[Federal Register Volume 60, Number 110 (Thursday, June 8, 1995)]
[Proposed Rules]
[Pages 30201-30208]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-13913]



 ========================================================================
 Proposed Rules
                                                 Federal Register
 ________________________________________________________________________
 
 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
 
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 

  Federal Register / Vol. 60, No. 110 / Thursday, June 8, 1995 / 
Proposed Rules  

[[Page 30201]]

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

Office of Federal Housing Enterprise Oversight

12 CFR Part 1750

RIN 2550-AA03


Minimum Capital

AGENCY: Office of Federal Housing Enterprise Oversight, HUD.

ACTION: Proposed rule.

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SUMMARY: The Office of Federal Housing Enterprise Oversight (OFHEO) 
proposes to issue a regulation for determining the minimum capital 
requirement for the Federal National Mortgage Association and the 
Federal Home Loan Mortgage Corporation (collectively, the Enterprises). 
The proposed regulation defines the necessary terms and sets forth the 
methodology for computing the minimum capital level. The proposed 
regulation also establishes procedures for the filing of quarterly 
minimum capital reports by each Enterprise. In addition, the proposed 
regulation establishes procedures under which OFHEO will determine the 
capital classification of each Enterprise on a quarterly basis.

DATES: Written comments on the proposed regulation must be received by 
August 7, 1995.

ADDRESSES: All comments concerning the proposed regulation should be 
addressed to Anne E. Dewey, General Counsel, Office of Federal Housing 
Enterprise Oversight, 1700 G Street NW., 4th Floor, Washington, D.C. 
20552. Copies of all communications received will be available for 
examination by interested parties at the Office of Federal Housing 
Enterprise Oversight.

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

SUPPLEMENTARY INFORMATION:

I. Background

    Title XIII of the Housing and Community Development Act of 1992, 
Pub. L. No. 102-550, known as the Federal Housing Enterprises Financial 
Safety and Soundness Act of 1992, 12 U.S.C. 4501 et seq. (Act), 
established the Office of Federal Housing Enterprise Oversight (OFHEO). 
OFHEO is an independent office within the Department of Housing and 
Urban Development with responsibility for ensuring that the Federal 
National Mortgage Association (Fannie Mae) and the Federal Home Loan 
Mortgage Corporation (Freddie Mac) (collectively, the Enterprises) are 
adequately capitalized and operating in a safe and sound manner. 
Included among the express statutory authorities of the Director of 
OFHEO is the authority to issue regulations establishing the capital 
level requirements.1

    \1\ Act, section 1313(b)(1) (12 U.S.C. 4513(b)(1)).
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    On February 8, 1995, OFHEO published an Advance Notice of Proposed 
Rulemaking 2 as the first step toward developing the risk-based 
capital regulation required by section 1361 of the Act.3 The risk-
based capital requirements will be based on a stress test to be 
developed by OFHEO. The stress test will determine the amount of 
capital that an Enterprise must hold to absorb the projected losses 
associated with credit and interest rate risks during a ten-year period 
of economic stress. That amount plus an additional 30 percent to cover 
management and operations risks will constitute the risk-based capital 
level of the Enterprise.

    \2\ 60 FR 7468, Feb. 8, 1995.
    \3\ 12 U.S.C. 4611.
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    Separate from the risk-based capital requirements, section 1362 of 
the Act prescribes the minimum capital requirement for the 
Enterprises.4 Unlike the risk-based capital requirements, which 
are based on the stress test, the minimum capital level is computed 
largely on the basis of statutorily established ratios that are applied 
to certain defined on- and off-balance sheet items of the Enterprises.

    \4\ 12 U.S.C. 4612.
    An Enterprise's capital serves as a cushion to absorb financial 
losses, thereby reducing the risk of failure. As specified by the Act, 
the minimum capital level of an Enterprise represents an essential 
amount of capital needed as protection against the broad categories of 
risk in its businesses. The minimum capital level is not designed to 
address the risks of specific exposures within these categories. In 
addition, none of the capital levels specified in the Act represents 
the amount needed by an Enterprise to operate safely and soundly under 
all circumstances.
    Section 1364 of the Act 5 requires the Director of OFHEO to 
determine the capital classification of each Enterprise not less than 
quarterly. The proposed minimum capital regulation provides procedures 
for each Enterprise to file a minimum capital level report each quarter 
and at other times, as required by the Director. In addition, it 
implements the provisions of section 1368 of the Act,6 which 
require OFHEO to provide each Enterprise with notice and an opportunity 
to comment on its capital classification.

    \5\ 12 U.S.C. 4614.
    \6\ 12 U.S.C. 4618.
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II. Interim Procedures

    As discussed below, the Act specifies the minimum capital ratios 
applicable to on-balance sheet assets and to certain off-balance sheet 
obligations, e.g., mortgage-backed securities (MBS), but requires 
adjustment of the minimum capital ratio applicable to other off-balance 
sheet obligations. Following the appointment of the Director of OFHEO, 
OFHEO implemented the statutory minimum capital and capital 
classification provisions by establishing, through administrative 
action, interim procedures for computing the minimum capital level. 
These interim procedures will continue to be used until the effective 
date of the final minimum capital regulation.

On-Balance Sheet Assets

    The interim procedures apply the minimum capital ratio applicable 
to on-balance sheet assets as specified in section 1362(a)(1) of the 
Act.7 That section establishes a minimum capital ratio of 2.50 
percent of the aggregate on-balance sheet assets of the Enterprises 
determined in accordance with generally accepted accounting principles 
(GAAP).

