[Federal Register Volume 75, Number 96 (Wednesday, May 19, 2010)]
[Proposed Rules]
[Pages 27951-27956]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-12012]
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FARM CREDIT ADMINISTRATION
12 CFR Part 652
RIN 3052-AC56
Federal Agricultural Mortgage Corporation Funding and Fiscal
Affairs; Farmer Mac Investments and Liquidity
AGENCY: Farm Credit Administration.
ACTION: Advance notice of proposed rulemaking (ANPRM).
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SUMMARY: The Farm Credit Administration (FCA, Agency, us, or we) is
considering amending our regulations governing the Federal Agricultural
Mortgage Corporation (Farmer Mac or the Corporation) non-program
investments and liquidity requirements. The objective of these
regulations is to ensure that Farmer Mac holds an appropriate level of
high-quality, liquid investments to maintain a sufficient liquidity
reserve, invest surplus funds, and manage interest rate risk.
DATES: You may send us comments by July 6, 2010.
ADDRESSES: We offer a variety of methods for you to submit comments on
this advanced notice of proposed rulemaking. For accuracy and
efficiency reasons, commenters are encouraged to submit comments by e-
mail or through the Agency's Web site. As facsimiles (fax) are
difficult for us to process and achieve compliance with section 508 of
the Rehabilitation Act, we are no longer accepting comments submitted
by fax. Regardless of the method you use, please do not submit your
comment multiple times via different methods. You may submit comments
by any of the following methods:
E-mail: Send us an e-mail at [email protected].
FCA Web site: http://www.fca.gov. Select ``Public
Commenters,'' then ``Public Comments,'' and follow the directions for
``Submitting a Comment.''
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Mail: Joseph T. Connor, Associate Director for Policy and
Analysis, Office of Secondary Market Oversight, Farm Credit
Administration, 1501 Farm Credit Drive, McLean, VA 22102-5090.
You may review copies of all comments we receive at our office in
McLean, Virginia, or on our Web site at http://www.fca.gov. Once you
are in the Web site, select ``Public Commenters,'' then ``Public
Comments,'' and follow the directions for ``Reading Submitted Public
Comments.'' We will show your comments as submitted, but for technical
reasons we may omit items such as logos and special characters.
Identifying information that you provide, such as phone numbers and
addresses, will be publicly available. However, we will attempt to
remove e-mail addresses to help reduce Internet spam.
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) 883-4056; or
Jennifer A. Cohn, Senior Counsel, Office of General Counsel, Farm
Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703)
883-4020.
SUPPLEMENTARY INFORMATION:
I. Objective
The objective of this ANPRM is to solicit public comments on
revisions and updates to Farmer Mac's non-program investment and
liquidity management regulations in light of investment and liquidity
risk issues that arose during the recent financial crisis. With the
benefit of information gained through this ANPRM and our internal
analysis, we will consider changes to the regulations to enhance their
fundamental objective: to ensure the safety and soundness and
continuity of Farmer Mac operations.
II. Background
Congress established Farmer Mac in 1988 as part of its effort to
resolve the agricultural crisis of the 1980s. Congress expected that
establishing a secondary market for agricultural and rural housing
mortgages would increase the availability of competitively priced
mortgage credit to America's farmers, ranchers, and rural homeowners.
In addition to serving its investor-stakeholders, Farmer Mac, like
all Government-sponsored enterprises (GSEs), has a public policy
purpose embedded in its corporate mission that arises from having been
created by an act of Congress. The public policy component of its
mission explicitly includes its service to customer-stakeholders
(farmers, ranchers, rural homeowners, and rural utility cooperatives,
all through their lenders).\1\ The public policy component also
includes protection of taxpayer-stakeholders. The latter arises from
Farmer Mac's ability to issue debt to the Department of the Treasury to
cover guarantee losses under certain circumstances.\2\ These two public
policy components of Farmer Mac's mission are, in some respects,
counterbalancing, as we now explain.
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\1\ See title VIII of the Farm Credit Act of 1971, as amended
(Act), 12 U.S.C. 2279aa-2279cc et seq.)
\2\ See section 8.13 of the Act.
