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: Final rule.

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

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

FCA Board (Board), adopts a final rule to amend its capital adequacy

and related regulations to address: interest rate risk; the grounds for

appointing a conservator or receiver; capital and bylaw requirements

for service corporations; and various computational issues and other

issues involving the capital regulations. The rule adds safety and

soundness requirements deferred from prior rulemakings, provides

greater consistency with capital requirements of other financial

regulators, and makes technical corrections.

EFFECTIVE DATE: This regulation shall become effective 30 days after

publication in the Federal Register during which either or both houses

of Congress are in session. Notice of the effective date will be

published in the Federal Register.

FOR FURTHER INFORMATION CONTACT:

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

Analysis, 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

The Agency proposed amendments to its capital regulations on

September 23, 1997 (62 FR 49623). The purpose of the proposed

regulations was to build on previous regulatory efforts by addressing

discrete issues related to capital that were deferred during

consideration of the capital adequacy regulations that became effective

in March 1997. The issues addressed in the proposed rule were:

Interest rate risk as it pertains to Farm Credit System

(System or FCS) institutions;

The definition of insolvency and of ``an unsafe or unsound

condition to transact business'' for the purpose of appointing a

conservator or receiver;

The establishment of capital and bylaw requirements for

System service corporations;

Changes to risk-weighting categories of assets;

The retirement of certain 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.

As described more fully below, the FCA Board has made revisions to

the proposed regulations on interest rate risk management programs, the

enumerated circumstances in which the FCA could consider an institution

to be in an unsafe or unsound condition for purposes of appointing a

conservator or receiver, and the proposal regarding the treatment of

``other comprehensive income'' in calculating regulatory capital. The

remaining regulations are adopted substantially as proposed.

Comments were received on the proposed regulations from the

System's Presidents' Finance Committee, which reflected the views of

the System's banks and associations (System joint comment); two Farm

Credit banks; and a jointly managed production credit association (PCA)

and Federal land credit association (FLCA). In addition, a third Farm

Credit bank submitted a sample computation of the proposed rule's

deferred-tax asset exclusion and asked the Agency to determine whether

it had been calculated properly. The respondents did not comment

generally on the overall thrust of the proposed rule; rather, their

comments addressed specific issues as described below. All of the

comments were carefully considered in the formulation of the final

rule.

II. Interest Rate Risk

New Secs. 615.5180 and 615.5181 are added to the investment

regulations to require each System bank to establish an interest rate

risk management program and to charge the bank's board of directors and

senior management with responsibility for maintaining effective

oversight. In addition, new Sec. 615.5182 imposes the same requirements

on all other System institutions \1\ (excluding the Federal

Agricultural Mortgage Corporation) \2\ with interest rate risk

exposure.

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

\1\ Section 1.2(a) of the Farm Credit Act of 1971, as amended,

(Act) identifies System institutions as Farm Credit Banks, banks for

cooperatives, production credit associations, Federal land bank

associations, and ``such other institutions as may be made a part of

the System, all of which shall be chartered by and subject to

regulation by the Farm Credit Administration.'' Such additional

institutions would include agricultural credit banks, agricultural

credit associations, Federal land credit associations, and service

corporations chartered under section 4.25 of the Act. For purposes

of the requirements of Sec. 615.5182, the Federal Agricultural

Mortgage Corporation is not included in the discussion of System

institutions.

\2\ Regulations affecting the Federal Agricultural Mortgage

Corporation will be issued separately.

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

The language in Sec. 615.5182 has been revised from the proposed

rule to clarify that the board and management of each System

institution have a duty to identify and manage interest rate risk

exposure at their institution. The new regulation requires institutions

other than banks to establish interest rate risk management programs

for all interest rate risk, including risk that is being managed by the

bank. The board of directors of an institution is accountable for all

interest rate risk exposure of the institution regardless of whether

the institution has contracted with the funding bank to manage certain

interest rate risks. Although the funding bank may manage the interest

rate risk, the institution's board is still accountable for ensuring

that risk exposures are appropriately identified and managed. In those

cases where an institution has interest rate risk exposure in excess of

any exposure covered by the bank, the institution will also be expected

to establish additional management requirements commensurate with the

level of such exposure.

To supplement these new regulations, which are general in nature,

the FCA Board recently adopted and published for comment a proposed

interest rate risk management policy. See 63 FR 27962, May 21, 1998.

The policy statement provides guidance to System institutions on

prudent interest rate risk management principles, as well as the

criteria the FCA will use to evaluate the adequacy and effectiveness of

a System institution's interest rate risk management. The proposed

guidelines are similar in approach to the interest rate risk guidelines

issued by other Federal financial institution regulatory agencies.\3\

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

\3\ The Office of the Comptroller of the Currency, the Federal

Deposit Insurance Corporation, and the Federal Reserve Board.