    \7\ 12 U.S.C. 4612(a)(1). [[Page 30202]] 
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Mortgage-Backed Securities 8

    \8\ Mortgage-backed securities are defined in the proposed 
regulation as securities, investments, or substantially equivalent 
instruments that represent an interest in a pool of loans secured by 
mortgages or deeds of trust where the principal or interest payments 
to the investor in the security or substantially equivalent 
instrument are guaranteed or effectively guaranteed by an 
Enterprise.
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    For MBS, the interim procedures apply the minimum capital ratio 
specified in section 1362(a)(2) of the Act.9 That section 
establishes a minimum capital ratio of 0.45 percent of the unpaid 
principal balance of outstanding MBS and substantially equivalent off-
balance sheet instruments 10 that the Enterprises issue or 
guarantee. It only applies to MBS and substantially equivalent 
instruments that are not included among the on-balance sheet items of 
the Enterprises.

    \9\ 12 U.S.C. 4612(a)(2).
    \10\ An off-balance sheet obligation is defined in the proposed 
regulation to mean a binding agreement, contract, or similar 
arrangement that requires or may require future payment(s) in money 
or kind by another party to an Enterprise or that effectively 
guarantees all or part of such payment(s) to third parties, where 
such agreement or contract is a source of credit risk for an 
Enterprise not included on its balance sheet.
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Other Off-Balance Sheet Obligations

    Section 1362(a)(3) of the Act 11 requires OFHEO to adjust the 
minimum capital ratios for off-balance sheet obligations other than 
MBS. That adjustment must reflect the differences between the credit 
risk of such obligations and the credit risk of MBS. That section 
further provides that commitments in excess of 50 percent of the 
average dollar amount of the commitments outstanding each quarter over 
the preceding four quarters are to be excluded from minimum capital 
level computations. The following discussion describes the interim 
procedures for determining minimum capital requirements for off-balance 
sheet obligations other than MBS.

    \11\ 12 U.S.C. 4612(a)(3).
Commitments \12\

    \12\ A commitment is defined in the proposed regulation to mean 
any contractual, legally binding arrangement that obligates an 
Enterprise to purchase mortgages for portfolio or securitization.
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    OFHEO determined that there is no significant difference between 
the credit risk of commitments and the credit risk of MBS. Therefore, 
the interim procedures set a minimum capital ratio for commitments of 
0.45 percent, which is applied to 50 percent of the average of the 
dollar amounts of commitments outstanding on the date for which the 
minimum capital level is being computed and the dates of the three 
preceding quarter-ends.
Multifamily Credit Enhancements
    Multifamily credit enhancements (MFCEs) are guarantees by an 
Enterprise of payments on multifamily mortgage revenue bonds issued by 
state and local housing finance agencies. The guarantees permit state 
and local agencies to obtain a lower cost of funds. The bonds are 
collateralized by multifamily mortgages to which the Enterprise has 
recourse in the event of a default. OFHEO concluded that the risk of 
MFCEs is most analogous to the risk of multifamily MBS. Therefore, the 
interim procedures apply the minimum capital ratio for MBS (0.45 
percent) to the outstanding principal amount of bonds with MFCEs.
Sold Portfolio Remittances Pending
    Sold portfolio remittances pending are funds held in custodial 
accounts awaiting collection by one of the Enterprises for disbursement 
to the holders of MBS. The obligations associated with these funds 
arise from the MBS accounting cycle in the accounting system of one of 
the Enterprises. Once payments of mortgage principal are received by a 
seller-servicer and placed in custodial accounts, the Enterprise 
reduces the reported amount of the MBS, or sold portfolio. The 
Enterprise eventually passes the mortgage principal payments to MBS 
investors.
    OFHEO concluded that the sold portfolio remittances pending are 
essentially part of MBS. Sold portfolio remittances pending are 
reflected separately only as a result of the accounting treatment used 
by one Enterprise. Therefore, the interim procedures apply the same 
minimum capital ratio for MBS (0.45 percent) to the dollar amount of 
sold portfolio remittances pending.
Interest Rate and Foreign Exchange Rate Contracts
    The Enterprises use interest rate contracts \13\ to obtain more 
desirable financing terms and hedge interest rate risk exposure. Fannie 
Mae uses foreign exchange rate contracts \14\ to fix the United States 
dollar costs of debt issued in foreign currencies. The credit risk 
associated with interest rate and foreign exchange rate contracts is 
the risk of loss that may result when a counterparty defaults.

    \13\ Interest rate contracts include single currency interest 
rate swaps, basis swaps, forward rate agreements, interest rate 
options purchased (including caps, collars, and floors), and other 
instruments that give rise to similar credit risks (including when-
issued securities and forward deposits accepted).
    \14\ Foreign exchange rate contracts include cross-currency 
interest rate swaps, forward foreign exchange contracts, currency 
options purchased, and other instruments that give rise to similar 
credit risks.
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    Because the credit risk of interest rate and foreign exchange rate 
contracts is not fundamentally different than the risk of those 
contracts to banks and bank holding companies, the interim procedures 
apply substantially the same requirements as the risk-based 
requirements that are applicable to banks and bank holding companies. 
Those bank-related requirements are contained in guidelines that have 
been adopted by the Board of Governors of the Federal Reserve System at 
12 C.F.R. Part 208, Appendix A, for state member banks, and at 12 
C.F.R. Part 225, Appendix A, for bank holding companies; by the 
Comptroller of the Currency at 12 C.F.R. Part 3, Appendix A, for 
national banks; and by the Federal Deposit Insurance Corporation at 12 
C.F.R. Part 325, Appendix A, for federally insured state nonmember 
banks (hereinafter referred to as the Guidelines).\15\

