[Federal Register Volume 61, Number 157 (Tuesday, August 13, 1996)]
[Proposed Rules]
[Pages 42092-42127]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-19890]



[[Page 42091]]


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Part II





Farm Credit Administration





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12 CFR Part 613, et al.



Eligibility and Scope of Financing; Loan Policies and Operations; 
Funding and Fiscal Affairs, Loan Policies and Operations, and Funding 
Operations; General Provisions; Definitions; Disclosure to 
Shareholders; Nondiscrimination in Lending; Capital Adequacy and 
Customer Eligibility; Proposed Rule

  Federal Register / Vol. 61, No. 157 / Tuesday, August 13, 1996 / 
Proposed Rules  

[[Page 42092]]



FARM CREDIT ADMINISTRATION

12 CFR Parts 613, 614, 615, 618, 619, 620, and 626

RIN 3052-AB10


Eligibility and Scope of Financing; Loan Policies and Operations; 
Funding and Fiscal Affairs, Loan Policies and Operations, and Funding 
Operations; General Provisions; Definitions; Disclosure to 
Shareholders; Nondiscrimination in Lending; Capital Adequacy and 
Customer Eligibility

AGENCY: Farm Credit Administration.

ACTION: Proposed rule.

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

SUMMARY: The Farm Credit Administration (FCA) through the FCA Board 
(Board) publishes for comment proposed amendments (reproposed rule) to 
the current regulations governing the capital adequacy provisions and 
the customer eligibility provisions for Farm Credit System (Farm 
Credit, FCS, or System) institutions. This rule adds core surplus and 
total surplus standards for banks, associations, and the Farm Credit 
Leasing Services Corporation (Leasing Corporation); adds a collateral 
ratio for banks; and adds procedures for setting higher capital 
standards for individual institutions and for issuing capital 
directives, when warranted. This rule also incorporates recent 
statutory amendments to the Farm Credit Act of 1971, as amended (Act), 
which govern the eligibility rules for lending under title III of the 
Act and provide Farm Credit banks and associations new authorities to 
participate with non-System lenders in loans to similar entities. 
Subsequent to the closing of the comment period for the original 
proposal, the Farm Credit System Reform Act of 1996 (1996 Reform Act) 
was enacted, necessitating certain conforming changes in the rule. The 
reproposal eliminates restrictions in the current eligibility 
regulations that are not required by the Act and makes other technical, 
clarifying, and conforming changes. This rule relocates the 
nondiscrimination in lending regulations to a new part without change.

DATES: Written comments should be received on or before September 12, 
1996.

ADDRESSES: Comments may be mailed or delivered to Patricia W. DiMuzio, 
Associate Director, Regulation Development, Office of Examination, Farm 
Credit Administration, McLean, VA 22102-5090 or sent by facsimile 
transmission to FAX number at (703) 734-5784. Copies of all 
communications received will be available for examination by interested 
parties in the Office of Examination, Farm Credit Administration.

FOR FURTHER INFORMATION CONTACT:

Dennis K. Carpenter, Senior Policy Analyst, and John J. Hays, Policy 
Analyst, Office of Examination, Farm Credit Administration, McLean, VA 
22102-5090, (703) 883-4498, TDD (703) 883-4444,

      or

Rebecca S. Orlich, Senior Attorney, and Richard A. Katz, Senior 
Attorney, Office of General Counsel, Farm Credit Administration, 
McLean, VA 22102-5090, (703) 883-4020, TDD (703) 883-4444.

SUPPLEMENTARY INFORMATION: The FCA published proposed amendments to the 
capital provisions of its regulations for Farm Credit institutions on 
July 25, 1995. See 60 FR 38521. Proposed amendments to the eligibility 
and scope of financing provisions of its regulations were published on 
September 11, 1995. See 60 FR 47103. The 90-day comment periods expired 
on October 25 and December 11, 1995, respectively. The FCA received 
over 300 comment letters from a wide audience in response to these 
proposed amendments. In response to the concerns of the commenters, the 
FCA has decided to repropose the amendments. Additionally, the 
proposals regarding System capital adequacy and customer eligibility 
requirements have been combined in a single rulemaking.

I. Summary of the Reproposed Rule

    A. The capital provisions of the reproposed regulations incorporate 
the following provisions:
    1. The 7-percent total surplus ratio remains unchanged from the 
originally proposed regulations.
    2. The unallocated surplus ratio contained in the originally 
proposed rule has been renamed the core surplus ratio and has been 
expanded to include other equities that are perpetual in nature and 
function. The minimum core surplus ratio would remain at 3.5 percent 
and include an institution's:
     Undistributed earnings/unallocated surplus;
     Perpetual stock; and
     Nonqualified allocated equities.
    The aforementioned stock and equities could not be subject to an 
established practice or plan of retirement or distribution. For an 
association, the core surplus ratio would be calculated net of its net 
investment in its affiliated bank.
    3. The computation of the net collateral ratio for banks excludes 
the effect of market fluctuations on the value of eligible investments, 
and the minimum standard is revised from the 104-percent standard in 
the original proposal to 103 percent of total liabilities.
    4. The use of risk-sharing agreements or similar contractual 
arrangements would be permitted on a temporary basis as part of an 
association's initial effort to reach the 3.5-percent core surplus 
ratio. After building its core surplus to 3.5 percent, each association 
would be required to maintain capital at this level net of its bank 
investment.
    5. The remaining provisions of the originally proposed regulations 
setting forth procedures for establishing individual institution 
capital ratios and for issuing capital directives are reproposed in 
substantially the same form as originally proposed.
    B. The eligibility provisions applicable to title I and title II 
lenders have been substantially narrowed from the original proposal and 
incorporate the following changes:
    1. All bona fide farmers, ranchers, and aquatic producers or 
harvesters remain eligible to borrow from the FCS for any agricultural 
or aquatic purpose. However, the reproposed regulation imposes 
additional restrictions on System loans for other credit needs. Under 
this reproposal, non-resident foreign nationals, farm owners who do not 
engage in agricultural production or farm management, and only legal 
entities meeting certain farmer ownership and agricultural activity 
tests could not obtain FCS financing for non-agricultural business 
needs. The reproposed regulation, however, permits individuals who are 
citizens and permanent residents of the United States and certain legal 
entities to obtain limited FCS financing for a non-agricultural 
business purpose if they actively farm, ranch, or fish. Non-
agricultural business purposes could not exceed the market value of the 
borrower's agricultural assets. Under the reproposed regulation, active 
farmers could obtain System financing for their housing and domestic 
needs without restriction, but owners of agricultural land could borrow 
for their housing and domestic needs only in an amount that does not 
exceed the value of their agricultural assets. Non-resident foreign 
nationals could borrow for housing and domestic needs that are 
reasonably related to their agricultural operations. Finally, the FCA 
rescinds its original proposal to prohibit Farm Credit Banks (FCBs) and 
direct lender associations from extending credit to cooperatives and 
other entities that are eligible to borrow from a title III bank.

[[Page 42093]]

    2. The reproposed regulation would permit a legal entity to obtain 
financing for a processing or marketing operation only if a majority of 
ownership is held by eligible borrowers.
    3. The reproposed regulation clarifies that farm-related businesses 
can receive System financing only if they provide farm-related services 
that are directly related to the agricultural production of farmers and 
ranchers. No business activities unrelated to agriculture may be 
financed under this authority.
    4. The reproposed regulation pertaining to rural housing would 
repeal a provision in the existing regulation that permits System 
lenders to finance non-farm rural homes in open country that has been 
annexed by a municipality of more than 2,500 persons. The FCA also 
would withdraw its original proposal to permit System lenders to offer 
home equity lines of credit without limitation on the borrower's use of 
the credit proceeds.
    C. The reproposed regulations governing domestic and international 
lending by title III banks would implement the relevant provisions of 
the 1996 Reform Act and make other clarifying changes.
    D. The reproposed regulation pertaining to the authority to 
participate in loans made to similar entities reflects two significant 
changes from the proposed regulation. First, the reproposed regulation 
would rescind a restriction in the original proposal that would have 
enabled a System institution to participate only in those similar 
entity loans that were compatible with its lending authority. Second, 
this reproposal would delete the non-statutory out-of-territory 
concurrence requirement in the proposed rule.

II. Public Comments Received

    The FCA received 126 comments in response to the proposed capital 
adequacy regulations. Six were telephone inquiries from System 
institutions requesting clarification of specific provisions or 
providing general impressions of the proposed regulations. The FCA 
received 120 comment letters, including a comment letter from the 
System's Presidents' Finance Committee, which reflected the views of 
many System banks and associations (System joint comment). Of the 
remaining comments, three were from System banks (AgFirst FCB, Western 
FCB, and St. Paul Bank for Cooperatives (St. Paul BC)), one was from 
the Leasing Corporation, 37 were from System associations, 26 were from 
cooperatives that were borrowers/shareholders of a System bank, 46 were 
from borrowers/shareholders of a single agricultural credit association 
(ACA), five were from various state and national cooperative councils 
(the National Council of Farmer Cooperatives, the North Carolina State 
Grange, the Minnesota Association of Cooperatives, the Cooperative 
Council of North Carolina, and the Virginia Council of Farmer 
Cooperatives (VCFC)), and one was from the American Bankers Association 
(ABA) on behalf of its commercial bank members. In addition, several 
groups of System representatives made oral presentations of their views 
to Agency staff.
    These commenters supported the general goals of the proposed 
capital regulations. The System, in its joint comment, stated that it 
was prepared to embrace regulations that encourage the building of a 
sound capital structure in System institutions and that promote 
confidence in the System by borrowers/shareholders, investors, and the 
public. The commenters noted specific areas of agreement with the FCA 
on a number of requirements. As described more fully below, however, 
each of the commenters objected to various provisions of the proposal. 
The ABA supported the proposed regulations to the extent that they 
``stiffened'' capital requirements for System institutions but did not 
believe the proposal was sufficiently stringent.
    The 191 comments received on the eligibility proposals included 
letters from seven Farm Credit banks: the FCB of Wichita; AgFirst FCB; 
the St. Paul BC; CoBank, Agricultural Credit Bank (CoBank); AgAmerica, 
FCB; the FCB of Texas; and AgriBank, FCB. Letters were also received 
from 70 Farm Credit associations, 29 commercial banks, 13 credit 
unions, 17 trade associations, 45 System borrowers, six members of 
Congress, and four government agencies. Trade association commenters 
were: the Farm Credit Council (FCC) on behalf of the eight banks and 
approximately 230 associations comprising the FCS; the Tenth District 
Federation of Production Credit Associations (Tenth District PCAs) 
representing the 17 production credit associations (PCAs) in Louisiana, 
New Mexico, and Texas; the Western District FCC representing the System 
lenders in Arizona, California, Hawaii, Idaho, Nevada, and Utah; the 
ABA, the Independent Bankers Association of America (IBAA), the 
Community Bankers of Kansas, the North Dakota Bankers Association 
(NDBA), the South Dakota Bankers Association, the Community Bankers 
Association of North Carolina (CBANC), each representing their member 
banks; the Credit Union National Association, representing more than 
12,300 credit unions through their State league affiliates; the New 
York Credit Union League, the North Dakota Credit Union League (NDCUL), 
the Indiana Credit Union League, each on behalf of their member credit 
unions; the VCFC on behalf of 80 member cooperatives in Virginia; the 
Farmers' Legal Action Group, Inc. (FLAG), a non-profit law center of 
the National Family Farm Coalition, which represents 38 farm and rural 
advocacy organizations in over 30 States; and the Maine Potato Board 
(MPB).
    Letters from government agencies included the North Dakota 
Department of Agriculture; the Vermont Department of Agriculture, Food 
and Markets; the Ohio Department of Commerce, Division of Financial 
Institutions; and the Federal Reserve Board. Six of the letters 
received from members of Congress transmitted letters on behalf of 
their constituents.
    All of these commenters approved of the FCA's goals of 
consolidating, streamlining, and clarifying the eligibility 
regulations, and no commenter objected to regulatory relief for FCS 
banks and associations. Individual commercial banks, their trade 
associations, and FLAG, however, asserted that many of the proposed 
regulations exceed the FCA's objective of reducing regulatory burdens 
on the FCS and would expand System financing beyond the mandate of the 
Act. Some of these commenters recommended that the FCA withdraw the 
proposed eligibility regulations and refer these issues to Congress for 
hearings on rural credit.

III. The Reproposed Rule

    After considering the comments received on the proposed regulations 
and further deliberating on the issues, the FCA reproposes a rule 
governing capital adequacy and customer eligibility for FCS financing 
as one. The FCA responds to the specific concerns of the commenters as 
it explains the provisions of the reproposal.

A. Core Surplus Ratio Capital Standard

    The FCA originally proposed that institutions have unallocated 
surplus of at least 3.5 percent of risk-weighted assets. For this 
purpose, unallocated surplus included common stock and noncumulative 
perpetual preferred stock held by nonborrowers, provided that the 
institution adhered to a policy of not retiring the stock. For 
associations, the net investment in the affiliated bank would have been 
subtracted from the unallocated surplus.

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    A number of respondents (primarily agricultural cooperatives, 
cooperative councils, System associations, and association borrowers) 
commented on the proposed unallocated surplus ratio. They challenged 
the concept of differentiating between allocated and unallocated 
capital on the ground that it created a bias against cooperative 
principles. They argued that patron ownership, as characterized by 
allocated capital, provides the same protection to the institution as 
unallocated capital and should not be given a lower priority. Borrowers 
from the System that were themselves cooperatives expected this 
requirement of the originally proposed regulation to result in lower 
patronage distributions and, accordingly, to increase the effective 
interest rates of their loans. They were concerned that the regulations 
conveyed a message that allocated capital is of lower quality than 
unallocated. These groups provided the following comments:
     Allocated and unallocated capital provide the same level 
of institution protection.
     Cooperative principles are diluted if patron ownership is 
discouraged. Cooperative principles encourage matching of current 
earnings or losses with current patrons through earnings or loss 
distributions and discourage accumulation of high levels of unallocated 
capital. Unallocated surplus as defined in the proposed regulation 
would conflict with these principles.
     Subchapter T tax treatment under the Internal Revenue Code 
could be threatened if significant levels of earnings are diverted to 
unallocated surplus. The commenters viewed this as being detrimental to 
capital accumulation in the System and believed that such a treatment 
could result in double taxation of System earnings.
    The commenters countered the FCA's statement that unallocated 
surplus provides a buffer to protect owners of allocated capital by 
stating that cooperative principles promote sharing the risks and 
rewards of the organization with patrons. Furthermore, some respondents 
stated that retaining substantial earnings that could otherwise be 
distributed to patrons might cause some business to move to 
competitors.
    Forty-six (46) comments on this issue were from borrowers/
shareholders of a single ACA. These borrowers expressed their view that 
the proposed unallocated surplus ratio requirement would greatly reduce 
patronage in their association. They objected to this result, stating 
that patronage allocations save taxes, enable the association to build 
capital, and have encouraged many borrowers who left their association 
in the 1980s to return.
    Several of the associations and a bank suggested that all of the 
allocated surplus be counted in the 3.5-percent surplus requirement. 
However, some of the commenters also acknowledged that the FCA might be 
reluctant to include the entire amount of allocated equities and, 
therefore, suggested, at a minimum, counting nonqualified allocated 
equities. Nonqualified allocated equities are patronage allocations on 
which the institution generally pays no cash to patrons at the time of 
the allocation and which are included in the institution's taxable 
income. Should the institution make distributions of the allocations to 
the patrons/borrowers at some future date, the patrons/borrowers 
recognize taxable income at that time, and the institution may then 
recapture a substantial portion, if not all, of the taxes paid 
previously. One System association commented that nonqualified 
allocated surplus ``carries a much lower degree of sensitivity with 
members because they do not incur any tax liability until it is 
revolved.'' Numerous commenters, including the System in its joint 
comment, made similar statements regarding borrowers' reduced 
expectations of distributions with respect to nonqualified allocated 
equities.
    Two commenters described classes of stock that they believe merit 
treatment as unallocated surplus. One association described a class of 
non-voting stock it has issued as patronage, rather than in connection 
with making a loan to a borrower. The association asserted that, 
because no shares have ever been retired, the stock has the same 
features of permanence and stability as unallocated surplus and thus 
should be included in the unallocated surplus ratio calculation. The 
association stated that it has informed the recipients of the stock 
that the stock will not be retired except in the unlikely event of 
liquidation of the association and that the value of the stock springs 
from the prospect of dividends that may be paid in the future, not from 
the prospect of retirement. The Leasing Corporation also asserted that 
the Class A stock and the Class C stock it has issued to Farm Credit 
banks have features of permanence and should likewise be included in 
the unallocated surplus ratio. Class A stock totaling $1.7 million is 
held equally by all Farm Credit banks, and such stock has been retired 
only in connection with bank mergers. Class C stock is issued and 
retired based on the amount of the net lease investments allocated to 
each bank.
    Many System banks and associations objected to the requirement that 
an association deduct its net investment in its affiliated bank when 
computing its unallocated surplus ratio calculation. The following is a 
summary of the comments made by the commenters:
     The proposal would reduce the amount of earnings on which 
taxes could be minimized.
     The proposal could result in the elimination of noncash 
patronage distributions and provide an undesirable incentive to operate 
at or just above cost for the institutions. This could damage the 
financial position of the entire System.
     The proposal violates the provisions of the Farm Credit 
Banks and Associations Safety and Soundness Act of 1992 (1992 
amendments) and is contrary to the FCA Board's policy statement on 
regulatory burden.
     A significant tax consequence will be incurred and reduced 
retained earnings will result because of some possible future financial 
difficulty. This does not make good business sense.
     There is no evidence that the potential increased tax 
liability is offset by any safety and soundness benefits.
    A number of commenters qualified their assertions that bank-equity 
assets should be included in an association's unallocated surplus ratio 
calculation. For example, one commenter stated that bank-equity assets 
should be counted as the same quality as other investments if the 
``control issue'' were adequately addressed. Another commenter stated 
that there is no evidence that accumulating earnings at the bank has a 
negative impact on association survival, as long as earnings remain 
accessible to the association.
    The System in its joint comment proposed an alternative method for 
calculating the unallocated surplus ratio for associations. It proposed 
that an association be permitted to count the after-tax value of its 
investment in its funding bank, so long as the bank would continue to 
meet all regulatory capital standards after a pro forma retirement of 
the association's allocated investment. Only if the bank would fail to 
meet one or more capital requirements, would the association be 
required to deduct the entire value of its allocated bank investment.
    Several institutions also suggested that a portion of the 
investment in the bank be deducted from the unallocated surplus and the 
rest of the investment be deducted from the allocated surplus. This 
would, according to the commenters, accomplish what they

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described as the FCA's goal of requiring adequate capital that is 
``interchangeable'' or ``fungible.''
    In response to all of these comments, the FCA has made a number of 
revisions in the reproposed rule. The term ``unallocated surplus 
ratio'' has been replaced with the term ``core surplus ratio,'' and the 
types of equities or accounts that may be included in the ratio have 
been expanded. The core surplus ratio minimum is 3.5 percent of the 
risk-adjusted asset base, unchanged from the minimum in the originally 
proposed rule, and includes all of the equities in the proposed rule's 
unallocated ratio, which are: Unallocated surplus, perpetual common 
stock held by non-borrowers, and noncumulative perpetual preferred 
stock held by non-borrowers, provided that the institution has no 
established plan or practice of retiring such stock. Core surplus 
includes three additional categories of equities or accounts that are 
considered by the FCA to be as permanent and stable as unallocated 
surplus. These equities or accounts are:
    1. Nonqualified patronage allocations, allocated to institution 
borrowers other than other System institutions, made from earnings that 
the institution has included in its gross taxable income at the time of 
allocation and that are not subject to distribution according to an 
established plan or practice. An institution operating on a Subchapter 
T basis would not be able to take a tax deduction for these allocations 
until they are distributed, at which time the tax liability would be 
passed to the recipient. In the event that a nonqualified patronage 
allocation is distributed, other than as a part of a pro rata 
distribution of all nonqualified allocations that were allocated in the 
same year, any remaining nonqualified allocations allocated in the same 
year will be disallowed from treatment as core surplus.
    2. Perpetual stock held by borrowers other than other System 
institutions that was not purchased as a condition of obtaining a loan, 
provided that the institution has no established plan or practice of 
retiring the stock. In the event that any such stock is retired other 
than on a pro rata basis, all other stock of the same class or series 
that was issued in the same year that the retired stock was issued will 
be disallowed from treatment as core surplus.
    3. Newly developed or modified capital instruments or balance sheet 
entries or accounts that the FCA determines are the functional 
equivalent of a component of core surplus. The FCA may permit one or 
more System institutions to include all or a portion of such 
instrument, entry, or account as core surplus, permanently or on a 
temporary basis.
    The reproposed rule also provides that, with respect to equities 
that are included in core surplus, if the FCA finds that a particular 
equity has characteristics or terms that diminish its contribution to 
an institution's ability to absorb losses, the FCA may require the 
deduction of all or a portion of such equity from core surplus.
    The purpose of the conditions pertaining to retirement and 
distribution of equities held by borrowers is to assure that amounts 
treated as core surplus are not retired, canceled, or applied against a 
borrower's indebtedness on a defaulted loan or at the request of 
individual borrowers. These conditions would not prevent an institution 
from exercising its statutory right to make such retirements or 
cancellations. However, should such retirements or cancellations occur, 
the remaining allocated amounts and stock could not be counted in the 
core surplus ratio. They could, however, continue to be counted in the 
total surplus ratio and permanent capital of the institution. The 
conditions placed on the equities' inclusion in core surplus merely 
recognize that this practice negates the desired stability features of 
these types of equities. The provision would not apply to borrower 
equities canceled in connection with a restructured loan, if an 
association is required to cancel the equities pursuant to section 
4.14B of the Act. If an association is statutorily required to cancel 
the equities, the remaining equities of the same class or series and 
issued in the same year as the canceled stock or equities will continue 
to be treated as core surplus.
    The core surplus requirement would replace the current requirement 
in Sec. 615.5330 that the BC and the agricultural credit bank (ACB) add 
at least 10 percent of net earnings after taxes to unallocated surplus 
until the unallocated surplus ratio reaches half of the minimum 
permanent capital requirement.
    The reproposed rule adds a definition of ``perpetual stock or 
equity'' as stock or equity that does not have a maturity date, cannot 
be redeemed at the option of the holder, and has no other provisions 
that will require the future redemption of the issue.
    The FCA continues to believe that institutions need a certain 
amount of capital that is not subject to regular distribution or 
retirement according to an established plan or practice. It is the 
FCA's position that such capital is necessary to protect institutions 
during periods of stress, which are part of the cyclical nature of the 
System institutions' business. In addition, System institutions are 
vulnerable to industry-wide or regional problems due to the high 
concentrations of certain commodities and loan volume in the 
agricultural sector. Consequently, in the reproposed rule the Agency 
excludes from the core surplus ratio any allocated equities that the 
recipient has included in his or her gross income and that the 
recipient can reasonably expect the institution to revolve in the near 
future.
    The FCA is persuaded that the included types of equities are 
sufficiently permanent and stable and should qualify as core surplus 
when: No tax liability has yet been incurred by the recipient, there is 
no plan or practice of distributing or retiring them on an established 
or fixed basis, and there is no reasonable expectation by the recipient 
regarding when the equities will be distributed or retired. Several 
System institutions have issued such stock or nonqualified allocations. 
In those cases where the borrowers have been notified of such 
allocations, it is the FCA's understanding that the institutions have 
informed their borrowers that such equities may only be distributed or 
stock retired, if ever, at an unspecified date in the future and solely 
at the discretion of the institution's board of directors. None of 
these equities have been retired by the institutions, and, as one such 
institution stated, there is a much lower degree of ``sensitivity'' 
with members because they do not incur tax liability until the equity 
is revolved.
    The FCA believes that permitting the inclusion of nonqualified 
equities meeting the reproposed rule's distribution conditions would 
eliminate most of the disincentives believed by several commenters to 
be embedded in the originally proposed rule for an institution to 
operate on a Subchapter T basis. The FCA believes that the revisions in 
the reproposed rule strike the appropriate balance between cooperative 
principles and safety and soundness objectives. The reproposed rule 
permits an institution to allocate its patronage-based income (using 
nonqualified allocations) and increase its core surplus ratio at the 
same time.
    Although the reproposed rule does not limit the amount of 
nonqualified allocations that can be included in the core surplus, the 
FCA expects that institutions would retain a healthy portion of the 
core surplus in unallocated surplus. This completely uncommitted 
capital is especially important to the institution during periods of 
stress, when operating losses or provisions to the allowance for loan

[[Page 42096]]

losses may result. Accordingly, should the regulations be adopted, 
future FCA examinations would include an assessment of the composition 
of core surplus, which will be reflected in the evaluation of the 
institution's capital and operating performance.
    The Class A stock issued by the Leasing Corporation and held by 
Farm Credit banks would qualify as core surplus. Class A stock 
represents the owner Farm Credit banks' initial investment in the 
Leasing Corporation, and retirement has occurred only with bank 
mergers. This stock has demonstrated a high degree of permanence and 
exhibits similar attributes to unallocated surplus. Accordingly, it 
would be eligible to satisfy the 3.5-percent core surplus and the 7-
percent total surplus requirements. The Leasing Corporation's Class C 
stock, however, represents stock purchased by the owner banks based on 
lease activity in their respective trade/geographic territories. As a 
result, Class C stock fluctuates with lease volume (much the same as 
the level of borrower stock in associations fluctuates with the amount 
of outstanding loans), and the stock level is adjusted quarterly. Due 
to steadily increasing lease volume, Class C stock has increased over 
the past 5 years. Since Class C stock fluctuates with lease volume, 
however, it does not, as currently structured, have the stability and 
permanence attributes of surplus and consequently cannot be included in 
either surplus ratio.
    The reproposed rule requires deduction of the association's net 
investment in its funding bank from core surplus for the purpose of 
computing the core surplus ratio for associations. This provision is 
unchanged from the proposed rule. The FCA required this deduction 
because of its strong belief that the retention of at least a minimum 
amount of capital that is not invested in (and therefore at risk and 
controlled by) the association's funding bank is critical to the 
financial health and autonomy of an association. When capital is 
retained at the bank, it is vulnerable to losses due to bank 
operations, as well as assistance programs for troubled associations in 
the district, and these are matters beyond the association's control. 
In a circumstance where most or all of the associations in a district 
become stressed, their investments in the bank could become most 
vulnerable at the time they are most needed.
    The FCA considered proposals of commenters, including the proposals 
in the System's joint comment, to revise the calculation in the 
proposed rule to include a portion of the net investment in the bank. 
These proposals do not provide assurance that the association would be 
able to survive independently in the event of a bank's financial 
adversity or failure. Because one of the primary reasons for 
establishing the minimum core surplus requirement is to assure 
association access to stable capital at all times, the commenters' 
proposals do not fully achieve the purpose of the core surplus ratio 
standard. The FCA believes that the ``control issue'' cannot be 
adequately addressed.
    Further, an association cannot have guaranteed access to its 
investment in the bank without the occurrence of a taxable event, the 
very situation some commenters seek to avoid by accumulating earnings 
at the bank.
    The FCA does not favor the commenters' proposal to deduct the net 
investment in the bank partly from the core surplus and partly from the 
total surplus of an association. The proposal does not meet the FCA's 
goal to ensure that each institution holds a minimum level of capital 
that is neither at risk at another System institution nor subject to 
expected regular revolvement to borrowers.
    As in the originally proposed rule, the reproposed rule will not 
permit inclusion of an association's net investment in its bank in the 
core surplus ratio calculation of either institution. The FCA has 
excluded the amount of the investment in the bank from both the bank's 
and the association's core surplus ratios because of the uncertainty of 
its accessibility by either institution. If an association were to 
fail, its investment in the bank would be offset against the bank's 
direct loan and thus eliminate that portion of capital on the bank's 
balance sheet. If the bank were to fail, the association's entire 
investment would become vulnerable to loss.
    The FCA does not agree with comments that the originally proposed 
unallocated surplus ratio computation, including deduction of the net 
investment in the bank, is inconsistent with the provisions of the 1992 
amendments to the Act. Those amendments provided that a bank and an 
association may, for the purpose of computing their permanent capital, 
agree on which institution could count as permanent capital the 
earnings of the bank that have been allocated to the association. The 
originally proposed rule did not make any changes to the permanent 
capital computation regarding the treatment of these allocated earnings 
to which the 1992 requirement relates, and neither would the reproposed 
rule. Measures such as the surplus ratios and the collateral ratio for 
banks are proposed to be added to better ensure the financial health of 
System institutions.
    Furthermore, as described below, the total surplus ratio 
computation would include the association's investment in the bank in 
either the association's or the bank's allocated surplus, in conformity 
with the institution's allotment agreement. As importantly, the 
investment is counted in the net collateral ratio for banks, a critical 
ratio reflecting liquidity and access to financial markets by the 
System as a whole, to the same extent that it is included in bank 
permanent capital. However, the FCA believes that a measurement of 
capital not committed to the borrower and not available to absorb loss 
at another System institution is needed to adequately evaluate the 
ability of a direct lender association to survive independently of its 
funding bank.
    The FCA notes that, despite some commenters' objections that the 
unallocated surplus ratio computation would inappropriately dissipate 
association capital by requiring that there be taxable earnings at the 
association level, nearly every taxable association in the System has 
had taxable earnings at the association level in the past 8 years. The 
FCA does not expect these associations to have to change their own 
capital adequacy plans significantly in order to achieve or maintain 
the minimum core surplus ratio standard (or, for that matter, the total 
surplus standard).
    One of the frequently cited objections to the core surplus ratio 
calculation--that the requirement would result in higher interest rates 
or lower patronage distributions to borrowers--would be the result of 
any requirement that an institution accumulate and retain additional 
capital. Nevertheless, the goals of an institution to provide the 
lowest possible prices or the highest possible patronage distributions 
must be balanced against the obligation to maintain necessary reserves. 
The FCA has concluded, based on its experience as the regulator of 
System institutions as well as its knowledge of the problems that other 
types of financial institutions have faced, successfully and 
unsuccessfully, that a certain amount of the highest quality of 
uncommitted, accessible capital is critical to the long-term health and 
survival of institutions. The FCA believes that strong core surplus 
capital levels are necessary to ensure a viable System and minimize 
risk to its creditors and investors, including shareholders.