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

The new interest rate risk regulations and policy statement will

improve FCA oversight of the System by supplementing existing capital

regulations, which specifically address only credit risk. The

regulations and policy statement will better inform System institutions

of the Agency's expectations for the management of

[[Page 39220]]

interest rate risk exposure. The potentially adverse effect that

interest rate risk may have on net interest income and the market value

of an institution's equity is of particular concern to the FCA. Unless

properly measured and managed, interest rate changes can have

significant adverse effects on System institutions' ability to generate

future earnings, build net worth, and maintain liquidity. The combined

effect of the final regulation and provisions of the policy statement

is to ensure sound interest rate risk management by all System

institutions.

With the publication for comment of the proposed interest rate risk

management policy, the FCA has addressed the one comment it received on

the proposed interest rate provisions. The System joint comment

included a request that the Agency continue its practice of following

the approaches taken by other Federal financial institution regulatory

agencies and that the System be provided with an opportunity to comment

on any proposed policy statement prior to final issuance.

III. Definition of Insolvency and ``Unsafe or Unsound Condition to

Transact Business''

The FCA Board adopts several changes to Sec. 627.2710, which sets

forth the grounds for appointing a conservator or receiver for a System

institution. First, the definition of ``insolvency'' as a ground for

appointing a conservator or receiver in paragraph (b)(1) is amended to

clarify that any stock or allocated equities held by current or former

borrowers are not ``obligations to members.'' There is no change in the

treatment of obligations to members such as investment bonds and

uninsured accounts. Second, the Agency revises 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 adds that ``having insufficient capital or

otherwise'' is a circumstance that the FCA could consider to be an

unsafe and unsound condition. The amendment also identifies capital and

collateral thresholds below which an institution could be considered to

be operating unsafely, as well as other conditions. The thresholds and

conditions are:

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

Sec. 615.5301(d)) below 102 percent.

2. For associations, a default by the association of one or more

terms of its general financing agreement (GFA) with its affiliated bank

that the FCA determines to be material.

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 total surplus (as defined by

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

5. For associations, stock impairment.

The final rule contains a revision in item 2 above, which as

proposed pertained to collateral that is insufficient to enable an

association to meet the requirements of its GFA with its affiliated

bank. The FCA Board changed the provision in response to the System's

joint comment that the term ``insufficient collateral'' in the second

threshold was too imprecise. The System joint comment stated that some

GFAs might have a more ``strident'' collateral test that could result

in a technical default that could be cured in a number of ways. The

System joint comment recommended instead that a ``continuing and

material default under the terms of the association's [GFA]'' be

considered to be an unsafe and unsound condition to transact business;

it stated that the materiality standard would eliminate minor matters,

and the requirement that the default be continuing would eliminate

defaults that could be cured. The jointly managed PCA/FLCA commented

that it supported the revision proposed in the System joint comment.

The FCA Board agrees in part with the suggestion in the System

joint comment. It is appropriate to provide that a material default of

the GFA would be considered an unsafe and unsound condition for

transacting business and, consequently, a ground for appointing a

conservator or receiver. However, a provision that the default must be

continuing is too restrictive, since a material default can indicate

severe problems even when the default might be cured by, or is waived

by action of the affiliated bank. The FCA Board further believes that

the Agency, not the bank nor the association, should be responsible for

determining, as a ground for appointing a conservator or receiver, what

constitutes a material default of the GFA. Therefore, the final rule is

revised by removing the reference to ``insufficient collateral'' in the

proposed rule and providing instead that an unsafe or unsound condition

for transacting business includes an association's default under the

terms of its GFA, where such default is determined by the Agency to be

material.

While no other comments were received on the remaining standards

and conditions, the FCA Board has made some minor adjustments in the

final rule for clarity and conformity.

As was noted in the preamble to the proposed regulations, the

thresholds and conditions are intended to be examples of what the

Agency considers to be an unsafe or unsound condition to transact

business for the purpose of appointing a conservator or receiver but

are not exclusive. The FCA will continue to have the discretion to

determine if an institution is in an unsafe or unsound condition to

transact business based on other activities or circumstances that are

not enumerated in the regulation. The FCA also retains the discretion

to not appoint a conservator or receiver even when any of the

enumerated circumstances exists. The Agency will evaluate the totality

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

The Board notes further that the delineation of the ``unsafe or

unsound'' thresholds in this regulation does not mean that an

institution is conclusively presumed to be operating safely and soundly

if it is above all of the enumerated thresholds. The FCA may still

consider an institution operating below minimum capital standards to be

operating unsafely and unsoundly, and take appropriate supervisory

action accordingly.