    \15\ The Guidelines are based upon a framework developed jointly 
by supervisory authorities from the countries that are represented 
on the Basle Committee on Banking Regulations and Supervisory 
Practices.
    The Guidelines convert off-balance sheet items into balance sheet 
equivalents by determining a credit equivalent amount (CEA) for each 
item. Risk-weights are applied to the CEA based on the type of 
counterparty and on the extent to which qualifying collateral has been 
posted.
    The CEA for interest rate and foreign exchange rate contracts is an 
estimate of the overall credit exposure associated with such contracts. 
Under the Guidelines, the CEA is the sum of two components: (1) the 
current exposure and (2) the potential future exposure. The current 
exposure (often referred to as ``replacement cost'') of a contract is 
equal to the contract's market value or zero, if its market value is 
negative. The potential future exposure of an interest rate or foreign 
exchange rate contract (often referred to as the ``add-on'') is 
calculated for each contract, regardless of its current market 
value.\16\ Potential future exposure is calculated by multiplying the 
notional amount of the contract by a credit conversion factor, which is 
determined by the remaining maturity and by the type of the contract 
(0.0 percent for interest rate contracts expiring in less than one year 
and 0.5 percent for those expiring in more than [[Page 30203]] one 
year; 1.0 percent for foreign exchange contracts expiring in less than 
one year and 5.0 percent for those expiring in more than a year).

    \16\ Because the floating rates associated with basis swaps are 
highly correlated, potential future exposure is not material; the 
credit exposure for these contracts is evaluated solely on the basis 
of the mark-to-market values.
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    Once the CEA of an interest rate or foreign exchange rate contract 
has been determined, the amount of the contract is assigned a risk-
weight (20 or 50 percent) appropriate to the counterparty or, if 
relevant, the nature of any collateral or guarantees. Total risk-
weighted assets are then multiplied by 8.0 percent \17\ to determine 
the amounts included in the Enterprise's minimum capital level.

    \17\ Eight percent represents the required ratio of total 
capital to risk-weighted assets contained in the Guidelines.
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    The interim procedures allow the Enterprises to recognize the risk-
reducing benefits of qualifying bilateral netting contracts as outlined 
in the Federal Reserve Board's final rule amending the risk-based 
capital guidelines (59 FR 62987, Dec. 7, 1994). Thus, the Enterprises 
may net positive and negative mark-to-market values of interest rate 
and foreign exchange rate contracts in the determination of the current 
exposure portion of the CEA.
    The interim procedures supplement the Guidelines in the area of 
foreign exchange rate contracts. Fannie Mae includes items associated 
with foreign exchange rate contracts on its balance sheet. With respect 
to such contracts, OFHEO determines the amount that would be required 
under the Guidelines and compares it to the amount that would result 
from applying the 2.50 percent ratio for on-balance sheet assets 
contained in the Act, and applies the higher amount.

III. Basis for the Proposed Minimum Capital Regulation 18

    \18\ In the course of developing this proposed regulation, OFHEO 
solicited and received comments and recommendations from the 
Enterprises regarding alternative approaches. One Enterprise 
asserted that a low minimum capital ratio for interest rate and 
foreign exchange rate contracts is justified because these contracts 
are not used for speculative purposes; credit losses on these 
contracts have not been experienced; the contracts are mostly 
executed under master netting agreements with counterparties that 
are investment-grade; and, depending on counterparty credit quality, 
require the posting of collateral or other credit enhancements. The 
Enterprise suggested that OFHEO continue to apply the Guidelines to 
calculate the CEA to measure the credit exposure of interest rate 
and foreign exchange rate contracts, but that OFHEO apply a fixed 
ratio of 0.45 percent to the CEA, rather than apply the 8.00 percent 
ratio and various risk-weights, as required by the Guidelines. The 
Enterprise suggested the elimination of risk-weights because it 
believes they do not measure credit quality. The Enterprise 
suggested that the enforcement of strict credit and performance 
standards for its counterparties, coupled with aggressive collateral 
requirements for credit exposure, eliminates the need for credit 
differentiation among counterparties and the corresponding risk-
weights. The Enterprise also recommended that OFHEO's regulations 
reflect, without amendment, the proposed and final changes to the 
Guidelines related to the calculation of current and potential 
future exposure. These changes would incorporate the impact of 
bilateral netting in the calculation of credit exposure, extend the 
capital treatment under the Guidelines to activities other than 
interest rate and currency contracts, and add higher credit 
conversion factors for longer-term contracts.
    The other Enterprise supported the application of the Guidelines 
to calculate the CEA and recommended that OFHEO apply, as a starting 
point, a capital ratio of 0.45 percent to that amount. It made 
further recommendations that would collectively have the effect of 
lowering the capital requirements, namely, that OFHEO consider: (1) 
easing the requirements under which bilateral netting contracts 
become ``qualifying,'' enabling an institution to ``net'' and thus 
reduce its current and potential future exposure; (2) increasing the 
benefit of netting over what proposed amendments to the Guidelines 
provide by applying the ``net-to-gross ratio'' (the current net 
positive market value of swaps divided by their current gross 
positive market value) on a portfolio-wide basis rather than 
counterparty-by-counterparty, and applying it to 100 percent of the 
notional amount rather than 50 percent; and (3) adjusting the 0.45 
percent capital ratio applied to the CEA of interest rate and 
foreign exchange rate contracts downward based on the credit ratings 
of the counterparties, collateral arrangements, and other credit 
enhancements.
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    The proposed regulation continues the interim approach with respect 
to on-balance sheet items, MBS, commitments, multifamily credit 
enhancements, and sold portfolio remittances pending. However, the 
proposed regulation modifies the interim approach with respect to 
interest rate and foreign exchange rate contracts. A discussion of how 
OFHEO arrived at the approach adopted by the proposed regulation 
follows.
    The Act requires OFHEO to adjust the statutory minimum capital 
ratio applicable to any class of off-balance sheet obligations if the 
credit risk of that class of obligations differs from the credit risk 
of MBS. OFHEO believes that the credit risk of interest rate and 
foreign exchange rate contracts, as measured by their CEAs, is 
significantly greater than that of MBS. Accordingly, the proposed 
regulation contains a minimum capital ratio for interest rate and 
foreign exchange rate contracts that is higher than the ratio 
applicable to MBS. Under the proposed regulation, this ratio will be 
applied to the CEAs of these contracts. The proposed regulation 
provides a relatively lower ratio for exposures that are collateralized 
than for those that are not collateralized. However, the proposed 
regulation does not distinguish between different types of 
counterparties. The minimum capital amount associated with interest 
rate and foreign exchange rate contracts under the proposed regulation 
is not expected to be substantially different than it is under the 
interim procedures.
Risk of MBS