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A fundamental premise of finance is the natural positive
relationship between risk and expected return. This means that when
Farmer Mac increases its expected return, it also increases its risk of
loss; the opposite is true when risk decreases. More return, in
general, will better position Farmer Mac to reduce the rates it charges
customers (a benefit to those stakeholders) and increase its earnings
(a benefit to investor-stakeholders). However, the risk Farmer Mac
assumes to earn a greater return increases the risk to others,
including ultimately taxpayers, and thus adds an offsetting cost to
these earnings benefits.
In general, a guiding principle for FCA in establishing regulations
is to maintain an appropriate balance between these costs and benefits,
i.e., attempting to maximize Farmer Mac's ability to serve its
customers and provide an appropriate return for investors while
ensuring that it engages in safe and sound operations, thereby
providing a high degree of certainty that Farmer Mac will continue to
be able to make its products available to serve
[[Page 27952]]
customers and will never need to issue debt to the Department of
Treasury.
Liquidity is a firm's ability to meet its obligations as they come
due without substantial negative impact on its operations or financial
condition. While the management of Farmer Mac's non-program investment
portfolio and its liquidity risk are closely linked, they are not
synonymous. Management of the non-program investment portfolio, and
specifically the associated market risk, is one component under the
general heading of liquidity risk management. Liquidity risk is the
risk that the Corporation is unable to meet expected obligations (and
reasonably estimated unexpected obligations) as they come due without
substantial adverse impact on its operations or financial condition.
Reasonably estimated liquidity risk should consider scenarios of debt
market disruptions, asset market disruptions such as industry sector
security price risk scenarios, as well as contingent liquidity events.
Contingent liquidity events include significant changes in overall
economic conditions, or events that would impact the market's
perception of Farmer Mac such as reputation risks and legal risks, as
well as a broad and significant deterioration in the agriculture sector
and its potential impact on Farmer Mac's need for cash to fulfill
obligations under the terms of products such as Long-Term Standby
Purchase commitments.
Farmer Mac's primary sources of liquidity are the principal and
interest it receives from non-program and program investments and its
access to debt markets. The sale of non-program investments--which
consist of investment securities, cash, and cash equivalents--provides
a secondary source of liquidity cushion in the event of a short-term
disruption in Farmer Mac's access to the capital markets that prevents
Farmer Mac from issuing new debt. The sale of Farmer Mac's program
investments in agricultural mortgages, rural home loans, and rural
utility cooperative loans could provide additional liquidity, although
the amount of liquidity provided by these instruments in times of
stress is uncertain. The reason for that uncertainty is that, with the
exception of the subset of these investments that are guaranteed by the
United States Department of Agriculture (USDA),\3\ we are not aware of
significantly active markets in which to sell them. As a result, FCA
regulations do not currently recognize any liquidity value in Farmer
Mac's program book of business (with the exception of a discounted
amount of the Farmer Mac II volume).
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\3\ Farmer Mac's program investments in loans that are
guaranteed by the USDA as described in section 8.0(9)(B) of the Act,
and which are securitized by Farmer Mac, are known as the ``Farmer
Mac II'' program.
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During 2008, the markets in corporate debt and asset-backed
securities experienced significant value reductions in response to the
general seizing up of these markets. For financial regulators, these
events highlighted the need to reevaluate the requirements for
liquidity risk management. This experience also has triggered broad re-
evaluation of liquidity risk management among institutions and
regulators globally--including a re-evaluation of the degree of
confidence that is assumed in corporate policies and regulatory
guidance regarding the availability of markets for debt issuance and
asset sales under stressful economic or market conditions. We are
interested in public response to questions regarding FCA regulatory
requirements related to Farmer Mac's management of market risk,
liquidity risk, and funding risk.
III. Section-by-Section Questions for Public Comment
A discussion of our existing regulations (which became effective in
the third quarter of 2005), along with our questions about changes we
are considering to these regulations, follow. For ease of use, Section
IV., at the end of this document, lists the key questions asked
throughout this section.
