[Federal Register Volume 71, Number 247 (Tuesday, December 26, 2006)]
[Rules and Regulations]
[Pages 77247-77262]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-21831]


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FARM CREDIT ADMINISTRATION

12 CFR Parts 652 and 655

RIN 3052-AC17


Federal Agricultural Mortgage Corporation Funding and Fiscal 
Affairs; Federal Agricultural Mortgage Corporation Disclosure and 
Reporting Requirements; Risk-Based Capital Requirements

AGENCY: Farm Credit Administration.

ACTION: Final rule.

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SUMMARY: The Farm Credit Administration (FCA, Agency, we) is amending 
regulations governing the Federal Agricultural Mortgage Corporation 
(Farmer Mac or the Corporation) risk-based capital stress test (RBCST 
or model). We are making these amendments in response to changing 
financial markets, new business practices and the evolution of the loan 
portfolio at Farmer Mac, as well as continued development of industry 
best practices among leading financial institutions. The rule modifies 
regulations in 12 CFR part 652, subpart B. The rule is intended to more 
accurately reflect risk in the model in order to improve the model's 
output--Farmer Mac's regulatory minimum risk-based capital level. The 
rule also clarifies Farmer Mac's reporting requirements in Sec.  
655.50(c).

DATES: Effective Date: This regulation will be effective the later of 
30 days after publication in the Federal Register during which time 
either or both Houses of Congress are in session, or March 31, 2007. We 
will publish a notice of the effective date in the Federal Register.

FOR FURTHER INFORMATION CONTACT: 

Joseph T. Connor, Associate Director for Policy and Analysis, Office of 
Secondary Market Oversight, Farm Credit Administration, McLean, VA 
22102-5090, (703) 883-4280, TTY (703) 883-4434;

 or

Rebecca S. Orlich, Senior Counsel, Office of the General Counsel, Farm 
Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703) 
883-4020.

SUPPLEMENTARY INFORMATION: 

I. Purpose

    The purpose of this rule is to revise the risk-based capital (RBC) 
regulations that apply to Farmer Mac. Our proposed rule was published 
in the Federal Register on November 17, 2005.\1\ The final rule makes 
the following changes to the RBCST:
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    \1\ 79 FR 69692. See the preamble to our proposed rule for a 
full discussion of our proposed changes.
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    1. Establishes specific proxy values for loans with missing or 
anomalous or ambiguous data. In the final rule, the Debt-to-Assets 
ratio (DA) proxy value is 0.50, the Loan-to-Value ratio (LTV) remains 
at 0.70, and the Debt Service Coverage ratio (DSC) is 1.25.
    2. Requires the application of known data on Long-term Standby 
Purchase Commitment (Standby) loans in the model.
    3. Revises the estimate of future years' miscellaneous income to 
the annualized 3-year weighted average of the most recent quarterly 
miscellaneous income rate as a fraction of the current quarter's sum of 
cash, investments, guaranteed securities, and loans held for 
investment.
    4. Revises the treatment of gain on sale of agricultural mortgage-
backed securities (AMBS) by applying the 3-year gain rate factor to the 
most recent 4 quarters of AMBS sales.
    5. Revises the method used to estimate operating expenses to a 
moving-average of operating expenses as a percent of non-program assets 
and on- and off-balance sheet program investments.
    The proposed rule also included provisions related to improved 
estimates of the carrying costs of troubled loans by revising 
assumptions regarding Loan Loss Resolution Timing (LLRT), and related 
to adding a component to reflect counterparty risk. These two items are 
not included in the final rule. The Agency plans to address these 
issues in a future rulemaking.
    In developing this rule, we considered the comments and 
recommendations pertaining to the RBCST in the Government 
Accountability Office (GAO) report entitled, ``Farmer Mac: Some 
Progress Made, but Greater Attention to Risk Management, Mission, and 
Corporate Governance is Needed.'' \2\ We also met with Farmer Mac 
representatives on several occasions prior to the development of the 
proposed rule and discussed possible Agency revisions to the RBCST.
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    \2\ 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 (2003). At the time 
of the report's publication, the GAO was known as the General 
Accounting Office.
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II. Background

    Our analysis of the RBCST has identified a need to update the model 
in response to changing financial markets, new business practices and 
the evolution of the loan portfolio at Farmer Mac, as well as continued 
development of industry best practices among leading financial 
institutions. Our goal is to ensure that the RBCST reflects changes in 
the Corporation's business structure and loan portfolio that have 
occurred since the model was originally developed by FCA, while 
complying with the statutory requirements and constraints on the 
model's design.
    Our proposed rule was published in the Federal Register on November 
17, 2005, and provided for a 90-day comment period to end on February 
15, 2006. We later extended and reopened the comment period, which 
ended on May 17, 2006.\3\
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    \3\ In response to requests from commenters, we extended the 
original comment period to April 17, 2006 (71 FR 7446, Feb. 13, 
2006), and subsequently reopened the comment period until May 17, 
2006 (71 FR 24613, Apr. 26, 2006).
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III. Comments

    We received seven comment letters on the proposed rule from the 
following: Farmer Mac, the Farm Credit Bank of Texas (FCBT), AgFirst 
Farm Credit Bank (AgFirst), U.S. AgBank FCB (U.S. AgBank), Sacramento 
Valley Farm Credit (Sac Valley), First Dakota National Bank (Dakota 
Mac), and AgStar

[[Page 77248]]

Financial Services, ACA (AgStar).\4\ In general, the commenters agreed 
with FCA's objective to revise the RBCST to reflect Farmer Mac's actual 
business risks more accurately but asserted that our proposal would not 
achieve that objective. The commenters contended that the proposed 
changes would result in a risk-based capital requirement that is higher 
than it should be and would drive up the cost of doing business with 
Farmer Mac. Specific comments were primarily focused on two changes: 
(1) The proposed data proxy values for loans with missing data; and (2) 
the method of implementing the carrying cost of nonperforming loans. 
The latter provision is not included in this final rule.
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    \4\ All of the commenters except Dakota Mac are Farm Credit 
institutions.
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IV. Summary of the Provisions of the Final Rule and FCA's Responses to 
Comments

    We begin by summarizing and responding to general comments on the 
proposed rule and then provide a summary of specific comments on the 
proposed rule and FCA's responses to the comments.

A. General Comments

    FCBT stated that its chief concern was that certain proposed 
changes appear to have been selected primarily for the purpose of 
increasing the risk-based capital requirement. FCBT and each of the 
other commenters criticized the proposed rule as not being based on 
Farmer Mac's actual underwriting practices and loss experience.
    U.S. AgBank called the proposed regulation overly prescriptive and 
stated that it would be better for FCA to direct Farmer Mac to create 
an RBCST calculation process that complies with the statute, than to 
continue the FCA-designed risk-based capital model. U.S. AgBank also 
stressed the importance of a model that is statistically valid and not 
biased toward overly conservative assumptions, thereby avoiding 
artificial results that could result in unintended consequences. It 
asserted that such consequences could include the compromising of sound 
governance practices at Farmer Mac and of management's accountability 
to its shareholders. Finally, U.S. AgBank said that the model is too 
inflexible given the dynamic nature of agricultural finance and Farmer 
Mac's lines of business that include unique risk factors such as part-
time farm loans.
    Sac Valley, FCBT, and AgFirst also provided their general support 
for the comments submitted by Farmer Mac. Sac Valley stated its 
concurrence with FCA's objective of estimating risk-based capital in a 
way that reflects the risks of Farmer Mac's business and incorporates 
as much as possible best business practices.

B. Proxy Data Values for Loans With Missing or Anomalous Loan 
Origination Data and for Standby Loans--Appendix A, Section 4.1 d.

1. FCA's Proposal
    As noted in the preamble to the proposed rule, the RBCST model was 
designed to use loan origination data--specifically the loan amount, 
DA, LTV, and DSC to estimate the lifetime probability of default on the 
loans, which is then seasoned to reflect the current age of the loan. 
At the time the model was designed, Farmer Mac had complete origination 
data for most loans in its portfolio. In 1998, it had complete 
origination data on approximately 88 percent of Cash Window loans, 
excluding pre-1996 loans. For the remaining loans, state-level average 
loss rates estimated from the loans with complete data were applied to 
loans where data were missing.
    Today, a significant proportion of Farmer Mac's current portfolio 
has incomplete or anomalous loan origination data, or has data that are 
not used in the model. Some data are missing because Farmer Mac has 
several programs whose underwriting standards do not require the 
collection of such data. These programs include part-time farm, 
seasoned and fast-track loans. In addition, the model treats unseasoned 
Standby loans for which loan origination data are available as if the 
loan data were missing. This means that, as of June 30, 2006, complete 
loan origination data were available, and used in the RBCST, on well 
under half of Farmer Mac's loan portfolio, excluding pre-1996 loans. We 
proposed to revise this part of the model to replace the application of 
state-level loss estimates with the application of specified proxy 
values to all loans with missing or anomalous data, and to use known 
data for unseasoned Standby loans when such data are known. The proxy 
values we proposed were a DA ratio of 0.60, an LTV ratio of 0.70, and a 
DSC ratio of 1.20. As we explained in the preamble to the proposed 
rule, we chose conservative proxy values directly related to Farmer 
Mac's underwriting standards on the ground that using conservative 
proxy data best preserves the theoretical and structural integrity of 
the RBCST.
2. Comments
    Farmer Mac agreed that the use of proxy values could be appropriate 
in these circumstances. It asserted, however, that the proposed proxy 
values are flawed because they are ``inconsistent with Farmer Mac's 
underwriting standards for the vast majority of full-time farm loans, 
as well as with Farmer Mac's own risk exposure in actual practice''; 
that they are ``arbitrary, unsupported by any reasoned methodology, and 
based on'' an incorrect interpretation of the Act; that they are 
``unacceptable because they do not correlate strongly, or even 
adequately, to Farmer Mac's actual core business and underwriting 
standards''; and that it knows of no requirement in the Act that the 
loans ``should, unto themselves, represent a worst-case scenario for 
the abuse of Farmer Mac underwriting discretion.'' Farmer Mac asserted 
that, ``if there is available information that would more closely 
approximate Farmer Mac's actual book of business, it should be 
utilized, as opposed to unrelated conservative proxy values.'' Farmer 
Mac raised a concern that the proposed proxy values ``likely will'' 
distort or misrepresent the risks of its business and ``create 
unintended incentives for or against particular classes of loans.''
    Farmer Mac recommended that the proxy values be based instead on 
its historical loan data, using a statistical process for the 
imputation of missing data, or alternatively selecting cutoff 
percentiles. Farmer Mac described possible methodologies and stated its 
view that there was no reason to depart from the model's current 
method, which it characterized as most similar to treatment of data 
that are ``Missing Completely At Random,'' absent ``evidence that [the 
current method] is untenable.'' Farmer Mac also contended that two of 
the proxy values, DA and DSC, are not relevant to its underwriting 
standards for part-time farm loans and offered to work with FCA to 
develop an appropriate RBCST submodel for those loans.
    The other commenters submitted comments that were very much in line 
with Farmer Mac's. They asserted that:
     The proxy values appear arbitrary and not supported in the 
preamble to the proposed rule by any defined methodology or evidence;
     The proxy values are not representative of the commenters' 
loan experience with Farmer Mac or with Farmer Mac's portfolio (as 
understood by the commenters) and are not representative of Farmer 
Mac's underwriting standards; and

[[Page 77249]]

