[Federal Register Volume 67, Number 204 (Tuesday, October 22, 2002)]
[Proposed Rules]
[Pages 64833-64835]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-26697]


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FARM CREDIT ADMINISTRATION

12 CFR Part 615

RIN 3052-AC05


Funding and Fiscal Affairs, Loan Policies and Operations, and 
Funding Operations; Capital Adequacy

AGENCY: Farm Credit Administration (FCA).

ACTION: Proposed rule.

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SUMMARY: The FCA proposes to amend its capital adequacy regulations to 
add a definition of total liabilities for the net collateral ratio 
calculation; limit the amount of term preferred stock that may count as 
total surplus; clarify the circumstances in which we may waive 
disclosure requirements for an issuance of equities by a Farm Credit 
System (FCS, Farm Credit or System) institution; and make several 
nonsubstantive technical changes. These amendments will update, modify, 
and clarify certain capital requirements.

DATES: Please send your comments to us by November 21, 2002.

ADDRESSES: You may send comments by electronic mail to [email protected] 
or through the Pending Regulations section of FCA's Web site, http://www.fca.gov. You may also send comments to Thomas G. McKenzie, 
Director, Regulation and Policy Division, Office of Policy and 
Analysis, Farm Credit Administration, 1501 Farm Credit Drive, McLean, 
Virginia 22102-5090 or by fax to (703) 734-5784. You may review copies 
of all comments we receive in the Office of Policy and Analysis, FCA.

FOR FURTHER INFORMATION CONTACT: Alan Markowitz, Senior Policy Analyst, 
Office of Policy and Analysis, Farm Credit Administration, McLean, VA 
22102-5090, (703) 883-4479; TTY (703) 883-4434; or Rebecca S. Orlich, 
Senior Attorney, Office of General Counsel, Farm Credit Administration, 
McLean, VA 22102-5090, (703) 883-4020, TTY (703) 883-2020.

SUPPLEMENTARY INFORMATION:

I. Objectives

    The objectives of our proposal are to:
    [sbull] Limit the effect of Statement of Financial Accounting 
Standards No. 133, Accounting for Derivative Instruments and Hedging 
Activities (SFAS 133), on the net collateral ratio;
    [sbull] Ensure that Farm Credit institutions do not overly rely on 
term preferred stock to meet regulatory capital requirements;
    [sbull] Explain how the FCA may include other debt or equity in the 
definition of permanent capital;
    [sbull] Clarify the requirements for the FCA to consider waiving 
disclosure requirements for issuances of stock to more than a single 
sophisticated investor; and
    [sbull] Make several nonsubstantive technical changes to our 
capital regulations.

II. Introduction

    The FCA is proposing changes to the capital adequacy regulations in 
order to update, modify, and clarify certain requirements. We propose 
revising the net collateral ratio calculation to limit the effect of 
new accounting rules for derivatives. This is in response to a petition 
we received last year from two System banks. We also propose limiting 
the amount of term preferred stock that can be counted in total 
surplus.
    Additionally, we propose excluding term preferred stock from 
liabilities in the calculation of the net collateral ratio for System 
banks to the extent that the stock is counted as total surplus. This 
latter proposed amendment reflects the capital treatment of term 
preferred stock issuances we recently reviewed for two System banks. As 
a result of our review of those recent stock issuances, we also 
identified a need to clarify certain requirements and make additional 
technical corrections. The proposed amendments are more fully described 
in the section-by-section analysis below.

III. Section-by-Section Analysis

Section 615.5201(e)--Definition of Direct Lender Institution

    We propose amending Sec.  615.5201(e) by removing the phrase ``loan 
of lease'' and adding, in its place, the phrase ``loan or lease'' to 
correct a typographical error.

