Organization; Funding and Fiscal Affairs, Loan Policies and Operations, and Funding Operations; Disclosure to Shareholders; Title V Conservators and Receivers; Capital Provisions

FARM CREDIT ADMINISTRATION

12 CFR Parts 611, 615, 620 and 627

RIN 3052-AB58

Organization; Funding and Fiscal Affairs, Loan Policies and

Operations, and Funding Operations; Disclosure to Shareholders; Title V

Conservators and Receivers; Capital Provisions

AGENCY: Farm Credit Administration.

ACTION: Proposed rule.

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SUMMARY: The Farm Credit Administration (FCA or Agency), through the

FCA Board (Board), issues a proposed rule to amend its capital adequacy

and related regulations to address interest rate risk as it pertains to

Farm Credit System (System) institutions, the definition of insolvency

for the purpose of appointing a receiver, the establishment of capital

and bylaw requirements for System service corporations, and changes to

risk-weighting categories. In addition, the proposed regulations

address the retirement of other allocated equities included in core

surplus, deferred-tax assets, the treatment of intra-System investments

for capital computation purposes, various other computational issues,

and other technical issues. The rule is intended to add safety and

soundness requirements deferred from prior rulemakings, provide more

consistency with capital requirements of other financial regulators,

and make technical corrections.

DATES: Written comments should be received on or before November 24,

1997.

ADDRESSES: Comments may be mailed or delivered to Patricia W. DiMuzio,

Director, Regulation Development Division, Office of Policy Development

and Risk Control, Farm Credit Administration, 1501 Farm Credit Drive,

McLean, Virginia 22102-5090 or sent by facsimile transmission to (703)

734-5784. Comments may also be submitted via electronic mail to ``reg-

[email protected].'' Copies of all communications received will be available

for review by interested parties in the Office of Policy Development

and Risk Control, Farm Credit Administration.

FOR FURTHER INFORMATION CONTACT:

Dennis K. Carpenter, Senior Policy Analyst, Office of Policy

Development and Risk Control, Farm Credit Administration, McLean, VA

22102-5090, (703) 883-4498, TDD (703) 883-4444,

or

Rebecca S. Orlich, Senior Attorney, Office of General Counsel, Farm

Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TDD (703)

883-4444.

SUPPLEMENTARY INFORMATION:

I. General

Capital adequacy and customer eligibility regulations, adopted in

January and effective in March 1997, added surplus and net collateral

ratios for System institutions and established procedures for setting

individual institution capital ratios and issuing capital directives.

See 62 FR 4429, January 30, 1997. The purpose of these proposed

regulations is to build on previous regulatory efforts by addressing

discrete issues related to capital that were deferred during the FCA's

consideration of its newly effective capital adequacy regulations. The

issues in this proposed rulemaking include: (1) Interest rate risk; (2)

the definition of insolvency for the purpose of appointing a

conservator or receiver; (3) the establishment of capital and bylaw

requirements for service corporations; and (4) various computational

issues, and other issues involving the capital regulations. The

objectives of these proposed amendments are:

1. To add provisions where the FCA believes significant capital

issues have not been previously addressed in the regulations. Expressly

addressing such issues in the regulations accords more certainty to

both the Agency and System institutions regarding supervisory

expectations and standards for enforcement.

2. To achieve consistency with the capital requirements of other

Federal banking regulatory agencies (the Office of the Comptroller of

the Currency, the Federal Deposit Insurance Corporation, the Federal

Reserve Board, and the Office of Thrift Supervision) in areas of

similar risk, such as risk-weighting of assets. In proposing changes,

the FCA is cognizant that circumstances unique or special to System

institutions may appropriately be addressed in a manner that differs

from the treatment of commercial banks and thrifts by the other Federal

banking regulators.

3. To make revisions and clarifications in the regulations that

address concerns raised by FCA examiners and System institutions.

4. To make technical corrections including removing some

inconsistencies in the computations of the core surplus and total

surplus ratios.

II. Interest Rate Risk

For the past several years, the FCA has studied the feasibility of

modifying the capital adequacy regulations to include a specific

interest rate risk exposure component. The current regulations take a

risk-based approach that addresses credit risk exposures but does not

specifically address other potential exposures. Of particular concern

to the FCA is the potentially adverse effect interest rate risk may

have on net interest income and the market value of an institution's

equity. Specifically, it is the risk of loss of net interest income or

the market value of on- and off-balance sheet positions caused by a

change in market interest rates. Similar actions to address interest

rate risk have been undertaken by the other Federal banking agencies,

which were required by section 305 of the Federal Deposit Insurance

Corporation Improvement Act of 1991 (FDICIA) (Pub. L. 102-242, 105

Stat. 2236, 2354 (12 U.S.C. 1828 note)) to revise their risk-based

capital guidelines to take adequate account of interest rate risk.

The FCA suspended development of the interest rate risk component

until completion of higher priority capital adequacy regulations. The

FCA is now proposing to add new Secs. 615.5180 and 615.5181 to require

banks to establish an interest rate risk management program and to

provide that the banks' boards of directors and senior management are

responsible for maintaining effective oversight. In addition, proposed

Sec. 615.5182 would require any other System institution (excluding the

Federal Agricultural

[[Page 49624]]

Mortgage Corporation 1) with significant interest rate risk

to establish a risk management program.

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\1\ Regulations affecting the Federal Agricultural Mortgage

Corporation will be issued separately.

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The proposed rule reflects the FCA's belief that an institution's

board and senior management are responsible for ensuring that risks are

adequately identified, measured, monitored and controlled.

Additionally, proposed Secs. 615.5350(b)(7) and 615.5355(a)(4) provide

that the FCA may take action against an institution for failure to

maintain sufficient capital for interest rate risk exposures.

Institutions found to have high levels of exposure or weak management

practices may be directed by the FCA to take corrective action,

including raising additional capital, strengthening management

expertise, improving management information and measurement systems,

reducing levels of exposure, or a combination thereof.

The requirements of the proposed rule are similar to interest rate

risk management requirements in Sec. 615.5135 of the investment

regulations. The existing regulation provides more specific criteria

regarding the interest rate risk management process. The proposed rule

is general in nature and sets forth the FCA's expectations regarding

board and management oversight, particularly maintaining adequate

capital for interest rate risk exposures. As a result, the proposed

rule provides a flexible regulatory approach to interest rate risk that

encourages innovations in risk management practices while ensuring that

the FCA can respond to emerging risks in an increasingly complex

financial marketplace.

The FCA intends to provide additional guidance on specific criteria

and guidelines in the form of a Board Policy Statement or Bookletter in

the future. The guidelines will establish a risk assessment approach

for the evaluation of capital adequacy specifically addressing interest

rate risk, similar to the approach taken by the other Federal banking

agencies, and would set forth the FCA's expectations for certain

aspects of the institution's ongoing internal control process. These

guidelines will address fundamental management practices for

identifying, managing, controlling, monitoring, and reporting interest

rate risk exposures. The guidelines will reflect the FCA's belief that

all institutions should establish a risk management program appropriate

for the level of an institution's overall interest rate risk exposure

and complexity of its holdings and activities.

III. Definition of Insolvency

The FCA proposes several changes to Sec. 627.2710, which sets forth

the grounds for appointing a conservator or receiver for a System

institution. First, the FCA proposes to amend the definition of

``insolvency'' as a ground for appointing a conservator or receiver in

paragraph (b)(1) to clarify that any stock or allocated equities held

by current or former borrowers are not ``obligations to members.'' The

FCA believes that this approach for determining insolvency is

consistent with financial statements based on generally accepted

accounting principles (GAAP) 2 and more appropriately

reflects the at-risk character of borrower stock and allocated

equities. There would be no change in the treatment of obligations to

members such as investment bonds and uninsured accounts. Second, the

FCA would revise paragraph (b)(3), which currently provides that a

conservator or receiver may be appointed if ``[t]he institution is in

an unsafe or unsound condition to transact business.'' The revision

would add that ``having insufficient capital or otherwise'' is a

circumstance that the FCA could consider to be an unsafe or unsound

condition. The proposed addition also identifies capital and collateral

benchmarks below which an institution could be considered to be

operating unsafely, as well as other conditions. The benchmarks and

conditions are:

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\2\ GAAP does not define insolvency. However, for the purposes

of this regulation, insolvency means total liabilities greater than

total assets based upon GAAP financial statements.

