[Federal Register Volume 63, Number 192 (Monday, October 5, 1998)]
[Notices]
[Pages 53423-53429]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-26620]


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FARM CREDIT SYSTEM INSURANCE CORPORATION


Policy Statement on the Secure Base Amount and Allocated 
Insurance Reserve Accounts

AGENCY: Farm Credit System Insurance Corporation.

ACTION: Notice of policy statement; request for comments.

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SUMMARY: The Farm Credit System Insurance Corporation (Corporation) is 
publishing for comment a Policy Statement on the Secure Base Amount and 
Allocated Insurance Reserve Accounts (AIRAs). This proposed Policy 
Statement establishes a framework for the periodic determination of the 
Farm Credit Insurance Fund's (Insurance Fund) secure base amount. It 
also implements the Corporation's authority to allocate excess 
Insurance Fund balances above the secure base amount into an account 
for each insured Farm Credit System Bank and one for the Farm Credit 
System Financial Assistance Corporation (FAC) stockholders.

DATES: Written comments must be submitted on or before January 4, 1999.

ADDRESSES: Comments should be mailed or delivered to Dorothy L. 
Nichols, General Counsel, Farm Credit System Insurance Corporation, 
1501 Farm Credit Drive, McLean, Virginia 22102. Copies of all comments 
will be available for examination by interested parties in the offices 
of the Farm Credit System Insurance Corporation.

FOR FURTHER INFORMATION CONTACT: Dorothy L. Nichols, General Counsel, 
Farm Credit System Insurance Corporation, 1501 Farm Credit Drive, 
McLean, Virginia 22102. (703) 883-4380, TDD (703) 883-4444.

SUPPLEMENTARY INFORMATION: In 1987, Congress directed the Corporation 
to build and manage the Insurance Fund to achieve and maintain the 
secure base amount (SBA). For insurance premium purposes, the statute 
defines the SBA as 2 percent of the aggregate outstanding insured 
obligations of all insured banks (excluding a percentage of state and 
Federally guaranteed loans) or such other percentage of the aggregate 
amount as the Corporation in its sole discretion determines is 
``actuarially sound.'' (12 U.S.C. 2277a-4(c)).
    The statute specifies a limited form of risk-based premium 
assessments: 25 basis points for nonaccrual loans; 15 basis points for 
loans in accrual status (excluding certain state and Federally 
guaranteed loans); and a very modest premium for government-guaranteed 
loans. (12 U.S.C. 2277a-4(a)). This formula was designed as an 
incentive for the Farm Credit System to make quality loans and at the 
same time build the Insurance Fund to a level that Congress believed 
would prevent a default on System debt obligations. In the Farm Credit 
System Reform Act of 1996, Congress gave the Corporation the discretion 
to reduce premium assessments before reaching the SBA. (12 U.S.C. 
2277a-4(a)(2)). The Board has

[[Page 53424]]

reduced the premiums, most recently in January 1998.
    The Board reviews premium assessments at least semiannually to 
determine whether to adjust premiums in response to changing 
conditions. The Board will continue this review even though the 
Insurance Fund reached the SBA at the end of the first quarter of 1998, 
because the law requires the Corporation to maintain the SBA. During 
the second quarter, growth in System insured debt outstanding caused 
the Insurance Fund to drop slightly below the SBA.

