[Federal Register Volume 69, Number 151 (Friday, August 6, 2004)]
[Proposed Rules]
[Pages 47984-48006]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-17570]



[[Page 47983]]

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Part II





Farm Credit Administration





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12 CFR Parts 607, 614, 615, and 620



Assessment and Apportionment of Administrative Expenses; Loan Policies 
and Operations; Funding and Fiscal Affairs, Loan Policies and 
Operations, and Funding Operations; Disclosure to Shareholders; Capital 
Adequacy Risk-Weighting Revisions; Proposed Rule

  Federal Register / Vol. 69, No. 151 / Friday, August 6, 2004 / 
Proposed Rules  

[[Page 47984]]


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FARM CREDIT ADMINISTRATION

12 CFR Parts 607, 614, 615, and 620

RIN 3052-AC09


Assessment and Apportionment of Administrative Expenses; Loan 
Policies and Operations; Funding and Fiscal Affairs, Loan Policies and 
Operations, and Funding Operations; Disclosure to Shareholders; Capital 
Adequacy Risk-Weighting Revisions

AGENCY: Farm Credit Administration.

ACTION: Proposed rule.

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SUMMARY: The Farm Credit Administration (FCA) proposes to change its 
regulatory capital standards on recourse obligations, direct credit 
substitutes, residual interests, asset- and mortgage-backed securities, 
guarantee arrangements, claims on securities firms, and certain 
qualified residential loans. We are modifying our risk-based capital 
requirements to more closely match a Farm Credit System (FCS or System) 
institution's relative risk of loss on these credit exposures to its 
capital requirements. In doing so, we propose to risk-weight recourse 
obligations, direct credit substitutes, residual interests, and asset- 
and mortgage-backed securities based on external credit ratings from 
nationally recognized statistical rating organizations (NRSROs). In 
addition, our proposal will make our regulatory capital treatment more 
consistent with that of the other financial regulatory agencies for 
transactions and assets involving similar risk and address financial 
structures and transactions developed by the market since our last 
update. We also propose to make a number of nonsubstantive changes to 
our regulations to make them easier to use.

DATES: Please send your comments to us by November 4, 2004.

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

FOR FURTHER INFORMATION CONTACT:

Laurie A. Rea, Senior Policy Analyst, Office of Policy and Analysis, 
Farm Credit Administration, McLean, VA 22102-5090, (703) 883-4479; TTY 
(703) 883-4434;
     or
Jennifer A. Cohn, 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 this proposed rule are to:
     Ensure FCS institutions maintain capital levels 
commensurate with their relative exposure to credit risk;
     Help achieve a more consistent regulatory capital 
treatment with the other financial regulatory agencies \1\ for 
transactions involving similar risk;
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    \1\ We refer collectively to the Office of the Comptroller of 
the Currency (OCC), the Board of Governors of the Federal Reserve 
System (Federal Reserve Board), the Federal Deposit Insurance 
Corporation (FDIC), and the Office of Thrift Supervision (OTS) as 
the ``other financial regulatory agencies.''
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     Address a recent recommendation by the United States 
General Accounting Office (GAO) to take appropriate measures to reduce 
potential safety and soundness issues that may arise from capital 
arbitrage; and
     Allow FCS institutions' capital to be used more 
efficiently in serving agriculture and rural America and supporting 
other System mission activities.

II. Background

A. Basis of Current Risk-Based Capital Rules

    Since the late 1980s, the regulatory capital requirements 
applicable to federally regulated financial institutions, including FCS 
institutions, have been based, in part, on the risk-based capital 
framework developed under the guidance of the Basel Committee on 
Banking Supervision (Basel Committee).\2\ We first adopted risk-
weighting categories for System assets as part of the 1988 regulatory 
capital revisions \3\ required by the Agricultural Credit Act of 1987 
\4\ and made minor revisions to these categories in 1998.\5\ Risk-
weighting is used to assign on- and off-balance sheet positions 
appropriate capital requirements and to compute the risk-adjusted asset 
base for FCS banks' and associations' permanent capital, core surplus, 
and total surplus ratios. The current risk-weighting categories are 
similar to those outlined in the Accord on International Convergence of 
Capital Measurement and Capital Standards (1988, as amended in 1998) 
(Basel Accord), which were also adopted by the other financial 
regulatory agencies. Our risk-based capital requirements are contained 
in subparts H and K of part 615 of our regulations.
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    \2\ The Basel Committee is a committee of central banks and bank 
supervisors/regulators from the major industrialized countries that 
formulate standards and guidelines related to banking and recommend 
them for adoption by member countries and others. All Basel 
Committee documents mentioned in this preamble are available on the 
Committee's Web site at www.bis.org/bcbs/.
    \3\ See 53 FR 39229 (October 6, 1988).
    \4\ Agricultural Credit Act of 1987, Pub. L. 100-233 (January 6, 
1988).
    \5\ See 63 FR 39219 (July 22, 1998).
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B. Implications of the New Basel Capital Accord

    In April 2003, the Basel Committee issued a consultative document 
on the proposed New Basel Capital Accord (Basel II). Basel II discusses 
potential modifications to the current Basel Accord, including the 
capital treatment of securitizations. The standards established by our 
proposal enhance risk sensitivity in a manner consistent with the 
standardized approach to credit risk under Basel II. The standardized 
approach establishes fixed risk weights corresponding to each 
supervisory risk weight category and makes use of external credit 
assessments to enhance risk sensitivity compared with the current Basel 
Accord. Similarly, under our proposal we use external credit ratings 
assigned by NRSROs as a basis for determining the credit quality and 
the resulting capital treatment for credit exposures.\6\ According to 
their most recent press release (May 11, 2004), the Basel Committee has 
achieved consensus on the remaining issues regarding the proposals for 
the new international capital standard. The Basel Committee also 
confirmed that the standardized and foundation approaches will be 
implemented from year-end 2006. However, the Committee indicated that 
another year of impact analysis will be needed to evaluate the most 
advanced approaches, and therefore these will not be implemented until 
year-end 2007. As we continue to review Basel II and assess its 
implications and appropriateness for FCS institutions, we may make 
further revisions to our capital regulations. In the interim, we 
welcome comments on the proposed

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new framework and its applicability to FCS institutions.
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    \6\ An NRSRO is a rating organization that the Securities and 
Exchange Commission recognizes as an NRSRO. See 12 CFR 615.5131(j). 
See also 66 FR 59632, 59639, 59655, 59662 (November 29, 2001).
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C. Rules Recently Adopted by the Other Financial Regulatory Agencies

    In developing these proposed changes, we also took into 
consideration recent changes the other financial regulatory agencies 
made to their capital rules. These changes are briefly described below.
    In November 2001, the other financial regulatory agencies issued a 
final rule that amended their risk-based capital regulations for 
positions that banking organizations \7\ hold in recourse obligations, 
direct credit substitutes, residual interests, and asset- and mortgage-
backed securities.\8\ The other financial regulatory agencies intended 
for these changes to produce more consistent capital treatment for 
credit risks associated with exposures arising from these positions. 
More specifically, the new risk-based standards tie capital 
requirements for these transactions to their relative risk exposure, as 
measured by credit ratings received from an NRSRO.
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    \7\ Banking organizations include banks, bank holding companies, 
and thrifts. See 66 FR 59614 (November 29, 2001).
    \8\ See 66 FR 59614 (November 29, 2001).
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    Similarly, in April 2002, the other financial regulatory agencies, 
consistent with the proposed changes to the Basel Accord, issued a rule 
that amended their risk-based capital standards for banking 
organizations with regard to the risk weighting of claims on, and 
claims guaranteed by, qualifying securities firms.\9\ The capital 
requirements for these claims are also tied in a similar manner to 
their relative risk exposure as measured by NRSRO credit ratings.
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    \9\ See 67 FR 16971 (April 9, 2002).
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    In January 2002, the other financial regulatory agencies (except 
the OTS) adopted a joint final rule governing the regulatory capital 
treatment of equity investments in nonfinancial companies held by 
banking organizations under various legal authorities.\10\ Among other 
changes in regulatory capital treatment, this joint final rule 
addresses the risk weighting of investments in small business 
investment companies (SBICs).
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    \10\ See 67 FR 3784 (January 25, 2002).
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    In August 2003, the other financial regulatory agencies issued for 
comment their views on the proposed framework for implementing the 
Basel II in the United States.\11\ The advance notice of proposed 
rulemaking (ANPRM) describes significant elements of the Advanced 
Internal Ratings-Based approach for credit risk (including credit 
exposures from securitizations) and the Advanced Measurement Approaches 
for operational risk. The ANPRM also specifies the criteria that would 
be used to determine banking organizations that would be required to 
use the advanced approaches.\12\
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    \11\ See 68 FR 45900 (August 4, 2003).
    \12\ Internationally active banking organizations with total 
assets of $250 billion or more or total on-balance sheet foreign 
exposures of $10 billion or more would be required to adopt the 
advanced approaches. All other banks would continue to apply the 
general risk-based capital rules, unless they opt-in.
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    Our proposal does not address the advanced approach for positions 
in securitizations (or any other credit exposures). The focus of this 
proposed rule is on improving the risk sensitivity of the current risk-
based capital through the use of external credit ratings.

D. FCA Rulemakings

    On February 19, 2003, the FCA Board adopted an interim final rule 
that amended our capital rules to allow System institutions to use a 
lower risk weighting for highly rated investments in non-agency \13\ 
asset-backed securities (ABS) and mortgage-backed securities (MBS), 
which have reduced exposure to credit risk.\14\ This was one of the 
changes the other financial regulatory agencies made in November 2001. 
Because this change was narrow and noncontroversial, relieved a 
regulatory burden, and immediately furthered the mission of the System, 
we adopted it without prepromulgation comment. This change became 
effective on May 13, 2003. We issued the interim final rule with a 
request for comments but received none.
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    \13\ Non-agency securities are securities not issued or 
guaranteed by the United States Government, a Government agency (as 
defined in Sec.  615.5201(f)), or a Government-sponsored agency (as 
defined in Sec.  615.5201(g)).
    \14\ See 68 FR 15045 (March 28, 2003).
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    Additionally, on April 22, 2004, FCA adopted changes to the risk-
based capital treatment for other financing institutions (OFIs).\15\ 
Those amendments also aimed to enhance the risk sensitivity of FCA's 
risk-based capital rules through changes in risk weightings. This 
proposed rule incorporates the changes made to our risk weightings 
through the OFI rulemaking.
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    \15\ See 69 FR 29852 (May 26, 2004).
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E. GAO Recommendation on Capital Arbitrage

    In a recent report, the GAO recommended that the FCA ``[c]reate a 
plan to implement actions currently under consideration to reduce 
potential safety and soundness issues that may arise from capital 
arbitrage activities of Farmer Mac and FCS institutions.'' \16\ This 
proposed rulemaking takes important steps to reduce potential safety 
and soundness issues that may result from securitization and guarantee/
credit protection arrangements that FCS institutions engage in with the 
Federal Agricultural Mortgage Corporation (Farmer Mac), domestic banks, 
and securities firms. In particular, we take measures to ensure that 
FCS institutions cannot alter their capital requirements simply by 
using different structures, arrangements or counterparties without 
changing the nature of the risks they assume or retain.
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    \16\ United States General Accounting Office, Farmer Mac: Some 
Progress Made, but Greater Attention to Risk Management, Mission, 
and Corporate Governance Is Needed, GAO-04-116, at page 59 (2003).
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III. Scope of Our Proposal

    Our proposal embraces many of the Basel Committee's objectives for 
improving risk sensitivity in regulatory capital rules and aligns our 
risk-based capital framework closely with the rules of the other 
financial regulatory agencies. However, because the scope of the FCS 
institutions' activities differs from the activities of banking 
organizations, our proposal is not identical to their rules. Their 
rules focus on traditional securitization activities, where a banking 
organization sells assets or credit exposures to increase its liquidity 
and manage credit risk. Our proposal places more emphasis on capital 
treatment of investments in ABS and MBS held for liquidity and other 
types of structured financial transactions and arrangements where an 
FCS institution transfers, retains, or assumes credit risk to manage 
its credit risk profile. Examples of these other types of transactions 
and arrangements are synthetic securitizations, financial guarantee 
arrangements, long-term standby purchase commitments, and credit 
derivatives.
    Like the other financial regulatory agencies, we are also proposing 
a ratings-based approach for claims on securities firms. Additionally, 
similar to the rules that the other financial regulatory agencies have 
adopted, our proposal also addresses risk weighting for authorized 
investments in nonfinancial companies. Subtitle H of the Consolidated 
Farm and Rural Development Act,\17\ as amended by section 6029 of the 
Farm Security and Rural Investment Act of 2002,\18\ authorizes System 
institutions to invest in rural business investment companies (RBICs). 
RBICs are similar to SBICs, in

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which banking organizations are allowed to invest.
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    \17\ Pub. L. 87-128 (August 8, 1961).
    \18\ Pub. L. 107-171 (May 3, 2002).
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    Furthermore, as the other financial regulatory agencies have done, 
we are making explicit our authority to modify a stated risk weight or 
credit conversion factor, if warranted, on a case-by-case basis.
    We invite comments on whether we should make any additional 
modifications to our risk-based capital rules to more closely align 
capital requirements for FCS institutions with their relative risk 
exposure and requirements for other banking organizations. We also 
invite comments on whether FCA should delay or accelerate 
implementation of any aspects of this proposal.

IV. Overview

A. General Approach

    We propose revisions to our capital rules that would implement a 
ratings-based approach for risk-weighting positions in recourse 
obligations, residual interests (other than credit-enhancing interest-
only strips), direct credit substitutes, and asset- and mortgage-backed 
securities. Highly rated positions will receive a favorable (less than 
100-percent) risk weighting. Positions that are rated below investment 
grade \19\ will receive a less favorable risk weighting (generally 
greater than 100-percent risk weight). The FCA proposes to apply this 
approach to positions based on their inherent risks rather than how 
they might be characterized or labeled.
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    \19\ Investment grade means a credit rating of AAA, AA, A or BBB 
or equivalent by an NRSRO.
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    As noted, our proposed ratings-based approach provides risk 
weightings for a variety of assets that have a wide range of credit 
ratings. We provide risk weightings for investments that are rated 
below investment grade, although they are not eligible investments 
under our current investment regulations.\20\ This proposed rule does 
not, however, expand the scope of eligible investments. It merely 
explains how to risk weight an investment that was eligible when 
purchased if its credit rating subsequently deteriorates. Such 
investments must still be disposed of in accordance with Sec.  
615.5143.\21\
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    \20\ See Sec.  615.5140.
    \21\ Section 615.5143 provides that an institution must dispose 
of an ineligible investment within 6 months unless FCA approves, in 
writing, a plan that authorizes divestiture over a longer period of 
time. An institution must dispose of an ineligible investment as 
quickly as possible without substantial financial loss.
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B. Asset Securitization

    This proposal necessitates an understanding of asset securitization 
and other structured transactions that are used as tools to manage and 
transfer credit risk. Therefore, we have included the following 
background explanation to aid our readers.
    Asset securitization is the process by which loans or other credit 
exposures are pooled and reconstituted into securities, with one or 
more classes or positions that may then be sold. Securitization 
provides an efficient mechanism for institutions to sell loan assets or 
credit exposures and thereby to increase the institution's liquidity. 
For purposes of this preamble, references to ``securitizations'' also 
include structured financial transactions or arrangements and synthetic 
transactions \22\ that generally create stratified credit risk 
positions, which may or may not be in the form of a security, whose 
performance is dependent upon a pool of loans or other credit 
exposures. For example, in a synthetic securitization, loans are not 
sold or transferred, but rather the performance of securities is tied 
to a reference pool of loan assets or other credit exposures.\23\
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    \22\ For examples of synthetic securitization structures, see 
Banking Bulletin 99-43, December 1999 (OCC); Supervision and 
Regulation Letter 99-32, Capital Treatment for Synthetic 
Collateralized Loan Obligations, November 15, 1999 (Federal Reserve 
Board).
    \23\ Synthetic transactions bundle credit risks associated with 
on-balance sheet assets or off-balance sheet items and sell them 
into the market.
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    Securitizations typically carve up the risk of credit losses from 
the underlying assets and distribute it to different parties. The 
``first dollar,'' or most subordinate, loss position is first to absorb 
credit losses; the most ``senior'' investor position is last to absorb 
losses; and there may be one or more loss positions in between 
(``second dollar'' loss positions). Each loss position functions as a 
credit enhancement for the more senior positions in the structure.
    Recourse, in connection with sales of whole loans or loan 
participations, is now frequently associated with asset 
securitizations. Depending on the type of securitization, the sponsor 
of a securitization may provide a portion of the total credit 
enhancement internally, as part of the securitization structure, 
through the use of excess spread accounts, overcollateralization, 
retained subordinated interests, or other similar on-balance sheet 
assets. When these or other on-balance sheet internal enhancements are 
provided, the enhancements are ``residual interests'' for regulatory 
capital purposes.
    A seller may also arrange for a third party to provide credit 
enhancement \24\ in an asset securitization. If another financial 
institution provides the third-party enhancement, then that institution 
assumes some portion of the assets' credit risk. In this proposed rule, 
all forms of third-party enhancements, i.e., all arrangements in which 
an FCS institution assumes credit risk from third-party assets or other 
claims that it has not transferred, are referred to as ``direct credit 
substitutes.''
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    \24\ The terms ``credit enhancement'' and ``enhancement'' refer 
to both recourse arrangements (including residual interests) and 
direct credit substitutes.
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    Many asset securitizations use a combination of recourse and third-
party enhancements to protect investors from credit risk. When third-
party enhancements are not provided, the institution ordinarily retains 
virtually all of the credit risk on the assets.