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1. For banks, a net collateral ratio (as defined by

Sec. 615.5301(d)) of 102 percent.

2. For associations, collateral insufficient to meet the

requirements of the association's general financing agreement with its

affiliated bank.

3. For all institutions, permanent capital (as defined in

Sec. 615.5201) of less than one-half the minimum required level for the

institution.

4. For all institutions, a relevant total surplus ratio (as defined

by Sec. 615.5301(i)) of less than 2 percent.

5. For associations, stock impairment.

The first two benchmarks address situations where an institution's

continued liquidity is in doubt. In setting the proposed net collateral

ratio benchmark at 102 percent, the FCA reviewed the requirements of

the System's Market Access Agreement (MAA), as well as the collateral

positions of the banks. The FCA also considered a 101-percent standard

because the MAA has a 101-percent eligible collateral benchmark below

which a bank's market access is restricted.3 After

deliberations, the FCA decided to propose a higher 102-percent

benchmark to allow time to appoint a conservator or receiver before a

bank is effectively unable to maintain normal funding activities. The

Agency requests comment on the appropriateness of the 102-percent

benchmark.

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\3\ The regulation's net collateral ratio is calculated net of

any association investments counted as permanent capital by

associations and determined using total liabilities, whereas

eligible collateral is determined by dividing available collateral

by obligations requiring collateralization.

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The third and fourth benchmarks identify situations where an

institution is substantially undercapitalized. The last condition

addresses a situation where an association could be exposed to

significant customer and marketing uncertainties that may have a

significant impact on financial viability or may affect other System

institutions.

These benchmarks and conditions are intended to be examples of what

the FCA would consider to be an unsafe or unsound condition to transact

business but are not exclusive. The Agency would continue to have the

discretion to deem an institution to be in an unsafe or unsound

condition to transact business based on other activities or

circumstances that are not enumerated in the regulation. The FCA notes

that, under this proposal, it also retains the discretion not to

appoint a conservator or receiver in the event that any of the

enumerated circumstances exist. The Agency would evaluate the totality

of circumstances before deciding what action, if any, to take.

In developing the proposed revision to this ground for appointing a

conservator or receiver, the FCA reviewed the prompt corrective action

benchmarks and tripwires used by the other Federal banking regulators

with respect to commercial banks and thrifts. The other agencies'

prompt corrective action regulations implement provisions of the FDICIA

requiring such agencies to take certain supervisory actions, including

the appointment of a conservator or receiver, well before insolvency is

reached, if an institution's capital declines to unacceptable levels.

Although the FCA is not subject to the FDICIA and continues to have

supervisory discretion when System institutions are in troubled

circumstances, the FCA supports the underlying philosophy of the FDICIA

to take supervisory action before an institution is insolvent. It has

been the experience of the FCA and the other Federal banking regulators

that the longer a failing institution is allowed to remain open, the

more difficult it will

[[Page 49625]]

ultimately be to resolve the affairs of the institution. Early

intervention is even more important in the Farm Credit System where

joint and several liability exists and where the financial health of

one institution can affect the public image of other System

institutions. The FCA notes that, for this reason, it is very likely

that the Agency would appoint a conservator or receiver well before

GAAP-based insolvency is reached.

IV. Service Corporations

A. Capital Requirements for Service Corporations

Section 4.25 of the Farm Credit Act of 1971, as amended (Act),

requires System institutions to submit proposals to form service

corporations to the FCA for issuance of a charter. Current regulations

require the submission of bylaws and proposed amounts and sources of

capitalization pursuant to Sec. 611.1135(b)(3)(vii), (4), and (5).

However, current regulations do not set standard capital requirements

for all service corporations. The FCA proposes to amend

Sec. 611.1135(c) to address the establishment of capital requirements

for service corporations.

Service corporations vary widely in their purpose and structure and

present different types of risks to their parent banks or associations.

The capital requirements for banks and associations would have little

relevance for most service corporations because most service

corporations have a small asset base and entirely different risks. Nor

does the FCA believe that any single minimum capital adequacy standard

is appropriate for all service corporations. The FCA instead proposes

to set minimum capital adequacy requirements in the corporate charter

approval process as a condition of approval. The FCA would monitor

compliance through the examination process.

B. Application of Bylaw Regulations to Service Corporations

The capitalization bylaw provisions in Sec. 615.5220 currently do

not apply to service corporations, including the Farm Credit Services

Leasing Corporation (FCL or Leasing Corporation). The FCA believes that

all institutions, including service corporations, should have capital

bylaws that meet the relevant requirements of that provision. The FCA,

therefore, proposes to amend Sec. 615.5220 by adding a new paragraph

(b) requiring all service corporations to have relevant capitalization

provisions in their bylaws. A conforming amendment to

Sec. 611.1135(b)(4) is also proposed.

V. Deferred-Tax Assets

A. The Proposed Rule

The FCA proposes to amend Sec. 615.5201 to add new paragraph (d) to

define deferred-tax assets that are dependent on future income or

future events. The FCA also proposes to amend Sec. 615.5210 to add a

new paragraph (e)(11) establishing a requirement to exclude certain

deferred-tax assets in capital calculations. Under the proposed rule,

deferred-tax assets that can be realized through carrybacks to taxes

paid on income earned in prior periods will not be excluded for

regulatory capital purposes. However, deferred-tax assets that can be

realized only if an institution earns sufficient taxable income in the

future or that are dependent on the occurrence of other future events

for realization will be partly excluded for regulatory capital

purposes. The proposed exclusion is the amount in excess of the amount

that the institution is expected to realize within 1 year of the most

recent calendar quarter-end date, based on the institution's financial

projections of taxable income and other events for that year, or the

amount in excess of 10 percent of core surplus capital existing before

the deduction of any disallowed tax assets, whichever is greater.

Excluded deferred-tax assets will be deducted from capital and from

assets for purposes of calculating capital ratios. This proposed

exclusion is consistent with requirements of the other Federal banking

agencies in response to the issuance by the Financial Accounting

Standards Board (FASB) of the Statement of Financial Accounting

Standards (SFAS) No. 109, ``Accounting for Income Taxes,'' in February

1992.

B. Discussion

Deferred-tax assets are assets that reflect, for financial

reporting purposes, amounts that will be realized as reductions of

future taxes or as refunds from a taxing authority. Deferred-tax assets

may arise because of limitations under tax laws that provide that

certain net operating losses or tax credits be carried forward if they

cannot be used to recover taxes previously paid. These ``tax

carryforwards'' are realized only if the institution generates

sufficient future taxable income during the carryforward period.

Deferred-tax assets may also arise from deductible temporary

differences in the tax and financial reporting of certain events. For

example, institutions may report higher income to taxing authorities

than they reflect in their financial records because their loan loss

provisions are expensed for reporting purposes but are not deducted for

tax purposes until the loans are charged off.

Deferred-tax assets arising from deductible temporary differences

may be ``carried back'' and recovered from taxes previously paid.

However, when deferred-tax assets arising from deductible temporary

differences exceed such previously paid tax amounts, they will be

realized only if there is sufficient future taxable income during the

carryforward period.

Another type of deferred-tax assets arises from deductible

temporary differences that are dependent on the occurrence of other

future events.4 These deferred-tax assets are not generally

available for ``carried back or carry forward'' treatment, but rather

are realized in the year the event occurs.

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\4\ The regulations of the other Federal banking agencies do not

address this type of deferred-tax assets because it is not

applicable to the operations of commercial banks or thrifts, but

SFAS No. 109 does encompass all types of such assets.

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As with the other Federal banking agencies, the FCA has certain

concerns about including in capital deferred-tax assets that are

dependent upon future taxable income. Realization of such assets

depends on whether a System institution that is subject to income tax

has sufficient future taxable income during the carryforward period.

Since an institution that is in a net operating loss carryforward

position is often experiencing financial difficulties, its prospects

for generating sufficient taxable income in the future are uncertain.

In addition, the future prospects for a financial services organization

can change rapidly. This raises concerns about the realization of

deferred-tax assets that are dependent upon future taxable income, even

when an institution appears to be sound and well managed. Thus, there

is considerable uncertainty in determining whether deferred-tax assets

will be realized. Many institutions are able to make reasonably

accurate projections of future taxable income for relatively short

periods of time, but beyond these short time periods, the reliability

of the projections tends to decrease significantly.