[[Page 42097]]

    Under the reproposed rule, the core surplus ratio must be 
calculated by the institution as of each monthend as follows:
    The ratio numerator:
    Undistributed earnings/unallocated surplus (as defined in the FCA 
Call Report instructions);
    Plus: Certain perpetual common or noncumulative preferred stock 
(held by entities other than System institutions) that was not 
purchased as a condition of obtaining a loan, provided that the 
institution has no established plan or practice of retiring the stock;
    Plus: Nonqualified patronage allocations held by persons or 
entities other than other System institutions, provided that the 
institution has no established plan or practice of retiring such 
nonqualified patronage;
    Less: For associations only, the net investment in its affiliated 
bank, which is--
    Total investment in bank:
    Less: Investment in association by bank;
    Less: Agency/servicing investment in bank;
    Less: Participations investment in bank;
    Divided by--
    The ratio denominator:
    Risk-adjusted asset base per the permanent capital regulations, 
excluding the net impact of unrealized gains or losses on available-
for-sale securities;
    Less: For associations only, the net investment in its affiliated 
bank.

B. Total Surplus Ratio

    The FCA originally proposed a requirement that each institution 
hold at least 7-percent total surplus, adjusted according to the 
permanent capital allotment agreement. Total surplus included the 
capital treated as unallocated surplus for the proposed unallocated 
surplus ratio, as well as certain allocated equities and stock.
    No specific objections to the total surplus ratio were received. 
Accordingly, the total surplus ratio minimum of 7 percent of the risk-
adjusted asset base and calculation of the ratio are reproposed without 
substantive change from the proposed rule. Equities that could be 
included in this ratio would be all of those equities that are included 
in core surplus for the core surplus ratio, as well as: (1) Allocated 
surplus and stock subject to a discretionary revolvement plan of 5 
years or more; and (2) term stock with an original maturity of at least 
5 years which is not retirable prior to its maturity (reduced by 20 
percent in each of the last 5 years of the life of the instrument). 
Double-counting of capital would be eliminated according to applicable 
allotment agreements.
    The calculation of the total surplus ratio, calculated by the 
institution as of each monthend with a minimum requirement of 7 
percent, is as follows:
    The ratio numerator:
    Undistributed earnings/unallocated surplus per FCA Call Report;
    Plus: Certain perpetual common or noncumulative perpetual preferred 
stock not purchased as a condition of obtaining a loan;
    Plus: Certain nonqualified and qualified allocated equities;
    Plus: Term stock with an original maturity of at least 5 years;
    Less: For associations only, an amount equal to the amount of 
allocated bank equities counted as permanent capital by the bank;
    Less: For banks only, an amount equal to the amount of bank 
equities counted as association capital.
    Divided by--
    The ratio denominator:
    Risk-adjusted asset base per the permanent capital regulations, 
excluding the net impact of any unrealized gains or losses on 
available-for-sale securities;
    Less: For associations only, allocated bank equities counted as 
permanent capital by the bank;
    Less: For banks only, an amount equal to the amount of bank 
equities counted as association capital.

C. Collateral Ratio

    The FCA originally proposed that all System banks should maintain a 
net collateral ratio of 104 percent of eligible assets (described in 
existing Sec. 615.5050), less an amount equal to the amount of bank 
equities counted as association permanent capital, divided by total 
liabilities.
    The FCA received numerous comments regarding the originally 
proposed 104-percent net collateral ratio requirement. All of the 
commenters on this issue took exception to the 104-percent level, 
asserting that the 103-percent level established by the System's Market 
Access Agreement (MAA) was sufficient. Commenters further asserted that 
the FCA had endorsed the MAA. They alleged that the higher regulatory 
requirement was inconsistent with the FCA's ``endorsement'' of MAA.
    One commenter expressed concern that the 104-percent collateral 
ratio requirement was counterproductive to building capital at the 
association level. This commenter stated that the thrust of the FCA's 
proposed rule was to encourage associations to build higher levels of 
capital. However, the high bank collateral requirement would result in 
the banks accumulating more capital through higher direct loan rates, 
which would reduce the association's ability to be competitive and 
accumulate higher levels of capital.
    The System's joint comment highlighted several perceived weaknesses 
in the wording of the originally proposed collateral requirement. 
Specifically, it said that the proposed rule incorrectly referred to a 
``collateral position'' required by FCA regulations and the Act. The 
System pointed out that neither Sec. 615.5050 nor the Act uses the term 
``collateral position'' but rather compares certain assets defined as 
collateral with certain obligations requiring collateralization. The 
System added that the proposed regulation ``incorrectly'' used total 
liabilities as the denominator, rather than ``obligations requiring 
collateralization.'' The System recommended revising the proposed net 
collateral ratio definition to explicitly eliminate the application of 
FAS No. 115, in accordance with a statement in the proposed rule's 
supplementary information that the effect of FAS No. 115 was intended 
to be excluded from all of the proposed ratios. FAS No. 115 is a 
statement of generally accepted accounting principles (GAAP) requiring 
financial statements to include the net effect of unrealized gains and 
losses resulting from available-for-sale securities.
    The FCA notes that its approval of the System banks' MAA did not 
constitute, and should not be interpreted as, a restriction on the 
FCA's authority to establish appropriate minimum capital or collateral 
standards. Moreover, any comparison of the rule's collateral ratio 
standard to the 103-percent collateral level in the MAA or the 
collateral calculation that is set forth for funding purposes in 
Sec. 615.5050 is inappropriate because the standards are calculated 
differently. The MAA standards and funding requirement do not include a 
deduction for a bank's equities that are not counted as permanent 
capital by that bank according to its allotment agreement. The 
reproposed rule's collateral standard would require this deduction. 
Furthermore, the rule's denominator is total liabilities, not 
``collateralized debt obligations'' as currently required by the MAA 
and Sec. 615.5050.
    The FCA reproposes a net collateral ratio requirement with 
substantially the same calculation as in the originally proposed rule. 
The FCA believes that the net collateral ratio in this rule would be a 
more precise measure of the

[[Page 42098]]

financial health of System banks than the collateral ratio in the MAA. 
A collateral ratio net of any bank assets counted as permanent capital 
by associations eliminates the double-leveraging of capital in System 
institutions. Using total liabilities as the denominator instead of 
``collateralized obligations'' makes the ratio more meaningful as a 
safety and soundness measure and prevents a bank from leveraging its 
balance sheet by obtaining funds from non-System sources, which are not 
classified as ``collateralized obligations.'' The FCA strongly believes 
that the net collateral ratio is a critical measure of financial health 
and provides an early measure of a bank's ability to obtain funds from 
the market place. Severe safety and soundness concerns arise if 
sufficient collateral is not available for banks to offer investors who 
purchase System debt instruments. The net collateral ratio in this rule 
is intended to provide an early ``tripwire'' to help avoid such severe 
situations.
    The FCA reproposes a minimum net collateral ratio standard of 103 
percent, reduced from the 104-percent requirement in the originally 
proposed rule. In light of the increased capital requirements of the 
two surplus standards for both banks and associations that the FCA is 
reproposing, a collateral standard of 103 percent will be sufficient in 
most cases to ensure the maintenance of a minimum level of protection 
and implementation of supervisory measures should market forces cause a 
decline in the underlying value of collateral. This standard generally 
provides additional assurance that a bank will maintain sufficient 
collateral for continued access to capital markets, because the System 
banks' MAA does not limit access to the capital markets until a bank's 
collateral ratio, as defined in the MAA, drops below 102 percent.
    The reproposed rule's net collateral requirement provides an 
earlier trigger for supervisory involvement than the MAA computation or 
the collateral requirement for funding purposes. It would provide a 
level of protection for operating and other forms of risk at the bank, 
and it is similar to the leverage ratios required by other regulators.
    The FCA has determined that the exclusion of the effect of FAS No. 
115 from the computation of the net collateral ratio could result in a 
differential treatment of eligible investments, according to whether 
they are designated as available for sale or held to maturity. Under 
Sec. 615.5050, a bank's entire investment portfolio must be valued at 
the lower of cost or market. Accordingly, applying the exclusion of the 
effect of FAS No. 115 will not negate the effect of temporary 
fluctuations in the market value against a bank's entire investment 
portfolio, because unrealized holding gains and losses under FAS No. 
115 apply only to the portion of a bank's investments classified as 
available for sale, not to investments classified as held to maturity. 
To ensure that the objective of this ratio is uniformly attained, the 
reproposed rule would require all eligible investments held by a bank 
to be valued based on their amortized costs for the purposes of 
calculating its net collateral ratio.
    Under the reproposed rule, the net collateral ratio is calculated 
as follows:
    The ratio numerator is a bank's net collateral, which equals:
    A bank's total eligible collateral as defined by Sec. 615.5050 
(except that eligible investments as described in Sec. 615.5140 are to 
be valued at their amortized cost),
    Less: An amount equal to that portion of the allocated investments 
of affiliated associations that is not counted as permanent capital of 
the bank.
    Divided by--
    The ratio denominator, which equals:
    The bank's total liabilities.

D. Compliance Issues

    The originally proposed rule required institutions below applicable 
minimum surplus and collateral standards to develop and submit a 
capital plan acceptable to the FCA for achieving minimum standards. An 
association below the unallocated surplus standard on the effective 
date of the rule had the option of including a Risk-Sharing Agreement 
with its affiliated bank as part of its capital plan. An association 
falling below the minimum standard after the rule's effective date 
could include a Risk-Sharing Agreement only with FCA approval. 
Institutions meeting the goals of FCA-approved capital plans would be 
deemed to be in compliance with minimum surplus and collateral 
standards. In addition, the FCA sought comment on whether the Risk-
Sharing Agreement should be a permanent option for associations.
    Two issues pertaining to compliance were raised by commenters. The 
first issue concerned how much time institutions will have to come into 
compliance with the ratios. The originally proposed rule required an 
institution not meeting applicable surplus or collateral requirements 
to submit to the FCA a capital plan for achieving and maintaining the 
standards, with appropriate annual progress toward meeting the 
standards. In the supplementary information to the proposed rule, the 
FCA stated that it expected capital plans submitted by institutions 
below the minimum surplus or collateral requirements to include a 
reasonable timeframe for achieving the minimum surplus or collateral 
standards.
    The St. Paul BC expressed significant concern about the 
``subjective nature'' of the reasonable timeframe ``requirement'' for 
achieving the minimum capital standards. The BC stated that a timeframe 
set by the FCA could restrict the bank from adequately serving its 
membership, require the accelerated restructuring of the balance sheet 
(apparently by having to reduce assets), and require a significant 
amount of patronage earnings to be retained as unallocated surplus. The 
BC said that the impact would be to: (1) Reduce earnings and patronage 
refunds; (2) dissipate capital; (3) significantly weaken its 
competitive position; and (4) potentially jeopardize the advantages of 
operating on a Subchapter T basis for tax purposes. Over two dozen of 
the bank's stockholders sent letters with essentially the same comment 
as the bank. One respondent stated that the FCA would appear to have 
``absolute discretion'' in determining what constitutes a reasonable 
timeframe. Two Farm Credit associations also expressed concern with the 
subjective nature of a ``reasonable timeframe.''
    The System in its joint comment stated that the FCA has an 
obligation to document in the regulation, and provide opportunity for 
comment on, the standard of care that should uniformly be employed by 
FCA staff for determining the ``reasonable timeframe.'' Furthermore, 
the System said that, due to the very sensitive nature of the System's 
cooperative relationship with its stockholders, the determination of a 
reasonable timeframe should be specified or outlined in FCA policy or 
regulation rather than being potentially applied judgmentally by the 
FCA staff, which may result in an uneven application of the criteria.
    The second compliance issue concerned whether an association could 
employ a Risk-Sharing Agreement as a permanent alternative to reaching 
a core surplus level of 3.5 percent. Some of the commenters stated that 
risk-sharing, if permitted on a permanent basis, would address the 
safety and soundness concerns raised by the FCA without an 
association's incurring a tax liability. Nevertheless, the proposed 
Risk-Sharing Agreement was criticized as too complicated and also as 
being a poor vehicle to recapture previously paid taxes. The proposed 
rule required risk-sharing to begin when losses exceeded

[[Page 42099]]

the current year's earnings. Commenters noted that this might prevent 
an association from recouping some of the taxes that might be 
recoverable from previous years and recommended that some mechanism be 
implemented to delay the risk-sharing trigger until all available taxes 
have been recouped.
    The System's joint comment included a description of a 
``contractual conversion mechanism'' that was, in its view, simpler 
than the proposed rule's Risk-Sharing Agreement and that contained 
activation provisions that would maximize tax benefits due to operating 
losses and help to mitigate an association's economic adversity. The 
System suggested that an association be permitted to include such a 
conversion provision in its capital plan until the end of 2006 without 
FCA approval.
    In the reproposed rule, the FCA has made several significant 
changes to the compliance provisions from the originally proposed rule. 
First, the FCA believes that the use of a capital plan (which is 
referred to as a ``capital restoration plan'' in the reproposed rule to 
distinguish it from other capital plans) to achieve minimum surplus or 
collateral ratios should be an option only for those institutions that 
are below a minimum standard on the effective date of this rule. For 
institutions that fall below a minimum surplus or collateral standard 
subsequent to the effective date of this rule, the FCA would address 
the noncompliance in the same way it treats other instances of 
noncompliance with FCA regulations. The Agency would decide on a case-
by-case basis what supervisory action, if any, to take with respect to 
the violation--from simply requiring the institution to submit a 
capital restoration plan to a more formal action. Any decision in this 
regard would depend on the level of an institution's capital and the 
severity of its problems. The FCA has proposed this change in order to 
have greater flexibility to impose requirements commensurate with the 
seriousness of the situation, or to take no formal action if the 
noncompliance appears minor, not due to mismanagement of the 
institution, and likely to be short-lived.
    Second, the FCA has deleted from the reproposed rule the definition 
of ``Risk-Sharing Agreement'' in order to give associations more 
latitude in devising mechanisms to achieve initial compliance with the 
core surplus requirement. The FCA agrees with commenters that different 
types of contractual arrangements, including arrangements that enable 
an association to take advantage of tax provisions for distressed 
institutions, could be an acceptable part of an association's plan to 
restore capital.
    Third, the FCA has added a requirement to report noncompliance with 
the surplus or collateral ratios to the FCA within 20 calendar days of 
the end of the month as of which the noncomplying ratio was computed.
    Fourth, the FCA has placed a limit of 180 days from the effective 
date of the rule for an institution not in compliance on the effective 
date to submit, and the FCA to approve, a capital restoration plan. The 
FCA believes that placing a limit on the time during which an 
institution has to submit an acceptable plan adds certainty and 
finality to the initial approval process.
    Finally, in response to commenters' suggestions, the FCA has added 
to the compliance provision in the reproposed rule a list of factors to 
be considered by the Agency in approving compliance plans. The factors 
include, as applicable:
    1. The conditions or circumstances leading to the institution's 
falling below minimum levels (and whether or not they were caused by 
actions of the institution or were beyond the institution's control);
    2. The exigency of those circumstances or potential problems;
    3. The overall condition, management strength, and future prospects 
of the institution and, if applicable, affiliated System institutions;
    4. The institution's capital, adverse asset (including nonaccrual 
and nonperforming loans), allowance for loss, and other ratios compared 
to the ratios of its peers or industry norms;
    5. How far an institution's ratio is below the minimum;
    6. The estimated rate at which the institution can reasonably be 
expected to generate additional earnings;
    7. The effect of the business changes required to increase capital;
    8. The institution's previous compliance practices, as appropriate;
    9. The views of the institution's directors and senior management 
regarding the plan; and
    10. Any other facts or circumstances that the FCA deems relevant.
    Notwithstanding the concerns of commenters regarding the 
``reasonable timeframe'' in which noncomplying institutions would be 
expected to achieve all minimum surplus and collateral standards, the 
FCA is not persuaded that the rule should specify a single timeframe in 
which institutions must meet the standards. The Agency continues to 
believe that not specifying a timeframe would allow maximum flexibility 
and latitude to determine the best course for building capital ratios 
to at least the minimum levels. In view of the wide range in both the 
amount of shortfall and the reasons for that shortfall among 
institutions not meeting the proposed requirements, the FCA concludes 
that no specific timeframe would be suitable in every case. The FCA 
anticipates that it would approve capital restoration plans that 
project appropriate annual progress toward compliance. The Agency 
recognizes that capital restoration plans must be realistic and that 
long-term plans may be appropriate in some circumstances.

E. Stock Retirement Provisions

    The FCA originally proposed to permit institution boards of 
directors to delegate discretion in the retirement of borrower stock to 
management as long as, after retirement, an institution would meet all 
of its applicable surplus and collateral requirements and its permanent 
capital ratio would remain above 9 percent. The FCA received two 
comments on the proposal. The ABA was troubled by the possibility that 
System institutions would be able to continue to retire stock, albeit 
with the specific approval of the board of directors, if the 
institution's permanent capital were below 9 percent. The trade 
association's particular concern was apparently the potential for 
insider abuse. The ABA recommended that stock retirements be prohibited 
when permanent capital is below 9 percent and that the proposal be 
revisited by the FCA to prevent conflicts of interest with insiders. A 
System association criticized the FCA's proposal as eliminating any 
flexibility on the part of management with respect to stock retirements 
and as setting too high a standard that would result in inappropriate 
involvement by a regulator at a point where an institution still has a 
relatively strong permanent capital position. The association suggested 
that management be allowed to retire ``de minimis'' amounts of stock as 
long as the permanent capital remains above 8 percent.
    The FCA reproposes the originally proposed stock retirement 
provisions without change. Accordingly, as long as after retirement an 
institution's core surplus and total surplus ratios (and, for banks, 
the collateral ratio) would meet or exceed applicable minimum 
standards, and the permanent capital position would remain above 9 
percent, the retirement of borrower stock could be delegated by the 
institution's board of directors to its management.
    The FCA notes that the ABA's proposal that no redemption of 
borrower stock be permitted if the association's capital falls below 9

[[Page 42100]]

percent is inconsistent with System institutions' statutory right to 
retire stock at the sole discretion of the board, as long as the 
institution meets its permanent capital standard. Although the FCA 
recognizes that there is a potential for abuse of discretion by 
institution board members in the retirement of their own equities, the 
FCA monitors retirements of stock owned by directors in the examination 
process and has never yet found this kind of abuse.
    The System association's suggestion that institution management be 
allowed to retire ``de minimis'' amounts of stock under delegated 
authority until the institution's permanent capital falls to 8 percent 
was also not accepted because, as the FCA interprets this suggestion, a 
stock retirement in an amount equal to as much as 1 percent of 
permanent capital would be considered to be ``de minimis.'' 
Furthermore, the FCA does not believe that the restrictions the 
reproposed regulation would place on delegation of stock retirements 
would be onerous or would significantly affect the institution's 
ability to operate in a flexible manner.

F. Individual Institution Capital Ratios and Capital Directives

    Subpart L, Establishment of Minimum Capital Ratios for an 
Individual Institution, and subpart M, Issuance of a Capital Directive, 
are reproposed in substantially the form in which they were originally 
proposed. The FCA does not agree with the suggestion of a commenter to 
eliminate the application of civil money penalties in cases where an 
individual institution capital ratio was not met but the otherwise 
applicable ratios were met, because the FCA's reason for setting a 
higher ratio in the first place would be its judgment that the 
institution would not be operating in a safe and sound manner if it 
were below the individually set ratio. The FCA also has not included a 
commenter's suggestion to establish an office of ombudsman. Should 
concerns arise regarding the fair application of individual institution 
ratios or capital directives to different institutions in the System, 
the FCA would address those concerns on a case-by-case basis.

G. Other Capital Issues

    1. Nine commenters, including the System's joint comment, raised 
concerns with the current practice of risk-weighting unused loan 
commitments with remaining maturities in excess of 1 year. Because this 
issue requires further study, it will be considered by the FCA in the 
next phase of its review of capital regulations.
    2. One commenter suggested that the surplus standards should not be 
applicable to Federal land bank associations (FLBAs) that do not have 
exposure to loan losses, as provided for in Sec. 615.5210(e)(9). The 
reproposed rule would make no changes in the application of surplus 
requirements to all FLBAs, because the Agency believes that these 
requirements would be minimal and would pose no hardship on any FLBA. 
Furthermore, FLBAs with no exposure to loan losses have very minimal 
levels of risk-adjusted assets to capitalize. The FCA believes that it 
is appropriate for every institution to have at least some level of 
positive surplus funds based on the level of operations. For this 
reason, the FCA has concluded that it is appropriate to have the same 
requirement apply to all associations, including FLBAs. The FCA notes 
that funds that are earned at the bank and distributed to the FLBAs are 
not taxable, adding no tax burden to the FLBAs.
    3. Other provisions of the proposed rule pertaining to the 
exclusion of the impact of unrealized gains and losses on available-
for-sale securities, as well as technical and conforming changes, are 
reproposed in the same form in which they were proposed.

H. Limitations on Financing Non-Agricultural Credit Needs of Bona Fide 
Farmers, Ranchers, Aquatic Producers or Harvesters

    Under reproposed Sec. 613.3000, all bona fide farmers, ranchers, 
and aquatic producers or harvesters would be eligible for FCS financing 
of their agricultural or aquatic needs. The reproposal would place 
limitations on all other credit to farmers, however, using criteria 
that are more specific and appropriate than those in the existing 
regulation. The reproposed regulation would distinguish individual 
farmers who actively produce agricultural products or manage a farming 
operation from passive farm owners, who meet the definition of a bona 
fide farmer only because they own agricultural land. Retired farmers 
who have been engaged in agricultural production, including 
incapacitated farmers, who own agricultural land and assume some 
portion of their tenant's production risk, would also be considered 
active farmers. Under the reproposed rule, active farmers would be 
given limited access to FCS financing for their other credit needs, but 
access becomes more limited or completely precluded for passive farm 
owners and non-resident foreign nationals.
1. Non-Agricultural Business Needs of the Borrower
    The reproposed regulation would allow FCS banks and associations to 
finance the non-agricultural business needs of citizens and permanent 
residents of the United States who are eligible under 
Sec. 613.3000(a)(3)(i). This financing would be limited to an amount 
that does not exceed the market value of the borrower's agricultural 
assets. The reproposed regulation does not permit System lenders to 
offer non-agricultural business financing to non-resident foreign 
nationals or individuals who are eligible because they own agricultural 
land as a passive investment pursuant to Sec. 613.3000(a)(3)(ii).
    The reproposed regulation does not represent a substantial change 
from the existing regulation on this point. The reproposal continues to 
link a borrower's access to FCS financing to his or her involvement in 
agriculture. The existing regulation views a farmer's involvement in 
agriculture as a continuum, ranging from full-time, to part-time, to a 
person ``whose business is essentially other than farming.'' It states 
as a guiding principle that the purposes for which credit may be 
extended ought to become more restricted as a borrower's status becomes 
further away from being a full-time farmer. The reproposal 
distinguishes instead between a farmer who actively engages in 
agricultural production or farm management and one who simply owns farm 
land. Only the active farmer is permitted to borrow for non-
agricultural business needs. Moreover, the reproposal contains a 
precise limit on the amount of such credit that may be extended. 
Although both the existing and reproposed regulations ensure that the 
System retains its focus on agricultural lending, the new approach 
relies on exact and objective standards that are more meaningful and 
easier to apply.
2. Housing and Domestic Needs
    Reproposed Sec. 613.3000(d)(1) would authorize citizens and 
permanent residents of the United States who are active farmers to 
obtain System financing for their housing and domestic needs without 
restriction other than their creditworthiness. Such borrowers have 
strong ties to agricultural or aquatic production and FCS financing for 
their housing and domestic needs should not alter their status as 
farmers, ranchers, and aquatic producers or harvesters.
    Reproposed Sec. 613.3000(d)(3) would allow individuals who own 
agricultural

[[Page 42101]]

land as a passive investment to obtain System financing for their 
housing and domestic needs in an amount that does not exceed the market 
value of their agricultural assets. Persons who are eligible solely 
because they own farm land are primarily engaged in vocations other 
than agriculture.
    In addition, reproposed Sec. 613.3000(d)(2) would allow non-
resident foreign nationals who actively engage in agricultural or 
aquatic production in the United States to obtain System financing for 
housing and domestic needs that are reasonably related to their 
agricultural or aquatic operations located in the U.S.A.
    More specifically, active farmers who are non-resident foreign 
nationals could obtain System financing only for a house that is 
located on or near their farm or ranch. Additionally, the FCA intends 
that the FCS extend credit to non-resident foreign nationals only for 
those housing and domestic needs that enable the borrower to conduct a 
farming operation in the United States. The FCA believes that non-
resident foreign nationals who are active farmers should not be allowed 
unrestricted System financing for their housing and domestic needs 
because they lack a permanent presence in the United States.
    Like the existing regulation, this proposal allows active farmers 
to obtain credit for their housing and domestic needs. It would 
expressly permit certain other farmers to borrow from the FCS for their 
housing and domestic needs but with the restrictions described above, 
which are intended to ensure that such credit is generally appropriate 
to their farming operations.
3. Definition of Agricultural Assets
    Because the amount of financing to an eligible borrower for other 
credit needs is limited to the market value of the borrower's 
agricultural assets, this term was the subject of a number of comments. 
The FCA's originally proposed regulation did not define ``agricultural 
assets,'' although the preamble to proposed Sec. 613.3000(a) stated 
that agricultural assets included ``real estate, a home that is located 
on a farm or ranch, equipment, chattel, and livestock.''
    System commenters asked the FCA to define ``agricultural assets'' 
in the regulation. They proposed a more expansive definition of 
``agricultural assets'' that, in their view, would reflect the 
diversity of agriculture. The FCC's comment suggested that 
``agricultural assets'' include ``all tangible and intangible assets 
reasonably necessary to, derived from, used in, or available for use in 
the borrower's agricultural or aquatic operation, including the 
borrower's personal residence, regardless of its location.'' The 
comment recommended that tangible and intangible assets include all 
personal property and financial assets used in the borrower's operation 
and the proceeds that are derived from the sale of agricultural assets. 
Under the System's proposal, receivables, cash, investments purchased 
with proceeds from the sale of agricultural assets, trademarks, motor 
vehicles, aircraft, seagoing vessels, and other personal property would 
be agricultural assets. System commenters also believed that off-farm 
residences should qualify as agricultural assets because farmers and 
producers in the fishing, timber, and nursery industries often live 
off-site.
    As requested by the commenters, the FCA has incorporated a 
definition of ``agricultural assets'' into the reproposed regulation. 
The definition in reproposed Sec. 613.3000(a)(1), however, is more 
narrow than the FCC's recommendations. The FCA has excluded 
intangibles, such as goodwill and trademarks, from the definition of 
``agricultural assets'' because the establishment of a definitive 
market value prior to sale is difficult to derive and, therefore, 
oftentimes unreliable. Personal property such as motor vehicles, 
aircraft, and seagoing vessels qualify as agricultural assets if the 
borrower uses them for agricultural or aquatic production. Similarly, 
cash, investments, and sale proceeds are not agricultural assets until 
they are reinvested in the borrower's farming, ranching, or aquatic 
operations. However, reproposed Sec. 613.3000(a)(1) does classify 
working capital as an agricultural asset. Working capital includes 
accounts receivables from agricultural sales, inventory used in the 
borrower's agricultural or aquatic business, and cash proceeds that are 
reinvested in the farming, ranching, or aquatic enterprise.
    Under the reproposed regulation, the principal residence of a 
farmer who is eligible under reproposed Sec. 613.3000(a)(3)(i) would be 
considered an agricultural asset regardless of whether it is located on 
agricultural land. This approach treats all active farmers equitably 
irrespective of where they live or type of their agricultural endeavor. 
Because the value of agricultural assets will determine the amount of 
funds available for other credit needs, these assets must be valued 
appropriately. Documentary support for the value should be included in 
the loan file.