I. Secure Base Amount Determination

    The law sets out a formula for determining the SBA: ``2 percent of 
the aggregate outstanding insured obligations of all insured System 
banks.'' (12 U.S.C. 2277a-4). It also allows the Corporation to choose 
another percentage, if the Corporation determines that the risks 
warrant it. Thus far, the Corporation has used the statutory formula.
    In the statute, an insured obligation is defined as any note, bond, 
debenture, or other obligation issued on behalf of an insured System 
bank under the appropriate subsection of section 4.2 of the Farm Credit 
Act (12 U.S.C. 2277a). The Policy Statement includes both principal and 
accrued interest in the definition of ``insured obligation'' because 
section 5.52 of the Act established the Corporation to ensure the 
timely payment of principal and interest to investors. Also, it is 
commonly understood that an issuer of bonds or notes has an obligation 
to pay a debt, which includes interest, when due.
    After calculating the insured obligations, the Corporation will 
apply the deductions specified in the statute for the government 
guaranteed portion of the System loans to determine the SBA. This 
calculation will be done at the end of each quarter. After the end of 
the calendar year, using the December 31 balances, the Corporation will 
decide whether the Insurance Fund exceeds the SBA. The Policy Statement 
uses the December 31 balances for this calculation because the statute, 
in the premium section, contemplates using a point in time method in 
this context (12 U.S.C. 2277a4(c)). If the Insurance Fund exceeds the 
SBA, the Corporation's Board will determine whether to segregate excess 
insurance funds.

II. Allocated Insurance Reserve Accounts

1. Determining Whether There Are Excess Funds To Deposit in the AIRAs 
or Whether a Withdrawal Is Required

    The Farm Credit System Reform Act of 1996 established a process for 
making partial distributions of the Insurance Fund's balance above the 
SBA. It established in the Insurance Fund an AIRA for the benefit of 
each insured System bank and one for the FAC stockholders. The AIRAs 
remain a part of the Insurance Fund and are available to the 
Corporation.
    AIRA allocations would be made only at the end of any year in which 
the Insurance Fund, plus the accumulated excess balance after deducting 
expenses and insurance obligations for the next year, is greater than 2 
percent. This is because the AIRAs are designed to absorb losses first, 
if necessary, or to capitalize growth to avoid the need to charge 
supplemental premiums.
    If the Insurance Fund exceeds the SBA at the end of any calendar 
year (using December 31 balances), the statute requires the Corporation 
to determine whether any excess funds exist for allocation to the 
AIRAs. In determining whether excess funds exist, the statute calls for 
the Corporation to first calculate ``the average secure base amount for 
the calendar year (using average daily balances).''
a. Authorized Deductions
    If the Insurance Fund exceeds the SBA, the statute requires that 
the Insurance Fund balance be adjusted downward by an estimate for the 
next calendar year of the:
    1. Corporation's operating costs; and
    2. Insurance obligations.
    The Corporation will deduct the operating expenses it expects to 
incur for the next calendar year. Estimated insurance obligations are 
defined in the Policy Statement to include all anticipated allowances 
for insurance losses, claims, and other potential statutory uses of the 
Insurance Fund. They are also defined to include an estimate of the 
expected growth of insured System debt for the next 12 months and the 
money needed to maintain the SBA with that level of growth.
    The Corporation prepares its financial statements on an accrual 
basis using generally accepted accounting principles (GAAP). GAAP 
requires the Corporation to recognize in its financial statements any 
probable loss that can be reasonably estimated. In the event of 
unanticipated bank failures, however, the Insurance Fund could drop 
below the SBA. Were the Insurance Fund to drop below the SBA, the 
Corporation would be required to collect insurance premiums to restore 
the Insurance Fund to the SBA. Because of the strong health of the Farm 
Credit System, the Insurance Fund is currently close to the SBA. 
However, there is no guarantee that the System or the economy will 
remain this healthy, particularly given the recent pressures on 
agriculture resulting from severe drought and the crisis in Asia. Thus, 
the Board has concluded that the Corporation should deduct probable 
losses estimated for the next year, recognizing that such a deduction 
could mean that no excess funds would be available for deposit in the 
AIRAs in a given year.
    Because the statutory requirement for the Insurance Fund includes 
not only achieving but also maintaining the SBA, the Policy Statement 
defines insurance obligations to include an estimate of expected growth 
in insured debt for the prospective 12 months, using a 3-year average 
to determine the estimate. This will minimize the effect of any short-
term periods of rapid growth, which might lead to an excessive 
prospective growth estimate.
    In the event of faster than expected growth in insured obligations, 
the Insurance Fund could drop below the SBA. If it did, the Corporation 
would be required to collect insurance premiums to restore the 
Insurance Fund to the SBA.
b. Allocation Formula When Excess Funds Are Available
    The Policy Statement includes the statutory formula for allocation 
of any excess Insurance Fund balances to FAC stockholders (10 percent) 
and to the insured System banks (90 percent). It also includes the 3-
year average loan balance formula the statute mandates when the 
Corporation adds balances to each AIRA. The amount of funds in the 
accounts each year may fluctuate, depending upon the annual calculation 
of the SBA and any excess Insurance Fund balance. Exhibit 1 is a 
hypothetical example of how the AIRA program will operate, including 
determining the amount of excess Insurance Fund balances and allocating 
the balances to individual AIRA holders.
c. Use of Allocated Amounts When Reductions Are Required
    The Policy Statement also interprets the statutory language 
governing use of the AIRAs when insurance obligations exceed estimated 
amounts. When actual expenses and insurance obligations exceed 
estimates from the previous