     The proposal, by requiring Farmer Mac to hold capital in 
excess of actual risk, could cause Farmer Mac to increase fees and 
could harm the secondary agricultural loan market and the commenters' 
business with Farmer Mac.
    The commenters recommended basing the proxy values on Farmer Mac 
historical loan data and using a ``well defined methodology'' to 
determine the values. In the section below, we address specific 
comments of Farmer Mac and other commenters.
3. Final Rule
    In the final rule, we establish proxy values for the DA, LTV, and 
DSC ratios that are related to Farmer Mac's underwriting standards, but 
we have moderated them somewhat from the proposed rule. In the final 
rule, the DA ratio proxy value is 0.50, down from 0.60 in the proposed 
rule; the LTV ratio remains at 0.70, the same value as in the proposed 
rule; and the DSC ratio is 1.25, up from 1.20 in the proposed rule. 
Upon further review and consideration of the ranges of Farmer Mac's 
underwriting standards and the relative proportions of the various loan 
types in the portfolio, we have decided that these values are more 
appropriate to the underwriting standards for the loan types that make 
up the preponderance of Farmer Mac's portfolio. In our judgment, these 
proxy values are appropriate for application to loan programs that have 
different underwriting standards but account for a smaller proportion 
of the portfolio. We believe these values are still sufficiently 
conservative to maintain the theoretical integrity of the model while 
avoiding unintended consequences related to inappropriate incentives to 
underwrite more aggressively in reduced-documentation loan programs. We 
note that, if the relative proportions of various loan types with 
differing underwriting standards change over time, the Agency may 
consider further adjustment to the proxy values.
    We disagree with many of the comments we received. To begin with, 
we do not believe our proposal is based on an incorrect interpretation 
of the Act or that it imposes ``worst-case'' proxy values. The Act 
provides FCA with significant discretion in establishing the RBCST. 
Section 8.32 of the Act states that the FCA (through the Director of 
the Office of Secondary Market Oversight (OSMO)) must, among other 
things, ``take into account appropriate distinctions based on various 
types of agricultural mortgage products, varying terms of Treasury 
obligations, and any other factors the Director considers appropriate * 
* *.'' \5\ The model uses, and will continue to use, Farmer Mac's 
``actual book of business'' as represented by actual data. The 
incompleteness or non-use of loan origination data for what is now a 
significant portion of Farmer Mac's portfolio is an important factor in 
evaluating the reliability of the RBCST output. The Agency must decide 
how best to treat the loans whose data are not in the model. We believe 
the model's current treatment is no longer adequate to represent loan 
risk for such a large portion of the portfolio. Our choice of 
conservative proxy values takes into consideration not only the role of 
the FCA to provide for the general supervision of the safe and sound 
performance of Farmer Mac under section 8.11(a) of the Act, but also 
Farmer Mac's actual loan data and practices. We do not believe the 
proxy values represent a ``worst-case scenario.'' In setting the proxy 
values, we considered Farmer Mac's actual practice of accepting loans 
with ratios that are riskier than those permitted under its 
underwriting standards when the loan has compensating strengths in 
other ratios or risk indicators. A ``worst-case'' approach would have 
yielded proxy values much higher than the proposed DA and LTV and much 
lower than the DSC.
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    \5\ 12 U.S.C. 2279bb-1(b)(1)(A).
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    We considered Farmer Mac's suggestion to substitute values based on 
Farmer Mac's historical loan data for the missing data.\6\ In our 
judgment, the historical data are not necessarily representative of the 
portion of the portfolio that is missing data, and they are not 
necessarily representative of Farmer Mac's future underwriting 
practices on loans for which they will not collect complete data. We do 
not agree with the underlying assumption of the comments that the 
historical loan data on full-time farm loans would correlate strongly 
with the loans missing data. In a circumstance where we cannot know the 
predictive value of the historical loan data, we do not agree that a 
valid statistical methodology is available to set the proxy levels. 
Moreover, as we have noted, the loans for which loan origination data 
are complete now represent a much smaller proportion of Farmer Mac's 
loan portfolio. Therefore, we concluded that using the historical data 
is not the best means to determine appropriate proxy values.
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    \6\ We note that the current version of the RBC model, through 
its application of average loss rates by state to loans with missing 
data, is similar to the approach recommended in the comment. The 
insufficiency of this approach and the significant proportion of 
loans that have incomplete data are, in fact, the conditions that 
prompted the development of this revision to the RBCST.
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    A statistical approach suggested by Farmer Mac is the SAS Proc MI 
multiple imputation (MI) procedure for developing consistent estimates 
of confidence limits around the mean of each individual underwriting 
variable for loans for which data existed. The implication is that 
these estimates would be appropriate for use as proxies in cases where 
the underwriting data were absent in individual loans. The specific 
process demonstrated assumes that the underwriting data are 
multivariate normal and that the missing elements may depend on the 
remaining observed variables, but not on their own values. The 
resampling method generates consistent estimates of the variances from 
which confidence limits around the statistics can be constructed.
    The MI methods cited in the comment are most often used in efforts 
to avoid deletion of observations in data sets with partially missing 
data, but for which portions of the covariate data sets exist.\7\ The 
use of no additional independent variables (e.g., age, loan size) which 
are observable across loans both with and without underwriting data 
implies: (i) No conditioning on additional variables was considered, 
and (ii) an assumption of equivalent distributions between those 
missing data and those not missing data.
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    \7\ For example, if multiple health factors/indicators 
individually contribute to incidence rates of a serious health 
problem, but not all variables are observed or collected on all 
individuals, MI procedures allow the use of the data with incomplete 
measures across the independent variables rather than excluding 
entire observations that are missing only portions of their 
independent variables.
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    We do not agree that the Farmer Mac-suggested method provides a 
reasonable method for identifying candidate proxy values for numerous 
reasons. First, we did not intend that the proxies represent mean 
values of the underwriting data in cases where the data exist, or as 
conditioned by the pattern of missing data from cases missing only a 
portion of the underwriting variables. We do not believe that this 
approach is reasonable given the stark differences in other 
characteristics of the subset of loans that do and do not have complete 
underwriting data. To emphasize this point, Table 1 is provided which 
summarizes key attributes of the loans grouped by whether the loan 
observation received at least one proxy value due to missing or 
anomalous data.

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                                 Table 1
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                                     No proxy    At least 1
               Data                    data        proxy       Combined
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Average Age (in years)...........         5.83        11.83         9.16
Average Current Balance..........  $433,568     $164,542     $284,199
Average Original Balance.........  $570,119     $267,039     $401,842
Number of Loans..................     7,269        9,074       16,343
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    As shown in the table, the loans missing data are considerably 
older (rendering the cases where a portion of the underwriting data 
does exist to be less likely to be reliable), have much smaller 
original balances, and have correspondingly lower current balances. 
Standard tests of the equivalence of means strongly reject the 
hypothesis of equivalence of the means between the two groups of loans 
by age, original size, or current balance (p-value = 0.0000, all 
cases).
    As an alternative to using an imputation methodology, Farmer Mac 
also suggested that percentile cutoffs of actual ratios in its 
portfolio of unseasoned standard full-time farm loans should be 
considered as an acceptable method to derive proxies, though less 
appropriate (in their view) than imputation of mean values. Farmer Mac 
asserted that the proposed proxy levels are statistical outliers.\8\ In 
general, we have the same concern here as with the multiple imputation 
approach regarding basing proxy values on historical measurements of a 
potentially uncorrelated portfolio. The appropriateness of using a 
cutoff percentile depends on the congruence in the data between the set 
missing underwriting data and those with data. Moreover, the 
distribution around a given ``consistent'' percentile choice is not 
necessarily comparable across the three underwriting variables (i.e., 
there may be only a small ``distance'' between the 95th percentile and 
the maximum D/A in the available data, while there is a large 
``distance'' from the 95th percentile of the order-adjusted DSC to the 
most undesirable one in the data set).\9\
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    \8\ The proposed DA proxy equated to the 95th percentile of 
Farmer Mac's portfolio of unseasoned full-time farm loans, the 
proposed LTV proxy equated to some percentile in excess of the 90th 
percentile, and the proposed DSC proxy equated to some percentile in 
excess of the 5th percentile (or, for greater ease of comparison, 
its inverse--the 95th percentile). In the final rule, the proxy 
values would equate to the 91st, 90th, and 9th percentiles 
respectively, as of June 30, 2006. Although we did not base our 
proxy values on the percentile cutoffs, we believe the relationships 
of those values to the percentile cutoffs is appropriate.
    \9\ Farmer Mac contends that the proposed proxies represent 
outliers in the data. However, we note that its comment includes a 
table showing that the proxy values indicated by the 95th 
percentiles in the set of unseasoned Full-time Farm loans all exceed 
Farmer Mac's underwriting limits for such loans. Thus, the proxy 
values would not appear to be unreasonably conservative.
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    We would also note that average loss rates generated by the RBCST's 
Credit Loss Module (CLM) are not especially sensitive to the level of 
the proxy values. To illustrate this point, we provide the following 
data tables. Table 2A sets forth the average loss rates generated by 
the CLM as of June 30, 2006, under various LTV and DA proxy value 
combinations, keeping DSC constant at 1.25. The table indicates that 
the average loss rate across all combinations presented varies within a 
range of 27 basis points. Under the final rule's proxy values (0.50, 
0.70, and 1.25, for DA, LTV, and DSC proxies, respectively) the table 
shows that at June 30, 2006 the average loss rate would have been 3.782 
percent.

                                                    Table 2A
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       DSC proxy = 1.25                                       LTV proxies
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DA Proxies....................  ..........     0.60        0.65        0.70        0.75        0.80
                                   0.45        3.694%      3.706%      3.724%      3.748%      3.783%
                                   0.50        3.751%      3.764%      3.782%      3.807%      3.842%
                                   0.55        3.811%      3.824%      3.843%      3.869%      3.905%
                                   0.60        3.874%      3.888%      3.907%      3.934%      3.966%
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    Table 2B presents the calculated average loss rate across 
combinations of DCS and DA ratios, holding LTV constant. Under these 
combinations, the average loss rate varies within a range of 16 basis 
points.

                                                    Table 2B
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            LTV proxy = 0.70                                            DSC proxies
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DA Proxies..............................  ..........     1.15        1.20        1.25        1.30        1.35
                                             0.45        3.736%      3.730%      3.724%      3.718%      3.712%
                                             0.50        3.794%      3.788%      3.782%      3.775%      3.769%
                                             0.55        3.856%      3.849%      3.843%      3.836%      3.830%
                                             0.60        3.921%      3.914%      3.907%      3.900%      3.894%
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    Table 2C presents the variation in the calculated average loss rate 
across combinations of DCS and LTV ratios, holding DA constant at the 
level in the final rule. Under these combinations, the average loss 
rate varies within a range of just 3 basis points.

[[Page 77251]]



                                                    Table 2C
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             DA proxy = 0.50                                            DSC proxies
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LTV proxies.............................  ..........     1.15        1.20        1.25        1.30        1.35
                                             0.60        3.763%      3.757%      3.751%      3.745%      3.739%
                                             0.65        3.776%      3.770%      3.764%      3.757%      3.751%
                                             0.70        3.794%      3.788%      3.782%      3.775%      3.769%
                                             0.75        3.820%      3.814%      3.807%      3.801%      3.795%
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    Rather than focusing on the distribution of underwriting ratios in 
the existing loan data sets through time, we instead chose proxy values 
that are near the conservative limits of the range of values that are 
acceptable to Farmer Mac under its underwriting standards for different 
types of loans (including, but not limited to, full-time farm loans). 
In addition, we took into consideration that Farmer Mac can accept 
underwriting ratios that exceed the stated ranges of its underwriting 
standards.\10\ We intended that the proxy values be sufficiently 
conservative to avoid underestimating the risk in the portfolio, but 
not at the extremes of Farmer Mac's underwriting standards. This 
approach recognizes that Farmer Mac would be unlikely to underwrite 
loans at its underwriting limits in each ratio category. These values 
are acceptable to Farmer Mac for underwriting purposes, as demonstrated 
by both its policies and its practices. Therefore, we believe that the 
proxy values are realistic as well as conservative and reflect Farmer 
Mac's actual business practices.
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    \10\ We note Farmer Mac's actual practice of accepting loans 
with ratios that are outside of the ranges, as permitted under its 
underwriting standards when the loan has compensating strengths in 
other ratios or risk indicators.
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    Farmer Mac's comment that the proposed proxy values ``likely will'' 
distort or misrepresent the risks of its business, as well as create 
unintended incentives for or against particular classes of loans, did 
not make clear exactly what unintended incentives or what classes of 
loans Farmer Mac had in mind. We would agree that, on an individual 
loan basis, using proxy data will ``misrepresent'' the loan to the 
extent that the proxy values understate or overstate the level of 
actual risk in the loan. The problem of the likely inexactitude in the 
calculation is necessitated by, and a direct result of, the uncertainty 
created by the missing data. This uncertainty is itself one component 
of the risk in Farmer Mac's loan portfolio. We believe that applying 
conservative proxy values is a way to consider adequately the actual 
risk in the loan as well as the added risk associated with this 
uncertainty. With respect to unintended incentives, it is true that, 
however we decide to treat loans with missing data--for example, if we 
were to apply proxy values based on historical loan data or related to 
underwriting standards, or even if we entirely removed loans with 
missing data from the model--we could create incentives for Farmer Mac 
and its business partners to expand or contract one or more lines of 
business or to modify program requirements. Indeed, in the model's 
current treatment of loans with missing data, one could argue that 
using state-level loss estimates may have been a disincentive for 
Farmer Mac to collect loan origination data in some cases. We believe 
that the proxy values in the final rule will minimize any potential 
incentive not to collect loan origination data on the great majority of 
loans, without providing inappropriate incentives to continue or 
terminate worthy and needed loan products.
    As we described above, Farmer Mac offered to work with FCA to 
develop an appropriate RBCST submodel for part-time farm loans since, 
in Farmer Mac's stated view, the DA and DSC ratios are ``not relevant'' 
to its underwriting standards for such loans.\11\ FCA weighed the added 
complexity of a submodel against potential benefits in improved 
accuracy of the RBC model's output, as well as the potential 
disincentive that might be created to underwrite part-time farm 
business in the absence of such a submodel. By our calculation of 
Farmer Mac-submitted data, the part-time farm loan volume is a very 
small percentage of the total modeled portfolio as of June 30, 2006. We 
do not consider this amount to be substantial and, therefore, do not 
see a compelling reason to add complexity to the model by adding a 
submodel at this time. We could consider a submodel in the future if 
the Corporation's part-time farm loan volume grows. We believe that the 
selected proxy data values appropriately balance the risk of a 
disincentive to underwrite part-time loans with the risk of an 
inappropriate incentive to underwrite more loans of this type with risk 
characteristics that exceed those of the proxy values.
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    \11\ Notwithstanding Farmer Mac's assertion that the DA and DSC 
ratios are not relevant, not all part-time farm loans are missing 
those data in Farmer Mac's submission of the RBCST as of June 30, 
2006.
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    AgStar commented specifically that the proxy values would reflect 
an especially unrealistic risk estimate on seasoned loans. We disagree 
with the comment because the model's loan seasoning adjustment occurs 
after loss rates are estimated. Therefore, the risk in seasoned loans 
in Farmer Mac's portfolio would continue to be adjusted downward in 
accordance with Section 2.2 of Appendix A. We expect the impact of the 
seasoning adjustment to be similar in magnitude in the revised RBCST 
model regardless of whether the proxy values are applied. The reason is 
that the model recognizes substantial risk mitigation through its 
seasoning adjustment component. However, we note that when a loan's 
origination date is among the missing data, and therefore age is not 
determinable, the final rule will substitute the ``cut off'' date for 
the origination date. In such cases, if a loan were several years old 
and only recently taken into Farmer Mac's portfolio, the risk-
mitigation of its true age could not be recognized. We believe our 
approach recognizes the risk created when a loan's origination date is 
not collected in a low-documentation loan program.
    AgStar also noted that recent unseasoned loans placed in the 
Standby program are better quality than the proxy values would 
estimate. While AgStar may have good information to substantiate this 
claim, if these loan records do not contain that information, the 
Agency must address the resulting uncertainty (i.e., risk). If a 
primary lender consistently has such information on Standby loans, it 
could benefit from including these data in the loan data submitted 
under the Standby program regardless of whether such data are required 
under the Standby program.