A. Section 652.10--Investment Management and Requirements
Effective risk management requires financial institutions to
establish: (1) Policies; (2) risk limits; (3) mechanisms for
identifying, measuring, and reporting risk exposures; and (4) strong
corporate governance including specific procedures and internal
controls. Section 652.10 requires Farmer Mac to establish and follow
certain fundamental practices to effectively manage risks in its
investment portfolio.
This provision requires Farmer Mac's board of directors to adopt
written policies that establish risk limits and guide the decisions of
investment managers. Board policies must establish objective criteria
so investment managers can prudently manage credit, market, liquidity,
and operational risks. Investment policies must provide for specific
risk limits and diversification requirements for the various classes of
eligible investments and for the entire investment portfolio. Risk
limits must be based on Farmer Mac's business mix, capital position,
the term structure of its debt, the cash flow attributes of both on-
and off-balance sheet obligations and risk tolerance capabilities. Risk
tolerance can be expressed through several parameters such as duration,
convexity, sector distribution, yield curve distribution, term
structure of debt, credit quality, risk-adjusted return, portfolio
size, total return volatility, or value-at-risk.\4\ Farmer Mac must use
a combination of parameters to appropriately limit its exposure to
credit and market risk. The policies must also establish other
controls--such as delegation of responsibilities, separation of duties,
timely and effective valuation practices, and routine reporting--that
are consistent with sound business practices.
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\4\ Duration measures a bond's or portfolio's price sensitivity
to a change in interest rates. Convexity measures the rate of change
in duration with respect to a change in interest rates. Yield curve
distribution refers to the distribution of the portfolio's
investments in short-, intermediate-, or long-term investments. Term
structure of debt refers to the distribution of the Corporation's
debt maturities over time. Value-at-risk is a methodology used to
measure market risk in an investment portfolio.
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1. Earnings Performance and Risk Benchmarks
We have questions regarding several areas of Sec. 652.10. Our
first general area of discussion pertaining to this section concerns
the usefulness of adding regulatory guidance to benchmark earnings
performance and risk profiles of the investment portfolio to evaluate
liquidity risk and non-program investment management. Section 652.10(c)
requires Farmer Mac's board to establish investment risk limits, and
Sec. 652.10(g) requires Farmer Mac's management to report to the board
on investment performance and risk. The regulation does not, however,
include specific requirements regarding acceptable levels of either
earnings performance (such as the spread over cost of funds or the
spread over an appropriate yield benchmark) or risk (such as measured
by historical variation of returns or as implied by changes in earnings
levels).
Risk is measured in terms of the uncertainty (i.e., volatility) of
the expected earnings stream. Inferences about real-time changes in
risk can be drawn from the real-time changes in prices, i.e., the yield
the market demands on the instruments at any point in time. An increase
in return demanded by investors implies greater risk. In this
discussion, we use return measurements as a proxy for relative risk
measurements.
Earnings spreads are performance indicators with implications
regarding relative risk. For example, in times of market turbulence,
investors may prefer
[[Page 27953]]
debt issued by Farmer Mac simply because it is GSE debt--a ``flight to
quality''--and not because of any positive developments in Farmer Mac's
business. With its debt in greater demand, its cost of funds would
decrease. The coupon interest Farmer Mac receives on its investments
would continue at its previous level.\5\ The result would be a widening
in the spread between Farmer Mac's earnings rates and its cost of
funds. Would this scenario clearly imply an increase in Farmer Mac's
liquidity risk?
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\5\ The scenario ignores interest rate effects which could
influence the spread in either direction depending on the
circumstances, and also the impact of any new investments over the
period.
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To ensure an appropriate level of earnings performance while
limiting risk to an acceptable level, should our regulations (and/or
Farmer Mac board policy) specify earnings performance benchmarks and
some acceptable band of earnings performance above and below such
benchmarks? The benchmark could be used to evaluate investment
portfolio earnings and risk. Earnings performance that is too low
compared to the benchmark would indicate a need for improved management
of earnings performance, and earnings performance that is too high
indicating unacceptable levels of liquidity risk, or credit risk, or
both? A detailed explanation and more detailed questions follow.
Investor behavior is an indicator of relative risk in the market.