C. Risk Management

    While asset securitization can enhance both credit availability and 
profitability, managing the risks associated with this activity poses 
significant challenges. While not new to FCS institutions, these risks 
may be less obvious and more complex than traditional lending 
activities. Specifically, securitization can involve credit, liquidity, 
operational, legal, and reputation risks that may not be fully 
recognized by management or adequately incorporated into risk 
management systems. The capital treatment required by this proposed 
rule addresses credit risk presented in securitizations and other 
credit risk mitigation techniques. Therefore, it is essential that an 
institution's compliance with capital standards be complemented by 
effective risk management practices and strategies.
    Similar to the other financial regulatory agencies, the FCA expects 
FCS institutions to identify, measure, monitor, and control 
securitization risks and explicitly incorporate the full range of those 
risks into their risk management systems. The board and management are 
responsible for adequate policies and procedures that address the 
economic substance of their activities and fully recognize and ensure 
appropriate management of related risks. Additionally, FCS institutions 
must be able to measure and manage their risk exposure from securitized 
positions, either retained or acquired. The formality and 
sophistication with which the risks of these activities are

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incorporated into an institution's risk management system should be 
commensurate with the nature and volume of its securitization 
activities.\25\
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    \25\ This proposal would not grant any new authorities to System 
institutions. It merely provides risk weightings for investments and 
transactions that are otherwise authorized.
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V. Section-by-Section Analysis of Proposed Changes

    The following discussion provides explanations, where necessary, of 
the more complex changes we propose. Most of the changes are necessary 
to more closely align our rules with those of the other financial 
regulatory agencies and to recognize relative risk exposure. As 
mentioned above, we have also made a number of organizational and plain 
language changes to make our rules easier to follow. These changes are 
discussed later in this preamble.

A. Section 615.5201--Definitions

    Because this rule would implement a new risk-weighting approach for 
recourse obligations, residual interests, direct credit substitutes, 
and other securitization and guarantee arrangements, we are proposing 
to amend Sec.  615.5201 to add a number of new definitions relating to 
these activities. We are also proposing to update certain other 
definitions as warranted. For the most part, to achieve consistency 
with the other financial regulatory agencies, we are proposing to adopt 
the same definitions as the other agencies.
1. Credit Derivative
    We propose to define credit derivative as a contract that allows 
one party (the protection purchaser) to transfer the credit risk of an 
asset or off-balance sheet credit exposure to another party (the 
protection provider). The value of a credit derivative is dependent, at 
least in part, on the credit performance of a ``reference asset.''
    The proposed definitions of ``recourse'' and ``direct credit 
substitute'' cover credit derivatives to the extent that an 
institution's credit risk exposure exceeds its pro rata interest in the 
underlying obligation. The ratings-based approach therefore applies to 
rated instruments such as credit-linked notes issued as part of a 
synthetic securitization.
    Credit derivatives can have a variety of structures. Therefore, we 
will continue to evaluate credit derivatives on a case-by-case basis. 
Furthermore, we will continue to use the December 1999 guidance on 
synthetic securitizations issued by the Federal Reserve Board and the 
OCC as a guide for determining appropriate capital requirements for FCS 
institutions and continue to apply the structural and risk management 
requirements outline in the 1999 guidance.\26\
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    \26\ See Banking Bulletin 99-43, December 1999 (OCC); 
Supervision and Regulation Letter 99-32, Capital Treatment for 
Synthetic Collateralized Loan Obligations, November 15, 1999 
(Federal Reserve Board).
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2. Credit-Enhancing Interest-Only Strip
    We propose to define the term ``credit-enhancing interest-only 
strip'' as an on-balance sheet asset that, in form or in substance, (1) 
Represents the contractual right to receive some or all of the interest 
due on transferred assets; and (2) exposes the institution to credit 
risk directly or indirectly associated with the transferred assets that 
exceeds its pro rata claim on the assets, whether through subordination 
provisions or other credit enhancement techniques. FCA proposes to 
reserve the right to identify other cash flows or related interests as 
credit-enhancing interest-only strips based on the economic substance 
of the transaction.
    Credit-enhancing interest-only strips include any balance sheet 
asset that represents the contractual right to receive some or all of 
the remaining interest cash flow generated from assets that have been 
transferred into a trust (or other special purpose entity), after 
taking into account trustee and other administrative expenses, interest 
payments to investors, servicing fees, and reimbursements to investors 
for losses attributable to the beneficial interests they hold, as well 
as reinvestment income and ancillary revenues \27\ on the transferred 
assets.
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    \27\ According to the Statement of Financial Accounting 
Standards No. 140, ancillary revenues include late charges on 
transferred assets.
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    Credit-enhancing interest-only strips are generally carried on the 
balance sheet at the present value of the reasonably expected net cash 
flow, adjusted for some level of prepayments if relevant, and 
discounted at an appropriate market interest rate. Typically, transfers 
of assets accounted for as a sale under generally accepted accounting 
principles (GAAP) result in the seller recording a gain on the portion 
of the transferred assets that has been sold. This gain is recognized 
as income, thus increasing the institution's capital position.
    Under the proposed rule, FCA would look to the economic substance 
of the transaction and reserve the right to identify other cash flows 
or spread-related assets as credit-enhancing interest-only strips on a 
case-by-case basis. For example, including some principal payments with 
interest and fee cash flows will not otherwise negate the regulatory 
capital treatment of that asset as a credit-enhancing interest-only 
strip. Credit-enhancing interest-only strips include both purchased and 
retained interest-only strips that serve in a credit-enhancing 
capacity, even though purchased interest-only strips generally do not 
result in the creation of capital on the purchaser's balance sheet.
3. Credit-Enhancing Representations and Warranties
    When an institution transfers or purchases assets, including 
servicing rights, it customarily makes or receives representations and 
warranties concerning those assets. These representations and 
warranties give certain rights to other parties and impose obligations 
upon the seller or servicer of those assets. To the extent such 
representations and warranties function as credit enhancements to 
protect asset purchasers or investors from credit risk, the proposed 
rule treats them as recourse or direct credit substitutes.
    More specifically, credit-enhancing representations and warranties 
are defined in the proposal as representations and warranties that: (1) 
Are made or assumed in connection with a transfer of assets (including 
loan-servicing assets); and (2) obligate an institution to protect 
investors from losses arising from credit risk in the assets 
transferred or loans serviced. As proposed, the term includes promises 
to protect a party from losses resulting from the default or 
nonperformance of another party or from an insufficiency in the value 
of collateral.
    The proposed definition is consistent with the other financial 
regulatory agencies' long-standing recourse treatment of 
representations and warranties that effectively guarantee performance 
or credit quality of transferred loans. However, a number of factual 
warranties unrelated to ongoing performance or credit quality are 
typically made. These warranties entail operational risk, as opposed to 
credit risk inherent in a financial guaranty, and are excluded from the 
definitions of recourse and direct credit substitute. Warranties that 
create operational risk include warranties that assets have been 
underwritten or collateral appraised in conformity with identified 
standards and warranties that permit the return of assets in instances 
of incomplete documentation, misrepresentation, or fraud. FCA expects 
FCS institutions to be able to demonstrate effective management of 
operational risks created by warranties.

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    Warranties or assurances that are treated as recourse or direct 
credit substitutes include warranties on the actual value of asset 
collateral or that ensure the market value corresponds to appraised 
value or the appraised value will be realized in the event of 
foreclosure and sale. Also, premium refund clauses, which can be 
triggered by defaults, are generally credit enhancements. A premium 
refund clause is a warranty that obligates the seller who has sold a 
loan at a price in excess of par, i.e., at a premium, to refund the 
premium, either in whole or in part, if the loan defaults or is prepaid 
within a certain period of time. However, certain premium refund 
clauses are not considered credit enhancements, including:
    (1) Premium refund clauses covering loans for a period not to 
exceed 120 days from the date of transfer. These warranties may cover 
only those loans that were originated within 1 year of the date of the 
transfer; and
    (2) Premium refund clauses covering assets guaranteed, in whole or 
in part, by the United States Government, a United States Government 
agency, or a United States Government-sponsored agency, provided the 
premium refund clause is for a period not to exceed 120 days from the 
date of transfer.
    Clean-up calls, an option that permits a servicer or its affiliate 
to take investors out of their positions prior to repayment of all 
loans, are also generally treated as credit enhancements. A clean-up 
call is not recourse or a direct credit substitute only if the 
agreement to repurchase is limited to 10 percent or less of the 
original pool balance. Repurchase of any loans 30 days or more past due 
would invalidate this exemption.
    Similarly, a loan-servicing arrangement is considered as recourse 
or a direct credit substitute if the institution, as servicer, is 
responsible for credit losses associated with the serviced loans. 
However, a cash advance made by a servicer to ensure an uninterrupted 
flow of payments to investors or the timely collection of the loans is 
specifically excluded from the definitions of recourse and direct 
credit substitute, provided that the servicer is entitled to 
reimbursement for any significant advances and this reimbursement is 
not subordinate to other claims. To be excluded from recourse and 
direct credit substitute treatment, an independent credit assessment of 
the likelihood of repayment of the servicer's cash advance should be 
made prior to advancing funds, and the institution should only make 
such an advance if prudent lending standards are met.
4. Direct Credit Substitute
    The proposed definition of direct credit substitute complements the 
definition of recourse. We propose the term ``direct credit 
substitute'' to refer to an arrangement in which an institution 
assumes, in form or in substance, credit risk directly or indirectly 
associated with an on- or off-balance sheet asset or exposure that was 
not previously owned by the institution (third-party asset) and the 
risk assumed by the institution exceeds the pro rata share of the 
institution's interest in the third-party asset. If the institution has 
no claim on the third-party asset, then the institution's assumption of 
any credit risk is a direct credit substitute. The term explicitly 
includes items such as the following:
     Financial standby letters of credit that support financial 
claims on a third party that exceed an institution's pro rata share in 
the financial claim;
     Guarantees, surety arrangements, credit derivatives, and 
similar instruments backing financial claims that exceed an 
institution's pro rata share in the financial claim;
     Purchased subordinated interests that absorb more than 
their pro rata share of losses from the underlying assets;
     Credit derivative contracts under which the institution 
assumes more than its pro rata share of credit risk on a third-party 
asset or exposure;
     Loans or lines of credit that provide credit enhancement 
for the financial obligations of a third party;
     Purchased loan-servicing assets if the servicer is 
responsible for credit losses or if the servicer makes or assumes 
credit-enhancing representations and warranties with respect to the 
loans serviced (servicer cash advances are not direct credit 
substitutes); and
     Clean-up calls on third-party assets. However, clean-up 
calls that are 10 percent or less of the original pool balance and that 
are exercisable at the option of the institution are not direct credit 
substitutes.
5. Externally Rated
    The proposal defines externally rated to mean that an instrument or 
obligation has received a credit rating from at least one NRSRO. The 
use of external credit ratings provides a way to determine credit 
quality relied upon by investors and other market participants to 
differentiate the regulatory capital treatment for loss positions 
representing different gradations of risk. This use permits more 
equitable treatment of transactions and structures in administering the 
risk-based capital requirements.
6. Financial Standby Letter of Credit
    Section 615.5201(o) of our regulations currently defines the term 
``standby letter of credit.'' We propose to change the term to 
financial standby letter of credit, but propose no substantive changes 
to the definition.
7. Government Agency
    This term is currently defined in two places in our capital 
regulations: Sec.  615.5201(f), which is our definitions section, and 
Sec.  615.5210(f)(2)(i)(D), which is our section on computing the 
permanent capital ratio. We propose to modify the Sec.  615.5201(f) 
definition by replacing it with the definition of Government agency 
currently in Sec.  615.5210(f)(2)(i)(D), and then delete the definition 
in Sec.  615.5210(f)(2)(i)(D). We believe these changes would 
streamline the regulation. We do not intend to change the meaning of 
this term.
8. Government-Sponsored Agency
    The term Government-sponsored agency is also currently defined in 
two places in our capital regulations (Sec.  615.5201(g), which is in 
the definitions section, and Sec.  615.5210(f)(2)(ii)(A), which is in 
the section on computing the permanent capital ratio). We propose to 
modify the definition in Sec.  615.5201(g) by replacing it with the 
Sec.  615.5210(f)(2)(ii)(A) definition of Government-sponsored agency, 
and then delete the redundant definition in Sec.  
615.5210(f)(2)(ii)(A). This proposed change simply streamlines our 
regulations and does not change the meaning of the term Government-
sponsored agency.
    Under this proposal, the term ``Government-sponsored agency'' would 
be defined as an agency or instrumentality chartered or established to 
serve public purposes specified by the United States Congress but whose 
obligations are not explicitly guaranteed by the full faith and credit 
of the United States Government. This definition includes Government-
sponsored enterprises, such as Fannie Mae and Farmer Mac, as well as 
Federal agencies, such as the Tennessee Valley Authority, that issue 
obligations that are not explicitly guaranteed by the United States' 
full faith and credit.
9. Nationally Recognized Statistical Rating Organization
    We propose to define NRSRO as a rating organization that the 
Securities and Exchange Commission (SEC) recognizes as an NRSRO. This 
definition

[[Page 47989]]

is identical to the existing definition in Sec.  615.5131(j) of our 
regulations.
10. Non-OECD Bank
    We propose to define non-OECD bank as a bank and its branches 
(foreign and domestic) organized under the laws of a country that does 
not belong to the OECD group of countries.\28\
---------------------------------------------------------------------------

    \28\ OECD stands for the Organization for Economic Cooperation 
and Development. The OECD is an international organization of 
countries that are committed to democratic government and the market 
economy. For purposes of our capital regulations, as well as those 
of the other financial regulatory agencies and the Basel Accord, 
OECD countries are those countries that are full members of the OECD 
or that have concluded special lending arrangements associated with 
the International Monetary Fund's General Arrangements to Borrow, 
excluding any country that has rescheduled its external sovereign 
debt within the previous 5 years. The OECD currently has 30 member 
countries. An up-to-date listing of member countries is available at 
www.oecd.org or www.oecdwash.org.
---------------------------------------------------------------------------

11. OECD Bank
    We propose to define OECD bank as a bank and its branches (foreign 
and domestic) organized under the laws of a country that belongs to the 
OECD group of countries. For purposes of our capital regulations, this 
term would include U.S. depository institutions.
12. Permanent Capital
    We propose to add language to clarify that permanent capital is 
subject to adjustments such as dollar-for-dollar reduction of capital 
for residual interests or other high-risk assets as described in 
proposed Sec.  615.5207. We do not propose any other changes.
13. Recourse
    The proposed rule defines the term ``recourse'' to mean an 
arrangement in which an institution retains, in form or in substance, 
any credit risk directly or indirectly associated with an asset it has 
sold (in accordance with GAAP) that exceeds a pro rata share of the 
institution's claim on the asset. If an institution has no claim on an 
asset it has sold, then the retention of any credit risk is recourse. A 
recourse obligation typically arises when an institution transfers 
assets in a sale and retains an explicit obligation to repurchase 
assets or to absorb losses due to a default on the payment of principal 
or interest or any other deficiency in the performance of the 
underlying obligor or some other party. Recourse may also exist 
implicitly if an institution provides credit enhancement beyond any 
contractual obligation to support assets it has sold.
    Our proposed definition of recourse is consistent with the other 
regulators' long-standing use of this term and incorporates existing 
practices regarding retention of risk in asset sales. The other 
financial regulatory agencies noted that third-party enhancements, 
e.g., insurance protection, purchased by the originator of a 
securitization for the benefit of investors, do not constitute 
recourse. The purchase of enhancements for a securitization or other 
structured transaction where the institution is completely removed from 
any credit risk will not, in most instances, constitute recourse. 
However, if the purchase or premium price is paid over time and the 
size of the payment is a function of the third party's loss experience 
on the portfolio, such an arrangement indicates an assumption of credit 
risk and would be considered recourse.
14. Residual Interest
    The proposed rule defines residual interest as any on-balance sheet 
asset that: (1) Represents an interest (including a beneficial 
interest) created by a transfer that qualifies as a sale (in accordance 
with GAAP) of financial assets, whether through a securitization or 
otherwise; and (2) exposes an institution to credit risk directly or 
indirectly associated with the transferred asset that exceeds a pro 
rata share of that institution's claim on the asset, whether through 
subordination provisions or other credit enhancement techniques.
    Residual interests generally include credit-enhancing interest-only 
strips, spread accounts, cash collateral accounts, retained 
subordinated interests (and other forms of overcollateralization), and 
similar assets that function as a credit enhancement. Residual 
interests generally do not include interests purchased from a third 
party. However, a purchased credit-enhancing interest-only strip is a 
residual interest because of its similar risk profile.
    This functional based definition reflects the fact that financial 
structures vary in the way they use certain assets as credit 
enhancements. Therefore, residual interests include any retained on-
balance sheet asset that functions as a credit enhancement in a 
securitization or other structured transaction, regardless of its 
characterization in financial or regulatory reports.
15. Rural Business Investment Companies
    The proposed rule adds a definition for RBICs. Section 6029 of the 
Farm Security and Rural Investment Act of 2002 \29\ amended the 
Consolidated Farm and Rural Development Act, as amended (7 U.S.C. 1921 
et seq.) by adding a new subtitle H, establishing a new ``Rural 
Business Investment Program.'' The new subtitle permits FCS 
institutions to establish or invest in RBICs, subject to specified 
limitations. While the Secretary of Agriculture is responsible for 
promulgating regulations governing RBICs, the FCA continues to be 
responsible for addressing any issues pertaining to FCS institutions' 
investments in RBICs, including risk-weighting those investments. We 
define RBICs by referring to the statutory definition as codified in 7 
U.S.C. 2009cc(14). That provision defines RBIC as ``a company that (A) 
has been granted final approval by the Secretary [of Agriculture] * * * 
and; (B) has entered into a participation agreement with the Secretary 
[of Agriculture].''
---------------------------------------------------------------------------

    \29\ Pub. L. 107-171.
---------------------------------------------------------------------------

16. Securitization
    The proposed rule defines securitization as the pooling and 
repackaging by a special purpose entity or trust of assets or other 
credit exposures that can be sold to investors. Securitization includes 
transactions that create stratified credit risk positions whose 
performance is dependent upon an underlying pool of credit exposures, 
including loans and commitments.
17. Other Terms
    We also propose to add definitions for the following terms:

 Bank
 Face Amount
 Financial Asset
 Qualified Residential Loan
 Qualifying Securities Firm
 Risk Participation
 Servicer Cash Advance
 Traded Position
 U.S. Depository Institution

Finally, we propose to carry over the remaining existing definitions 
without substantive change.