C. Calculation of Miscellaneous Income and Gain on Sale of AMBS--
Appendix A, Section 4.2(3)

    Farmer Mac commented that more accurate moving average calculations 
of miscellaneous income and gain on sale of AMBS would be achieved by 
first

[[Page 77252]]

calculating individual ratios, annualizing the ratios and then 
computing the moving average over the appropriate time horizon. We do 
not agree that Farmer Mac's suggested approach would be more accurate. 
Our approach provides a volume-weighted measure of miscellaneous income 
that is more accurate and generally less sensitive to variations in 
asset volumes than the Farmer Mac-suggested approach. Under Farmer 
Mac's suggested approach, each individual observation has the same 
weight regardless of the level of the relevant assets. The weighted 
average approach to AMBS avoids counting each undefined (0/0) ratio as 
an individual observation which would skew the average.
    Similarly, in the case of gain on sale of AMBS, we believe our 
approach to generating the weighted average rate of gain is less 
potentially volatile than the Farmer Mac-suggested approach. Moreover, 
Farmer Mac's suggestion that the calculated amount be annualized would 
be incorrectly applied in this case, regardless of the method adopted, 
because the calculated rate is as applicable and appropriate on an 
annual basis as it is on a quarterly basis. To multiply the calculated 
rate by 4 would overstate the rate of gain.

D. Operating Expense Regression Equation--Appendix A, Section 4.2(3)

    In the RBCST's operating expense regression equation, we proposed a 
change that would remove the dummy variable from the equation and 
include multiple variables to account for different business 
activities.
    Farmer Mac agreed in principle with the extension of the 
independent variables in the regression and the elimination of the 
dummy variable but argued that the intent of the proposed regression 
was to provide marginal impacts of different activities to the 
operating expenses. It observed that the individual coefficient signs 
are not entirely consistent with expected relationships and offered two 
alternative proposals to enable projections of their operating expenses 
to be applied within the model. The first alternative proposed involves 
calculation of a simple average of recent operating expenses applied as 
a constant in the model. They refer to this approach as being analogous 
to that used to estimate MI rates and gains on AMBS rates.
    The second approach offered by Farmer Mac involves a regression 
framework across similar expense categories as proposed by us, but 
expresses these in cost share form. Their proposed approach contains 
similar drawbacks as those Farmer Mac raised regarding FCA's proposed 
approach and suffers specific problems in expressing logarithms of 
values which may be zero at times.
    In light of the recent evolution of their cost structures and 
changing relative scales of their program activities, we agree with the 
comment that an approach to accurately reflect their cost structures 
can be obtained from recent data and applied forward within the 
existing constructs of the model. Farmer Mac proposes the use of 
average expenses to reflect future experiences. We note that in periods 
of increasing costs, the recent average will have a negative bias, and 
during periods of decreasing costs, that there will be a positive bias. 
We accept the moving average application of expenses and agree that it 
is consistent with the spirit of the calculations of the rates for 
miscellaneous income and gains on sales of AMBSs. In specific 
application, we require that the operating expense rate be calculated 
as the average of operating expense rates calculated as the annualized 
expenses as shares of the sum of on-balance sheet assets and off-
balance sheet program activities over the most recent 4 quarters 
inclusive of the current submission date. This average rate is applied 
to the current quarter's on-balance sheet assets and off-balance sheet 
program activities. That share will then be applied forward to the 
balances of the same categories throughout the 10-year period of the 
RBCST model.

E. Change to Disclosure Regulations

    We proposed to clarify Sec.  655.50(c) to state that Farmer Mac 
must provide FCA with copies of its substantive correspondence with the 
Securities and Exchange Commission (SEC). We received no comments on 
this proposal and adopt it without change in the final rule.

V. Issues Not Addressed in Final Rule

A. Carrying Costs of Troubled Loans--Appendix A, Section 4.2(3)

    We proposed to improve estimates of carrying costs of troubled 
loans by revising the Loan Loss Resolution Timing to reflect that 
problem loans may take longer than the 1 year assumed in the existing 
model's loss-severity rate. Farmer Mac commented that it agreed with 
aspects of the proposed change but had concerns about some of the 
modifications, as well as the validity of certain assumptions we made.
    The Agency has elected to address this revision in a future 
rulemaking out of a desire to review further the scaling factor applied 
to loan loss volume in order to estimate the amount of associated 
unpaid principal balance, and to review any new information that may be 
available from Farmer Mac regarding its actual loan resolution timing. 
The proposed scaling factor is derived from the average principal 
amortization of loans in the current portfolio and would be 
recalculated on a quarterly basis. While we received no comments on the 
scaling factor, we believe that the principal amortization of actual 
nonperforming loans at Farmer Mac might provide an opportunity to 
improve the estimate of unpaid principal balance associated with 
nonperforming loans during the LLRT period.

B. Spreadsheet Linkage for Funding Off-Balance Sheet Loans

    This comment from Farmer Mac deals with a component of the revision 
dealing with the carrying cost of nonperforming loans. Because the 
Agency has elected to address this revision in a future rulemaking for 
reasons explained in ``A'' above, we do not address this comment here.

C. Adding a Component To Reflect Counterparty Risk--Appendix A, Section 
4.1e.

    The proposed rule's provisions related to the estimation of 
counterparty risk are not included in the final rule and will be 
addressed by the Agency in a future rulemaking. Specifically, while we 
received no comments on the approach to identifying or applying the 
counterparty risk component, we have elected to review the Office of 
Federal Housing Enterprise Oversight (OFHEO) haircut levels, confirm 
the applicability of the OFHEO haircut schedules for application to 
yields rather than individual cash flows, and consider the formal 
development of a calculation tool with fixed-category investment 
instrument definitions.
    In the preamble to the proposed rule, we requested comment on 
potential methods to incorporate three specific risks into the model in 
future proposed regulations. The three risks are: The risk associated 
with the AgVantage portfolio; the risk of a stress-induced increase in 
Farmer Mac's cost of funds; and the counterparty risk associated with 
the derivatives portfolio and specifically the replacement cost of 
defaulted derivative contracts. However, we received no comments on 
these topics.

[[Page 77253]]

VI. Other Comments Received

A. Method of Historical Loss Estimation

    Farmer Mac reiterated comments it made to our first rule 
implementing the RBCST that was published in the Federal Register on 
November 12, 1999. (See 64 FR 61740.) The comments criticize the 
methodology employed to quantify the worst-case historical benchmark 
loss experience, stating that it is unsubstantiated by actual loss 
experience. In this rulemaking, we proposed no changes related to this 
aspect of the RBC model and are, therefore, not adopting Farmer Mac's 
recommended changes in the final rule. However, we note that the 
Agency's position on this issue remains consistent with our response 
that was published in the final rule implementing the RBC model on 
April 12, 2001. (See 66 FR 19048.)

B. Spreadsheet Financial Statement Formats

    In its comment letter, Farmer Mac asked us to update the RBCST's 
Balance Sheet and Income Statement categories. Farmer Mac commented 
that populating financial statement data has become time-consuming for 
its staff due to changes in its SEC reporting formats that are not 
reflected in the RBC model. While we would prefer to make the 
submission preparation process as efficient as possible, we have 
observed that Farmer Mac's financial statements have been changing 
format with relative frequency over recent years. For that reason, we 
hesitate to expend resources to modify the formats in the model if 
these could become outdated relatively soon. However, we agree that 
such updates should be done periodically in order to keep the formats 
reasonably close. For that reason, while we have made no changes to the 
financial statement formats in this rule, we would expect to make such 
changes in consultation with Farmer Mac through the technical change 
process (i.e., without rulemaking).

VII. Technical Changes to the RBCST in the Final Rule

    In section 4.2b(3)(E) of the Appendix, we have deleted specific 
guarantee fee values for post-1996 Farmer Mac I assets, pre-1996 Farmer 
Mac I assets, and Farmer Mac II assets because specific values are not 
applied in the stress test. The stress test applies quarterly updates, 
supplied by Farmer Mac, of the weighted average guarantee rates for 
each category of assets.

VIII. Impact of Final Rule Changes on Required Risk-Based Capital

    The table below provides an indication of the impact of the 
revisions in the quarter ended June 30, 2006. Lines 1 through 4 present 
the impacts if only that revision were made to the current version and 
the column labeled ``Difference'' calculates the impact of that 
individual change for the quarter ended June 30, 2006, compared to the 
minimum requirement calculated using the currently active Version 1.25. 
Line 5 presents the impact of all of the revisions in Version 2.0 (the 
model as revised in this final rule).\12\
---------------------------------------------------------------------------

    \12\ Please note that Farmer Mac announced on October 6, 2006, 
that it intends to restate certain financial results for several 
recent reporting periods. The calculations in the table could change 
based on the restatement.

------------------------------------------------------------------------
  Calculated regulatory minimum capital      6/30/2006      Difference
------------------------------------------------------------------------
RBCST Version 1.25 (calculated as of 6/           67,660  ..............
 30/2006)
RBCST 2.0 Individual Change Impacts:
    (1) CLM Changes: Data Proxies and             93,523          25,862
     Standby Treatment..................
    (2) Miscellaneous Income Treatment..          59,932          -7,728
    (3) Gain on Sale of AMBS............          67,660               0
    (4) Operating Expenses..............          95,297          27,637
    (5) Total RBCST Version 2.0 Impact..         113,431          45,771
------------------------------------------------------------------------

    As shown in the table, implementation of the data proxies and the 
revised operating expense estimation result in the greatest impact on 
the calculated risk-based capital requirements.

IX. 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. 
Farmer Mac has assets and annual income over the amounts that would 
qualify them as small entities. Therefore, Farmer Mac is not considered 
a ``small entity'' as defined in the Regulatory Flexibility Act.

List of Subjects

12 CFR Part 652

    Agriculture, Banks, banking, Capital, Investments, Rural areas.

12 CFR Part 655

    Accounting, Agriculture, Banks, banking, Accounting and reporting 
requirements, Disclosure and reporting requirements, Rural areas.

0
For the reasons stated in the preamble, parts 652 and 655 of chapter 
VI, title 12 of the Code of Federal Regulations are amended as follows:

PART 652--FEDERAL AGRICULTURAL MORTGAGE CORPORATION FUNDING AND 
FISCAL AFFAIRS

0
1. The authority citation for part 652 continues to read as follows:

    Authority: Secs. 4.12, 5.9, 5.17, 8.11, 8.31, 8.32, 8.33, 8.34, 
8.35, 8.36, 8.37, 8.41 of the Farm Credit Act (12 U.S.C. 2183, 2243, 
2252, 2279aa-11, 2279bb, 2279bb-1, 2279bb-2, 2279bb-3, 2279bb-4, 
2279bb-5, 2279bb-6, 2279cc); sec. 514 of Pub. L. 102-552, 106 Stat. 
4102; sec. 118 of Pub. L. 104-105, 110 Stat. 168.