For purposes of this explanation, we divide the universe of investors
into two general categories by risk tolerance--either risk-seeking or
risk-averse. In periods of ``flight to quality,'' two changes occur in
investor behavior relative to the pre-turbulence baseline: (1) Risk-
seeking investors demand higher yields (and theoretically the increase
is specifically higher liquidity premium or credit premium, or both)
\6\ and (2) risk-averse investors accept lower yields from perceived
higher-quality issuers. In periods of ``flight to quality,'' interest
rates on non-GSE debt securities would tend to move up, while interest
rates on GSE debt would tend to move down. For Farmer Mac, this has two
implications: (1) Its cost of funds declines; and (2) the liquidity
risk in its non-program investments increases. The latter occurs
because the market's view of the relative liquidity and credit strength
of marketable securities has deteriorated--which is why investments
purchased in a more normal environment would then sell at discount to
par in order to provide risk-seeking investors with the increased
liquidity/credit premiums they require.\7\
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\6\ Yields are generally viewed as containing four compensation
components: (1) The risk-free rate (which includes a load for
expected inflation), (2) credit premium over the risk-free rate,
which compensates the investor for default risk, (3) liquidity
premium over the risk-free rate, which compensates the investor for
the risk that he will be unable to sell the investment quickly at,
or near, par, and (4) premium associated with the value of embedded
options (if any). For purposes of this explanation, we assume
option-adjusted spreads to remove the impact on spreads of changes
in the value of embedded options.
\7\ Excluding Treasury and GSE investments with regard, at
least, to credit risk.
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The market's perception of liquidity and credit quality constantly
fluctuates. Therefore, a key question is: Is there some level of
increased earnings spread (relative to an appropriate spread benchmark)
that could reasonably be assumed to indicate an unacceptable amount of
increased liquidity risk? We do not believe that an institution should
be penalized for a decline in the liquidity of what had previously been
acceptable investments due to events over which it had no influence.
However, should the regulations (or board policy) recognize the reduced
liquidity in the investment portfolio and guide management's response
to steer the institution back toward a more acceptable level of
liquidity risk? If so, how might Farmer Mac's liquidity management
policy establish limits around an investment portfolio benchmark,
either statically or dynamically, to reflect the potential changes in
investment value that can occur in stressful market or economic
environments?
There may be market-based measures such as spreads (and the amount
of time over which unusually wide or narrow spreads are sustained) that
would be more dynamic indicators of liquidity risk and enhance the
recognition of, and response to, significantly increased risks through
discounting procedures that are indexed to major changes in such
indicators. Dynamic indicators could be included in Farmer Mac board
policy and, when exceeded, simply instruct management to steer the
portfolio back toward the targeted indicator level over some period of
time. From a conceptual perspective, a dynamic indicator showing an
unusually wide spread may indicate increased risk in the liquidity
value of the investment portfolio. Further, an unusual degree of
narrowing of spreads (that occurs despite no change in Farmer Mac's
financial position) may indicate reduced risk in the liquidity value of
the investment portfolio. Therefore, a dynamic indicator based on
earnings spreads of eligible securities might be used to establish
limits that would trigger a rebalancing of the investment portfolio.
This rebalancing would help ensure that the portfolio maintains
stability in market value even under stressful conditions.\8\
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\8\ In addition, another scenario may be worth considering. Is
there a plausible scenario under which Farmer Mac's cost of funds
would drop precipitously enough to increase earnings spreads above
some wide threshold over benchmark spreads that would be due solely
to positive developments in Farmer Mac's business, and therefore
have no implications on the liquidity risk of its investments?
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We recognize that one possible complicating factor to such spread
limits might be the inability in some cases to clearly identify the
underlying funding instruments (and therefore the costs) of a given
subset of Farmer Mac's investments. Therefore, return levels (i.e.,
yields) might offer another indication of relative risk. Yield
thresholds might be an alternative for a dynamic threshold to help
ensure that portfolio liquidity risk does not exceed acceptable levels.
For example, would it be appropriate for Farmer Mac to set triggers
based on weighted-average yield thresholds set at some level above a
benchmark eligible investment portfolio return--which, when triggered,
would require management to rebalance the investment portfolio (or
asset class within the portfolio)?