    In developing the proposed regulation, OFHEO analyzed the relative 
risk of interest rate and foreign exchange rate contracts as compared 
with MBS. The source of credit risk of MBS to the Enterprises is the 
risk of defaults and losses on the underlying mortgages. Guarantee fees 
provide a continuing source of income to offset these losses.
    The aggregate risk associated with the Enterprises' underlying 
mortgages is low because the Enterprises have--
     Very broad geographic diversification;
     Strict and consistent mortgage underwriting standards; and
     Requirements for minimum initial collateralization of 125 
percent (i.e., maximum 80 percent loan-to-value ratio) or supplemental 
mortgage insurance, as well as increasing levels of collateralization 
as loans amortize and property values increase.
    Neither Enterprise has experienced a net credit loss on its MBS. 
Annual losses to date have ranged from two basis points to ten basis 
points (expressed as a percentage of the outstanding portfolio) and 
have been easily covered by guarantee fee income, which has ranged from 
20 to 25 basis points.

Risks of Interest Rate and Foreign Exchange Rate Contracts

    The Enterprises limit the credit risk of interest rate and foreign 
exchange rate contracts by restricting their business to high quality 
counterparties and adjusting collateral requirements on the basis of 
the current replacement cost and counterparty credit quality of 
interest rate and foreign exchange rate contracts. Notwithstanding 
these limitations of risk, interest rate and foreign exchange rate 
contracts entail the following risks beyond those of MBS:
     Large swings in market rates, on which interest rate and 
foreign exchange rate contracts are based, may simultaneously increase 
exposure to, and risk of default by, one or more counterparties, which 
are typically financial firms.
     While losses may be infrequent, systemic problems could 
cause disproportionately high losses when they do occur.
     Counterparty risk is concentrated. The loss resulting from 
the default of a single counterparty could be many times larger than 
the amount of capital that would be associated with the application of 
a 0.45 percent capital ratio.
     The interest rate and foreign exchange rate contracts 
market is [[Page 30204]] comparatively new; therefore, the functioning 
of this market is less predictable in terms of operational and legal 
risk.
     Interest rate and foreign exchange rate contract exposures 
are not as fully-collateralized as are the mortgages underlying the 
Enterprises' MBS.
     There is no current stream of fee income to offset losses 
on interest rate and foreign exchange rate contracts associated with 
counterparty failures.
    The effect of these differences is difficult to quantify. 
Derivative markets are relatively new. While the Enterprises have not 
experienced any losses on interest rate or foreign exchange rate 
contracts, recent losses by major participants make clear that the 
unexpected, sudden failure of a financial firm that is a counterparty 
is a risk that must be seriously considered.
    Based on a weighing of these factors, the proposed regulation 
applies a higher ratio to the CEAs of interest rate and foreign 
exchange rate contracts than to MBS. The proposed regulation applies a 
ratio of 3.00 percent to uncollateralized exposure and a ratio of 1.50 
percent to collateralized exposure. OFHEO believes that the proposed 
regulation will encourage prudent management of counterparty risk by 
reducing the capital requirement by half to the extent a counterparty 
posts collateral that qualifies under the Guidelines. This approach is 
consistent with a minimum capital level that focuses on the general 
risk characteristics of instruments rather than the credit quality of 
third parties.
    The proposed regulation continues to allow the Enterprises to 
recognize the risk-reducing benefits of qualifying bilateral netting 
contracts. As under the interim procedures, the Enterprises are allowed 
to net positive and negative mark-to-market values of interest rate and 
foreign exchange rate contracts in the determination of the current 
exposure portion of the CEA.\19\

