[Federal Register Volume 68, Number 30 (Thursday, February 13, 2003)]
[Rules and Regulations]
[Pages 7309-7313]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-2082]


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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

Office of Federal Housing Enterprise Oversight

12 CFR Part 1750

RIN 2550-AA26


Risk-Based Capital

AGENCY: Office of Federal Housing Enterprise Oversight, HUD.

ACTION: Final Rule.

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SUMMARY: The Office of Federal Housing Enterprise Oversight (OFHEO) is 
adopting an amendment to Appendix A to Subpart B of 12 CFR part 1750 
Risk-Based Capital. The amendment, which more accurately incorporates 
and implements Financial Accounting Standard 133 in the stress test, is 
intended to enhance the accuracy of the calculation of the risk-based 
capital requirement for the Enterprises.

EFFECTIVE DATE: March 17, 2003.

FOR FURTHER INFORMATION CONTACT: Robert Pomeranz, Senior Accounting 
Specialist, Office of Risk Analysis and Model Development, telephone 
(202) 414-3796 or Marvin L. Shaw, Senior Counsel, telephone (202) 414-
8913 (not toll free numbers), Office of Federal Housing Enterprise 
Oversight, Fourth Floor, 1700 G Street, NW., Washington, DC 20552. The 
telephone number for the Telecommunications Device for the Deaf is 
(800) 877-8339.

SUPPLEMENTARY INFORMATION:

Background

    OFHEO published a final regulation setting forth a risk-based 
capital stress test on September 13, 2001, 12 CFR part 1750 (the Rule), 
which formed the basis for determining the risk-based capital 
requirement for the federally sponsored housing enterprises--Federal 
National Mortgage Association (Fannie Mae) and Federal Home Loan 
Mortgage Corporation (Freddie Mac) (collectively, the Enterprises).\1\
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    \1\ Risked-based Capital, 66 FR 47730 (September 13, 2001, 12 
CFR part 1750, as amended, 67 FR 11850 (March 15, 2002), 67 FR 19321 
(April 19, 2002), 67 FR 66533 (November 1, 2002).
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    On September 12, 2002, OFHEO published a notice of proposed 
rulemaking (NPRM), 67 FR 57760, which proposed twelve technical and 
corrective amendments to the Rule.

[[Page 7310]]

These proposed amendments were intended to make minor technical 
corrections to the Rule, and to account more appropriately for 
Financial Accounting Standard No. 133 (FAS 133).\2\ This amendment does 
not alter the FAS 133 accounting standard; it simply corrects the 
manner in which FAS 133 is incorporated into the stress test. Although 
the NPRM was subject to a ten-day comment period, OFHEO reopened and 
extended the comment period regarding the two FAS 133-related proposed 
amendments, noting that it might move to final action on any of the 
other ten.\3\ On November 1, 2002, OFHEO published a final rule, which 
adopted eight of the technical and corrective amendments.\4\ OFHEO is 
adopting three of the other amendments in today's final rule.\5\
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    \2\ Financial Accounting Standards Board Statement of Financial 
Accounting Standards No. 133, ``Accounting for Derivative 
Instruments and Hedging Activities,'' June 1998.
    \3\ Risk-based Capital, 67 FR 61300 (September 30, 2002).
    \4\ Risk-based Capital, 67 FR 66533 (November 1, 2002).
    \5\ OFHEO has determined that it is appropriate to delay 
adopting the amendment that would correct the description of 
``unamortized balance'' in Table 3-56 and Table 3-57 (amendment 
7 in the NPRM), because that same term appears in numerous 
other places throughout the rule. OFHEO is conducting a systematic 
review of the entire Rule to ensure that this term is used and 
defined consistently. In the meantime, users of the stress test code 
will not be affected, because the Risk-based Capital Report 
Instructions, which are used to prepare data for the model, are 
correct.
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Comments

    OFHEO received comments in response to the NPRM from Fannie Mae, 
Freddie Mac, FM Watch, and the Honorable Richard H. Baker. In response 
to the September 30 notice that extended the comment period, OFHEO 
subsequently received one supplemental comment, which was submitted by 
FM Watch. The comments addressed the appropriateness of the proposed 
amendments related to FAS 133. Commenters also addressed procedural 
issues such as the effective date for the proposed amendments related 
to FAS 133 and the AOLTV Table, the length of the comment period, and 
the use of guidelines to supplement the Rule. Commenters also addressed 
issues related to regulatory impacts, particularly whether the proposal 
was ``economically significant'' under Executive Order 12866 and 
whether the proposal complies with the OFHEO's and the Office of 
Management and Budget's (OMB's) guidelines on information quality.