Certain deferred-tax assets are realized upon the occurrence of

certain future events other than taxable income. The same supervisory

concerns exist regarding these tax assets as regarding tax assets

dependent on future income. Several System institutions have

significant amounts of deferred-tax assets that represent the expected

refund of income taxes previously paid on earnings distributed in the

form of nonqualified allocations of patronage to

[[Page 49626]]

their stockholders. The realization of these deferred-tax assets is

dependent not on future taxable income but rather on actions of the

institutions to retire stock or allocated surplus associated with the

nonqualified distributions. However, an institution might be unable to

retire this stock and allocated equities during periods of financial

difficulties when conversion of these deferred-tax assets to cash would

be needed.

In addition, as it becomes less likely that deferred-tax assets

will be realized, an institution is required under SFAS 109 to reduce

its deferred-tax assets through increases to the asset's valuation

allowance. Additions to this allowance would reduce an institution's

regulatory capital at precisely the time it likely needs additional

capital support.

C. Determination of the Deferred-Tax Exclusion

The FCA proposes to require the exclusion of the greater of the

amount of deferred-tax assets dependent on future income or events that

are not expected to be realized within 1 year, or the amount by which

the deferred-tax assets exceed 10 percent of core surplus capital

before the exclusion. To determine the deferred-tax exclusion, an

institution would assume that all temporary differences fully reverse

as of the calculation date. The amount of deferred-tax assets that are

dependent upon future taxable income that is expected to be realized

within 1 year means the amount of such deferred-tax assets that could

be absorbed by the amount of income taxes that are expected to be

payable based upon the institution's projected future taxable income

for the next 12 months. Estimates of taxable income for the next year

should include the effect of tax-planning strategies that the

institution intends to implement to realize tax carryforwards that will

otherwise expire during the year. Consistent with the other banking

agencies and SFAS No. 109, the FCA believes that tax planning

strategies are often carried out to prevent the expiration of such

carryforwards. Deferred taxes that are dependent on other future events

(other than future taxable income) and that are not expected to be

realized within 1 year are to be deducted in the determination of the

institution's capital measurements.

The FCA believes that institutions will not have significant

difficulty in implementing these proposed limits. System institutions

routinely make financial projections as part of their annual business

planning process. Both the 1-year and 10-percent computations are

straightforward and relatively simple. The Agency also believes that

most System institutions would not be negatively affected by the

implementation of this exclusion of deferred-tax assets. A small number

of institutions that have significant tax-deferred assets may be

initially unable to satisfy the core surplus ratio but should be able

to comply within a relatively short time frame.

The proposed partial exclusion is intended to balance the continued

concerns of the Agency about deferred-tax assets that are dependent

upon future taxable income and other future events against the fact

that such assets will, in many cases, be realized. The exclusion based

on 10 percent of core surplus also would ensure that System

institutions could not place excessive reliance on deferred-tax assets

to satisfy the minimum capital standards.

D. Additional Guidance

The following additional guidance is provided to assist System

institutions' understanding of how the FCA proposes to implement the

deferred-tax exclusion.

1. Projecting Future Taxable Income and Other Events

Institutions may use the financial projections for planning the

current fiscal year (adjusted for any significant changes that have

occurred or are expected to occur) when applying the exclusion at an

interim date within each fiscal year. In addition, while the proposed

rule does not specify how originating temporary differences should be

treated for purposes of projecting taxable income and other events for

the next year, each institution should decide whether to adjust its

financial projections for originating temporary differences and should

follow a reasonable and consistent approach.

2. Tax Jurisdictions

Under this proposed rule, an institution would not be required to

determine its exclusion of deferred-tax assets on a jurisdiction-by-

jurisdiction basis. While an approach that looks at each jurisdiction

separately may be more accurate from a theoretical standpoint, the FCA

is in agreement with the other Federal banking agencies that the

greater precision achieved by mandating such an approach would not

outweigh the complexities involved and the inherent cost to

institutions. Therefore, to limit regulatory burden, an institution

would have the option to calculate one overall exclusion of deferred-

tax assets that covers all tax jurisdictions in which it operates.

3. Available-for-Sale Securities

Under SFAS No. 115, ``Accounting for Certain Investments in Debt

and Equity Securities'' (SFAS No. 115), available-for-sale securities

are reported at fair value, with unrealized holding gains and losses on

such securities, net of tax effects, included in a separate component

of stockholders' equity. The Agency's current regulations exclude from

regulatory capital the amount of net unrealized holding gains and

losses on available-for-sale securities. It would be consistent to

exclude the deferred tax effects relating to unrealized holding gains

and losses on these available-for-sale securities from the calculation

of the allowable amount of deferred-tax assets for regulatory capital

purposes. However, requiring the exclusion of such deferred tax effects

may add significant complexity to the regulatory capital standards and

in most cases would not have a significant impact on regulatory capital

ratios.

The FCA proposes to permit, but not require, institutions to adjust

the amount of deferred-tax assets and liabilities arising from marking-

to-market available-for-sale debt securities. This choice should reduce

the implementation burden for institutions not wanting to contend with

the complexity arising from such adjustments, while permitting those

institutions that want to achieve greater precision to make such

adjustments. However, institutions must follow a consistent approach

with respect to such adjustments.

VI. Computational Issues

Following the implementation of the new capital adequacy

provisions, various System institution representatives and FCA

examiners have identified certain capital computational concerns and

interpretive issues. Such issues primarily involved the computation of

the total surplus and core surplus capital requirements. These issues

are addressed below as technical corrections to the existing capital

adequacy regulations.

A. Average Daily Balance Requirement

The FCA has received comments from System institutions voicing

concern with the requirement to calculate the total and core surplus

ratios using month-end balances. Institutions have commented that using

month-end balances results in significant variability in the ratios due

simply to seasonal lending trends. They recommended that

[[Page 49627]]

the total and core surplus ratios be calculated using the same basis as

permanent capital. The permanent capital ratio is computed using

average daily balances for the most recent 3-month period.

The FCA proposes to amend Sec. 615.5330(c) to require computation

of the total surplus, core surplus, and risk-adjusted asset base using

average daily balances for the most recent 3 months in the same way

they are used for the calculation of permanent capital. The FCA is

proposing this change for the following reasons:

1. The change will smooth out seasonal fluctuations in month-end

balances that may result in undue volatility of the total and core

surplus ratios;

2. The requirement is not a burden on System institutions because

they already have the information-processing capability to compute the

3-month average of daily balances for various balance sheet accounts;

3. The change achieves consistency in the calculation methodology

with regulatory permanent capital requirements; and

4. The 3-month average daily balance methodology is less

susceptible to adjustment by delaying or advancing the recognition of

various business activities compared to the month-end balances

methodology.

Existing Sec. 615.5205 requires institutions to maintain at all

times a permanent capital ratio of at least the minimum required level.

The FCA proposes to amend Sec. 615.5330(a) and (b) to extend this

requirement to the total and core surplus ratios as well. In each case

the ratios would be calculated as described above. This change would

also ensure ongoing compliance with the requirements of

Sec. 615.5240(c), which allows an institution's board of directors to

delegate borrower stock retirements to management under certain

conditions, including the maintenance of capital ratios at or above the

minimum requirements.

The FCA is not proposing to change the requirement in

Sec. 615.5335(b) to compute the net collateral ratio using month-end

balances at a specific point in time. However, the FCA proposes that

banks expressly be required to achieve and maintain at all times a net

collateral ratio at or above the regulatory minimum. In addition, banks

must have the capability to calculate the net collateral ratio at any

time using the balances outstanding at the computation date. Having

this capability is important to banks to support daily issuances of

debt securities to meet their funding needs.