[[Page 53425]]

year end, the law requires the Corporation to reduce the balances in 
the AIRAs by proportional amounts. The statute, however, doesn't 
prescribe how the proportional amounts are to be determined.
    The Board has concluded that the Corporation should use the same 
technique to calculate reductions to the AIRAs as the statute uses to 
calculate additions, i.e., the 3-year average loan balance formula. 
This weighted average allocation formula ensures that any reductions to 
AIRA balances are accomplished in the same manner as the allocations. 
The Corporation considered other approaches for making required 
reductions, including using equal proportions for each AIRA account. 
Using equal proportions, however, results in the holder of smaller AIRA 
balances receiving the same amount of any required AIRA reduction as 
the largest account holder.

2. AIRA Accumulation Cycle

    The law authorizes payments of a portion of AIRA balances to the 
System banks and FAC stockholders ``as soon as practicable during each 
calendar year beginning more than 8 years after the date on which the 
aggregate of the amounts' in the Insurance Fund exceeds the SBA. (12 
U.S.C. 2277a-4). While this language could be subject to varying 
interpretations, the Insurance Fund first attained the SBA in the first 
quarter of 1998, and thus payments could begin 8 years later. The Board 
has concluded that it is reasonable to consider making the first 
payment as soon as practicable after the first quarter in 2006. The 
proposed Policy Statement adopts the earliest possible payout date: 8 
calendar years after the quarter-end when the SBA was initially 
attained.
    An important corollary issue is how to address an interruption in 
the 8-year period. For example, if after establishing the AIRAs, the 
Corporation has to use them for an insurance action, or if the System 
experiences extraordinary growth in debt outstanding causing the AIRA 
balances to be depleted, does the accumulation cycle begin anew? If the 
Insurance Fund falls below the SBA for a brief time or dips below the 
SBA late in the 8-year cycle, should the accumulation cycle begin 
again?
    The Corporation believes that Congress designed the accumulation 
period to serve as a minimum time horizon for the accumulation of 
excess Insurance Fund balances to allow for the creation of a secondary 
Insurance Reserve. The AIRA provision was included in lieu of providing 
the Corporation with the authority to collect supplemental insurance 
premiums. Congress decided that when supplemental insurance premiums 
were needed to strengthen the Insurance Fund during periods of stress 
in agriculture, the System might be unable to pay significant 
additional amounts and that might adversely affect System institutions' 
viability. The 1996 Act as proposed in the House included a 5-year 
accumulation period, which was subsequently increased to 8 years to 
reconcile with the Senate's budget scoring procedures.
    The Policy Statement leaves the issue of selecting an alternative 
accumulation period open to decision on a case-by-case basis. This 
approach preserves maximum flexibility to tailor any alternative 
accumulation period to best fit the causes of a future shortfall in the 
Insurance Fund. For example, the circumstances where a period of rapid 
growth causes a temporary (or small) decline in the Insurance Fund 
below the SBA for one or more quarters are far less serious than a 
decline in the Insurance Fund caused by losses as a result of increased 
risk at System banks and associations.