I. Financing for Legal Entities

    The FCA proposed to allow any legal entity that is chartered in the 
United States to qualify as an eligible System borrower if it met the 
definition of a bona fide farmer, rancher, aquatic producer or 
harvester. Such legal entities would be able to obtain financing for 
any of their agricultural needs. The FCA proposed, however, to limit 
System financing of the non-agricultural credit needs of legal 
entities. Under the original proposal, legal entities would not have 
been eligible for financing for their other credit needs if they were 
publicly traded or less than 50 percent of the borrower's assets were 
used in agricultural or aquatic production. The FCA's original proposal 
would have allowed all other legal entities to receive financing for 
non-agricultural purposes in an amount that did not exceed the market 
value of their agricultural assets. The FCA reasoned that this approach 
would continue to authorize System banks and associations to finance 
the other credit needs of family farm corporations and other small- and 
medium-sized legal entities that are closely held by bona fide farmers, 
ranchers, and aquatic producers or harvesters. The restrictions in 
proposed Sec. 613.3000(d)(3) were designed to ensure that previously 
ineligible agribusiness corporations and conglomerates could obtain FCS 
financing only for their agricultural or aquatic needs.
    The FCA received 17 comments about its proposed limitations on the 
financing of legal entities. All System commenters supported the FCA's 
proposal to repeal the existing eligibility restrictions on legal 
entities because they believe that the organizational structure of the 
borrower should not determine eligibility. However, System commenters 
opposed various aspects of the proposed restrictions on their ability 
to finance the non-agricultural credit needs of certain legal entities.
    In contrast, commercial banks, their trade associations, and FLAG 
opposed the FCA's proposal to revise the eligibility and scope of 
financing criteria for legal entities. These comments addressed whether 
certain legal entities should be eligible for agricultural credit and 
the extent to which they should be permitted to borrow from the System 
for their other credit needs. One commenter asserted that family farm 
corporations are the only legal entities that should qualify for System 
financing. Others believed a legal entity should be eligible for 
agricultural credit only if agriculture is its primary focus. Another 
commenter favored retaining the three-pronged

[[Page 42102]]

eligibility test in former Sec. 613.3020(b). Two other commenters 
suggested that legal entities should be ineligible to borrow from Farm 
Credit banks and associations unless they are owned by farmers, 
ranchers, or aquatic producers or harvesters who actively engage in 
agricultural or aquatic production.
    Both System and non-System commenters opposed the FCA's proposal to 
deny publicly traded corporations access to System funding for their 
non-agricultural credit needs. Some System commenters opposed excluding 
publicly traded corporations from such financing because they believe 
that current and potential System borrowers will, in the future, raise 
capital by selling their equities on public exchanges.
    Other commenters opposed the FCA's approach toward publicly traded 
corporations because, in their view, it was not sufficiently 
restrictive. They expressed concern that a privately owned conglomerate 
would be able to obtain System financing for its non-agricultural 
activities by simply restructuring its subsidiaries so that 50 percent 
of their assets would be used in agricultural production.
    After considering all the comments, the FCA has decided to: (1) 
Retain the eligibility criteria for legal entities in proposed 
Sec. 613.3000(a)(4); and (2) revise proposed Sec. 613.3000(d)(3), which 
addresses the authority of FCS banks and associations to finance the 
non-agricultural credit needs of legal entities. Under reproposed and 
redesignated Sec. 613.3000(a)(5), a legal entity will qualify as a bona 
fide farmer if it meets the eligibility criteria in reproposed 
Sec. 613.3000(a)(3)(i). Reproposed Sec. 613.3000(a)(5) includes a 
technical correction that adds tribal authorities to the list of 
governmental units under whose laws legal entities can be organized. 
Reproposed Sec. 613.3000(c) authorizes System banks and associations to 
extend credit to an eligible legal entity for any agricultural or 
aquatic purpose.
    Reproposed Sec. 613.3000(d)(4) would continue to restrict which 
legal entities could obtain financing for non-agricultural business 
needs and the amount of such credit. A legal entity could obtain non-
agricultural financing only if more than 50 percent of its equity is 
owned by individuals who actively engage in agricultural or aquatic 
production to generate income and either more than 50 percent of its: 
(1) Assets are used in agricultural or aquatic production; or (2) 
income is derived from agricultural or aquatic activities. Moreover, 
the credit would be limited to an amount that does not exceed the 
market value of its agricultural assets at the time the loan is closed. 
Because the reproposed regulation would require the borrower to meet 
these requirements at the time the loan is closed, a System lender 
would not be able to finance the other credit needs of a legal entity 
unless its agricultural activities, after the extension of credit, 
would exceed its non-agricultural activities.
    The FCA believes that the reproposed regulation will strike an 
appropriate balance among the concerns of all commenters. In response 
to System concerns, reproposed Sec. 613.3000 would repeal all 
regulatory restrictions that previously prevented System banks and 
associations from providing agricultural credit to corporate farmers. 
The reproposed regulation permits all bona fide farmers, including all 
legal entities, to obtain System financing for any agricultural or 
aquatic purpose. However, both individual and corporate farmers must be 
eligible under Sec. 613.3000(a)(3)(i) before they can borrow from the 
FCS for their non-agricultural business needs, and then only in an 
amount that does not exceed the market value of their agricultural 
assets. This ensures that only farmers who actively engage in 
agricultural or aquatic production could obtain System financing for 
their non-agricultural business needs.
    The reproposed regulation effectively prevents publicly traded 
corporations from obtaining System financing for their non-agricultural 
needs unless more than 50 percent of the equity is held by active 
farmers, ranchers, and aquatic producers or harvesters are allowed to 
borrow from the FCS for such purposes. Additionally, these changes 
would keep lending to legal entities agriculturally focused because: 
(1) A majority of the income or assets of such borrowers must be 
related to agricultural or aquatic production; and (2) the amount of 
non-agricultural credit may never exceed the market value of any 
borrower's agricultural assets.
    The FCA disagrees with commenters who favor enabling the System to 
finance the other credit needs of all legal entities engaged in 
agriculture. Because the primary mission of the FCS is to finance 
agriculture and aquaculture, FCA regulations have consistently imposed 
restrictions of some type on non-agricultural loan purposes to System 
borrowers. The FCA believes the availability of non-agricultural credit 
for both individuals and legal entities should be proportionally 
related to the borrower's involvement in agricultural or aquatic 
production. Farmer ownership, combined with agricultural assets or 
agricultural income, are the best measures of whether a legal entity 
focuses on agriculture. Accordingly, the reproposed regulation would 
ensure that such lending is proportional, while giving the FCS ample 
flexibility to respond to the evolving needs of all agricultural 
producers in a rapidly changing economic environment.
    The FCA also disagrees with commenters who suggest that the 
regulation should favor individual borrowers over legal entities. The 
FCA observes that the Act does not accord individuals preference over 
legal entities. For this reason, FCA regulations should not influence 
the decision whether to conduct agricultural or aquatic operations in 
an individual capacity or as a legal entity.

J. Nationality of the Borrower

    The FCA received ten comments about proposed 
Sec. 613.3000(a)(3)(ii), which governs the eligibility of non-resident 
foreign nationals who have been admitted into the United States 
pursuant to a provision in 8 U.S.C. 1101(a)(15) that authorizes such 
individuals to own property, or to operate or manage a business in this 
country. System commenters generally supported the FCA's original 
proposal while other commenters opposed it. System commenters opined 
that the proposed regulation was consistent with the Act, which imposes 
no eligibility restriction on foreign nationals. Some System commenters 
suggested that the FCA extend eligibility to foreign national legal 
entities that have not established a domestic subsidiary because no 
Federal law precludes System banks or associations from lending to such 
parties.
    In contrast, a commercial bank opined that the FCA's proposal was 
``unfair and unwarranted'' because American citizens would compete with 
foreign nationals for funding from the FCS. Three commenters asserted 
that loans to non-resident foreign nationals are inherently unsafe and 
unsound. One commenter believes that System loans to non-resident 
foreign nationals slow the national economy and worsen the trade 
deficit between the United States and other countries. Two other 
commenters claimed that FCS financing to non-resident foreign nationals 
forces small family farms out of business. A trade association 
questioned whether the Act authorizes the FCS to finance foreign 
nationals.
    The FCA disagrees with the argument that the FCS lacks the legal 
authority to extend credit to farmers, ranchers, and aquatic producers 
and harvesters who

[[Page 42103]]

are not American citizens. Section 1.1(a) of the Act states that the 
mission of the FCS is to improve the ``income and well-being of 
American farmers and ranchers.'' Neither that provision or any other 
provision of the Act explicitly or implicitly restricts eligibility for 
System loans to American citizens. The general rulemaking provisions of 
section 5.17(a)(9) of the Act allow the FCA to enact regulations that 
govern the eligibility of foreign nationals to borrow from FCS 
institutions.
    Since 1976, FCA regulations have allowed certain foreign nationals 
who have been lawfully admitted into the United States for permanent 
residence and conduct agricultural or aquatic operations within its 
territory to borrow from System banks and associations that operate 
under titles I or II of the Act. Legal entities that are owned or 
controlled by eligible foreign nationals also qualify for System 
financing under existing FCA regulations.
    Foreign nationals and foreign national legal entities that lawfully 
engage in agricultural or aquatic production in the United States 
invest their capital, labor, time, and effort in the American 
agricultural economy. In this context, these persons contribute 
primarily to the economy of the United States, not their country of 
origin. Contrary to the comments of commercial bankers, the United 
States benefits from the endeavors of these farmers, just as it does 
from any other farmer who helps supply abundant and affordable food to 
the American consumer.
    The FCA also rejects arguments that loans to foreign nationals are 
inherently unsafe and unsound. Although loans to non-resident foreign 
nationals may expose System banks and associations to different risks, 
the FCA notes that the FCS, like all lenders, should have the 
capability to identify and manage the risks associated with lending to 
non-resident foreign nationals.
    The reproposed regulation, however, further restricts the access of 
non-resident foreign nationals to the System for their other credit 
needs. The original proposal would have authorized non-resident foreign 
nationals to obtain System financing for their housing, domestic, and 
non-agricultural business needs in an amount that does not exceed the 
market value of their agricultural assets in the United States. In 
contrast, reproposed Sec. 613.3000(d)(2) prohibits such borrowers from 
obtaining System financing in any amount for non-agricultural business 
needs. The FCA believes that the additional restriction on loans to 
non-resident foreign nationals is justified because their legal status 
limits their activities within the United States. As a general rule, 
the visas of non-resident foreign nationals do not allow them wide 
latitude to change their business activities within the United States. 
Accordingly, the reproposed regulation ensures that FCS lending to 
foreign nationals is limited to agricultural purposes and housing and 
domestic needs that are reasonably related to the borrower's farming 
operation in the United States.
    The FCA does not agree with the commenters' recommendation that the 
regulation allow System lenders to finance foreign national legal 
entities that have not established a domestic subsidiary. Reproposed 
Sec. 613.3000(b) treats all United States corporations exactly alike 
regardless of the nationality of their owners. This approach simplifies 
the regulation and avoids any safety and soundness issues that could 
arise from the absence of a domestic charter by the borrower. Because 
foreign corporations that produce agricultural products in the United 
States are able to establish a subsidiary under domestic laws, any such 
creditworthy enterprise that desires financing from an FCS lender will 
be eligible to obtain it.
    One System association suggested that Mexican or Canadian farmers 
or ranchers who obtain farm-related services in the United States 
should be eligible for FCS financing. More specifically, the commenter 
recommended that the FCA authorize System banks and associations to 
finance Mexican ranchers who periodically bring their cattle into Texas 
to use local feedlots. The commenter believes that such an approach 
would be consistent with the spirit of the North American Free Trade 
Agreement (NAFTA).
    The FCA does not accept this suggestion. Doing so would require the 
FCA to expand the definition of a bona fide farmer or rancher to 
individuals who neither conduct an agricultural operation inside the 
United States nor own agricultural land in the United States. Such 
parties farm or ranch outside of the United States, where the FCS has 
no authority to lend under titles I and II of the Act.

K. Legal Entities Eligible To Borrow From a BC or ACB

    Under the FCA's original proposal, legal entities that are eligible 
to borrow from a BC or ACB would not have qualified for financing from 
an FCB or FCS association. Although the FCA acknowledged that some 
cooperatives have outstanding loans with FCBs and associations, the 
Agency expressed concern that the revised eligibility standard for 
legal entities might significantly expand competition within the FCS. 
Accordingly, the FCA invited comment on the appropriateness of a 
regulatory prohibition on FCB and association loans to cooperatives and 
asked commenters to offer alternative solutions.
    The FCA received 84 letters of comment on its proposal to deny 
eligible title III borrowers access to financing at FCBs and direct 
lender associations. Although the St. Paul BC, CoBank, and a pair of 
jointly managed associations favored this proposal, six FCBs, 49 
associations, the Tenth District PCAs, 16 agricultural cooperatives and 
one individual opposed it.
    Most FCBs and direct lender associations contended that titles I 
and II of the Act permit them to lend to agricultural cooperatives and 
related entities that are also eligible BC or ACB borrowers. Many 
commenters claimed that a regulatory prohibition on FCB and association 
loans to cooperatives and their related entities is contrary to the 
language and intent of the Act. Many commenters asserted that this 
proposal was contrary to the FCA's Regulatory Philosophy Statement, 
because a ban on FCB and association loans to eligible title III 
borrowers is not necessary to implement or interpret the Act or promote 
safety and soundness. Some FCS associations claimed that the FCA's 
original proposed regulation lacked balance because it would allow a BC 
or ACB to serve FCB and association customers.
    As requested by the FCA, several commenters offered alternatives 
that address the Agency's concerns about intra-System competition. Many 
commenters suggested that the FCA delete this prohibition from the 
regulation and initiate a negotiated rulemaking, or impanel an Advisory 
Committee pursuant to section 5.12 of the Act, to address all intra-
System competition issues. Several associations suggested that the 
regulation require FCBs and their associations to obtain consent from a 
title III lender before they extend credit to a cooperative or related 
entity.1 A jointly managed FLCA and PCA advised the FCA to allow 
an FCB or direct lender association to make loans below a specified 
dollar amount to cooperatives without the consent of a title III 
lender. If the loan exceeded this

[[Page 42104]]

threshold, the FCB or direct lender would be required to either: (1) 
Obtain consent from a title III lender; or (2) sell a participation 
interest in the loan to the St. Paul BC or CoBank. An FCB and one of 
its affiliated associations suggested that the regulation authorize 
FCBs and associations to lend only to those cooperatives that engage in 
or finance agricultural production.
---------------------------------------------------------------------------

    \1\  Former regulations in subpart B of part 616 controlled 
intra-System competition by allowing title I and II lenders to lend 
to small cooperatives with the concurrence of the district BC. 12 
CFR 616.6040 was originally adopted by the FCA in 1979. See 44 FR 
69633 (Dec. 4, 1979). It was repealed in 1990. See 55 FR 24888 (June 
19, 1990).
---------------------------------------------------------------------------

    The FCA has decided to withdraw the proposal to prohibit lending by 
FCBs and associations to borrowers also eligible under title III. The 
removal of this prohibition from the regulation acknowledges the status 
quo within the FCS. Currently, titles I and II lenders finance certain 
cooperatives and their related entities under their statutory powers. 
The FCA finds that permitting this continued overlap is preferable to 
the alternative approaches suggested by some commenters. The consent 
requirement could unacceptably burden the loan approval process for 
both System lenders and their borrowers. The FCA has no basis for 
setting a specific dollar limit for loans to cooperatives that would be 
responsive to smaller cooperatives' needs.
    The FCA is aware that intra-System competition causes deep concern 
within the FCS and can have significant implications for the FCS as a 
whole. As noted earlier, many commenters have suggested that the FCA 
address intra-System competition issues, using a participatory 
approach, such as a negotiated rulemaking or an Advisory Committee. The 
FCA believes this recommendation merits further consideration. It will 
continue to monitor competition among System institutions and consider 
methods to address these issues. The FCA continues to encourage System 
institutions to resolve specific issues regarding intra-System 
competition by mutual agreement.

L. Other Issues Raised by Commenters

1. Definition of Bona Fide Farmer, Rancher, and Aquatic Producer or 
Harvester
    Proposed Sec. 613.3000(a)(2) would define a bona fide farmer, 
rancher, or aquatic producer or harvester as an individual or legal 
entity that either: (1) Produces agricultural products, or produces or 
harvests aquatic products to generate income; or (2) owns agricultural 
land. The preamble to the proposed regulation noted that this 
definition does not represent a significant departure from the existing 
regulation.
    One FCB and several of its affiliated associations sought 
modification to this definition. First, these commenters recommended 
that the FCA change the term ``produces agricultural products'' to 
``engages in the production of agricultural products,'' to clarify that 
eligibility is not determined by farmer's actual crop yield. These 
commenters expressed concern that proposed Sec. 613.3000(a)(2) could 
result in a bona fide farmer becoming ineligible for an operating loan 
due to a crop failure in a previous year. Although the FCA has not 
incorporated the commenters' recommendation into the reproposed 
regulation, the Agency reaffirms its position that crop failures do not 
affect borrower eligibility.
    The same FCB and an affiliated association requested that the FCA 
revise proposed Sec. 613.3000(a)(2)(i) to encompass parties who provide 
for the husbandry of wild and domesticated animals. The FCA has always 
regarded husbandry of farm and ranch animals as an agricultural 
activity and believes that no additional regulatory changes are needed.
    The FCB and many of its affiliated associations also asked the FCA 
to clarify whether the term ``eligible borrower'' in proposed 
Secs. 613.3000(b) and 613.3010 refers to parties who already have 
outstanding System loans. The FCA responds that eligibility is not 
determined by whether the applicant is a current FCS borrower. Instead, 
``eligible borrower'' refers to bona fide farmers, ranchers, and 
aquatic producers or harvesters who qualify for System financing under 
Secs. 613.3000(b) and 613.3010.
2. GSE Status
    Many commercial banks and credit unions questioned whether System 
financing for the other credit needs of agricultural and aquatic 
producers is compatible with GSE status because they believe GSE status 
gives the FCS unfair competitive advantages over commercial banks, 
credit unions, and other lenders. Some commenters asserted that the FCS 
should be allowed to compete with other lenders for non-agricultural 
loans to farmers only when such System lending will fulfill a market 
need that has been neglected by non-GSE lenders.
    The FCA disagrees and observes that the Act expressly authorizes 
System lenders to finance a farmer's other credit needs. Section 1.1(c) 
of the Act reflects Congress' expectation that the FCS will be a 
competitive source of loans to agricultural and aquatic producers. It 
is precisely this competition that achieves the express objectives of 
Congress of increasing the availability and reducing the cost of credit 
to agriculture, aquaculture, and other rural needs that are specified 
by the Act. These comments overlook the primary purpose of the FCS, 
which is to provide reliable credit to agriculture at all times, 
including those periods when commercial lenders find it unprofitable or 
too risky to lend to agriculture. To continue to perform this function 
as the methods and modalities of agriculture change, the FCS must be 
free of unnecessary regulatory restrictions that impede its flexibility 
to meet the credit needs of agricultural producers.
3. Need for Outstanding Agricultural Loans
    Two commercial bank trade associations objected to permitting 
System lenders to finance a farmer's other credit needs unless the 
borrower has an outstanding agricultural loan from the FCS.
    The FCA believes that allowable financing for other credit needs 
should be related to the borrower's involvement in agriculture, rather 
than whether there is an agricultural loan outstanding to the borrower. 
Therefore, the FCA has responded to the commenters' concern by limiting 
FCS financing for a non-agricultural business need to active farmers 
eligible under Sec. 613.3000(a)(3)(i). As in the proposed regulation, 
the amount of such credit would be limited to the market value of the 
borrower's agricultural assets. The reproposed regulation would not 
allow the FCS to extend non-agricultural business credit to passive 
owners of agricultural land.
    The Act does not require that a borrower have an outstanding 
agricultural loan from a System lender in order to obtain financing for 
another purpose. Rather, it grants the FCA discretion to determine the 
limitations on non-agricultural lending to farmers and ranchers. The 
reproposed regulation would preserve the System's agricultural focus by 
limiting the amount of credit available for non-agricultural business 
purposes and would make it available only to active farmers. This 
approach ensures that non-agricultural business lending is proportional 
to each borrower's commitment to agriculture.
4. Partnership With Commercial Lenders
    A State agency suggested that the regulation require System lenders 
to participate with commercial banks in non-agricultural business loans 
and use commercial bank underwriting standards for such loans. The FCA 
does not agree that this should be a requirement.

[[Page 42105]]

5. Asset Limitation for Non-Agricultural Lending
    Two commercial bank commenters opposed the FCA's proposal to link 
the amount of non-agricultural credit to the market value of the 
borrower's agricultural assets. One commenter claimed that this 
proposal would establish a credit union bond for the FCS. This comment 
seems to indicate that any borrower who meets the regulatory definition 
of a ``bona fide farmer'' can obtain System financing for any credit 
need. The FCA disputes this allegation because the amount of a farmer's 
agricultural assets does not establish eligibility for a System loan, 
but rather limits the borrower's access to the FCS for non-agricultural 
business loans.
    These commenters urged the FCA to use agricultural income, not 
agricultural assets, as the standard for limiting a farmer's access to 
the FCS for non-agricultural business credit because they believe that 
income is a better barometer of a borrower's relationship to 
agriculture. The commenters noted that an income test would more 
effectively ensure that System lending for non-agricultural purposes is 
not concentrated on older and wealthier part-time farmers, who may have 
substantial agricultural assets, but derive a small amount of income 
from these assets.
    After considering this suggestion, the FCA continues to believe 
that agricultural assets, not agricultural income, provide a more 
useful and readily available measure of a borrower's involvement in 
agriculture. Agricultural income is too volatile to be an accurate 
measure of a borrower's overall commitment to agriculture because 
income tends to fluctuate from 1 year to the next. Further, 
agricultural income as a sole measure may not provide the FCS with 
sufficient flexibility to provide financing that enables farmers to 
remain on the farm, as Congress intended. In contrast, ownership of 
agricultural assets tends to increase gradually over time because a 
significant capital investment is needed to acquire agricultural land, 
equipment, and chattel. Assets generally collateralize debt and provide 
the financial means to borrow during periods of low income.
6. Loans to Certain Classes of Borrowers
    Several commercial bank commenters favored retaining eligibility 
restrictions on part-time farmers and other types of farmers who they 
believe have tenuous ties to agriculture. For example, some comments 
stated that farmers with minimal agricultural production should be 
precluded from obtaining System financing for non-agricultural 
purposes. These commenters generally believed that Congress did not 
intend for the FCS to extend credit to passive owners of agricultural 
land, part-time farmers, or farmers with minimal production.
    The Act does not require a minimum level of involvement in 
agriculture for a farmer to qualify for FCS financing. Section 1.1(b) 
of the Act specifically states that the objective is to provide ``[a] 
permanent system of credit for agriculture which will be responsive to 
the credit needs of all types of agricultural producers having a basis 
for credit.'' The FCA's proposal to update its eligibility regulations 
so they respond to the changes in agriculture is fully supported by the 
Act and its legislative history.
    The reproposed regulation would implement sections 1.1(b), 1.9(1), 
1.11(a), and 2.4(a) of the Act by enabling the FCS institutions to be 
responsive to the credit needs of all types of agricultural producers 
while diversifying repayment sources of its agricultural loan 
portfolios. The reproposal would ensure that the FCS can continue to 
fulfill its statutory mission to meet the credit needs of agriculture, 
which is undergoing significant restructuring and consolidation. 
Diversification of lending within the agricultural sector also promotes 
safety and soundness by reducing risks and increasing earnings and 
capital.
    The FCA recognizes the increasingly important role that off-farm 
income plays in allowing farmers to stay on their farms. For this 
reason, reproposed Sec. 613.3000 would grant Farm Credit banks and 
associations additional flexibility to finance part-time farmers than 
is allowed by existing regulations. Because the reproposed regulation 
limits the funds available for the borrower's non-agricultural business 
needs, FCS lending to such borrowers is kept well within the boundaries 
of the Act.
    Other commercial banking interests expressed concerns about FCS 
loans to borrowers who plan to convert land to a non-agricultural use. 
They favor retaining a provision in existing Sec. 613.3005(a), which 
states that ``credit shall not be extended where investment in 
agricultural assets for speculative appreciation is a primary factor.'' 
The FCA shares the commenters' concerns about loans to a party who 
purchases agricultural land with the intent to eventually convert it to 
a higher-valued, non-agricultural use. The reproposed regulation should 
effectively control this activity because it would prohibit a passive 
investor in agricultural land from obtaining System loans for a non-
agricultural business purpose.
    After considering the comments of all interested parties, the FCA 
has revised Sec. 613.3000, and reproposes it for further comment. The 
FCA's approach is responsive to the credit needs of agriculture in 
today's environment, and it eliminates unnecessary paperwork 
requirements and reduces other regulatory burdens on System 
institutions. It balances the needs of System institutions and their 
borrowers with the concerns of commercial banks and credit unions. The 
reproposed regulation clearly recognizes that the primary mission of 
the FCS is to finance agricultural credit needs, while allowing limited 
financing of other credit needs, of farmers, ranchers, and aquatic 
producers or harvesters as specified by the Act.