0
2. Revise subpart B to part 652 to read as follows:
Subpart B--Risk-Based Capital Requirements
Sec.
652.50 Definitions.
652.55 General.
652.60 Corporation board guidelines.
652.65 Risk-based capital stress test.
652.70 Risk-based capital level.
652.75 Your responsibility for determining the risk-based capital 
level.
652.80 When you must determine the risk-based capital level.
652.85 When to report the risk-based capital level.
652.90 How to report your risk-based capital determination.
652.95 Failure to meet capital requirements.
652.100 Audit of the risk-based capital stress test.
Appendix A--Subpart B of Part 652--Risk-Based Capital Stress Test

Subpart B--Risk-Based Capital Requirements


Sec.  652.50  Definitions.

    For purposes of this subpart, the following definitions will apply:

[[Page 77254]]

    Farmer Mac, Corporation, you, and your means the Federal 
Agricultural Mortgage Corporation and its affiliates as defined in 
subpart A of this part.
    Our, us, or we means the Farm Credit Administration.
    Regulatory capital means the sum of the following as determined in 
accordance with generally accepted accounting principles:
    (1) The par value of outstanding common stock;
    (2) The par value of outstanding preferred stock;
    (3) Paid-in capital, which is the amount of owner investment in 
Farmer Mac in excess of the par value of stock;
    (4) Retained earnings; and,
    (5) Any allowances for losses on loans and guaranteed securities.
    Risk-based capital means the amount of regulatory capital 
sufficient for Farmer Mac to maintain positive capital during a 10-year 
period of stressful conditions as determined by the risk-based capital 
stress test described in Sec.  652.65.


Sec.  652.55  General.

    You must hold risk-based capital in an amount determined in 
accordance with this subpart.


Sec.  652.60  Corporation board guidelines.

    (a) Your board of directors is responsible for ensuring that you 
maintain total capital at a level that is sufficient to ensure 
continued financial viability and--provide for growth. In addition, 
your capital must be sufficient to meet statutory and regulatory 
requirements.
    (b) No later than 65 days after the beginning of Farmer Mac's 
planning year, your board of directors must adopt an operational and 
strategic business plan for at least the next 3 years. The plan must 
include:
    (1) A mission statement;
    (2) A review of the internal and external factors that are likely 
to affect you during the planning period;
    (3) Measurable goals and objectives;
    (4) Forecasted income, expense, and balance sheet statements for 
each year of the plan; and,
    (5) A capital adequacy plan.
    (c) The capital adequacy plan must include capital targets 
necessary to achieve the minimum, critical and risk-based capital 
standards specified by the Act and this subpart as well as your capital 
adequacy goals. The plan must address any projected dividends, equity 
retirements, or other action that may decrease your capital or its 
components for which minimum amounts are required by this subpart. You 
must specify in your plan the circumstances in which stock or equities 
may be retired. In addition to factors that must be considered in 
meeting the statutory and regulatory capital standards, your board of 
directors must also consider at least the following factors in 
developing the capital adequacy plan:
    (1) Capability of management;
    (2) Strategies and objectives in your business plan;
    (3) Quality of operating policies, procedures, and internal 
controls;
    (4) Quality and quantity of earnings;
    (5) Asset quality and the adequacy of the allowance for losses to 
absorb potential losses in your retained mortgage portfolio, securities 
guaranteed as to principal and interest, commitments to purchase 
mortgages or securities, and other program assets or obligations;
    (6) Sufficiency of liquidity and the quality of investments; and,
    (7) Any other risk-oriented activities, such as funding and 
interest rate risks, contingent and off-balance sheet liabilities, or 
other conditions warranting additional capital.


Sec.  652.65  Risk-based capital stress test.

    You will perform the risk-based capital stress test as described in 
summary form below and as described in detail in Appendix A to this 
subpart. The risk-based capital stress test spreadsheet is also 
available electronically at http://www.fca.gov. The risk-based capital 
stress test has five components:
    (a) Data requirements. You will use the following data to implement 
the risk-based capital stress test.
    (1) You will use Corporation loan-level data to implement the 
credit risk component of the risk-based capital stress test.
    (2) You will use Call Report data as the basis for Corporation data 
over the 10-year stress period supplemented with your interest rate 
risk measurements and tax data.
    (3) You will use other data, including the 10-year Constant 
Maturity Treasury (CMT) rate and the applicable Internal Revenue 
Service corporate income tax schedule, as further described in Appendix 
A to this subpart.
    (b) Credit risk. The credit risk part estimates loan losses during 
a period of sustained economic stress.
    (1) For each loan in the Farmer Mac I portfolio, you will determine 
a default probability by using the logit functions specified in 
Appendix A to this subpart with each of the following variables:
    (i) Borrower's debt-to-asset ratio at loan origination;
    (ii) Loan-to-value ratio at origination, which is the loan amount 
divided by the value of the property;
    (iii) Debt-service-coverage ratio at origination, which is the 
borrower's net income (on- and off-farm) plus depreciation, capital 
lease payments, and interest, less living expenses and income taxes, 
divided by the total term debt payments;
    (iv) The origination loan balance stated in 1997 dollars based on 
the consumer price index; and,
    (v) The worst-case percentage change in farmland values (23.52 
percent).
    (2) You will then calculate the loss rate by multiplying the 
default probability for each loan by the estimated loss-severity rate, 
which is the average loss of the defaulted loans in the data set (20.9 
percent).
    (3) You will calculate losses by multiplying the loss rate by the 
origination loan balances stated in 1997 dollars.
    (4) You will adjust the losses for loan seasoning, based on the 
number of years since loan origination, according to the functions in 
Appendix A to this subpart.
    (5) The losses must be applied in the risk-based capital stress 
test as specified in Appendix A to this subpart.
    (c) Interest rate risk. (1) During the first year of the stress 
period, you will adjust interest rates for two scenarios, an increase 
in rates and a decrease in rates. You must determine your risk-based 
capital level based on whichever scenario would require more capital.
    (2) You will calculate the interest rate stress based on changes to 
the quarterly average of the 10-year CMT. The starting rate is the 3-
month average of the most recent CMT monthly rate series. To calculate 
the change in the starting rate, determine the average yield of the 
preceding 12 monthly 10-year CMT rates. Then increase and decrease the 
starting rate by:
    (i) 50 percent of the 12-month average if the average rate is less 
than 12 percent; or
    (ii) 600 basis points if the 12-month average rate is equal to or 
higher than 12 percent.
    (3) Following the first year of the stress period, interest rates 
remain at the new level for the remainder of the stress period.
    (4) You will apply the interest rate changes scenario as indicated 
in Appendix A to this subpart.
    (5) You may use other interest rate indices in addition to the 10-
year CMT subject to our concurrence, but in no event can your risk-
based capital level be less than that determined by using only the 10-
year CMT.
    (d) Cashflow generator. (1) You must adjust your financial 
statements based on the credit risk inputs and interest rate risk 
inputs described above to

[[Page 77255]]

generate pro forma financial statements for each year of the 10-year 
stress test. The cashflow generator produces these financial 
statements. You may use the cashflow generator spreadsheet that is 
described in Appendix A to this subpart and available electronically at 
http://www.fca.gov. You may also use any reliable cashflow program that 
can develop or produce pro forma financial statements using generally 
accepted accounting principles and widely recognized financial modeling 
methods, subject to our concurrence. You may disaggregate financial 
data to any greater degree than that specified in Appendix A to this 
subpart, subject to our concurrence.
    (2) You must use model assumptions to generate financial statements 
over the 10-year stress period. The major assumption is that cashflows 
generated by the risk-based capital stress test are based on a steady-
state scenario. To implement a steady-state scenario, when on- and off-
balance sheet assets and liabilities amortize or are paid down, you 
must replace them with similar assets and liabilities. Replace 
amortized assets from discontinued loan programs with current loan 
programs. In general, keep assets with small balances in constant 
proportions to key program assets.
    (3) You must simulate annual pro forma balance sheets and income 
statements in the risk-based capital stress test using Farmer Mac's 
starting position, the credit risk and interest rate risk components, 
resulting cashflow outputs, current operating strategies and policies, 
and other inputs as shown in Appendix A to this subpart and the 
electronic spreadsheet available at http://www.fca.gov.
    (e) Calculation of capital requirement. The calculations that you 
must use to solve for the starting regulatory capital amount are shown 
in Appendix A to this subpart and in the electronic spreadsheet 
available at http://www.fca.gov.


Sec.  652.70  Risk-based capital level.

    The risk-based capital level is the sum of the following amounts:
    (a) Credit and interest rate risk. The amount of risk-based capital 
determined by the risk-based capital test under Sec.  652.65.
    (b) Management and operations risk. Thirty (30) percent of the 
amount of risk-based capital determined by the risk-based capital test 
in Sec.  652.65.


Sec.  652.75  Your responsibility for determining the risk-based 
capital level.

    (a) You must determine your risk-based capital level using the 
procedures in this subpart, Appendix A to this subpart, and any other 
supplemental instructions provided by us. You will report your 
determination to us as prescribed in Sec.  652.90. At any time, 
however, we may determine your risk-based capital level using the 
procedures in Sec.  652.65 and Appendix A to this subpart, and you must 
hold risk-based capital in the amount we determine is appropriate.
    (b) You must at all times comply with the risk-based capital levels 
established by the risk-based capital stress test and must be able to 
determine your risk-based capital level at any time.
    (c) If at any time the risk-based capital level you determine is 
less than the minimum capital requirements set forth in section 8.33 of 
the Act, you must maintain the statutory minimum capital level.


Sec.  652.80  When you must determine the risk-based capital level.

    (a) You must determine your risk-based capital level at least 
quarterly, or whenever changing circumstances occur that have a 
significant effect on capital, such as exposure to a high volume of, or 
particularly severe, problem loans or a period of rapid growth.
    (b) In addition to the requirements of paragraph (a) of this 
section, we may require you to determine your risk-based capital level 
at any time.
    (c) If you anticipate entering into any new business activity that 
could have a significant effect on capital, you must determine a pro 
forma risk-based capital level, which must include the new business 
activity, and report this pro forma determination to the Director, 
Office of Secondary Market Oversight, at least 10-business days prior 
to implementation of the new business program.


Sec.  652.85  When to report the risk-based capital level.

    (a) You must file a risk-based capital report with us each time you 
determine your risk-based capital level as required by Sec.  652.80.
    (b) You must also report to us at once if you identify in the 
interim between quarterly or more frequent reports to us that you are 
not in compliance with the risk-based capital level required by Sec.  
652.70.
    (c) If you make any changes to the data used to calculate your 
risk-based capital requirement that cause a material adjustment to the 
risk-based capital level you reported to us, you must file an amended 
risk-based capital report with us within 5-business days after the date 
of such changes;
    (d) You must submit your quarterly risk-based capital report for 
the last day of the preceding quarter not later than the last business 
day of April, July, October, and January of each year.


Sec.  652.90  How to report your risk-based capital determination.

    (a) Your risk-based capital report must contain at least the 
following information:
    (1) All data integral for determining the risk-based capital level, 
including any business policy decisions or other assumptions made in 
implementing the risk-based capital test;
    (2) Other information necessary to determine compliance with the 
procedures for determining risk-based capital as specified in Appendix 
A to this subpart; and
    (3) Any other information we may require in written instructions to 
you.
    (b) You must submit each risk-based capital report in such format 
or medium, as we require.


Sec.  652.95  Failure to meet capital requirements.

    (a) Determination and notice. At any time, we may determine that 
you are not meeting your risk-based capital level calculated according 
to Sec.  652.65, your minimum capital requirements specified in section 
8.33 of the Act, or your critical capital requirements specified in 
section 8.34 of the Act. We will notify you in writing of this fact and 
the date by which you should be in compliance (if applicable).
    (b) Submission of capital restoration plan. Our determination that 
you are not meeting your required capital levels may require you to 
develop and submit to us, within a specified time period, an acceptable 
plan to reach the appropriate capital level(s) by the date required.


Sec.  652.100  Audit of the risk-based capital stress test.

    You must have a qualified, independent external auditor review your 
implementation of the risk-based capital stress test every 3 years and 
submit a copy of the auditor's opinion to us.

Appendix A--Subpart B of Part 652--Risk-Based Capital Stress Test

1.0 Introduction.
2.0 Credit Risk.
2.1 Loss-Frequency and Loss-Severity Models.
2.2 Loan-Seasoning Adjustment.
2.3 Example Calculation of Dollar Loss on One Loan.
2.4 Calculation of Loss Rates for Use in the Stress Test.
3.0 Interest Rate Risk.
3.1 Process for Calculating the Interest Rate Movement.
4.0 Elements Used in Generating Cashflows.
4.1 Data Inputs.