III. Issues for Later Consideration

    The statute authorizes initial payment of any balances in the AIRAs 
beginning more than 8 years after attainment of the SBA, which could be 
as early as 2006. As this date approaches, the Corporation's Board will 
have to consider the Corporation's authority to reduce or eliminate 
AIRA payments, and calculation of the initial AIRA payment components.
    The Board believes that these issues can be better addressed after 
the Corporation obtains experience in administering the AIRA program 
over several years. Also, the likelihood of payment beginning in 2006 
must be considered somewhat uncertain at this time. The uncertainty 
stems from factors that will determine whether and how much of any AIRA 
accumulations will occur. These factors are:
    1. Future growth in the level of insured debt outstanding;
    2. Possible insurance claims or losses; and
    3. Level of investment earnings.

Because the Corporation can not predict any of these factors with 
certainty now, it seems prudent to gain more experience with excess 
Insurance Fund balances before making these decisions about future 
payments.

IV. Comments

    The Corporation's Board is seeking public comment on the issues 
discussed in the proposed Policy Statement. After consideration of the 
comments, the Board will make its final determination and issue a 
Policy Statement setting out its decision.

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[[Page 53428]]

Farm Credit System Insurance Corporation Policy Statement on the 
Secure Base Amount and Allocated Insurance Reserve Account Program, 
NV 98-03

    Adoption Date: September 23, 1998.
    Effect on Previous Action: None.
    Source of Authority: Section 5.55 of the Farm Credit Act of 1971, 
as amended (the Act); 12 U.S.C. 2277a-4.
    Whereas, section 5.52 of the Act established the Farm Credit System 
Insurance Corporation (Corporation) to, among other things, insure the 
timely payment of principal and interest on Farm Credit System 
obligations (12 U.S.C. 2277a-1); and
    Whereas, section 5.55 of the Act mandates that the Corporation will 
build and manage the Farm Credit Insurance Fund (Insurance Fund) to 
attain and maintain a secure base amount (SBA), defined as 2 percent of 
the aggregate outstanding insured obligations of all insured System 
banks (excluding a percentage of State and Federally guaranteed loans) 
or such other percentage of the aggregate amount as the Corporation 
determines is actuarially sound; and
    Whereas, the Farm Credit System Reform Act of 1996, Pub. L. 104-
105, 110 Stat. 162 (Feb. 10, 1996), amended section 5.55 of the Act to: 
(1) Establish in the Insurance Fund an Allocated Insurance Reserve 
Account (AIRA) for the benefit of each insured System bank and one for 
the Farm Credit System Financial Assistance Corporation (FAC) 
stockholders; (2) Allocate any excess balances to these AIRAs; and (3) 
Eventually make partial distributions of the excess funds in the AIRAs.
    Now, therefore, the Corporation's Board of Directors (Board) adopts 
the following Policy Statement to govern the calculation of the secure 
base amount, the determination of any excess insurance reserves, the 
establishment of the AIRAs, and the method for allocating any excess 
insurance reserves to the AIRAs.