M. Processing or Marketing Regulation

    The FCA originally proposed to redesignate, restructure, and revise 
the regulation that enables FCBs, ACBs, and direct lender associations 
to finance the processing or marketing activities of bona fide farmers, 
ranchers, and aquatic producers or harvesters under titles I and II of 
the Act, simplifying and clarifying existing Sec. 613.3045 and 
eliminating unnecessary regulatory burdens.
    As originally proposed by the FCA, Sec. 613.3010(a)(1) would have 
relaxed a regulatory requirement that bona fide farmers, ranchers, and 
aquatic producers or harvesters own 100 percent of an eligible 
processing or marketing operation. Instead, the FCA's original proposal 
would have required farmers, ranchers, and aquatic producers or 
harvesters to own a ``controlling interest'' in a processing or 
marketing operation, and the Agency sought input from interested 
parties about how this term should be defined.
    Comments on proposed Sec. 613.3010 were received from the FCC, 
three Farm Credit banks, 17 Farm Credit associations, seven Farm Credit 
borrowers, and the CBANC, IBAA, and MPB. Seven System borrowers and the 
MPB offered comments in general support of the amendments. One borrower 
stated that removing existing restrictions would strengthen the 
System's ability to finance emerging needs, and another borrower stated 
that the amendments would allow the financing of more value-added 
agricultural products. CoBank expressed concern that the proposed 
regulation would expand the authorities of FCBs and FCS associations to 
finance

[[Page 42106]]

processing or marketing enterprises and thereby increase intra-System 
competition. The CBANC opposed proposed Sec. 613.3010 because it would 
broaden the authority of System banks and associations to finance 
processing or marketing operations.
    The commenters identified three specific areas of concern related 
to proposed Sec. 613.3010. First, System commenters and the IBAA 
responded to the FCA's request for guidance about how the term 
``controlling interest'' should be defined in Sec. 613.3010(a)(1). 
Second, System commenters questioned whether the Act requires borrowers 
to ``consistently'' supply throughput. Finally, the IBAA objected to 
the repeal of the documentation requirements of Sec. 613.3045(e) 
raising a question about whether the paperwork obligations of 
Sec. 613.3045(e) are required by law.
1. Farmer Control
    The FCA requested guidance about how the regulation should define 
``controlling interest'' in a separate processing or marketing unit 
that is eligible to borrow from an FCB, ACB, or direct lender 
association. Several FCS respondents urged the FCA to adopt the FCC's 
suggested definition of ``controlling interest,'' which is patterned 
after section 2(a)(2) of the Bank Holding Company Act, (BHCA), 12 
U.S.C. 1841(a)(2), and section 10 of the Homeowners' Loan Act (HOLA), 
12 U.S.C. 1467a. Although the St. Paul BC and CoBank did not oppose the 
FCC's recommendation, they expressed concern about intra-System 
competition for processing or marketing loans. These commenters cited 
passages in the legislative history to sections 1.11(a) and 2.4(a) of 
the Act to suggest that Congress may not have intended to expand 
eligibility beyond bona fide farmers, ranchers, and aquatic producers 
or harvesters to a new class of ``agribusiness'' borrower. The IBAA 
claimed that the Act requires bona fide farmers, ranchers, and aquatic 
producers or harvesters to own 100 percent of the processing or 
marketing unit, in order for the enterprise to be ``directly related'' 
to the borrowers' farming operations. Several respondents also asked 
the FCA to clarify whether Sec. 613.3010(a)(1) requires a processing or 
marketing operator to have an outstanding FCS agricultural or aquatic 
loan.
    Rather than define ``controlling interest,'' Sec. 613.3010(a)(1) 
would require bona fide farmers, ranchers, and aquatic producers or 
harvesters to own more than 50 percent of the voting stock or equity of 
an eligible processing or marketing operation. This approach balances 
the needs of titles I and II lenders for greater flexibility to finance 
processing or marketing operations with the limitations in sections 
1.11(a) and 2.4(a) of the Act. Sections 1.11(a) and 2.4(a) of the Act 
allow titles I and II lenders to lend only to processing or marketing 
operations that are ``directly related'' to the borrowers' agricultural 
or aquatic activities. According to several passages in the legislative 
history, Congress intended that titles I and II lenders would finance 
only the processing or marketing operations of farmers, ranchers, and 
aquatic producers or harvesters who are already eligible to borrow from 
these institutions for their agricultural or aquatic activities.2 
Another passage in the legislative history indicates that current 
sections 1.11(a) and 2.4(a) of the Act do not authorize FCBs and their 
affiliated associations to ``finance a new class of borrowers,'' 3 
while a colloquy between two Senators suggests that the intent was to 
prohibit ``agribusiness marketers and processors'' from borrowing from 
titles I and II institutions.4
---------------------------------------------------------------------------

    \2\ S.R. No. 96-837, 96th Cong., 2d. Sess. 47 (June 26, 1980).
    \3\ Id.
    \4\ Colloquy between Senators Stewart and Zorinsky, 126 Cong. 
Rec. 16560 (Dec. 13, 1980).
---------------------------------------------------------------------------

    The FCA disagrees with the view that the Act requires agricultural 
or aquatic producers to own all of the equity of a separate processing 
and marketing operation. Nothing in the plain language of sections 
1.11(a) and 2.4(a) of the Act or their legislative history supports 
this position. In fact, a passage in the legislative history indicates 
that Congress expressly contemplated joint processing or marketing 
ventures between agricultural or aquatic producers and investors as 
long as ineligible parties do not ``exercise substantial control of the 
facility or activity financed by the loan.'' 5 The 100-percent 
ownership requirement in existing Sec. 613.3045(b)(2)(iii) is a 
regulatory policy, which the FCA has discretion to change.
---------------------------------------------------------------------------

    \5\ Id.
---------------------------------------------------------------------------

    The FCA believes that the 100-percent ownership requirement in 
existing Sec. 613.3045(b)(2)(iii) is overly restrictive. For example, 
it denies otherwise eligible farmer-owned processing or marketing 
operations alternative credit options merely because employees or 
investors own a minority interest in the business. Agriculture and 
aquaculture would benefit from the relaxation of this ownership 
requirement because the reproposed regulation is designed to increase 
the availability of affordable and dependable credit for businesses 
that add value to farm products and commodities.
    The FCA declines to adopt the System's suggestion that it define 
``controlling interest'' units by importing provisions of the BHCA and 
the HOLA into Sec. 613.3010(a)(1). Under the System's proposal, 
eligible borrowers would be deemed to hold a controlling interest in a 
processing or marketing unit if they: (1) Directly or indirectly or 
acting through one or more other persons own, control, or have power to 
vote 25 percent or more of the voting shares of the legal entity; (2) 
control in any manner the election of a majority of the directors, 
trustees, general partners, or managers of the legal entity; or (3) 
they own, control, or have power to vote at least 5 percent or more of 
the voting shares of the legal entity and directly or indirectly 
exercise a controlling influence over the management or policies of the 
legal entity. System commenters have not explained why the ``control'' 
standards in the BHCA and the HOLA are suitable for processing and 
marketing operations that would qualify for financing under sections 
1.11(a) and 2.4(a) of the Act.
    The FCA believes that the definition of ``control'' in the BHCA and 
the HOLA are inappropriate for Sec. 613.3010, because it would enable 
System banks and associations to finance processing or marketing 
operations that are substantially controlled by parties who are not 
bona fide farmers, ranchers, and aquatic producers or harvesters.
    In response to the inquiry from an FCB and some of its affiliated 
associations, the FCA confirms that this regulation would not require 
an applicant for a processing or marketing loan to have an outstanding 
agricultural or aquatic loan with a System bank or association.
2. Throughput Requirements
    Fifteen System commenters objected to the proposed requirement for 
borrowers to ``consistently'' produce some of the throughput used in 
the processing or marketing operation. The FCC and most System banks 
and associations stated that neither the current regulation's use of 
the word ``sustained,'' nor the proposed regulation's use of the term 
``consistently,'' are justified by the plain language of the Act. These 
commenters claim that sections 1.11(a)(1) and 2.4(a)(1) of the Act only 
require borrowers to ``supply some portion'' of the total throughput. 
Two commenters suggested the FCA amend Sec. 613.3010(a)(2) so it would 
allow FCBs and associations to finance borrowers

[[Page 42107]]

who are ``capable of producing some portion of the throughput.'' 
Several commenters suggested that the FCA remove this requirement 
because it implied that the borrower would cease being eligible for 
financing when market conditions dictated that they process crops 
through another processor/marketer. All commenters, except the BC and 
ACB, would prefer to have the regulations restate the statutory 
language.
    The FCA disagrees with the commenters. Although the words 
``consistently'' or ``sustained basis'' do not appear in the text of 
sections 1.11(a) and 2.4(a) of the Act, such a term is needed in the 
regulation in order to implement the statutory requirement that 
eligible processing or marketing operations be ``directly related'' to 
the borrowers' agricultural or aquatic production activities. The 
legislative history explains that the Act requires ``a demonstrated 
relationship between the total processing and marketing activities and 
the applicant's own production.'' 6
---------------------------------------------------------------------------

    \6\  S.R. No. 96-837, supra.
---------------------------------------------------------------------------

    In order to provide FCBs, ACBs, and direct lender associations with 
greater flexibility to finance processing or marketing operations under 
the scope of sections 1.11(a) and 2.4(a) of the Act, reproposed 
Sec. 613.3010(a)(2) would require the borrower or its owners to 
``regularly'' supply throughput. The term ``consistently'' implies that 
there can be no variation in the level or timing of the borrower's 
throughput contribution, whereas the term ``regularly'' provides the 
borrower with greater flexibility to address unexpected problems in 
supplying throughput.
    The FCA does not accept the suggestion of several System commenters 
that the regulation confer eligibility on processing or marketing 
borrowers who are ``capable'' of producing throughput because the mere 
capacity to contribute throughput, without more, does not satisfy the 
Act's requirement that borrowers ``supply'' throughput.
3. Regulatory Burdens
    The IBAA opposes the repeal of the documentation requirements in 
existing Sec. 613.3045(e), asserting that this provision is necessary 
to implement statutory eligibility requirements. The FCA disagrees. 
Compliance with eligibility requirements is adequately assured through 
the lenders' internal policies and the examination and enforcement 
powers of the FCA. Existing Sec. 613.3045(e) dictates detailed 
management and operational procedures to System institutions. Such 
``command and control'' requirements are incompatible with the FCA's 
Regulatory Philosophy Statement and the President's initiative to 
reduce regulatory burdens under the National Performance Review. 
Accordingly, the FCA continues to propose the repeal of 
Sec. 613.3045(e).
    No comments were received on the provisions in paragraph (b) 
addressing the portfolio limitations and, therefore, the FCA has not 
revised this provision in its reproposal.

N. Farm-Related Business Regulation

    The FCA originally proposed to redesignate and revise the 
regulation that authorizes FCBs, ACBs, and direct lender associations 
to make loans to farm-related businesses. Existing Secs. 613.3050 and 
619.9120 would have been replaced with a new regulation, Sec. 613.3020, 
which is closely aligned with the plain language of sections 1.9(2), 
1.11(c)(1), and 2.4(a)(3) of the Act. This change would have repealed 
existing regulatory requirements that are not required by the Act. The 
FCA proposed these revisions because existing Secs. 613.3050 and 
619.9120 are unnecessarily restrictive and appear to frustrate the 
ability of System banks and associations to finance statutorily 
eligible and creditworthy farm-related businesses, needlessly denying 
many farm-related businesses a competitive credit option. The preamble 
to the FCA's original proposal noted that farm-related business loans 
comprise less than 1 percent of all System loans, and many FCS banks 
and associations have no farm-related business loans in their 
portfolios.
    The FCA received 58 comments about proposed Sec. 613.3020. Of this 
total, 26 comments were received from System banks, associations, and 
the FCC. The FCA also received comments from three commercial banks and 
four banking trade associations, four credit unions and one of their 
trade associations, three State government agencies, 17 individuals, 
and FLAG.
    Most of the comment letters from commercial banks, credit unions, 
and their trade association pertained to competition between private 
sector lenders and the FCS. FLAG opposed the proposed regulation 
because it would create opportunities for outside investors, who do not 
contribute to the prosperity of local farm communities, to obtain FCS 
funding for farm-related businesses. The FCA has already responded to 
these concerns in earlier sections of this preamble.
    The individual commenters and three State government agencies 
supported proposed Sec. 613.3020 because it would bolster the 
agricultural economy by enabling FCS banks and associations to provide 
affordable credit to local farm-related businesses that serve farmers 
and ranchers. These commenters stated that farm-related businesses 
provide essential services to production agriculture and rural America. 
One State Government agency asserted that the FCS should only finance 
businesses (other than farming, ranching, and aquatic operations) that 
add value to agricultural products.
    A number of commenters requested clarifications or modifications to 
this regulation.
1. Types of Services
    Under Sec. 613.3020(a) of the original proposal, an individual or 
legal entity who furnishes services to farmers and ranchers that are 
directly related to their agricultural operations would be eligible to 
borrow from System lenders. Two commenters claimed that the language of 
proposed Sec. 613.3020(a) is too broad and ambiguous because virtually 
any business in an agriculture community, including a gas station or 
accounting firm, could argue that it is an eligible farm-related 
business.
    To prevent any such misinterpretation, the FCA revises proposed 
Sec. 613.3020(a) to clarify that a business must furnish ``farm-related 
services'' in order to qualify for System financing. Businesses that 
offer non-agricultural services to farmers and ranchers do not qualify 
as eligible farm-related businesses under sections 1.11(c)(1) and 
2.4(a)(3) of the Act. Some examples of ``farm-related services'' that 
would be covered by the reproposed regulation are: (1) Spraying crops; 
(2) harvesting; (3) transporting agricultural commodities to grain 
elevators, livestock markets or other markets, and other processing 
centers; (4) custom feed mixing operations; (5) veterinary services; 
(6) drying or preserving farm commodities or products; (7) repairing 
and servicing farm implements, equipment and machinery; (8) computer 
and aerial mapping of soil and crop conditions; (9) nutritional 
analysis for livestock production; and (10) specialized animal 
husbandry services. Reproposed Sec. 613.3020 would no longer require an 
eligible farm-related business to furnish services on the farms or 
ranches of its customers because the plain language of sections 
1.11(c)(1) and 2.4(a)(3) of the Act and their legislative history do 
not impose an ``on-farm'' requirement.
2. Custom-type Services
    Commercial bank commenters opposed the FCA's proposal to repeal

[[Page 42108]]

Sec. Sec. 613.3050(a) and 619.9120, which required eligible farm-
related businesses to furnish ``custom-type services'' to farmers and 
ranchers. ``Custom-type services'' are functions that farmers and 
ranchers can perform for themselves, but instead hire outside 
contractors to perform these tasks. One commenter suggested that an 
amendment to the Act would be necessary before the FCA could repeal 
this regulatory requirement.
    The FCA disagrees that sections 1.11(c)(1) and 2.4(a)(3) of the Act 
limit eligibility for financing to those businesses that furnish 
``custom-type services'' to their customers. Although passages in the 
legislative history to the Act contain examples of ``custom-type 
services'' that farmers and ranchers may perform for themselves, these 
examples appear illustratory. The FCA finds no evidence to support the 
contention that sections 1.11(c)(1) and 2.4(a)(3) of the Act preclude 
System banks and associations from financing farm-related services that 
are directly related to agricultural production. Under the 
circumstances, the repeal of Secs. 613.3020(a) and 619.9120 would 
advance the purpose and objectives of the Act because farmers today 
rely on technologically advanced services that they cannot perform for 
themselves. Such services enable farmers and ranchers to: (1) Increase 
their income; (2) reduce their operating costs; (3) improve farm 
productivity; and (4) satisfy consumer demands for improved food 
quality and specialty food products.
3. Financing Other Purposes
    Several commercial bank trade associations asserted that proposed 
Sec. 613.3020(b)(1) would actually enable an eligible borrower who 
derives more than 50 percent of its income from furnishing farm-related 
services to obtain System financing for non-agricultural purposes.
    The FCA proposed Sec. 613.3020(b)(1) so that FCS banks and 
associations could, to the extent allowed by sections 1.11(c)(1) and 
2.4(a)(3) of the Act, finance farm-related businesses that sell some 
agricultural goods or inputs that are not consumed in its services to 
farmers and ranchers. The FCA intended that proposed 
Sec. 613.3020(b)(1) would allow FCBs, ACBs, and direct lender 
associations to provide ``whole firm'' financing to businesses that 
primarily furnish farm-related services to farmers and ranchers. Under 
the FCA's proposal, the following farm-related businesses, for example, 
could become eligible for System loans because they derive more than 
half of their income from providing farm-related services separately 
from selling farm goods or inputs: (1) Veterinary services that sell 
medications and supplemental feed mixes directly to farmers and 
ranchers; (2) farm equipment repair and maintenance services that also 
sell spare parts to their customers; and (3) crop fertilizing services 
that sell mixtures that farmers will apply to the soil between routine 
service calls. Because the borrower must derive more than 50 percent of 
its income, as measured on a gross sales or net sales basis, from 
furnishing farm-related services, the proposed regulation was designed 
to ensure that System banks and associations extend ``whole firm'' 
financing only to a farm-related business that primarily provides 
services, rather than goods or inputs, to its customers.
    Sections 1.11(c)(1) and 2.4(a)(3) of the Act do not authorize FCBs, 
ACBs, and direct lender associations to finance the non-agricultural 
activities of farm-related businesses, and this was not the intent of 
the FCA. The FCA has revised this provision to ensure that financing 
under this section is provided only for farm-related business purposes. 
Reproposed Sec. 613.3020(b) would authorize an FCB, ACB, or direct 
lender association to finance: (1) All of the farm-related business 
activities of an eligible borrower who derives more than 50 percent of 
its annual income (as consistently measured on either a gross sales or 
net sales basis) from furnishing farm-related services that are 
directly related to the agricultural production of farmers and 
ranchers; or (2) only the farm-related services activities of an 
eligible borrower who derives 50 percent or less of its annual income 
(as consistently measured on either a gross sales or net sales basis) 
from furnishing farm-related services that are directly related to the 
agricultural production of farmers and ranchers. This revision will 
prevent System banks and associations from financing the borrower's 
non-agricultural enterprises.
4. Income Test
    The FCC and most System commenters suggested that the FCA revise 
proposed Sec. 613.3020(b) so that a farm-related business could obtain 
System financing for all of its needs if some minimum percentage of its 
operations, as measured either on an income or asset basis, consists of 
furnishing farm-related services to farmers and ranchers. The FCC and 
most System institutions suggested that the FCA authorize System 
lenders to finance all of the needs of a business that derived at least 
20 percent of income from furnishing farmers and ranchers with farm-
related services. Two other commenters suggested that the FCA set the 
threshold at 10 percent or lower.
    These commenters urged the FCA to lower the 50-percent threshold in 
proposed Sec. 613.3020(b) because they assert that System banks and 
associations will be unable to compete in this segment of the 
agricultural credit market unless they can finance all of the 
borrower's operations. These commenters note that farm-related 
businesses usually conduct diversified operations that include farm 
supply and other types of business in addition to farm-related 
services. The commenters believe that the proposed approach may be 
unworkable because these diversified operations experience seasonal 
fluctuations in demand and are unlikely to segregate their diversified 
operations in their financial statements.
    The FCC and one FCS association suggested an alternative to the 
income percentage test that would prevent System banks and associations 
from becoming concentrated in loans to businesses that do not primarily 
furnish farm-related services to farmers and ranchers. Under this 
alternative, the total outstanding loans of each FCB, ACB, or direct 
lender association to farm-related businesses that devote less than 50 
percent of their operations to farm-related services would be limited 
to 15 percent of the institution's total outstanding loans at the end 
of the preceding fiscal year.
    Although a portfolio limitation could achieve this policy result, 
the FCA has not adopted this suggestion because it does not believe 
that safety and soundness concerns require such controls or that such a 
limitation would be consistent with Congressional intent. The 
reproposed regulation maintains the threshold for whole firm financing 
at 50 percent. Allowing whole firm financing to a business that derives 
only a minority of its income from providing agricultural services is 
difficult to reconcile with sections 1.11(a)(1) and 2.4(a)(3) of the 
Act.
    The FCA also declines requests to include assets as an additional 
measure of whether a borrower primarily furnishes services or sells 
supplies because it is virtually impossible to distinguish whether 
certain assets are consumed in providing farm-related services or sold 
as supplies.
5. Intra-System Competition
    The BC and ACB expressed concern about intra-System competition for 
farm-related business loans. Although these two commenters did not

[[Page 42109]]

specifically object to proposed Sec. 613.3020 or the FCC's 
recommendations, they supported a provision in proposed 
Sec. 613.3000(a)(4) that would prohibit FCBs and direct lender 
associations from extending credit to legal entities that are eligible 
to borrow from a BC or an ACB. As discussed earlier, reproposed 
Sec. 613.3000 would not prohibit FCBs and direct lenders from lending 
to certain cooperatives and their related entities. Although the FCA 
acknowledges the small overlap of the authorities of System 
institutions that operate under titles I, II, or III of the Act to 
finance farm-related businesses, neither the Act nor the regulations 
permit FCBs and their affiliated direct lender associations to extend 
whole firm financing to entities that sell primarily farm supplies. 
Therefore, intra-System competition should be limited. The FCA intends 
to review this issue again when it considers all aspects of intra-
System competition.

O. Rural Home Regulation

    The FCA originally proposed to redesignate and substantially revise 
the regulations that govern System loans to non-farm rural homeowners. 
The FCA received general comments on rural home lending from 22 
parties, including FCS associations, credit unions, commercial banks, 
trade associations, borrowers, and a State agency.
    Many FCS commenters offered general support for the proposed 
revisions to the rural home financing regulations. Borrowers stated 
that the amendments would have a positive effect on the rural economy 
and may keep more people living in rural America. The FCC stated that 
the proposed regulations clarify the authority of the FCS to finance 
both non-farm rural homes and the housing needs of agricultural 
producers. The FCC also supported the repeal of several regulatory 
requirements that are not required by the Act, but restrict the ability 
of the FCS to finance the housing and domestic needs of rural home 
borrowers. Three borrowers, one trade organization, and one 
governmental agency supported the provisions allowing home equity 
loans.
    Non-System lenders and their trade associations opposed the 
proposed amendments. Their comments addressed such topics as potential 
customers, the geographic areas where loans could be made, and other 
matters. A credit union stated that the proposed regulations would hurt 
credit unions because it believed that non-farmers could borrow from 
the FCS to build homes, condominiums, and duplexes in non-rural areas. 
Another credit union objected to the possibility of increased 
competition from FCS rural home financing. Several commercial banking 
interests commented that the proposed amendments would expand the 
number of non-farmer mortgage borrowers expected to use System 
resources, loosening the bond between farmers and ranchers and the FCS.
    These comments reflect incorrect assumptions about the rural home 
provisions of the Act and FCA regulations. Sections 1.11(b) and 2.4(b) 
of the Act allow FCS banks and associations to finance single-family, 
moderately priced dwellings in rural areas where the population does 
not exceed 2,500 inhabitants for rural residents who are not 
agricultural or aquatic producers. The Act also limits such loans to 15 
percent of the outstanding loans of System banks and associations.
    The proposed regulations distinguished housing loans for farmers 
under sections 1.11(a) and 2.4(a) of the Act from home loans for non-
farmers under sections 1.11(b) and 2.4(b) of the Act. Because rural 
home loans are limited to 15 percent of outstanding loans and because 
only farmer borrowers are voting stockholders of FCS institutions, the 
clear separation provided for in the proposed amendments would not 
dilute the agricultural focus of the FCS, as some commenters suggest.
1. Loan-to-Value Ratio
    Two commercial banking interests commented that the proposed 
regulation would permit higher loan-to-value ratios on rural home 
loans.
    Loan-to-value limitations are set by the Act and not altered by the 
regulation. Section 1.10(a) of the Act and Sec. 614.4210(b) require a 
long-term mortgage loan to be secured by a first lien interest in real 
estate that does not exceed 85 percent of the appraised value of the 
mortgaged property, except that FCS banks and associations may finance 
up to 97 percent of the appraised value of the property if the loan is 
guaranteed by a governmental agency. In addition, section 12 of the 
1996 Reform Act 7 recently amended section 1.10(a) of the Act so 
that System mortgage lenders can rely on private mortgage insurance 
when the loan-to-value exceeds 85 percent. Under these circumstances, 
the repeal of the loan-to-value ratio in existing Sec. 613.3040(c) is 
compatible with section 1.10(a) of the Act.
---------------------------------------------------------------------------

    \7\ Pub. L. 104-105, 110 Stat. 162 (Feb. 10, 1996).
---------------------------------------------------------------------------

2. Owner-Occupied Dwellings
    Two commenters objected to the proposed elimination of the 
regulatory requirement that the dwelling be owner-occupied. The FCA's 
original proposal retained the existing requirement that the home be 
used as the primary residence of a rural resident but it would permit 
the owner to lease the property to another rural resident. The FCA 
believes that eliminating the regulatory owner-occupancy requirement 
advances the rationale for this authority, which is to ensure the 
availability of housing for rural residents. Therefore, the reproposal 
would also repeal the existing regulatory requirement that the borrower 
occupy the dwelling.
3. Consumer Protection Laws
    A commercial banker questioned whether consumer protection laws 
apply to FCS rural home loans. The FCS's rural home lending practices 
are subject to the same Federal consumer protection laws and 
implementing regulations of the Board of Governors of the Federal 
Reserve System and the Department of Housing and Urban Development as 
are commercial banks. The FCA proposed to relocate the 
nondiscrimination in lending regulations in subpart E of part 613 to a 
new part 626 to give them more prominence. These regulations address 
the prohibitions of the Equal Credit Opportunity Act (15 U.S.C. 1601 et 
seq.) and the Fair Housing Act (42 U.S.C. 3601 et seq.). In addition, 
rural home lending transactions are subject to the requirements of the 
Truth-in-Lending Act (implemented at 12 CFR 226) and the Real Estate 
Settlement Procedures Act (implemented at 24 CFR 3500).
4. Agricultural Loan Priority
    One commenter objected to the FCA's decision to delete existing 
Sec. 613.3040(d)(3), which reflects the Agency's policy commitment to 
Congress that agricultural loans will have priority over non-farm rural 
home loans.
    The FCA is not rescinding its policy commitment to Congress that 
agricultural loans will always have priority over rural home loans. 
Indeed, the preamble discussing the proposed deletion of 
Sec. 613.3040(d)(3) stated that ``the FCA continues to adhere to this 
commitment.'' The FCA's decision to propose deletion 
Sec. 613.3040(d)(3) is unchanged because it is a policy statement 
rather than an enforceable regulation. The deleted provision added 
nothing to the FCA's statutory powers to ensure that the credit needs 
of