B. Sections 615.5210 and 615.5211--Ratings-Based Approach for Positions 
in Securitizations

1. Sections 615.5210 and 615.5211--General
    As described in the overview section of this preamble, each loss 
position in an asset securitization structure functions as a credit 
enhancement for the more senior loss positions in the structure. 
Historically, neither our risk-based capital standards nor those of the 
other financial regulatory agencies varied the capital requirements for 
different credit enhancements or loss positions to reflect differences 
in the relative credit risks represented by the

[[Page 47990]]

positions. To address this issue, the other financial regulatory 
agencies implemented a multilevel, ratings-based approach to assess 
capital requirements on recourse obligations, residual interests 
(except credit-enhancing interest-only strips), direct credit 
substitutes, and senior and subordinated positions in asset-backed 
securities and mortgage-backed securities based on their relative 
exposure to credit risk. The approach uses credit ratings from NRSROs 
to measure relative exposure to credit risk and determine the 
associated risk-based capital requirement.
    Under this rulemaking, we are proposing to adopt similar 
requirements. These changes would bring our regulations into close 
alignment with those of the other financial regulatory agencies for 
externally rated positions in securitizations with similar risks. We 
are also proposing to apply a ratings-based approach to unrated 
positions in Government-sponsored agency securitizations based on the 
issuer's credit rating beginning 18 months after the effective date of 
a final rule.
    Currently, the other financial regulatory agencies do not apply a 
ratings-based approach to securities issued by Government-sponsored 
agencies; these securities are generally risk-weighted at 20 percent. 
The other financial regulatory agencies do, however, apply the ratings-
based approach to rated positions in privately issued mortgage 
securities (e.g. collateralized mortgage obligations and real estate 
investment conduits) that are backed by agency mortgage pass-through 
securities. Further, the other financial regulatory agencies uniformly 
risk-weight stripped mortgage backed securities issued by Government-
sponsored agencies at 100 percent because of their higher risk 
assessment. Additionally, the other financial regulatory agencies 
reserve the authority to require a higher risk weighting on any 
position (including positions in Government-sponsored agency 
securitizations) based on the underlying risks of the position.
    The market has historically regarded securities issued by 
Government-sponsored agencies as posing minimal credit risk. However, 
we are concerned that subordinated positions, residual interests, or 
exposures to counterparties (including Government-sponsored agencies) 
that are not highly rated or are unrated may pose significant risks to 
FCS institutions. We are also concerned about the unique structural and 
operational risks that securitizations may present. Therefore, we 
believe it is appropriate to apply the ratings-based approach to all 
positions in securitizations that are not guaranteed by the full faith 
and credit of the United States.
    Furthermore, the use of credit ratings would provide an objective 
basis for determining credit quality as relied upon by investors or 
other market participants. These ratings would then be used to 
differentiate the regulatory capital treatment for loss positions based 
on different gradations of risk. This approach would enable us to apply 
the risk-based capital treatment to a wide variety of transactions and 
structures in a more equitable manner.
    Additionally, Sec.  615.5210(f) of the proposed regulation would 
grant FCA the authority to override the use of certain ratings or the 
ratings on certain instruments, either on a case-by-case basis or 
through broader supervisory policy, if necessary or appropriate to 
address the risk that an instrument poses to FCS institutions.
2. Section 615.5210(b)--Positions that Qualify for the Ratings-Based 
Approach
    Under Sec.  615.5210(b) of our proposed rule, certain positions in 
securitizations qualify for the ratings-based approach. These positions 
in securitizations are eligible for the ratings-based approach, 
provided the positions have favorable external ratings (as explained 
below) by at least one NRSRO. Eighteen months after the effective date 
of the final rule, the ratings based approach will be implemented for 
unrated positions in securitizations that are guaranteed by Government-
sponsored agencies based on the issuer credit rating of the agency. 
During the transition period before this provision is effective, FCS 
institutions may continue to risk-weight their unrated positions in 
securitizations that are guaranteed by Government-sponsored agencies at 
20-percent, regardless of whether the agency maintains an issuer rating 
by an NRSRO.
    More specifically, the following positions in securitizations 
qualify for the ratings-based approach if they satisfy the criteria set 
forth below:
     Recourse obligations;
     Direct credit substitutes;
     Residual interests (other than credit-enhancing interest-
only strips);\30\ and
---------------------------------------------------------------------------

    \30\ We propose to exclude credit-enhancing interest-only strips 
from the ratings-based approach because of their high-risk profile, 
as discussed under section V.C.1. of this preamble.
---------------------------------------------------------------------------

     Asset- and mortgage-backed securities.
3. Section 615.5210(b)--Application of the Ratings-Based Approach
    Under proposed Sec.  615.5210, the capital requirement for a 
position that qualifies for the ratings-based approach is computed by 
multiplying the face amount of the position by the appropriate risk 
weight as determined by the position's external credit rating. In the 
case of unrated positions in securitizations guaranteed by Government-
sponsored agencies beginning 18 months after the effective date of the 
final rule, the issuer's credit rating will be used to determine the 
appropriate risk-weight for the position.
    A position that is traded and externally rated qualifies for the 
ratings-based approach if its long-term external rating is one grade 
below investment grade or better (e.g., BB or better) or its short-term 
external rating is investment grade or better (e.g., A-3, P-3).\31\ If 
the position receives more than one external rating, the lowest rating 
would apply. This requirement eliminates the potential for rating 
shopping. Currently, individual securities issued and guaranteed by 
Government-sponsored agencies generally do not have external ratings 
from NRSROs. If, however, a position in an agency securitization does 
have an external rating, that rating must be used to determine the 
appropriate risk-weighting for the position.
---------------------------------------------------------------------------

    \31\ These ratings are examples only. Different NRSROs may have 
different ratings for the same grade.
---------------------------------------------------------------------------

    A position that is externally rated but not traded qualifies for 
the ratings-based approach if it satisfies the following criteria:
     It must be externally rated by more than one NRSRO;
     Its long-term external rating must be one grade below 
investment grade or better (e.g., BB or better) or its short-term 
external rating must be investment grade or better (e.g., A-3, P-3). If 
the position receives more than one external rating, the lowest rating 
would apply;
     The ratings must be publicly available; and
     The ratings must be based on the same criteria used to 
rate traded positions.
    The proposed rule also specifically provides that an unrated 
position that is guaranteed by a Government-sponsored agency would 
qualify for the ratings-based approach based on the Government-
sponsored agency's issuer credit rating beginning 18 months after the 
effective date of the final rule.
    Under the ratings-based approach, the capital requirement for a 
position that qualifies for the ratings-based approach

[[Page 47991]]

is computed by multiplying the face amount of the position by the 
appropriate risk weight determined in accordance with the following 
tables: \32\
---------------------------------------------------------------------------

    \32\ See paragraphs (b)(14), (c)(3), (d)(6), and (e) of proposed 
Sec.  615.5211.

                      Risk-Based Capital Requirements for Long-Term Issue or Issuer Ratings
----------------------------------------------------------------------------------------------------------------
           Rating category              Rating examples \33\                Risk weight (in percent)
----------------------------------------------------------------------------------------------------------------
Highest or second highest investment  AAA or AA..............  20.
 grade.
Third highest investment grade......  A......................  50.
Lowest investment grade.............  BBB....................  100.
One category below investment grade.  BB.....................  200.
More than one category below          B or below or Unrated..  Not eligible for the ratings-based approach.
 investment grade, or unrated.
----------------------------------------------------------------------------------------------------------------


                          Risk-Based Capital Requirements for Short-Term Issue Ratings
----------------------------------------------------------------------------------------------------------------
     Short-term rating category           Rating examples                  Risk weight  (in percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade............  A-1, P-1...............  20.
Second highest investment grade.....  A-2, P-2...............  50.
Lowest investment grade.............  A-3, P-3...............  100.
Below investment grade, or unrated..  B or lower (Not Prime).  Not eligible for the ratings--based approach.
----------------------------------------------------------------------------------------------------------------

    The charts for long-term and short-term ratings are not identical 
because rating agencies use different methodologies. Each short-term 
rating category covers a range of longer-term rating categories. For 
example, a P-1 rating could map to a long-term rating as high as Aaa or 
as low as A3.
---------------------------------------------------------------------------

    \33\ These ratings are examples only. Different NRSROs may have 
different ratings for the same grade. Further, ratings are often 
modified by either a plus or minus sign to show relative standing 
within a major rating category. Under the proposed rule, ratings 
refer to the major rating category without regard to modifiers. For 
example, an investment with a long-term rating of ``A-'' would be 
risk weighted at 50 percent.
---------------------------------------------------------------------------

    These proposed amendments would not change the risk-weight 
requirement that FCA recently adopted for eligible asset- and mortgage-
backed securities that continue to be highly rated.\34\ These 
amendments simply make our rule language more consistent with that used 
by the other financial regulatory agencies for these types of 
transactions.
---------------------------------------------------------------------------

    \34\ See 68 FR 15045, March 24, 2003.
---------------------------------------------------------------------------

C. Section 615.5210(c)--Treatment of Positions in Securitizations That 
Do Not Qualify for the Ratings-Based Approach

1. Section 615.5210(c)(1), (c)(2), and (c)(3)--Positions Subject to 
Dollar-for-Dollar Capital Treatment
    We propose to subject certain positions in asset securitizations 
that do not qualify for the ratings-based approach to dollar-for-dollar 
capital treatment. These positions include:
     Residual interests that are not externally rated;
     Credit-enhancing interest-only strips; and
     Positions that have long-term external ratings that are 
two grades below investment grade or lower (e.g., B or lower) or short-
term external ratings that are one grade below investment grade or 
lower (e.g., B or lower, Not Prime).\35\
---------------------------------------------------------------------------

    \35\ See paragraphs (c)(1), (c)(2), and (c)(3) of proposed Sec.  
615.5210.
---------------------------------------------------------------------------

    We emphasize that credit-enhancing positions in securitizations of 
Government-sponsored agencies are subject to the same capital treatment 
as positions in non-agency securitizations with similar risk profiles. 
For example, if an FCS institution retains or purchases an unrated 
subordinated interest in a Government-sponsored agency securitization 
that provides a credit enhancement for the entire pool of loans in the 
securitization, then the FCS institution must hold capital dollar-for-
dollar for the amount of that position.
    Under the dollar-for-dollar treatment, an FCS institution must 
deduct from capital and assets the face amount of the position. This 
means, in effect, one dollar in total capital must be held against 
every dollar held in these positions, even if this capital requirement 
exceeds the full risk-based capital charge.
    We propose the dollar-for-dollar treatment for the credit-enhancing 
and highly subordinated positions listed above because these positions 
raise a number of supervisory concerns that the other financial 
regulatory agencies also share.\36\ The level of credit risk exposure 
associated with deeply subordinated assets, particularly subinvestment 
grade and unrated residual interests, is extremely high. They are 
generally subordinated to all other positions, and these assets are 
subject to valuation concerns that might lead to loss as explained 
further below. Additionally, the lack of an active market makes these 
assets difficult to independently value and relatively illiquid.
---------------------------------------------------------------------------

    \36\ See 66 FR 59614 (November 29, 2001).
---------------------------------------------------------------------------

    In particular, there are a number of concerns regarding residual 
interests. A banking organization can inappropriately generate ``paper 
profits'' (or mask actual losses) through incorrect cash flow modeling, 
flawed loss assumptions, inaccurate prepayment estimates, and 
inappropriate discount rates. Such practices often lead to an inflation 
of capital, falsely making the banking organization appear more 
financially sound. Also, embedded within residual interests, including 
credit-enhancing interest-only strips, is a significant level of credit 
and prepayment risk that make their valuation extremely sensitive to 
changes in underlying assumptions. For these reasons we, like the other 
financial regulatory agencies, concluded that a higher capital 
requirement is warranted for unrated residual interests and all credit-
enhancing interest-only strips. Furthermore, the ``low-level exposure 
rule,'' discussed below, does not apply to these positions in 
securitizations. For example, if an FCS institution holds a 10-percent 
residual interest that is not externally rated in a $100 million

[[Page 47992]]

securitization, its capital charge would be $10 million. If an FCS 
institution purchases a $25 million position in an ABS that is 
subsequently downgraded to B or lower, its capital charge would be $25 
million, the full amount of the position.
    We note that the final rules adopted by the other financial 
regulatory agencies impose both a dollar-for-dollar risk weighting for 
residual interests that do not qualify for the ratings-based approach 
and a concentration limit on a subset of those residual interests--
credit-enhancing interest-only strips--for the purpose of calculating a 
bank's leverage ratio. Under their combined approach, credit-enhancing 
interest-only strips are limited to 25 percent of a banking 
organization's Tier 1 capital. Everything above that amount is deducted 
from Tier 1 capital. Generally, under the other financial regulatory 
agencies' rules, all other residual interests that do not qualify for 
the ratings-based approach (including any credit-enhancing interest-
only strips that were not deducted from Tier 1 capital) are subject to 
a dollar-for-dollar risk weighting. The combined capital charge is 
limited to the face amount of a banking organization's residual 
interests.
    As indicated previously, we are proposing a one-step approach for 
these positions in securitizations. This would require FCS institutions 
to deduct from capital and assets the face amount of their position. 
The resulting total capital charge is virtually the same under both 
approaches. However, we found that the one-step approach is easier to 
apply to FCS institutions because the way they compute their regulatory 
capital standards differs from the way other banking organizations 
compute their standards.
2. Section 615.5210(c)(4)--Unrated Recourse Obligations and Direct 
Credit Substitutes
    As discussed in the definitions section, the contractual retention 
of credit risk by an FCS institution associated with assets it has sold 
generally constitutes recourse.\37\ The definitions of recourse and 
direct credit substitute complement each other, and there are many 
types of recourse arrangements and direct credit substitutes that can 
be assumed through either on- or off-balance sheet credit exposures 
that are not externally rated. Under Sec.  615.5210(c)(4) of this 
proposal, FCS institutions would be required to hold capital against 
the entire outstanding amount of assets supported (e.g., all more 
senior positions) by an on-balance recourse obligation or direct credit 
substitute that is unrated. This treatment parallels our approach for 
off-balance sheet recourse obligations and direct credit substitutes, 
as discussed later under the computation of credit equivalent amounts. 
For example, if an FCS institution retains an on-balance sheet first-
loss position through a recourse arrangement or direct credit 
substitute in a pool of rural housing loans that qualify for a 50-
percent risk weight, the FCS institution would include the full amount 
of the assets in the pool, risk-weighted at 50 percent, in its risk-
weighted assets for purposes of determining its risk-based capital 
ratios. The low-level exposure rule \38\ provides that the dollar 
amount of risk-based capital required for assets transferred with 
recourse should not exceed the maximum dollar amount for which an FCS 
institution is contractually liable.
---------------------------------------------------------------------------