2. Contingency Liquidity Funding Plan
Our second area of discussion pertaining to this regulation
concerns Sec. 652.10(c)(3). That provision requires that Farmer Mac's
investment policies describe the liquidity characteristics of eligible
investments that it will hold to meet its liquidity needs and
objectives, but it does not require liquidity contingency funding
planning. Such plans are generally regarded as a key component of good
corporate governance, and Farmer Mac currently has a contingency
funding plan in place. Would it be appropriate for our regulations to
require a liquidity contingency funding plan? If so, how specific
should the regulation be regarding required components of the plan
versus simply requiring that the plan reasonably reflect current
standards, for example, those specified by the Basel Committee on
Banking Supervision? \9\
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\9\ ``Principles for Sound Liquidity Risk Management and
Supervision'', Basel Committee on Banking Supervision, Bank for
International Settlements, September 2008 (or successor document, in
the future). This document can be found at http://www.bis.org/publ/bcbs144.htm.
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3. Debt Maturity Management Plan
Third, the maturity structure of Farmer Mac's debt is a key driver
of its liquidity position at any given time and
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a key input to the calculation of its minimum liquidity reserve
requirement (discussed in Section III.B. of this preamble). Under
normal yield curve conditions, long-term debt--debt maturing in greater
than 1 year--is more costly than short-term debt--debt maturing in less
than 1 year. Long-term debt, however, is generally viewed as adding
stability and strength to a corporation's liquidity position compared
to short-term debt given the need to frequently roll over such debt.
Farmer Mac's term structure of debt, as published in its balance
sheet, has normally been heavily weighted in short-term debt. Farmer
Mac often synthetically extends the term of much of its short-funded
debt using swap contracts, which results in a lower net cost of funds
compared to simply issuing longer term debt. The fact that these
combinations of debt and derivative positions behave like longer term
debt contributes to the stability and strength of its liquidity
position. However, the practice adds counterparty risk on the swaps and
short-term debt rollover risk to Farmer Mac's overall liquidity risk
position compared to issuing long-term debt.
In light of the marginal funding instability that results from
relying primarily on shorter term debt--even when the maturity is
extended synthetically--would it be appropriate to require Farmer Mac
to establish a debt maturity management plan? If so, how might such a
requirement be structured?
We recognize that the minimum daily liquidity reserve requirement
includes incentives to this same end of moderating the term structure
of debt. However, this question asks specifically whether this
additional requirement would appropriately augment the minimum daily
liquidity reserve requirement and partially compensate for some of the
shortcomings of that measurement discussed in Section III.B. of this
preamble.
4. Evidence of Market for Program Investments
Finally, as discussed above, we are aware of no significantly
active markets in which Farmer Mac could sell its program investments
held on-balance sheet (other than Farmer Mac II assets), and therefore
the amount of liquidity provided by these investments is uncertain. We
recognize that Farmer Mac from time to time has sold these instruments
successfully in the past. Moreover, the principal and interest cash
flows on these assets provide liquidity in the normal course of
business. In light of the foregoing, should the availability of a
liquid market for Farmer Mac's program investments be considered in the
Corporation's liquidity contingency funding plan? \10\
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\10\ Section 652.10, on investment management and requirements,
currently governs only non-program investment activities. This would
be a new requirement governing the liquidity of Farmer Mac's program
investments.
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B. Section 652.20(a)--Minimum Daily Liquidity Reserve Requirement
The minimum daily liquidity reserve requirement found at Sec.
652.20(a) requires Farmer Mac to hold eligible liquidity instruments
such as cash, eligible non-program investments, and/or Farmer Mac II
assets (subject to certain discounts) to fund its operations for a
minimum of 60 days.\11\
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\11\ The purpose of this minimum daily liquidity reserve
requirement is to enable Farmer Mac to continue its operations if
its access to the capital markets were impeded or otherwise
disrupted.
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This ``days-of-liquidity'' metric, while useful, has drawbacks.
Perhaps foremost among those drawbacks is that this metric contains
information about a single point-in-time, but it provides no projected
information. A large days-of-liquidity measurement today provides
little or no information about what the measurement might be tomorrow.
