[Federal Register Volume 69, Number 220 (Tuesday, November 16, 2004)]
[Proposed Rules]
[Pages 67070-67073]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-25395]


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FARM CREDIT ADMINISTRATION

12 CFR Part 615

RIN 3052-AC22


Funding and Fiscal Affairs, Loan Policies and Operations, and 
Funding Operations; Investments, Liquidity, and Divestiture

AGENCY: Farm Credit Administration.

ACTION: Proposed rule.

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SUMMARY: The Farm Credit Administration (FCA, we, or our) proposes to 
amend our liquidity reserve requirement for the banks of the Farm 
Credit System (System). The proposed rule would increase the minimum 
liquidity reserve requirement to 90 days. We also propose to change the 
eligible investment limit from 30 percent of total outstanding loans to 
35 percent of total outstanding loans.

DATES: You may send your comments on or before January 3, 2005.

ADDRESSES: Comments may be sent by electronic mail to [email protected], 
through the Pending Regulations section of our Web site at http://www.fca.gov or through the Government-wide http://www.regulations.gov 
portal. You may also send written comments to S. Robert Coleman, 
Director, Regulation and Policy Division, Office of Policy and 
Analysis, Farm Credit Administration, 1501 Farm Credit Drive, McLean,

[[Page 67071]]

Virginia 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) 883-4498; TTY (703) 883-4434; orLaura McFarland, 
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:
    1. Ensure Farm Credit banks have adequate liquidity in the case of 
market disruption or other extraordinary situations;
    2. Improve the flexibility of Farm Credit banks to meet liquidity 
reserve requirements;
    3. Strengthen the safety and soundness of Farm Credit banks; and,
    4. Enhance the ability of the System to supply credit to 
agriculture and rural America in all economic conditions.