IV. Service Corporations

A. Capital Requirements for Service Corporations

The FCA Board amends Sec. 611.1135(c) to provide that minimum

capital requirements may be imposed on a service corporation as a

condition of approval of the service corporation's charter. The Agency

will monitor a service corporation's compliance with individually

established capital standards through the examination process. No

comments were received on the proposed revision, and the FCA Board

adopts the rule as proposed.

B. Application of Bylaw Regulations to Service Corporations

Section 615.5220 is amended by adding a new paragraph (b) requiring

each service corporation to have relevant capitalization provisions in

its bylaws. A conforming amendment to Sec. 611.1135(b)(4) is also

adopted. No comments were received on these provisions, and they are

adopted as proposed.

V. Deferred-Tax Assets

The FCA amends Sec. 615.5210 to add a new paragraph (e)(11)

establishing a requirement to exclude certain deferred-

[[Page 39221]]

tax assets in capital calculations. Section 615.5201 is also amended to

add new paragraph (d) to define deferred-tax assets that are dependent

on future income or future events. These amendments are adopted without

change from the proposal.

Under this rule, when an institution computes its required capital

ratios, it is not required to exclude deferred-tax assets that can be

realized through carrybacks to taxes paid on income earned in prior

periods. However, the rule excludes a portion of the deferred-tax

assets: (1) That an institution can realize only if it earns sufficient

taxable income in the future; or (2) that are dependent on the

occurrence of other future events for realization. The portion of

deferred-tax assets that must be excluded is the greater of:

(1) The deferred-tax assets in excess of the amount that the

institution expects 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

(2) The deferred-tax assets in excess of 10 percent of core surplus

capital existing before the deduction of any disallowed tax assets.

An institution must deduct the excluded deferred-tax assets from

capital and from assets when calculating capital ratios.

The Agency received one comment and a sample computation regarding

its proposal. The System joint comment objected to the FCA's statement,

in the preamble to the proposed regulation, that the proposed exclusion

was consistent with requirements implemented by the other Federal

financial institution regulatory agencies. The other agencies provide

that commercial banks and thrifts must deduct deferred-tax assets in

excess of 10 percent of their Tier 1 capital or in excess of the amount

expected to be realized within 1 year (whichever is greater). The

System joint comment asserted that the FCA's use of core surplus as the

basis for the 10-percent limitation was not consistent with the other

agencies' approach. Rather, the System contended, the 10-percent

limitation in the calculation should be 10 percent of permanent

capital, not core surplus, because permanent capital was ``a

conservative equivalent of Tier 1 capital'' for commercial banks and

thrifts.

The Agency disagrees with the characterization of permanent capital

as a ``conservative equivalent'' of a commercial bank's Tier 1 capital.

The components of Tier 1 capital are generally more stable than many

components of permanent capital. It is true that common stockholders'

equity, which is included in permanent capital but not core surplus, is

a component of a commercial bank or thrift's Tier 1 capital. However, a

commercial bank or thrift does not routinely retire its common stock.

By contrast, most Farm Credit institutions routinely retire common

stock and distribute allocated surplus. The Agency implemented a core

surplus requirement to ensure that institutions have an amount of

stable capital that is not generally subject to routine retirements or

distributions for at least the next 3 years.\4\ Furthermore, other

components of permanent capital such as term stock are not included by

commercial banks in Tier 1 capital and may be included in Tier 2

capital only up to an amount that equals the amount of the commercial

bank's Tier 1 capital.\5\ There are no such restrictions on a Farm

Credit institution's permanent capital--nearly all capital is included

without limit, except equity holdings between FCS institutions. Because

of these significant functional differences, permanent capital and Tier

1 capital are not equivalent. The FCA Board continues to believe that

core surplus is a more appropriate basis on which to limit the

inclusion of deferred-tax assets and, therefore, adopts the regulation

as proposed.

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

\4\ Associations may include routinely distributed allocated

equities in core surplus if such equities are not scheduled for

retirement in the next 3 years.

\5\ Consequently, a commercial bank or thrift that fails to meet

its Tier 1 minimum standard will also fail to meet its overall (Tier

1 plus Tier 2) risk-based standard, no matter how much capital it

may have that meets the definition of Tier 2 capital.

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

VI. Computational Issues

The FCA Board adopts technical corrections to the existing capital

adequacy regulations, primarily involving the computation of the total

surplus and core surplus capital requirements, as described below.

A. Average Daily Balance Requirement

The FCA Board adopts 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. Under the existing

regulations, the total and core surplus ratios have been calculated

using month-end balances. The change is made in response to requests

from a number of institutions who commented that using month-end

balances results in significant variability in the ratios due simply to

seasonal lending trends.

One comment was received regarding proposed Sec. 615.5330(c). The

commenter supported the change on the ground that basing the

calculations on point-in-time assets could lead to a distorted view of

the capital position of an institution lending to agriculture due to

its cyclical nature.