Are there other metrics or approaches that might improve upon,
augment, or appropriately replace days-of-liquidity as currently used
in Sec. 652.20(a)? For example, in the current days-of-liquidity
calculation, once discounts have been applied to assets, each liquid
asset dollar (net of discounts) is viewed (for purposes of the
calculation) as being of equal quality and liquidity value. However,
clearly there is greater liquidity value in, for example, the amount of
undiscounted cash dollars in that total than there is in the dollars
associated with corporate debt securities. Under the current rule, the
debt securities are discounted at either 5 percent or 10 percent for
purposes of estimating liquidity value, but the actual amount realized
in a sale would depend on many factors. If stress developed suddenly in
the market, the debt securities might be worth considerably less than
the discounted amounts, but the cash dollars would not change.
Therefore, to recognize greater differences in the liquidity value
of different asset classes, and to augment the minimum days-of-
liquidity requirement, would it be appropriate to establish a
subcategory of the minimum days-of-liquidity requirement that would
include, for example, only cash or Treasury securities in the
definition of ``primary liquid assets'' but also set a smaller minimum
required number of days? Recognizing that liquidity risk cannot be
eliminated for Farmer Mac, could a ``primary'' days-of-liquidity
minimum add significant certainty to Farmer Mac's liquidity policies at
an acceptable cost? We recognize that the return on such investments is
likely to be lower than Farmer Mac's funding costs, which would create
a drag on earnings. If such a requirement is warranted, what would be
the appropriate number of minimum primary days-of-liquidity, balancing
the benefits gained from maintaining these higher quality liquid assets
against their higher cost?
C. Section 652.20(c)--Discounts
Section 652.20(c) requires Farmer Mac to apply specified discounts
to all investments in the liquidity portfolio, other than cash and
overnight investments, in order to reflect the risk of diminished
marketability of even these liquid investments under adverse market
conditions. The investments that must be discounted include money
market instruments, floating and fixed rate debt and preferred stock
securities, diversified investment funds, and Farmer Mac II assets. In
the wake of the recent disruptions in financial markets, we are
considering whether a more conservative view of the discounts is
appropriate.
At the same time, we recognize that deep discounts, if actually
realized during a liquidation, impact not only Farmer Mac's ability to
meet obligations in a timely manner, but also its capital position. In
other words, the loss on sale of these assets at extremely deep
discounts could, at large volumes, have a very detrimental impact on
capital levels.
Thus, in setting this policy, there is a trade-off between setting
deeper, more conservative discounts versus the alternative of excluding
those assets from eligibility (or, in the case of Farmer Mac II assets,
excluding them from the liquidity reserve) because appropriately deep
discounts might reasonably be so deep that, if realized, they could
destabilize Farmer Mac's capital position. In light of these concerns,
would it be appropriate to re-evaluate the discounts in Sec. 652.20(c)
to better reflect the risk of diminished marketability of liquid
investments under adverse conditions? If so, which ones and what would
be the appropriate degree of change? In particular, we request public
comment on whether the discount currently applied on Farmer Mac II
securities is appropriate.
In addition, the existing, relatively coarse discounting schedule
could
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overlook important liquidity-quality characteristics of individual
investments. Would it be appropriate to refine the schedule of
discounts in Sec. 652.20(c)? For example, there is no difference in
the discounts applied to AAA-rated versus AA-rated corporate debt
securities. Conversely, is the coarseness of the current discount
schedule more desirable because of its simplicity?
D. Section 652.35(a)--Eligible Non-Program Investments
The current rule provides Farmer Mac with a broad array of eligible
high-quality, liquid investments while providing a regulatory framework
that can readily accommodate innovations in financial products and
analytical tools.
Farmer Mac may purchase and hold the eligible non-program
investments listed in Sec. 652.35 to maintain liquidity reserves,
manage interest rate risk, and invest surplus short-term funds. As we
stated in our preamble adopting this rule, only investments that can be
promptly converted into cash without significant loss are suitable for
achieving these objectives.\12\ We further stated our intent that all
eligible investments be either traded in active and universally
recognized secondary markets or valuable as collateral.\13\ For many of
the investments, the regulation requires that they not exceed certain
maximum percentages of the total non-program investment portfolio. We
established these portfolio caps to limit credit risk exposures,
promote diversification, and encourage investments in securities that
exhibit low levels of price volatility and liquidity risk. In addition,
the table sets single obligor limits to help reduce exposure to
counterparty risk.