II. Background

    The System is a nationwide network of borrower-owned lending 
cooperatives. Congress created the System as a Government-sponsored 
enterprise (GSE) to provide a permanent, reliable source of credit and 
related services to American agriculture and aquatic producers. The 
System meets this broad public need by financing agriculture and 
related businesses in rural areas. The System obtains funds to provide 
this financing through the issuance of Systemwide debt securities.\1\ 
Section 1.5(15) of the Farm Credit Act of 1971, as amended, (the Act) 
permits Farm Credit banks to make investments as authorized by FCA.\2\ 
We issue regulations under section 5.17(a)(9) of the Act to ensure the 
safe and sound operations of the System.
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    \1\ Farm Credit banks use the Federal Farm Credit Banks Funding 
Corporation (Funding Corporation) to issue and market Systemwide 
debt securities. The Funding Corporation is owned by the Farm Credit 
banks.
    \2\ Pub. L. 92-181, 85 Stat. 583. Section 4.2 of the Act 
authorizes Farm Credit banks to issue Systemwide debt securities as 
a means of obtaining funds for the System's operations and to invest 
excess funds.
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    Our regulatory responsibilities include issuing regulations to 
ensure the System has adequate liquidity during market disruptions or 
other extraordinary situations so that it can meet the ongoing 
financing needs of agriculture and rural America. Under this authority, 
we issued Sec.  615.5134 requiring Farm Credit banks to maintain a 
liquidity reserve sufficient to fund operations for approximately 15 
days. We also issued Sec.  615.5132 restricting the investment 
authority of Farm Credit banks to 30 percent of total outstanding 
loans. The liquidity reserve provision was established to protect the 
System against potential market disruptions, while the regulatory 
investment limit prevents Farm Credit banks from using their GSE status 
to borrow favorably from the capital markets and accumulate large 
investment portfolios for arbitrage activities.
    The liquidity of Farm Credit banks depends largely upon access to 
the debt markets. Consistent market access is essential to the System's 
mission of providing financing to agriculture and rural America in both 
good and bad times. In the event that access to the debt market becomes 
impeded, Farm Credit banks must have sufficient liquidity to pay for 
maturing obligations. The importance of sufficient liquidity has become 
more evident in recent years. Since we established the current minimum 
liquidity requirement, investors, credit rating agencies, and market 
participants have become increasingly concerned with liquidity risk in 
financial institutions, including GSEs.\3\ A Basel Committee report 
also recommends assessing market access under both normal and adverse 
circumstances.\4\ Adverse circumstances directly affecting Farm Credit 
banks would include systemic events that essentially shut down the 
financial system, unfavorable events within the agricultural sector, or 
deterioration in the financial performance of an individual Farm Credit 
bank that triggers a condition of the Market Access Agreement.\5\
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    \3\ We last amended these regulations in 1999. See 64 FR 28884 
(May 28, 1999).
    \4\ ``Sound Practices for Managing Liquidity in Banking 
Organizations,'' Basel Committee on Banking Supervision, www.bis.org 
(accessed June 2, 2004).
    \5\ See 2003 Amended and Restated Market Access Agreement, 
Articles III, IV, and V (68 FR 2037, January 15, 2003).
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    The events of September 11, 2001 led to a significant market 
disruption causing the normal coordination of payments and funding in 
the markets to break down. The massive damage to property and 
communications systems resulted in financial institutions collectively 
growing short of liquidity. The Federal Reserve supplied significant 
short-term liquidity to market participants, ensuring that the 
financial systems in the United States continued to function. As a 
result, the Farm Credit banks and other GSEs continued to raise funds 
by issuing short-term debt securities.
    The events of September 11, 2001, as well as geopolitical 
instability, corporate scandals, problems of the telecommunications 
industry, and widespread credit deterioration contributed to a 
reduction in investors' risk tolerance. Investors were concerned that 
corporations were overly dependent on short-term debt. Credit rating 
agencies downgraded several non-financial commercial paper issues, 
effectively shutting many corporations out of the short-term debt 
market. By September 2002, the commercial paper market had shrunk by 
more than 50 percent. Investors also questioned liquidity risk 
associated with the GSEs' heavy reliance on short-term debt. Most GSEs, 
including the System, responded by increasing longer term debt 
issuances and decreasing short-term debt outstanding.
    In response to market events, Farm Credit banks also entered a 
voluntary Common Minimum Liquidity Standard (CMLS) agreement to 
maintain more than the existing regulatory liquidity reserve 
requirement.\6\ The banks agreed in the CMLS to maintain at least 90 
days of liquidity. The two largest housing GSEs had previously 
implemented similar voluntary liquidity commitments.\7\
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    \6\ Farm Credit System Annual Information Statement, at 49 
(2003).
    \7\ ``Freddie Mac and Fannie Mae Announce Enhancements to Risk 
Management, Capital and Disclosure Practices and Standards,'' Press 
Release, October 19, 2000, www.fanniemae.com (accessed June 3, 
2004).
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    While the Farm Credit banks operated during the events of 2001 
without accessing their liquidity reserve, we support the current 
industry trend of building a higher liquidity reserve to reduce 
potential risks from market disruptions of greater duration or 
magnitude. We also believe that ongoing investor concerns about the 
safe and sound operations of financial institutions in times of crisis 
must be addressed, in part, through regulatory action. If access to the 
debt markets is hindered or investor confidence in Systemwide debt 
securities erodes for any reason, the System must have adequate 
liquidity to sustain operations and fulfill its Congressional mandate.
    For these reasons, we propose to increase the regulatory liquidity 
reserve requirement to 90 days. We note that the proposed change is a 
minimum reserve level. Farm Credit banks may need to set a higher 
target liquidity reserve