[[Page 77256]]

4.2 Assumptions and Relationships.
4.3 Risk Measures.
4.4 Loan and Cashflow Accounts.
4.5 Income Statements.
4.6 Balance Sheets.
4.7 Capital.
5.0 Capital Calculations.
5.1 Method of Calculation.

1.0 Introduction

    a. Appendix A provides details about the risk-based capital 
stress test (stress test) for Farmer Mac. The stress test calculates 
the risk-based capital level required by statute under stipulated 
conditions of credit risk and interest rate risk. The stress test 
uses loan-level data from Farmer Mac's agricultural mortgage 
portfolio or proxy data as described in section 4.1 d.(3) below, as 
well as quarterly Call Report and related information to generate 
pro forma financial statements and calculate a risk-based capital 
requirement. The stress test also uses historic agricultural real 
estate mortgage performance data, relevant economic variables, and 
other inputs in its calculations of Farmer Mac's capital needs over 
a 10-year period.
    b. Appendix A establishes the requirements for all components of 
the stress test. The key components of the stress test are: 
Specifications of credit risk, interest rate risk, the cashflow 
generator, and the capital calculation. Linkages among the 
components ensure that the measures of credit and interest rate risk 
pass into the cashflow generator. The linkages also transfer 
cashflows through the financial statements to represent values of 
assets, liabilities, and equity capital. The 10-year projection is 
designed to reflect a steady state in the scope and composition of 
Farmer Mac's assets.

2.0 Credit Risk

    Loan loss rates are determined by applying loss-frequency and 
loss-severity equations to Farmer Mac loan-level data. From these 
equations, you must calculate loan losses under stressful economic 
conditions assuming Farmer Mac's portfolio remains at a ``steady 
state.'' Steady state assumes the underlying characteristics and 
risks of Farmer Mac's portfolio remain constant over the 10 years of 
the stress test. Loss rates are computed from estimated dollar 
losses for use in the stress test. The loan volume subject to loss 
throughout the stress test is then multiplied by the loss rate. 
Lastly, the stress test allocates losses to each of the 10 years 
assuming a time pattern for loss occurrence as discussed in section 
4.3, ``Risk Measures.''

2.1 Loss-Frequency and Loss-Severity Models

    a. Credit risks are modeled in the stress test using historical 
time series loan-level data to measure the frequency and severity of 
losses on agricultural mortgage loans. The model relates loss 
frequency and severity to loan-level characteristics and economic 
conditions through appropriately specified regression equations to 
account explicitly for the effects of these characteristics on loan 
losses. Loan losses for Farmer Mac are estimated from the resulting 
loss-frequency equation combined with the loss-severity factor by 
substituting the respective values of Farmer Mac's loan-level data 
or proxy data as described in section 4.1 d.(3) below, and applying 
stressful economic inputs.
    b. The loss-frequency equation and loss-severity factor were 
estimated from historical agricultural real estate mortgage loan 
data from the Farm Credit Bank of Texas (FCBT). Due to Farmer Mac's 
relatively short history, its own loan-level data are insufficiently 
developed for use in estimating the default frequency equation and 
loss-severity factor. In the future, however, expansions in both the 
scope and historic length of Farmer Mac's lending operations may 
support the use of its data in estimating the relationships.
    c. To estimate the equations, the data used included FCBT loans, 
which satisfied three of the four underwriting standards Farmer Mac 
currently uses (estimation data). The four standards specify: (1) 
The debt-to-assets ratio (D/A) must be less than 0.50, (2) the loan-
to-value ratio (LTV) must be less than 0.70, (3) the debt-service-
coverage ratio (DSCR) must exceed 1.25, (4) and the current ratio 
(current assets divided by current liabilities) must exceed 1.0. 
Furthermore, the D/A and LTV ratios were restricted to be less than 
or equal to 0.85.
    d. Several limitations in the FCBT loan-level data affect 
construction of the loss-frequency equation. The data contained 
loans that were originated between 1979 and 1992, but there were 
virtually no losses during the early years of the sample period. As 
a result, losses attributable to specific loans are only available 
from 1986 through 1992. In addition, no prepayment information was 
available in the data.
    e. The FCBT data used for estimation also included as performing 
loans, those loans that were re-amortized, paid in full, or merged 
with a new loan. Including these loans may lead to an understatement 
of loss-frequency probabilities if some of the re-amortized, paid, 
or merged loans experience default or incur losses. In contrast, 
when the loans that are re-amortized, paid in full, or merged are 
excluded from the analysis, the loss-frequency rates are overstated 
if a higher proportion of loans that are re-amortized, paid in full, 
or combined (merged) into a new loan are non-default loans compared 
to live loans.\1\
---------------------------------------------------------------------------

    \1\ Excluding loans with defaults, 11,527 loans were active and 
7,515 loans were paid in full, re-amortized or merged as of 1992. A 
t-test\2\ of the differences in the means for the group of defaulted 
loans and active loans indicated that active loans had significantly 
higher D/A and LTV ratios, and lower current ratios than defaulted 
loans where loss occurred. These results indicate that, on average, 
active loans have potentially higher risk than loans that were re-
amortized, paid in full, or merged.
---------------------------------------------------------------------------

    f. The structure of the historical FCBT data supports estimation 
of loss frequency based on origination information and economic 
conditions. Under an origination year approach, each observation is 
used only once in estimating loan default. The underwriting 
variables at origination and economic factors occurring over the 
life of the loan are then used to estimate loan-loss frequency.
    g. The final loss-frequency equation is based on origination 
year data and represents a lifetime loss-frequency model. The final 
equation for loss frequency is:

p = 1/(1+exp(-(BX))

Where:

BX = (-12.62738) + 1.91259 [middot] X1 + (-0.33830) 
[middot] X2 / (1 + 0.0413299)Periods + (-
0.19596) [middot] X3 + 4.55390 [middot] (1-exp((-
0.00538178) [middot] X4) + 2.49482 [middot] X5

Where:

 p is the probability that a loan defaults and has positive 
losses (Pr (Y=1 [bond] x));
 X1 is the LTV ratio at loan origination raised 
to the power 5.3914596; \2\
---------------------------------------------------------------------------

    \2\ Loss probability is likely to be more sensitive to changes 
in LTV at higher values of LTV. The power function provides a 
continuous relationship between LTV and defaults.
---------------------------------------------------------------------------

 X2 is the largest annual percentage decline in 
FCBT farmland values during the life of the loan dampened with a 
factor of 0.0413299 per year; \3\
---------------------------------------------------------------------------

    \3\ The dampening function reflects the declining effect that 
the maximum land value decline has on the probability of default 
when it occurs later in a loan's life.
---------------------------------------------------------------------------

 X3 is the DSCR at loan origination;
 X4 is 1 minus the exponential of the product of 
negative 0.00538178 and the original loan balance in 1997 dollars 
expressed in thousands; and
 X5 is the D/A ratio at loan origination.

    h. The estimated logit coefficients and p-values are: \4\
---------------------------------------------------------------------------

    \4\ The nonlinear parameters for the variable transformations 
were simultaneously estimated using SAS version 8e NLIN procedure. 
The NLIN procedure produces estimates of the parameters of a 
nonlinear transformation for LTV, dampening factor, and loan-size 
variables. To implement the NLIN procedure, the loss-frequency 
equation and its variables are declared and initial parameter values 
supplied. The NLIN procedure is an iterative process that uses the 
initial parameter values as the starting values for the first 
iteration and continues to iterate until acceptable parameters are 
solved. The initial values for the power function and dampening 
function are based on the proposed rule. The procedure for the 
initial values for the size variable parameter is provided in an 
Excel spreadsheet posted at http://www.fca.gov. The Gauss-Newton 
method is the selected iterative solving process. As described in 
the preamble, the loss-frequency function for the nonlinear model is 
the negative of the log-likelihood function, thus producing maximum 
likelihood estimates. In order to obtain statistical properties for 
the loss-frequency equation and verify the logistic coefficients, 
the estimates for the nonlinear transformations are applied to the 
FCBT data and the loss-frequency model is re-estimated using the SAS 
Logistic procedure. The SAS procedures, output reports and Excel 
spreadsheet used to estimate the parameters of the loss-frequency 
equation are located on the Web site http://www.fca.gov.

[[Page 77257]]



------------------------------------------------------------------------
                                           Coefficients       p-value
------------------------------------------------------------------------
Intercept...............................       -12.62738         <0.0001
X1: LTV variable........................         1.91259          0.0001
X2: Max land value decline variable.....         0.33830         <0.0001
X3: DSCR................................        -0.19596          0.0002
X4: Loan size variable..................         4.55390         <0.0001
X5: D/A ratio...........................         2.49482         <0.0000
------------------------------------------------------------------------

    i. The low p-values on each coefficient indicate a highly 
significant relationship between the probability ratio of loan-loss 
frequency and the respective independent variables. Other goodness-
of-fit indicators are:

Hosmer and Lemeshow goodness-of-fit p-value................       0.1718
Max-rescaled R\2\..........................................       0.2015
Concordant.................................................        85.2%
Disconcordant..............................................        12.0%
Tied.......................................................         2.8%
 

    j. These variables have logical relationships to the incidence 
of loan default and loss, as evidenced by the findings of numerous 
credit-scoring studies in agricultural finance.\5\ Each of the 
variable coefficients has directional relationships that 
appropriately capture credit risk from underwriting variables and, 
therefore, the incidence of loan-loss frequency. The frequency of 
loan loss was found to differ significantly across all of the loan 
characteristics and lending conditions. Farmland values represent an 
appropriate variable for capturing the effects of exogenous economic 
factors. It is commonly accepted that farmland values at any point 
in time reflect the discounted present value of expected returns to 
the land.\6\ Thus, changes in land values, as expressed in the loss-
frequency equation, represent the combined effects of the level and 
growth rates of farm income, interest rates, and inflationary 
expectations--each of which is accounted for in the discounted, 
present value process.
---------------------------------------------------------------------------

    \5\ Splett, N.S., P. J. Barry, B. Dixon, and P. Ellinger. ``A 
Joint Experience and Statistical Approach to Credit Scoring,'' 
Agricultural Finance Review, 54(1994):39-54.
    \6\ Barry, P. J., P. N. Ellinger, J. A. Hopkin, and C. B. Baker. 
Financial Management in Agriculture, 5th ed., Interstate Publishers, 
1995.
---------------------------------------------------------------------------

    k. When applying the equation to Farmer Mac's portfolio, you 
must get the input values for X1, X3, 
X4, and X5 for each loan in Farmer Mac's 
portfolio on the date at which the stress test is conducted, using 
either submitted data or proxy data as described in section 4.1 
d.(3) below. For the variable X2, the stressful input 
value from the benchmark loss experience is -23.52 percent. You must 
apply this input to all Farmer Mac loans subject to loss to 
calculate loss frequency under stressful economic conditions.\7\ The 
maximum land value decline from the benchmark loss experience is the 
simple average of annual land value changes for Iowa, Illinois, and 
Minnesota for the years 1984 and 1985.\8\
---------------------------------------------------------------------------

    \7\ On- and off-balance sheet Farmer Mac I agricultural mortgage 
program assets booked after the 1996 Act amendments are subject to 
the loss calculation.
    \8\ While the worst-case losses, based on origination year, 
occurred during 1983 and 1984, this benchmark was determined using 
annual land value changes that occurred 2 years later.
---------------------------------------------------------------------------

    l. Forecasting with data outside the range of the estimation 
data requires special treatment for implementation. While the 
estimation data embody Farmer Mac values for various loan 
characteristics, the maximum farmland price decline experienced in 
Texas was -16.69 percent, a value below the benchmark experience of 
-23.52 percent. To control for this effect, you must apply a 
procedure that restricts the slope of all the independent variables 
to that observed at the maximum land value decline observed in the 
estimation data. Essentially, you must approximate the slope of the 
loss-frequency equation at the point -16.69 percent in order to 
adjust the probability of loan default and loss occurrence for data 
beyond the range in the estimating data. The adjustment procedure is 
shown in step 4 of section 2.3 entitled, ``Example Calculation of 
Dollar Loss on One Loan.''
    m. Loss severity was not found to vary systematically and was 
considered constant across the tested loan characteristics and 
lending conditions. Thus, the simple weighted average by loss volume 
of 20.9 percent is used in the stress test.\9\ You must multiply 
loss severity with the probability estimate computed from the loss-
frequency equation to determine the loss rate for a loan.
---------------------------------------------------------------------------

    \9\ We calculated the weighted-average loss severity from the 
estimation data.
---------------------------------------------------------------------------

    n. Using original loan balance results in estimated 
probabilities of loss frequency over the entire life of a loan. To 
account for loan seasoning, you must reduce the loan-loss exposure 
by the cumulative probability of loss already experienced by each 
loan as discussed in section 2.2 entitled, ``Loan-Seasoning 
Adjustment.'' This subtraction is based on loan age and reduces the 
loss estimated by the loss-frequency and loss-severity equations. 
The result is an age-adjusted lifetime dollar loss that can be used 
in subsequent calculations of loss rates as discussed in section 
2.4, ``Calculation of Loss Rates for Use in the Stress Test.''