B. Maintenance of Core Surplus and Total Surplus Ratios

The FCA Board adopts several changes to its requirements that

institutions maintain core surplus and total surplus ratios. Paragraphs

(a) and (b) of Sec. 615.5330 are amended to add the phrase ``at all

times'' to the requirement that institutions must maintain core surplus

and total surplus ratios of at least the minimum required level. The

amendatory language clarifies that institutions must have the

capability to calculate capital ratios every day, so that management

decisions relative to loans in excess of the institution's loan limits,

stock retirements, and other matters related to capital levels are made

with knowledge of the institution's current capital ratios. For

example, the institution must be able to calculate capital ratios on

any date stock is retired, to ensure that minimum capital levels will

be maintained after the retirement.

Section 615.5335 is also amended to expressly require banks to

achieve and maintain at all times a net collateral ratio at or above

the regulatory minimum, as well as to have the capability to calculate

the net collateral ratio at any time using the balances outstanding at

the computation date. No comments were received on these revisions, and

they are adopted without change from the proposed rule.

C. Treatment of Intra-System Investments and Other Adjustments

1. Reciprocal Investments

The FCA amends Sec. 615.5210(e)(1) to clarify the treatment of

reciprocal holdings between two System institutions in the capital

calculations. Institutions must eliminate reciprocal holdings before

making the other required adjustments relating to intra-System

investments. The Agency makes this clarification because some

institutions have incorrectly made other required adjustments for

intra-System investments before eliminating the reciprocal investments

when calculating capital positions. The Agency intended that

elimination of investments by one System institution in another

institution be applied on a net basis after eliminating reciprocal

holdings. See 53 FR 16956, May 12, 1988. This ``netting

[[Page 39222]]

effect'' ensures that System institutions eliminate cross-capital

investments prior to other adjustments required by the capital

regulations.

A System bank, which presently has investments in several of its

affiliated associations, recommended that the Agency eliminate the

reciprocal investment provisions from the regulations for the following

reasons: (1) The FCA currently has prior approval authority over

investments by Farm Credit banks in associations and could, therefore,

control where the investment counts in the capital calculations; (2)

the recently added capital ratios are more comprehensive and preclude

the need for the reciprocal investment provisions; and (3) it is

illogical for the bank to count its investment in the association in

the bank's net collateral ratio, since the bank does not have access to

the investment.

The FCA disagrees with the commenter's rationale for how reciprocal

investments should be counted. Reciprocal investments must be

eliminated from the capital calculations because the exchange of

reciprocal stock creates no tangible worth or resources to absorb loss.

This is a characteristic of all reciprocal investments, irrespective of

the reasons why the reciprocal investment was made. It is not

appropriate for any institution to be exempted from this treatment, as

the commenter implies. Placing the requirement in the capital

regulations ensures that all institutions calculate their capital in

the same way, and that the Agency, investors, and others are then able

to make meaningful comparisons of one institution's capital ratios with

another institution's ratios. The approach suggested by the commenter

would add unnecessary and inappropriate inconsistencies in the capital

calculations of institutions.

The FCA Board also disagrees with the commenter's assertion that

the newly added capital ratios make unnecessary the elimination of

reciprocal investments in the permanent capital calculation. On the

contrary, the new ratios have not diminished the importance of the

permanent capital ratio as a reasonable indication of an institution's

available permanent capital. The permanent capital ratio continues to

be a key measurement in several important respects. An institution's

lending limit is based on its level of permanent capital and specifies

how large a loan or loans the institution can make to a single

borrower. The institution is statutorily prohibited from retiring stock

when its permanent capital is below the required minimum. Finally, with

the adoption of this rule, if an institution's permanent capital falls

below a level equal to one-half of the required minimum, a regulatory

ground for appointing a conservator or receiver exists.

The commenter's assumption that a bank's investment in an

association is included in the bank's net collateral is incorrect.

Section 615.5301(c) of the regulations provides that net collateral is

the value of a bank's collateral as defined by Sec. 615.5050, less an

amount equal to the bank's allocations to associations that are not

counted as permanent capital by the bank. Section 615.5050 does not

include a bank's investment in an association in bank collateral, but

does include the following:

Notes and other obligations representing loans made under

the Act;

Real or personal property acquired in connection with

loans made under the Act;

Obligations of the United States or an agency thereof;

Other bank assets (including marketable securities)

approved by the FCA; and

Cash or cash equivalents.

The Agency notes that the commenter may have assumed that, because

its investments in its associations were approved by the FCA pursuant

to Sec. 615.5171, they qualify for inclusion in collateral as ``other

bank assets . . . approved by the Farm Credit Administration.'' This is

an incorrect interpretation of the collateral definition, which covers

only bank assets that have been approved by the Agency specifically for

inclusion as collateral. As is clear from the list of assets that may

count as collateral, only highly liquid investments qualify. A bank's

investment in an affiliated association is not liquid: there is no

market for the stock, and--as the commenter points out--the bank does

not have access to the investment. Consequently, it would be

inappropriate to include the bank's investment in its associations in

the net collateral.