    \37\ As previously discussed, the proposed rule defines the term 
``recourse'' to mean an arrangement in which an institution retains, 
in form or in substance, any credit risk directly or indirectly 
associated with an asset it has sold, if the credit risk exceeds a 
pro rata share of the institution's claim on the asset. If an 
institution has no claim on an asset that it has sold, then the 
retention of any credit risk is recourse.
    \38\ See proposed Sec.  615.5210(e).
---------------------------------------------------------------------------

    The other financial regulatory agencies currently permit their 
banking organizations to use three alternative approaches (i.e., 
internal ratings, program ratings, and computer programs) for 
determining the capital requirements for certain unrated direct credit 
substitutes and recourse obligations in asset-backed commercial paper 
programs. The other financial regulatory agencies also recently issued 
an interim final rule and a proposed rule on the capital treatment for 
asset-backed commercial paper programs that are consolidated onto the 
balance sheets of the sponsoring banks. This change is the result of a 
recently issued accounting interpretation, Financial Accounting 
Standards Board Interpretation No. 46, Consolidation of Variable 
Interest Entities.\39\ At this time, the FCA has decided not to address 
the capital requirements for asset-backed commercial paper programs due 
to the limited involvement FCS institutions presently have in these 
programs. FCA will continue to determine the capital requirements for 
such programs on a case-by-case basis, but does request further comment 
on the appropriate capital treatment for these activities.
---------------------------------------------------------------------------

    \39\ See 68 FR 56530 (October 1, 2003).
---------------------------------------------------------------------------

3. Sections 615.5210(c)(5) and 615.5211(d)(7)--Stripped Mortgage-Backed 
Securities (SMBS)
    Under proposed Sec. Sec.  615.5210(c)(5) and 615.5211(d)(7), SMBS 
and similar instruments, such as interest-only strips that are not 
credit-enhancing or principal-only strips (including such instruments 
guaranteed by Government-sponsored agencies), are assigned to the 100-
percent risk-weight category. Even if highly rated, these securities do 
not receive the more favorable capital treatment available to other 
mortgage securities because of their higher market risk profile. 
Typically, SMBS contain a higher degree of price volatility associated 
with mortgage prepayments. As indicated previously, credit-enhancing 
positions in securitization are subject to dollar-for-dollar capital 
treatment.
4. Section 615.5211(d)--Unrated Positions in Asset-Backed Securities 
and Mortgage-Backed Securities
    Unrated positions in mortgage- and asset-backed securities that do 
not qualify for the ratings-based approach would generally be assigned 
to the 100-percent risk-weight category under the proposal. This would 
include unrated positions in securitizations guaranteed by Government-
sponsored agencies without issuer credit ratings beginning 18 months 
after the effective date of the final rule.
    The FCA recognizes that the proposed risk-based capital 
requirements can provide a more favorable treatment for certain unrated 
positions in securitizations than those rated below investment grade. 
For this reason, FCA will look to the substance of the transaction to 
determine whether a higher capital requirement is warranted based on 
the risk characteristics of the position. Additionally, because of the 
many advantages, including pricing, liquidity, and favorable capital 
treatment on highly rated positions in asset securitizations, we 
believe this overall regulatory approach provides ample incentives for 
all participants to obtain external ratings.

D. Section 615.5210(d)--Senior Positions Not Externally Rated

    For senior positions not externally rated, the following capital 
treatment applies under proposed Sec.  615.5210(d). If an FCS 
institution retains an unrated position that is senior or preferred in 
all respects (including collateral and maturity) to a rated position 
that is traded, the position is treated as if it had the same rating 
assigned to the rated position. These senior unrated positions

[[Page 47993]]

qualify for the risk weighting of the subordinated rated positions as 
long as the subordinate rated position is: (1) Traded; and (2) remains 
outstanding for the entire life of the unrated position, thus providing 
full credit support for the term of the unrated position.

E. Section 615.5210(e)--Low-Level Exposure Rule

    Section 615.5210(e) of the proposed rule limits the maximum risk-
based capital requirement to the lesser of the maximum contractual 
exposure or the full capital charge against the outstanding amount of 
assets transferred with recourse. When the proposed low-level exposure 
rule applies, an institution would generally hold capital dollar-for-
dollar against the amount of its maximum contractual exposure. Thus, if 
the maximum contractual exposure to loss retained or assumed in 
connection with recourse obligation or a direct credit substitute is 
less than the full risk-based capital requirement for the assets 
enhanced, the risk-based capital requirement is limited to the maximum 
contractual exposure.
    In the absence of any other recourse provisions, the on-balance 
sheet amount of assets retained or assumed in connection with a 
recourse obligation or direct credit substitute represents the maximum 
contractual exposure. For example, assume that $100 million of loans is 
sold and securitized and an FCS institution provides a $5 million 
credit enhancement through a recourse obligation. Instead of holding 7 
percent or $7 million of capital, the low-level exposure limits the 
risk-based requirement to the $5 million maximum contractual loss 
exposure, with $5 million held dollar-for-dollar against capital.

F. Section 615.5211--Risk Categories--Balance Sheet Assets

1. Section 615.5211(b)(6)--Securities and Other Claims on, and Portions 
of Claims, Guaranteed by Government-Sponsored Agencies
    Under proposed Sec.  615.5211(b)(6), securities and other claims 
on, and portions of claims guaranteed by, Government-sponsored agencies 
are generally assigned to the 20-percent risk-weight category.\40\ For 
example, this risk-based capital treatment applies to investments in 
debt securities or other similar obligations issued by agencies. 
Beginning eighteen months after the effective date of the final rule, 
this provision would exclude, positions in securitizations guaranteed 
by Government-sponsored agencies, such as asset- and mortgage-backed 
securities, which we have already discussed, and claims on Government-
sponsored agencies that are described in the next section of this 
preamble.
---------------------------------------------------------------------------

    \40\ Assets in this category include, for example, asset- or 
mortgage-backed securities that are issued or guaranteed by 
Government-sponsored agencies.
---------------------------------------------------------------------------

2. Sections 615.5211(b)(7), (c)(4) and (d)(11)--Treatment of Assets 
Covered by Credit Protection Provided by Government-Sponsored Agencies 
and OECD Banks
    This proposal addresses the risk-based capital treatment for assets 
covered by credit protection provided by Government-sponsored agencies 
and OECD banks.
    FCS institutions use a variety of credit risk mitigation strategies 
to alter their risk profiles. Credit protection may be obtained through 
credit default swaps, loss purchase commitments, guarantees, and other 
similar arrangements. These transactions or arrangements often contain 
a number of structural complexities and may impose additional 
operational and counterparty risk on FCS institutions that use these 
arrangements. In an Informational Memorandum dated October 23, 2003, 
the agency specifically informed FCS institutions of its concerns 
regarding excessive risk exposure to single counterparties and 
suggested that FCS institution boards consider engaging in business 
transactions only with counterparties rated in one of the two highest 
rating categories by an NRSRO.
    We believe FCS institutions should enter into these types of 
financial arrangements only with sophisticated entities that are 
financially strong and well capitalized. We believe a ratings-based 
approach coupled with a close examination of the unique features of 
these transactions will help create the appropriate incentives for FCS 
institutions to carefully select their counterparties and fully 
understand the risks transferred, retained, or assumed through these 
arrangements. FCS institutions should also take appropriate measures to 
manage additional operational risks that may be created by these 
arrangements. FCS institutions should thoroughly review and understand 
all the legal definitions and parameters of these instruments, 
including credit events that constitute default, as well as 
representations and warranties, to determine how well the contract will 
perform under a variety of economic conditions.
    We believe it is appropriate to differentiate the capital 
requirements for these types of arrangements based on an assessment of 
the risks retained, transferred to investors or other third parties, or 
assumed in the form of counterparty risk. Thus, we are proposing to 
implement a ratings-based approach for assigning capital requirements 
to assets covered by credit protection arrangements, including credit 
derivatives (e.g., credit default swaps), loss purchase commitments, 
guarantees and other similar arrangements.\41\
---------------------------------------------------------------------------

    \41\ As under our existing regulations, all other claims on OECD 
banks will continue to be risk-weighted at 20 percent regardless of 
the OECD bank's rating or lack thereof. See proposed Sec.  
615.5211(b)(6).
---------------------------------------------------------------------------

    The implementation of this provision beginning 18 months after the 
effective date of the final rule will allow FCS institutions to assess 
their current risk mitigation techniques, counterparty risk exposures, 
and long-term capital adequacy objectives and make any adjustments that 
are necessary.
    The following table indicates the risk weightings for assets 
covered by credit protection or guarantees based on the provider's 
credit rating when this provision becomes effective.

----------------------------------------------------------------------------------------------------------------
                                                                                                 BBB or below or
        Credit Protection Provider Credit Rating \42\             AAA to AA            A             unrated
----------------------------------------------------------------------------------------------------------------
Risk weight of assets covered (in percent)...................              20               50              100
----------------------------------------------------------------------------------------------------------------

    During the transition period, FCS institutions may continue to risk 
weight

[[Page 47994]]

assets covered by credit protection contracts with OECD banks and 
Government-sponsored agencies at 20 percent. After the transition 
period ends, FCS institutions may only risk-weight loan assets (or 
portions of assets) covered by these arrangements at 20 percent 
provided the Government-sponsored agency or OECD bank providing the 
credit protection maintains an issuer credit rating in one of the two 
highest investment grade ratings from at least one NRSRO (if the credit 
protection provider is rated by more than one NRSRO the lowest rating 
applies).\43\ If the credit protection provider is rated in the third 
investment grade category (e.g., ``A'') by an NRSRO, a 50-percent risk 
weight will apply to the assets covered by the contract. If the credit 
protection provider is rated in the lowest investment grade category or 
below, or is not rated, a 100-percent risk weight will apply to the 
assets covered by the contract.\44\
---------------------------------------------------------------------------

    \42\ These ratings are examples only. Different NRSROs may have 
different ratings for the same grade. Further, ratings are often 
modified by either a plus or minus sign to show relative standing 
within a major rating category. Under the proposed rule, ratings 
refer to the major rating category without regard to modifiers. For 
example, an investment with a long-term rating of ``A-'' would be 
risk weighted at 50 percent.
    \43\ See proposed Sec.  615.5211(b)(7).
    \44\ See proposed Sec.  615.5211(c)(4).
---------------------------------------------------------------------------

    Additionally, FCS institutions may recognize the credit protection 
in calculating their capital requirements only if the guarantee, credit 
derivative, or agreement represents a direct claim on the protection 
provider and it explicitly references specific assets. The agreement 
must also have legal certainty and be irrevocable and unconditional 
(there should be no clause in the contract that allows the protection 
provider to unilaterally cancel the credit coverage, and there should 
be no clause that prevents the protection provider from being obligated 
to pay out in a timely manner). FCS institutions must also satisfy the 
FCA that they have established appropriate controls to manage any 
additional operational risks that might be associated with such 
arrangements.
    In situations where an FCS institution assumes a first loss 
position on loan assets covered by credit protection contracts, the FCS 
institution must hold capital on a dollar-for-dollar basis to support 
its first loss position. The remaining balance covered by the contract 
may be risk weighted based on the guarantor's or counterparty's credit 
rating as explained above. Under the proposal, an FCS institution's 
risk-based capital requirement is limited to the maximum dollar amount 
for which an FCS institution is contractually liable on the first loss 
position plus the capital charge for the remaining assets or the full 
capital charge (e.g., 7 percent) for all the assets covered by the 
arrangement. For example, if an FCS institution retains a 2-percent 
first loss position in $100 of loan assets covered by a guarantee from 
an OECD bank rated ``A,'' the FCS institution's combined capital charge 
for all the assets would be $2 for the first loss position plus $98 
risk weighted at 50 percent multiplied by 7 percent, or $5.43.
    As noted previously, we believe the use of credit ratings provides 
an objective basis for determining credit risk as relied upon by 
investors or other market participants. We believe this approach 
results in a more equitable treatment for all types of credit 
protection providers under our capital rules. Furthermore, this allows 
FCA to differentiate capital requirements based on an FCS institution's 
relative exposure to risk. Because the nature and structure of such 
arrangements may vary significantly, FCA reserves the authority to 
evaluate each arrangement individually and to make an appropriate 
capital determination as circumstances may warrant.
    The other financial regulatory agencies have not yet implemented 
the ratings-based approach suggested under the Basel II proposal for 
claims on, or guarantees by, OECD banks or Government-sponsored 
agencies. The methodology that we propose to apply to certain 
guarantee/credit derivative arrangements is a limited application of 
the ratings-based approach proposed under Basel II for individual 
claims on and guarantees by banks (i.e., Standardized Approach).\45\ As 
previously noted, at this time we are continuing to evaluate Basel II 
and may propose additional amendments to more fully implement a 
ratings-based approach for other types of claims on or guarantees by 
financial institutions through a future rulemaking.
---------------------------------------------------------------------------

    \45\ See The New Basel Capital Accord Consultative Document, 
Basel Committee on Banking Supervision, April 2003.
---------------------------------------------------------------------------

3. Section 615.5211(a)(5), (b)(15), and (b)(16)--Treatment of Claims on 
Qualifying Securities Firms
    We are adding claims on qualifying securities firms to the current 
risk-based capital requirements.\46\ In doing so, our proposal aims to 
level the playing field among OECD banks, Government-sponsored agencies 
and securities firms (that meet certain qualifying standards) that 
provide guarantees.
---------------------------------------------------------------------------

    \46\ Under proposed Sec.  615.5201, ``qualifying securities 
firm'' means: (1) A securities firm incorporated in the United 
States that is a broker-dealer that is registered with the SEC and 
that complies with the SEC's net capital regulations; and (2) a 
securities firm incorporated in any other OECD-based country, if the 
institution is subject to supervision and regulation comparable to 
that imposed on depository institutions in OECD countries.
---------------------------------------------------------------------------

    Specifically, we propose to adopt a 0-percent risk weight for 
claims on, or guaranteed by, qualifying securities firms that are 
collateralized by cash on deposit in the institution or by securities 
issued or guaranteed by the United States or OECD central governments, 
provided that a positive margin of collateral is required to be 
maintained on such a claim on a daily basis, taking into account any 
change in the institution's exposure to the obligor or counterparty 
under the claim in relation to the market value of the collateral held 
in support of the claim.\47\
---------------------------------------------------------------------------

    \47\ Proposed Sec.  615.5211(a)(5).
---------------------------------------------------------------------------

    We also propose to reduce from 100 percent to 20 percent the risk 
weighting applied to all other claims on and claims guaranteed by 
qualifying securities firms that satisfy specified external rating 
requirements.\48\ Specifically, we propose to adopt a 20-percent risk 
weighting for all claims on and claims guaranteed by a qualifying 
securities firm that has a long-term issuer credit rating in one of the 
two highest investment-grade rating categories from an NRSRO, or if the 
claim is guaranteed by the qualifying securities firm's parent company 
with such a rating.\49\
---------------------------------------------------------------------------

    \48\ Proposed Sec.  615.5211(b)(15).
    \49\ If ratings are available from more than one NRSRO, the 
lowest rating will be used to determine whether the rating standard 
has been met.
---------------------------------------------------------------------------

    We note that this ratings criteria is consistent with our proposed 
criteria for obtaining a 20-percent risk weight on assets covered by 
certain credit protection arrangements with Government-sponsored 
agencies and OECD banks described above. This proposal applies a higher 
rating standard to securities firms than the other financial regulatory 
agencies adopted to ensure consistency throughout our rules. Otherwise, 
the potential for capital arbitrage would exist when securities firms 
provide guarantees or credit protection through structured transactions 
and agreements. If we did not apply the higher standard to securities 
firms, an institution could receive a more favorable capital treatment 
by obtaining credit protection from a securities firm than a 
Government-sponsored agency or OECD bank, even when the underlying risk 
was the same. To avoid this result, we have crafted the regulations so 
that the

[[Page 47995]]

capital treatment is commensurate with the underlying risks.
    Finally, we propose a 20-percent risk weight for certain 
collateralized claims on qualifying securities firms without regard to 
satisfaction of the rating standard, provided the claim arises under a 
contract that:
     Is a reverse repurchase/repurchase agreement or securities 
lending/borrowing transaction executed under standard industry 
documentation;
     Is collateralized by liquid and readily marketable debt or 
equity securities;
     Is marked-to-market daily;
     Is subject to a daily margin maintenance requirement under 
the standard documentation; and
     Can be liquidated, terminated, or accelerated immediately 
in bankruptcy or similar proceeding, and the security or collateral 
agreement will not be stayed or voided, under applicable law of the 
relevant country.\50\
---------------------------------------------------------------------------

    \50\ See proposed Sec.  615.5211(b)(16).
---------------------------------------------------------------------------