    \19\ Proposals by the Comptroller of the Currency (59 FR 45243, 
Sept. 1, 1994) and the Board of Governors of the Federal Reserve 
System (59 FR 43508, Aug. 24, 1994) would make other changes to the 
Guidelines. First, they would increase the number of credit 
conversion factors that are used to measure the potential future 
exposure, subjecting contracts with longer maturities to higher 
factors. Second, they would set new credit conversion factors for 
contracts related to equities, precious metals, and other 
commodities. (These are not currently relevant to the Enterprises.) 
Finally, they would change the way that potential future exposure is 
calculated when the contracts are subject to a qualifying bilateral 
netting agreement, resulting in a reduction in the amount of capital 
required for the netted interest rate and foreign exchange rate 
contracts.
    OFHEO will continue to review the progress of the banking agency 
proposals which permit similar risk-reducing benefits of netting in 
the calculation of potential future exposure and which address other 
issues identified in this proposal. OFHEO will make a determination 
of the appropriateness of the inclusion of these changes in the 
minimum capital regulation if and when these banking agency 
proposals become effective.
    In developing this proposal, OFHEO compared the results of the 
application of the interim procedures and the proposed regulation with 
respect to interest rate and foreign exchange rate contracts. For each 
of the past five quarters, OFHEO determined the weighted average 
capital ratio that resulted from the application of the interim 
procedures for all interest rate and foreign exchange rate contracts. 
The weighted average capital ratio for each Enterprise over this period 
ranged between 2.24 percent and 3.41 percent. Had the ratios in the 
proposed regulation been used, the average ratio for each Enterprise 
would have ranged from 2.32 percent to 3.00 percent. Thus, the 
application of the ratios in the proposed regulation will result in a 
minimum capital level roughly consistent with the minimum capital level 
under the interim procedures.
    OFHEO considered the argument that because MBS are accorded a much 
lower capital ratio by the Act than MBS under the Guidelines, 
consistency requires that interest rate and foreign exchange rate 
contracts be accorded a similarly lower ratio. Unlike the Enterprises, 
institutions subject to the Guidelines do not issue MBS that are fully 
guaranteed by the institutions. The Guidelines would apply the same 
capital ratio to MBS backed by the issuers' guarantees as is applied to 
mortgages held in portfolio. Banks' mortgage loans held in portfolio 
are considerably more risky than the mortgages underlying the 
Enterprises' MBS because they are not as well-diversified, on average 
have experienced higher loss rates, are not required to be as well-
collateralized, and are not protected by a stream of guarantee fee 
income.
    OFHEO has also considered the argument that OFHEO should establish 
a low minimum capital ratio for interest rate and foreign exchange rate 
contracts in recognition of the steps the Enterprises take to manage 
that risk. Further, OFHEO has considered the argument that OFHEO should 
apply different minimum capital ratios for interest rate and foreign 
exchange rate contracts based on the specific counterparty risk of the 
contract. OFHEO believes that these arguments are inconsistent with the 
purpose of minimum capital requirements. The proposed minimum capital 
regulation is designed to establish an essential amount of capital that 
an Enterprise, with given levels of outstanding business, must hold to 
address broad categories of risks. The minimum capital ratios should 
reflect risk inherent in types of instruments, not the Enterprises' 
current practices.

IV. Proposed Minimum Capital Regulation: Section-by-Section Summary

    The proposed regulation sets forth the minimum capital requirements 
that will replace the interim procedures currently in use. The proposed 
minimum capital regulation also establishes procedures for the filing 
of minimum capital reports by the Enterprises each quarter, or at other 
times as required by the Director. The proposed minimum capital 
regulation also requires OFHEO to provide each Enterprise with notice 
and opportunity to comment on its capital classification. A summary of 
the treatment of the on- and off-balance sheet items, the filing 
procedures, and the notice of capital classification follows.

On-Balance Sheet Assets

    The minimum capital ratio for on-balance sheet assets is specified 
in section 1362(a)(1) of the Act.\20\ That section establishes a 
minimum capital ratio equal to 2.50 percent of the aggregate on-balance 
sheet assets of the Enterprises determined in accordance with GAAP. The 
proposed regulation adopts that ratio.

    \20\ 12 U.S.C. 4612(a)(1).
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Mortgage-Backed Securities

    Section 1362(a)(2) of the Act \21\ establishes a minimum capital 
ratio of 0.45 percent of the unpaid principal balance of outstanding 
MBS and substantially equivalent instruments issued or guaranteed by 
the Enterprises that are not included in the on-balance sheet assets of 
the Enterprises. The proposed regulation adopts that ratio.

    \21\ 12 U.S.C. 4612(a)(2).
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Other Off-Balance Sheet Obligations

    Section 1362(a)(3) of the Act \22\ also establishes a minimum 
capital ratio of 0.45 percent for all other off-balance sheet 
obligations, except as adjusted by the Director to reflect the 
differences in the credit risk of those off-balance sheet obligations 
in relation to MBS and substantially equivalent instruments. The 
proposed regulation continues the interim treatment for three of the 
four major categories of off-balance sheet obligations: (1) commitments 
will require capital equal to 0.45 percent of 50 percent of the average 
dollar amount [[Page 30205]] of commitments outstanding each quarter 
over the preceding four quarters, (2) multifamily credit enhancements 
will require capital equal to 0.45 percent of the unpaid principal 
balance, and (3) sold portfolio remittances pending will require 
capital equal to 0.45 percent of the dollar amount.\23\ Any individual 
interest rate and foreign exchange rate contract or group of contracts 
subject to a recognized netting agreement will require capital equal to 
3.00 percent of the CEA, except to the extent that the Enterprises hold 
qualifying collateral. The portion of the CEA equal to the market value 
of the collateral for that contract or group of contracts will equal 
1.50 percent.

    \22\ 12 U.S.C. 4612(a)(3).
    \23\ Freddie Mac accounts for these funds held by seller-
servicers in custodial accounts separately from MBS until principal 
payments are passed on to MBS investors. Fannie Mae includes these 
custodial accounts in its MBS accounts.
Minimum Capital Report

    The proposed regulation requires that each Enterprise file with the 
Director of OFHEO a minimum capital report each quarter or at other 
times, as required by the Director. The report will contain the 
information required by OFHEO in written instructions to the 
Enterprise, including, but not limited to, an estimate of the minimum 
capital level and an estimate of core capital overage or shortfall 
relative to the estimated minimum capital level. The proposed 
regulation provides the Director flexibility to determine the specific 
items to be included in the minimum capital report. The proposed 
regulation also addresses the timing, certification, and amendment of 
the report. The information provided by each Enterprise in the minimum 
capital report will be used by OFHEO in determining the capital 
classification of the Enterprise.