[[Page 42110]]

agricultural or aquatic producers received priority during a financial 
crisis. For these reasons, no party should be concerned by the repeal 
of former Sec. 613.3040(d)(3).
5. Definition of Rural Area
    The FCA originally proposed to define a ``rural area'' as ``a 
designated rural area within a State or the Commonwealth of Puerto Rico 
including communities that have a population of not more than 2,500 
inhabitants based on the latest decennial census of the United 
States.'' The FCA received comments from 17 parties on the definition 
of rural area in proposed Sec. 613.3030(a)(3).
    No commenters supported the FCA's proposal to rely on the Census to 
identify rural areas where the population does not exceed 2,500 
inhabitants. Both System and non-System commenters stated that sparse 
population is not the sole determinant of a rural area. These 
commenters claimed that reliance on the Census ignores the social and 
economic characteristics of a rural area. Commercial banks, credit 
unions, and their trade associations opposed the FCA's original 
proposal because it would allow System banks and associations to 
finance housing in the rural pockets of metropolitan areas, where the 
commenters claim credit from other lenders is readily available. System 
commenters asserted that the Census designations would increase their 
regulatory burdens, but decrease their flexibility to offer home 
financing to residents of communities that are rural in nature. Some 
FCS associations claimed that the proposed regulation would require 
them to consult a Census map for each loan application to determine if 
the borrower's home is located in a designated rural area. Other FCS 
commenters advised the FCA that Census data is not updated frequently 
enough to reflect the changing demographics of rural areas. All 
commenters advised the FCA that the existing Sec. 613.3040 provides the 
most workable definition of a rural area.
    These comments have persuaded the FCA that Census information may 
not adequately implement the provision of the Act that defines a rural 
area. For this reason, the FCA withdraws its original proposal to rely 
solely on the Census for determining rural areas.
    Reproposed Sec. 613.3030(a)(3) would define a rural area as ``open 
country within a State or the Commonwealth of Puerto Rico, and may 
include communities that have a population of not more than 2,500 
persons.'' The FCA has decided to delete the passage in 
Sec. 613.3040(a)(3) that authorized Farm Credit banks and associations 
to make loans in open agricultural areas within ``towns'' where the 
population exceeds 2,500 inhabitants, subject to Agency prior approval. 
This provision addressed special situations where a municipality 
annexed the surrounding countryside or two municipalities merged, and 
as a result, the population of the new political entity exceeded 2,500 
inhabitants. The FCA has rarely used this prior approval authority 
during the past 25 years. The reproposed regulation would delete this 
provision because it creates unnecessary confusion.
6. Definition of Moderately Priced Housing
    The FCA originally proposed a two-part definition for moderately 
priced housing. The first part was a safe harbor provision, and it 
would have applied to the price of any home that satisfies the criteria 
in section 8.0 of the Act pertaining to rural home loans that 
collateralize securities that are guaranteed by the Federal 
Agricultural Mortgage Corporation (Farmer Mac). Under the second part 
of the original proposal, FCS banks and associations would be 
authorized to finance ``moderately priced'' rural homes that have a 
value no higher than the 75th percentile of housing values in the rural 
area where the dwelling is located in accordance with the most recent 
edition of the Census of Housing.
    The FCA received several comments criticizing this proposed change. 
Two FCS associations commented that the amendment would impose 
restrictions not found in the Act or in existing regulations and would 
limit FCS's ability to serve rural residents. Some FCS associations 
commented that proposed Sec. 613.3030(a)(4) is flawed because they 
believe that it is neither possible nor desirable to devise a clear 
single standard for moderately priced housing in rural areas across the 
United States. Although the FCC agreed with FCA's objective of 
establishing a clear standard, it stated that the proposal does not 
meet this objective because the proposed regulation would provide the 
FCS with less flexibility than the former regulation to finance 
moderately priced homes.
    A commercial bank trade association objected to the definition of 
``moderately priced'' homes in proposed Sec. 613.3030(a)(4) because it 
allows System lenders to make home loans in rural pockets of 
metropolitan areas where the population does not exceed 2,500 persons 
pursuant to the latest Census of the United States. This commenter 
expressed concern that the proposal would allow the FCS to finance 
moderately priced housing on the fringes of urbanized areas, and could 
redirect the System away from lending to rural America, farmers and 
ranchers.
    The FCA received comments from four parties, including three FCS 
associations and one trade organization about the use of Farmer Mac 
criteria as a safe harbor provision. The FCC supported this provision 
because the Farmer Mac criteria have a Congressionally mandated 
relationship to the FCS's rural home authorities and are thus suitable 
as one possible measure of moderately priced housing. This commenter 
urged the FCA to allow additional standards, as well, that would take 
into account geographical differences in housing values. Several 
associations shared the view that an additional standard is needed that 
would recognize higher housing costs in certain areas. As an example, 
one association noted that a 2000 square foot home in its territory 
would exceed the Farmer Mac criteria.
    The FCA also received comments from 22 parties objecting to the use 
of Census data to determine the value of moderately priced housing. 
Many System institutions commented that the use of Census data is not 
required by the Act or the existing regulations. Moreover, they 
observed that Census data are not useful for a number of reasons, 
including: (1) They are based on subjective estimates of the homeowners 
rather than market transactions; (2) the Census survey is conducted 
every 10 years and thus the data are soon outdated; and (3) the data 
cut across market boundaries which leads to wide and arbitrary 
differences in the definition of moderate price between counties or 
census blocks.
    Six FCS associations provided examples of the adverse effects of 
using the Census housing data to determine the value of moderately 
priced housing. They commented that using Census data would: (1) 
Restrict the market, competitiveness, and spreads; (2) reduce the 
current maximum limit the FCS institutions use for moderately priced 
housing in some areas by 50 percent or more; and (3) result in a 
significant increase in administrative work.
    Most System commenters offered specific recommendations for how the 
FCA could revise this regulation to determine the value of moderately 
priced housing. Fourteen commenters recommended that the Federal Home 
Loan Mortgage Corporation (Freddie Mac) or Federal National Mortgage 
Association (Fannie Mae) limits determine the moderately priced

[[Page 42111]]

standard for System rural home lending. These commenters believed that 
the Freddie Mac and Fannie Mae thresholds would avoid the defects of 
the Census data and would provide for a level playing field with 
competitors. Other commenters suggested that FCA retain the definition 
in the existing regulation to provide System lenders with greater 
flexibility to use other reasonable methods to determine moderately 
priced values. Another frequent suggestion was to authorize System 
institutions to rely on any accepted independent study or formula from 
a credible regional or national source.
    The FCC offered two approaches. First, the Farmer Mac limit would 
be used as a safe harbor provision and a higher limit could be adopted 
if it were supported by a study that established local standards for 
moderately priced housing, based on actual sales. In the alternative, 
the FCC suggested that the System could use any combination of Farmer 
Mac criteria, Freddie Mac or Fannie Mae guidelines, information 
provided by the Department of Housing and Urban Development, 
information on income provided by the Census, local sales data, or 
market studies.
    The FCA continues to believe that the Farmer Mac standard for the 
value of a rural home is a useful method for determining moderately 
priced housing because the criteria in section 8.0 of the Act are 
directly related to home financing in rural areas of 2,500 inhabitants 
and the System's rural housing authorities. For this reason, homes that 
satisfy the Farmer Mac criteria would be considered moderately priced 
under reproposed Sec. 613.3030(a)(4)(i). In response to System comments 
that Farmer Mac criteria ignore variations in housing costs in 
different rural areas, the FCA points out that section 101 of the 1996 
Reform Act clarifies that the Farmer Mac limit of $100,000 (as adjusted 
for inflation since 1988) refers to the value of the dwelling only, 
exclusive of the value of the land on which it is situated.8 This 
statutory clarification provides flexibility for lending in areas where 
land values are higher.
---------------------------------------------------------------------------

    \8\ Ibid.
---------------------------------------------------------------------------

    Reproposed Sec. 613.3030(a)(4)(ii) would also allow FCS lenders to 
finance rural homes that are below the 75th percentile of housing 
values for the rural area where it is located, as determined by data 
from a credible, independent, and recognized national or regional 
source, such as a Federal, State, or local government agency, or an 
industry source. Each System bank or association will bear the burden 
of demonstrating that the price range it selects reflects moderately 
priced housing in the specific locale where its rural home loans are 
made. FCS institutions may use the Census of Housing data for their 
studies but are not be required to do so. If this reproposal is adopted 
as a final regulation, the FCA will review the methods used during 
examinations of FCS institutions.
    The FCA has decided not to incorporate the maximum loan amount used 
by Freddie Mac or Fannie Mae into the reproposed regulation. The FCA 
believes that the Freddie Mac and Fannie Mae maximum loan amounts may 
not be representative generally of moderately priced housing in rural 
areas because they include housing values in urban and suburban 
communities. Furthermore, the Freddie Mac and Fannie Mae maximum loans 
amounts are not necessarily a measure of moderately priced housing.
7. Home Equity Lending
    The FCA's original proposal would have allowed non-farm rural 
homeowners to obtain home equity loans and lines of credit from System 
lenders, secured by the rural home, without a restriction on the 
borrower's use of the proceeds.
    The FCA received comments from seven parties, including one 
commercial bank, five trade associations, one borrower, and one 
governmental body on the eligibility requirements for rural home 
lending. A Farm Credit borrower supported home equity loans because the 
commenter believes that this authority would enhance the ability of the 
FCS to finance the agricultural community. The FCC, commenting 
generally on the amendments to the rural home lending regulations, 
stated that the proposed regulations clarify that FCS institutions may 
offer equity line-of-credit loans to rural homeowners. The FCC agreed 
that equity line-of-credit loans would enable FCS to better fulfill its 
statutory mission of providing an adequate and flexible flow of credit 
into rural areas.
    The NDCUL and a commercial banker stated without explanation that 
the FCS should not be allowed to make home equity loans for consumer 
purposes to rural residents who are not farmers, ranchers, or aquatic 
producers or harvesters. A State governmental agency opposed the FCA's 
proposal as presenting unfair competition with commercial banks and 
credit unions. Another commenter contended that home equity consumer 
loans to borrowers who are not farmers, ranchers, or aquatic producers 
or harvesters are not within the System's statutory mission.
    Three banking trade associations also opposed this proposal. One 
stated that it does not believe that ``home equity lending comports 
with this GSE's statutory reasons for existence.'' It expressed concern 
that home equity lending may be used for consumer purposes rather than 
housing purposes and that home equity lending would reduce available 
FCS funds for rural housing loans because of the portfolio limitation. 
The commenter stated that the FCA presents no evidence that such home 
equity lending is an unmet need in a very competitive home equity 
lending market. Another commenter objected because it does not believe 
that there is express authority for home equity lending and that being 
a full-service lender to rural residents does not comport with the 
System's reason for existence. A third trade association stated that 
several of its members questioned the advisability of FCS making home 
equity loans because they believe that such loans are risky. This 
commenter asked that the FCA provide a detailed explanation of the 
underwriting standards that are envisioned for home equity lending. It 
also noted that loan proceeds could be for consumer goods, which it 
deems as inappropriate for the FCS.
    In response to the comments from banking interests, the FCA 
rescinds its original proposal regarding home equity lending and 
restores the purpose restrictions contained in existing 
Sec. 613.3040(c) as reproposed Sec. 613.3030(c). The FCA notes that 
System lenders are not precluded from extending authorized credit to 
rural homeowners through revolving lines of credit. The reproposal 
would, however, require that such credit extensions be limited to the 
purposes specified. This change to the proposed rule on home equity 
lending makes unnecessary the proposed conforming amendments to 
Sec. 614.4222, and those proposed amendments are now withdrawn.
    No comments were received on proposed Sec. 613.3030 (a)(1) or 
(a)(2), and it is included in the reproposed regulation without 
revision. No comments were received on proposed Sec. 613.3030(c), and 
it is redesignated as reproposed Sec. 613.3030(d).

P. Allowable Real Estate Security

    The FCA received 12 comments about the requirements for the type of 
allowable real estate security for long-term mortgage loans in 
Sec. 614.4210(a). Most commenters requested that the FCA clarify that 
housing for agricultural producers is not subject to the

[[Page 42112]]

limitations on location, type of housing, or price for rural home 
lending. Many commenters also supported increased flexibility in the 
types of real estate collateral that could be counted toward the 
statutory 85-percent loan-to-value limitation.
    The FCA reaffirms that the limitations for the type of house and 
the value of the house for rural home lending apply only to housing for 
individuals who are not farmers, ranchers, or aquatic producers or 
harvesters. As stated in the discussion of financing a farmer's housing 
and domestic needs, such housing can be financed under farm lending 
authorities for a bona fide farmer, rancher, or aquatic producer or 
harvester.
    The FCA has considered the issue of allowable collateral for long-
term mortgage lending under title I of the Act when it proposed 
amendments to the loan underwriting regulations on March 12, 1996. See 
61 FR 16403 (April 15, 1996). Under that proposed rule, the FCA would 
continue to limit the types of collateral that can secure a mortgage 
loan, but it allows flexibility so that the collateral remains 
primarily agricultural in nature. The rule also would continue the 
requirement that the loan-to-value ratio not exceed 85 percent. The FCA 
will consider comments to its proposal of March 12, 1996, before it 
adopts final amendments to Sec. 614.4210(a) and other regulations that 
govern loan underwriting and collateral standards.

Q. Title III Domestic Lending Regulation

    The FCA's original proposal would significantly restructure and 
clarify the regulations that govern eligibility and scope of financing 
for BCs and ACBs. More specifically, the FCA initially proposed to 
redesignate existing Sec. 613.3110 as Sec. 613.3100, and rearrange this 
regulation so it addresses the authority of BCs and ACBs to finance the 
following class of borrowers: (1) Cooperatives, their parents, 
subsidiaries and other related entities that serve agricultural or 
aquatic producers; (2) electric, telecommunication, and cable 
television utilities; (3) water and waste disposal facilities; and (4) 
domestic lessors.
    As noted in the preamble to the original proposal, many proposed 
revisions reflect provisions of the 1992 amendments 9 and the Farm 
Credit System Agricultural Export and Risk Management Act (1994 
Act).10 After the comment period for this proposed rulemaking 
expired, the 1996 Reform Act was enacted into law. The 1996 Reform Act 
amended two provisions in section 3.8 of the Act that govern the 
eligibility of certain cooperatives and rural utilities to borrow from 
banks that operate under title III of the Act. Accordingly, the FCA has 
incorporated these statutory amendments into reproposed Sec. 613.3100.
---------------------------------------------------------------------------

    \9\ Pub. L. 102-552, 106 Stat. 4102 (Oct. 28, 1992).
    \10\ Pub. L. 103-376, 108 Stat. 3497 (Oct. 19, 1994).
---------------------------------------------------------------------------

    Comments were received from the St. Paul BC, CoBank, ABA, IBAA and 
NDBA. In general, the comments from the St. Paul BC and CoBank 
supported the proposed regulation. These commenters, however, requested 
clarification or modification of certain provisions of the original 
proposal. CoBank and the St. Paul BC supported the FCA's proposal to 
repeal existing Secs. 613.3005 and 613.3110(b)(2), which prescribe 
business objectives and management practices for title III banks.
    The three commercial bank trade associations endorsed all revisions 
that implement amendments to the Act. Otherwise, these three commenters 
opposed revisions concerning service cooperatives that provide 
financially related services and cable television utilities.
1. Definitions
    CoBank objected to the FCA's decision to delete the words ``a 
combination of such associations and farmers, ranchers, or producers or 
harvesters of aquatic products'' from the definition of a cooperative 
in proposed Sec. 613.3100(a)(1). The commenter claimed that this 
revision is a ``step backwards'' for certain cooperative combinations. 
Because of the commenter's concern, the previous wording is reinserted 
into the reproposed regulation with minor stylistic revisions.
     The comments from bank trade associations opposed 
Sec. 613.3100(a)(5) as proposed, because it would allow a BC or ACB to 
finance cooperatives that provide business and financially related 
services to their members. These commenters claim that Congress 
intended that the BCs and ACBs only finance cooperatives that aid 
production agriculture and that such service cooperatives should be 
served exclusively by commercial lenders.
     CoBank objected that proposed Sec. 613.3100(a)(5) would require an 
eligible service cooperative to be ``predominantly'' involved in 
providing business and financially related services to farmers, 
ranchers, and aquatic producers or harvesters. The commenter observes 
that the word ``predominantly'' does not appear in section 3.8(a) of 
the Act. CoBank asserted that including it in the definition converts a 
scope of financing question into an eligibility issue.
     The arguments against permitting title III lending to cooperatives 
that provide business and financial services to farmers are not 
supported by the Act and its legislative history. Section 3.8(a) of the 
Act expressly authorizes BCs and ACBs to finance eligible cooperatives 
that furnish ``business services or services'' to farmers, ranchers, 
aquatic producers or harvesters, or their cooperatives. This authority 
to finance service cooperatives has its origins in the Farm Credit Act 
of 1935.11 The legislative history to this provision reveals that 
Congress contemplated that these System banks would lend to service 
cooperatives that offered financially related services, such as 
insurance, to their members.12 In 1980, Congress amended section 
3.8(a)(4) of the Act so that service cooperatives would continue to 
qualify for FCS loans so long as 60 percent of their members are 
farmers, ranchers, or aquatic producers or harvesters. The 1996 Reform 
Act enables existing cooperative borrowers to retain their eligibility 
for BC or ACB loans if more than 50 percent of their members are 
agricultural or aquatic producers. Thus, the Act and its legislative 
history clearly refute the belief that BCs and ACBs lack authority to 
finance business and financially related service cooperatives. 
Furthermore, nothing in the Act or its legislative history supports the 
commenters' contention that a BC or ACB is authorized to finance only 
cooperatives that assist ``on-farm'' agricultural production. For these 
reasons, the FCA rejects the view that FCS banks operating under title 
III of the Act lack authority to finance cooperatives that furnish 
business and financially related services to agricultural and aquatic 
producers.
---------------------------------------------------------------------------

    \11\ P.L. No. 87-74, 49 Stat. 317 (June 3, 1935).
    \12\ H.R. 155, 74th Cong., 1st Sess. (Feb. 18, 1935) p. 9; Farm 
Credit Act of 1935: Hearings on S. 1384 Before the Senate Committee 
on Banking and Currency, 74th Cong., 1st Sess. p. 22 (Jan. 29, 
1935).
---------------------------------------------------------------------------

    The FCA agrees with the comment that the word ``predominantly'' in 
proposed Sec. 613.3100(a)(5) is more restrictive than the statute, 
since section 3.8(a) of the Act, as amended, establishes specific 
thresholds for farmer membership in an eligible service cooperative. 
Thus, the FCA deletes the word ``predominantly'' from reproposed 
Sec. 613.3100(a)(5).
 2. Cooperatives and Other Entities Serving Other Agricultural or 
Aquatic Producers
    Section 613.3100(b) governs the eligibility of agricultural or 
aquatic

[[Page 42113]]

cooperatives and their related entities to borrow from title III 
lenders. Other eligible entities include: (1) The parent of an eligible 
cooperative; (2) a subsidiary or other legal entity in which an 
eligible cooperative has an ownership interest; and (3) a non-profit 
entity that satisfies the criteria in section 3.8(b)(1)(D) of the Act.
    Section 14 of the 1996 Reform Act amended section 3.8(a) of the Act 
to permit the continued eligibility of pre-existing cooperative 
borrowers as long as at least 50 percent of the voting control is held 
by farmers, ranchers, aquatic producers or harvesters, or their 
cooperatives. Section 14 of the 1996 Reform Act also amended section 
3.8(b)(1)(D) of the Act so that eligible non-profit entities and their 
subsidiaries also benefit from this statutory change. Accordingly, 
reproposed Sec. 613.3100(b)(1)(i) and (b)(2)(iii) incorporates these 
statutory provisions of the 1996 Reform Act.
    Both System commenters expressed support for proposed 
Sec. 613.3100(b)(2)(ii), which allows a title III bank to extend credit 
to an entity in which an eligible cooperative is a minority owner. Such 
financing is limited to the cooperative's percentage of ownership 
multiplied by the borrowing entity's total assets. CoBank asked for 
clarification on three questions about how title III banks should 
measure the borrower's total assets: (1) Are the entity's total assets 
measured at the beginning or the end of a capital project? (The 
commenter suggested that the end of a project is the better measure.) 
(2) How should assets be measured for borrowers with wide seasonal 
fluctuations in assets? (The commenter recommended that the seasonal 
peak in assets be the appropriate measure.) (3) Should the borrower's 
assets be measured according to their book or market value? (The 
commenter believes that book value, as the more conservative standard, 
is appropriate.)
    The FCA believes each of the suggested clarifications is reasonable 
and consistent with the intent of section 3.7(b)(2)(A)(ii) of the Act. 
However, a uniform method of calculating total assets cannot be 
developed for all three scenarios. Thus, the FCA believes that each 
title III lender should establish in its lending policies the most 
appropriate measure of the borrower's assets depending on the nature of 
the credit request. For this reason, the FCA makes no modification to 
the reproposed regulation at this time. However, the FCA may issue 
regulatory guidance on asset measurement practices in the future.
3. Electric and Telecommunication Utilities
    Section 613.3100(c) of the original proposal and the reproposal 
contains rural utility lending authorities. The FCA received comments 
from CoBank, the St. Paul BC, and the IBAA on proposed 
Sec. 613.3100(c). One comment suggested that the FCA retitle the 
section to read ``Electric and telecommunications utilities,'' because 
cable television is widely recognized as a subset of 
telecommunications. The FCA accepts this recommendation and has 
incorporated this change into the title of reproposed Sec. 613.3100(c).
     CoBank objected to the FCA's proposal to delete from the 
regulations explicit reference to farmer-owned utility cooperatives 
that are eligible to borrow from a BC or ACB under section 3.8(a) of 
the Act, instead of the Rural Utilities Service (RUS) provisions in 
section 3.8(b)(1)(A) of the Act. CoBank asserts that such authority 
exists in the statute, and therefore, it should be retained in the 
regulation even though it is not likely to be used frequently. The FCA 
accedes to the commenter's request and incorporates this statutory 
authority into reproposed Sec. 613.3100(c)(1)(i). The remaining 
provisions of reproposed Sec. 613.3100(c)(1) have been renumbered 
accordingly.
     The 1996 Reform Act repealed the RUS and Rural Telephone Bank 
(RTB) certification requirements in section 3.8(b)(1)(A) of the Act. 
Accordingly, reproposed Sec. 613.3100(c)(1)(ii)(C) revises the original 
proposal to conform with the revised statute. The St. Paul BC suggested 
that the FCA relocate the phrase ``other entities, or the subsidiaries 
of such cooperatives'' in paragraph (c)(1)(i)(C) to the end of that 
paragraph with appropriate stylistic revisions. The commenter observed 
that section 3.8(b)(1)(A) of the Act does not require the subsidiary of 
a cooperative or other entity to be eligible for a RUS or RTB loan. The 
FCA agrees with the commenter, and reproposed Sec. 613.3100(c)(1)(iii) 
will specifically govern loans by title III banks to subsidiaries of 
cooperatives and other entities that are eligible to borrow from the 
RUS or RTB. The FCA has, accordingly, renumbered the remaining 
provisions of reproposed Sec. 613.3100(c)(1).
     The St. Paul BC and CoBank requested that the FCA delete 
references to RUS and RTB regulations in proposed Sec. 613.3100(c)(2) 
because the Act does not subject BCs and ACBs to the scope of financing 
provisions of the Rural Electrification Act of 1936, as amended (REA 
Act). One comment letter included selected passages from the 
legislative history that indicate that Congress did not intend that 
title III banks adhere to the same loan purpose restrictions as the RUS 
or RTB. These commenters claimed that proposed Sec. 613.3100(c)(2) is 
more restrictive than the Act and would deny creditworthy and eligible 
rural utilities access to System credit to the full extent of the law.
     The commenters have persuaded the FCA that the references in 
proposed Sec. 613.3100(c)(2) to RUS and RTB regulations could prevent 
BCs and ACBs from financing rural utilities to the extent allowed by 
the Act. For this reason, references to the REA Act and RUS and RTB 
regulations are omitted from reproposed Sec. 613.3100(c)(2). Instead, 
the reproposed regulation would authorize lending for electric or 
telecommunication services in a rural area as allowed by the Act.
     The IBAA opposed provisions in proposed Sec. 613.3100(c)(2), which 
would authorize BCs and ACBs to finance a subsidiary of a rural 
electric or telecommunications utility that operates a licensed cable 
television carrier. This commenter claimed that the proposed regulation 
appears to conflict with the REA Act because it would allow a cable 
television subsidiary of a rural utility to borrow from a BC or ACB 
even though the REA Act expressly prohibits the RUS and RTB from 
financing cable television. In this commenter's view, the proposed 
regulation circumvents the REA Act by severing eligibility from scope 
of financing.
     The IBAA also notes that the System sought legislation in the 
spring of 1995 to enhance the ability of the title III banks to finance 
the ``rural information highway,'' including telecommunications 
services beyond basic telephone service to rural communities. Because 
no such legislation was enacted, or introduced, the commenter believes 
that title III banks lack the current authority to finance cable 
television carriers.
     Section 3.8(b)(1)(A) of the Act authorizes BCs and ACBs to finance 
rural utilities that are eligible to borrow from the RUS and RTB, and 
their subsidiaries. A cable television carrier qualifies for financing 
from a title III bank if it is the subsidiary of a rural utility that 
is eligible to borrow from the RUS or RTB. Although the Rural 
Electrification Act of 1936, as amended, prohibits the RUS or RTB from 
financing the cable television subsidiary, section 3.8(b)(1)(A) of the 
Act expressly authorizes a BC or ACB to extend credit to the same 
subsidiary. The FCA's position is clearly supported by the legislative 
history to section

[[Page 42114]]

3.8(b)(1)(A) of the Act, which reveals that Congress specifically 
intended to authorize title III banks to finance cable television 
carriers that are ineligible for RUS or RTB loans. The sponsor of 
section 3.8(b)(1)(A) stated:


     In addition, this authority will enable rural telephone systems 
and their subsidiaries to obtain financing for certain projects that 
contribute to the economic well-being of the telephone system's 
service area. Many of these projects undertaken by rural telephone 
systems involve so-called non-Act purposes-meaning that such 
projects are ineligible for REA financing under the Rural 
Electrification Act. These non-Act purposes usually involve 
providing of communication services such as cable television 
facilities and cellular radio facilities * * * (emphasis added)


The System's 1995 legislative initiative does not affect this existing 
authority. The legislative proposal would have expanded the lending 
authority of title III banks in a number of respects, including 
permitting them to finance cable television carriers that are not 
subsidiaries of entities eligible to borrow under the REA Act. Thus, 
the comment that FCA's regulation exceeds statutory authority lacks 
merit.
     The St. Paul BC notes that the restriction on financing to 
entities that are partially owned by an eligible utility appears in 
proposed Sec. 613.3100(c)(3), but no provision of this regulation 
expressly declares such entities to be eligible borrowers.
    The FCA agrees that the regulation would be clearer if the 
eligibility of such entities were set forth in Sec. 613.3100(c)(1). 
Accordingly, the FCA has added a new paragraph (c)(1)(iv), to 
reproposed Sec. 613.3100. This addition makes proposed 
Sec. 613.3100(c)(3) unnecessary, and it is deleted from the reproposed 
regulation.
 4. Water and Waste Disposal Facilities
    CoBank provided the only comment on this section of the regulation. 
The commenter objected to the word ``solely'' in proposed 
Sec. 613.3100(d)(2), which governs the financing authority for water 
and waste disposal facilities for title III banks. The commenter argues 
that such a restriction is not in the Act and that title III banks need 
the flexibility to finance ownership transfers so that water and waste 
disposal utilities can adjust to changes in their rural customer base 
and continue as viable entities. CoBank urges the FCA to construe the 
terms ``maintaining'' and ``operating'' in section 3.7(f) of the Act as 
allowing title III lenders the flexibility to finance ownership 
transfers for water and waste disposal facilities. The commenter 
expressed concern that the use of the word ``solely'' in 
Sec. 613.3100(d)(2) will have a chilling effect on the types of prudent 
financing that BCs and ACBs can provide these borrowers.
    Both section 3.7(f) of the Act and Sec. 613.3100(d)(2) authorize 
title III banks to extend financing to certain entities for the purpose 
of ``installing, maintaining, expanding, improving or operating water 
and waste disposal facilities in rural areas.'' As the FCA interprets 
section 3.7(f) of the Act, the sale of ownership interests in such 
entities is reasonably within the scope of ``maintaining'' or 
``operating'' a rural water or waste disposal facility. Therefore, 
revision of Sec. 613.3100(d)(2) is unnecessary.
5. Domestic Lessors
    The FCA received no comments about proposed Sec. 613.3100(e), which 
authorizes BCs and ACBs to make loans to domestic lessors, pursuant to 
section 3.7(a) of the Act. This provision remains in the reproposed 
regulation without revision.