Section 615.5201(l)--Definition of Permanent Capital

    We propose adding a new paragraph (8) to the definition of 
permanent capital in Sec.  615.5201(l). This proposed amendment 
reflects a statutory change to section 4.3A of the Farm Credit Act of 
1971, as amended, by the Farm Credit Banks and Associations Safety and 
Soundness Act of 1992 (1992 Act). The 1992 Act added section 
4.3A(a)(1)(E), which includes in permanent capital any debt or equity 
instrument or other account that the FCA determines appropriate to be 
considered as permanent capital. The proposed amendment states that we 
may include a debt or equity instrument in permanent capital in whole 
or in part, and on a permanent or temporary basis. The language of this 
proposal is similar to language in existing Sec.  615.5301(b)(1)(iv) 
and (i)(5), which states that we may include additional items in core 
or total surplus when we deem their inclusion to be appropriate. The 
inclusion of additional items would give institutions more flexibility 
in meeting their capital requirements.
    We considered proposing that term subordinated debt could be 
counted as permanent capital in much the same way that we currently 
allow term preferred stock to be counted. However, since no System 
institution has issued subordinated debt, we have decided to consider 
the inclusion of subordinated debt in permanent capital on a case-by-
case basis, should we receive a specific proposal by a System 
institution.

Section 615.5250(c)(5)--Waiver of Disclosure Requirements

    We propose amending Sec.  615.5250(c)(5) to clarify the 
circumstances in which we may waive any or all of the disclosures we 
require institutions to make to potential investors in stock issuances. 
The existing waiver language has been interpreted by some institutions 
to apply only when a single investor acquires all the equities of an 
entire class issued by an institution. Our revision clarifies that we 
may waive disclosure requirements when the following conditions are 
met: (1) Equities are sold only to sophisticated investors; (2) 
equities are sold in blocks of $100,000 or more; and (3) purchasers of 
equities agree that any subsequent sale or transfer must be in blocks 
of $100,000 or more. Any subsequent sale or transfer of equities that 
is less than $100,000 must receive our prior written approval.
    We also propose to correct the reference to paragraph (b) in 
existing paragraph (c)(5). The reference should be to the disclosure 
requirements in paragraph (c)(1).

Section 615.5301(i)--Definition of Total Surplus

    We propose to add a new paragraph (4) to the definition of total 
surplus in Sec.  615.5301(i) to limit the amount of term preferred 
stock that may be included in total surplus to 25 percent of permanent

[[Page 64834]]

capital. Conforming changes are proposed to paragraph (3).
    Our existing regulations include term preferred stock in total 
surplus without limit. We are proposing a limitation equal to 25 
percent of permanent capital, to ensure that System institutions do not 
overly rely on this type of capital in their operations. This 
limitation is generally comparable to the treatment of intermediate-
term preferred stock in the regulatory capital requirements for 
commercial banks. Commercial banks' Federal financial regulators 
exclude term preferred stock from Tier 1 capital and limit the amount 
of intermediate-term preferred stock that can count as Tier 2 capital 
to an amount equal to 50 percent of Tier 1 capital.\1\ In addition, the 
amount a commercial bank may count as Tier 2 capital can be no greater 
than its Tier 1 capital. This means, in effect, that no more than 25 
percent of a commercial bank's minimum total regulatory (Tier 1 + Tier 
2) capital may consist of term preferred stock.\2\ We believe a similar 
limit to that imposed on commercial banks is also appropriate for 
System institutions and, therefore, are proposing a limitation on the 
total surplus ratio.
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    \1\ See 12 CFR part 325, app. A (I.A.2(d)) (Federal Deposit 
Insurance Corporation); 12 CFR part 3, app. A (2(b)(4)) (Comptroller 
of the Currency); and 12 CFR part 208, app. A (II.A.2(iv)) (Board of 
Governors of the Federal Reserve System).
    \2\ This example assumes that a commercial bank has Tier 2 
capital equal in amount to its Tier I capital.
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    We note that the proposal would not prohibit System institutions 
from issuing preferred stock in excess of what may be counted as total 
surplus, but such excess amounts would not qualify as total surplus. 
The preferred stock would, however, be treated as permanent capital to 
the extent permitted in the permanent capital calculation.