Discussion of Issues

1. FAS 133

    The NPRM included two changes to reflect the impact of FAS 133 on 
the stress test. The first of these, number 11 in the NPRM preamble, 
would modify the calculation of common stock dividends to reflect the 
effects of FAS 133 adjustments on after-tax income. The second, number 
12 in the NPRM preamble, would modify the calculation of risk-based 
capital to account more fully for changes that FAS 133 required in the 
computation of Total Capital. As explained below, after considering all 
the comments on the proposed FAS 133-related changes, OFHEO has 
determined that the changes are appropriate and timely and is adopting 
them as proposed. Changes in the language from the proposed amendments 
clarify the rule, but have no substantive affect.
    All five comment letters addressed the FAS 133-related changes. 
Both Enterprises were supportive of the changes, but suggested that 
OFHEO not waive the 30-day delay in effective date that is ordinarily 
required of final rules. Congressman Baker's letter voiced concern that 
the impact on the Enterprises' capital from amendment number 12 was so 
significant that OFHEO should extend the comment period.\6\
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    \6\ Id. note 3.
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    As noted above, FM Watch provided two comment letters. The first, 
which was submitted within the initial 10-day comment period, requested 
additional time for comment and urged OFHEO to delay action on the 
changes related to FAS 133 until OFHEO had more data on the affect of 
those changes on the Enterprises' risk-based capital. The letter also 
questioned whether the thirty percent add-on for management and 
operations risk should be applied after, rather than before FAS 133-
related adjustments were made to the capital requirement. In FM Watch's 
second letter, received during the extended comment period, it stated 
that without additional background as to the implications OFHEO 
anticipates from the amendment, FM Watch was unable to provide informed 
comments on the proposal. The second letter, therefore, largely 
reiterated its earlier comments on the FAS 133-related amendments and 
requested that OFHEO defer action until additional quarters of data on 
the financial impact of the changes are available.
    None of the comment letters took issue with the need for or the 
importance of the proposed FAS 133-related changes. Two commenters 
believed it necessary to delay action until the impact of the changes 
on the Enterprises' capital could be measured for a few more quarters. 
Neither, however, recommended that the change should not be implemented 
eventually. Nor did any commenter suggest that the proposed changes did 
not tie capital more closely to risk or that there was a better 
alternative methodology.
    Commentary regarding the final rule's effective date was unanimous 
in supporting a delayed effective date for implementation of these 
amendments. The Administrative Procedure Act, 5 U.S.C. 552(d), provides 
that the effective date for substantive rules will be delayed at least 
30 days after publication, except in certain circumstances not 
applicable in this case. Accordingly, OFHEO has determined these 
changes take effect 30 days after the notice is published in the 
Federal Register. The effect of this determination is that OFHEO will 
incorporate these amendments related to FAS 133 in the capital 
calculation process starting with data submitted by the Enterprises for 
the fourth quarter of 2002, which OFHEO anticipates receiving from the 
Enterprises in early 2003. The first capital classification under the 
amended rule will occur approximately two months after publication.
    Two of the comments suggested that the proposed change related to 
the effect of FAS 133 on total capital may be in error by adding the 
effects of FAS 133 after the thirty percent add-on for management and 
operations risk. After consideration of these comments, OFHEO has 
decided to utilize the methodology proposed in the NPRM.
    As explained in greater detail in the NPRM preamble, the stress 
test, in essence, measures the amount of capital that would be consumed 
by an Enterprise during the ten-year stress period. This amount of 
capital is referred to in the amended regulation as ``stress-test 
capital.'' The Federal Housing Enterprises Financial Safety and 
Soundness Act of 1992 (12 U.S.C. 4501 et seq.) (1992 Act) provides that 
stress-test capital should be increased by thirty percent to account 
for management and operations risk. The proposed amendment follows 
exactly that approach. However, the statute also requires that the 
risk-based capital requirement be expressed as an amount of ``total 
capital,'' which can be compared to an Enterprise's current total 
capital to determine whether a deficiency exists. Because total capital 
is adjusted up or down before the start of the stress test to delete 
the impact of