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minimum as part of their investment management policies, recognizing 
that in adverse situations a significantly higher liquidity reserve may 
be needed to protect against prolonged market disruptions.
    Additionally, we propose to apply discounts on assets used to fund 
the liquidity reserve. Farm Credit banks may only use cash and eligible 
investments to fund the liquidity reserve. The discounts approximate 
the cost of liquidating an investment portfolio over a short period of 
time in adverse situations. Investments used to fund the liquidity 
reserve must be readily marketable. We define readily marketable assets 
to be investments that can be quickly converted into cash at a 
reasonable cost and in a timely manner.
    We are also proposing two other amendments to our regulations: (1) 
Changing the eligible investment limit from 30 percent of total 
outstanding loans to 35 percent of total outstanding loans; and (2) 
requiring Farm Credit banks to establish and maintain a contingency 
plan. Under current Sec.  615.5132, each Farm Credit bank may only hold 
investments equaling no more than 30 percent of the bank's total 
outstanding loans. This limit, when combined with a larger liquidity 
reserve requirement, may restrict Farm Credit banks' ability to 
effectively manage their balance sheet. Therefore, we propose changing 
the limit to 35 percent of a bank's total outstanding loans.
    In order to increase liquidity, Farm Credit banks must either 
increase liquid investments or the duration of their debt. Increasing 
the liquidity reserve requirement without a corresponding change in the 
investment limit could reduce the banks' ability to effectively react 
to a variety of market conditions. For example, in a declining interest 
rate environment, a bank may want to shorten the duration of its 
liabilities to more closely match assets that may be subject to faster 
prepayments in a declining rate environment. However, if a bank has 
reached its investment limitation, the minimum liquidity reserve 
requirement would eventually constrain a bank's ability to shorten the 
duration of its debt. We believe a change in the limit of eligible 
investments is warranted to provide the banks with additional 
flexibility to successfully meet their liquidity needs and accomplish 
their asset/liability management strategies in all economic conditions. 
While making the limit less restrictive, we also note that the housing 
GSE regulatory agencies do not place a ceiling on total investments.\8\
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    \8\ The Federal Housing Finance Board limits Federal Home Loan 
Bank (FHLB) investments in mortgage-backed securities to 300 percent 
of the bank's previous month-end capital and limits non-mortgage 
investments to 11 percent of total assets. See 12 CFR 966 and FHLB 
Financial Report (2003). The Office of Federal Housing Enterprise 
Oversight provides general guidance pertaining to non-mortgage 
investments but no limitations. See 12 CFR 1720.
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    We also propose to require Farm Credit banks to have a liquidity 
contingency plan as part of their investment policies. The proposed 
changes to our existing regulations are explained in more detail in the 
section-by-section analysis below.

III. Section-by-Section Analysis

A. Investment Purposes [Sec.  615.5132]

    We propose amending Sec.  615.5132 by changing the current eligible 
investment limit from 30 percent of total outstanding loans to 35 
percent of total outstanding loans. Farm Credit banks use investments 
to manage short-term surplus funds, meet the minimum liquidity reserve 
requirement and manage interest rate risk. We believe a limit change to 
35 percent of total outstanding loans would provide the banks with more 
flexibility to successfully meet their liquidity needs and accomplish 
their asset/liability management strategies. This change would allow 
Farm Credit banks sufficient latitude to effectively react to rapidly 
changing market conditions that can impact bank performance while still 
limiting the banks' ability to arbitrage their GSE status in the debt 
markets.