2. Computation of Total and Core Surplus Ratios

The FCA Board clarifies the treatment of intra-System equity

investments and other deductions in the computations of total and core

surplus. For the calculation of total surplus, Sec. 615.5301(i)(7) is

amended to more clearly require the same deductions as those made in

the computation of permanent capital. In addition, paragraphs (a)(2)

and (a)(3) of Sec. 615.5330, which specify how a bank and an

association treat an association's investment in its bank in the

calculation of total surplus, are eliminated because the treatment is

now covered by revised Sec. 615.5301(i)(7). No comments were received

on the proposed amendments to the total surplus calculation, and they

are adopted without change.

With respect to core surplus, Sec. 615.5301(b)(4) is amended to

require the deduction of most intra-System investments in the

computation of the core surplus of both the investing and the issuing

institutions. However, investments to capitalize loan participations

are not deducted from the investing institution's core surplus. In the

preamble to the proposed rule, the FCA invited comment on this approach

and an alternative approach of eliminating intra-System investments

relating to loan participations from the core surplus of the investing

institution. No comments were received on this issue, and the FCA Board

finds no reason to revise its earlier proposal; thus, the amendment is

adopted as proposed.

The core surplus computation in existing Sec. 615.5301(b)(3) is

amended to require institutions to make adjustments for loss-sharing

agreements and for deferred-tax assets, as well as for investments in

the Farm Credit Services Leasing Corporation (Leasing Corporation) and

for goodwill. No comments were received on this proposal, and the

proposal is adopted without change.

3. Investments in Service Corporations

The FCA Board amends Sec. 615.5210(e)(6) to require an institution

to deduct its investments in service corporations from total capital

for purposes of computing permanent capital. This is an expansion of

the existing regulation, which requires an institution to deduct only

its investment in the Leasing Corporation. The change conforms to the

Agency's view that such capital investments are committed to support

risks at the service corporation level and that such capital

investments must be available to meet any capital needs of the service

corporation. The investing institution must also deduct the investments

when calculating its core and total surplus. The FCA received no

comments on the proposed provision and adopts it with only minor

technical changes.

D. Farm Credit System Financial Assistance Corporation (FAC)

Obligations

The FCA amends 615.5210(a) to provide that Farm Credit institutions

shall exclude FAC obligations from their balance sheets only if such

obligations were issued to pay capital preservation

[[Page 39223]]

and loss-sharing agreements. This amendment conforms the regulation to

the language of section 6.9(e)(3)(E) of the Act and narrows the

existing regulation, which excludes all FAC obligations from

institutions' balance sheets. The Agency received no comments on this

provision and adopts it as proposed.

E. Risk-Weighting Categories and Credit Conversion Factors for

Calculating Risk-Adjusted Assets

The FCA Board adopts modifications to the risk-weighting categories

for on-and off-balance-sheet assets in Sec. 615.5210(f) and adds

related definitions in Sec. 615.5201. The modifications provide a more

accurate weighting of assets relative to their risk and incorporate

recent changes to the Basle Accord,\6\ as well as provide consistency

with the requirements of the other Federal financial institution

regulatory agencies. No comments were received on the proposed

revisions, and the FCA Board adopts without change the following

revisions:

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

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

Supervisory Practices, under the auspices of the Bank for

International Settlements in Basle, Switzerland. Under this

agreement the other Federal financial institution regulatory

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.

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

The elimination of the 10-percent category in

Sec. 615.5210(f)(2)(ii);

The 20-percent risk-weighting category that includes

conditional guarantees and Government-sponsored agency securities not

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

Language distinguishing the Organization for Economic

Cooperation and Development (OECD)-based group of countries from non-

OECD-based countries; and

Credit conversion factors for derivative transactions.

Additionally, in new Sec. 615.5201(m)(2), which defines

``qualifying bilateral netting contract,'' a definition of the term

``walkaway clause'' has been added.

The FCA Board also adopts an amendment to change the risk weighting

for unused commitments with an original maturity of less than 14 months

to zero percent. Under the existing regulation, the zero-percent

category applies to loan commitments of up to only 12 months. One

commenter supported the proposed change but recommended that unused

loan commitments with an original maturity of 14 to 25 months be risk-

weighted at 10 percent and that those of longer original maturity be

risk-weighted at 20 percent; currently, any unused commitments in

excess of 12 months are risk-weighted at 50 percent. The commenter

stated that such changes would not be material in terms of risk and

would allow Farm Credit institutions to offer more timely service at a

lower cost to the institutions. The FCA agrees with the commenter that

lowering the risk weighting of loans or other assets could potentially

lower the costs of institutions that do not presently have capital well

in excess of their minimum requirements. However, the Agency disagrees

with the commenter's assertion that such changes would not be material

in terms of risk. On the contrary, the changes would enable Farm Credit

institutions to increase loan commitments by two to five times without

a corresponding increase in the amount of capital required to be held.