R. Title III International Lending Regulation

    The FCA originally proposed to redesignate and substantially revise 
the regulation that implements the international lending authorities of 
BCs and ACBs. The new regulation would implement provisions in the 1994 
Act, which expanded the authority of BCs and ACBs to finance the 
import, export, and international business operations of cooperatives 
and other eligible borrowers. The FCA also proposed several conforming 
and technical amendments to Secs. 614.4010(d), 614.4020(a), 614.4233, 
and subpart Q of part 614 to reflect the expanded international lending 
powers of title III banks.
    Section 3.7(d) of the Act requires the FCA to consult with the 
Board of Governors of the Federal Reserve System (Board of Governors) 
whenever it formulates regulations pertaining to the international 
lending activities of title III banks so that the new ``regulations 
conform to national banking policies, objectives, and limitations.'' 
The FCA submitted the proposed international lending regulations to the 
Board of Governors for review and evaluation on August 9, 1995. On 
December 8, 1995, the Board of Governors informed the Chairman of the 
FCA, by letter, that it had no objection to the new regulations. The 
Board of Governors, however, advised the FCA that increased 
international lending increased the risk of loss to BCs and ACBs, which 
should be closely monitored.
    Comments about the original proposal were received from a 
commercial banker, a member of the CoBank board, CoBank, the ABA, IBAA, 
and the NDBA. The three commercial bank trade associations supported 
Sec. 613.3200 because it implements the 1994 Act. The commercial 
banker, however, commented that the expansion or FCS powers would place 
the FCS in direct competition with commercial banks for international 
loans without any of the regulatory mandates and responsibilities that 
commercial bankers face. The FCA responded to similar comments earlier 
in this preamble and finds the commercial banker's comment without 
foundation. The CoBank board member supported the proposed regulation 
as important to the evolving international business environment. 
CoBank's response supported most of the proposed regulation, including 
the definition of farm supply cooperatives and the treatment of import 
and export transactions. CoBank, however, had substantive comments on 
the two provisions which are discussed below.
    CoBank asserted that provisions in proposed Secs. 613.3200 (d) and 
(e), which limit subsidiary financing to international business 
``transactions,'' are more narrow than the Act. The comment states that 
the Act contains no such limitation and only requires that, subject to 
limitations regarding percentage of ownership and plant relocation, the 
financing be ``for the purpose of facilitating its domestic or foreign 
business operations * * *'' (emphasis added). CoBank also cites a 
technical analysis attached to an FCA letter dated August 17, 1994, to 
then House Agriculture Committee Chairman de la Garza in support of its 
position.
    The FCA's use of the terms ``transactions involving international 
business operations'' and ``international business transaction'' 
referred to the foreign business operations of the domestic or foreign 
entities, and it was not intended to limit the type of financing that 
is authorized by the Act. In order to clear up any confusion, the FCA 
has revised the title to reproposed Sec. 613.3200(d) by omitting the 
words ``transactions involving.'' Furthermore, the FCA has substituted 
``operations'' for ``transaction'' in reproposed Sec. 613.3200(e).

S. Similar Entity Participation Regulation

    The FCA proposed Sec. 613.3300 to implement the new authority of 
System banks and associations to participate in loans made by non-
System lenders to ``similar entities''--ineligible persons whose 
operations are functionally

[[Page 42115]]

similar to those of eligible borrowers. The proposed definition of 
``similar entity'' requires that a majority of the entity's income be 
derived from, or a majority of its assets be invested in, the conduct 
of activities that are performed by eligible borrowers. The FCA 
solicited comments on: (1) Whether the regulation should provide a 
specific listing of the parties who qualify as similar entities; (2) 
whether the regulation ought to provide further guidance about the new 
financially related service (FRS) authority; (3) how the regulation can 
best accord equitable treatment to both the funding banks and their 
affiliated associations; and (4) whether consent for out-of-territory 
participations on similar entity loans ought to be required.
    The FCA received 37 comment letters on its original proposal 
concerning similar entity authority. Comment letters were received from 
the FCC, six Farm Credit banks, 27 FCS associations, the ABA, IBAA, and 
NDBA.
    Comments by FCS institutions were mixed. Some institutions 
supported the various definitions and provisions in proposed 
Sec. 613.3300, whereas others recommended a broader interpretation of 
the statutory provision. The ABA, IBAA, and NDBA believe that the 
proposal to permit System banks to participate with non-System lenders 
in loans to similar entities exceeds the authority that Congress has 
granted. Although the ABA stated that the proposal appears to comply 
with recent amendments to the Act, it claims that the expanded 
eligibility rules in Secs. 613.3000, 613.3010, and 613.3020 negate the 
need for similar entity authority. The IBAA stated that the proposal 
appears to go much further in the types of similar entities than 
Congress originally anticipated to be eligible. The commenter also 
requested more definition and a more narrow interpretation of the 
statutory language.
    The FCA affirms that its original proposal regarding similar 
entities is within the parameters of the Act. Proposed Sec. 613.3300 
closely tracked the language of the Act. The fact that System banks and 
associations may have greater flexibility to finance eligible borrowers 
within the scope of their statutory powers does not render their 
similar entity participation authorities unnecessary.
1. Providing a List
    Twenty-nine FCS commenters opposed incorporating a specific list of 
the parties who qualify as similar entities in the regulation, because 
they saw no need for or discernible benefit from having such a list. 
Some System institutions commented that to the extent that a list may 
be useful, similar entities can be identified through a bookletter or 
other guidance. System commenters perceived that any list of eligible 
similar entities could be unduly restrictive and that the similar 
entity authorities should provide maximum latitude for risk 
diversification. The IBAA suggested that the regulation provide such a 
listing.
    The FCA concludes that the inherent difficulty of anticipating 
every type of entity that might qualify and the time required to amend 
regulations makes a regulatory listing impracticable for this 
authority. Accordingly, the reproposed regulation does not list similar 
entities. However, the FCA will monitor such activity through its 
examination process and evaluate the need for further guidance.
2. Guidance on Financially Related Services (FRS) Authority
    Four FCS associations commented that further guidance on FRS 
authorities is not needed because the approved list of services already 
exists. CoBank requests that the FCA clarify that the related services 
regulations of part 618 do not apply to transaction-type items for 
similar entity loans. The commenter believes that unless the lender can 
react quickly to a request, the opportunity for participation may be 
lost.
    The reproposed regulation does not provide any further guidance on 
FRS authorities as they pertain to similar entity transactions. The FCA 
may, however, provide such other forms of guidance as may be determined 
necessary in the future.
3. Definitions
    The FCA received no comment on the definition of ``participation'' 
in Sec. 613.3300(a)(1), which mirrors provisions in sections 3.1(11) 
and 4.18A of the Act. Thus, the reproposed regulation does not change 
this definition.
    Although System institutions generally were supportive of the FCA's 
original proposal, many considered the definition of ``similar entity'' 
to be more narrow and restrictive than the Act. These commenters 
asserted that it provides System lenders with little opportunity to 
participate in loans to similar entities, because most persons or legal 
entities involved in production agriculture already qualify as eligible 
borrowers under title I or II. These commenters also recommended that 
the FCA revise Sec. 613.3300(a)(2) so it treats a party who is eligible 
to borrow directly from certain FCS associations engaged in short-term 
lending under Secs. 613.3000, 613.3010, or 613.3020 as a similar entity 
for an association engaged in long-term mortgage lending, and vice 
versa. In other words, the commenters suggested that a party who is an 
eligible borrower for an FCS institution that operates under title I 
should qualify as a similar entity for a title II association and a 
title II borrower as a similar entity for title I associations. Other 
System commenters disagreed with this approach and supported the FCA's 
proposal on this issue.
    The St. Paul BC commented that the proposed definition could be 
read to mean that a party eligible for a loan from an association would 
not qualify as a ``similar entity'' with respect to a BC, and vice 
versa. Therefore, the commenter proposed specific regulatory language 
that would classify an eligible title III borrower as a similar entity 
for FCBs and direct lender associations, and vice versa.
    The definition of ``similar entity'' in Sec. 613.3300(a)(2) closely 
tracks sections 3.1(11)(B)(ii) and 4.18A(a)(2) and provides FCS 
institutions with the flexibility allowed by law. The FCA disagrees 
with those commenters who assert that the same borrower may be an 
eligible borrower under title I, but a similar entity under title II of 
the Act. The plain language of section 4.18A(a)(2) of the Act makes it 
clear that a similar entity is one who is ineligible to borrow directly 
from a title I bank or a direct lender association. Section 4.18A(a)(2) 
of the Act makes it equally clear that the eligibility of the borrower, 
not the lending powers of a System institution, determines similar 
entity status. There is no distinction in the Act between the types of 
borrowers who are eligible for financing under title I and title II.
    The FCA agrees with the St. Paul BC that a party who is eligible to 
borrow under title III of the Act can qualify as a similar entity under 
titles I and II of the Act. However, the FCA declines to amend 
Sec. 613.3300(a)(2) as the commenter suggests because the commenter's 
concerns already are adequately addressed by proposed Sec. 613.3300 
(e)(3) and (e)(4), which is redesignated in the reproposed regulation 
as Sec. 613.3300 (d)(2) and (d)(3), respectively.
4. Similar Entity Transactions
    Ten System commenters considered Sec. 613.3300(b), as originally 
proposed, to be too restrictive and they urged the FCA to delete the 
words ``for purposes similar to those for which an eligible borrower 
could obtain financing from the participating FCS institutions.'' These 
commenters believe that the Act

[[Page 42116]]

imposes no such limitation on the phrase ``functionally similar.'' In 
addition, the commenters believe that the FCA's original proposal 
contradicts the intent of Congress because section 4.18A(b) of the Act 
grants title I banks and direct lender associations similar entity 
authority ``notwithstanding any other provision of this Act.'' The 
commenters strongly supported a broader interpretation of section 4.18A 
of the Act.
    CoBank objected to a statement in the preamble that identified 
certain rural utilities as similar entities. CoBank commented that 
there is no statutory basis for limiting participations in similar 
entity loans to electric utilities in rural areas. The FCA assures the 
commenter that the preamble passage to the proposed regulation only 
provided one example of a similar entity. This illustration was not 
intended to limit the authority of title III banks to participate in 
loans to similar entities.
    In conjunction with its recommended definition of similar entity, 
the St. Paul BC also recommended a corresponding change be made to 
Sec. 613.3300(b) by deleting the language ``that is not eligible to 
borrower directly under Secs. 613.3000, 613.3010, 613.3100, or 
613.3200.''
    The FCA believes that its interpretation clarifying ``functionally 
similar'' is consistent with the plain language of the Act and complies 
with Congressional intent. The ``notwithstanding'' language in section 
4.18A does not negate the rest of this same provision, which states 
that FCBs, ACBs, and direct lender associations ``may participate in 
any loan of a type otherwise authorized under title I or II. * * *'' 
Section 4.18A of the Act did not alter the lending authorities of title 
I and II lenders. Instead, the similar entity provisions of the Act 
authorize such banks and associations to participate with non-System 
lenders in loans to ineligible borrowers. Although many commenters 
stated that the Act does not define and therefore does not limit the 
phrase ``functionally similar,'' the fact that the Act contains this 
phrase implies there are some restrictions. For this reason, the FCA 
continues to believe that similar entity loans must be for purposes 
that are similar to those for which an eligible borrower could obtain 
FCS financing. In addition, the FCA did not adopt the recommendation to 
eliminate the references to the regulations defining ``eligible 
borrower.'' However, the FCA notes that these references do not prevent 
a title III bank from participating in a similar entity loan to a party 
who is eligible to borrow under titles I and II of the Act but 
ineligible to borrow under title III, and vice versa. Therefore, 
reproposed Sec. 613.3300(b) is unchanged from the original proposal.
5. Compatibility With Lending Authorities Under Titles I and II of the 
Act
    System commenters were evenly divided about proposed 
Sec. 613.3300(c), which would have required an institution to 
participate in only those loans it is authorized to make; i.e., short- 
and intermediate-term versus long-term loans. Two FCS banks and several 
associations supported the FCA's approach as a reasonable 
interpretation of the Act. The commenters believe that proposed 
Sec. 613.3300(c) implements the passage in section 4.18A(b) of the Act 
that refers to ``any loan of a type otherwise authorized under title I 
or II of the Act.'' One commenter states that the term ``authorized'' 
in the Act implies that a particular institution has the authority in 
question to make the loan except for the fact that the borrower is 
ineligible, and thus is a similar entity. These commenters also 
expressed concern about intra-System competition for similar entity 
loans. Some commenters opined that proposed Sec. 613.3300(c) promotes 
safety and soundness by requiring System institutions to participate in 
loans that are compatible with their expertise.
    Two FCBs and six associations opposed proposed Sec. 613.3300(c), 
and they asked the FCA to delete it from the regulation. These 
commenters assert that Sec. 613.3300(c) is incompatible with the 
underlying purpose of sections 3.1(11)(B) and 4.18A of the Act, which 
was to promote risk diversification. These commenters believe that the 
risk diversification purpose is best served if a System bank or 
association can participate in similar entity loans that are 
incompatible with their short-, intermediate-, or long-term lending 
powers. These commenters opined that proposed Sec. 613.3300(c) is 
contrary to the FCA's Regulatory Philosophy Statement of eliminating 
regulatory restrictions that neither implement or interpret the Act nor 
promote safety and soundness. These commenters claim that proposed 
Sec. 613.3300(c) unduly restricts their ability to exercise their 
statutory powers.
    The FCA has concluded that, while both interpretations of the Act 
are reasonable, eliminating this restriction in proposed 
Sec. 613.3300(c) gives better effect to the statutory language and the 
Congressional purpose of section 4.18A of the Act. The express purpose 
of this provision is to assist FCS banks and associations in managing 
risk. The FCA agrees that participation in similar entity loans that 
differ from an institution's portfolio of either short- and 
intermediate-term loans or long-term loans promotes risk 
diversification. Additionally, the FCA notes that credit facility loan 
transactions, which comprise separate loans with different terms to a 
single borrower, are often the subject of loan participations. A rule 
that would permit only ACAs, but not FCBs or other associations, to 
participate in such transactions could substantially limit the ability 
of titles I and II lenders to make use of their similar entity 
participation authority. Accordingly, the FCA has omitted this 
restriction from the reproposed regulation.
6. Restrictions on Similar Entity Participations
    No comments were received on proposed Sec. 613.3300(d), and this 
paragraph has been redesignated as paragraph (c) in the reproposed 
regulation.
7. Funding Bank Approval
    The FCA originally proposed a requirement that a direct lender 
association obtain approval from its funding bank before it could 
participate in a similar entity loan. The FCA further proposed that a 
request for approval from an association could only be denied for 
safety and soundness reasons affecting the bank.
    The FCC, CoBank, and an FCS association supported proposed 
Sec. 613.3000(e)(1). The FCC commented that its members support the 
paragraph as written because it provides adequate safeguards. One 
association believes that direct lenders should have maximum freedom to 
participate in similar entity loans without the regulation specifying 
funding bank approval.
    The FCA redesignates proposed Sec. 613.3300(e)(1) as reproposed 
Sec. 613.3300(d)(1) without further revision. Further, reproposed 
Sec. 613.33300(d)(1) directly implements the statutory requirement that 
an association obtain approval from its funding bank.
8. Territorial Concurrence
    The FCA proposed that the out-of-territory concurrence requirements 
in Sec. 614.4070 apply to all titles I and II institutions that 
participate with non-System lenders in loans to similar entities.
    Ten System institutions supported FCA's territorial concurrence 
requirement, but many of these

[[Page 42117]]

commenters suggested some modifications to avoid unnecessary burdens. 
These commenters advised the FCA that the consent requirement could 
prove burdensome for titles I and II lenders when a similar entity has 
operations spread throughout several States. These commenters 
recommended that the FCA amend the regulation so it requires consent 
only from the FCS lender where the site of the similar entity's home 
office is located.
    The FCB of Texas believes that the proposed territorial concurrence 
requirement is both appropriate and consistent with the Act, because 
there is no intrinsic difference between the operations of similar 
entities and eligible borrowers that justify different treatment.
    Six System institutions opposed the territorial concurrence 
requirement in proposed Sec. 613.3300(e)(2), because they believe 
operational matters are more appropriately addressed between respective 
banks and associations. Another FCS association believes that 
territorial concurrence should not be imported from Sec. 614.4070 
because it would impede the statutory mandate allowing similar entity 
participations and would not further any legitimate anti-competition 
policy. AgAmerica, FCB, does not believe that the territorial 
concurrence requirement in Sec. 614.4070 should be extended to similar 
entity participations because Congress imposed concurrence requirements 
only between BCs and FCBs. Therefore, the commenter believes the 
regulation should not require titles I and II lenders to obtain any 
type of territorial concurrence from each other. One FCS association 
requested greater flexibility and recommended that institutions 
operating under joint management be allowed to offer products over the 
largest territory served by either association.
    Several institutions also stated that a relationship with the 
original lender would be impaired if the association must seek the 
consent of other System institutions, because the originator usually 
has a very short time period to line up participants. However, another 
FCS association believes that FCS institutions generally should not be 
in competition with each other, because the System was created to serve 
the same specific public purpose. Many FCS commenters recommended that 
FCA address these intra-System competition issues at a later time and 
in a broader context. Some commenters suggested that a negotiated 
rulemaking be undertaken by the FCA.
    After considering these comments, the FCA is persuaded that the 
territorial concurrence requirements between title I and II 
institutions for similar entity participations is not advisable. As 
noted by many commenters, the Act contains no territorial restriction 
on similar entity participations other than requiring consensual 
arrangements only between title I institutions and title III banks. 
Indeed, the Act indicates that the Congress granted this authority in 
order to assist System institutions in managing risk. Geographical 
diversity is a useful tool for agricultural lenders to reduce their 
concentration of risk, and a concurrence requirement could frustrate an 
institution's goal to achieve portfolio diversity.
    Moreover, the policy reason for imposing the territorial 
concurrence requirement for eligible loans do not apply to 
participations in loans to ineligible borrowers. The concurrence 
requirement in Sec. 614.4070 precludes a System lender from making a 
loan to an out-of-territory borrower who is the potential customer of 
another System institution without that institution's consent. When the 
borrower whose loan is the subject of the participation would not be 
eligible for a loan from the System institution serving the borrower's 
territory, this concern is not present. In other words, because the 
System lender has no authority to make the loan in the first instance, 
it has no claim to relinquish through territorial concurrence. 
Furthermore, since the amount of such participations is limited to 15 
percent of the portfolio, competition for similar entity participations 
is not likely to have a serious adverse effect on any institution.
    The FCA's decision is also influenced by the concern that a 
concurrence requirement could seriously impede the System's ability to 
use its new authority to participate in loans to similar entities. 
Institutions are often given only a brief opportunity to buy a 
participation in a transaction, and the delay resulting from seeking 
concurrence may effectively preclude involvement in the transaction. 
This outcome is even more likely when the participation involves an 
interest in a pool of loans covering a broad geographical territory and 
requires the consent of more than one System lender. For these reasons, 
the FCA has deleted the territorial concurrence requirement between 
titles I and II lenders in reproposed and redesignated 
Sec. 613.3300(d), and the remaining paragraphs are renumbered 
accordingly.
9. Method of Approval
    The FCA originally proposed that all approvals required by 
Sec. 613.3300 could be granted on an annual basis and under such terms 
and conditions as the various FCS institutions may agree.
    Eight System commenters encouraged FCA to promote the development 
of standing agreements between entities or even Systemwide agreements. 
CoBank recommended a standing agreement rather than annual agreements 
for various concurrences because the parties could develop parameters 
for all transactions.
    The FCA believes that its original proposal provides FCS 
institutions with ample flexibility to develop agreements required by 
the Act. Agreements among System institutions can specify that consent 
by the FCS lender where the similar entity is located will suffice. No 
further FCA direction is needed at this time. The other approvals 
provided for in this paragraph are consistent with the statutory 
requirements. Therefore, proposed Sec. 613.3300(e)(5) is reproposed and 
designated as Sec. 613.3300(d)(4) without revision.
10. Borrower Rights
    AgFirst and three FCS associations stated that Sec. 613.3300(f) 
creates the potential for confusion because it deals with matters that 
are clearly set forth in the Act and otherwise in FCA regulations. In 
response to the commenters' concern, the FCA agrees and has deleted 
this section from the reproposed regulation.
11. Borrower Stock
    Twenty-one FCS commenters requested deletion of proposed 
Sec. 613.3300(g) because it creates the potential for confusion and 
deals with matters that are clearly set forth in the Act and otherwise 
in FCA regulations. All commenters also stated that it is not necessary 
to reflect in an institution's capitalization bylaws whether or not 
participation certificates are required for similar entity loans. Both 
the FCC and CoBank indicated that stockholder approval of revisions to 
the bylaws under these circumstances is excessive and costly.
    The FCA noted in the preamble to the proposed rule that the 
requirements of this paragraph are consistent with section 4.3A of the 
Act and Sec. 615.5220 of the FCA regulations. The FCA accepts the 
commenters justification for deleting this paragraph. However, a System 
institution must comply with section 4.3A of the Act if it needs to 
sell equities for similar entity participations to meet its capital 
requirements, but its current

[[Page 42118]]

bylaws do not already address this matter.

T. Other Proposed Amendments

    The FCA received no comments on the proposed amendments to parts 
614, 618, 619, and 626. These regulations, except for Sec. 614.4222, 
are reproposed without revision. The proposal to amend Sec. 614.4222 is 
withdrawn.

IV. Regulatory Impact and FCA Regulatory Philosophy

    These reproposed regulations are consistent with the FCA Board's 
Policy Statement on Regulatory Philosophy and achieve the Board's 
objective of creating an environment that promotes the confidence of 
borrowers/shareholders, investors and the public in the System's 
financial strength and future viability. See 60 FR 26034, May 16, 1995. 
The objective of the reproposed revisions to the capital regulations is 
to establish standards that encourage the building of a sound capital 
structure in System institutions. The building of a sound capital 
structure at each institution would improve the likelihood of an 
institution's survival during periods of economic stress and thereby 
improve the safety and soundness of the System as a whole. The FCA 
believes that these reproposed regulations provide a meaningful 
measurement of capital adequacy and would be appropriate for all System 
institutions to which they would apply.
    The capital provisions of this rule would apply to all System 
banks, associations, and the Leasing Corporation. During the last 5 
years, most of these institutions have been steadily increasing both 
types of surplus identified by the reproposed regulations, and the FCA 
estimates that most, if not all, of the institutions would achieve the 
minimum standards in 7 years or less if these trends continue.
    The reproposed amendments to the customer eligibility regulations 
would remove many of the existing restrictions that are not required by 
the Act or necessary to implement it. The objective of these reproposed 
provisions is to implement the Act's broad authority to finance the 
agricultural, aquatic, and other credit needs of bona fide farmers, 
ranchers, and aquatic producers or harvesters. These regulations 
respond to the concerns of commenters by balancing the rights of System 
and non-System lenders.
    Most importantly, however, the reproposed regulations would permit 
the System to continue to fulfill its statutory mission of providing a 
dependable and competitive source of credit for American agriculture as 
it evolves in a rapidly changing market place.

List of Subjects

12 CFR Part 613

    Agriculture, Banks, banking, Credit, Rural areas.

12 CFR Part 614

    Agriculture, Banks, banking, Flood insurance, Foreign trade, 
Reporting and recordkeeping requirements, Rural areas.

12 CFR Part 615

    Accounting, Agriculture, Banks, banking, Government securities, 
Investments, Rural areas.

12 CFR Part 618

    Agriculture, Archives and records, Banks, banking, Insurance, 
Reporting and recordkeeping requirements, Rural areas, Technical 
assistance.

12 CFR Part 619

    Agriculture, Banks, banking, Rural areas.

12 CFR Part 620

    Accounting, Agriculture, Banks, banking, Reporting and 
recordkeeping requirements, Rural areas.

12 CFR Part 626

    Advertising, Aged, Agriculture, Banks, banking, Civil rights, 
Credit, Fair housing, Marital status discrimination, Sex 
discrimination, Signs and symbols.

    For the reasons stated in the preamble, parts 613, 614, 615, 618, 
619, 620, and 626 of chapter VI, title 12 of the Code of Federal 
Regulations are proposed to be amended to read as follows:

PART 613--ELIGIBILITY AND SCOPE OF FINANCING

    1. The authority citation for part 613 is revised to read as 
follows:

    Authority: Secs. 1.5, 1.7, 1.9, 1.10, 1.11, 2.2, 2.4, 2.12, 3.1, 
3.7, 3.8, 3.22, 4.18A, 4.25, 4.26, 4.27, 5.9, 5.17 of the Farm 
Credit Act (12 U.S.C. 2013, 2015, 2017, 2018, 2019, 2073, 2075, 
2093, 2122, 2128, 2129, 2143, 2206a, 2211, 2212, 2213, 2243, 2252).

    2. Subparts A, B, C, and D of part 613 are revised to read as 
follows:

Subpart A--Financing Under Titles I and II of the Farm Credit Act

Sec.
613.3000  Financing for farmers, ranchers, and aquatic producers or 
harvesters.
613.3010  Financing for processing or marketing operations.
613.3020  Financing for farm-related service businesses.
613.3030  Rural home financing.

Subpart B--Financing for Banks Operating Under Title III of the Farm 
Credit Act

613.3100  Domestic lending.
613.3200  International lending.

Subpart C--Similar Entity Authority Under Sections 3.1(11)(B) and 4.18A 
of the Act

613.3300  Participations and other interests in loans to similar 
entities.

Subpart A--Financing Under Titles I and II of the Farm Credit Act


Sec. 613.3000  Financing for farmers, ranchers, and aquatic producers 
or harvesters.