B. Liquidity Reserve Requirement

1. Minimum Liquidity Reserve Days [Sec.  615.5134(a)]
    We propose amending Sec.  615.5134(a) to establish a minimum 
liquidity reserve sufficient to fund 90 days of maturing obligations 
and other bank borrowings. We determined that the existing reserve 
requirement of approximately 15 days of liquidity, while adequate under 
normal operations and for short-term disruptions, is insufficient for 
prolonged market disruption. For example, during the agricultural 
crisis of the 1980s, the System suffered tremendous financial stress 
and the market required a higher rate of return for System debt. The 
Farm Credit banks reacted to the crisis by increasing their liquidity 
reserves over 220 percent between 1985 and 1986 to protect against 
further market disruption.\9\
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    \9\ Farm Credit System Annual Information Statement, at 4 
(1986).
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    We propose a mandatory minimum 90-day liquidity reserve to provide 
a safeguard for borrowers and investors. Under the proposed minimum, 
Farm Credit banks will be able to continue to fulfill their mission in 
a safe and sound manner, even under extreme market conditions. The 
proposed rule specifies that the reserve amount is based on the 
discounted value of the liquid assets. These discounts are discussed in 
section III.B.3. of this preamble.
    The proposed rule would also remove the existing liquidity reserve 
calculation in Sec.  615.5134(a). We believe a specific number of days 
is less burdensome than the procedure of calculating days and will 
result in greater accuracy when determining reserve levels.
2. Minimum Investment Rating [Sec.  615.5134(a)]
    The proposed rule would require that certain investments used to 
fund the liquidity reserve carry one of the two highest ratings from a 
Nationally Recognized Statistical Rating Organization (NRSRO) in order 
to be counted toward the reserve requirement. Higher rated investments 
are generally more liquid, less volatile, and can be quickly converted 
into cash without significant loss. The proposed rule would also allow 
Farm Credit banks to include investments that are not rated in their 
liquidity reserves, if the investments are issued by an issuer that has 
one of the two highest ratings or they are guaranteed by the full faith 
and credit of the United States Government.
3. Discounts [Sec.  615.5134(c)]
    The proposed rule would replace the calculations in Sec.  
615.5134(c) with discounts of assets used to fund the liquidity 
reserve. Each investment would be discounted to consider the cost of 
liquidating an investment portfolio over a short period of time in 
adverse situations. We believe a system of discounting assets more 
accurately reflects true market conditions. For example, investments 
that are less interest rate sensitive, such as short-term and variable 
rate instruments that remain below their cap, are given less of a 
discount because they are exposed to less price risk. The discount for 
long-term fixed rate instruments is higher because of greater market 
risk.
    The proposed discounting method is calculated as follows:

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                                                            Multiply by
                       Instrument                          (in percent)
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Cash and overnight investments..........................             100

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Money market instruments & floating rate debt securities              95
 below contractual rate.................................
Fixed rate debt securities..............................              90
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4. Liquidity Contingency Plan [Sec.  615.5134(d)]
    The proposed rule would add a new Sec.  615.5134(d) requiring each 
Farm Credit bank to develop a contingency plan in order to ensure the 
most effective use of the liquidity reserve. The proposed rule would 
require the plan to be annually reviewed and updated, if necessary. 
This requirement is similar to the requirement in Sec.  615.5133(a) 
that the investment management policies be reviewed annually, making 
all needed changes. We expect a contingency plan to contain a strategy 
with clear procedures to address liquidity shortfalls in the event of 
market disruption. The proposed rule would allow the banks to include 
the contingency plan in their investment policy documents. We encourage 
the banks to use the Basel Committee report on managing liquidity in 
banking organizations as a guide when developing the contingency plan.

IV. Miscellaneous

1. Technical Changes
    We propose replacing ``Farm Credit banks, bank for cooperatives, 
and agricultural credit banks,'' in Sec.  615.5132 and Sec.  615.5134 
with ``Farm Credit bank'' pursuant to the definition contained in Sec.  
619.9140 of our regulations. As a conforming change, we propose 
removing the definition for ``Bank'' from Sec.  615.5131(b) because it 
is unnecessary and redesignating the subsequent paragraphs. We also 
propose changing Sec.  615.5174(a) to correct the cross-reference to 
Sec.  615.5131(g) to reflect the redesignation of paragraphs.
2. Other Issues
    We are seeking comments on the procedure for disposing of 
ineligible investments under Sec.  615.5143. Our existing regulation 
requires a Farm Credit bank to divest itself of formerly eligible 
investments that have become ineligible. Divestiture must occur within 
6 months unless we have approved a divestiture plan extending the time 
to divest. Prior to this rulemaking, a Farm Credit bank asked us to 
provide investment flexibility instead of divestiture when facing 
unavoidable financial loss. We are seeking comments on this matter, 
specifically for those situations when general economic conditions 
cause an investment to become ineligible or when the eligibility of an 
investment may be restored.