New Section 615.5301(j)--Definition of Total Liabilities

    In May 2001, two System banks petitioned us to revise the net 
collateral ratio calculation requirements in Sec.  615.5301 in response 
to the new accounting requirements for derivatives in SFAS 133, as 
promulgated by the Financial Accounting Standards Board (FASB). The 
banks asserted that the accounting changes imposed by SFAS 133 reduced 
their net collateral ratios in a way they believe was unintended.
    In response to the banks' petition, we are proposing a new Sec.  
615.5301(j) to define ``total liabilities'' for the purpose of 
calculating the net collateral ratio. The net collateral ratio is a 
bank's net collateral, as defined in Sec.  615.5301(c), divided by the 
bank's total liabilities. Proposed Sec.  615.5301(j)(1) specifies that 
total liabilities are valued in accordance with generally accepted 
accounting principles (GAAP), with the following exclusions for the 
effects of SFAS 133: (1) Adjustments to the carrying amount \3\ of any 
liability that is designated as being hedged; and (2) any derivative 
recognized as a liability that is designated as a hedging instrument.
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    \3\ GAAP define the carrying amount of a liability as the face 
amount of a liability increased or decreased by any applicable 
accrued interest payable and any applicable unamortized premium, 
discount, finance charges, or issue costs.
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    Prior to SFAS 133, GAAP allowed many derivative instruments to be 
treated by System banks as off-balance sheet items. However, with the 
adoption of SFAS 133, System banks must now recognize all derivative 
instruments at their fair value as either an asset or a liability on 
the balance sheet. If a derivative instrument qualifies as a designated 
hedge,\4\ System banks may be required to adjust the carrying value of 
certain assets or liabilities.
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    \4\ Under SFAS 133, derivative instruments designated as hedges 
routinely reduce an entity's exposure to changes in the fair value 
of an asset or liability (i.e., fair value hedge) or changes in 
expected future cash flows (i.e., cash flow hedge) attributable to a 
particular risk. For Farm Credit banks, derivative instruments are 
routinely used to reduce their exposure to (hedge against) changes 
in market interest rates.
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    As a result of SFAS 133, System banks that use derivatives may have 
to recognize an increase in the amount of total liabilities when 
calculating their net collateral ratios. These increases in total 
liabilities have resulted in lower net collateral ratios than what the 
banks would have had under the previous accounting requirements for 
derivative instruments.
    Under SFAS 133, a System bank's total liabilities will often 
increase for a derivative instrument designated as hedged. This 
resulting increase in the bank's liabilities from a derivative 
instrument designated as a hedge has no offsetting equivalent increase 
in the collateral amount used in the computation of its net collateral 
ratio because of the way net collateral is defined in Sec.  
615.5301(c). Thus, a derivative instrument used by a bank to hedge 
against interest rate risk can often result in an unintended decline in 
the bank's net collateral ratio.
    We believe a bank's net collateral ratio should not be negatively 
affected by derivative instruments appropriately used to hedge against 
interest rate risk or other types of market risks. Appropriate use of 
derivatives as hedges protects System banks against a true economic 
decline in their net collateral. Accordingly, our proposed amendments 
would exclude the effect of SFAS 133 on the calculation of the net 
collateral ratio for derivative instruments that qualify as hedges 
under SFAS 133.
    Conversely, we believe derivative instruments that are not 
designated to hedge specific assets or liabilities do not provide 
adequate protections for interest rate or other market risks. 
Therefore, our definition of total liabilities includes derivative 
instruments that do not qualify as designated hedges.
    Proposed Sec.  615.5301(j)(2) would also exclude from total 
liabilities the amount of term preferred stock that is eligible to be 
counted as total surplus in the numerator of a bank's calculation of 
its total surplus ratio. In the absence of such exclusion, our existing 
rule could require certain forms of term preferred stock to be 
considered liabilities. The proposed exclusion would eliminate the 
potential inconsistency of treating a particular balance sheet item as 
a liability for net collateral purposes but as capital for the total 
surplus ratio.

IV. Regulatory Flexibility Act

    Pursuant to section 605(b) of the Regulatory Flexibility Act (5 
U.S.C. 601 et seq.), the FCA hereby certifies that the proposed rule 
will not have a significant economic impact on a substantial number of 
small entities. Each of the banks in the System, considered together 
with its affiliated associations, has assets and annual income in 
excess of the amounts that would qualify them as small entities. 
Therefore, System institutions are not ``small entities'' as defined in 
the Regulatory Flexibility Act.