Thus, the final rule does not reduce the 50-percent risk weighting on

loan commitments with an original maturity of greater than 14 months.

As stated in the preamble to the proposed regulations, the FCA

intends to make the risk-weighting requirements of its regulations

consistent with the requirements of the other Federal financial

institution regulatory agencies, to the extent appropriate to the

System. In this case, the FCA Board believes it is appropriate to

extend the zero-percent risk-weighting category to loans with an

original maturity of 14 months, even though this is a deviation from

the 12-month zero-percent risk-weighting category of the other

regulators. Farm Credit institutions are more directly affected by the

seasonal cycles of agriculture than are most commercial banks and

thrifts because of the System's agriculture-specific charter. Extending

the zero-percent category by 2 months will not increase materially the

risk in System institutions' portfolios. A 14-month category for zero-

percent risk weighting takes into consideration the fact that many Farm

Credit institutions make loans on an annual renewal cycle. The practice

of these institutions is to perform the credit review and subsequent

commitment 30 to 60 days prior to the end of the current loan

commitment in order to have loan commitments in place at the beginning

of each annual cycle. The revision adopted by the FCA Board will enable

institutions to risk-weight these annual loan commitments at zero

percent without substantially raising the associated risk.

The System's joint comment recommended that the FCA adopt, as

final, a risk-weighting change proposed by the other Federal financial

institution regulatory agencies in November 1997. The other agencies

proposed to revise the risk-based capital treatment of recourse

obligations, direct credit substitutes, and securitized transactions.

One proposed revision of the other regulators would lower the risk

weighting for AAA-rated asset-backed securities from 100 percent to 20

percent. The System asked in its joint comment that the Agency

incorporate this change when it adopts these capital regulations in

final form, asserting that it is unlikely that the amendment proposed

by the other agencies will be challenged. FCA staff's discussions with

the other regulators indicated no final decisions are imminent as to

what the other agencies' final rule will address and when it will be

adopted. The FCA Board believes that a change to FCA's current risk

weighting of such assets is not appropriate at this time. However, the

Agency will continue to monitor the efforts of the other regulatory

agencies and evaluate the appropriateness of FCA's capital requirements

should the other regulatory agencies implement a 20-percent risk

weighting for AAA-rated asset-backed securities.

VII. Other Issues

A. Retirement of Certain Allocated Equities Included in Core Surplus

The FCA Board amends Sec. 615.5301(b)(2) to generally disallow

certain allocated equities from treatment as association core surplus

in the event of partial retirements of similar equities allocated in

the same year. However, the revised regulation allows certain allocated

equities to remain a part of core surplus when: (1) Partial retirements

are required by section 4.14B of the Act, (2) an equityholder has

defaulted on a loan, or (3) an equityholder whose loan has been repaid

has died, and the institution's capital plan provides for retirement in

that circumstance.

Previously, the regulation did not specifically address partial

retirements of the type of allocated equities that associations may

include in core surplus pursuant to Sec. 615.5301(b)(2). By this

change, treatment of such allocated equities is consistent with the

treatment in Sec. 615.5301(b)(1)(ii) of nonqualified allocated equities

not distributed according to a plan or practice. The Agency had

intended to treat partial retirements of all allocated equities in the

same way. The change makes the consistent treatment clear for all types

of allocated equities. The Agency received no comments on this

provision and adopts it as proposed.

[[Page 39224]]

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

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

Pursuant to section 4.15 of the Act, a new Sec. 615.5230(b)(5) is

added to require banks to make a good faith effort to locate at least

two nominees for each director position and to try to assure

representation on the board that is reflective of the bank's territory.

The Agency proposed these changes to implement the statutory

requirement to adopt regulations assuring a choice for bank director

positions and board diversity. The regulation requires written

documentation of the effort a bank makes in the event it is unable to

find at least two nominees for each position. The bank must also keep a

record of the type of agriculture engaged in by each director on its

board. In addition, a reference is added in Sec. 611.350, the subpart

on director elections, to the cooperative principles set forth in

Sec. 615.5230 that apply to such elections.

One commenter asserted that the new regulations should not apply to

situations where directors are nominated by shareholders rather than by

a nominating committee. (The Act requires only associations to utilize

a nominating committee, but other institutions may also choose to do

so.) A Farm Credit bank submitted a comment in which it described its

nominating process: the bank sends ballots to all eligible shareholders

to solicit nominations for director positions, and the two individuals

receiving the highest number of votes become the nominees. In the event

that one of the nominees withdraws from the election, the bank asks the

candidate with the third-highest number of votes to run, but the bank

is sometimes unsuccessful. Consequently, only one candidate remains for

the office.