V. Regulatory Flexibility Act

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

List of Subjects in 12 CFR Part 615

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

    For the reasons stated in the preamble, part 615 of chapter VI, 
title 12 of the Code of Federal Regulations is proposed to be amended 
as follows:

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

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

    Authority: Secs. 1.5, 1.7, 1.10, 1.11, 1.12, 2.2, 2.3, 2.4, 2.5, 
2.12, 3.1, 3.7, 3.11, 3.25, 4.3, 4.3A, 4.9, 4.14B, 4.25, 5.9, 5.17, 
6.20, 6.26, 8.0, 8.3, 8.4, 8.6, 8.7, 8.8, 8.10, 8.12 of the Farm 
Credit Act (12 U.S.C. 2013, 2015, 2018, 2019, 2020, 2073, 2074, 
2075, 2076, 2093, 2122, 2128, 2132, 2146, 2154, 2154a, 2160, 2202b, 
2211, 2243, 2252, 2278b, 2278b-6, 2279aa, 2279aa-3, 2279aa-4, 
2279aa-6, 2279aa-7, 2279aa-8, 2279aa-10, 2279aa-12); sec. 301(a) of 
Pub. L. 100-233, 101 Stat. 1568, 1608.

Subpart E--Investment Management


Sec.  615.5131  [Amended]

    2. Amend Sec.  615.5131 by:
    a. Removing paragraph (b) and redesignating existing paragraphs (c) 
through (m) as paragraphs (b) through (l), consecutively; and
    b. Removing the reference ``Sec.  615.5131(i)'' and adding in its 
place, the reference ``Sec.  615.5131(h)'' in paragraph (a).
    3. Revise Sec.  615.5132 to read as follows:


Sec.  615.5132  Investment purposes.

    Each Farm Credit bank is allowed to hold eligible investments, 
listed under Sec.  615.5140, in an amount not to exceed 35 percent of 
its total outstanding loans, to comply with the liquidity reserve 
requirement of Sec.  615.5134, manage surplus short-term funds, and 
manage interest rate risk under Sec.  615.5135.
    4. Amend Sec.  615.5134 by revising paragraphs (a) and (c) and by 
adding new paragraph (d) to read as follows:


Sec.  615.5134  Liquidity reserve requirement.

    (a) Each Farm Credit bank must maintain a liquidity reserve of cash 
and the eligible investments under Sec.  615.5140, discounted in 
accordance with paragraph (c) of this section, sufficient to fund 90 
days of maturing obligations and other borrowings of the bank. Money 
market instruments, floating, and fixed rate debt securities used to 
fund the liquidity reserve must be backed by the full faith and credit 
of the United States or rated in one of the two highest NRSRO credit 
categories. If not rated, the issuer's NRSRO credit rating, if one of 
the two highest, may be used.
* * * * *
    (c) The liquid assets of the liquidity reserve are discounted as 
follows:
    (1) Multiply cash and overnight investments by 100 percent.
    (2) Multiply money market instruments and floating rate debt 
securities that are below the contractual cap rate by 95 percent of the 
market value.
    (3) Multiply fixed rate debt securities by 90 percent of the market 
value.
    (4) Multiply individual securities in diversified investment funds 
by the discounts that would apply to the securities if held separately.
    (d) Each Farm Credit bank must have a contingency plan to address 
liquidity shortfalls during market disruptions. The board of directors 
must review the plan each year, making all needed changes. Farm Credit 
banks may incorporate these requirements into their Sec.  615.5133 
investment management policies.

Subpart F--Property, Transfers of Capital, and Other Investments


Sec.  615.5174  [Amended]

    5. Amend Sec.  615.5174 by removing the reference``Sec.  
615.5131(g)'' and adding in its place, the reference``Sec.  
615.5131(f)'' in paragraph (a).

    Dated: November 10, 2004.
Jeanette C. Brinkley,
Secretary, Farm Credit Administration Board.
[FR Doc. 04-25395 Filed 11-15-04; 8:45 am]
BILLING CODE 6705-01-P