[Federal Register Volume 70, Number 168 (Wednesday, August 31, 2005)]
[Rules and Regulations]
[Pages 51586-51590]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-17266]


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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: Final rule.

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SUMMARY: The Farm Credit Administration (FCA, we, or our) issues this 
final rule amending our liquidity reserve requirement for the banks of 
the Farm Credit System (System) to ensure the banks have adequate 
liquidity. The final rule increases the minimum liquidity reserve 
requirement to 90 days, increases the eligible investment limit to 35 
percent of total outstanding loans and requires Farm Credit banks to 
develop and maintain liquidity

[[Page 51587]]

contingency plans. These enhanced requirements will improve the ability 
of Farm Credit banks to supply agricultural credit in all economic 
situations.

DATES: This regulation will be effective 30 days after the publication 
in the Federal Register during which either or both Houses of Congress 
are in session. We will publish a notice of the effective date in the 
Federal Register.

FOR FURTHER INFORMATION CONTACT:

Wade Wynn, Financial Analyst, Office of Regulatory Policy, Farm Credit 
Administration, McLean, VA 22102-5090, (703) 883-4498; TTY (703) 883-
4434; or
Laura McFarland, Senior Attorney, Office of General Counsel, Farm 
Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703) 
883-4020.

SUPPLEMENTARY INFORMATION:

I. Objectives

    The objectives of this rule are to:
     Ensure Farm Credit banks have adequate liquidity in the 
case of market disruption or other extraordinary situations;
     Improve the flexibility of Farm Credit banks to meet 
liquidity reserve requirements;
     Strengthen the safety and soundness of Farm Credit banks; 
and
     Enhance the ability of the System to supply credit to 
agriculture and rural America in all economic conditions.

II. Background

    Congress created the System as a government-sponsored enterprise 
(GSE) to provide a permanent, stable, and reliable source of credit and 
related services to American agriculture and aquatic producers. Farm 
Credit banks obtain funds to provide this financing through System-wide 
debt securities.\1\ If access to the debt market becomes temporarily 
impeded, Farm Credit banks must have enough liquidity to continue 
operations and pay maturing obligations.
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    \1\ Farm Credit banks use the Federal Farm Credit Banks Funding 
Corporation (Funding Corporation) to issue and market System-wide 
debt securities. The Funding Corporation is owned by the Farm Credit 
banks.
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    In 1993, we issued Sec.  615.5134 requiring each Farm Credit bank 
to maintain a liquidity reserve sufficient to fund operations for 
approximately 15 days.\2\ We also issued Sec.  615.5132 restricting 
eligible investments of Farm Credit banks to 30 percent of total 
outstanding loans. The investment limit authorizes Farm Credit banks to 
hold eligible investments for the purposes of (1) Maintaining a 
liquidity reserve (2) managing surplus short-term funds, and (3) 
managing interest rate risk. The liquidity reserve provision ensures 
the safety and soundness of Farm Credit banks, protecting the System 
from potential market disruptions, and the 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. To supplement the regulatory minimum liquidity 
reserve, and to respond to market conditions and expectations, the Farm 
Credit banks entered into a voluntary Common Minimum Liquidity Standard 
(CMLS) agreement to maintain at least 90 days of liquidity. All Farm 
Credit banks currently exceed the voluntary minimum liquidity reserve 
requirement.\3\
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    \2\ 58 FR 63034 (November 30, 1993).
    \3\ The System's liquidity position was 174 days at March 31, 
2005. See Farm Credit System Quarterly Information Statement, at 21 
(May 9, 2005).
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    On November 16, 2004, we published a proposed rule (69 FR 67070) to 
increase the minimum liquidity reserve requirement to 90 days and raise 
the maximum eligible investment limit to 35 percent of total 
outstanding loans. We also proposed that Farm Credit banks develop and 
maintain contingency plans to ensure the most effective use of the 
liquidity reserve and to address potential liquidity shortfalls in the 
event of market disruptions. This final rule addresses the comments 
received on the proposed rule.

III. Comments and Our Response

    We received 5 comments on our proposed rule from three Farm Credit 
banks, the Farm Credit Council (FCC) representing its membership, and 
the American Bankers Association (ABA). We also received one comment 
from a Farm Credit bank as part of our regulatory burden initiative. 
All commenters supported increasing the liquidity reserve requirement. 
However, the ABA objected to raising the investment limit, while System 
commenters asked us to further increase or remove the limit. System 
commenters also asked us to clarify other aspects of our proposed rule.
    We discuss those aspects, along with the individual comments 
associated with our proposed changes, and our response below. 
Commenters also responded to our request for comments on the existing 
rule for disposing of ineligible investments, which we discuss 
separately below.
    Those areas of the proposed rule that did not receive comments are 
finalized as proposed.