I. Secure Base Amount Determination

    As stated in the Corporation's Policy Statement Concerning 
Adjustments to the Insurance Premiums (BM-11-JUL-96-02), the Board will 
review the premium assessments at least semiannually to determine 
whether to adjust premiums in response to changing conditions. The 
Board will continue this review even after the Insurance Fund achieves 
the SBA because the law requires the Corporation to maintain the SBA. 
Thus, the Corporation must ensure that as the Farm Credit System's 
insured debt grows, or if the Insurance Fund suffers a significant 
loss, the Insurance Fund remains at the SBA.
    The Farm Credit Reform Act of 1996 established a process for making 
partial distributions of the Insurance Fund's balance above the SBA. If 
excess reserves accumulate, these distributions can begin at a point 8 
years after the Insurance Fund reaches the SBA, but no sooner than 
2006. To begin the process the Corporation must define ``the aggregate 
outstanding insured obligations'' of all the System banks. Then it must 
follow the steps in the statute to determine the SBA. Finally, at the 
end of any calendar year in which the Insurance Fund attains the secure 
base amount, the Corporation must determine whether any excess funds 
exist for allocation to the AIRAs.
    The principal calculation for determining whether the Insurance 
Fund is at the SBA amount will be 2 percent of the aggregate adjusted 
insured obligations defined as follows:
    1. ``Insured obligation'' means any note, bond, debenture, or other 
obligation issued under subsection (c) or (d) of section 4.2 of the 
Farm Credit Act on or before January 5, 1989, on behalf of any System 
bank; and after such date, which, when issued, is issued on behalf of 
any insured System bank and is outstanding at the quarter-end. The 
balance outstanding at the quarter-end shall include principal and 
accrued interest payable as reported by the banks in the call reports 
submitted to the Farm Credit Administration.
    2. The balance of insured obligations determined in Number 1 shall 
be reduced by an amount equal to the sum of:
    (a) 90 percent of the guaranteed portions of principal outstanding 
on Federal Government-guaranteed loans in accrual status at all System 
institutions; and
    (b) 80 percent of the guaranteed portions of principal outstanding 
on State Government-guaranteed loans in accrual status at all System 
institutions.
    At the end of any calendar year when the Insurance Fund balance 
exceeds the SBA, calculated using December 31, balances (point-in-time 
method), the Corporation will determine whether any excess insurance 
reserves exist for allocation to the AIRAs.

II. Allocated Insurance Reserve Accounts

1. Determination of Excess Insurance Fund Balances

    An allocated insurance reserve account (AIRA) shall be established 
in the Insurance Fund for each insured System bank and for FAC 
stockholders. Amounts representing excess Insurance Fund balances may 
be allocated to the AIRAs. The AIRAs remain a part of the Insurance 
Fund and are available to the Corporation.
(a) Authorized Deductions
    In determining whether there are any excess insurance reserves, the 
December 31, Insurance Fund balance will first be adjusted downward by:
    (1) The Corporation's estimated operating expenses for the next 12 
months; and
    (2) The Corporation's estimated insurance obligations for the next 
12 months.
    The Corporation will budget for the next calendar year operating 
expenses and it will deduct the operating expenses it expects to incur. 
When determining estimated insurance obligations, the Corporation will 
include all anticipated allowances for insurance losses, claims, and 
other potential statutory uses of the Insurance Fund. Estimated 
insurance obligations shall also include an estimate of the expected 
growth of insured System debt for the next 12 months. This percentage 
will be the average annual growth in insured debt for the past three 
calendar years, using average daily balances. Using this growth 
estimate will result in retaining the amount of money necessary in the 
general Insurance Fund to capitalize growth in the SBA for the next 
year.
    The adjusted aggregate yearend Insurance Fund balance will then be 
compared with the SBA calculated using an average daily balance method 
for the previous calendar year. The statute requires use of an average 
daily balance method for calculating the SBA only for purposes of 
determining the amount of any excess Insurance Fund balances.
    When the aggregate adjusted Insurance Fund balance exceeds the SBA 
amount calculated using the average daily balance method, the excess 
Fund balance shall be allocated to the accounts of each insured System 
bank and to the FAC stockholders.
    (b) Allocation Formula When Excess Funds Are Available
    (1) Ten percent of the excess Insurance Fund balance shall be 
credited to the AIRA for all holders, in the aggregate, of Financial 
Assistance Corporation stock. The total amount that may be allocated to 
this AIRA is limited to $56 million.
    (2) The remaining amount of the excess Insurance Fund balance shall 
be credited to the AIRAs for each insured System bank. The basis for 
crediting the