4. Section 615.5211(c)(2)--Treatment of Qualified Residential Loans
    Existing Sec.  613.3030 authorizes System institutions to provide 
financing to rural homeowners for the purpose of buying, remodeling, 
improving, and repairing rural homes. ``Rural homeowner'' is defined as 
an individual who resides in a rural area and is not a bona fide 
farmer, rancher, or producer or harvester of aquatic products. ``Rural 
home'' means a single-family moderately priced dwelling located in a 
rural area that will be owned and occupied as the rural homeowner's 
principal residence. ``Rural area'' means open country within a state 
or the Commonwealth of Puerto Rico, which may include a town or village 
that has a population of not more than 2,500 persons. Existing Sec.  
615.5210(f)(2)(iii)(B) assigns these rural home loans, provided they 
are secured by first lien mortgages or deeds of trust, to the 50-
percent risk-weight category. However, residential loans to bona fide 
farmers, ranchers, and producers and harvesters of aquatic products are 
currently considered to be agricultural loans and are risk-weighted at 
100 percent under Sec.  615.5210(f)(2)(iv).
    Proposed Sec.  615.5211(c)(2) would assign a 50-percent risk weight 
to all qualified residential loans, as defined in proposed Sec.  
615.5201. To be a qualified residential loan, a loan must be either: 
(i) A rural home loan, as authorized by Sec.  613.3030,\51\ or (ii) a 
single-family residential loan to a bona fide farmer, rancher, or 
producer or harvester of aquatic products.\52\ A qualified residential 
loan must be secured by a first lien mortgage or deed of trust, must 
have been approved in accordance with prudent underwriting standards, 
must not be past due 90 days or more or carried in nonaccrual status, 
and must have a monthly amortization schedule. In addition, the secured 
residence and residential site must have a deed separate from other 
adjoining land and a permanent right-of-way access.
---------------------------------------------------------------------------

    \51\ As discussed above, these loans are currently included in 
the 50-percent risk-weight category.
    \52\ As discussed above, these loans currently receive a 100-
percent risk weighting.
---------------------------------------------------------------------------

    We propose this change because we believe that all residential 
loans that meet the standards set forth in the definition of qualified 
residential loan, whether made to farmers, ranchers, or aquatic 
producers or harvesters or not, pose the same level of risk. This view 
is consistent with that of the other financial regulatory agencies. 
Under their rules, a loan that is fully secured by a first lien on a 
one- to four-family residential property is assigned to the 50-percent 
risk-weight category as long as the loan has been approved in 
accordance with prudent underwriting standards and is not past due 90 
days or more or carried in nonaccrual status.\53\ The other financial 
regulatory agencies do not distinguish whether such a loan is made to a 
farmer or a non-farmer.
---------------------------------------------------------------------------

    \53\ See, e.g., FDIC regulations at 12 CFR Part 325, Appendix A, 
II.C., Category 3.
---------------------------------------------------------------------------

    Consistent with the position of the other financial regulatory 
agencies, any residential loan that does not meet the definition of a 
qualified residential loan would be assigned to the 100-percent risk-
weight category.
5. Section 615.5211(d)(8)--Treatment of Investments in Rural Business 
Investment Companies
    As previously discussed, the Farm Security and Rural Investment Act 
(Pub. L. 107-171) recently amended the Consolidated Farm and Rural 
Development Act, 7 U.S.C. 1921 et seq., to permit FCS institutions to 
establish or invest in RBICs subject to certain limitations. A RBIC has 
a similar mission and objectives to serve rural entrepreneurs as a SBIC 
does to serve qualifying small businesses. Currently, the other 
financial regulatory agencies risk-weight investments in SBICs at 100 
percent and deduct from capital an escalating percentage of SBIC 
investments that exceed 15 percent of capital.\54\ FCA proposes to 
risk-weight RBICs at 100 percent.\55\ FCA is not proposing to limit the 
amount of RBIC investments that can receive the 100-percent risk weight 
because a System institution is precluded by statute from making an 
investment in a RBIC in excess of 5 percent of the capital and surplus 
of the institution.\56\ This statutory limitation imposes adequate 
controls on risk from these investments.
---------------------------------------------------------------------------

    \54\ See 67 FR 3784, January 25, 2002.
    \55\ See proposed Sec.  615.5211(d)(8).
    \56\ 7 U.S.C. 2009cc-9(b).
---------------------------------------------------------------------------

G. Section 615.5212(b)(4)(i)--Computation of Credit-Equivalent Amounts 
for Direct Credit Substitutes and Recourse Obligations

    We propose to modify our current methodology for determining the 
credit equivalent amount of off-balance sheet direct credit substitutes 
and propose to add a similar provision for recourse obligations. Under 
the proposal, the credit equivalent amount for a direct credit 
substitute or recourse obligation is the full amount of the credit-
enhanced assets for which an institution directly or indirectly retains 
or assumes credit risk multiplied by a 100-percent conversion 
factor.\57\ To determine the institution's risk-weighted assets for an 
off-balance sheet recourse obligation or a direct credit substitute, 
the credit equivalent amount is assigned to the risk weight category 
appropriate to the obligor in the underlying transaction, after 
considering any associated guarantees or collateral.
---------------------------------------------------------------------------

    \57\ See proposed Sec.  615.5212(b)(4)(i).
---------------------------------------------------------------------------

    The proposal eliminates the current anomalies between direct credit 
substitutes and recourse arrangements that expose an institution to the 
same amount of risk but different capital requirements. These changes 
would also provide consistent risk-based capital treatment for 
positions with similar risk exposures regardless of whether they are 
structured as on- or off-balance sheet transactions. For example, as 
noted previously, for a direct credit substitute that is an on-balance 
sheet asset, e.g., a purchased subordinated security, an institution 
must also calculate risk-weighted assets using the amount of the direct 
credit substitute and the full amount of the assets it supports, 
meaning all the more senior positions in the structure. This is another 
change necessary to make our rules consistent with the current rules 
established by the other financial regulatory agencies.

H. Section 615.5210(f)--Reservation of Authority

    Financial institutions are developing novel transactions that do 
not fit into conventional risk-weight categories or credit conversion 
factors in the current standards. Financial institutions are also 
devising novel instruments that

[[Page 47996]]

nominally fit into a particular category, but impose levels of risk on 
the financial institutions that are not commensurate with the risk-
weight category for the asset, exposure or instrument. Accordingly, 
Sec.  615.5210(f) of the proposed rule more explicitly indicates that 
FCA, on a case-by-case basis, may determine the appropriate risk weight 
for any asset or credit equivalent amount and the appropriate credit 
conversion factor for any off-balance sheet item in these 
circumstances. Exercise of this authority may result in a higher or 
lower risk weight or credit equivalent amount for these assets or off-
balance sheet items. This reservation of authority explicitly 
recognizes the retention of sufficient discretion to ensure that novel 
financial assets, exposures, and instruments will be treated 
appropriately under the regulatory capital standards.

VI. Other Changes

    In addition to the changes detailed above, we also propose to make 
a number of other changes. We propose most of these changes for clarity 
or plain language purposes or to eliminate obsolete references. These 
changes are described below.

A. Section 615.5211--Changes to Listing of Balance Sheet Assets

    We propose to clarify the listing of balance sheet assets 
identified in each risk-weight category in proposed Sec.  615.5211 to 
more closely align the regulatory language with our long-standing 
policy positions. This new regulatory language also mirrors the 
language used by the other financial regulatory agencies to the extent 
applicable to System institutions. Over the years, we have interpreted 
our risk-weighting categories consistently with the other financial 
regulatory agencies. In some instances, however, the listing of assets 
included in each category is not as specific or clear as that of the 
other financial regulatory agencies. We propose these amendments for 
the purpose of clarity and consistency with the other financial 
regulatory agencies.
1. Section 615.5211(a)--0-Percent Category
    We propose to reorganize the order of the assets listed in the 0-
percent risk-weight category.\58\ We propose to add a listing for 
portions of local currency claims on, or unconditionally guaranteed by, 
non-OECD central governments (including non-OECD central banks), to the 
extent the institution has liabilities booked in that currency (Sec.  
615.5211(a)(4)). We also propose to revise the language in Sec. Sec.  
615.5211(a)(1), 615.5211(a)(2), and 615.5211(a)(3).\59\ Finally, we 
propose to delete existing Sec.  615.5210(f)(2)(i)(C), which puts 
goodwill in the 0-percent category. Proposed Sec.  615.5207(g) (which 
we propose to carry over without substantive change from existing Sec.  
615.5210(e)(7)) provides that an institution must deduct from total 
capital an amount equal to all goodwill before it assigns assets to the 
risk-weighting categories. Thus, it is unnecessary to assign goodwill 
to a risk-weighting category.
---------------------------------------------------------------------------

    \58\ Except where otherwise indicated, all references are to the 
proposed regulation.
    \59\ See existing Sec.  615.5210(f)(2)(i)(A), (f)(2)(i)(B), and 
(f)(2)(i)(C).
---------------------------------------------------------------------------

2. Section 615.5211(b)--20-Percent Category
    We propose to reorganize the order of the assets listed in the 20-
percent risk-weight category.\60\ We propose to add the following 
assets in addition to the changes previously discussed:
---------------------------------------------------------------------------

    \60\ Except where otherwise indicated, all references are to the 
proposed regulation.
---------------------------------------------------------------------------

     Portions of loans and other claims collateralized by cash 
on deposit (Sec.  615.5211(b)(9));
     Portions of claims collateralized by securities issued by 
official multinational lending institutions or regional development 
institutions in which the United States Government is a shareholder or 
contributing member (Sec.  615.5211(b)(12)); and
     Investments in shares of mutual funds whose portfolios are 
permitted to hold only assets that qualify for the zero or 20-percent 
risk-weight categories (Sec.  615.5211(b)(13)).
    We propose to revise the language in Sec.  615.5211(b)(3),\61\ 
(b)(4),\62\ (b)(5),\63\ (b)(6),\64\ (b)(8),\65\ (b)(10),\66\ and 
(b)(11)\67\ to make them easier to read.
---------------------------------------------------------------------------

    \61\ Consolidated from existing Sec.  615.5210(f)(2)(ii)(D) and 
(f)(2)(ii)(E).
    \62\ Existing Sec.  615.5210(f)(2)(ii)(F).
    \63\ Consolidated from existing Sec.  615.4210(f)(2)(ii)(B) and 
(f)(2)(ii)(J).
    \64\ This provision is not contained in current FCA regulations.
    \65\ Consolidated from existing Sec.  615.5210(f)(2)(ii)(A) and 
(f)(2)(ii)(C).
    \66\ See existing Sec.  615.5210(f)(2)(ii)(G).
    \67\ See existing Sec.  615.5210(f)(2)(ii)(H).
---------------------------------------------------------------------------

3. Section 615.5211(c)--50-Percent Category
    In the 50-percent risk-weight category, we propose to add a listing 
for revenue bonds or similar obligations, including loans and leases, 
that are obligations of a state or political subdivisions of the United 
States or other OECD countries but for which the government entity is 
committed to repay the debt only out of revenue from the specific 
projects financed.\68\ We are making these revisions to further 
distinguish the varying degrees of risk associated with investments in 
different types of revenue bonds. This change also parallels the rules 
of the other financial regulatory agencies. We also propose to make 
plain language changes to Sec.  615.5211(c)(1).\69\
---------------------------------------------------------------------------

    \68\ Proposed Sec.  615.5211(c)(5). This provision is not 
contained in current FCA regulations.
    \69\ See existing Sec.  615.5210(f)(2)(iii)(A).
---------------------------------------------------------------------------

4. Section 615.5211(d)--100-Percent Category
    The existing 100-percent risk-weight category lists only four 
assets, including a catch-all: All other assets not specified in the 
other risk-weight categories, including, but not limited to, leases, 
fixed assets, and receivables. Consistent with the other financial 
regulatory agencies, and to provide clearer guidance, we propose to 
itemize many of the assets that are currently included within the 
catch-all, including:
     Claims on, or portions of claims guaranteed by, non-OECD 
central governments (except such claims that are included in other 
risk-weighting categories), and all claims on non-OECD state and local 
governments (Sec.  615.5211(d)(3));
     Industrial development bonds and similar obligations 
issued under the auspices of states or political subdivisions of the 
OECD-based group of countries for the benefit of a private party or 
enterprise where that party or enterprise, not the government entity, 
is obligated to pay the principal and interest (Sec.  615.5211(d)(4));
     Premises, plant, and equipment; other fixed assets; and 
other real estate owned (Sec.  615.5211(d)(5)).
     If they have not already been deducted from capital, 
investments in unconsolidated companies, joint ventures, or associated 
companies; deferred-tax assets; and servicing assets (Sec.  
615.5211(d)(9)); and
     All other assets not specified, including, but not limited 
to, leases and receivables (Sec.  615.5211(d)(12)).

B. Other Nonsubstantive Changes

    We propose to change the heading of Sec.  615.5200 from ``General'' 
to ``Capital planning'' to better reflect the content of this section. 
We do not propose any other changes to this section.
    We propose to break up Sec.  615.5210, which is cumbersome to use 
because of its length, into seven separate regulatory sections. The 
newly redesignated sections are:


[[Page 47997]]


     Sec.  615.5206--Permanent capital ratio computation
     Sec.  615.5207--Capital adjustments and associated 
reductions to assets
     Sec.  615.5208--Allotment of allocated investments
     Sec.  615.5209--Deferred-tax assets
     Sec.  615.5210--Risk-adjusted assets
     Sec.  615.5211--Risk categories--balance sheet assets
     Sec.  615.5212--Credit conversion factors--off-balance 
sheet items

This reorganization should make these provisions easier to use. We do 
not intend any substantive changes with this reorganization.
    We propose to delete an obsolete reference to the Farm Credit 
System Financial Assistance Corporation in Sec.  615.5201.
    We propose to add paragraph (k) to newly redesignated Sec.  
615.5207 for clarity.
    We propose to make minor, nonsubstantive, plain language, and 
organizational changes throughout the revised regulation.
    Because we propose to reorganize this regulation, references to the 
regulation in other FCA regulations need to be updated. Accordingly, we 
propose to make conforming reference updates in parts 607, 614, and 620 
of this chapter.

VII. 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 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

12 CFR Part 607

    Accounting, Agriculture, Banks, banking, Reporting and 
recordkeeping requirements, 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 620

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

    For the reasons stated in the preamble, we propose to amend parts 
607, 614, 615, and 620 of chapter VI, title 12 of the Code of Federal 
Regulations as follows:

PART 607--ASSESSMENT AND APPORTIONMENT OF ADMINISTRATIVE EXPENSES

    1. The authority citation for part 607 continues to read as 
follows:

    Authority: Secs. 5.15, 5.17 of the Farm Credit Act (12 U.S.C. 
2250, 2252) and 12 U.S.C. 3025.


Sec.  607.2  [Amended]

    2. Amend Sec.  607.2(b) introductory text by removing the reference 
``Sec.  615.5210(f)'' and adding in its place ``Sec.  615.5210.''

PART 614--LOAN POLICIES AND OPERATIONS

    3. The authority citation for part 614 continues 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, 
4.13B, 4.14, 4.14A, 4.14C, 4.14D, 4.14E, 4.18, 4.18A, 4.19, 4.25, 
4.26, 4.27, 4.28, 4.36, 4.37, 5.9, 5.10, 5.17, 7.0, 7.2, 7.6, 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, 2097, 2121, 2122, 2124, 2128, 2129, 2131, 2141, 2149, 2183, 
2184, 2201, 2202, 2202a, 2202c, 2202d, 2202e, 2206, 2206a, 2207, 
2211, 2212, 2213, 2214, 2219a, 2219b, 2243, 2244, 2252, 2279a, 
2279a-2, 2279b, 2279c-1, 2279f, 2279f-1, 2279aa, 2279aa-5); sec. 413 
of Pub. L. 100-233, 101 Stat. 1568, 1639.

Subpart J--Lending and Leasing Limits

    4. Revise Sec.  614.4351(a) introductory text to read as follows:


Sec.  614.4351  Computation of lending and leasing limit base

    (a) Lending and leasing limit base. An institution's lending and 
leasing limit base is composed of the permanent capital of the 
institution, as defined in Sec.  615.5201 of this chapter, with 
adjustments applicable to the institution provided for in Sec.  
615.5207 of this chapter, and with the following further adjustments:
* * * * *

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

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

Subpart H--Capital Adequacy

    6. Revise the heading of Sec.  615.5200 to read as follows:


Sec.  615.5200  Capital planning.

* * * * *
    7. Revise Sec.  615.5201 to read as follows:


Sec.  615.5201  Definitions.