A. Investment Purposes [Sec.  615.5132]

    The FCC and Farm Credit banks generally agreed with increasing the 
eligible investment limit, but also urged us to remove the limit. One 
Farm Credit bank stated that the investment limit was arbitrary and 
does not provide the System with adequate flexibility. Another argued 
that the limit constrains the bank's ability to achieve a higher level 
of liquidity if necessary. The FCC commented that investment limits 
should be set by the bank's board of directors and not by regulation. 
The FCC argued that an effective risk management program provides a 
better framework for controlling risk and a regulatory investment limit 
places an artificial and unnecessary burden on the System with no 
resulting benefit. Three Farm Credit banks alternatively suggested 
investment limits of 40 and 50 percent of total outstanding loans if 
the limit is not removed. One Farm Credit bank further recommended, as 
an alternative to a 40-percent investment limit, to include unused 
commitments with total outstanding loans when calculating the 
percentage of investments.
    The ABA opposed increasing the investment limit. The ABA argued 
that the Farm Credit banks have been able to successfully fund their 
individual liquidity reserves under the current investment limit. The 
ABA commented that the increase would allow the System to accumulate 
larger investment portfolios to further arbitrage profits, thereby 
diverting financial resources away from farmers, ranchers, and rural 
homeowners. The ABA also commented that a higher investment limit is 
unnecessary because the System is a GSE and, during times of systemic 
stress, investors generally flock to safer investments, including GSE 
debt securities.
    We disagree that an eligible investment limit is unnecessary or 
that the increase is inappropriate. We believe an investment limit 
ensures agricultural loans comprise the greatest portion of the 
System's assets, thereby fulfilling its mission of financing 
agriculture and rural America. We limit total eligible investments to 
prevent Farm Credit banks from engaging in inappropriate investment 
activities that are incompatible with their GSE status. Additionally, 
we disagree that a higher investment limit is unnecessary. The 
combination of an increased minimum liquidity reserve requirement and 
investment limit is designed to address

[[Page 51588]]

situations where the System's access to the debt market becomes 
temporarily impeded. We recognize the Farm Credit banks have been 
successful at maintaining appropriate levels of liquidity and managing 
their balance sheets under the existing investment limit and current, 
favorable market conditions. However, a larger liquidity reserve 
requirement, without a corresponding increase in the investment limit, 
could constrain the ability of Farm Credit banks to manage operations 
under different market conditions. Under more adverse market 
conditions, Farm Credit banks may not be able to increase their days of 
liquidity through extending the duration of debt without incurring 
substantial cost. The higher investment limit provides each Farm Credit 
bank additional flexibility to meet the larger liquidity reserve 
requirement and to effectively manage their balance sheets in all 
economic conditions.
    Similarly, we reject the suggestions for a higher investment limit 
than the one proposed.\4\ Increasing the eligible investment limit to 
35 percent is appropriate given the six-fold increase in the minimum 
liquidity reserve requirement. We believe a 5-percent higher investment 
limit addresses the 90-day minimum liquidity reserve requirement 
without compromising the System's responsibility to finance 
agriculture. Should an emergency situation arise when greater 
investments are necessary, Farm Credit banks may request FCA approval 
to temporarily increase the investment limit under Sec.  615.5136(a).
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    \4\ The FCA has recently authorized, as eligible investments 
under Sec.  615.5140(e), pilot mission-related investment programs 
that are not subject to the regulatory investment limit of Sec.  
615.5132. Instead, the authorizations provide for a separate, 
additional investment limit for the duration of the pilot program. 
Because the investments are limited to mission-related investments, 
we believe they are compatible with the System's GSE status. See 
``Investments in Rural America'Pilot Investment Programs,'' FCA 
Informational Memorandum (January 11, 2005).
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    The ABA commented that increasing the investment limit allows Farm 
Credit banks more room to engage in risky on-balance sheet maturity 
mismatching. The ABA stated that FCA should take steps to reduce the 
System's dependence on hedge counterparties. Specifically, the ABA 
noted that the System, by using derivative instruments, has been 
transforming longer-term debt in the 1-to-5 year repricing interval 
into shorter-term debt in the 0-to-6 month repricing interval. The ABA 
argues that an investment limit increase allows even more room to 
engage in extreme maturity mismatching, creating the potential for 
gambling on interest-rate swings.
    We do not agree with the commenter that the Farm Credit banks have 
used their investment authority to engage in inappropriate activity. 
The transformation of longer-term debt into shorter-term debt using 
interest rate swaps correlates with the Farm Credit banks' voluntary 
initiative to increase liquidity reserves. The Farm Credit banks have 
collectively increased total earning assets and decreased interest-
bearing liabilities in the 0-to-6 month bucket to increase days of 
liquidity. The System has also increased the issuance of synthetic 
variable rate-debt to compensate for the mismatch.
    We have previously stated that any speculative use of derivatives 
would be considered an unsafe and unsound banking practice.\5\ We 
recognize that derivative financial instruments are useful risk 
management tools to hedge against interest rate and liquidity risk and 
are an essential part of any interest rate risk management program. 
Each Farm Credit bank is required to establish and maintain investment 
policies that limit counterparty risk in investments and financial 
derivatives. We require each Farm Credit bank to establish interest 
rate risk exposure limits, to determine criteria to comply with the 
limits, to identify and analyze causes of risk, and to conduct interest 
rate shock tests. Our examination staff reviews these policies and 
monitors interest rate risk in Farm Credit banks, including 
counterparty risk in financial derivatives. We have the appropriate 
safeguards in place to effectively regulate Farm Credit banks without 
inhibiting their ability to successfully serve agriculture and rural 
America.
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    \5\ ``Guidelines for Using Derivative Products,'' FCA Bookletter 
BL-023 (October 31, 1995) and 63 FR 33281.
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    For the reasons discussed above, this section of the rule is 
adopted as proposed. In so doing, we emphasize that the original 
purpose of our investment limit remains unchanged.