[[Page 53429]]

excess balance to each bank's AIRA shall be the ratio of its average 
daily accrual loan principal outstanding for the three prior years 
divided by the total average daily accrual loan principal outstanding 
for all System banks. System bank loan volume for making these 
allocations is defined in section 5.55(d) to include all retail loans 
made by direct lending associations, their insured System banks and 
other financing institutions (OFIs) being financed by insured System 
banks (12 U.S.C. 2277a-4(d)). The statute also requires that a 
reduction be made from each bank's ratio (numerator and denominator) 
for the guaranteed portions of government-guaranteed loans similarly on 
an average daily balance basis for the three-year period. An example of 
the allocation formula is shown in Exhibit 1.
(c) Use of Allocated Amounts When Reductions Are Required
    When the Corporation's actual operating expenses and insurance 
obligations exceed the estimated amounts used to determine any year's 
AIRA balances, section 5.55(e)(5) requires AIRA balances to absorb such 
excess expenses before using other amounts in the Insurance Fund (12 
U.S.C. 2277a-4(e)(5)). To the extent reductions are made in AIRA 
balances to absorb Corporation expenses and actual insurance 
obligations, each AIRA will be reduced by its proportional amount in 
accordance with the statute. The same formula used to make allocations 
of excess Insurance Fund balances shall be used to reduce AIRA balances 
when necessary. Ten percent of any necessary AIRA reduction will be 
applied to the FAC stockholder AIRA. The remaining 90 percent will be 
applied to the System insured banks' AIRAs on the basis of the ratio of 
each bank's average daily accrual loan principal outstanding for the 
three prior years divided by the total average daily accrual loan 
principal outstanding for all System banks.

2. AIRA Accumulation Cycle

    Section 5.55(e)(6) permits the Insurance Corporation's Board at its 
discretion to make payments of AIRA balances to the account-holders 
after a minimum time period (12 U.S.C. 2277a-4(e)(6)). The minimum time 
period specified is more than 8 years after the date on which the 
aggregate amount in the Insurance Fund exceeds the secure base amount 
calculated using quarter-end balances.
    The initial starting point for the 8-year period shall be the first 
calendar quarter-end when the Insurance Fund has attained or exceeded 
its SBA. The initial attainment occurred during the first quarter of 
1998. The first payment would be in the second quarter of 2006.
    Should the Insurance Fund drop below the secure base amount at any 
subsequent quarter-end during the 8-year period, the Corporation's 
Board may restart the accumulation period. For example, the Insurance 
Fund might drop below the SBA as a result of rapid growth in insured 
System debt outstanding, or incurring insurance claims or losses. The 
Board in its discretion may select an accumulation period, to begin at 
the next quarter-end when the aggregate in the Insurance Fund again 
attains the secure base amount. Any alternative accumulation period 
however, cannot result in any payment before April 2006. The Board will 
consider the following factors in determining selection of an 
alternative accumulation period:
    (a) The reason that the Insurance Fund dropped below the SBA (i.e. 
as a result of growth in insured debt vs. an insurance expense at a 
troubled institution). The current level of the Insurance Fund and the 
amount of money and time needed to attain the SBA;
    (b) The likelihood and probable amount of any losses to the 
Insurance Fund;
    (c) The overall condition of the Farm Credit System, including the 
level and quality of capital, earnings, asset growth, asset quality, 
loss allowance levels, asset liability management, as well as the 
collateral ratios of the insured banks;
    (d) The health and prospects for the agricultural economy, 
including the potential impact of governmental farm policy and the 
effect of the globalization of agriculture on opportunities and 
competition for U.S. producers; and
    (e) The risks in the financial environment that may cause a 
problem, even when there is no imminent threat, such as volatility in 
the level of interest rates, the use of sophisticated investment 
securities and derivative instruments, and increasing competition from 
non-System financial institutions.

III. Issues for Later Consideration

    Because of multiple factors (including rapid growth and the amount 
of any insurance obligations) which could affect future AIRA balances 
and the uncertainty of future payments, the Corporation has deferred 
consideration of several issues to a date closer to the year 2006. The 
Board anticipates gaining experience in the administration of the AIRA 
program over the next few years and expects to have a better basis for 
determining these issues, which include:
    Board discretionary authority to limit or restrict AIRA payments; 
and
    2. Calculation of the initial AIRA payment components.

    Dated: September 30, 1998.
Floyd Fithian,
Secretary to the Board, Farm Credit System Insurance Corporation.
[FR Doc. 98-26620 Filed 10-2-98; 8:45 am]
BILLING CODE 6710-01-P