2.2 Loan-Seasoning Adjustment

    a. You must use the seasoning function supplied by FCA to adjust 
the calculated probability of loss for each Farmer Mac loan for the 
cumulative loss exposure already experienced based on the age of 
each loan. The seasoning function is based on the same data used to 
determine the loss-frequency equation and an assumed average life of 
14 years for agricultural mortgages. If we determine that the 
relationship between the loss experience in Farmer Mac's portfolio 
over time and the seasoning function can be improved, we may augment 
or replace the seasoning function.
    b. The seasoning function is parameterized as a beta 
distribution with parameters of p = 4.288 and q = 5.3185.\10\ How 
the loan-seasoning distribution is used is shown in Step 7 of 
section 2.3, ``Example Calculation of Dollar Loss on One Loan.''
---------------------------------------------------------------------------

    \10\ We estimated the loan-seasoning distribution from portfolio 
aggregate charge-off rates from the estimation data. To do so, we 
arrayed all defaulting loans where loss occurred according to the 
time from origination to default. Then, a beta distribution, 
[beta](p, q), was fit to the estimation data scaled to the maximum 
time a loan survived (14 years).
---------------------------------------------------------------------------

2.3 Example Calculation of Dollar Loss on One Loan

    Here is an example of the calculation of the dollar losses for 
an individual loan with the following characteristics and input 
values: \11\
---------------------------------------------------------------------------

    \11\ In the examples presented we rounded the numbers, but the 
example calculation is based on a larger number of significant 
digits. The stress test uses additional digits carried at the 
default precision of the software.

Loan Origination Year......................................         1996
Loan Origination Balance...................................   $1,250,000
LTV at Origination.........................................          0.5
D/A at Origination.........................................          0.5
DSCR at Origination........................................       1.3984
Maximum Percentage Land Price Decline (MAX)................       -23.52
 

    Step 1: Convert 1996 Origination Value to 1997 dollar value 
(LOAN) based on the consumer price index and transform as follows:
$1,278,500 = $1,250,000 [middot] 1.0228
0.998972 = 1 - exp((-.00538178) [middot] $1,278,500 / 1000)
    Step 2: Calculate the default probabilities using -16.64 percent 
and -16.74 percent land value declines as follows: \12\

    \12\ This process facilitates the approximation of slope needed 
to adjust the loss probabilities for land value declines greater 
than observed in the estimation data.
---------------------------------------------------------------------------

Where:

Z1 = (-12.62738) + 1.91259 [middot] 
LTV5.3914596 - 0.33830 [middot] (-16.6439443) - 0.19596 
[middot] DSCR + 4.55390 [middot] 0.998972 + 2.49482 [middot] DA = (-
1.428509)
Default Loss Frequency at (-16.64%) =

1 / 1 + exp-(-1.428509) = 0.19333111
And

Z1 = (-12.62738) + 1.91259 [middot] 
LTV5.3914596 - 0.33830 [middot] (-16.7439443) - 0.19596 
[middot] DSCR + 4.55390 [middot] 0.998972 + 2.49482 [middot] DA = (-
1.394679)

Loss Frequency Probability at (-16.74%) =
1 / 1 + exp-(-1.394679) = 0.19866189


[[Page 77258]]


    Step 3: Calculate the slope adjustment. You must calculate slope 
by subtracting the difference between ``Loss-Frequency Probability 
at -16.64 percent'' and ``Loss-Frequency Probability at -16.74 
percent'' and dividing by -0.1 (the difference between -16.64 
percent and -16.74 percent) as follows:

0.05330776 = (0.19333111 - 0.19866189) / -0.1

    Step 4: Make the linear adjustment. You make the adjustment by 
increasing the loss-frequency probability where the dampened 
stressed farmland value input is less than -16.69 percent to reflect 
the stressed farmland value input, appropriately discounted. As 
discussed previously, the stressed land value input is discounted to 
reflect the declining effect that the maximum land value decline has 
on the probability of default when it occurs later in a loan's 
life.\13\ The linear adjustment is the difference between -16.69 
percent land value decline and the adjusted stressed maximum land 
value decline input of -23.52 multiplied by the slope estimated in 
Step 3 as follows:
---------------------------------------------------------------------------

    \13\ The dampened period is the number of years from the 
beginning of the origination year to the current year (i.e., January 
1, 1996 to January 1, 2000 is 4 years).

Loss Frequency at -16.69 percent =
Z1 = (-12.62738) + (1.91259)(LTV5.3914596) - 
(0.33830)(-16.6939443) - (0.19596)(DSCR) + (4.55390)(0.998972) + 
(2.49482)(DA) = -1.411594
And

1 / 1 + exp-(-1.411594) = 0.19598279
Dampened Maximum Land Price Decline = (-20.00248544) = (-
23.52)(1.0413299)-4
Slope Adjustment = 0.17637092 = 0.053312247 [middot] (-16.6939443 - 
(-20.00248544))
Loan Default Probability = 0.37235371 = 0.19598279 + 0.17637092

    Step 5: Multiply loan default probability times the average 
severity of 0.209 as follows:
0.077821926 = 0.37235371 [middot] 0.209

    Step 6: Multiply the loss rate times the origination loan 
balance as follows:

$97,277 = $1,250,000 [middot] 0.077821926

    Step 7: Adjust the origination based dollar losses for 4 years 
of loan seasoning as follows:

$81,987 = $97,277 - $97,277 [middot] (0.157178762) \14\
---------------------------------------------------------------------------

    \14\ The age of adjustment of 0.157178762 is determined from the 
beta distribution for a 4-year-old loan.
---------------------------------------------------------------------------

2.4 Calculation of Loss Rates for Use in the Stress Test

    a. You must compute the loss rates by state as the dollar 
weighted average seasoned loss rates from the Cash Window and 
Standby loan portfolios by state. The spreadsheet entitled, ``Credit 
Loss Module.XLS'' can be used for these calculations. This 
spreadsheet is available for download on our Web site, www.fca.gov, 
or will be provided upon request. The blended loss rates for each 
state are copied from the ``Credit Loss Module'' to the stress test 
spreadsheet for determining Farmer Mac's regulatory capital 
requirement.
    b. The stress test use of the blended loss rates is further 
discussed in section 4.3, ``Risk Measures.''

3.0 Interest Rate Risk

    The stress test explicitly accounts for Farmer Mac's 
vulnerability to interest rate risk from the movement in interest 
rates specified in the statute. The stress test considers Farmer 
Mac's interest rate risk position through the current structure of 
its balance sheet, reported interest rate risk shock-test 
results,\15\ and other financial activities. The stress test 
calculates the effect of interest rate risk exposure through market 
value changes of interest-bearing assets, liabilities, and off-
balance sheet transactions, and thereby the effects to equity 
capital. The stress test also captures this exposure through the 
cashflows on rate-sensitive assets and liabilities. We discuss how 
to calculate the dollar impact of interest rate risk in section 4.6, 
``Balance Sheets.''
---------------------------------------------------------------------------

    \15\ See paragraph c. of section 4.1 entitled, ``Data Inputs,'' 
for a description of the interest rate risk shock-reporting 
requirement.
---------------------------------------------------------------------------

3.1 Process for Calculating the Interest Rate Movement

    a. The stress test uses the 10-year Constant Maturity Treasury 
(10-year CMT) released by the Federal Reserve in HR. 15, ``Selected 
Interest Rates.'' The stress test uses the 10-year CMT to generate 
earnings yields on assets, expense rates on liabilities, and changes 
in the market value of assets and liabilities. For stress test 
purposes, the starting rate for the 10-year CMT is the 3-month 
average of the most recent monthly rate series published by the 
Federal Reserve. The 3-month average is calculated by summing the 
latest monthly series of the 10-year CMT and dividing by three. For 
instance, you would calculate the initial rate on June 30, 1999, as:

------------------------------------------------------------------------
                                                                10-year
                                                                  CMT
                          Month end                             monthly
                                                                 series
------------------------------------------------------------------------
04/1999......................................................       5.18
05/1999......................................................       5.54
06/1999......................................................       5.90
Average......................................................       5.54
------------------------------------------------------------------------

    b. The amount by which the stress test shocks the initial rate 
up and down is determined by calculating the 12-month average of the 
10-year CMT monthly series. If the resulting average is less than 12 
percent, the stress test shocks the initial rate by an amount 
determined by multiplying the 12-month average rate by 50 percent. 
However, if the average is greater than or equal to 12 percent, the 
stress test shocks the initial rate by 600 basis points. For 
example, determine the amount by which to increase and decrease the 
initial rate for June 30, 1999, as follows:

------------------------------------------------------------------------
                                                                10-year
                                                                  CMT
                          Month end                             monthly
                                                                 series
------------------------------------------------------------------------
07/1998......................................................       5.46
08/1998......................................................       5.34
09/1998......................................................       4.81
10/1998......................................................       4.53
11/1998......................................................       4.83
12/1998......................................................       4.65
01/1999......................................................       4.72
02/1999......................................................       5.00
03/1999......................................................       5.23
04/1999......................................................       5.18
05/1999......................................................       5.54
06/1999......................................................       5.90
12-Month Average.............................................       5.10
------------------------------------------------------------------------


------------------------------------------------------------------------
          Calculation of shock amount
------------------------------------------------------------------------
12-Month Average Less than 12%................  Yes.
12-Month Average..............................  5.10.
Multiply the 12-Month Average by..............  50%.
Shock in basis points equals..................  255.
------------------------------------------------------------------------

    c. You must run the stress test for two separate changes in 
interest rates: (i) An immediate increase in the initial rate by the 
shock amount; and (ii) immediate decrease in the initial rate by the 
shock amount. The stress test then holds the changed interest rate 
constant for the remainder of the 10-year stress period. For 
example, at June 30, 1999, the stress test would be run for an 
immediate and sustained (for 10 years) upward movement in interest 
rates to 8.09 percent (5.54 percent plus 255 basis points) and also 
for an immediate and sustained (for 10 years) downward movement in 
interest rates to 2.99 percent (5.54 percent minus 255 basis 
points). The movement in interest rates that results in the greatest 
need for capital is then used to determine Farmer Mac's risk-based 
capital requirement.

4.0 Elements Used in Generating Cashflows

    a. This section describes the elements that are required for 
implementation of the stress test and assessment of Farmer Mac 
capital performance through time. An Excel spreadsheet named FAMC 
RBCST, available at http://www.fca.gov, contains the stress test, 
including the cashflow generator. The spreadsheet contains the 
following seven worksheets:
    (1) Data Input;
    (2) Assumptions and Relationships;
    (3) Risk Measures (credit risk and interest rate risk);
    (4) Loan and Cash Flow Accounts;
    (5) Income Statements;
    (6) Balance Sheets; and
    (7) Capital.
    b. Each of the components is described in further detail below 
with references where appropriate to the specific worksheets within 
the Excel spreadsheet. The stress test may be generally described as 
a set of linked financial statements that evolve over a period of 10 
years using generally accepted accounting conventions and specified 
sets of stressed inputs. The stress test uses the initial financial 
condition of Farmer Mac, including earnings and funding 
relationships, and the credit and interest rate stressed inputs to 
calculate Farmer Mac's capital performance

[[Page 77259]]

through time. The stress test then subjects the initial financial 
conditions to the first period set of credit and interest rate risk 
stresses, generates cashflows by asset and liability category, 
performs necessary accounting postings into relevant accounts, and 
generates an income statement associated with the first interval of 
time. The stress test then uses the income statement to update the 
balance sheet for the end of period 1 (beginning of period 2). All 
necessary capital calculations for that point in time are then 
performed.
    c. The beginning of the period 2 balance sheet then serves as 
the departure point for the second income cycle. The second period's 
cashflows and resulting income statement are generated in similar 
fashion as the first period's except all inputs (i.e., the periodic 
loan losses, portfolio balance by category, and liability balances) 
are updated appropriately to reflect conditions at that point in 
time. The process evolves forward for a period of 10 years with each 
pair of balance sheets linked by an intervening set of cashflow and 
income statements. In this and the following sections, additional 
details are provided about the specification of the income-
generating model to be used by Farmer Mac in calculating the risk-
based capital requirement.