B. Treatment of Intra-System Investments and Other Adjustments

1. Reciprocal Investments

The FCA proposes to clarify Sec. 615.5210(e)(1) of the capital

adequacy regulations that addresses the treatment of reciprocal

holdings between two System institutions. The current regulation has

not consistently been interpreted by institutions to require that the

cross-elimination of reciprocal holdings be made before making the

other required adjustments relating to intra-System investments. The

FCA intended that elimination of investments between two System

institutions be applied on a net basis after adjusting for reciprocal

holdings (see 53 FR 16956, May 12, 1988). As an example, if institution

A has a $100 equity investment in institution B, and institution B has

a $25 equity investment in institution A, the net investment after

offsetting reciprocal holdings is $75 (i.e., $100--$25). The regulatory

offsetting requirement results in the elimination of $25 from the

capital and assets of both institutions. This ``netting effect''

ensures that double-counted cross-capital investments made by System

institutions are eliminated prior to other adjustments required by the

capital regulations. In the example above, the remaining $75 net

investment is then the amount used when applying the other intra-System

investment-related provisions of the regulations to the computation of

permanent capital, total surplus, and core surplus. The FCA believes

this clarification is necessary to avoid possible misinterpretations

that may result in incorrect deductions.

2. Computation of Total and Core Surplus

The FCA proposes to clarify the treatment of intra-System equity

investments and other deductions for the computation of total and core

surplus. For the calculation of total surplus, the FCA proposes to

amend Sec. 615.5301(i)(7) to more clearly require the same deductions

made in the computation of permanent capital. When calculating total

surplus, System institutions should eliminate intra-System investments

and other deductions from total surplus in a manner consistent with the

elimination of such investments when an institution calculates its

permanent capital. These eliminations are necessary to ensure that the

investing institution does not include certain intra-System investments

when computing total surplus and makes similar deductions such as

elimination of certain tax-deferred assets. The FCA views most intra-

System investments as a commitment of capital between related entities.

From a regulatory capital adequacy perspective, elimination of most

intra-System investments by the investing institution appropriately

reflects that the capital commitment is in the related issuing

institution. 5

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\5\ Only the issuing institution may include such equities in

its total surplus, and only to the extent such equities qualify

pursuant to Sec. 615.5301(i).

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The FCA also proposes to eliminate Sec. 615.5330(a)(2) and (a)(3)

because these paragraphs are no longer necessary. As previously

discussed, the FCA is proposing to amend Sec. 615.5301(i)(7) to require

the same deductions to be made in computing total surplus as are

required for the calculation of permanent capital. With this revision

to Sec. 615.5301(i)(7), the existing requirements of Sec. 615.5330

(a)(2) and (a)(3) are redundant.

With respect to core surplus, some institutions have interpreted

the existing regulation as not requiring the elimination of an

investment in another System institution (except for associations'

investments in their affiliated banks), as is required in the

calculation of other regulatory capital measurements. The FCA believes

that the elimination of most intra-System investments from core surplus

is also appropriate. For this reason, the FCA is proposing to amend

Sec. 615.5301(b)(4) to require the elimination of most intra-System

investments from the computation of the core surplus of both the

investing and the issuing institutions. However, investments to

capitalize loan participations would not be eliminated from the

investing institution's core surplus. The FCA views investments between

System institutions resulting from loan participations as a pass-

through of member-purchased or allocated equity. Because the issuing

institution does not count such equities as core surplus, the FCA

believes that elimination of such pass-through investments from the

investing institution's core surplus would be unnecessary. The FCA

invites comment on this approach and the alternative approach of

eliminating intra-System investments relating to loan participations

from the core surplus of the investing institution.

For the core surplus computation, existing Sec. 615.5301(b)(3)

requires institutions to make the deductions set forth in

Sec. 615.5210(e)(6) and (e)(7) for investments in the Leasing

Corporation and for goodwill. The Agency intended for other relevant

adjustments required for permanent capital to be made in the

[[Page 49628]]

core surplus ratio as well. Therefore, the FCA proposes to amend the

core surplus computation also to require adjustments for loss-sharing

agreements and for deferred-tax assets.

3. Investments in Service Corporations

Existing Sec. 615.5210(e)(6) requires an institution to deduct its

investment in the FCL from total capital for purposes of computing its

permanent capital. The FCA proposes to require institutions to deduct

their investments in all other service corporations as well. This

change would be in conformity with the FCA's view that the capital is

committed to support risks at the service corporation level and would

clarify that such capital would be available to meet any capital

requirements imposed by the Agency on service corporations. The

required deductions would also be made in the investing institution's

core and total surplus computations.

C. Counting Farm Credit System Financial Assistance Corporation (FAC)

Obligations as a Liability on an Institution's Balance Sheet

Section 615.5210(a) of the existing regulations provides that no

FAC obligations shall be included in the balance sheets of any Farm

Credit institution. The FCA proposes to restrict this treatment to only

those FAC obligations that were issued to pay capital preservation and

loss-sharing agreements.

System institutions are obligated under the Act to: (1) Repay

Treasury-paid interest from direct assistance and general Systemwide

FAC debt; (2) pay interest on direct assistance FAC obligations; and

(3) pay principal and interest on capital preservation-related FAC

debt. Section 6.9(e)(3)(E) of the Act provides that certain obligations

of the FAC issued in connection with the capital preservation and loss-

sharing agreements not be included in the obligations of any

institution for reporting purposes. In 1988, when the FCA determined

that this exception to GAAP should also be included in the capital

regulations, it made the exception broader than the statute by applying

it to all FAC obligations. Since the relevant provision of the Act

refers only to the obligations of the FAC that were issued in

connection with the repayment of capital preservation agreements, the

FCA proposes to conform the language of the regulation to the statute.

D. Changes in Risk-Weighting Categories and Credit Conversion Factors

for Calculating Risk-Adjusted Assets

The FCA proposes modifications to the risk-weighting categories for

on-and off-balance-sheet assets in Sec. 615.5210(f). The purposes of

the modifications are to provide a more accurate weighting of assets

relative to their risk and to incorporate recent changes to the Basle

Accord, 6 as well as to provide consistency with the

requirements of the other Federal banking agencies. The following

changes are proposed:

---------------------------------------------------------------------------

\6\ Agreed to by the Committee on Banking Regulations and

Supervisory Practices, under the auspices of the Bank for

International Settlements in Basle, Switzerland (Basle Committee).

Under this agreement the other Federal banking agencies that are

signatories to the Accord are bound to consider such direction and

revise their regulations accordingly. The FCA, for consistency

purposes, also chooses to consider and revise its regulations, as

appropriate to the System.

---------------------------------------------------------------------------

1. Elimination of the 10-Percent Category

The FCA proposes to eliminate this risk-weight category as set

forth in existing Sec. 615.5210(f)(2)(ii). The assets in this category

would be reassigned to other categories that more accurately reflect

their credit risks, consistent with the risk-weighting treatment by the

other Federal banking agencies. Securities issued by the U.S.

Government or its agencies and portions of loans and other assets

guaranteed by the full faith and credit of the U.S. Government or its

agencies would be risk-weighted at 0 percent in Sec. 615.5210(f)(2)(i).

Cash items in the process of collection and portions of loans and other

assets collateralized by securities of the U.S. Government or its

agencies would be risk-weighted at 20 percent in new

Sec. 615.5210(f)(2)(ii). These changes would make the FCA's risk-

weighting of these items consistent with that of the other financial

regulators.

2. Risk-Weighting of Assets That Are Conditionally Guaranteed by the

U.S. Government or Its Agencies at 20 Percent

Such assets are not specifically distinguished from unconditional

guarantees in the FCA's current weighting scheme. However, the FCA is

now proposing to differentiate between unconditional guarantees, which

have a risk-weighting of 0 percent, and conditional guarantees, which

are proposed to be risk-weighted at 20 percent, in new

Sec. 615.5210(f)(2)(ii)(B). Government-sponsored agency securities not

backed by the full faith and credit of the U.S. Government would also

be risk-weighted at 20 percent. In developing the proposed revisions,

the FCA believes that such guarantees pose some risk and that 20

percent is the appropriate risk-weighting for the general credit risk

and would conform to the treatment of such assets by the other

financial regulators.

3. Modification of the Definitions of Two Items Involving Foreign Banks

Claims on foreign banks with an original maturity of 1 year or less

are now risk-weighted at 20 percent, and those with an original

maturity of more than 1 year are weighted at 100 percent. For risk-

weighting purposes, the FCA proposes to make a distinction between the

Organization for Economic Cooperation and Development (OECD)-based

group of countries 7 and non-OECD-based countries in the

same fashion as the other Federal banking agencies. Generally,

membership in the OECD indicates that such member countries have lower

levels of sovereign risk and, therefore, justifies a lower risk-

weighting. The FCA proposes to risk-weight all claims on OECD banks at

20 percent in new Sec. 615.5210(f)(2)(ii), regardless of maturity, and

claims on non-OECD banks at 20 percent when the remaining maturity is 1

year or less. Claims on non-OECD banks with a remaining maturity of

more than 1 year would be risk-weighted at 100 percent in new

Sec. 615.5210(f)(2)(iv). The FCA has added a definition of OECD in

Sec. 615.5201(j).