    For the purpose of this subpart, the following definitions apply:
    Allocated investment means earnings allocated but not paid in cash 
by a System bank to an association or other recipient.
    Bank means an institution that:
    (1) Engages in the business of banking;
    (2) Is recognized as a bank by the bank supervisory or monetary 
authority of the country of its organization or principal banking 
operations;
    (3) Receives deposits to a substantial extent in the regular course 
of business; and
    (4) Has the power to accept demand deposits.
    Commitment means any arrangement that legally obligates an 
institution to:
    (1) Purchase loans or securities;
    (2) Participate in loans or leases;
    (3) Extend credit in the form of loans or leases;
    (4) Pay the obligation of another;
    (5) Provide overdraft, revolving credit, or underwriting 
facilities; or
    (6) Participate in similar transactions.
    Credit conversion factor means that number by which an off-balance 
sheet item is multiplied to obtain a credit equivalent before placing 
the item in a risk-weight category.
    Credit derivative means a contract that allows one party (the 
protection purchaser) to transfer the credit risk of an asset or off-
balance sheet credit exposure to another party (the protection 
provider). The value of a credit derivative is dependent, at least

[[Page 47998]]

in part, on the credit performance of a ``reference asset.''
    Credit-enhancing interest-only strip
    (1) The term credit-enhancing interest-only strip means an on-
balance sheet asset that, in form or in substance:
    (i) Represents the contractual right to receive some or all of the 
interest due on transferred assets; and
    (ii) Exposes the institution to credit risk directly or indirectly 
associated with the transferred assets that exceeds its pro rata claim 
on the assets, whether through subordination provisions or other credit 
enhancement techniques.
    (2) FCA reserves the right to identify other cash flows or related 
interests as credit-enhancing interest-only strips. In determining 
whether a particular interest cash flow functions as a credit-enhancing 
interest-only strip, FCA will consider the economic substance of the 
transaction.
    Credit-enhancing representations and warranties
    (1) The term credit-enhancing representations and warranties means 
representations and warranties that:
    (i) Are made or assumed in connection with a transfer of assets 
(including loan-servicing assets), and
    (ii) Obligate an institution to protect investors from losses 
arising from credit risk in the assets transferred or loans serviced.
    (2) Credit-enhancing representations and warranties include 
promises to protect a party from losses resulting from the default or 
nonperformance of another party or from an insufficiency in the value 
of the collateral.
    (3) Credit-enhancing representations and warranties do not include:
    (i) Early-default clauses and similar warranties that permit the 
return of, or premium refund clauses covering, loans for a period not 
to exceed 120 days from the date of transfer. These warranties may 
cover only those loans that were originated within 1 year of the date 
of the transfer;
    (ii) Premium refund clauses covering assets guaranteed, in whole or 
in part, by the United States Government, a United States Government 
agency, or a United States Government-sponsored agency, provided the 
premium refund clause is for a period not to exceed 120 days from the 
date of transfer;
    (iii) Warranties that permit the return of assets in instances of 
fraud, misrepresentation, or incomplete documentation; or
    (iv) Clean-up calls if the agreements to repurchase are limited to 
10 percent or less of the original pool balance (except where loans 30 
days or more past due are repurchased).
    Deferred-tax assets that are dependent on future income or future 
events means:
    (1) Deferred-tax assets arising from deductible temporary 
differences dependent upon future income that exceed the amount of 
taxes previously paid that could be recovered through loss carrybacks 
if existing temporary differences (both deductible and taxable and 
regardless of where the related tax-deferred effects are recorded on 
the institution's balance sheet) fully reverse;
    (2) Deferred-tax assets dependent upon future income arising from 
operating loss and tax carryforwards;
    (3) Deferred-tax assets arising from temporary differences that 
could be recovered if existing temporary differences that are dependent 
upon other future events (both deductible and taxable and regardless of 
where the related tax-deferred effects are recorded on the 
institution's balance sheet) fully reverse.
    Direct credit substitute means an arrangement in which an 
institution assumes, in form or in substance, credit risk directly or 
indirectly associated with an on- or off-balance sheet asset or 
exposure that was not previously owned by the institution (third-party 
asset) and the risk assumed by the institution exceeds the pro rata 
share of the institution's interest in the third-party asset. If the 
institution has no claim on the third-party asset, then the 
institution's assumption of any credit risk is a direct credit 
substitute. Direct credit substitutes include, but are not limited to:
    (1) Financial standby letters of credit that support financial 
claims on a third party that exceed an institution's pro rata share in 
the financial claim;
    (2) Guarantees, surety arrangements, credit derivatives, and 
similar instruments backing financial claims that exceed an 
institution's pro rata share in the financial claim;
    (3) Purchased subordinated interests that absorb more than their 
pro rata share of losses from the underlying assets;
    (4) Credit derivative contracts under which the institution assumes 
more than its pro rata share of credit risk on a third-party asset or 
exposure;
    (5) Loans or lines of credit that provide credit enhancement for 
the financial obligations of a third party;
    (6) Purchased loan-servicing assets if the servicer is responsible 
for credit losses or if the servicer makes or assumes credit-enhancing 
representations and warranties with respect to the loans serviced. 
Servicer cash advances as defined in this section are not direct credit 
substitutes; and,
    (7) Clean-up calls on third-party assets. However, clean-up calls 
that are 10 percent or less of the original pool balance and that are 
exercisable at the option of the institution are not direct credit 
substitutes.
    Direct lender institution means an institution that extends credit 
in the form of loans or leases to eligible borrowers in its own right 
and carries such loan or lease assets on its books.
    Externally rated means that an instrument or obligation has 
received a credit rating from at least one NRSRO.
    Face amount means:
    (1) The notional principal, or face value, amount of an off-balance 
sheet item;
    (2) The amortized cost of an asset not held for trading purposes; 
and
    (3) The fair value of a trading asset.
    Financial asset means cash or other monetary instrument, evidence 
of debt, evidence of an ownership interest in an entity, or a contract 
that conveys a right to receive from or exchange cash or another 
financial instrument with another party.
    Financial standby letter of credit means a letter of credit or 
similar arrangement that represents an irrevocable obligation to a 
third-party beneficiary:
    (1) To repay money borrowed by, or advanced to, or for the account 
of, a second party (the account party); or
    (2) To make payment on behalf of the account party, in the event 
that the account party fails to fulfill its obligation to the 
beneficiary.
    Government agency means an agency or instrumentality of the United 
States Government whose obligations are fully and explicitly guaranteed 
as to the timely repayment of principal and interest by the full faith 
and credit of the United States Government.
    Government-sponsored agency means an agency or instrumentality 
chartered or established to serve public purposes specified by the 
United States Congress but whose obligations are not explicitly 
guaranteed by the full faith and credit of the United States 
Government.
    Institution means a Farm Credit Bank, Federal land bank 
association, Federal land credit association, production credit 
association, agricultural credit association, Farm Credit Leasing 
Services Corporation, bank for cooperatives, agricultural credit bank, 
and their successors.
    Nationally recognized statistical rating organization (NRSRO) means 
a rating organization that the Securities and Exchange Commission 
recognizes as an NRSRO.
    Non-OECD bank means a bank and its branches (foreign and domestic)

[[Page 47999]]

organized under the laws of a country that does not belong to the OECD 
group of countries.
    Nonagreeing association means an association that does not have an 
allotment agreement in effect with a Farm Credit Bank or agricultural 
credit bank pursuant to Sec.  615.5207(b)(2).
    OECD means the group of countries that are full members of the 
Organization for Economic Cooperation and Development, regardless of 
entry date, as well as countries that have concluded special lending 
arrangements with the International Monetary Fund's General Arrangement 
to Borrow, excluding any country that has rescheduled its external 
sovereign debt within the previous 5 years.
    OECD bank means a bank and its branches (foreign and domestic) 
organized under the laws of a country that belongs to the OECD group of 
countries. For purposes of this subpart, this term includes U.S. 
depository institutions.
    Performance-based standby letter of credit means any letter of 
credit, or similar arrangement, however named or described, that 
represents an irrevocable obligation to the beneficiary on the part of 
the issuer to make payment as a result of any default by a third party 
in the performance of a nonfinancial or commercial obligation.
    Permanent capital, subject to adjustments as described in Sec.  
615.5207, includes:
    (1) Current year retained earnings;
    (2) Allocated and unallocated earnings (which, in the case of 
earnings allocated in any form by a System bank to any association or 
other recipient and retained by the bank, must be considered, in whole 
or in part, permanent capital of the bank or of any such association or 
other recipient as provided under an agreement between the bank and 
each such association or other recipient);
    (3) All surplus;
    (4) Stock issued by a System institution, except:
    (i) Stock that may be retired by the holder of the stock on 
repayment of the holder's loan, or otherwise at the option or request 
of the holder;
    (ii) Stock that is protected under section 4.9A of the Act or is 
otherwise not at risk;
    (iii) Farm Credit Bank equities required to be purchased by Federal 
land bank associations in connection with stock issued to borrowers 
that is protected under section 4.9A of the Act;
    (iv) Capital subject to revolvement, unless:
    (A) The bylaws of the institution clearly provide that there is no 
express or implied right for such capital to be retired at the end of 
the revolvement cycle or at any other time; and
    (B) The institution clearly states in the notice of allocation that 
such capital may only be retired at the sole discretion of the board of 
directors in accordance with statutory and regulatory requirements and 
that no express or implied right to have such capital retired at the 
end of the revolvement cycle or at any other time is thereby granted;
    (5) Term preferred stock with an original maturity of at least 5 
years and on which, if cumulative, the board of directors has the 
option to defer dividends, provided that, at the beginning of each of 
the last 5 years of the term of the stock, the amount that is eligible 
to be counted as permanent capital is reduced by 20 percent of the 
original amount of the stock (net of redemptions);
    (6) Financial assistance provided by the Farm Credit System 
Insurance Corporation that the FCA determines appropriate to be 
considered permanent capital; and
    (7) 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.
    Qualified residential loan:
    (1) The term qualified residential loan means:
    (i) A rural home loan, as authorized by Sec.  613.3030, and
    (ii) A single-family residential loan to a bona fide farmer, 
rancher, or producer or harvester of aquatic products.
    (2) A qualified residential loan must be secured by a first lien 
mortgage or deed of trust, must have been approved in accordance with 
prudent underwriting standards, must not be past due 90 days or more or 
carried in nonaccrual status, and must have a monthly amortization 
schedule. In addition, the secured residence and residential site must 
have a deed separate from other adjoining land and a permanent right-
of-way access.
    Qualifying bilateral netting contract means a bilateral netting 
contract that meets at least the following conditions:
    (1) The contract is in writing;
    (2) The contract is not subject to a walkaway clause, defined as a 
provision that permits a non-defaulting counterparty to make lower 
payments than it would make otherwise under the contract, or no payment 
at all, to a defaulter or to the estate of a defaulter, even if the 
defaulter or the estate of the defaulter is a net creditor under the 
contract;
    (3) The contract creates a single obligation either to pay or 
receive the net amount of the sum of positive and negative mark-to-
market values for all derivative contracts subject to the qualifying 
bilateral netting contract;
    (4) The institution receives a legal opinion that represents, to a 
high degree of certainty, that in the event of legal challenge the 
relevant court and administrative authorities would find the 
institution's exposure to be the net amount;
    (5) The institution establishes a procedure to monitor relevant law 
and to ensure that the contracts continue to satisfy the requirements 
of this section; and
    (6) The institution maintains in its files adequate documentation 
to support the netting of a derivatives contract.
    Qualifying securities firm means:
    (1) A securities firm incorporated in the United States that is a 
broker-dealer that is registered with the Securities and Exchange 
Commission (SEC) and that complies with the SEC's net capital 
regulations (17 CFR 240.15c3-1); and
    (2) A securities firm incorporated in any other OECD-based country, 
if the institution is able to demonstrate that the securities firm is 
subject to supervision and regulation (covering its direct and indirect 
subsidiaries, but not necessarily its parent organizations) comparable 
to that imposed on depository institutions in OECD countries. Such 
regulation must include risk-based capital requirements comparable to 
those imposed on depository institutions under the Accord on 
International Convergence of Capital Measurement and Capital Standards 
(1988, as amended in 1998) (Basel Accord).
    Recourse means an institution's retention, in form or in substance, 
of any credit risk directly or indirectly associated with an asset it 
has sold (in accordance with generally accepted accounting principles) 
that exceeds a pro rata share of the institution's claim on the asset. 
If an institution has no claim on an asset it has sold, then the 
retention of any credit risk is recourse. A recourse obligation 
typically arises when an institution transfers assets in a sale and 
retains an explicit obligation to repurchase assets or to absorb losses 
due to a default on the payment of principal or interest or any other 
deficiency in the performance of the underlying obligor or some other 
party. Recourse may also exist implicitly if an institution provides 
credit enhancement beyond

[[Page 48000]]

any contractual obligation to support assets it has sold. Recourse 
obligations include, but are not limited to:
    (1) Credit-enhancing representations and warranties made on 
transferred assets;
    (2) Loan-servicing assets retained pursuant to an agreement under 
which the institution will be responsible for losses associated with 
the loans serviced. Servicer cash advances as defined in this section 
are not recourse obligations;
    (3) Retained subordinated interests that absorb more than their pro 
rata share of losses from the underlying assets;
    (4) Assets sold under an agreement to repurchase, if the assets are 
not already included on the balance sheet;
    (5) Loan strips sold without contractual recourse where the 
maturity of the transferred portion of the loan is shorter than the 
maturity of the commitment under which the loan is drawn;
    (6) Credit derivatives issued that absorb more than the 
institution's pro rata share of losses from the transferred assets; and
    (7) Clean-up call on assets the institution has sold. However, 
clean-up calls that are 10 percent or less of the original pool balance 
and that are exercisable at the option of the institution are not 
recourse arrangements.
    Residual interest:
    (1) The term residual interest means any on-balance sheet asset 
that:
    (i) Represents an interest (including a beneficial interest) 
created by a transfer that qualifies as a sale (in accordance with 
generally accepted accounting principles) of financial assets, whether 
through a securitization or otherwise; and
    (ii) Exposes an institution to credit risk directly or indirectly 
associated with the transferred asset that exceeds a pro rata share of 
the institution's claim on the asset, whether through subordination 
provisions or other credit enhancement techniques.
    (2) Residual interests generally include credit-enhancing interest-
only strips, spread accounts, cash collateral accounts, retained 
subordinated interests (and other forms of overcollateralization), and 
similar assets that function as a credit enhancement.
    (3) Residual interests further include those exposures that, in 
substance, cause the institution to retain the credit risk of an asset 
or exposure that had qualified as a residual interest before it was 
sold.
    (4) Residual interests generally do not include interests purchased 
from a third party. However, purchased credit-enhancing interest-only 
strips are residual interests.
    Risk-adjusted asset base means the total dollar amount of the 
institution's assets adjusted in accordance with Sec.  615.5207 and 
weighted on the basis of risk in accordance with Sec. Sec.  615.5211 
and 615.5212.
    Risk participation means a participation in which the originating 
party remains liable to the beneficiary for the full amount of an 
obligation (e.g., a direct credit substitute) notwithstanding that 
another party has acquired a participation in that obligation.
    Rural Business Investment Company has the definition given in 7 
U.S.C. 2009cc(14).
    Securitization means the pooling and repackaging by a special 
purpose entity or trust of assets or other credit exposures that can be 
sold to investors. Securitization includes transactions that create 
stratified credit risk positions whose performance is dependent upon an 
underlying pool of credit exposures, including loans and commitments.
    Servicer cash advance means funds that a mortgage servicer advances 
to ensure an uninterrupted flow of payments, including advances made to 
cover foreclosure costs or other expenses to facilitate the timely 
collection of the loan. A servicer cash advance is not a recourse 
obligation or a direct credit substitute if:
    (1) The servicer is entitled to full reimbursement and this right 
is not subordinated to other claims on the cash flows from the 
underlying asset pool; or
    (2) For any one loan, the servicer's obligation to make 
nonreimbursable advances is contractually limited to an insignificant 
amount of the outstanding principal amount on that loan.
    Stock means stock and participation certificates.
    Total capital means assets minus liabilities, valued in accordance 
with generally accepted accounting principles (GAAP), except that 
liabilities do not include obligations to retire stock protected under 
section 4.9A of the Act.
    Traded position means a position retained, assumed, or issued that 
is externally rated, where there is a reasonable expectation that, in 
the near future, the rating will be relied upon by:
    (1) Unaffiliated investors to purchase the position; or
    (2) An unaffiliated third party to enter into a transaction 
involving the position, such as a purchase, loan, or repurchase 
agreement.
    U.S. depository institution means branches (foreign and domestic) 
of federally insured banks and depository institutions chartered and 
headquartered in the 50 states of the United States, the District of 
Columbia, Puerto Rico, and United States territories and possessions. 
The definition encompasses banks, mutual or stock savings banks, 
savings or building and loan associations, cooperative banks, credit 
unions, international banking facilities of domestic depository 
institutions, and U.S.-chartered depository institutions owned by 
foreigners. The definition excludes branches and agencies of foreign 
banks located in the U.S. and bank holding companies.


Sec.  615.5210  [Removed]

    8. Remove existing Sec.  615.5210.
    9. Add new Sec. Sec.  615.5206 through 615.5212 to read as follows:


Sec.  615.5206  Permanent capital ratio computation.