The Agency is not persuaded by the Farm Credit bank's assertion

that, because the bank uses a shareholder nomination process rather

than a nominating committee, it should not have to document in writing

its attempts to assure at least two nominees for each director

position. Section 4.15 of the Act states in pertinent part that FCA

regulations on the election of bank directors shall ``assure a choice

of two nominees for each elective office to be filled;'' the Act makes

no reference to nominating committees. Institutions must make good

faith efforts to assure at least two candidates, but the Agency does

not intend or expect the written documentation of these efforts to be

burdensome. The bank needs merely to provide a brief but reasonable

description of its efforts to seek a second nominee for inclusion in

its records. This regulation does not require two nominees for each

position. Instead, it requires documentation of the bank's efforts to

secure at least two nominees. The FCA Board adopts the regulation

without change from the proposal.

C. Statement of Financial Accounting Standards (SFAS) No. 130,

Reporting Comprehensive Income

Sections 615.5210(e)(10), 615.5301(b)(5), and 615.5301(i)(4) are

amended to extend the exclusion currently applicable to unrealized

gains or losses on available-for-sale securities to all transactions

covered by the definition of ``accumulated other comprehensive income''

contained in the Financial Accounting Standards Board's (FASB) recently

issued SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 sets

forth standards for reporting and displaying comprehensive income in a

full set of financial statements for fiscal years beginning after

December 15, 1997. Transactions covered by this new statement will be

reported as a separate component of the equity (capital) section in the

statement of financial position.

The amendments are adopted in response to a suggestion made in the

System's joint comment. The Agency did not propose any changes to the

regulations in the proposed rule, on the ground that it saw no

compelling reasons to limit the impact of SFAS No. 130. But in the

preamble to the proposed rule, the FCA Board invited comment on what

effect, if any, SFAS No. 130 should have on the current capital

standards.

The System, in its joint comment, recommended that the Agency amend

the capital regulations to extend the exclusion currently applicable to

unrealized gains or losses on available-for-sale securities to all

transactions defined by SFAS No. 130 as ``accumulated other

comprehensive income.'' The commenter pointed out that the current

capital regulations at Sec. 615.5210(e)(10) exclude the net impact of

unrealized gains or losses on available-for-sale securities from the

computation of permanent capital. The commenter observed that the items

included in the category of ``other comprehensive income'' pursuant to

SFAS No. 130 are similar in nature to such unrealized gains or losses

and that it would be appropriate to treat them in the same way.

The FCA Board is persuaded by the System's joint comment and adopts

the System's suggested change. The Agency agrees that it is generally

more appropriate to treat components of capital with comparable

characteristics and terms in a like manner under the capital standards.

However, in the event that the FCA determines that an individual

component, entry, or account has characteristics or terms that diminish

its contribution to an institution's ability to absorb losses,

Secs. 615.5301(b)(6) and 615.5301(f)(6) of the current regulations

provide the Agency with sufficient flexibility to require the deduction

of all or a portion of such a component, entry, or account from core

surplus or total surplus.

D. Conforming Amendments

The FCA Board adopts several other clarifying changes to wording of

the total surplus and core surplus definitions. Paragraphs (b)(1)(ii)

and (iii), (b)(2), and (i)(2) and (3) of Sec. 615.5301 are amended to

provide additional clarity to the definitions. Paragraph (b)(1)(ii) is

amended to clarify that the term ``allocated equities'' includes

allocated stock. The FCA is concerned that some institutions may

otherwise interpret the regulation as permitting institutions to treat

allocated stock either as allocated equities (as described in

paragraphs (b)(1)(ii) and (b)(2)) or as perpetual stock (as described

in paragraphs (b)(1)(iii) and (i)(3)) when calculating core and total

surplus. In fact, the allocated stock must be treated as allocated

equities in the calculations. The FCA is also changing

Sec. 615.5301(b)(2) to clarify that, for purposes of the capital ratio

calculations, ``revolvement'' of allocated equities means any

retirement of those equities, whether or not the institution has a

formal revolvement plan. This change is made to avoid the implication

that revolvement means something other than retirement.

Furthermore, in Sec. 615.5301(b)(2)(ii), the phrase ``if subject to

revolvement, are not scheduled for revolvement during the next 3

years'' is replaced with the phrase ``if subject to a plan or practice

of revolvement or retirement, are not scheduled or intended to be

revolved or retired during the next 3 years'' in order to parallel more

closely the language in paragraphs (b)(1)(ii) and (iii) of

Sec. 615.5301. A parallel change is made to Sec. 615.5301(i)(2) by

replacing the phrase `` which, if subject to revolvement of retirement,

have an original planned revolvement or retirement date of not less

than 5 years'' with the phrase ``that are not subject to a plan or

practice of revolvement or retirement of 5 years or less.'' These

changes clarify that ``subject to

[[Page 39225]]

revolvement'' has the same meaning as the other references to a plan or

practice of revolvement or retirement in the core surplus and total

surplus definitions.