---------------------------------------------------------------------------

\7\ OECD means countries that are full members of the

Organization for Economic Cooperation and Development. As of August

1997, the OECD includes the following countries: Australia, Austria,

Belgium, Canada, the Czech Replublic, Denmark, Finland, France,

Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, South

Korea, Luxembourg, Mexico, the Netherlands, New Zealand, Norway,

Poland, Portugal, Spain, Sweden, Switzerland, Turkey, the United

Kingdom, and the United States. Saudia Arabia has concluded special

lending arrangements with the International Monetary Fund (IMF)

associated with the IMF's General Arrangements to Borrow which,

together with the aforementioned countries that are full members of

the OECD, comprise the OECD-based group of countries.

---------------------------------------------------------------------------

4. Risk-Weighting of Unused Commitments With an Original Maturity of

Less Than 14 Months at 0 Percent

Unused commitments with an original maturity of more than 1 year

now have a 50-percent credit conversion factor, which means that 50

percent of the face amount of such commitments must be added to the

appropriate risk-weighting category, usually 100 percent. Many loans

made by Farm Credit institutions are on annual renewal cycles. It is

the established practice of

[[Page 49629]]

many of these institutions that, in order to have loan commitments in

place at the beginning of each annual cycle, the credit review and

subsequent commitment are typically done 30 to 60 days prior to the end

of the current loan commitment. Consequently, such ``advance''

commitments have been classified in the 50-percent credit conversion

category. The FCA has concluded that these annual advance commitments

do not differ substantially from commitments made with an original

maturity of 1 year or less.

The FCA proposes in Sec. 615.5210(f)(3)(ii) to classify in the 0-

percent credit conversion category those binding commitments with an

original maturity of 14 months or less. This change is intended to

recognize that the timing of the issuance of binding commitments is

appropriately related to the annual operating cycle of borrowers, so

that institutions can continue current practices and be able to risk-

weight such loans at 0 percent.

5. Revision of Credit Conversion Factors for Derivative Transactions

In September 1995, the other Federal banking agencies adopted final

amendments to their risk-based capital regulations relating to

derivative transactions based on the Basle Committee's recommendations.

See 60 FR 46171, September 5, 1995.8 Their final rule

amended the matrix of conversion factors used to calculate potential

future exposure and permitted institutions to recognize the effects of

qualifying bilateral netting arrangements in the calculation of

potential future exposure. The matrix of conversion factors used to

calculate potential future exposure was expanded to take into account

innovations in the derivatives markets. Specifically, the matrix was

modified by adding higher conversion factors to address long-dated

transactions (e.g., contracts with remaining maturities over 5 years),

and new conversion factors were added to cover certain types of

derivative transactions not previously covered.

---------------------------------------------------------------------------

\8\ In July 1994 the Basle Accord was revised to permit

institutions to net positive and negative mark-to-market values of

rate contracts entered into with a single counterparty subject to a

qualifying, legally enforceable, bilateral netting agreement. Based

upon this revision to the Basle Accord, the other Federal banking

agencies revised their risk-based capital regulations accordingly.

---------------------------------------------------------------------------

In conformity with the other Federal banking agencies, the FCA

proposes to amend Sec. 615.5210(f)(3)(iii) to permit institutions to

net positive and negative mark-to-market values of derivatives

contracts entered into with a single counterparty subject to a

qualifying, legally enforceable bilateral netting arrangement for

purposes of determining credit equivalent amounts. The FCA is adding a

definition of ``qualifying bilateral netting contract'' in new

Sec. 615.5201(m). The FCA also proposes to adopt the formula used by

the other Federal banking agencies for current and potential future

exposure for contracts subject to qualifying bilateral netting

agreements. The formula is expressed as Anet = (0.4 x

Agross)+ 0.6(NGR x Agross) where:

a. Anet is the adjusted potential future credit

exposure;

b. Agross is the sum of potential future credit

exposures determined by multiplying the notional principal amount by

the appropriate credit conversion factor; and

c. NGR is the ratio of the net current credit exposure divided by

the gross current credit exposure determined as the sum of only the

positive mark-to-markets for each derivative contract with the single

counterparty.

In addition, the FCA proposes to amend the conversion factor matrix

as set forth in the following table:

Conversion Factor Matrix

[In percent]

------------------------------------------------------------------------

Interest Exchange

Remaining maturity rate rate Commodity

------------------------------------------------------------------------

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

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

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

------------------------------------------------------------------------

The FCA would further require that, for any derivative contracts

that do not fall into one of the categories above, the potential future

credit exposure must be determined using the commodity conversion

factors.

VII. Other Issues

A. Retirement of Other Allocated Equities Included in Core Surplus

The FCA's recently adopted capital adequacy regulations permit

associations to include, subject to limitations, both nonqualified and

qualified allocated equities in core surplus. The regulations permit

the inclusion of nonqualified allocated equities that are not

distributed according to an established plan or practice. The

regulations further allow associations to include in core surplus other

allocated equities (i.e., qualified or nonqualified notices of

allocation) with an original maturity of at least 5 years and not

scheduled for revolvement during the next 3 years. The preamble to the

Capital Adequacy and Customer Eligibility final rule (62 FR 4429,

January 30, 1997) discussed disallowing a series or class of allocated

equities from treatment as core surplus in the event of partial

retirements. The preamble also described exceptions to the disallowance

requirement if an institution retires allocated equities in the event

of loan default or the death of the equityholder. However, in the

regulation the disallowance for partial retirements, as well as the

exceptions, appeared to apply only to the nonqualified allocated

equities without a plan or practice of revolvement.

Several System associations have asked the FCA whether the other

allocated equities includible in core surplus would also be disallowed

in the event of partial retirement. The remaining equities would be

disallowed, and the related exceptions would apply in such

circumstances. The FCA is now proposing to amend

Sec. 615.5310(b)(2)(ii) in order to ensure consistent treatment of all

allocated equities counted as core surplus in the event of partial

retirements.

[[Page 49630]]

B. Ensuring Two Nominees for Each Bank Director's Position and Ensuring

Representation on the Board of all Types of Agriculture in the District

Section 4.15 of the Act requires associations to ``endeavor to

assure'' that, when directors are elected, there are at least two

nominees for each position and that representation of all types of

agriculture practiced in the territory is achieved to the extent

possible. The statute goes on to say that ``[r]egulations of the Farm

Credit Administration governing the election of bank directors shall

similarly assure a choice of two nominees for each elective office to

be filled and that the bank board represent as nearly as possible all

types of agriculture in the district.'' The FCA interprets the

provision to require banks to make a good faith effort to locate at

least two nominees and to try to assure representation on the board

that is reflective of the bank's territory. The Agency proposes to add

a new paragraph (5) to Sec. 615.5230(b) to require documentation of

that effort. In the event that a bank is unable to find at least two

nominees for each position, the bank would be required to keep written

documentation of its efforts to do so. The bank would also be required

to keep a record of the type of agriculture engaged in by each director

on its board.

In addition, the FCA proposes to add Sec. 611.350 to add a

reference in the subpart on director elections to the cooperative

principles set forth in Sec. 615.5230 that apply to such elections.

C. Statement of SFAS No. 130, Reporting Comprehensive Income

The FASB recently issued SFAS No. 130, Reporting Comprehensive

Income (Statement). This Statement sets forth standards for reporting

and display of comprehensive income in a full set of financial

statements. For fiscal years beginning after December 15, 1997, this

Statement will require financial statements to display a balance

representing the accumulation of other comprehensive income. This new

balance will be displayed separately from retained earnings and

additional paid-in capital in the equity (capital) section of the

statement of financial position. For the most part, the FCA believes

that the Statement represents only a change in display of existing

financial transactions and, therefore, does not introduce any new

issues that have an effect on the Agency's current regulatory capital

standards. The FCA believes that current standards in the capital

regulations already address the transactional items that comprise the

newly separated component of equity. Accordingly, the FCA has

determined that there are no compelling reasons to change the capital

standards to take into account the changes in the display of financial

transactions resulting from this Statement. The Agency invites any

parties with an interest in this issue to submit comments.