B. Liquidity Reserve Requirement

1. Liquidity Reserve Calculation [Sec.  615.5134(a)]
    All commenters supported increasing the minimum liquidity reserve 
requirement from approximately 15 days to 90 days, adding a rating 
element to investments used to fund the liquidity reserve, and the 
method of discounting those investments to reflect market value in the 
event of liquidation. One Farm Credit bank asked that all investment 
grade securities be included in the liquidity reserve, not just highly 
rated investments. This same commenter asked for clarification on the 
eligibility of Federal Agricultural Mortgage Corporation (FAMC) 
agricultural mortgage-backed securities for liquidity purposes.
    We believe a regulatory minimum liquidity reserve should be funded 
with highly rated investments, which are generally more liquid, less 
volatile, and can be quickly converted to cash without significant 
loss. We therefore finalize investment rating requirements as proposed. 
FAMC securities may not be used to fund a Farm Credit bank's liquidity 
reserve. FAMC securities, while not listed in Sec.  615.5140, are 
identified as eligible investments under Sec.  615.5174. However, Sec.  
615.5174(c)(3) specifically states that FAMC securities may not be used 
to maintain a Farm Credit bank's liquidity reserve. This prohibition 
addresses the concern of concentration risk. If the System had real or 
perceived credit problems due to a crisis in the agricultural economy 
and could not access the market at reasonable rates, those same 
economic factors may also adversely affect the price and liquidity of 
FAMC securities.
    System commenters additionally requested clarification of the 
meaning of the regulatory language ``maturing obligations and other 
borrowings of the bank.'' They also asked whether proceeds from System 
debt issuances are applied to the liquidity reserve on the trade date 
or settlement date.
    In response to these requests, we are adding clarifying language to 
the final rule. The final rule clarifies that ``maturing obligations 
and other borrowings of the bank'' excludes both interest receivable 
and interest payable, since interest received generally offsets 
interest due. The liquidity reserve calculation should be a simple 
procedure that excludes both interest receivable and interest payable. 
The final rule also clarifies that proceeds from debt issuances are to 
be applied to the liquidity reserve on the contractual trade date. 
While many longer-term System debt issuances do not trade and settle on 
the same date, the risk of settlement default is extremely low. The 
Funding Corporation enters into a contractual agreement with selling 
group members on the trade date with the firm expectation of receiving 
cash from System debt issuances on the settlement date. As trades are 
made, the selling group members are contractually obligated to deliver 
cash to the Funding Corporation on the settlement date. In the event of 
a systemic market disruption, cash proceeds from debt issuances are as 
likely to be delayed as are payments of maturing obligations.

[[Page 51589]]