    (a) Definitions. For purposes of this subpart, the following 
definitions apply:
    (1) Agricultural assets means agricultural land including 
facilities and improvements thereon; livestock, machinery, equipment, 
working capital, chattel, and vessels that are used for agricultural or 
aquatic production; and the principal residence of an individual 
borrower who qualifies under paragraph (a)(3)(i) of this section.
    (2) Agricultural land means land that is devoted to or available 
for the production of agricultural or aquatic products.
    (3) Bona fide farmer, rancher, or producer or harvester of aquatic 
products means:
    (i) An individual or legal entity that generates income by actively 
producing agricultural products, producing or harvesting aquatic 
products, managing an agricultural or aquatic operation, or an 
individual who is a retired farmer who owns agricultural land and 
assumes some portion of the production risk of a tenant; or
    (ii) An individual or legal entity that owns agricultural land.
    (4) Individual means a natural person who is either:
    (i) A citizen of the United States; or
    (ii) A foreign national who has been lawfully admitted into the 
United States for permanent residency pursuant to 8 U.S.C. 1101(a)(20) 
(permanent resident), or on a visa pursuant to a provision in 8 U.S.C. 
1101(a)(15) (non-resident) that authorizes such individual to own 
property or operate or manage a business.
    (5) Legal entity means any partnership, corporation, trust, estate, 
or other legal entity that is established pursuant to the laws of the 
United States, any State thereof, the Commonwealth of Puerto Rico, the 
District of Columbia, or any tribal authority and is legally authorized 
to conduct a business.
    (b) Eligible borrower. A bona fide farmer, rancher, or producer or 
harvester of aquatic products is eligible

[[Page 42119]]

to borrow under either title I or II of the Act.
    (c) Financing for agricultural or aquatic needs. A borrower who is 
eligible under paragraph (b) of this section may obtain financing for 
any agricultural or aquatic purpose.
    (d) Financing for other credit needs.
    (1) Individual eligible borrowers who are either citizens or 
permanent residents of the United States, and at a minimum satisfy the 
criteria of paragraph (a)(3)(i) of this section, may obtain financing 
for:
    (i) Their housing and domestic needs; and
    (ii) Other business needs in an amount that, at the time the loan 
is closed, does not exceed the market value of their agricultural or 
aquatic assets.
    (2) Individual eligible borrowers who are non-resident foreign 
nationals and at a minimum satisfy the criteria of paragraph (a)(3)(i) 
of this section may obtain financing for their domestic needs and 
housing reasonably related to their agricultural or aquatic operations 
in the U.S.A.
    (3) Individual borrowers who are eligible only under paragraph 
(a)(3)(ii) of this section may obtain financing for their housing and 
domestic needs in an amount that, at the time the loan is closed, does 
not exceed the market value of their agricultural or aquatic assets.
    (4) A legal entity may obtain financing for its other credit needs 
in an amount that, at the time the loan is closed, does not exceed the 
market value of its agricultural assets, only if more than 50 percent 
of voting stock or equity of the borrowing legal entity is owned by 
individuals who comply with the requirements in paragraph (a)(3)(i) of 
this section and either:
    (i) More than 50 percent of the assets of the borrowing legal 
entity is used in agricultural or aquatic production; or
    (ii) More than 50 percent of the annual income of the borrowing 
legal entity is derived from agricultural or aquatic activities.


Sec. 613.3010  Financing for processing or marketing operations.

    (a) Eligible borrowers. A borrower is eligible for financing for a 
processing or marketing operation under titles I and II of the Act, 
only if the borrower meets the following requirements:
    (1) The borrower is either a bona fide farmer, rancher, or producer 
or harvester of aquatic products, or is a legal entity in which 
eligible borrowers under Sec. 613.3000(b) own more than 50 percent of 
the voting stock or equity; and
    (2) The borrower or an owner of the borrowing legal entity 
regularly produces some portion of the throughput used in the 
processing or marketing operation.
    (b) Portfolio restrictions for certain processing and marketing 
loans. Processing or marketing loans to eligible borrowers who 
regularly supply less than 20 percent of the throughput are subject to 
the following restrictions:
    (1) Bank limitation. The aggregate of such processing and marketing 
loans made by a Farm Credit bank shall not exceed 15 percent of all its 
outstanding retail loans at the end of the preceding fiscal year.
    (2) Association limitation. The aggregate of such processing and 
marketing loans made by all direct lender associations affiliated with 
the same Farm Credit bank shall not exceed 15 percent of the aggregate 
of their outstanding retail loans at the end of the preceding fiscal 
year. Each Farm Credit bank, in conjunction with all its affiliated 
direct lender associations, shall ensure that such processing or 
marketing loans are equitably allocated among its affiliated direct 
lender associations.
    (3) Calculation of outstanding retail loans. For the purposes of 
this paragraph, ``outstanding retail loans'' includes loans, loan 
participations, and other interests in loans that are either bought 
without recourse or sold with recourse.


Sec. 613.3020  Financing for farm-related service businesses.

    (a) Eligibility. An individual or legal entity that furnishes farm-
related services to farmers and ranchers that are directly related to 
their agricultural production is eligible to borrow from a Farm Credit 
bank or association that operates under titles I or II of the Act.
    (b) Purposes of financing. A Farm Credit Bank, agricultural credit 
bank, or direct lender association may finance:
    (1) All of the farm-related business activities of an eligible 
borrower who derives more than 50 percent of its annual income (as 
consistently measured on either a gross sales or net sales basis) from 
furnishing farm-related services that are directly related to the 
agricultural production of farmers and ranchers; or
    (2) Only the farm-related services activities of an eligible 
borrower who derives 50 percent or less of its annual income (as 
consistently measured on either a gross sales or net sales basis) from 
furnishing farm-related services that are directly related to the 
agricultural production of farmers and ranchers.


Sec. 613.3030  Rural home financing.

    (a) Definitions.
    (1) Rural homeowner means an individual who is not a bona fide 
farmer, rancher, or producer or harvester of aquatic products.
    (2) Rural home means a single-family moderately priced dwelling 
located in a rural area that will be the occupant's principal 
residence.
    (3) Rural area means open country within a State or the 
Commonwealth of Puerto Rico, which may include a town or village that 
have a population of not more than 2,500 persons.
    (4) Moderately priced means the price of any rural home that 
either:
    (i) Satisfies the criteria in section 8.0 of the Act pertaining to 
rural home loans that collateralize securities that are guaranteed by 
the Federal Agricultural Mortgage Corporation; or
    (ii) Is below the 75th percentile of housing values for the rural 
area where it is located, as determined by data from a credible, 
independent, and recognized national or regional source, such as a 
Federal, State, or local government agency, or an industry source.
    (b) Eligibility. Any rural homeowner is eligible to obtain 
financing on a rural home. No borrower shall have a loan from the Farm 
Credit System on more than one rural home at any one time.
    (c) Purposes of financing. Loans may be made to rural homeowners 
for the purpose of buying, building, remodeling, improving, repairing 
rural homes, and refinancing existing indebtedness thereon.
    (d) Portfolio limitations. (1) The aggregate of retail rural home 
loans by any Farm Credit Bank or agricultural credit bank shall not 
exceed 15 percent of the total of all of its outstanding loans at any 
one time.
    (2) The aggregate of rural home loans made by each direct lender 
association shall not exceed 15 percent of the total of its outstanding 
loans at the end of its preceding fiscal year, except with the prior 
approval of its funding bank.
    (3) The aggregate of rural home loans made by all direct lender 
associations that are funded by the same Farm Credit bank shall not 
exceed 15 percent of the total outstanding loans of all such 
associations at the end of the funding bank's preceding fiscal year.

Subpart B--Financing for Banks Operating Under Title III of the 
Farm Credit Act


Sec. 613.3100  Domestic lending.

    (a) Definitions. For purposes of this subpart, the following 
definitions apply:
    (1) Cooperative means any association of farmers, ranchers, 
producers or

[[Page 42120]]

harvesters of aquatic products, or any federation of such associations, 
or a combination of such associations and farmers, ranchers, or 
producers or harvesters of aquatic products that conducts business for 
the mutual benefit of its members and has the power to:
    (i) Process, prepare for market, handle, or market farm or aquatic 
products;
    (ii) Purchase, test, grade, process, distribute, or furnish farm or 
aquatic supplies; or
    (iii) Furnish business and financially related services to its 
members.
    (2) Farm or aquatic supplies and farm or aquatic business services 
are any goods or services normally used by farmers, ranchers, or 
producers and harvesters of aquatic products in their business 
operations, or to improve the welfare or livelihood of such persons.
    (3) Public utility means a cooperative or other entity that is 
licensed under Federal, State, or local law to provide electric, 
telecommunication, cable television, water, or waste treatment 
services.
    (4) Rural area means all territory of a State that is not within 
the outer boundary of any city or town having a population of more than 
20,000 inhabitants based on the latest decennial census of the United 
States.
    (5) Service cooperative means a cooperative that is involved in 
providing business and financially related services (other than public 
utility services) to farmers, ranchers, aquatic producers or 
harvesters, or their cooperatives.
    (b) Cooperatives and other entities that serve agricultural or 
aquatic producers.--(1) Eligibility of cooperatives. A bank for 
cooperatives or an agricultural credit bank may lend to a cooperative 
that satisfies the following requirements:
    (i) Unless the bank's board of directors establishes by resolution 
a higher voting control threshold for any type of cooperative, the 
percentage of voting control of the cooperative held by farmers, 
ranchers, producers or harvesters of aquatic products, or cooperatives 
shall be 80 percent except:
    (A) Sixty (60) percent for a service cooperative;
    (B) Sixty (60) percent for local farm supply cooperatives that have 
historically served the needs of a community that would not be 
adequately served by other suppliers and have experienced a reduction 
in the percentage of membership by agricultural or aquatic producers 
due to changed circumstances beyond their control; and
    (C) Sixty (60) percent for local farm supply cooperatives that 
provide or will provide needed services to a community, and are or will 
be in competition with a cooperative specified in 
Sec. 613.3100(b)(1)(i)(B);
    (ii) The cooperative deals in farm or aquatic products, or products 
processed therefrom, farm or aquatic supplies, farm or aquatic business 
services, or financially related services with or for members in an 
amount at least equal in value to the total amount of such business it 
transacts with or for non-members, excluding from the total of member 
and non-member business, transactions with the United States, or any 
agencies or instrumentalities thereof, or services or supplies 
furnished by a public utility; and
    (iii) The cooperative complies with one of the following two 
conditions:
     (A) No member of the cooperative shall have more than one vote 
because of the amount of stock or membership capital owned therein; or
    (B) The cooperative restricts dividends on stock or membership 
capital to 10 percent per year or the maximum percentage per year 
permitted by applicable State law, whichever is less.
     (iv) Any cooperative that has received a loan from a bank for 
cooperatives or an agricultural credit bank shall, without regard to 
the requirements in paragraph (b)(1)(i) of this section, continue to be 
eligible for as long as more than 50 percent (or such higher percentage 
as is established by the bank board) of the voting control of the 
cooperative is held by farmers, ranchers, producers or harvesters of 
aquatic products, or other eligible cooperatives.
    (2) Other eligible entities. The following entities are eligible to 
borrow from banks for cooperatives and agricultural credit banks:
    (i) Any legal entity that holds more than 50 percent of the voting 
control of a cooperative that is an eligible borrower under paragraph 
(b)(1) of this section and uses the proceeds of the loan to fund the 
activities of its cooperative subsidiary on the terms and conditions 
specified by the bank;
    (ii) Any legal entity in which an eligible cooperative has an 
ownership interest, provided that if such interest is less than 50 
percent, financing shall not exceed the percentage that the eligible 
cooperative owns in such entity multiplied by the value of the total 
assets of such entity; or
    (iii) Any creditworthy private entity operated on a non-profit 
basis that satisfies the requirements for a service cooperative and 
complies with the requirements of either paragraphs (b)(1)(i)(A) and 
(b)(1)(iii) of this section, or paragraph (b)(1)(iv) of this section, 
and any subsidiary of such entity. An entity that is eligible to borrow 
under this paragraph shall be organized to benefit agriculture in 
furtherance of the welfare of the farmers, ranchers, and aquatic 
producers or harvesters who are its members.
    (c) Electric and telecommunication utilities.--(1) Eligibility. A 
bank for cooperatives or an agricultural credit bank may lend to:
    (i) Electric and telephone cooperatives as defined by section 
3.8(a)(4)(A) of the Act that satisfy the eligibility criteria in 
paragraph (b)(1) of this section;
    (ii) Cooperatives and other entities that:
    (A) Have received a loan, loan commitment, insured loan, or loan 
guarantee from the Rural Utilities Service of the United States 
Department of Agriculture to finance rural electric and 
telecommunication services;
    (B) Have received a loan or a loan commitment from the Rural 
Telephone Bank of the United States Department of Agriculture; or
    (C) Are eligible under the Rural Electrification Act of 1936, as 
amended, for a loan, loan commitment, or loan guarantee from the Rural 
Utilities Service or the Rural Telephone Bank.
    (iii) The subsidiaries of cooperatives or other entities that are 
eligible under paragraph (c)(1)(ii) of this section.
    (iv) Any legal entity that holds more than 50 percent of the voting 
control of any public utility that is an eligible borrower under 
paragraph (c)(1)(ii) of this section, and uses the proceeds of the loan 
to fund the activities of the eligible subsidiary on the terms and 
conditions specified by the bank.
    (v) Any legal entity in which an eligible utility under paragraph 
(c)(1)(ii) of this section has an ownership interest, provided that if 
such interest is less than 50 percent, financing shall not exceed the 
percentage that the eligible utility owns in such entity multiplied by 
the value of the total assets of such entity.
    (2) Purposes for financing. A bank for cooperatives or agricultural 
credit bank may extend credit to entities that are eligible to borrow 
under paragraph (c)(1) of this section in order to provide electric or 
telecommunication services in a rural area. A subsidiary that is 
eligible to borrow under paragraph (c)(1)(iii) of this section may also 
obtain financing from a bank for cooperatives or agricultural credit 
bank to operate a licensed cable television utility.
    (d) Water and waste disposal facilities.--(1) Eligibility. A 
cooperative or a public agency, quasi-public agency,

[[Page 42121]]

body, or other public or private entity that, under the authority of 
State or local law, establishes and operates water and waste disposal 
facilities in a rural area, as that term is defined by paragraph (a)(5) 
of this section, is eligible to borrow from a bank for cooperatives or 
an agricultural credit bank.
    (2) Purposes for financing. A bank for cooperatives or agricultural 
credit bank may extend credit to entities that are eligible under 
paragraph (d)(1) of this section solely for installing, maintaining, 
expanding, improving, or operating water and waste disposal facilities 
in rural areas.
    (e) Domestic lessors. A bank for cooperatives or agricultural 
credit bank may lend to domestic parties to finance the acquisition of 
facilities or equipment that will be leased to shareholders of the bank 
for use in their operations located inside of the United States.


Sec. 613.3200  International lending.

    (a) Definition. For the purpose of this section only, the term 
``farm supplies'' refers to inputs that are used in a farming or 
ranching operation, but excludes agricultural processing equipment, 
machinery used in food manufacturing or other capital goods which are 
not used in a farming or ranching operation.
    (b) Import transactions. The following parties are eligible to 
borrow from a bank for cooperatives or an agricultural credit bank 
pursuant to section 3.7(b) of the Act for the purpose of financing the 
import of agricultural commodities or products therefrom, aquatic 
products, and farm supplies into the United States:
    (1) An eligible cooperative as defined by Sec. 613.3100(b);
    (2) A counterparty with respect to a specific import transaction 
with a voting stockholder of the bank for the substantial benefit of 
the shareholder; and
    (3) Any foreign or domestic legal entity in which eligible 
cooperatives hold an ownership interest.
    (c) Export transactions. Pursuant to section 3.7(b)(2) of the Act, 
a bank for cooperatives or an agricultural credit bank is authorized to 
finance the export (including the cost of freight) of agricultural 
commodities or products therefrom, aquatic products, or farm supplies 
from the United States to any foreign country. The board of directors 
of each bank for cooperatives and agricultural credit bank shall adopt 
policies that ensure that exports of agricultural products and 
commodities, aquatic products, and farm supplies which originate from 
eligible cooperatives are financed on a priority basis. The total 
amount of balances outstanding on loans made under this paragraph shall 
not, at any time, exceed 50 percent of the capital of any bank for 
cooperatives or agricultural credit bank for loans that:
    (1) Finance the export of agricultural commodities and products 
therefrom, aquatic products, or farm supplies that are not originally 
sourced from an eligible cooperative; and
    (2) At least 95 percent of the loan amount is not guaranteed by a 
department, agency, bureau, board, or commission of the United States 
or a corporation that is wholly owned directly or indirectly by the 
United States.
    (d) International business operations. A bank for cooperatives or 
an agricultural credit bank may finance a domestic or foreign entity 
which is at least partially owned by eligible cooperatives described in 
Sec. 613.3100(b), and facilitates the international business operations 
of such cooperatives.
    (e) Restrictions. (1) When eligible cooperatives own less than 50 
percent of a foreign or domestic legal entity, the amount of financing 
that a bank for cooperatives or agricultural credit bank may provide to 
the entity for imports, exports, or international business operations 
shall not exceed the percentage of ownership that eligible cooperatives 
hold in such entity multiplied by the value of the total assets of such 
entity; and
    (2) A bank for cooperatives or agricultural credit bank shall not 
finance the relocation of any plant or facility from the United States 
to a foreign country.

Subpart C--Similar Entity Authority Under Sections 3.1(11)(B) and 
4.18A of the Act


Sec. 613.3300  Participations and other interests in loans to similar 
entities.

    (a) Definitions.
    (1) Participate and participation, for the purpose of this section, 
refer to multi-lender transactions, including syndications, 
assignments, loan participations, subparticipations, other forms of the 
purchase, sale, or transfer of interests in loans, or other extensions 
of credit, or other technical and financial assistance.
    (2) Similar entity means a party that is ineligible for a loan from 
a Farm Credit bank or association, but has operations that are 
functionally similar to the activities of eligible borrowers in that a 
majority of its income is derived from, or a majority of its assets are 
invested in, the conduct of activities that are performed by eligible 
borrowers.
    (b) Similar entity transactions. A Farm Credit bank or a direct 
lender association may participate with a lender that is not a Farm 
Credit System institution in loans to a similar entity that is not 
eligible to borrow directly under Secs. 613.3000, 613.3010, 613.3020, 
613.3100, or 613.3200, for purposes similar to those for which an 
eligible borrower could obtain financing from the participating FCS 
institution.
    (c) Restrictions. Participations by a Farm Credit bank or 
association in loans to a similar entity under this section are subject 
to the following limitations:
    (1) Lending limits.
    (i) Farm Credit banks operating under title I of the Act and direct 
lender associations. The total amount of all loan participations that 
any Farm Credit Bank, agricultural credit bank, or direct lender 
association has outstanding under paragraph (b) of this section to a 
single credit risk shall not exceed:
    (A) Ten (10) percent of its total capital; or
     (B) Twenty-five (25) percent of its total capital if a majority of 
the shareholders of the respective Farm Credit bank or direct lender 
association so approve.
    (ii) Farm Credit banks operating under title III of the Act. The 
total amount of all loan participations that any bank for cooperative 
or agricultural credit bank has outstanding under paragraph (b) of this 
section to a single credit risk shall not exceed 10 percent of its 
total capital;
    (2) Percentage held in the principal amount of the loan. The 
participation interest in the same loan held by one or more Farm Credit 
bank(s) or association(s) shall not, at any time, equal or exceed 50 
percent of the principal amount of the loan; and
    (3) Portfolio limitations. The total amount of participations that 
any Farm Credit bank or direct lender association has outstanding under 
paragraph (b) of this section shall not exceed 15 percent of its total 
outstanding assets at the end of its preceding fiscal year.
    (d) Approval by other Farm Credit System institutions. (1) No 
direct lender association shall participate in a loan to a similar 
entity under paragraph (b) of this section without the approval of its 
funding bank. A funding bank shall deny such requests only for safety 
and soundness reasons affecting the bank.
    (2) No Farm Credit Bank or direct lender association shall 
participate in a loan to a similar entity that is eligible to borrow 
under Sec. 613.3100(b) without the prior approval of the bank for 
cooperatives or agricultural credit bank

[[Page 42122]]

that, at the time the loan is made, has the greatest volume of loans 
made under title III of the Act in the State where the headquarters 
office of the similar entity is located.
    (3) No bank for cooperatives or agricultural credit bank shall 
participate in a loan to a similar entity that is eligible to borrow 
under Secs. 613.3010 or 613.3020 without the prior consent of the Farm 
Credit Bank(s) in whose chartered territory the similar entity conducts 
operations.
    (4) All approvals required under paragraph (d) of this section may 
be granted on an annual basis and under such terms and conditions as 
the various Farm Credit System institutions may agree.

Subpart E--Nondiscrimination in Lending


Secs. 613.3145, 613.3150, 613.3151, 613.3152, 613.3160, 613.3170, 
613.3175 (Subpart E)  [Redesignated]

    3. Subpart E of part 613, consisting of Secs. 613.3145, 613.3150, 
613.3151, 613.3152, 613.3160, 613.3170, and 613.3175 is redesignated as 
new part 626, consisting of Secs. 626.6000, 626.6005, 626.6010, 
626.6015, 626.6020, 626.6025, and 626.6030 respectively.

PART 614--LOAN POLICIES AND OPERATIONS

    4. The authority citation for part 614 is revised to read as 
follows:

    Authority: 42 U.S.C. 4012a, 4104a, 4104b, 4106, and 4128; secs. 
1.3, 1.5, 1.6, 1.7, 1.9, 1.10, 1.11, 2.0, 2.2, 2.3, 2.4, 2.10, 2.12, 
2.13, 2.15, 3.0, 3.1, 3.3, 3.7, 3.8, 3.10, 3.20, 3.28, 4.12, 4.12A, 
4.13, 4.13B, 4.14, 4.14A, 4.14C, 4.14D, 4.14E, 4.18, 4.18A, 4.19, 
4.36, 4.37, 5.9, 5.10, 5.17, 7.0, 7.2, 7.6, 7.7, 7.8, 7.12, 7.13, 
8.0, 8.5 of the Farm Credit Act (12 U.S.C. 2011, 2013, 2014, 2015, 
2017, 2018, 2019, 2071, 2073, 2074, 2075, 2091, 2093, 2094, 2096, 
2121, 2122, 2124, 2128, 2129, 2131, 2141, 2149, 2183, 2184, 2199, 
2201, 2202, 2202a, 2202c, 2202d, 2202e, 2206, 2206a, 2207, 2219a, 
2219b, 2243, 2244, 2252, 2279a, 2279a-2, 2279b, 2279b-1, 2279b-2, 
2279f, 2279f-1, 2279aa, 2279aa-5); sec. 413 of Pub. L. 100-233, 101 
Stat. 1568, 1639; sec. 207 of Pub. L. 104-105, 110 Stat. 162.

Subpart A--[Amended]

    5. Subpart A of part 614 is amended by removing the reference 
``613.3020'' each place it appears and adding in its place 
``613.3000''; by removing the reference ``613.3045'' each place it 
appears and adding in its place ``613.3010''; by removing the reference 
``613.3040'' each place it appears and adding in its place 
``613.3030''; by removing the reference ``613.3050'' each place it 
appears and adding in its place ``613.3020''; by removing the reference 
``613.3110'' each place it appears and adding in its place 
``613.3100(b)(1)''; and by removing the reference ``613.3110(c)'' each 
place it appears and adding in its place ``613.3100(b)(2), (c) and 
(d)''.
    6. Section 614.4010 is amended by removing the words ``export or'' 
each place they appear in paragraphs (d)(4) and (d)(5); by removing the 
reference ``(d)(3)'' and adding in its place ``(d)(4)'' in paragraph 
(d)(5); and by adding new paragraphs (d)(6) and (d)(7) to read as 
follows.


Sec. 614.4010  Agricultural credit banks.

* * * * *
    (d) * * *
* * * * *
    (6) Any party, subject to the requirements in Sec. 613.3200(c) of 
this chapter, for the export (including the cost of freight) of 
agricultural commodities or products therefrom, aquatic products, or 
farm supplies from the United States to any foreign country, in 
accordance with Sec. 614.4233 and subpart Q of this part 614; and
    (7) Domestic or foreign parties in which eligible cooperatives, as 
defined in Sec. 613.3100 of this chapter, hold an ownership interest, 
for the purpose of facilitating the international business operations 
of such cooperatives pursuant to the requirements of Sec. 613.3200(d) 
and (e) of this chapter.
* * * * *
    7. Section 614.4020 is amended by removing the words ``export or'' 
each place they appear in paragraphs (a)(4) and (a)(5); by adding after 
the words ``bank's board'', the reference ``, Sec. 614.4233,'' in 
paragraph (a)(4); by removing the words ``board policy'' and adding in 
their place, the words ``policies of the bank's board, Sec. 614.4233,'' 
in paragraph (a)(5); and by adding new paragraphs (a)(6) and (a)(7) to 
read as follows:


Sec. 614.4020  Banks for cooperatives.

    (a) * * *
* * * * *
    (6) Any party, subject to the requirements in Sec. 613.3200(c) of 
this chapter, for the export (including the cost of freight) of 
agricultural commodities or products therefrom, aquatic products, or 
farm supplies from the United States to any foreign country, in 
accordance with Sec. 614.4233 and subpart Q of this part 614; and
    (7) Domestic or foreign parties in which eligible cooperatives, as 
defined in Sec. 613.3100 of this chapter, hold an ownership interest, 
for the purpose of facilitating the international business operations 
of such cooperatives pursuant to the requirements in Sec. 613.3200(d) 
and (e) of this chapter.
* * * * *

Subpart E--Loan Terms and Conditions

    8. Section 614.4233 is amended by revising the introductory 
paragraph to read as follows:


Sec. 614.4233  International loans.

    Term loans made by banks for cooperatives and agricultural credit 
banks under the authority of section 3.7(b) of the Act and 
Sec. 613.3200 of this chapter to foreign or domestic parties who are 
not shareholders of the bank shall be subject to following conditions:
* * * * *

Subpart P--Farm Credit Bank and Agricultural Credit Bank Financing 
of Other Financing Institutions


Sec. 614.4610  [Amended]

    9. Section 614.4610 is amended by removing the words ``an 
association in the district'' and adding in their place, the words 
``any association funded by the bank'' in the first sentence and 
removing the reference ``Sec. 613.3040(d)(2)'' and adding in its place 
the reference ``Secs. 613.3010(b)(1) and 613.3030(d)''.

Subpart Q--Banks for Cooperatives Financing International Trade

    10. The heading for subpart Q is amended by adding after the words 
``Banks for Cooperatives'' the words ``and Agricultural Credit Banks''.


Sec. 614.4700  [Amended]

    11. Section 614.4700 is amended by adding after the words ``banks 
for cooperatives'' the words ``and agricultural credit banks'' each 
place they appear in paragraphs (a), introductory text, (b), and (h).


Sec. 614.4710  [Amended]

    12. Section 614.4710 is amended by adding after the words ``banks 
for cooperatives'' the words ``and agricultural credit banks'' each 
place they appear in the introductory paragraph and paragraph (c); by 
adding after the words ``bank for cooperatives''' the words ``or 
agricultural credit bank's'' in paragraph (a)(1)(ii); by adding after 
the words ``bank for cooperatives'' the words ``or an agricultural 
credit bank'' each place they appear in paragraphs (a)(1), (a)(1)(i), 
(a)(3), (a)(5) and (b)(1).