E. Conforming Amendments

The FCA proposes to amend Sec. 620.5 to require institutions to

disclose information on their surplus and collateral ratios in the

annual report to shareholders. Conforming, nonsubstantive changes are

also proposed in Sec. 615.5201(h) to replace ``allocation'' with

``allotment'' and in Secs. 615.5210(b) and 615.5260(a)(3)(ii) to remove

obsolete language.

List of Subjects

12 CFR Part 611

Agriculture, Banks, banking, Rural areas.

12 CFR Part 615

Accounting, Agriculture, Banks, banking, Government securities,

Investments, Rural areas.

12 CFR Part 620

Accounting, Agriculture, Banks, banking, Reporting and

recordkeeping requirements, Rural areas.

12 CFR Part 627

Agriculture, Banks, banking, Claims, Rural areas.

For the reasons stated in the preamble, parts 611, 615, 620, and

627 of chapter VI, title 12 of the Code of Federal Regulations are

proposed to be amended to read as follows:

PART 611--ORGANIZATION

1. The authority citation for part 611 continues to read as

follows:

Authority: Secs. 1.3, 1.13, 2.0, 2.10, 3.0, 3.21, 4.12, 4.15,

4.21, 5.9, 5.10, 5.17, 7.0--7.13, 8.5(e) of the Farm Credit Act (12

U.S.C. 2011, 2021, 2071, 2091, 2121, 2142, 2183, 2203, 2209, 2243,

2244, 2252, 2279a--2279f-1, 2279aa-5(e)); secs. 411 and 412 of Pub.

L. 100-233, 101 Stat. 1568, 1638; secs. 409 and 414 of Pub. L. 100-

399, 102 Stat. 989, 1003, and 1004.

Subpart C--Election of Directors

2. Section 611.350 is added to read as follows:

Sec. 611.350 Application of cooperative principles to the election of

directors.

In the election of directors, each System institution shall comply

with the applicable cooperative principles set forth in Sec. 615.5230

of this chapter.

Subpart I--Service Organizations

3. Section 611.1135 is amended by revising paragraphs (b)(4) and

(c) to read as follows:

Sec. 611.1135 Incorporation of service organizations.

* * * * *

(b) * * *

(4) The proposed bylaws, which shall include the provisions

required by Sec. 615.5220(b) of this chapter.

* * * * *

(c) Approval. The Farm Credit Administration may condition the

issuance of a charter, including imposing minimum capital requirements,

as it deems appropriate. For good cause, the Farm Credit Administration

may deny the application. Upon approval by the Farm Credit

Administration of a completed application, which shall be kept on file

at the Farm Credit Administration, the Agency shall issue a charter for

the service corporation which shall thereupon become a corporate body

and a Federal instrumentality.

* * * * *

PART 615--FUNDING AND FISCAL AFFAIRS, LOAN POLICIES AND OPERATIONS,

AND FUNDING OPERATIONS

4. The authority citation for part 615 continues to read as

follows:

Authority: Secs. 1.5, 1.7, 1.10, 1.11, 1.12, 2.2, 2.3, 2.4, 2.5,

2.12, 3.1, 3.7, 3.11, 3.25, 4.3, 4.3A, 4.9, 4.14B, 4.25, 5.9, 5.17,

6.20, 6.26, 8.0, 8.3, 8.4, 8.6, 8.7, 8.8, 8.10, 8.12 of the Farm

Credit Act (12 U.S.C. 2013, 2015, 2018, 2019, 2020, 2073, 2074,

2075, 2076, 2093, 2122, 2128, 2132, 2146, 2154, 2154a, 2160, 2202b,

2211, 2243, 2252, 2278b, 2278b-6, 2279aa, 2279aa-3, 2279aa-4,

2279aa-6, 2279aa-7, 2279aa-8, 2279aa-10, 2279aa-12); sec. 301(a) of

Pub. L. 100-233, 101 Stat. 1568, 1608.

Subpart E--Investment Management

5. Section 615.5135 is amended by revising the introductory

paragraph to read as follows:

Sec. 615.5135 Management of interest rate risk.

The board of directors of each Farm Credit Bank, bank for

cooperatives, and agricultural credit bank shall develop and implement

an interest rate risk management program as set forth in subpart G of

this part. The board of directors shall adopt an interest rate risk

management section of an asset/liability management policy which

establishes

[[Page 49631]]

interest rate risk exposure limits as well as the criteria to determine

compliance with these limits. At a minimum, the interest rate risk

management section shall establish policies and procedures for the bank

to:

* * * * *

6. A new subpart G is added to read as follows:

Subpart G--Risk Assessment and Management

Sec.

615.5180 Interest rate risk management by banks--general.

615.5181 Bank interest rate risk management program.

615.5182 Interest rate risk management by associations and other

Farm Credit System institutions other than banks.

Subpart G--Risk Assessment and Management

Sec. 615.5180 Interest rate risk management by banks--general.

The board of directors of each Farm Credit Bank, bank for

cooperatives, and agricultural credit bank shall develop and implement

an interest rate risk management program tailored to the needs of the

institution and consistent with the requirements set forth in

Sec. 615.5135 of this part. The program shall establish a risk

management process that effectively identifies, measures, monitors, and

controls interest rate risk.

Sec. 615.5181 Bank interest rate risk management program.

(a) The board of directors of each Farm Credit Bank, bank for

cooperatives, and agricultural credit bank is responsible for providing

effective oversight to the interest rate risk management program and

must be knowledgeable of the nature and level of interest rate risk

taken by the institution.

(b) Senior management is responsible for ensuring that interest

rate risk is properly managed on both a long-range and a day-to-day

basis.

Sec. 615.5182 Interest rate risk management by associations and other

Farm Credit System institutions other than banks.

Associations and other Farm Credit System institutions other than

banks, excluding the Federal Agricultural Mortgage Corporation, with

interest rate risk that could lead to significant declines in net

income or in the market value of capital shall comply with the

requirements of Secs. 615.5180 and 615.5181. The interest rate risk

program shall be commensurate with the level of direct interest rate

exposure under the management control of the institution.

Subpart H--Capital Adequacy

7. Section 615.5201 is amended by removing the word ``allocation''

and adding in its place, the word ``allotment'' in paragraph (h);

redesignating paragraphs (d), (e), (f), (g), (h), (i), (j), (k), (l),

(m), and (n) as paragraphs (e), (f), (g), (h), (i), (k), (l), (n), (o),

(p), and (q) respectively; and adding new paragraphs (d), (j), and (m)

to read as follows:

Sec. 615.5201 Definitions.

* * * * *

(d) Deferred-tax assets that are dependent on future income or

future events means:

(1) Deferred-tax assets arising from deductible temporary

differences dependent upon future income that exceed the amount of

taxes previously paid that could be recovered through loss carrybacks

if existing temporary differences (both deductible and taxable and

regardless of where the related tax deferred effects are recorded on

the institution's balance sheet) fully reverse;

(2) Deferred-tax assets dependent upon future income arising from

operating loss and tax carryforwards; or

(3) Deferred-tax assets arising from temporary differences that

could be recovered if existing temporary differences that are dependent

upon other future events (both deductible and taxable and regardless of

where the related tax deferred effects are recorded on the

institution's balance sheet) fully reverse.

* * * * *

(j) OECD means the group of countries that are full members of the

Organization for Economic Cooperation and Development, regardless of

entry date, as well as countries that have concluded special lending

arrangements with the International Monetary Fund's General Arrangement

to Borrow, excluding any country that has rescheduled its external

sovereign debt within the previous 5 years.

* * * * *

(m) Qualifying bilateral netting contract means a bilateral netting

contract that meets at least the following conditions:

(1) The contract is in writing;

(2) The contract is not subject to a walkaway clause;

(3) The contract creates a single obligation either to pay or to

receive the net amount of the sum of positive and negative mark-to-

market values for all derivative contracts subject to the qualifying

bilateral netting contract;

(4) The institution receives a legal opinion that represents, to a

high degree of certainty, that in the event of legal challenge the

relevant court and administrative authorities would find the

institution's exposure to be the net amount;

(5) The institution establishes a procedure to monitor relevant law

and to ensure that the contracts continue to satisfy the requirements

of this section; and

(6) The institution maintains in its files adequate documentation

to support the netting of a derivatives contract.