    (a) The institution's permanent capital ratio is determined on the 
basis of the financial statements of the institution prepared in 
accordance with generally accepted accounting principles except that 
the obligations of the Farm Credit System Financial Assistance 
Corporation issued to repay banks in connection with the capital 
preservation and loss-sharing agreements described in section 6.9(e)(1) 
of the Act shall not be considered obligations of any institution 
subject to this regulation prior to their maturity.
    (b) The institution's asset base and permanent capital are computed 
using average daily balances for the most recent 3 months.
    (c) The institution's permanent capital ratio is calculated by 
dividing the institution's permanent capital, adjusted in accordance 
with Sec.  615.5207 (the numerator), by the risk-adjusted asset base 
(the denominator) as determined in Sec.  615.5210, to derive a ratio 
expressed as a percentage.
    (d) Until September 27, 2002, payments of assessments to the Farm 
Credit System Financial Assistance Corporation, and any part of the 
obligation to pay future assessments to the Farm Credit System 
Financial Assistance Corporation that is recognized as an expense on 
the books of a bank or association, shall be included in the capital of 
such bank or association for the purpose of determining its compliance 
with regulatory capital requirements, to the extent allowed by section 
6.26(c)(5)(G) of the Act. If the bank directly or indirectly passes on 
all or part of the payments to its affiliated associations pursuant to 
section 6.26(c)(5)(D) of the

[[Page 48001]]

Act, such amounts shall be included in the capital of the associations 
and shall not be included in the capital of the bank. After September 
27, 2002, no payments of assessments or obligations to pay future 
assessments may be included in the capital of the bank or association.


Sec.  615.5207  Capital adjustments and associated reductions to 
assets.

    For the purpose of computing the institution's permanent capital 
ratio, the following adjustments must be made prior to assigning assets 
to risk-weight categories and computing the ratio:
    (a) Where two Farm Credit System institutions have stock 
investments in each other, such reciprocal holdings must be eliminated 
to the extent of the offset. If the investments are equal in amount, 
each institution must deduct from its assets and its total capital an 
amount equal to the investment. If the investments are not equal in 
amount, each institution must deduct from its total capital and its 
assets an amount equal to the smaller investment. The elimination of 
reciprocal holdings required by this paragraph must be made prior to 
making the other adjustments required by this section.
    (b) Where a Farm Credit Bank or an agricultural credit bank is 
owned by one or more Farm Credit System institutions, the double 
counting of capital is eliminated in the following manner:
    (1) All equities of a Farm Credit Bank or agricultural credit bank 
that have been purchased by other Farm Credit institutions are 
considered to be permanent capital of the Farm Credit Bank or 
agricultural credit bank.
    (2) Each Farm Credit Bank or agricultural credit bank and each of 
its affiliated associations may enter into an agreement that specifies, 
for the purpose of computing permanent capital only, a dollar amount 
and/or percentage allotment of the association's allocated investment 
between the bank and the association. Section 615.5208 provides 
conditions for allotment agreements or defines allotments in the 
absence of such agreements.
    (c) A Farm Credit Bank or agricultural credit bank and a recipient, 
other than an association, of allocated earnings from such bank may 
enter into an agreement specifying a dollar amount and/or percentage 
allotment of the recipient's allocated earnings in the bank between the 
bank and the recipient. Such agreement must comply with the provisions 
of paragraph (b) of this section, except that, in the absence of an 
agreement, the allocated investment must be allotted 100 percent to the 
allocating bank and 0 percent to the recipient. All equities of the 
bank that are purchased by a recipient are considered as permanent 
capital of the issuing bank.
    (d) A bank for cooperatives and a recipient of allocated earnings 
from such bank may enter into an agreement specifying a dollar amount 
and/or percentage allotment of the recipient's allocated earnings in 
the bank between the bank and the recipient. Such agreement must comply 
with the provisions of paragraph (b) of this section, except that, in 
the absence of an agreement, the allocated investment must be allotted 
100 percent to the allocating bank and 0 percent to the recipient. All 
equities of a bank that are purchased by a recipient shall be 
considered as permanent capital of the issuing bank.
    (e) Where a bank or association invests in an association to 
capitalize a loan participation interest, the investing institution 
must deduct from its total capital an amount equal to its investment in 
the participating institution.
    (f) The double-counting of capital by a service corporation 
chartered under section 4.25 of the Act and its stockholder 
institutions must be eliminated by deducting an amount equal to the 
institution's investment in the service corporation from its total 
capital.
    (g) Each institution must deduct from its total capital an amount 
equal to all goodwill, whenever acquired.
    (h) To the extent an institution has deducted its investment in 
another Farm Credit institution from its total capital, the investment 
may be eliminated from its asset base.
    (i) Where a Farm Credit Bank and an association have an enforceable 
written agreement to share losses on specifically identified assets on 
a predetermined quantifiable basis, such assets must be counted in each 
institution's risk-adjusted asset base in the same proportion as the 
institutions have agreed to share the loss.
    (j) The permanent capital of an institution must exclude the net 
effect of all transactions covered by the definition of ``accumulated 
other comprehensive income'' contained in the Statement of Financial 
Accounting Standards No. 130, as promulgated by the Financial 
Accounting Standards Board.
    (k) For purposes of calculating capital ratios under this part, 
deferred-tax assets are subject to the conditions, limitations, and 
restrictions described in Sec.  615.5209.
    (l) Capital may also need to be reduced for potential loss exposure 
on any recourse obligations, direct credit substitutes, residual 
interests, and credit-enhancing interest-only-strips in accordance with 
Sec.  615.5210.


Sec.  615.5208  Allotment of allocated investments.

    (a) The following conditions apply to agreements that a Farm Credit 
Bank or agricultural credit bank enters into with an affiliated 
association pursuant to Sec.  615.5207(b)(2):
    (1) The agreement must be for a term of 1 year or longer.
    (2) The agreement must be entered into on or before its effective 
date.
    (3) The agreement may be amended according to its terms, but no 
more frequently than annually except in the event that a party to the 
agreement is merged or reorganized.
    (4) On or before the effective date of the agreement, a certified 
copy of the agreement, and any amendments thereto, must be sent to the 
field office of the Farm Credit Administration responsible for 
examining the institution. A copy must also be sent within 30 calendar 
days of adoption to the bank's other affiliated associations.
    (5) Unless the parties otherwise agree, if the bank and the 
association have not entered into a new agreement on or before the 
expiration of an existing agreement, the existing agreement will 
automatically be extended for another 12 months, unless either party 
notifies the Farm Credit Administration in writing of its objection to 
the extension prior to the expiration of the existing agreement.
    (b) In the absence of an agreement between a Farm Credit Bank or an 
agricultural credit bank and one or more associations, or in the event 
that an agreement expires and at least one party has timely objected to 
the continuation of the terms of its agreement, the following formula 
applies with respect to the allocated investments held by those 
associations with which there is no agreement (nonagreeing 
associations), and does not apply to the allocated investments held by 
those associations with which the bank has an agreement (agreeing 
associations):
    (1) The allotment formula must be calculated annually.
    (2) The permanent capital ratio of the Farm Credit Bank or 
agricultural credit bank must be computed as of the date that the 
existing agreement terminates, using a 3-month average daily balance, 
excluding the allocated investment from nonagreeing associations but 
including any allocated investments of agreeing associations that are 
allotted to the bank

[[Page 48002]]

under applicable allocation agreements. The permanent capital ratio of 
each nonagreeing association must be computed as of the same date using 
a 3-month average daily balance, and must be computed excluding its 
allocated investment in the bank.
    (3) If the permanent capital ratio for the Farm Credit Bank or 
agricultural credit bank calculated in accordance with Sec.  615.5211 
is 7 percent or above, the allocated investment of each nonagreeing 
association whose permanent capital ratio calculated in accordance with 
Sec.  615.5211 is 7 percent or above must be allotted 50 percent to the 
bank and 50 percent to the association.
    (4) If the permanent capital ratio of the Farm Credit Bank or 
agricultural credit bank calculated in accordance with Sec.  615.5211 
is 7 percent or above, the allocated investment of each nonagreeing 
association whose capital ratio is below 7 percent must be allotted to 
the association until the association's capital ratio reaches 7 percent 
or until all of the investment is allotted to the association, 
whichever occurs first. Any remaining unallotted allocated investment 
must be allotted 50 percent to the bank and 50 percent to the 
association.
    (5) If the permanent capital ratio of the Farm Credit Bank or 
agricultural credit bank calculated in accordance with Sec.  615.5211 
is less than 7 percent, the amount of additional capital needed by the 
bank to reach a permanent capital ratio of 7 percent must be 
determined, and an amount of the allocated investment of each 
nonagreeing association must be allotted to the Farm Credit Bank or 
agricultural credit bank, as follows:
    (i) If the total of the allocated investments of all nonagreeing 
associations is greater than the additional capital needed by the bank, 
the allocated investment of each nonagreeing association must be 
multiplied by a fraction whose numerator is the amount of capital 
needed by the bank and whose denominator is the total amount of 
allocated investments of the nonagreeing associations, and such amount 
must be allotted to the bank. Next, if the permanent capital ratio of 
any nonagreeing association is less than 7 percent, a sufficient amount 
of unallotted allocated investment must then be allotted to each 
nonagreeing association, as necessary, to increase its permanent 
capital ratio to 7 percent, or until all such remaining investment is 
allotted to the association, whichever occurs first. Any unallotted 
allocated investment still remaining must be allotted 50 percent to the 
bank and 50 percent to the nonagreeing association.
    (ii) If the additional capital needed by the bank is greater than 
the total of the allocated investments of the nonagreeing associations, 
all of the remaining allocated investments of the nonagreeing 
associations must be allotted to the bank.
    (c) If a payment or part of a payment to the Farm Credit System 
Financial Assistance Corporation pursuant to section 6.9(e)(3)(D)(ii) 
of the Act would cause a bank to fall below its minimum permanent 
capital requirement, the bank and one or more association shall amend 
their allocation agreements to increase the allotment of the allocated 
investment to the bank sufficiently to enable the bank to make the 
payment to the Farm Credit System Financial Assistance Corporation, 
provided that the associations would continue to meet their minimum 
permanent capital requirement. In the case of a nonagreeing 
association, the Farm Credit Administration may require a revision of 
the allotment sufficient to enable the bank to make the payment to the 
Farm Credit System Financial Assistance Corporation, provided that the 
association would continue to meet its minimum permanent capital 
requirement. The Farm Credit Administration Board may, at the request 
of one or more of the institutions affected, waive the requirements of 
this paragraph if the Board deems it is in the overall best interest of 
the institutions affected.


Sec.  615.5209  Deferred-tax assets.

    For purposes of calculating capital ratios under this part, 
deferred-tax assets are subject to the conditions, limitations, and 
restrictions described in this section.
    (a) Each institution must deduct an amount of deferred-tax assets, 
net of any valuation allowance, from its assets and its total capital 
that is equal to the greater of:
    (1) The amount of deferred-tax assets that is dependent on future 
income or future events in excess of the amount that is reasonably 
expected to be realized within 1 year of the most recent calendar 
quarter-end date, based on financial projections for that year, or
    (2) The amount of deferred-tax assets that is dependent on future 
income or future events in excess of 10 percent of the amount of core 
surplus that exists before the deduction of any deferred-tax assets.
    (b) For purposes of this calculation:
    (1) The amount of deferred-tax assets that can be realized from 
taxes paid in prior carryback years and from the reversal of existing 
taxable temporary differences may not be deducted from assets and from 
equity capital.
    (2) All existing temporary differences should be assumed to fully 
reverse at the calculation date.
    (3) Projected future taxable income should not include net 
operating loss carryforwards to be used within 1 year or the amount of 
existing temporary differences expected to reverse within that year.
    (4) Financial projections must include the estimated effect of tax-
planning strategies that are expected to be implemented to minimize tax 
liabilities and realize tax benefits. Financial projections for the 
current fiscal year (adjusted for any significant changes that have 
occurred or are expected to occur) may be used when applying the 
capital limit at an interim date within the fiscal year.
    (5) The deferred tax effects of any unrealized holding gains and 
losses on available-for-sale debt securities may be excluded from the 
determination of the amount of deferred-tax assets that are dependent 
upon future taxable income and the calculation of the maximum allowable 
amount of such assets. If these deferred-tax effects are excluded, this 
treatment must be followed consistently over time.


Sec.  615.5210  Risk-adjusted assets.

    (a) Computation. Each asset on the institution's balance sheet and 
each off-balance-sheet item, adjusted by the appropriate credit 
conversion factor in Sec.  615.5212, is assigned to one of the risk 
categories specified in Sec.  615.5211. The aggregate dollar value of 
the assets in each category is multiplied by the percentage weight 
assigned to that category. The sum of the weighted dollar values from 
each of the risk categories comprises ``risk-adjusted assets,'' the 
denominator for computation of the permanent capital ratio.
    (b) Ratings-based approach. (1) Under the ratings-based approach:
    (i) Beginning 18 months after the effective date of this section, a 
position in a securitization that is unrated and guaranteed by a 
Government-sponsored agency is assigned to the appropriate risk-weight 
category based on the issuer credit rating of the agency.
    (ii) A rated position in a securitization (provided it satisfies 
the criteria specified in paragraph (b)(3) of this section) is assigned 
to the appropriate risk-weight category based on its external rating.
    (2) Provided they satisfy the criteria specified in paragraph 
(b)(3) of this

[[Page 48003]]

section, the following positions qualify for the ratings-based 
approach:
    (i) Recourse obligations;
    (ii) Direct credit substitutes;
    (iii) Residual interests (other than credit-enhancing interest-only 
strips); and
    (iv) Asset-or mortgage-backed securities.
    (3) A position specified in paragraph (b)(2) of this section 
qualifies for a ratings-based approach provided it satisfies the 
following criteria:
    (i) If the position is traded and externally rated, its long-term 
external rating must be one grade below investment grade or better 
(e.g., BB or better) or its short-term external rating must be 
investment grade or better (e.g., A-3, P-3). If the position receives 
more than one external rating, the lowest rating applies.
    (ii) If the position is not traded and is externally rated,
    (A) It must be externally rated by more than one NRSRO;
    (B) Its long-term external rating must be one grade below 
investment grade or better (e.g., BB or better) or its short-term 
external rating must be investment grade or better (e.g., A-3, P-3 or 
better). If the ratings are different, the lowest rating applies;
    (C) The ratings must be publicly available; and
    (D) The ratings must be based on the same criteria used to rate 
traded positions.
    (iii) Beginning 18 months after the effective date of this section, 
the position is unrated and is guaranteed by a Government-sponsored 
agency.
    (c) Positions in securitizations that do not qualify for a ratings-
based approach. The following positions in securitizations do not 
qualify for a ratings-based approach, whether or not they are 
guaranteed by Government-sponsored agencies. They are treated as 
indicated.
    (1) For any residual interest that is not externally rated, the 
institution must deduct from capital and assets the face amount of the 
position (dollar-for-dollar reduction).
    (2) For any credit-enhancing interest-only strip, the institution 
must deduct from capital and assets the face amount of the position 
(dollar-for-dollar reduction).
    (3) For any position that has a long-term external rating that is 
two grades below investment grade or lower (e.g., B or lower) or a 
short-term external rating that is one grade below investment grade or 
lower (e.g., B or lower, Not Prime), the institution must deduct from 
capital and assets the face amount of the position (dollar-for-dollar 
reduction).
    (4) Any recourse obligation or direct credit substitute (e.g., a 
purchased subordinated security) that is not externally rated is risk 
weighted using the amount of the recourse obligation or direct credit 
substitute and the full amount of the assets it supports, i.e., all the 
more senior positions in the structure. This treatment is subject to 
the low-level exposure rule set forth in paragraph (e) of this section. 
This amount is then placed into a risk-weight category according to the 
obligor or, if relevant, the guarantor or the nature of the collateral.
    (5) Any stripped mortgage-backed security or similar instrument, 
such as an interest-only strip that is not credit-enhancing or a 
principal-only strip, is assigned to the 100-percent risk-weight 
category described in Sec.  615.5211(d)(7).
    (d) Senior positions not externally rated. For a position in a 
securitization that is not externally rated but is senior in all 
features to a traded position (including collateralization and 
maturity), an institution may apply a risk weight to the face amount of 
the senior position based on the traded position's external rating. 
This section will apply only if the traded position provides 
substantial credit support for the entire life of the unrated position.
    (e) Low-level exposure rule. If the maximum contractual exposure to 
loss retained or assumed by an institution in connection with a 
recourse obligation or a direct credit substitute is less than the 
effective risk-based capital requirement for the credit-enhanced 
assets, the risk-based capital required under paragraph (c)(4) of this 
section is limited to the institution's maximum contractual exposure, 
less any recourse liability account established in accordance with 
generally accepted accounting principles. This limitation does not 
apply when an institution provides credit enhancement beyond any 
contractual obligation to support assets it has sold.
    (f) Reservation of authority. The FCA may, on a case-by-case basis, 
determine the appropriate risk weight for any asset or credit 
equivalent amount that does not fit wholly within one of the risk 
categories set forth in Sec.  615.5211 or that imposes risks that are 
not commensurate with the risk weight otherwise specified in Sec.  
615.5211 for the asset or credit equivalent. In addition, the FCA may, 
on a case-by-case basis, determine the appropriate credit conversion 
factor for any off-balance sheet item that does not fit wholly within 
one of the credit conversion factors set forth in Sec.  615.5212 or 
that imposes risks that are not commensurate with the credit conversion 
factor otherwise specified in Sec.  615.5212 for the item. In making 
this determination, the FCA will consider the similarity of the asset 
or off-balance sheet item to assets or off-balance sheet items 
explicitly treated in Sec. Sec.  615.5211 or 615.5212, as well as other 
relevant factors.