Notice of Capital Classification

    Section 1368 of the Act 24 requires OFHEO to provide the 
Enterprises with notice of, and an opportunity to comment on, the 
proposed minimum capital classification. This proposed regulation 
provides that before OFHEO determines the capital classification of an 
Enterprise, OFHEO will provide the Enterprise with written notice of 
the proposed classification and a 30-day period during which each 
Enterprise may submit its views regarding the classification. The 
proposed regulation provides that OFHEO may extend the period for up to 
30 days and may shorten the period to less than 30 days if the Director 
determines that the condition of an Enterprise so warrants. Following 
the expiration of the response period, OFHEO will take into 
consideration any comments received from an Enterprise prior to issuing 
the final notice of capital classification.

    \24\ 12 U.S.C. 4618.
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Regulatory Impact

Executive Order 12606, The Family
    This proposed regulation does not have potential for significant 
impact on family formulation, maintenance, and general well-being, and 
thus, is not subject to review under Executive Order 12606.
Executive Order 12612, Federalism
    This proposed regulation has no federalism implications that 
warrant the preparation of a Federalism Assessment in accordance with 
Executive Order 12612.
Executive Order 12866, Regulatory Planning and Review
    This proposed regulation has been reviewed by the Office of 
Management and Budget pursuant to Executive Order 12866.
Unfunded Mandates Reform Act of 1995
    This proposed regulation does not include a federal mandate that 
may result in the expenditure by State, local, and tribal governments, 
in the aggregate, or by the private sector, of $100,000,000 or more 
(adjusted annually for inflation) in any one year. As a result, this 
proposed regulation does not warrant the preparation of an assessment 
statement in accordance with the Unfunded Mandates Reform Act of 1995.
Regulatory Flexibility Act
    This proposed regulation will not have significant economic impact 
on a substantial number of small entities.
Paperwork Reduction Act
    This proposed regulation contains no information collection 
requirements that require the approval of the Office of Management and 
Budget pursuant to the Paperwork Reduction Act of 1980, 44 U.S.C. 3501 
et seq.

List of Subjects in 12 CFR Part 1750

    Minimum capital, capital classifications.
    Accordingly, for the reasons set forth in the preamble, OFHEO 
proposes to amend Chapter XVII of Title 12 of the Code of Federal 
Regulations by adding Part 1750 to read as follows:

PART 1750--CAPITAL

Subpart A--Minimum Capital

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

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

Subpart B--[Reserved]

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

Subpart A--Minimum Capital


Sec. 1750.1  General.

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


Sec. 1750.2  Definitions.

    For purposes of this Subpart A, the following definitions shall 
apply.
    Act means the Federal Housing Enterprises Financial Safety and 
Soundness Act of 1992, found at Title XIII of the Housing and Community 
Development Act of 1992, Pub. L. No. 102-550, 12 U.S.C. 4501 et seq.
    Affiliate means any entity that controls, is controlled by, or is 
under common control with, an Enterprise, except as otherwise provided 
by the Director.
    Commitment means any contractual, legally binding arrangement that 
obligates an Enterprise to purchase mortgages for portfolio or 
securitization.
    Core Capital (1) means the sum of--
    (i) the par or stated value of outstanding common stock,
    (ii) the par or stated value of perpetual, noncumulative preferred 
stock,
    (iii) paid-in capital, and
    (iv) retained earnings; and
    (2) Does not include any amounts the Enterprise could be required 
to pay at the option of an investor to retire capital or debt 
instruments.
    Director means the Director of OFHEO.
    Enterprise means the Federal National Mortgage Association and any 
affiliate thereof or the Federal Home Loan [[Page 30206]] Mortgage 
Corporation and any affiliate thereof.
    Foreign exchange rate contracts means cross-currency interest rate 
swaps, forward foreign exchange contracts, currency options purchased, 
and any other instruments that give rise to similar credit risks.
    Interest rate contracts means single currency interest rate swaps, 
basis swaps, forward rate agreements, interest rate options purchased 
(including caps, collars and floors purchased), and any other 
instruments that give rise to similar credit risks (including when-
issued securities and forward deposits accepted).
    Mortgage-backed security means a security, investment, or 
substantially equivalent instrument that represents an interest in a 
pool of loans secured by mortgages or deeds of trust where the 
principal or interest payments to the investor in the security or 
substantially equivalent instrument are guaranteed or effectively 
guaranteed by an Enterprise.
    Multifamily credit enhancement means a guarantee by an Enterprise 
of the payments on a multifamily mortgage revenue bond issued by a 
state or local housing finance agency.
    Notional amount means the face value of the underlying financial 
instrument(s) on which an interest rate or foreign exchange rate 
contract is based.
    Off-balance sheet obligation means a binding agreement, contract, 
or similar arrangement that requires or may require future payment(s) 
in money or kind by another party to an Enterprise or that effectively 
guarantees all or part of such payment(s) to third parties, where such 
agreement or contract is a source of credit risk that is not included 
on its balance sheet.
    OFHEO means the Office of Federal Housing Enterprise Oversight.
    Other off-balance sheet obligations means all off-balance sheet 
obligations of an Enterprise that are not mortgage-backed securities or 
substantially equivalent instruments.
    Perpetual, noncumulative preferred stock means preferred stock that 
(1) does not have a maturity date, (2) provides the issuer the ability 
and the legal right to eliminate dividends and does not permit the 
accruing or payment of impaired dividends, (3) cannot be redeemed at 
the option of the holder, and (4) has no other provisions that will 
require future redemption of the issue, in whole or in part, or that 
will reset the dividend periodically based, in whole or in part, on the 
Enterprise's current credit standing, such as auction rate, money 
market, or remarketable preferred stock, or that may cause the dividend 
to increase to a level that could create an incentive for the issuer to 
redeem the instrument, such as exploding rate stock.
    Qualifying collateral means cash on deposit, securities issued or 
guaranteed by the central governments of the OECD-based group of 
countries,1 United States Government agencies, or United States 
Government-sponsored agencies, and securities issued or guaranteed by 
multilateral lending institutions or regional development banks.