* * * * *

6. Section 615.5210 is amended by adding new paragraph (e)(11);

removing paragraph (f)(2)(v); and revising paragraphs (a), (b), (e)

introductory text, (e)(1), (e)(6), (f)(2)(i), (f)(2)(ii), heading of

(f)(2)(iii), (f)(2)(iv), (f)(3) introductory text, (f)(3)(ii)(A), and

(f)(3)(iii) to read as follows:

Sec. 615.5210 Computation of the permanent capital ratio.

(a) The institution's permanent capital ratio shall be determined

on the basis of the financial statements of the institution prepared in

accordance with generally accepted accounting principles except that

the obligations of the Farm Credit System Financial Assistance

Corporation issued to repay banks in connection with the capital

preservation and loss-sharing agreements described in section 6.9(e)(1)

of the Act shall not be considered obligations of any institution

subject to this regulation prior to their maturity.

(b) The institution's asset base and permanent capital shall be

computed using average daily balances for the most recent 3 months.

* * * * *

(e) For the purpose of computing the institution's permanent

capital ratio, the following adjustments shall be made prior to

assigning assets to risk-weight categories and computing the ratio:

(1) Where two Farm Credit System institutions have stock

investments in each other, such reciprocal holdings shall be eliminated

to the extent of the offset. If the investments are equal in amount,

each institution shall deduct from its assets and its total capital an

amount equal to the investment. If the investments are not equal in

amount, each institution shall deduct from its total capital and its

assets an amount equal to the smaller investment. The elimination of

reciprocal holdings required by this paragraph shall be made prior to

making the other adjustments required by this subsection.

* * * * *

(6) The double-counting of capital between a service corporation

chartered

[[Page 49632]]

under section 4.25 of the Act and its owner institutions shall be

eliminated by deducting an amount equal to their investment in the

service corporation from their total capital.

* * * * *

(11) For purposes of calculating capital ratios under this part,

deferred-tax assets are subject to the conditions, limitations, and

restrictions described in this paragraph.

(i) Each institution shall deduct an amount of deferred-tax assets,

net of any valuation allowance, from its assets and its total capital

that is equal to the greater of:

(A) The amount of deferred-tax assets that are dependent on future

income or future events in excess of the amount that is reasonably

expected to be realized within 1 year of the most recent calendar

quarter-end date, based on financial projections for that year, or

(B) The amount of deferred-tax assets that are dependent on future

income or future events in excess of ten (10) percent of the amount of

core surplus that exists before the deduction of any deferred-tax

assets.

(ii) For purposes of this calculation:

(A) The amount of deferred-tax assets that can be realized from

taxes paid in prior carryback years and from the reversal of existing

taxable temporary differences shall not be deducted from assets and

from equity capital.

(B) All existing temporary differences should be assumed to fully

reverse at the calculation date.

(C) Projected future taxable income should not include net

operating loss carryforwards to be used within 1 year or the amount of

existing temporary differences expected to reverse within that year.

(D) Financial projections shall include the estimated effect of tax

planning strategies that are expected to be implemented to minimize tax

liabilities and realize tax benefits. Financial projections for the

current fiscal year (adjusted for any significant changes that have

occurred or are expected to occur) may be used when applying the

capital limit at an interim date within the fiscal year.

(E) The deferred tax effects of any unrealized holding gains and

losses on available-for-sale debt securities may be excluded from the

determination of the amount of deferred-tax assets that are dependent

upon future taxable income and the calculation of the maximum allowable

amount of such assets. If these deferred-tax effects are excluded, this

treatment must be followed consistently over time.

(f) * * *

(2) * * *

(i) Category 1: 0 Percent.

(A) Cash on hand and demand balances held in domestic or foreign

banks.

(B) Claims on Federal Reserve Banks.

(C) Goodwill.

(D) Direct claims on and portions of claims unconditionally

guaranteed by the United States Treasury, United States Government

agencies, or central governments in other OECD countries. A United

States Government agency is defined as an instrumentality of the United

States Government whose obligations are fully and explicitly guaranteed

as to the timely repayment of principal and interest by the full faith

and credit of the United States Government.

(ii) Category 2: 20 Percent.

(A) Portions of loans and other assets collateralized by United

States Government-sponsored agency securities. A United States

Government-sponsored agency is defined as an agency originally

chartered or established to serve public purposes specified by the

United States Congress but whose obligations are not explicitly

guaranteed by the full faith and credit of the United States

Government.

(B) Portions of loans and other assets conditionally guaranteed by

the United States Government or its agencies.

(C) Portions of loans and other assets collateralized by securities

issued or guaranteed (fully or partially) by the United States

Government or its agencies (but only to the extent guaranteed).

(D) Claims on domestic banks (exclusive of demand balances).

(E) Claims on, or guarantees by, OECD banks.

(F) Claims on non-OECD banks with a remaining maturity of 1 year or

less.

(G) Investments in State and local government obligations backed by

the ``full faith and credit of State or local government.'' Other

claims (including loans) and portions of claims guaranteed by the full

faith and credit of a State government (but only to the extent

guaranteed).

(H) Claims on official multinational lending institutions or

regional development institutions in which the United States Government

is a shareholder or contributor.

(I) Loans and other obligations of and investments in Farm Credit

institutions.

(J) Local currency claims on foreign central governments to the

extent that the Farm Credit institution has local liabilities in that

country.

(K) Cash items in the process of collection.

(iii) Category 3: 50 Percent.

* * * * *

(iv) Category 4: 100 Percent.

(A) All other claims on private obligors.

(B) Claims on non-OECD banks with a remaining maturity greater than

1 year.

(C) All other assets not specified above, including but not limited

to, leases, fixed assets, and receivables.

(D) All non-local currency claims on foreign central governments,

as well as local currency claims on foreign central governments that

are not included in Category 2(J).

* * * * *

(3) * * *

(i) * * *

(ii) Credit conversion factors shall be applied to off-balance-

sheet items as follows:

(A) 0 Percent.

(1) Unused commitments with an original maturity of 14 months or

less; or

(2) Unused commitments with an original maturity of greater than 14

months if:

* * * * *

(iii) Credit equivalents of interest rate contracts and foreign

exchange contracts.

(A) Credit equivalents of interest rate contracts and foreign

exchange contracts (except single currency floating/floating interest

rate swaps) shall be determined by adding the replacement cost (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.

Conversion Factor Matrix

[In Percent]

------------------------------------------------------------------------

Interest Exchange

Remaining maturity rate rate Commodity

------------------------------------------------------------------------

One year or less................. 0.0 1.0 10.0

[[Page 49633]]

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

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

------------------------------------------------------------------------

(B) For any derivative contract that does not fall within one of

the categories in the above table, the potential future credit exposure

shall be calculated using the commodity conversion factors. The net

current exposure for multiple derivative contracts with a single

counterparty and subject to a qualifying bilateral netting contract

shall be the net sum of all positive and negative mark-to-market values

for each derivative contract. The positive sum of the net current

exposure shall be added to the adjusted potential future credit

exposure for the same multiple contracts with a single counterparty.

The adjusted potential future credit exposure shall be computed as

Anet=(0.4 x Agross)+0.6 (NGR x

Agross) where:

(1) Anet is the adjusted potential future credit

exposure;

(2) Agross is the sum of potential future credit

exposures determined by multiplying the notional principal amount by

the appropriate credit conversion factor; and

(3) NGR is the ratio of the net current credit exposure divided by

the gross current credit exposure determined as the sum of only the

positive mark-to-markets for each derivative contract with the single

counterparty.

* * * * *

Subpart I--Issuance of Equities

9. Section 615.5220 is amended by redesignating paragraphs (a)

through (h) as new paragraphs (1) through (8) consecutively; by adding

the paragraph designation ``(a)'' to the introductory text; and by

adding a new paragraph (b) to read as follows:

Sec. 615.5220 Capitalization bylaws.

* * * * *

(b) The board of directors of each service corporation (including

the Leasing Corporation) shall adopt capitalization bylaws, subject to

the approval of its voting shareholders, that set forth the

requirements of paragraphs (a)(1), (a)(2), and (a)(3) of this section

to the extent applicable. Such bylaws shall also set forth the manner

in which equities will be retired and the manner in which earnings will

be distributed.