[[Page 7311]]

FAS 133, it is appropriate to make the opposite adjustment at the end 
of the calculation, so as to compare apples with apples (or total 
capital with total capital).\7\ Adding the FAS 133 impact in before the 
thirty percent add-on, as FM Watch suggests, would cause the adjustment 
at the end to be thirty percent greater than the adjustment at the 
beginning, overstating the value (in either a positive or negative 
direction) of the derivatives in an Enterprise's portfolio. OFHEO has 
not found that modifying its proposed approach in that manner would 
improve the sensitivity of the stress test to risk. Further, no 
commenter has identified a compelling rationale for such a change.
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    \7\ Mathematically, the same result could be achieved by simply 
comparing starting capital (the capital at the beginning, ``time 
zero,'' of the stress period) to stress test capital plus thirty 
percent. This was the way OFHEO had structured the calculation until 
FAS 133 altered the composition of total capital by including some 
changes in the market value of derivatives. OFHEO determined that it 
is unnecessarily complex to estimate market values throughout the 
stress test and, therefore, adjusted the starting amount of total 
capital to remove the market value changes. In order to provide a 
risk-based capital requirement that can be compared directly to 
actual, or unadjusted, ``total capital,'' it is necessary to 
reverse-adjust stress test capital (which does not include market 
value changes) by adding back the market value changes that were 
removed at the start of the stress test.
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    FM Watch contends that OFHEO lacks authority under the 1992 Act to 
add in the FAS 133-related adjustment after the 30 percent add-on. 
However, the Act expresses no such limitation on OFHEO's broad 
discretion to determine appropriate losses or gains on interest rate 
hedging activities, which are, in part, reflected in the changes in 
derivatives market value that FAS 133 adds to total capital. 12 U.S.C. 
4611(a)(4).

2. Use of Guidelines

    OFHEO proposed to amend the rule by replacing a static table 
containing fixed weighted average amortized original LTV (AOLTV) values 
with a notation that the table would be updated as necessary with a 
guideline (Guideline 404) that would be available on OFHEO's web site. 
Other guidelines related to Risk-Based Capital include Guideline 402 
``Interest Rates'' and Guideline 403 ``Average Loan Size.''
    Freddie Mac stated that OFHEO is required by statute to issue all 
provisions related to risk-based capital requirements through notice-
and-comment rulemaking, as opposed to OFHEO's reference to guidelines. 
Specifically, Freddie Mac believes that the Rule must include detailed 
descriptions of the precise methodologies that such guidelines would 
apply. Freddie Mac further stated that a change in a guideline should 
be effective only as of the end of the first reporting period beginning 
60 days or more after the publication of such change.
    OFHEO disagrees with Freddie Mac's view that guidelines are 
inappropriate. OFHEO believes that guidelines are necessary and 
appropriate for various aspects of implementing the Risk-Based Capital 
Requirement, provided the guideline addresses the finer details of the 
stress test where OFHEO requires the flexibility to make rapid or 
frequent changes, such as updating index changes. Such guidelines, 
which are used by other financial regulators, allow rapid response to 
rapidly changing circumstances and can be incorporated into the rule at 
a later date if such an incorporation appears advisable.
    As to the effective dates for guidelines, OFHEO does not feel it 
necessary to announce a fixed rule. In the event that a new guideline 
or change to a guideline might impact capital significantly, OFHEO will 
consider the need for the Enterprises to plan their business strategies 
with capital requirements in mind. In this case, the Enterprises have 
had sufficient notice of Guideline 404, given its minor impact, to 
adapt to it. Accordingly, OFHEO has determined that a 30-day delay in 
effectiveness is adequate.