    \1\ The OECD-based group of countries is comprised of all full 
members of the Organization for Economic Cooperation and Development 
(OECD), as well as countries that have concluded special lending 
arrangements with the International Monetary Fund (IMF) associated 
with the Fund's General Arrangements to Borrow. The OECD includes 
the following countries: Australia, Austria, Belgium, Canada, 
Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, 
Japan, Luxembourg, the Netherlands, New Zealand, Norway, Portugal, 
Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the 
United States. Saudi Arabia has concluded special lending 
arrangements with the IMF associated with the IMF's General 
Arrangements to Borrow.
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Sec. 1750.3  Procedures and timing.

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


Sec. 1750.4  Minimum capital level computation.

    (a) The minimum capital level for each Enterprise shall be computed 
by adding the following amounts:
    (1) 2.50 percent times the aggregate on-balance sheet assets of the 
Enterprise;
    (2) 0.45 percent times the unpaid principal balance of mortgage-
backed securities and substantially equivalent instruments that were 
issued or guaranteed by the Enterprise;
    (3) 0.45 percent of 50 percent of the average dollar amount of 
commitments outstanding each quarter over the preceding four quarters;
    (4) 0.45 percent of the outstanding principal amount of bonds with 
multifamily credit enhancements;
    (5) 0.45 percent of the dollar amount of sold portfolio remittances 
pending;
    (6) (i) 3.00 percent of the credit equivalent amount of interest 
rate and foreign exchange rate contracts except to the extent of the 
current market value of posted qualifying collateral, computed in 
accordance with Appendix A to this subpart;
    (ii) 1.50 percent of the credit equivalent amount of interest rate 
and foreign exchange rate contracts equal to the market value of posted 
qualifying collateral, computed in accordance with Appendix A to this 
subpart; and
    (7) 0.45 percent of the outstanding amount of other off-balance 
sheet obligations, excluding commitments, multifamily credit 
enhancements, sold portfolio remittances pending, and interest rate 
contracts and foreign exchange rate contracts, except as adjusted by 
the Director to reflect differences in the credit risk of such 
obligations in relation to mortgage-backed securities.
    (b) Any asset or financial obligation that can be properly 
classified in more than one of the categories enumerated in paragraphs 
(a)(1) through (7) of this section shall be classified in the category 
that yields the highest minimum capital level.
    (c) As used in this section, the term ``preceding four quarters'' 
means the last day of the quarter just ended (or the date for which the 
minimum capital report is filed, if different), and the three preceding 
quarter-ends.


Sec. 1750.5  Notice of capital classification.

    (a) Pursuant to section 1364 of the Act (12 U.S.C. 4614), OFHEO is 
required to determine the capital classification of [[Page 30207]] each 
Enterprise on a not less than quarterly basis.
    (b) The determination of the capital classification shall be made 
following a notice to, and opportunity to respond by, the Enterprise.
    (1) Not later than 60 calendar days after the date for which the 
minimum capital report is filed, OFHEO will provide each Enterprise 
with a proposed notice of classification in accordance with section 
1368 of the Act (12 U.S.C. 4618). The proposed notice shall contain the 
following information:
    (i) the proposed classification;
    (ii) the proposed minimum capital level; and
    (iii) the summary computation of the proposed minimum capital 
level.
    (2) Each Enterprise shall have a period of 30 calendar days 
following receipt of a proposed notice of classification to submit a 
response regarding the proposed classification. The response period may 
be extended for up to 30 additional calendar days at the sole 
discretion of the Director. The Director may shorten the response 
period with the consent of the Enterprise or without such consent if 
the Director determines that the condition of the Enterprise requires a 
shorter period.
    (3) The Director shall take into consideration any response to the 
proposed notice received from the Enterprise and shall issue a final 
notice of capital classification for each Enterprise not later than 30 
calendar days following the end of the response period in accordance 
with section 1368 of the Act (12 U.S.C. 4618).
Appendix A to Subpart A of Part 1750--Minimum Capital Level Components 
for Interest Rate and Foreign Exchange Rate Contracts

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

1. Interest Rate Contracts

    a. Single currency interest rate swaps.
    b. Basis swaps.
    c. Forward rate agreements.
    d. Interest rate options purchased (including caps, collars, and 
floors).
    e. Any other instrument that gives rise to similar credit risks 
(including when-issued securities and forward deposits accepted).

2. Foreign Exchange Rate Contracts

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

3. Calculation of Credit Equivalent Amounts

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

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

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

4. Avoidance of Double Counting

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

5. Collateral

    The sufficiency of collateral and guarantees for off-balance 
sheet items is determined by the market value of the collateral in 
relation to the credit equivalent amount. Collateral held against a 
netting contract is not recognized for minimum capital level 
purposes unless it is legally available to support the single legal 
obligation credit by the netting contract. The only forms of 
collateral that are formally recognized by the minimum capital level 
framework are cash on deposit in the bank; securities issued or 
guaranteed by the central governments of the OECD-based group of 
countries,1 United States Government agencies, or United States 
Government-sponsored agencies; and securities issued by multilateral 
lending institutions or regional development banks. Excess 
collateral held against one contract or a group of contracts for 
which a recognized netting agreement exists may not be considered.