10. Section 615.5230 is amended by adding a new paragraph (b)(5) to

read as follows:

Sec. 615.5230 Implementation of cooperative principles.

* * * * *

(b) * * *

(5) Each bank shall endeavor to assure that there is a choice of at

least two nominees for each elective office to be filled and that the

board represent as nearly as possible all types of agriculture in the

district. If fewer than two nominees for each position are named, the

efforts of the bank to locate two willing nominees shall be documented

in the books and records of the bank. The bank shall also maintain a

list of the type or types of agriculture engaged in by each director on

its board.

Subpart J--Retirement of Equities

11. Section 615.5260 is amended by revising paragraph (a)(3)(ii) to

read as follows:

Sec. 615.5260 Retirement of eligible borrower stock.

(a) * * *

(3) * * *

(ii) In the case of participation certificates and other equities,

face or equivalent value; or

* * * * *

Subpart K--Surplus and Collateral Requirements

12. Section 615.5301 is amended by revising paragraphs (a),

(b)(2)(ii), (b)(3), (b)(4), and (i)(7) to read as follows:

Sec. 615.5301 Definitions.

* * * * *

(a) The terms deferred-tax assets that are dependent on future

income or future events, institution, permanent capital, and total

capital shall have the meanings set forth in Sec. 615.5201.

* * * * *

(b) * * *

(2) * * *

(ii) The allocated equities, if subject to revolvement, are not

scheduled for revolvement during the next 3 years, provided that, in

the event that such allocated equities included in core surplus are

retired, other than as required by section 4.14B of the Act, or in

connection with a loan default or the death of an equityholder whose

loan has been repaid (to the extent provided for in the institution's

capital adequacy plan), any remaining such allocated equities that were

allocated in the same year will be excluded from core surplus.

(3) The deductions required to be made by an institution in the

computation of its permanent capital pursuant to Sec. 615.5210(e)(6),

(7), (9), and (11) shall also be made in the computation of its core

surplus. Deductions required by Sec. 615.5210(e)(1) shall also be made

to the extent that they do not duplicate deductions calculated pursuant

to this section and required by Sec. 615.5330(b)(2).

(4) Equities issued by System institutions and held by other System

institutions shall not be included in the core surplus of the issuing

institution or of the holder, unless approved pursuant to paragraph

(b)(1)(iv) of this section, except that equities held in connection

with a loan participation shall not be excluded by the holder. This

paragraph shall not apply to investments by an association in its

affiliated bank, which are governed by Sec. 615.5301(b)(1)(i).

* * * * *

(i) * * *

(7) Any deductions made by an institution in the computation of its

permanent capital pursuant to Sec. 615.5210(e) shall also be made in

the computation of its total surplus.

13. Section 615.5330 is revised to read as follows:

Sec. 615.5330 Minimum surplus ratios.

(a) Total surplus.

(1) Each institution shall achieve and at all times maintain a

ratio of at least 7 percent of total surplus to the risk-adjusted asset

base.

(2) The risk-adjusted asset base is the total dollar amount of the

institution's assets adjusted in accordance with Sec. 615.5301(i)(7)

and weighted on the basis of risk in accordance with Sec. 615.5210(f).

(b) Core surplus.

(1) Each institution shall achieve and at all times maintain a

ratio of core surplus to the risk-adjusted asset base of at least 3.5

percent, of which no more than 2 percentage points may consist of

[[Page 49634]]

allocated equities otherwise includible pursuant to Sec. 615.5301(b).

(2) Each association shall compute its core surplus ratio by

deducting an amount equal to the net investment in the bank from its

core surplus.

(3) The risk-adjusted asset base is the total dollar amount of the

institution's assets adjusted in accordance with Secs. 615.5301(b)(3)

and 615.5330(b)(2), and weighted on the basis of risk in accordance

with Sec. 615.5210(f).

(c) An institution shall compute its risk-adjusted asset base,

total surplus, and core surplus ratios using average daily balances for

the most recent 3 months.

14. Section 615.5335 is revised to read as follows:

Sec. 615.5335 Bank net collateral ratio.

(a) Each bank shall achieve and at all times maintain a net

collateral ratio of at least 103 percent.

(b) At a minimum, a bank shall compute its net collateral ratio as

of the end of each month. A bank shall have the capability to compute

its net collateral ratio a day after the close of a business day using

the daily balances outstanding for assets and liabilities for that

date.

Subpart L--Establishment of Minimum Capital Ratios for an

Individual Institution

15. Section 615.5350 is amended by adding a new paragraph (b)(7) to

read as follows:

Sec. 615.5350 General--Applicability.

* * * * *

(b) * * *

(7) An institution with significant exposures to declines in net

income or in the market value of its capital due to a change in

interest rates and/or the exercising of embedded or explicit options.

Subpart M--Issuance of a Capital Directive

16. Section 615.5355 is amended by revising paragraph (a)(4) to

read as follows:

Sec. 615.5355 Purpose and scope.

(a) * * *

(4) Take other action, such as reduction of assets or the rate of

growth of assets, restrictions on the payment of dividends or

patronage, or restrictions on the retirement of stock, to achieve the

applicable capital ratios, or reduce levels of interest rate and other

risk exposures, or strengthen management expertise, or improve

management information and measurement systems; or

* * * * *

PART 620--DISCLOSURE TO SHAREHOLDERS

17. The authority citation for part 620 continues to read as

follows:

Authority: Secs. 5.17, 5.19, 8.11 of the Farm Credit Act (12

U.S.C. 2252, 2254, 2279aa-11); sec. 424 of Pub. L. 100-233, 101

Stat. 1568, 1656.

Subpart A--General

Sec. 620.1 [Amended]

18. Section 620.1 is amended by removing the reference

``Sec. 615.5201(j)'' and adding in its place, the reference

``Sec. 615.5201(l)'' in paragraph (j).

Subpart B--Annual Report to Shareholders

Sec. 620.5 [Amended]

19. Section 620.5 is amended by removing the word ``permanent''

from paragraphs (d)(2), (g)(4)(v), and (g)(4)(vi); by revising

paragraph (f)(3); and by adding paragraph (f)(4) to read as follows:

Sec. 620.5 Contents of the annual report to shareholders.

* * * * * *

(f) * * *

(3) For all banks (on a bank-only basis):

(i) Permanent capital ratio.

(ii) Total surplus ratio.

(iii) Core surplus ratio.

(iv) Net collateral ratio.

(4) For all associations:

(i) Permanent capital ratio.

(ii) Total surplus ratio.

(iii) Core surplus ratio.

* * * * *

PART 627--TITLE V CONSERVATORS AND RECEIVERS

20. The authority citation for part 627 continues to read as

follows:

Authority: Secs. 4.2, 5.9, 5.10, 5.17, 5.51, 5.58 of the Farm

Credit Act (12 U.S.C. 2183, 2243, 2244, 2252, 2277a, 2277a-7).

Subpart A--General

21. Section 627.2710 is amended by revising paragraphs (b)(1) and

(b)(3) to read as follows:

Sec. 627.2710 Grounds for appointment of conservators and receivers.

* * * * *

(b) * * *

(1) The institution is insolvent, in that the assets of the

institution are less that its obligations to creditors and others,

including its members. For purposes of determining insolvency,

``obligations to members'' shall not include stock or allocated

equities held by current or former borrowers.

* * * * *

(3) The institution is in an unsafe and unsound condition to

transact business, including having insufficient capital or otherwise.

For purposes of this regulation, ``unsafe or unsound condition'' shall

include, but shall not be limited to, the following conditions:

(i) For banks, a net collateral ratio of 102 percent.

(ii) For associations, collateral insufficient to meet the

requirements of the association's general financing agreement with its

affiliated bank.

(iii) For all institutions, permanent capital of less than one-half

the minimum required level for the institution.

(iv) For all institutions, a relevant total surplus ratio of less

than 2 percent.

(v) For associations, stock impairment.

* * * * *

Dated: September 17, 1997.

Floyd Fithian,

Secretary, Farm Credit Administration Board.

[FR Doc. 97-25107 Filed 9-22-97; 8:45 am]

BILLING CODE 6705-01-P