.2. Under the income tax section, it must first be determined whether it is appropriate to carry forward tax losses or recapture tax credits. The tax section then establishes the appropriate income tax liability that permits the calculation of final net income (loss), which is credited (debited) to the retained earnings account.
Jeanette Brinkley,
1. This includes loan data where certain origination data are not collected by Farmer Mac as well as other data anomalies or ambiguous loan data.
3. Farmer Mac provided data on historical problem loan resolution timing which were used by FCA to estimate the time interval for problem loan resolution. As additional data become available, FCA may recalculate the LLRT interval.
4. The LLRT period is equal to the period of time in excess of the portion of carrying costs already assumed in the RBCST's loss-severity rate. The loss-severity rate is assumed to incorporate losses associated with a period of 1 year of carrying defaulted loans and, thus, the LLRT period is equal to the FCA-determined actual period minus one.
5. Keenan, S., Carty L., Shtogrin I., “Historical Default Rates of Corporate Bond Issuers, 1920-1997,” published by Moody's Investor's Services, February 1998.
6. Hickman, W. Braddock, “Corporate Bond Quality and Investor Experience,” A Study by the National Bureau of Economic Research, Princeton University Press, Princeton, 1955.
7. The term “derivative” refers to over-the-counter financial derivative instruments used by Farmer Mac to hedge interest rate risk and synthetically extend the term structure of its debt to reduce funding costs.
8. Duncan, D. and M. Singer, “The Farm Credit System Crisis and Agency Security Yield-Spread Response” Agricultural Finance Review, 1992: 30-42.
1. Excluding loans with defaults, 11,527 loans were active and 7,515 loans were paid in full, re-amortized or merged as of 1992. A t-test 2. of the differences in the means for the group of defaulted loans and active loans indicated that active loans had significantly higher D/A and LTV ratios, and lower current ratios than defaulted loans where loss occurred. These results indicate that, on average, active loans have potentially higher risk than loans that were re-amortized, paid in full, or merged.
4. The nonlinear parameters for the variable transformations were simultaneously estimated using SAS version 8e NLIN procedure. The NLIN procedure produces estimates of the parameters of a nonlinear transformation for LTV, dampening factor, and loan-size variables. To implement the NLIN procedure, the loss-frequency equation and its variables are declared and initial parameter values supplied. The NLIN procedure is an iterative process that uses the initial parameter values as the starting values for the first iteration and continues to iterate until acceptable parameters are solved. The initial values for the power function and dampening function are based on the proposed rule. The procedure for the initial values for the size variable parameter is provided in an Excel spreadsheet posted at http://www.fca.gov.
The Gauss-Newton method is the selected iterative solving process. As described in the preamble, the loss-frequency function for the nonlinear model is the negative of the log-likelihood function, thus producing maximum likelihood estimates. In order to obtain statistical properties for the loss-frequency equation and verify the logistic coefficients, the estimates for the nonlinear transformations are applied to the FCBT data and the loss-frequency model is re-estimated using the SAS Logistic procedure. The SAS procedures, output reports and Excel spreadsheet used to estimate the parameters of the loss-frequency equation are located on the Web site http://www.fca.gov.
14. The age adjustment of 0.157178762 is determined from the beta distribution for a 4-year-old loan.
16. Application of proxy data recognizes that underwriting data on seasoned standby loans are not reviewed by Farmer Mac in favor of other criteria and frequently not origination data.
17. Any rating that appears in more than one category column is assigned to the lower FCA rating category.
[FR Doc. 05-22730 Filed 11-16-05; 8:45 am]