Sec.  615.5211  Risk categories--balance sheet assets.

    Section 615.5210(c) specifies certain balance sheet assets that are 
not assigned to the risk categories set forth below. All other balance 
sheet assets are assigned to the percentage risk categories as follows:
    (a) Category 1: 0 Percent
    (1) Cash (domestic and foreign).
    (2) Balances due from Federal Reserve Banks and central banks in 
other OECD countries.
    (3) Direct claims on, and portions of claims unconditionally 
guaranteed by, the U.S. Treasury, government agencies, or central 
governments in other OECD countries.
    (4) Portions of local currency claims on, or unconditionally 
guaranteed by, non-OECD central governments (including non-OECD central 
banks), to the extent the institution has liabilities booked in that 
currency.
    (5) Claims on, or guaranteed by, qualifying securities firms that 
are collateralized by cash on deposit in the institution or by 
securities issued or guaranteed by the United States (including U.S. 
Government agencies) or OECD central governments, provided that a 
positive margin of collateral is required to be maintained on such a 
claim on a daily basis, taking into account any change in the 
institution's exposure to the obligor or counterparty under the claim 
in relation to the market value of the collateral held in support of 
the claim.
    (b) Category 2: 20 Percent
    (1) Cash items in the process of collection.
    (2) Loans and other obligations of and investments in Farm Credit 
institutions.
    (3) All claims (long- and short-term) on, and portions of claims 
(long- and short-term) guaranteed by, OECD banks (excluding claims 
described in paragraphs (b)(7), (c)(4) or (d)(11) of this section).
    (4) Short-term (remaining maturity of 1 year or less) claims on, 
and portions of short-term claims guaranteed by, non-OECD banks.
    (5) Portions of loans and other claims conditionally guaranteed by 
the U.S. Treasury, government agencies, or central governments in other 
OECD countries and portions of local currency claims conditionally 
guaranteed by non-

[[Page 48004]]

OECD central governments to the extent that the institution has 
liabilities booked in that currency.
    (6) Securities and other claims on, and portions of claims 
guaranteed by, Government-sponsored agencies (excluding positions in 
securitizations described in Sec.  615.5210 and claims that are 
described in (b)(7), (c)(4) or (d)(11) of this section), without regard 
to issuer credit rating.
    (7)(i) Until 18 months after this rule's effective date, assets or 
portions of assets covered by credit protection provided by Government-
sponsored agencies and OECD banks through credit derivatives (e.g., 
credit default swaps), loss purchase commitments, guarantees, and other 
similar arrangements;
    (ii) Beginning 18 months after the effective date of this section, 
assets or portions of assets covered by credit protection provided by 
Government-sponsored agencies and OECD banks through credit derivatives 
(e.g., credit default swaps), loss purchase commitments, guarantees, 
and other similar arrangements, provided the Government-sponsored 
agencies and OECD banks have an issuer credit rating in one of the two 
highest investment grade ratings from at least one NRSRO (if the credit 
protection provider is rated by more than one NRSRO the lowest rating 
applies).
    (8) Portions of loans and other claims (including repurchase 
agreements) collateralized by securities issued or guaranteed by the 
U.S. Treasury, government agencies, Government-sponsored agencies or 
central governments in other OECD countries.
    (9) Portions of loans and other claims collateralized by cash held 
by the institution or its funding bank.
    (10) General obligation claims on, and portions of claims 
guaranteed by, the full faith and credit of states or other political 
subdivisions or OECD countries, including U.S. state and local 
governments.
    (11) Claims on, and portions of claims guaranteed by, official 
multinational lending institutions or regional development institutions 
in which the U.S. Government is a shareholder or a contributing member.
    (12) Portions of claims collateralized by securities issued by 
official multilateral lending institutions or regional development 
institutions in which the U.S. Government is a shareholder or 
contributing member.
    (13) Investments in shares of mutual funds whose portfolios are 
permitted to hold only assets that qualify for the zero or 20-percent 
risk categories.
    (14) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips) and asset- 
or mortgage-backed securities that:
    (i) Are externally rated in the highest or second highest 
investment grade category, e.g., AAA, AA, in the case of long-term 
ratings, or the highest rating category, e.g., A-1, P-1, in the case of 
short-term ratings; or
    (ii)(A) Until 18 months after the effective date of this section, 
are unrated and are guaranteed by a Government-sponsored agency;
    (B) Beginning 18 months after the effective date of this section, 
are unrated and are guaranteed by a Government-sponsored agency with an 
issuer credit rating in the highest or second highest investment grade 
category, e.g., AAA or AA.
    (15) Claims on, and claims guaranteed by, qualifying securities 
firms provided that:
    (i) The qualifying securities firm, or at least one issue of its 
long-term debt, has a rating in one of the highest two investment grade 
rating categories from an NRSRO (if the securities firm or debt has 
more than one NRSRO rating the lowest rating applies); or
    (ii) The claim is guaranteed by a qualifying securities firm's 
parent company with such a rating.
    (16) Certain collateralized claims on qualifying securities firms 
without regard to satisfaction of the rating standard, provided that 
the claim arises under a contract that:
    (i) Is a reverse repurchase/repurchase agreement or securities 
lending/borrowing transaction executed under standard industry 
documentation;
    (ii) Is collateralized by liquid and readily marketable debt or 
equity securities;
    (iii) Is marked-to-market daily;
    (iv) Is subject to a daily margin maintenance requirement under the 
standard documentation; and
    (v) Can be liquidated, terminated, or accelerated immediately in 
bankruptcy or similar proceeding, and the security or collateral 
agreement will not be stayed or avoided, under applicable law of the 
relevant country.
    (17) Claims on other financing institutions provided that:
    (i) The other financing institution qualifies as an OECD bank or it 
is owned and controlled by an OECD bank that guarantees the claim, or
    (ii) The other financing institution has a rating in one of the 
highest three investment-grade rating categories from a NRSRO or the 
claim is guaranteed by a parent company with such a rating, and
    (iii) The other financing institution has endorsed all obligations 
it pledges to its funding Farm Credit bank with full recourse.
    (c) Category 3: 50 Percent
    (1) All other investment securities with remaining maturities under 
1 year, if the securities are not eligible for the ratings-based 
approach or subject to the dollar-for-dollar capital treatment.
    (2) Qualified residential loans.
    (3) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips) and asset- 
or mortgage-backed securities that:
    (i) Are rated in the third highest investment grade category, e.g., 
A, in the case of long-term ratings, or the second highest rating 
category, e.g., A-2, P-2, in the case of short-term ratings; or
    (ii) Beginning 18 months after the effective date of this section, 
are unrated and are guaranteed by a Government-sponsored agency with an 
issuer credit rating in the third highest investment grade category, 
e.g., A.
    (4) Beginning 18 months after the effective date of this section, 
assets or portions of assets covered by credit protection provided by 
Government-sponsored agencies and OECD banks through credit derivatives 
(e.g., credit default swaps), loss purchase commitments, guarantees, 
and other similar arrangements, provided the Government-sponsored 
agencies and OECD banks have an issuer credit rating in the third 
highest investment grade category, e.g., A, from at least one NRSRO (if 
they are rated by more than one NRSRO the lowest rating applies).
    (5) Revenue bonds or similar obligations, including loans and 
leases, that are obligations of state or political subdivisions of the 
United States or other OECD countries but for which the government 
entity is committed to repay the debt only out of revenue from the 
specific projects financed.
    (6) Claims on other financing institutions that:
    (i) Are not covered by the provisions of paragraph (b)(17) of this 
section, but otherwise meet similar capital, risk identification and 
control, and operational standards, or
    (ii) Carry an investment-grade or higher NRSRO rating or the claim 
is guaranteed by a parent company with such a rating, and
    (iii) The other financing institution has endorsed all obligations 
it pledges to its funding Farm Credit bank with full recourse.
    (d) Category 4: 100 Percent. This category includes all assets not 
specified in the categories above or below nor deducted dollar-for-
dollar from capital

[[Page 48005]]

and assets as discussed in Sec.  615.5210(c). This category comprises 
standard risk assets such as those typically found in a loan or lease 
portfolio and includes:
    (1) All other claims on private obligors;
    (2) Claims on, or portions of claims guaranteed by, non-OECD banks 
with a remaining maturity exceeding 1 year; and
    (3) Claims on, or portions of claims guaranteed by, non-OECD 
central governments that are not included in paragraphs (a)(4) or 
(b)(4) of this section, and all claims on non-OECD state and local 
governments.
    (4) Industrial-development bonds and similar obligations issued 
under the auspices of states or political subdivisions of the OECD-
based group of countries for the benefit of a private party or 
enterprise where that party or enterprise, not the government entity, 
is obligated to pay the principal and interest.
    (5) Premises, plant, and equipment; other fixed assets; and other 
real estate owned.
    (6) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips) and asset- 
or mortgage-backed securities that:
    (i) Are rated in the lowest investment grade category, e.g., BBB, 
in the case of long-term ratings, or the third highest rating category, 
e.g., A-3, P-3, in the case of short-term ratings; or
    (ii) Beginning 18 months after the effective date of this section, 
are unrated and are guaranteed by a Government-sponsored agency that 
has an issuer credit rating in or below the lowest investment grade 
category, e.g., BBB, or that is unrated.
    (7) Stripped mortgage-backed securities and similar instruments, 
such as interest-only strips that are not credit-enhancing and 
principal-only strips (including such instruments guaranteed by 
Government-sponsored agencies).
    (8) Investments in Rural Business Investment Companies.
    (9) If they have not already been deducted from capital:
    (i) Investments in unconsolidated companies, joint ventures, or 
associated companies.
    (ii) Deferred-tax assets.
    (iii) Servicing assets.
    (10) All non-local currency claims on foreign central governments, 
as well as local currency claims on foreign central governments that 
are not included in any other category;
    (11) Beginning 18 months after the effective date of this section, 
assets or portions of assets covered by credit protection provided by 
Government-sponsored agencies and OECD banks through credit derivatives 
(e.g., credit default swaps), loss purchase commitments, guarantees, 
and other similar arrangements, provided the Government-sponsored 
agencies and OECD banks have an issuer credit rating in the lowest 
investment grade category, e.g., BBB, or below from at least one NRSRO 
(if they are rated by more than one NRSRO the lowest rating applies) or 
are unrated;
    (12) Claims on other financing institutions that do not otherwise 
qualify for a lower risk-weight category under this section; and
    (13) All other assets not specified above, including but not 
limited to leases and receivables.
    (e) Category 5: 200 Percent. Recourse obligations, direct credit 
substitutes, residual interests (other than credit-enhancing interest-
only strips) and asset- or mortgage-backed securities that are rated 
one category below the lowest investment grade category, e.g., BB.


Sec.  615.5212  Credit conversion factors--off-balance sheet items.

    (a) The face amount of an off-balance sheet item is generally 
incorporated into risk-weighted assets in two steps. For most off-
balance sheet items, the face amount is first multiplied by a credit 
conversion factor. (In the case of direct credit substitutes and 
recourse obligations the full amount of the assets enhanced are 
multiplied by a credit conversion factor). The resultant credit 
equivalent amount is assigned to the appropriate risk-weight category 
described in Sec.  615.5211 according to the obligor or, if relevant, 
the guarantor or the collateral.
    (b) Conversion factors for various types of off-balance sheet items 
are as follows:
    (1) 0 Percent
    (i) Unused commitments with an original maturity of 14 months or 
less;
    (ii) Unused commitments with an original maturity greater than 14 
months if:
    (A) They are unconditionally cancellable by the institution; and
    (B) The institution has the contractual right to, and in fact does, 
make a separate credit decision based upon the borrower's current 
financial condition before each drawing under the lending arrangement.
    (2) 20 Percent. Short-term, self-liquidating, trade-related 
contingencies, including but not limited to commercial letters of 
credit.
    (3) 50 Percent
    (i) Transaction-related contingencies (e.g., bid bonds, performance 
bonds, warranties, and performance-based standby letters of credit 
related to a particular transaction).
    (ii) Unused loan commitments with an original maturity greater than 
14 months, including underwriting commitments and commercial credit 
lines.
    (iii) Revolving underwriting facilities (RUFs), note issuance 
facilities (NIFs) and other similar arrangements pursuant to which the 
institution's customer can issue short-term debt obligations in its own 
name, but for which the institution has a legally binding commitment to 
either:
    (A) Purchase the obligations its customer is unable to sell by a 
stated date; or
    (B) Advance funds to its customer if the obligations cannot be 
sold.
    (4) 100 Percent
    (i) The full amount of the assets supported by direct credit 
substitutes and recourse obligations for which an institution directly 
or indirectly retains or assumes credit risk. For risk participations 
in such arrangements acquired by the institution, the full amount of 
assets supported by the main obligation multiplied by the acquiring 
institution's percentage share of the risk participation. The capital 
requirement under this paragraph is limited to the institution's 
maximum contractual exposure, less any recourse liability account 
established under generally accepted accounting principles.
    (ii) Acquisitions of risk participations in bankers acceptances.
    (iii) Sale and repurchase agreements, if not already included on 
the balance sheet.
    (iv) Forward agreements (i.e., contractual obligations) to purchase 
assets, including financing facilities with certain drawdown.
    (c) Credit equivalents of interest rate contracts and foreign 
exchange contracts. (1) Credit equivalents of interest rate contracts 
and foreign exchange contracts (except single-currency floating/
floating interest rate swaps) are determined by adding the replacement 
cost (mark-to-market value, if positive) to the potential future credit 
exposure, determined by multiplying the notional principal amount by 
the following credit conversion factors as appropriate.

[[Page 48006]]



                                            Conversion Factor Matrix
                                                  [In Percent]
----------------------------------------------------------------------------------------------------------------
                       Remaining maturity                          Interest rate   Exchange rate     Commodity
----------------------------------------------------------------------------------------------------------------
1 year or less..................................................             0.0             1.0            10.0
Over 1 to 5 years...............................................             0.5             5.0            12.0
Over 5 years....................................................             1.5             7.5            15.0
----------------------------------------------------------------------------------------------------------------

    (2) For any derivative contract that does not fall within one of 
the categories in the above table, the potential future credit exposure 
is be calculated using the commodity conversion factors. The net 
current exposure for multiple derivative contracts with a single 
counterparty and subject to a qualifying bilateral netting contract is 
the net sum of all positive and negative mark-to-market values for each 
derivative contract. The positive sum of the net current exposure is 
added to the adjusted potential future credit exposure for the same 
multiple contracts with a single counterparty. The adjusted potential 
future credit exposure is computed as Anet = (0.4 x 
Agross) + 0.6 (NGR x Agross) where:
    (i) Anet is the adjusted potential future credit 
exposure;
    (ii) Agross is the sum of potential future credit 
exposures determined by multiplying the notional principal amount by 
the appropriate credit conversion factor; and
    (iii) NGR is the ratio of the net current credit exposure divided 
by the gross current credit exposure determined as the sum of only the 
positive mark-to-markets for each derivative contract with the single 
counterparty.
    (3) Credit equivalents of single-currency floating/floating 
interest rate swaps are determined by their replacement cost (mark-to-
market).

Subpart K--Surplus and Collateral Requirements

    10. Amend Sec.  615.5301 by revising paragraphs (b)(3), (i)(2), and 
(i)(8) to read as follows:


Sec.  615.5301  Definitions.

    (b) * * *
    (3) The deductions that must be made by an institution in the 
computation of its permanent capital pursuant to Sec.  615.5207(e), 
(f), (h), and (j) shall also be made in the computation of its core 
surplus. Deductions required by Sec.  615.5207(a) shall also be made to 
the extent that they do not duplicate deductions calculated pursuant to 
this section and required by Sec.  615.5330(b)(2).
* * * * *
    (i) * * *
    (2) Allocated equities, including allocated surplus and stock, that 
are not subject to a plan or practice of revolvement or retirement of 5 
years or less and are eligible to be included in permanent capital 
pursuant to Sec.  615.5201; and
* * * * *
    (8) Any deductions made by an institution in the computation of its 
permanent capital pursuant to Sec.  615.5207 shall also be made in the 
computation of its total surplus.
* * * * *


Sec.  615.5330  [Amended]

    11. Amend Sec.  615.5330 by removing the reference ``Sec.  
615.5210(f)'' and adding in its place ``Sec.  615.5210'' in paragraphs 
(a)(2) and (b)(3).

PART 620--DISCLOSURE TO SHAREHOLDERS

    12. 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); secs. 424 of Pub. L. 100-233, 101 
Stat. 1568, 1656.

Subpart A--General


Sec.  620.1  [Amended]

    13. Amend Sec.  620.1(j) by removing the reference ``Sec.  
615.5201(l)'' and adding in its place ``Sec.  615.5201.''

    Dated: July 30, 2004.
Jeanette C. Brinkley,
Secretary, Farm Credit Administration Board.
[FR Doc. 04-17570 Filed 8-5-04; 8:45 am]
BILLING CODE 6705-01-P