    The FCC further requested we explain what the maturity date would 
be for obligations that have embedded ``put'' and ``call'' options, 
which give an investor or a Farm Credit bank the option to redeem an 
obligation before the contractual maturity date. We expect Farm Credit 
banks to use, for liquidity reserve calculations, the earlier of: the 
obligation's contractual maturity date, the ``call date'' for which the 
call option has been executed, or the ``put date'' for securities.
    Although we received no comments on the frequency of calculating 
the liquidity reserve, we are adding language to the final rule to 
clarify that Farm Credit banks must satisfy the 90-day minimum 
liquidity reserve requirement on a daily basis. Farm Credit banks are 
expected to calculate the liquidity reserve on a daily basis to ensure 
compliance.
2. Discounts [Sec.  615.5134(c)]
    The ABA supported discounting assets used to fund the liquidity 
reserve. The FCC asked us to clarify how floating rate debt securities, 
which exceed contractual cap rates, are discounted. The Farm Credit 
banks made no individual comments on the discounts.
    We are adding language to the final rule to clarify that floating 
rate debt security coupons meeting or exceeding a contractual cap rate 
are treated as a fixed rate debt security and discounted at 90 percent. 
Any floating rate debt security that is below the contractual cap rate 
is discounted at 95 percent.
3. Other Comments--Eligible Investments [Sec.  615.5140]
    Our proposed rule addressed the liquidity of Farm Credit banks; it 
did not address the eligible investment categories used to fund the 
liquidity reserve. However, we received comments from the FCC and two 
Farm Credit banks on existing eligible investments under Sec.  
615.5140. The commenters recommended changes to individual investment 
limits and the inclusion of additional investment authorities. The FCC 
and one Farm Credit bank specifically recommended allowing loans 
supported by GSE-issued long-term standby purchase commitments (LTSPCs) 
to fund the liquidity reserve. The FCC explained that they consider 
loans supported by GSE-issued LTSPCs as liquid assets suitable for the 
liquidity reserve.
    This final rulemaking does not change Sec.  615.5140, nor add loans 
that are credit enhanced by GSE LTSPCs to the list of items that may be 
used to fund the liquidity reserve. However, we intend to reconsider 
the issue of loans covered by GSE-issued LTSPCs, as well as the Sec.  
615.5140 list of eligible investments, in future rulemaking.
    The System commenters also recommended changing the requirements 
for independently verifying the purchase and sale of investments under 
Sec.  615.5133(f); obligor limits under Sec.  615.5140(d)(1); and 
stress testing under Sec.  615.5141. The FCC and a Farm Credit bank 
commented that Sec.  615.5133(f) adds an unnecessary cost with no 
resulting benefit. One Farm Credit bank recommended modifying the 
stress-testing requirements of mortgage-backed securities under Sec.  
615.5141 to allow testing on a portfolio basis instead of on individual 
securities. This same commenter suggested specific obligor limits under 
Sec.  615.5140(d)(1). We are not addressing these comments in this 
final rulemaking, but intend to address them in future rulemakings.

C. Liquidity Contingency Plan [new Sec.  615.5134(d)]

    Only the ABA commented on the proposed requirement that each Farm 
Credit bank develop a contingency plan to ensure the most effective use 
of the liquidity reserve. The ABA supported establishment of such a 
plan. We adopt this section of the rule as proposed.

D. Disposal of Ineligible Investments [Sec.  615.5143]

    We asked for comments on whether we should change our existing 
divestiture regulation for those situations when general economic 
conditions cause investments to become ineligible or when eligibility 
may be restored. The ABA commented that the existing requirements are 
sufficient, pointing out that Farm Credit banks may submit 
individualized plans to divest themselves of investments that become 
ineligible after acquisition. The FCC commented that mandatory 
divestiture should be eliminated when investments become ineligible due 
to credit downgrades or failed stress tests. The FCC recommended 
replacing the existing rule with a requirement that banks develop a 
plan to deal with investments that become ineligible. Three Farm Credit 
banks recommended the mandatory divestiture provision be eliminated and 
replaced with a general requirement that Farm Credit banks develop 
their own procedures for handling ineligible investments. One bank 
recommended the rule distinguish between investments that are 
ineligible when acquired and those that later become ineligible.
    We reviewed the comments submitted and appreciate the perspectives 
shared. We are taking the comments under advisement and may propose 
changes to this area of our regulations in the future.

IV. Regulatory Flexibility Act

    Pursuant to section 605(b) of the Regulatory Flexibility Act (5 
U.S.C. 601 et seq.), FCA hereby certifies the 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.


0
For the reasons stated in the preamble, part 615 of chapter VI, title 
12 of the Code of Federal Regulations is amended as follows:

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

0
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]

0
2. Amend Sec.  615.5131 by:
0
a. Removing paragraph (b) and redesignating existing paragraphs (c) 
through (m) as paragraphs (b) through (l), consecutively; and
0
b. Removing the reference ``Sec.  615.5131(i)'' and adding in its 
place, the reference ``Sec.  615.5131(h)'' in paragraph (a).
0
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

[[Page 51590]]

surplus short-term funds, and manage interest rate risk under Sec.  
615.5135.

0
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, 
discounted in accordance with paragraph (c) of this section, sufficient 
to fund 90 days of the principal portion of maturing obligations and 
other borrowings of the bank at all times. The liquidity reserve may 
only be funded from cash, including cash due from traded but not yet 
settled debt, and the eligible investments under Sec.  615.5140. 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 and floating rate debt 
securities that meet or exceed the contractual cap rate 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]

0
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: August 25, 2005.
Jeanette C. Brinkley,
Secretary, Farm Credit Administration Board.
[FR Doc. 05-17266 Filed 8-30-05; 8:45 am]
BILLING CODE 6705-01-P