Sec. 614.4720  [Amended]

    13. Section 614.4720 is amended by adding after the words ``Banks 
for cooperatives'' the words ``and

[[Page 42123]]

agricultural credit banks'' in the first sentence of the introductory 
paragraph.


Sec. 614.4800  [Amended]

    14. Section 614.4800 is amended by adding after the words ``A bank 
for cooperatives'' the words ``or an agricultural credit bank'' in the 
first sentence.


Sec. 614.4810  [Amended]

    15. Section 614.4810 is amended by adding after the words ``banks 
for cooperatives'' the words ``and agricultural credit banks'' each 
place they appear in paragraphs (a), introductory text, and (b).


Sec. 614.4900  [Amended]

    16. Section 614.4900 is amended by adding after the words ``a bank 
for cooperatives'' the words ``or an agricultural credit bank'' each 
place they appear in paragraphs (a) through (d); and by adding after 
the words ``banks for cooperatives'' the words ``and agricultural 
credit banks'' in the first sentence of paragraph (i).5

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

     17. 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, 8.4, 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-4, 2279aa-6, 2279aa-7, 2279aa-
8, 2279aa-10, 2279aa-12); sec. 301(a) of Pub. L. 100-233, 101 Stat. 
1568, 1608; sec. 105 of Pub. L. 104-105, 110 Stat. 162, 163-64.

Subpart H--Capital Adequacy


Sec. 615.5201  [Amended]

    18. Section 615.5201 is amended by adding the words ``Federal land 
credit association,'' after the words ``Federal land bank 
association,''; and by removing the words ``National Bank for 
Cooperatives,'' and adding in their place, the words ``agricultural 
credit bank,'' in paragraph (g).
    19. Section 615.5205 is revised to read as follows:


Sec. 615.5205  Minimum permanent capital standards.

    Each Farm Credit System institution shall at all times maintain 
permanent capital at a level of at least 7 percent of its risk-adjusted 
asset base.
    20. Section 615.5210 is amended by removing paragraphs (f)(2)(i)(D) 
and (f)(2)(v)(D); redesignating paragraph (f)(2)(v)(E) as new paragraph 
(f)(2)(v)(D); adding a new paragraph (e)(2)(ii)(G)(10); and revising 
paragraphs (e)(2)(ii)(G)(7) and (f)(2)(i)(C) to read as follows:


Sec. 615.5210  Computation of the permanent capital ratio.

* * * * *
    (e) * * *
    (2) * * *
    (ii) * * *
    (G) * * *
    (7) Each institution shall deduct from its total capital an amount 
equal to any goodwill.
* * * * *
    (10) The permanent capital of an institution shall exclude the net 
impact of unrealized holding gains or losses on available-for-sale 
securities.
    (f) * * *
    (2) * * *
    (i) * * *
    (C) Goodwill.
* * * * *


Sec. 615.5216  [Removed and reserved]

    21. Section 615.5216 is removed and reserved.

Subpart I--Issuance of Equities


Sec. 615.5220  [Amended]

    22. Section 615.5220 is amended by removing paragraph (f), 
redesignating existing paragraphs (g), (h), and (i) as paragraphs (f), 
(g), and (h), respectively; removing the words ``may be more than, 
but'' each place they appear in paragraphs (d) and (e); by adding the 
words ``, agricultural credit banks (with respect to loans other than 
to cooperatives),'' after the words ``For Farm Credit Banks'' in 
paragraph (d); by adding the words ``and agricultural credit banks 
(with respect to loans to cooperatives)'' after the words ``For banks 
for cooperatives'' in paragraph (e); and by removing the words 
``(including interim standards)'' in newly designated paragraph (f).


Sec. 615.5230  [Amended]

    23. Section 615.5230 is amended by removing the words ``preferred 
stock to be issued to the Farm Credit System Financial Assistance 
Corporation and'' in paragraph (b)(1).
    24. Section 615.5240 is amended by removing paragraph (b); 
redesignating the introductory paragraph and paragraph (a) introductory 
text as paragraphs (a) and (b) introductory text, respectively; adding 
a new paragraph (c); and revising newly designated paragraph (a) to 
read as follows:


Sec. 615.5240  Permanent capital requirements.

    (a) The capitalization bylaws shall enable the institution to meet 
the minimum permanent capital adequacy standards established under 
subparts H and K of this part and the total capital requirements 
established by the board of directors of the institution.
* * * * *
    (c) An institution's board of directors may delegate to management 
the decision whether to retire borrower stock, provided that:
    (1) The institution's permanent capital ratio will be in excess of 
9 percent after any such retirements;
    (2) The institution meets and maintains all applicable minimum 
surplus and collateral standards;
    (3) Any such retirements are in accordance with the institution's 
capital adequacy plan or capital restoration plan; and
    (4) The aggregate amount of stock purchases, retirements, and the 
net effect of such activities are reported to the board of directors 
each quarter.


Sec. 615.5250  [Amended]

    25. Section 615.5250 is amended by removing paragraph (c); 
redesignating paragraphs (d) and (e) as paragraphs (c) and (d), 
respectively; by removing the words ``(including interim standards)'' 
in paragraphs (a)(4)(ii) and newly designated (c)(3); and by removing 
the words ``, including interim standards'' in paragraph (a)(4)(iii).

Subpart J--Retirement of Equities


Sec. 615.5260  [Amended]

    26. Section 615.5260 is amended by adding the word ``or'' at the 
end of paragraph (a)(2)(i); removing ``; or'' at the end of paragraph 
(a)(2)(ii) and inserting a period in its place; and by removing 
paragraphs (a)(2)(iii) and (d).


Sec. 615.5270  [Amended]

    27. Section 615.5270 is amended by removing the words ``(including 
interim standards)'' in paragraph (b).
    28. Subpart K is revised to read as follows:

Subpart K--Surplus and Collateral Requirements

Sec.
615.5301  Definitions.
615.5330  Minimum surplus ratios.
615.5335  Bank net collateral ratio.
615.5336  Reporting and compliance.

Subpart K--Surplus and Collateral Requirements


Sec. 615.5301  Definitions.

    For the purposes of this subpart, the following definitions shall 
apply:

[[Page 42124]]

    (a) The terms institution, permanent capital, risk-adjusted asset 
base, and total capital shall have the meanings set forth in 
Sec. 615.5201.
    (b) Core surplus.
    (1) Core surplus includes:
    (i) Undistributed earnings/unallocated surplus;
    (ii) Perpetual common or noncumulative perpetual preferred 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 as a part of a 
pro rata retirement of all stock of the same class or series that was 
issued in the same year as the retired stock, the remaining perpetual 
stock shall be excluded from core surplus.
    (iii) Nonqualified allocated equities 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 as a part of a pro rata 
distribution of nonqualified allocations that were allocated in the 
same year as the distributed allocation, the remaining nonqualified 
allocations will be excluded from core surplus.
    (iv) A newly developed or modified capital instrument or a 
particular balance sheet entry or account that the Farm Credit 
Administration has determined to be the functional equivalent of a 
component of core surplus. The Farm Credit Administration may permit 
one or more institutions to include all or a portion of such 
instrument, entry, or account as core surplus, permanently, or on a 
temporary basis, for purposes of this subpart.
    (2) Core surplus shall not include equities held by other System 
institutions.
    (3) The net impact of unrealized holding gains or losses on 
available-for-sale securities shall be excluded from core surplus.
    (4) The Farm Credit Administration may, if it finds that a 
particular component, balance sheet entry, or account has 
characteristics or terms that diminish its contribution to an 
institution's ability to absorb losses, require the deduction of all or 
a portion of such component, entry, or account from core surplus.
    (c) Net collateral means the value of a bank's collateral as 
defined by Sec. 615.5050 (except that eligible investments as described 
in Sec. 615.5140 are to be valued at their amortized cost), less an 
amount equal to that portion of the allocated investments of affiliated 
associations that is not counted as permanent capital by the bank.
    (d) Net collateral ratio means a bank's net collateral, divided by 
the bank's total liabilities.
    (e) Net investment in the bank means the total investment by an 
association in its affiliated bank, less reciprocal investments and 
investments resulting from a loan originating/service agency 
relationship, including participations.
    (f) Nonqualified allocated equities means allocations of earnings 
that are not deducted from the gross taxable income of the allocating 
institution at the time of allocation.
    (g) Perpetual stock or equity means stock or equity not having a 
maturity date, not redeemable at the option of the holder, and having 
no other provisions that will require the future redemption of the 
issue.
    (h) Total surplus means:
    (1) Undistributed earnings/unallocated surplus;
    (2) Allocated equities, including allocated surplus and stock 
which, if subject to revolvement, have a revolvement of not less than 5 
years and are eligible to be included in permanent capital pursuant to 
Sec. 615.5201(j)(4)(iv); and
    (3) 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 in each of the last 5 
years of the life of the instrument.
    The total surplus of an institution shall exclude the net impact of 
unrealized holding gains or losses on available-for-sale securities.


Sec. 615.5330  Minimum surplus ratios.

    (a) Total surplus. Each institution shall achieve and maintain a 
ratio of at least 7 percent of total surplus to the risk-adjusted asset 
base.
    (b) Core surplus.
    (1) Each institution shall achieve and maintain a ratio of core 
surplus to the risk-adjusted asset base of at least 3.5 percent.
    (2) Each association shall compute its core surplus ratio by 
deducting an amount equal to the net investment in its affiliated Farm 
Credit bank from both its core surplus and its risk-adjusted asset 
base.
    (c) An institution shall compute its total surplus and core surplus 
ratios as of the end of each month.


Sec. 615.5335  Bank net collateral ratio.

    (a) Each bank shall achieve and maintain a net collateral ratio of 
at least 103 percent.
    (b) A bank shall compute its net collateral ratio as of the end of 
each month.


Sec. 615.5336  Reporting and compliance.

    (a) Reporting and noncompliance. An institution that falls below 
any applicable minimum surplus or collateral standard shall report its 
noncompliance to the Farm Credit Administration within 20 calendar days 
following the monthend that the institution initially determines that 
it is not in compliance with the standard.
    (b) Initial institution compliance requirements. Each institution 
that fails to satisfy any of its minimum applicable surplus and net 
collateral ratios upon the effective date of these regulations shall 
submit a capital restoration plan for achieving and maintaining the 
standards, demonstrating appropriate annual progress toward meeting the 
goal, to the Farm Credit Administration within 60 days of the effective 
date of the regulations. If the capital restoration plan is not 
approved by the Farm Credit Administration, the Agency shall inform the 
institution of the reasons for disapproval, and the association shall 
submit a revised capital restoration plan within the time specified by 
the Farm Credit Administration.
    (c) Approval of compliance plans. In determining whether to approve 
a capital restoration plan submitted under this section, the FCA shall 
consider the following factors, as applicable:
    (1) The conditions or circumstances leading to the institution's 
falling below minimum levels (and whether or not they were caused by 
actions of the institution or were beyond the institution's control);
    (2) The exigency of those circumstances or potential problems;
    (3) The overall condition, management strength, and future 
prospects of the institution and, if applicable, affiliated System 
institutions;
    (4) The institution's capital, adverse assets (including nonaccrual 
and nonperforming loans), allowance for loss, and other ratios compared 
to the ratios of its peers or industry norms;
    (5) How far an institution's ratios are below the minimum 
requirements;
    (6) The estimated rate at which the institution can reasonably be 
expected to generate additional earnings;
    (7) The effect of the business changes required to increase 
capital;
    (8) The institution's previous compliance practices, as 
appropriate;

[[Page 42125]]

    (9) The views of the institution's directors and senior management 
regarding the plan; and
    (10) Any other facts or circumstances that the FCA deems relevant.
    (d) Initial compliance. An institution that fails to meet either or 
both of the minimum applicable surplus ratios or net collateral ratio 
established in Sec. 615.5330 on the effective date of such section 
shall be deemed to be in compliance with such section, provided that 
the institution is in compliance with a capital restoration plan that 
is approved by the Farm Credit Administration within 180 days of the 
effective date of these regulations.
    (e) Noncompliance. An institution that has met the minimum 
applicable surplus ratios and net collateral ratio established in 
Sec. 615.5330 on or after the effective date of this section and 
subsequently falls below one or more minimum ratios shall be in 
violation of Sec. 615.5330.
    29. Subparts L and M are added to read as follows:

Subpart L--Establishment of Minimum Capital Ratios for an Individual 
Institution

Sec.
615.5350  General--Applicability.
615.5351  Standards for determination of appropriate individual 
institution minimum capital ratios.
615.5352  Procedures.
615.5353  Relation to other actions.
615.5354  Enforcement.

Subpart M--Issuance of a Capital Directive

615.5355  Purpose and scope.
615.5356  Notice of intent to issue a capital directive.
615.5357  Response to notice.
615.5358  Decision.
615.5359  Issuance of a capital directive.
615.5360  Reconsideration based on change in circumstances.
615.5361  Relation to other administrative actions.

Subpart L--Establishment of Minimum Capital Ratios for an 
Individual Institution


Sec. 615.5350  General--Applicability.

    (a) The rules and procedures specified in this subpart are 
applicable to a proceeding to establish required minimum capital ratios 
that would otherwise be applicable to an institution under 
Secs. 615.5205, 615.5330, and 615.5335. The Farm Credit Administration 
is authorized to establish such minimum capital requirements for an 
institution as the Farm Credit Administration, in its discretion, deems 
to be necessary or appropriate in light of the particular circumstances 
of the institution. Proceedings under this subpart also may be 
initiated to require an institution having capital ratios greater than 
those set forth in Secs. 615.5205, 615.5330, or 615.5335 to continue to 
maintain those higher ratios.
    (b) The Farm Credit Administration may require higher minimum 
capital ratios for an individual institution in view of its 
circumstances. For example, higher capital ratios may be appropriate 
for:
    (1) An institution receiving special supervisory attention;
    (2) An institution that has, or is expected to have, losses 
resulting in capital inadequacy;
    (3) An institution with significant exposure due to operational 
risk, interest rate risk, the risks from concentrations of credit, 
certain risks arising from other products, services, or related 
activities, or management's overall inability to monitor and control 
financial risks presented by concentrations of credit and related 
services activities;
    (4) An institution exposed to a high volume of, or particularly 
severe, problem loans;
    (5) An institution that is growing rapidly; or
    (6) An institution that may be adversely affected by the activities 
or condition of System institutions with which it has significant 
business relationships or in which it has significant investments.


Sec. 615.5351  Standards for determination of appropriate individual 
institution minimum capital ratios.

    The appropriate minimum capital ratios for an individual 
institution cannot be determined solely through the application of a 
rigid mathematical formula or wholly objective criteria. The decision 
is necessarily based in part on subjective judgment grounded in Agency 
expertise. The factors to be considered in the determination will vary 
in each case and may include, for example:
    (a) The conditions or circumstances leading to the Farm Credit 
Administration's determination that higher minimum capital ratios are 
appropriate or necessary for the institution;
    (b) The exigency of those circumstances or potential problems;
    (c) The overall condition, management strength, and future 
prospects of the institution and, if applicable, affiliated 
institutions;
    (d) The institution's capital, adverse assets (including nonaccrual 
and nonperforming loans), allowance for loss, and other ratios compared 
to the ratios of its peers or industry norms; and
    (e) The views of the institution's directors and senior management.


Sec. 615.5352  Procedures.

    (a) Notice. When the Farm Credit Administration determines that 
minimum capital ratios greater than those set forth in Secs. 615.5205, 
615.5330, or 615.5335 are necessary or appropriate for a particular 
institution, the Farm Credit Administration will notify the institution 
in writing of the proposed minimum capital ratios and the date by which 
they should be reached (if applicable) and will provide an explanation 
of why the ratios proposed are considered necessary or appropriate for 
the institution.
    (b) Response.
    (1) The institution may respond to any or all of the items in the 
notice. The response should include any matters which the institution 
would have the Farm Credit Administration consider in deciding whether 
individual minimum capital ratios should be established for the 
institution, what those capital ratios should be, and, if applicable, 
when they should be achieved. The response must be in writing and 
delivered to the designated Farm Credit Administration official within 
30 days after the date on which the institution received the notice. In 
its discretion, the Farm Credit Administration may extend the time 
period for good cause. The Farm Credit Administration may shorten the 
time period with the consent of the institution or when, in the opinion 
of the Farm Credit Administration, the condition of the institution so 
requires, provided that the institution is informed promptly of the new 
time period.
    (2) Failure to respond within 30 days or such other time period as 
may be specified by the Farm Credit Administration shall constitute a 
waiver of any objections to the proposed minimum capital ratios or the 
deadline for their achievement.
    (c) Decision. After the close of the institution's response period, 
the Farm Credit Administration will decide, based on a review of the 
institution's response and other information concerning the 
institution, whether individual minimum capital ratios should be 
established for the institution and, if so, the ratios and the date the 
requirements will become effective. The institution will be notified of 
the decision in writing. The notice will include an explanation of the 
decision, except for a decision not to establish individual minimum 
capital requirements for the institution.
    (d) Submission of plan. The decision may require the institution to 
develop and submit to the Farm Credit Administration, within a time 
period specified, an acceptable plan to reach

[[Page 42126]]

the minimum capital ratios established for the institution by the date 
required.
    (e) Reconsideration based on change in circumstances. If, after the 
Farm Credit Administration's decision in paragraph (c) of this section, 
there is a change in the circumstances affecting the institution's 
capital adequacy or its ability to reach the required minimum capital 
ratios by the specified date, either the institution or the Farm Credit 
Administration may propose a change in the minimum capital ratios for 
the institution, the date when the minimums must be achieved, or the 
institution's plan (if applicable). The Farm Credit Administration may 
decline to consider proposals that are not based on a significant 
change in circumstances or are repetitive or frivolous. Pending a 
decision on reconsideration, the Farm Credit Administration's original 
decision and any plan required under that decision shall continue in 
full force and effect.


Sec. 615.5353  Relation to other actions.

    In lieu of, or in addition to, the procedures in this subpart, the 
required minimum capital ratios for an institution may be established 
or revised through a written agreement or cease and desist proceedings 
under part C of title V of the Act, or as a condition for approval of 
an application.


Sec. 615.5354  Enforcement.

    An institution that does not have or maintain the minimum capital 
ratios applicable to it, whether required in subparts H and K of this 
part, in a decision pursuant to this subpart, in a written agreement or 
temporary or final order under part C of title V of the Act, or in a 
condition for approval of an application, or an institution that has 
failed to submit or comply with an acceptable plan to attain those 
ratios, will be subject to such administrative action or sanctions as 
the Farm Credit Administration considers appropriate. These sanctions 
may include the issuance of a capital directive pursuant to subpart M 
of this part or other enforcement action, assessment of civil money 
penalties, and/or the denial or condition of applications.

Subpart M--Issuance of a Capital Directive


Sec. 615.5355  Purpose and scope.

    (a) This subpart is applicable to proceedings by the Farm Credit 
Administration to issue a capital directive under sections 4.3(b) and 
4.3A(e) of the Act. A capital directive is an order issued to an 
institution that does not have or maintain capital at or greater than 
the minimum ratios set forth in Secs. 615.5205, 615.5330, and 615.5335; 
or established for the institution under subpart L, by a written 
agreement under part C of title V of the Act, or as a condition for 
approval of an application. A capital directive may order the 
institution to:
    (1) Achieve the minimum capital ratios applicable to it by a 
specified date;
    (2) Adhere to a previously submitted plan to achieve the applicable 
capital ratios;
    (3) Submit and adhere to a plan acceptable to the Farm Credit 
Administration describing the means and time schedule by which the 
institution shall achieve the applicable capital ratios;
    (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
    (5) A combination of any of these or similar actions. A capital 
directive may also be issued to the board of directors of an 
institution, requiring such board to comply with the requirements of 
section 4.3A(d) of the Act prohibiting the reduction of permanent 
capital.
    (b) A capital directive issued under this rule, including a plan 
submitted under a capital directive, is enforceable in the same manner 
and to the same extent as an effective and outstanding cease and desist 
order which has become final as defined in section 5.25 of the Act. 
Violation of a capital directive may result in assessment of civil 
money penalties in accordance with section 5.32 of the Act.


Sec. 615.5356  Notice of intent to issue a capital directive.

    The Farm Credit Administration will notify an institution in 
writing of its intention to issue a capital directive. The notice will 
state:
    (a) The reasons for issuance of the capital directive;
    (b) The proposed contents of the capital directive, including the 
proposed date for achieving the minimum capital requirement; and
    (c) Any other relevant information concerning the decision to issue 
a capital directive.


Sec. 615.5357  Response to notice.

    (a) An institution may respond to the notice by stating why a 
capital directive should not be issued and/or by proposing alternative 
contents for the capital directive or seeking other appropriate relief. 
The response shall include any information, mitigating circumstances, 
documentation, or other relevant evidence that supports its position. 
The response may include a plan for achieving the minimum capital 
ratios applicable to the institution. The response must be in writing 
and delivered to the Farm Credit Administration within 30 days after 
the date on which the institution received the notice. In its 
discretion, the Farm Credit Administration may extend the time period 
for good cause. The Farm Credit Administration may shorten the 30-day 
time period:
    (1) When, in the opinion of the Farm Credit Administration, the 
condition of the institution so requires, provided that the institution 
shall be informed promptly of the new time period;
    (2) With the consent of the institution; or
    (3) When the institution already has advised the Farm Credit 
Administration that it cannot or will not achieve its applicable 
minimum capital ratios.
    (b) Failure to respond within 30 days or such other time period as 
may be specified by the Farm Credit Administration shall constitute a 
waiver of any objections to the proposed capital directive.


Sec. 615.5358  Decision.

    After the closing date of the institution's response period, or 
receipt of the institution's response, if earlier, the Farm Credit 
Administration may seek additional information or clarification of the 
response. Thereafter, the Farm Credit Administration will determine 
whether or not to issue a capital directive, and if one is to be 
issued, whether it should be as originally proposed or in modified 
form.


Sec. 615.5359  Issuance of a capital directive.

    (a) A capital directive will be served by delivery to the 
institution. It will include or be accompanied by a statement of 
reasons for its issuance.
    (b) A capital directive is effective immediately upon its receipt 
by the institution, or upon such later date as may be specified 
therein, and shall remain effective and enforceable until it is stayed, 
modified, or terminated by the Farm Credit Administration.


Sec. 615.5360  Reconsideration based on change in circumstances.

    Upon a change in circumstances, an institution may request the Farm 
Credit Administration to reconsider the terms of its capital directive 
or may propose changes in the plan to achieve the institution's 
applicable minimum capital ratios. The Farm Credit Administration also 
may take such action on its own motion. The Farm

[[Page 42127]]

Credit Administration may decline to consider requests or proposals 
that are not based on a significant change in circumstances or are 
repetitive or frivolous. Pending a decision on reconsideration, the 
capital directive and plan shall continue in full force and effect.


Sec. 615.5361  Relation to other administrative actions.

    A capital directive may be issued in addition to, or in lieu of, 
any other action authorized by law, including cease and desist 
proceedings, civil money penalties, or the conditioning or denial of 
applications. The Farm Credit Administration also may, in its 
discretion, take any action authorized by law, in lieu of a capital 
directive, in response to an institution's failure to achieve or 
maintain the applicable minimum capital ratios.

PART 618--GENERAL PROVISIONS

    30. The authority citation for part 618 continues to read as 
follows:

    Authority: Secs. 1.5, 1.11, 1.12, 2.2, 2.4, 2.5, 2.12, 3.1, 3.7, 
4.12, 4.13A, 4.25, 4.29, 5.9, 5.10, 5.17 of the Farm Credit Act (12 
U.S.C. 2013, 2019, 2020, 2073, 2075, 2076, 2093, 2122, 2128, 2183, 
2200, 2211, 2218, 2243, 2244, 2252).

Subpart A--Related Services


Sec. 618.8005  [Amended]

    31. Section 618.8005 is amended by removing the reference 
``Secs. 613.3010, 613.3020(a)(1), (a)(2), (b), and 613.3045'' in 
paragraph (a) and adding in its place, the reference 
``Secs. 613.3000(a) and (b), 613.3010, and 613.3300'' and by removing 
the reference ``Secs. 613.3110 and 613.3120'' and adding in its place, 
the reference ``Secs. 613.3100, 613.3200, and 613.3300'' in paragraph 
(b).

Subpart J--Internal Controls


Sec. 618.8440  [Amended]

    32. Section 618.8440 is amended by removing the reference 
``Sec. 615.5200(b)'' and adding in its place, the references 
``Secs. 615.5200(b), 615.5330 (c) or (d), and 615.5335(b)'' in 
paragraph (b)(6).

PART 619--DEFINITIONS

    33. The authority citation for part 619 is revised to read as 
follows:

    Authority: Secs. 1.7, 2.4, 4.9, 5.9, 5.12, 5.17, 5.18, 7.0, 7.6, 
7.7, 7.8 of the Farm Credit Act (12 U.S.C. 2015, 2075, 2160, 2243, 
2246, 2252, 2253, 2279a, 2279b, 2279b-1, 2279b-2).


Secs. 619.9025, 619.9030, 619.9040, 619.9065, 619.9080, 619.9090, 
619.9100, 619.9120, 619.9150, 619.9160, 619.9190, 619.9220, 619.9270, 
619.9280, 619.9300, and 619.9310  [Removed]

    34. Sections 619.9025, 619.9030, 619.9040, 619.9065, 619.9080, 
619.9090, 619.9100, 619.9120, 619.9150, 619.9160, 619.9190, 619.9220, 
619.9270, 619.9280, 619.9300, and 619.9310 are removed.

PART 620--DISCLOSURE TO SHAREHOLDERS

    35. 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 B--Annual Report to Shareholders

    36. Section 620.5 is amended by revising paragraphs (d)(1)(ix) and 
(g)(4)(ii) to read as follows:


Sec. 620.5  Contents of the annual report to shareholders.

* * * * *
    (d) * * *
    (1) * * *
    (ix) The statutory and regulatory restriction regarding retirement 
of stock and distribution of earnings pursuant to Sec. 615.5215, and 
any requirements to add capital under a plan approved by the Farm 
Credit Administration pursuant to Secs. 615.5330, 615.5335, 615.5351, 
or 615.5357.
* * * * *
    (g) * * *
    (4) * * *
    (ii) Describe any material trends or changes in the mix and cost of 
debt and capital resources. The discussion shall consider changes in 
permanent capital, core and total surplus, and net collateral 
requirements, debt, and any off-balance-sheet financing arrangements.
* * * * *

PART 626--NONDISCRIMINATION IN LENDING

    37. The authority citation for part 626 is added to read as 
follows:

    Authority: Secs. 1.5, 2.2, 2.12, 3.1, 5.9, 5.17 of the Farm 
Credit Act (12 U.S.C. 2013, 2073, 2093, 2122, 2243, 2252); 42 U.S.C. 
3601 et seq.; 15 U.S.C. 1691 et seq.; 12 CFR 202, 24 CFR 100, 109, 
110.


Sec. 626.6025  [Amended]

    38. Newly designated Sec. 626.6025 is amended by removing the 
reference ``Sec. 613.3160(b)'' and adding in its place, the reference 
``Sec. 626.6020(b)'' in paragraph (b).
* * * * *
    Dated: July 31, 1996.
Nan P. Mitchem,
Acting Secretary, Farm Credit Administration Board.
[FR Doc. 96-19890 Filed 8-12-96; 8:45 am]
BILLING CODE 6705-01-P