4.1 Data Inputs

    The stress test requires the initial financial statement 
conditions and income generating relationships for Farmer Mac. The 
worksheet named ``Data Inputs'' contains the complete data inputs 
and the data form used in the stress test. The stress test uses 
these data and various assumptions to calculate pro forma financial 
statements. For stress test purposes, Farmer Mac is required to 
supply:
    a. Call Report Schedules RC: Balance Sheet and RI: Income 
Statement. These schedules form the starting financial position for 
the stress test. In addition, the stress test calculates basic 
financial relationships and assumptions used in generating pro forma 
annual financial statements over the 10-year stress period. 
Financial relationships and assumptions are in section 4.2, 
``Assumptions and Relationships.''
    b. Cashflow Data for Asset and Liability Account Categories. The 
necessary cashflow data for the spreadsheet-based stress test are 
book value, weighted average yield, weighted average maturity, 
conditional prepayment rate, weighted average amortization, and 
weighted average guarantee fees. The spreadsheet uses this cashflow 
information to generate starting and ending account balances, 
interest earnings, guarantee fees, and interest expense. Each asset 
and liability account category identified in this data requirement 
is discussed in section 4.2, ``Assumptions and Relationships.''
    c. Interest Rate Risk Measurement Results. The stress test uses 
the results from Farmer Mac's interest rate risk model to represent 
changes in the market value of assets, liabilities, and off-balance 
sheet positions during upward and downward instantaneous shocks in 
interest rates of 300, 250, 200, 150, and 100 basis points. The 
stress test uses these data to calculate a schedule of estimated 
effective durations representing the market value effects from a 
change in interest rates. The stress test uses a linear 
interpolation of the duration schedule to relate a change in 
interest rates to a change in the market value of equity. This 
calculation is described in section 4.4 entitled, ``Loan and 
Cashflow Accounts,'' and is illustrated in the referenced worksheet 
of the stress test.
    d. Loan-Level Data for all Farmer Mac I Program Assets.
    (1) The stress test requires loan-level data for all Farmer Mac 
I program assets to determine lifetime age-adjusted loss rates. The 
specific loan data fields required for running the credit risk 
component are:

Farmer Mac I Program Loan Data Fields

Loan Number
Ending Scheduled Balance
Group
Pre/Post Act
Property State
Product Type
Origination Date
Loan Cutoff Date
Original Loan Balance
Original Scheduled P&I
Original Appraised Value
Loan-to-Value Ratio
Debt-to-Assets Ratio
Current Assets
Current Liabilities
Total Assets
Total Liabilities
Gross Farm Revenue
Net Farm Income
Depreciation
Interest on Capital Debt
Capital Lease Payments
Living Expenses
Income & FICA Taxes
Net Off-Farm Income
Total Debt Service
Guarantee/Commitment Fee
Seasoned Loan Flag
    (2) From the loan-level data, you must identify the geographic 
distribution by state of Farmer Mac's loan portfolio and enter the 
current loan balance for each state in the ``Data Inputs'' 
worksheet. The lifetime age-adjustment of origination year loss 
rates was discussed in section 2.0, ``Credit Risk.'' The lifetime 
age-adjusted loss rates are entered in the ``Risk Measures'' 
worksheet of the stress test. The stress test application of the 
loss rates is discussed in section 4.3, ``Risk Measures.''
    (3) Under certain circumstances, described below, you must 
substitute the following data proxies for the variables LTV, DSCR, 
and D/A: LTV = 0.70, DSCR = 1.25, and D/A = 0.50. The substitution 
must be done whenever any of these data are missing, i.e., cells are 
blank, or one or more of the conditions in the following table is 
true.

------------------------------------------------------------------------
                 Condition                              Apply
------------------------------------------------------------------------
1. Total Assets = 0........................  Proxy D/A.
2. Total Liabilities = 0...................  Proxy D/A.
3. Total assets less total liabilities <0..  Proxy D/A.
4. Total debt service = 0 or not calculable  Proxy DSCR.
5. Net farm income = 0.....................  Proxy DSCR.
6. LTV ratio = 0...........................  Proxy LTV.
7. Total assets less than original           Proxy LTV, D/A.
 appraised value.
8. Total liabilities less than the original  Proxy D/A.
 loan amount.
9. Total debt service is less than original  Proxy DSCR.
 scheduled principal and interest payment.
10. Depreciation, interest on capital debt,  Proxy DSCR.
 capital lease payments, or living expenses
 are reported as less than zero.
11. Original Scheduled Principal and         Proxy DSCR.
 Interest is greater than Total Debt
 Service.
12. Calculated LTV (original loan amount     The greater of the two LTV
 divided by original appraised value) does    ratios.
 not equal the submitted LTV ratio.
13. Any of the fields referenced in ``1.''   Proxy all related ratios.
 through ``12.'' above are blank or contain
 spaces, periods, zeros, negative amounts,
 or fonts formatted to any setting other
 than numbers.
------------------------------------------------------------------------

    In addition, the following loan data adjustments must be made in 
response to the situations listed below:

[[Page 77260]]



------------------------------------------------------------------------
               Situation                         Data adjustment
------------------------------------------------------------------------
Original loan balance is less than       Substitute scheduled balance
 scheduled loan balance.                  for origination.
Purchase (commitment) date (a.k.a.       Insert the quarter end ``as
 ``cutoff'' date) field and Origination   of'' date of the RBCST
 date field are both blank.               submission.
Origination date field is blank........  Model based on Cutoff date.
Seasoned Standby loans that include      Proxy data applied.*
 loan data.
------------------------------------------------------------------------
* Application of proxy data recognizes that underwriting data on
  seasoned Standby loans are not reviewed by Farmer Mac in favor of
  other criteria and frequently not origination data.

    Further, because it would not be possible to compile an 
exhaustive list of loan data anomalies, FCA reserves the authority 
to require an explanation on other data anomalies it identifies and 
to apply the loan data proxies on such cases until the anomaly is 
adequately addressed by the Corporation.
    e. Other Data Requirements. Other data elements are taxes paid 
over the previous 2 years, the corporate tax schedule, selected line 
items from Schedule RS-C of the Call Report, and 10-year CMT 
information as discussed in section 3.1 entitled, ``Process for 
Calculating the Interest Rate Movement.'' The stress test uses the 
corporate tax schedule and previous taxes paid to determine the 
appropriate amount of taxes, including available loss carry-backs 
and loss carry-forwards. Three line items found in sections Part 
II.2.a. and 2.b. of Call Report Schedule RS-C Capital Calculation 
must also be entered in the ``Data Inputs'' sheet. The two line 
items found in Part II.2.a. contain the dollar volume off-balance 
sheet assets relating to the Farmer Mac I and II programs. The off-
balance sheet program asset dollar volumes are used to calculate the 
operating expense regression on a quarterly basis. The single-line 
item found in Part II.2.b. provides the amount of other off-balance 
sheet obligations and is presented in the balance sheet section of 
the stress test for purposes of completeness. The 10-year CMT 
quarterly average of the monthly series and the 12-month average of 
the monthly series must be entered in the ``Data Inputs'' sheet. 
These two data elements are used to determine the starting interest 
rate and the level of the interest rate shock applied in the stress 
test.

4.2 Assumptions and Relationships

    a. The stress test assumptions are summarized on the worksheet 
called ``Assumptions and Relationships.'' Some of the entries on 
this page are direct user entries. Other entries are relationships 
generated from data supplied by Farmer Mac or other sources as 
discussed in section 4.1, ``Data Inputs.'' After current financial 
data are entered, the user selects the date for running the stress 
test. This action causes the stress test to identify and select the 
appropriate data from the ``Data Inputs'' worksheet. The next 
section highlights the degree of disaggregation needed to maintain 
reasonably representative financial characterizations of Farmer Mac 
in the stress test. Several specific assumptions are established 
about the future relationships of account balances and how they 
evolve.
    b. From the data and assumptions, the stress test computes pro 
forma financial statements for 10 years. The stress test must be run 
as a ``steady state'' with regard to program balances, and where 
possible, will use information gleaned from recent financial 
statements and other data supplied by Farmer Mac to establish 
earnings and cost relationships on major program assets that are 
applied forward in time. As documented in the stress test, entries 
of ``1'' imply no growth and/or no change in account balances or 
proportions relative to initial conditions with the exception of 
pre-1996 loan volume being transferred to post-1996 loan volume. The 
interest rate risk and credit loss components are applied to the 
stress test through time. The individual sections of that worksheet 
are:
    (1) Elements related to cashflows, earnings rates, and 
disposition of discontinued program assets.
    (A) The stress test accounts for earnings rates by asset class 
and cost rates on funding. The stress test aggregates investments 
into the categories of: Cash and money market securities; commercial 
paper; certificates of deposit; agency mortgage-backed securities 
and collateralized mortgage obligations; and other investments. With 
FCA's concurrence, Farmer Mac is permitted to further disaggregate 
these categories. Similarly, we may require new categories for 
future activities to be added to the stress test. Loan items 
requiring separate accounts include the following:
    (i) Farmer Mac I program assets post-1996 Act;
    (ii) Farmer Mac I program assets post-1996 Act Swap balances;
    (iii) Farmer Mac I program assets pre-1996 Act;
    (iv) Farmer Mac I AgVantage securities;
    (v) Loans held for securitization; and
    (vi) Farmer Mac II program assets.
    (B) The stress test also uses data elements related to 
amortization and prepayment experience to calculate and process the 
implied rates at which asset and liability balances terminate or 
``roll off'' through time. Further, for each category, the stress 
test has the capacity to track account balances that are expected to 
change through time for each of the above categories. For purposes 
of the stress test, all assets are assumed to maintain a ``steady 
state'' with the implication that any principal balances retired or 
prepaid are replaced with new balances. The exceptions are that 
expiring pre-1996 Act program assets are replaced with post-1996 Act 
program assets.
    (2) Elements related to other balance sheet assumptions through 
time. As well as interest earning assets, the other categories of 
the balance sheet that are modeled through time include interest 
receivable, guarantee fees receivable, prepaid expenses, accrued 
interest payable, accounts payable, accrued expenses, reserves for 
losses (loans held and guaranteed securities), and other off-balance 
sheet obligations. The stress test is consistent with Farmer Mac's 
existing reporting categories and practices. If reporting practices 
change substantially, the above list will be adjusted accordingly. 
The stress test has the capacity to have the balances in each of 
these accounts determined based upon existing relationships to other 
earning accounts, to keep their balances either in constant 
proportions of loan or security accounts, or to evolve according to 
a user-selected rule. For purposes of the stress test, these 
accounts are to remain constant relative to the proportions of their 
associated balance sheet accounts that generated the accrued 
balances.
    (3) Elements related to income and expense assumptions. Several 
other parameters that are required to generate pro forma financial 
statements may not be easily captured from historic data or may have 
characteristics that suggest that they be individually supplied. 
These parameters are the gain on agricultural mortgage-backed 
securities (AMBS) sales, miscellaneous income, operating expenses, 
reserve requirement, and guarantee fees.
    (A) The stress test applies the actual weighted average gain 
rate on sales of AMBS over the most recent 3 years to the dollar 
amount of AMBS sold during the most recent four quarters in order to 
estimate gain on sale of AMBS over the stress period.
    (B) The stress test assumes miscellaneous income at a level 
equal to the average of the most recent 3-year's actual 
miscellaneous income as a percent of the sum of; cash, investments, 
guaranteed securities, and loans held for investment.
    (C) Operating costs are determined in the model using weighted 
moving average of operating expenses as a percentage of the sum of 
on-balance sheet assets and off-balance sheet program activities 
over the previous four quarters inclusive of the current submission 
date. The share will then be applied forward to the balances of the 
same categories throughout the 10-year period of the RBCST model. As 
additional data accumulate, the specification will be re-examined 
and modified if we deem changing the specification results in a more 
appropriate representation of operating expenses.
    (D) The reserve requirement as a fraction of loan assets can 
also be specified. However, the stress test is run with the reserve 
requirement set to zero. Setting the parameter to zero causes the 
stress test to calculate a risk-based capital level that is 
comparable to regulatory capital, which includes reserves. Thus, the 
risk-based capital requirement contains the regulatory capital 
required, including reserves. The amount of total capital that is 
allocated to the reserve account

[[Page 77261]]

is determined by GAAP. The stress test applies quarterly updates of 
the weighted average guarantee rates for post-1996 Farmer Mac I 
assets, pre-1996 Farmer Mac I assets, and Farmer Mac II assets.
    (4) Elements related to earnings rates and funding costs.
    (A) The stress test can accommodate numerous specifications of 
earnings and funding costs. In general, both relationships are tied 
to the 10-year CMT interest rate. Specifically, each investment 
account, each loan item, and each liability account can be specified 
as fixed rate, or fixed spread to the 10-year CMT with initial rates 
determined by actual data. The stress test calculates specific 
spreads (weighted average yield less initial 10-year CMT) by 
category from the weighted average yield data supplied by Farmer Mac 
as described earlier. For example, the fixed spread for Farmer Mac I 
program post-1996 Act mortgages is calculated as follows:

Fixed Spread = Weighted Average Yield less 10-year CMT 0.014 = 
0.0694--0.0554

    (B) The resulting fixed spread of 1.40 percent is then added to 
the 10-year CMT when it is shocked to determine the new yield. For 
instance, if the 10-year CMT is shocked upward by 300 basis points, 
the yield on Farmer Mac I program post-1996 Act loans would change 
as follows:

Yield = Fixed Spread + 10-year CMT .0994 = .014 + .0854

    (C) The adjusted yield is then used for income calculations when 
generating pro forma financial statements. All fixed-spread asset 
and liability classes are computed in an identical manner using 
starting yields provided as data inputs from Farmer Mac. The fixed-
yield option holds the starting yield data constant for the entire 
10-year stress test period. You must run the stress test using the 
fixed-spread option for all accounts except for discontinued program 
activities, such as Farmer Mac I program loans made before the 1996 
Act. For discontinued loans, the fixed-rate specification must be 
used if the loans are primarily fixed-rate mortgages.
    (5) Elements related to interest rate shock test. As described 
earlier, the interest rate shock test is implemented as a single set 
of forward interest rates. The stress test applies the up-rate 
scenario and down-rate scenario separately. The stress test also 
uses the results of Farmer Mac's shock test, as described in 
paragraph c. of section 4.1, ``Data Inputs,'' to calculate the 
impact on equity from a stressful change in interest rates as 
discussed in section 3.0 titled, ``Interest Rate Risk.'' The stress 
test uses a schedule relating a change in interest rates to a change 
in the market value of equity. For instance, if interest rates are 
shocked upward so that the percentage change is 262 basis points, 
the linearly interpolated effective estimated duration of equity is 
-6.7405 years given Farmer Mac's interest rate measurement results 
at 250 and 300 basis points of -6.7316 and 76.7688 years, 
respectively found on the effective duration schedule. The stress 
test uses the linearly interpolated estimated effective duration for 
equity to calculate the market value change by multiplying duration 
by the base value of equity before any rate change from Farmer Mac's 
interest rate risk measurement results with the percentage change in 
interest rates.