The Agency amends 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 adopted 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.

These amendments are adopted without change from the proposed rule.

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

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 removing the first sentence of

the introductory paragraph and adding two sentences in its place 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 interest rate risk exposure limits as well as the criteria

to determine compliance with these limits. * * *

* * * * *

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.

Any association or other Farm Credit System institution 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

management program required under Sec. 615.5181 shall be commensurate

with the level of interest rate risk of the institution.

Subpart H--Capital Adequacy

Sec. 615.5201 [Amended]

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),

[[Page 39226]]

(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, defined as a

provision that permits a non-defaulting counterparty to make lower

payments than it would make otherwise under the contract, or no payment

at all, to a defaulter or to the estate of a defaulter, even if the

defaulter or the estate of the defaulter is a net creditor under the

contract;

(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.

* * * * *

8. 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), (e)(10), (f)(2)(i), (f)(2)(ii),

heading of (f)(2)(iii), (f)(2)(iv), (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 section.

* * * * *

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

chartered under section 4.25 of the Act and its stockholder

institutions shall be eliminated by deducting an amount equal to the

institution's investment in the service corporation from its total

capital.

* * * * *

(10) The permanent capital of an institution shall exclude the net

effect of all transactions covered by the definition of ``accumulated

other comprehensive income'' contained in the Statement of Financial

Accounting Standards No. 130, as promulgated by the Financial

Accounting Standards Board.

(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

[[Page 39227]]

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) * * *

(ii) * * *

(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

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

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

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

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

(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 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 Farm Credit Leasing Services Corporation) shall adopt

capitalization bylaws, subject to the approval of its voting

shareholders, that set forth the

[[Page 39228]]

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 represents 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 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)(1)(ii), (b)(1)(iii), (b)(2)(ii), (b)(3), (b)(4), (b)(5), (i)(2),

(i)(3), (i)(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) * * *

(1) * * *

(ii) Nonqualified allocated equities (including stock) that are not

distributed according to an established plan or practice, provided

that, in the event that a nonqualified patronage allocation is

distributed, 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 nonqualified allocations that

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

(iii) Perpetual common or noncumulative perpetual preferred stock

(other than allocated stock) that is not retired according to an

established plan or practice, provided that, in the event that stock

held by a borrower is retired, other than as required by section 4.14B

of the Act or in connection with a loan default to the extent provided

for in the institution's capital plan, the remaining perpetual stock of

the same class or series shall be excluded from core surplus;

* * * * *

(2) * * *

(ii) The allocated equities, if subject to a plan or practice of

revolvement or retirement, are not scheduled or intended to be revolved

or retired 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).

(5) The core surplus of an institution shall exclude the net effect

of all transactions covered by the definition of ``accumulated other

comprehensive income'' contained in the Statement of Financial

Accounting Standards No. 130, as promulgated by the Financial

Accounting Standards Board.

* * * * *

(i) * * *

(2) Allocated equities, including allocated surplus and stock, that

are not subject to a plan or practice of revolvement or retirement of 5

years or less and are eligible to be included in permanent capital

pursuant to Sec. 615.5201(j)(4)(iv); and

(3) Stock (other than allocated stock) that is not purchased or

held as a condition of obtaining a loan, provided that it is either

perpetual stock or term stock with an original maturity of at least 5

years, and provided that the institution has no established plan or

practice of retiring such perpetual stock or of retiring such term

stock prior to its stated maturity. The amount of term stock that is

eligible to be included in total surplus shall be reduced by 20 percent

(net of redemptions) at the beginning of each of the last 5 years of

the term of the instrument.

(4) The total surplus of an institution shall exclude the net

effect of all transactions covered by the definition of ``accumulated

other comprehensive income'' contained in the Statement of Financial

Accounting Standards No. 130, as promulgated by the Financial

Accounting Standards Board.

* * * * *

(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 a 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 a least 3.5 percent, of which no more than 2 percentage points may

consist of 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

[[Page 39229]]

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 than 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 or 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 below 102 percent.

(ii) For associations, a default by the association of one or more

terms of its general financing agreement with its affiliated bank that

the Farm Credit Administration determines to be a material default.

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

the minimum required level for the institution.

(iv) For all institutions, a total surplus ratio of less than 2

percent.

(v) For associations, stock impairment.

* * * * *

Dated: July 15, 1998.

Floyd Fithian,

Secretary, Farm Credit Administration Board.

[FR Doc. 98-19394 Filed 7-21-98; 8:45 am]

BILLING CODE 6705-01-P