3. Comment Period

    Congressman Baker and FM Watch requested a longer period of time 
for public comment on the proposed change related to FAS 133. In 
response to these requests, OFHEO extended the comment period until 
October 29, 2002. This extension allowed the public approximately six 
weeks to comment on the initial proposal. Only one commenter, FM Watch, 
submitted a comment during the extended comment period. Its comment 
simply amplified its earlier position.

4. Other Comments

    Other comments received are beyond the scope of the amendment. 
Because these comments are not relevant to the substance of the 
proposal, they are not addressed in the preamble.

Regulatory Impacts

Executive Order 12866

    OMB determined that these amendments are ``significant'' for 
purposes of review under EO 12866.
    Two commenters questioned OFHEO's conclusion that the FAS 133 
amendments are not economically significant within the meaning of 
Executive Order 12866. Both comments referred to the fact that the 
changes would have impacted Freddie Mac's risk-based capital 
requirement by more than $1.6 billion in a recent period. Neither 
comment, however, contends that the rule has resulted in costs to the 
Enterprises in excess of $100 million. Because the minimum capital 
requirement would have required more capital than the amended risk-
based requirement in that period, the change would not have required 
Freddie Mac to raise any additional capital. Therefore, the commenters 
have not demonstrated that the change would have created cost for 
Freddie Mac. However, even if the amendment were to have the affect in 
some future period of requiring an Enterprise to raise capital or 
otherwise alter its hedging strategies, it is speculative to opine at 
this point that, in the absence of this amendment, the Enterprise would 
not have recognized the capital problem with its internal stress tests 
and taken equally expensive measures to deal with it.
    Further, this essentially technical change, required to implement 
accounting standards imposed by a separate regulatory authority, does 
not raise the type of economic issues for which the detailed cost/
benefit analysis required by the Executive Order was intended. No 
commenter has suggested that there is some less expensive means of 
implementing FAS 133 in the risk-based capital regulation or that OFHEO 
should continue to account for FAS 133 improperly.
    Nevertheless, given the fact that this regulation is new and only 
recently became fully enforceable, OMB has exercised its discretion to 
review the FAS 133-related amendments formally to determine whether 
they have any important policy implications for the Administration or 
other Federal agencies.

OMB Information Quality Guideline

    An additional issue raised by FM Watch concerned the application of 
OFHEO's recently issued ``Final Guidelines for Ensuring Quality of 
Disseminated Information and Procedures for Correction by the Public'' 
(67 FR 63672, September 15, 2002) (the Information Quality Guideline). 
In its letter, FM Watch indicates that the Rule may not be consistent 
with OFHEO's Information Quality Guideline because (i) in the two-day 
period between the posting of the amendment on the OFHEO Web site and 
publication in the Federal Register OFHEO revised the estimated impact 
of the FAS 133 amendments and (ii) FM Watch was unable to replicate 
OFHEO's

[[Page 7312]]

conclusions. OFHEO notes that its revision to the estimate of the 
impact of the change was not a violation of the guidelines in this 
area. The initial error was rectified immediately and the correct 
information was published in the Federal Register and was available to 
all commenters during the entire comment period. With respect to the 
issue of replicability, the stress test model set forth in the Rule has 
been replicated by the Enterprises and largely incorporated into their 
operations. The ability of the Enterprises' to replicate the model 
demonstrates that OFHEO has met the burden imposed by both OFHEO's and 
OMB's data quality guidelines. OFHEO will continue to assist others to 
replicate the stress test by making available the stress test computer 
code and by publishing a stylized data set for their use in testing and 
replication.

Paperwork Reduction Act

    These amendments do not contain any information collection 
requirements that require the approval of OMB under the Paperwork 
Reduction Act (44 U.S.C. 3501 et seq.).

Regulatory Flexibility Act

    The Regulatory Flexibility Act (5 U.S.C. 601 et. seq.) requires 
that a regulation that has a significant economic impact on a 
substantial number of small entities, small businesses, or small 
organizations must include an initial regulatory flexibility analysis 
describing the regulation's impact on small entities. Such an analysis 
need not be undertaken if the agency has certified that the regulation 
does not have a significant economic impact on a substantial number of 
small entities. 5 U.S.C. 605(b). OFHEO has considered the impact of the 
regulation under the Regulatory Flexibility Act. The General Counsel of 
OFHEO certifies that this regulation is not likely to have a 
significant economic impact on a substantial number of small business 
entities because the regulation is applicable only to the Enterprises, 
which are not small entities for purposes of the Regulatory Flexibility 
Act.