4.3 Risk Measures

    a. This section describes the elements of the stress test in the 
worksheet named ``Risk Measures'' that reflect the interest rate 
shock and credit loss requirements of the stress test.
    b. As described in section 3.1, the stress test applies the 
statutory interest rate shock to the initial 10-year CMT rate. It 
then generates a series of fixed annual interest rates for the 10-
year stress period that serve as indices for earnings yields and 
cost of funds rates used in the stress test. (See the ``Risk 
Measures'' worksheet for the resulting interest rate series used in 
the stress test.)
    c. The Credit Loss Module's state-level loss rates, as described 
in section 2.4 entitled, ``Calculation of Loss Rates for Use in the 
Stress Test,'' are entered into the ``Risk Measures'' worksheet and 
applied to the loan balances that exist in each state. The 
distribution of loan balances by state is used to allocate new loans 
that replace loan products that roll off the balance sheet through 
time. The loss rates are applied both to the initial volume and to 
new loan volume that replaces expiring loans. The total life of loan 
losses that are expected at origination are then allocated through 
time based on a set of user entries describing the time-path of 
losses.
    d. The loss rates estimated in the credit risk component of the 
stress test are based on an origination year concept, adjusted for 
loan seasoning. All losses arising from loans originated in a 
particular year are expressed as lifetime age-adjusted losses 
irrespective of when the losses actually occur. The fraction of the 
origination year loss rates that must be used to allocate losses 
through time are 43 percent to year 1, 17 percent to year 2, 11.66 
percent to year 3, and 4.03 percent for the remaining years. The 
total allocated losses in any year are expressed as a percent of 
loan volume in that year to reflect the conversion to exposure year.

4.4 Loan and Cashflow Accounts

    The worksheet labeled ``Loan and Cashflow Data'' contains the 
categorized loan data and cashflow accounting relationships that are 
used in the stress test to generate projections of Farmer Mac's 
performance and condition. As can be seen in the worksheet, the 
steady-state formulation results in account balances that remain 
constant except for the effects of discontinued programs. For assets 
with maturities under 1 year, the results are reported for 
convenience as though they matured only one time per year with the 
additional convention that the earnings/cost rates are annualized. 
For the pre-1996 Act assets, maturing balances are added back to 
post-1996 Act account balances. The liability accounts are used to 
satisfy the accounting identity, which requires assets to equal 
liabilities plus owner equity. In addition to the replacement of 
maturities under a steady state, liabilities are increased to 
reflect net losses or decreased to reflect resulting net gains. 
Adjustments must be made to the long- and short-term debt accounts 
to maintain the same relative proportions as existed at the 
beginning period from which the stress test is run. The primary 
receivable and payable accounts are also maintained on this 
worksheet, as is a summary balance of the volume of loans subject to 
credit losses.

4.5 Income Statements

    a. Information related to income performance through time is 
contained on the worksheet named ``Income Statements.'' Information 
from the first period balance sheet is used in conjunction with the 
earnings and cost-spread relationships from Farmer Mac supplied data 
to generate the first period's income statement. The same set of 
accounts is maintained in this worksheet as ``Loan and Cashflow 
Accounts'' for consistency in reporting each annual period of the 
10-year stress period of the test. The income from each interest-
bearing account is calculated, as are costs of interest-bearing 
liabilities. In each case, these entries are the associated interest 
rate for that period multiplied by the account balances.
    b. The credit losses described in section 2.0, ``Credit Risk,'' 
are transmitted through the provision account, as is any change 
needed to re-establish the target reserve balance. For determining 
risk-based capital, the reserve target is set to zero as previously 
indicated in section 4.2. Under the income tax section, it must 
first be determined whether it is appropriate to carry forward tax 
losses or recapture tax credits. The tax section then establishes 
the appropriate income tax liability that permits the calculation of 
final net income (loss), which is credited (debited) to the retained 
earnings account.

4.6 Balance Sheets

    a. The worksheet named ``Balance Sheets'' is used to construct 
pro forma balance sheets from which the capital calculations can be 
performed. As can be seen in the Excel spreadsheet, the worksheet is 
organized to correspond to Farmer Mac's normal reporting practices. 
Asset accounts are built from the initial financial statement 
conditions, and loan and cashflow accounts. Liability accounts 
including the reserve account are likewise built from the previous 
period's results to balance the asset and equity positions. The 
equity section uses initial conditions and standard accounts to 
monitor equity through time. The equity section maintains separate 
categories for increments to paid-in-capital and retained earnings 
and for mark-to-market effects of changes in account values. The 
process described below in the ``Capital'' worksheet uses the 
initial retained earnings and paid-in-capital account to test for 
the change in initial capital that permits conformance to the 
statutory requirements. Therefore, these accounts must be maintained 
separately for test solution purposes.
    b. The market valuation changes due to interest rate movements 
must be computed utilizing the linearly interpolated schedule of 
estimated equity effects due to changes in interest rates, contained 
in the ``Assumptions & Relationships'' worksheet. The stress test 
calculates the dollar change in the market value of equity by 
multiplying the base value

[[Page 77262]]

of equity before any rate change from Farmer Mac's interest rate 
risk measurement results, the linearly interpolated estimated 
effective duration of equity, and the percentage change in interest 
rates. In addition, the earnings effect of the measured dollar 
change in the market value of equity is estimated by multiplying the 
dollar change by the blended cost of funds rate found on the 
``Assumptions & Relationships'' worksheet. Next, divide by 2 the 
computed earnings effect to approximate the impact as a theoretical 
shock in the interest rates that occurs at the mid-point of the 
income cycle from period t 0 to period t 1. 
The measured dollar change in the market value of equity and related 
earnings effect are then adjusted to reflect any tax-related 
benefits. Tax adjustments are determined by including the measured 
dollar change in the market value of equity and the earnings effect 
in the tax calculations found in the ``Income Statements'' 
worksheet. This approach ensures that the value of equity reflects 
the economic loss or gain in value of Farmer Mac's capital position 
from a change in interest rates and reflects any immediate tax 
benefits that Farmer Mac could realize. Any tax benefits in the 
module are posted through the income statement by adjusting the net 
taxes due before calculating final net income. Final net income is 
posted to accumulated unretained earnings in the shareholders' 
equity portion of the balance sheet. The tax section is also 
described in section 4.5 entitled, ``Income Statements.''
    c. After one cycle of income has been calculated, the balance 
sheet as of the end of the income period is then generated. The 
``Balance Sheet'' worksheet shows the periodic pro forma balance 
sheets in a format convenient to track capital shifts through time.
    d. The stress test considers Farmer Mac's balance sheet as 
subject to interest rate risk and, therefore, the capital position 
reflects mark-to-market changes in the value of equity. This 
approach ensures that the stress test captures interest rate risk in 
a meaningful way by addressing explicitly the loss or gain in value 
resulting from the change in interest rates required by the statute.

4.7 Capital

    The ``Capital'' worksheet contains the results of the required 
capital calculations as described below, and provides a method to 
calculate the level of initial capital that would permit Farmer Mac 
to maintain positive capital throughout the 10-year stress test 
period.

5.0 Capital Calculation

     a. The stress test computes regulatory capital as the sum of 
the following:
    (1) The par value of outstanding common stock;
    (2) The par value of outstanding preferred stock;
    (3) Paid-in capital;
    (4) Retained earnings; and
    (5) Reserve for loan and guarantee losses.
    b. Inclusion of the reserve account in regulatory capital is an 
important difference compared to minimum capital as defined by the 
statute. Therefore, the calculation of reserves in the stress test 
is also important because reserves are reduced by loan and guarantee 
losses. The reserve account is linked to the income statement 
through the provision for loan-loss expense (provision). Provision 
expense reflects the amount of current income necessary to rebuild 
the reserve account to acceptable levels after loan losses reduce 
the account or as a result of increases in the level of risky 
mortgage positions, both on- and off-balance sheet. Provision 
reversals represent reductions in the reserve levels due to reduced 
risk of loan losses or loan volume of risky mortgage positions. The 
liabilities section of the ``Balance Sheets'' worksheet also 
includes separate line items to disaggregate the Guarantee and 
commitment obligation related to the Financial Accounting Standards 
Board Interpretation No. 45 (FIN 45) Guarantor's Accounting and 
Disclosure Requirements for Guarantees, Including Indirect 
Guarantees of Indebtedness of Others. This item is disaggregated to 
permit accurate calculation of regulatory capital post-adoption of 
FIN 45. When calculating the stress test, the reserve is maintained 
at zero to result in a risk-based capital requirement that includes 
reserves, thereby making the requirement comparable to the statutory 
definition of regulatory capital. By setting the reserve requirement 
to zero, the capital position includes all financial resources 
Farmer Mac has at its disposal to withstand risk.

5.1 Method of Calculation

    a. Risk-based capital is calculated in the stress test as the 
minimum initial capital that would permit Farmer Mac to remain 
solvent for the ensuing 10 years. To this amount, an additional 30 
percent is added to account for managerial and operational risks not 
reflected in the specific components of the stress test.
    b. The relationship between the solvency constraint (i.e., 
future capital position not less than zero) and the risk-based 
capital requirement reflects the appropriate earnings and funding 
cost rates that may vary through time based on initial conditions. 
Therefore, the minimum capital at a future point in time cannot be 
directly used to determine the risk-based capital requirement. To 
calculate the risk-based capital requirement, the stress test 
includes a section to solve for the minimum initial capital value 
that results in a minimum capital level over the 10 years of zero at 
the point in time that it would actually occur. In solving for 
initial capital, it is assumed that reductions or additions to the 
initial capital accounts are made in the retained earnings accounts, 
and balanced in the debt accounts at terms proportionate to initial 
balances (same relative proportion of long- and short-term debt at 
existing initial rates). Because the initial capital position 
affects the earnings, and hence capital positions and appropriate 
discount rates through time, the initial and future capital are 
simultaneously determined and must be solved iteratively. The 
resulting minimum initial capital from the stress test is then 
reported on the ``Capital'' worksheet of the stress test. The 
``Capital'' worksheet includes an element that uses Excel's 
``solver'' or ``goal seek'' capability to calculate the minimum 
initial capital that, when added (subtracted) from initial capital 
and replaced with debt, results in a minimum capital balance over 
the following 10 years of zero.

PART 655--FEDERAL AGRICULTURAL MORTGAGE CORPORATION DISCLOSURE AND 
REPORTING REQUIREMENTS

0
3. The authority citation for part 655 continues to read as follows:

    Authority: Sec. 8.11 of the Farm Credit Act (12 U.S.C. 2279aa-
11).

Subpart B--Reports Relating to Securities Activities of the Federal 
Agricultural Mortgage Corporation


Sec.  655.50  [Amended]

0
4. Section 655.50 is amended by removing the word ``should'' and adding 
in its place, the word ``must'' in the second sentence of paragraph 
(c).

    Dated: December 15, 2006.
James M. Morris,
Acting Secretary, Farm Credit Administration Board.
 [FR Doc. E6-21831 Filed 12-22-06; 8:45 am]
BILLING CODE 6705-01-P