    \1\ The OECD-based group of countries is comprised of all full 
members of the Organization for Economic Cooperation and Development 
(OECD), as well as countries that have concluded special lending 
arrangements with the International Monetary Fund (IMF) associated 
with the Fund's General Arrangements to Borrow. The OECD includes 
the following countries: Australia, Austria, Belgium, Canada, 
Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, 
Japan, Luxembourg, the Netherlands, New Zealand, Norway, Portugal, 
Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the 
United States. Saudi Arabia has concluded special lending 
arrangements with the IMF associated with the IMF's General 
Arrangements to Borrow.
6. Netting

    a. For purposes of this Appendix A, netting refers to the 
offsetting of positive and negative mark-to-market values in the 
determination of a current exposure to be used in the calculation of 
a credit equivalent amount. Any legally enforceable form of 
bilateral netting (that is, netting with a single counterparty) of 
interest rate contracts and foreign exchange rate contracts is 
recognized for purposes of calculating the credit equivalent amount 
provided that:
    i. The netting is accomplished under a written netting contract 
that creates a single legal obligation, covering all included 
individual contracts, with the effect that the Enterprise would have 
a claim to receive, or obligation to pay, only the net amount of the 
sum of the positive and negative mark-to-market values on included 
individual contracts in the event that a counterparty, or a 
counterparty to whom the contract has been validly assigned, fails 
to perform due to default, insolvency, liquidation, or similar 
circumstances.
    ii. The Enterprise obtains a written and reasoned legal 
opinion(s) representing that in the event of a legal challenge--
including one resulting from default, insolvency, liquidation, or 
similar circumstances--the relevant court and administrative 
authorities would find the Enterprise's exposure to be such a net 
amount under:

[[Page 30208]] --The law of the jurisdiction in which the 
counterparty is chartered or the equivalent location in the case of 
noncorporate entities, and if a branch of the counterparty is 
involved, then also under the law of the jurisdiction in which the 
branch is located;
--The law that governs the individual contracts covered by the 
netting contract; and
--The law that governs the netting contract.

    iii. The Enterprise establishes and maintains procedures to 
ensure that the legal characteristics of netting contracts are kept 
under review in the event of possible changes in relevant law.
    iv. The Enterprise maintains in its files documentation adequate 
to support the netting of rate contracts, including a copy of the 
bilateral netting contract and necessary legal opinions.
    b. A contract containing a walkaway clause is not eligible for 
netting for purposes of calculating the credit equivalent 
amount.2

    \2\ A walkaway clause is a provision in a netting contract that 
permits a non-defaulting counterparty to make lower payments than it 
would make otherwise under the contract, or no payment at all, to a 
defaulter or to the estate of a defaulter, even if the defaulter or 
the estate of the defaulter is a net creditor under the contract.
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    c. By netting individual contracts for the purpose of 
calculating its credit equivalent amount, the Enterprise represents 
that it has met the requirements of this Appendix A and all the 
appropriate documents are in the Enterprise's files and available 
for inspection by OFHEO. OFHEO may determine that an Enterprise's 
files are inadequate or that a netting contract, or any of its 
underlying individual contracts, may not be legally enforceable 
under any one of the bodies of law described in this Appendix A. If 
such a determination is made, the netting contract may be 
disqualified from recognition for minimum capital level purposes or 
underlying individual contracts may be treated as though they are 
not subject to the netting contract.
    d. The credit equivalent amount of rate contracts that are 
subject to a qualifying bilateral netting contract is calculated by 
adding the current exposure of the netting contract and the sum of 
the estimates of the potential future credit exposures on all 
individual contracts subject to the netting contract, estimated in 
accordance with section 3 of this Appendix A. Offsetting contracts 
in the same currency maturing on the same date will have lower 
potential future exposure as well as lower current exposure. 
Therefore, for purposes of calculating potential future credit 
exposure to a netting counterparty for foreign exchange rate 
contracts and other similar contracts in which notional principal is 
equivalent to cash flows, total notional principal is defined as the 
net receipts falling due on each value date in each currency.
    e. The current exposure of the netting contract is determined by 
summing all positive and negative mark-to-market values of the 
individual contracts included in the netting contract. If the net 
sum of the mark-to-market values is positive, then the current 
exposure of the netting contract is equal to that sum. If the net 
sum of the mark-to-market values is zero or negative, then the 
current exposure of the netting contract is zero. OFHEO may 
determine that a netting contract qualifies for minimum capital 
level netting treatment even though certain individual contracts may 
not qualify. In such instances, the nonqualifying contracts should 
be treated as individual contracts that are not subject to the 
netting contract.
    f. In the event a netting contract covers contracts that are 
normally excluded from the minimum capital level computation--for 
example, foreign exchange rate contracts with an original maturity 
of fourteen calendar days or less, or instruments traded on 
exchanges that require daily payment of variation margin--an 
Enterprise may elect consistently either to include or exclude all 
mark-to-market values of such contracts when determining net current 
exposure.

Subpart B--[Reserved]

    Dated: June 1, 1995.
Aida Alvarez,
Director, Office of Federal Housing Enterprise Oversight.
[FR Doc. 95-13913 Filed 6-7-95; 8:45 am]
BILLING CODE 4220-01-P