List of Subjects in 12 CFR Part 1750

    Capital classification, Mortgages, Risk-based capital.

    Accordingly, for the reasons stated in the preamble, OFHEO amends 
12 CFR part 1750 as follows:

PART 1750--CAPITAL

    1. The authority citation for part 1750 continues to read as 
follows:

    Authority: 12 U.S.C. 4513, 4514, 4611, 4612, 4614, 4615, 4618.


    2. Amend Appendix A to subpart B of part 1750 as follows:
    a. Revise Table 3-59 in paragraph 3.7.2.3;
    b. Revise paragraph 3.10.3.2 [a] 2.; and
    c. Add new paragraph 3.12.3 [a] 9. after paragraph 3.12.3 [a] 8.


Appendix A to Subpart B of Part 1750-Risk-Based Capital Test 
Methodology and Specifications

* * * * *
3.7.2.3 * * *

     Table 3-59--Aggregate Enterprise Amortized Original LTV (AOLTV0)
                            Distribution \1\
------------------------------------------------------------------------
                                                                Wt Avg
                 Original LTV                       UPB       AOLTV for
                                               Distribution     Range
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00404. The contents of the
  table appear at http://www.OFHEO.gov.
Note: Amortized Original LTV (also known as the ``current-loan-to-
  original-value'' ratio) is the Original LTV adjusted for the change in
  UPB but not for changes in property value.

* * * * *
3.10.3.2 * * *
    [a]* * *

2. Common Stock. In the first year of the Stress Test, dividends are 
paid on common stock in each of the four quarters after preferred 
dividends, if any, are paid unless the Enterprise's capital is, or 
after the payment, would be, below the estimated minimum capital 
requirement.
    a. First Quarter. In the first quarter, the dividend is the 
dividend per share ratio for common stock from the quarter preceding 
the Stress Test times the current number of shares of common stock 
outstanding.
    b. Subsequent Quarters.
    (1) In the three subsequent quarters, if the preceding quarter's 
after tax income is greater than after tax income in the quarter 
preceding the Stress Test, (adjusted by the ratio of the Enterprise's 
retained earnings and retained earnings after adjustments are made that 
revert investment securities and derivatives to amortized cost), pay 
the larger of (1) the dividend per share ratio for common stock from 
the quarter preceding the Stress Test times the current number of 
shares of common stock outstanding or (2) the average dividend payout 
ratio for common stock for the four quarters preceding the start of the 
Stress Test times the preceding quarter's after tax income (adjusted by 
the reciprocal of the ratio of the Enterprise's retained earnings and 
retained earnings after adjustments are made that revert investment 
securities and derivatives to amortized cost) less preferred dividends 
paid in the current quarter. In no case may the dividend payment exceed 
an amount equal to core capital less the estimated minimum capital 
requirement at the end of the preceding quarter.
    (2) If the previous quarter's after tax income is less than or 
equal to after tax income in the quarter preceding the Stress Test 
(adjusted by the ratio of the Enterprise's retained earnings and 
retained earnings after adjustments are made that revert investment 
securities and derivatives to amortized cost), pay the lesser of (1) 
the dividend per share ratio for common stock for the quarter preceding 
the Stress Test times the current number of shares of common stock 
outstanding or (2) an amount equal to core capital less the estimated 
minimum capital requirement at the end of the preceding quarter, but 
not less than zero.
* * * * *
3.12.3 * * *
    [a]* * *
9. Subtract the net increase (or add the net decrease) in Retained 
Earnings related to Fair Value Hedges at the start of the stress test 
made in accordance with section 3.10.3.6.2[a]1.b. of this appendix.


[[Page 7313]]


    Dated: January 24, 2003.
Armando Falcon, Jr.
Director, Office of Federal Housing Enterprise Oversight.
[FR Doc. 03-2082 Filed 02-12-03; 8:45 am]
BILLING CODE 4220-01-P