List of Subjects in 12 CFR Part 615

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

    For the reasons stated in the preamble, we propose to amend part 
615 of chapter VI, title 12 of the Code of Federal Regulations as 
follows:

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

    1. The authority citation for part 615 continues to read as 
follows:

    Authority: Secs. 1.5, 1.7, 1.10, 1.11, 1.12, 2.2, 2.3, 2.4, 2.5, 
2.12, 3.1, 3.7, 3.11, 3.25, 4.3, 4.3A, 4.9, 4.14B, 4.25, 5.9, 5.17, 
6.20, 6.26, 8.0, 8.3, 8.4, 8.6, 8.7, 8.8, 8.10, 8.12 of the Farm 
Credit Act (12 U.S.C. 2013, 2015, 2018, 2019, 2020, 2073, 2074, 
2075, 2076, 2093, 2122, 2128, 2132, 2146, 2154, 2154a, 2160, 2202b, 
2211, 2243, 2252, 2278b, 2278b-6, 2279aa, 2279aa-3, 2279aa-4, 
2279aa-6, 2279aa-7, 2279aa-8, 2279aa-10, 2279aa-12);

[[Page 64835]]

sec. 301(a) of Pub. L. 100-233, 101 Stat. 1568, 1608.

Subpart H--Capital Adequacy

    2. Amend Sec.  615.5201 as follows:
    a. Remove the words ``loan of lease'' in paragraph (e) and add in 
their place, the words ``loan or lease''; and
    b. Add a new paragraph (l)(8).


Sec.  615.5201  Definitions.

    (l) * * *
    (8) Any other debt or equity instruments or other accounts the FCA 
has determined are appropriate to be considered permanent capital. The 
FCA may permit one or more institutions to include all or a portion of 
such instrument, entry, or account as permanent capital, permanently or 
on a temporary basis, for purposes of this part.
* * * * *

Subpart I--Issuance of Equities

    3. Amend Sec.  615.5250 by revising paragraph (c)(5) to read as 
follows:


Sec.  615.5250  Disclosure requirements.

    (c) * * *
    (5) For a class of stock, the FCA may waive any or all of the 
disclosure requirements of paragraph (c)(1) of this section when each 
investor acquires at least $100,000 of the stock if the sophistication 
of the purchaser warrants, provided that subsequent transfers of the 
stock in amounts of less than $100,000 must receive the prior written 
approval of the FCA.
* * * * *

Subpart K--Surplus and Collateral Requirements

    4. Amend Sec.  615.5301 as follows:
    a. Redesignate paragraphs (i)(4) through (i)(7) as paragraphs 
(i)(5) through (i)(8);
    b. Remove the reference ``Sec.  615.5201(j)(4)(iv)'' in paragraph 
(i)(2) and add in its place, the reference ``Sec.  
615.5201(l)(4)(iv)'';
    c. Revise paragraph (i)(3);
    d. Add a new paragraph (i)(4); and
    e. Add a new paragraph (j).


Sec.  615.5301  Definitions.

    (i) * * *
    (3) Common and perpetual preferred stock (other than allocated 
stock) that is not purchased or held as a condition of obtaining a 
loan, provided that the institution has no established plan or practice 
of retiring such stock;
    (4) Term preferred stock that is not purchased or held as a 
condition of obtaining a loan, up to a maximum of 25 percent of the 
institution's permanent capital (as calculated after deductions 
required in the permanent capital ratio computation). The amount of 
includible term stock must be reduced by 20 percent (net of 
redemptions) at the beginning of each of the last 5 years of the term 
of the instrument;
* * * * *
    (j) Total liabilities means liabilities valued in accordance with 
generally accepted accounting principles (GAAP), except that total 
liabilities shall exclude the following:
    (1) As set forth in Statement of Financial Accounting Standards No. 
133, Accounting for Derivative Instruments and Hedging Activities, as 
promulgated by the Financial Accounting Standards Board--
    (i) Adjustments to the carrying amount of any liability designated 
as being hedged; and
    (ii) Any derivative recognized as a liability that is designated as 
a hedging instrument.
    (2) Term preferred stock to the extent such stock is included as 
total surplus in the computation of the bank's total surplus ratio 
pursuant to Sec.  615.5301(i).

    Dated: October 16, 2002.
Jeanette C. Brinkley,
Acting Secretary, Farm Credit Administration Board.
[FR Doc. 02-26697 Filed 10-21-02; 8:45 am]
BILLING CODE 6705-01-P