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\12\ 70 FR 40641 (July 14, 2005).
\13\ Id.
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Would the experience gained during the financial markets crisis of
2008 and 2009 justify adjustments to many of the portfolio limits in
Sec. 652.35 to add conservatism to them and improve diversification of
the portfolio? We invite comments on appropriate changes for each asset
class, final maturity limit, credit rating requirement, portfolio
concentration limit, and other restrictions. We also request comment on
several specific provisions, as follows.
1. Section 652.35(a)(1)--Obligations of the United States
Section 652.35(a)(1) permits Farmer Mac to invest in Treasuries and
other obligations (except mortgage securities) fully insured or
guaranteed by the United States Government or Government agency without
limitation. Given that Farmer Mac might not always hold the ``on the
run'' (i.e., highest liquidity) issuance of Treasury securities, would
imposing maximum maturity limitations enhance the resale value of these
investments in stressful conditions?
2. Section 652.35(a)(2)--Obligations of Government-Sponsored Agencies
In light of the recent financial instability of Government-
sponsored agencies such as Fannie Mae and Freddie Mac, would it be
appropriate to revise this section to put concentration limits on
exposure to these entities in Sec. 652.35(a)(2)? \14\
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\14\ Under Sec. 652.35(a)(2), Government-sponsored agency
mortgage securities, but no other such securities, are limited to 50
percent of Farmer Mac's total non-program investment portfolio. In
addition, Sec. 652.35(d)(1) bars Farmer Mac from investing more
than 100 percent of its regulatory capital in any one Government-
sponsored agency.
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3. Section 652.35(a)(3)--Municipal Securities
Section 652.35(a)(3) authorizes investment in municipal securities.
Currently, revenue bonds are limited to 15 percent or less of Farmer
Mac's total investment portfolio, while general obligations have no
such limitation. The maturity limits and credit rating requirements are
also more generous for general obligations. The requirements in Sec.
652.35(a)(3) carry the implied assumption that general obligation bonds
are always less risky than revenue bonds. But is that always the case?
In the scenario of severe economic recession, could a municipal
issuer's tax base erode faster than the revenues on a bridge or toll
road, for example? Would it be more appropriate for our regulation to
limit both sub-categories equally?
4. Section 652.35(a)(6)--Mortgage Securities
Section 652.35(a)(6) authorizes investments in non-Government
agency or Government-sponsored agency securities that comply with 15
U.S.C. 77(d)5 or 15 U.S.C. 78c(a)(41). These types of mortgage
securities are typically issued by private sector entities and are
mostly comprised of securities that are collateralized by ``jumbo''
mortgages with principal amounts that exceed the maximum limits of
Fannie Mae or Freddie Mac programs. We invite comment on whether it is
appropriate to include mortgage securities collateralized by ``jumbo''
mortgages as an eligible liquidity investment.
5. Section 652.35(a)(8)--Corporate Debt Securities
Section 652.35(a)(8) authorizes investment in corporate debt
securities. The rule does not contain concentration limits related to
industry sector exposure. We request comment on whether such industry
sector exposure limits should be added. Further, is it appropriate to
allow investments in subordinated debt as the current rule does? If so,
is it appropriate that subordinated debt receives discounts and
investment limits at the same level as more senior types of corporate
debt?
E. Section 652.35(d)(1)--Obligor Limits
An appropriate level of diversification is a key attribute of a
liquidity investment portfolio. In Sec. 652.35(d)(1), we prohibit
Farmer Mac from investing more than 25 percent of its regulatory
capital in eligible investments issued by any single entity, issuer, or
obligor. Government-sponsored agencies have a different obligor limit;
Farmer Mac may not invest more than 100 percent of its regulatory
capital in any one Government-sponsored agency. There are no obligor
limits for Government agencies.
Do the obligor limits in Sec. 652.35(d)(1) generally provide for
an adequate level of diversification? Specifically, in light of the
uncertainty associated with the current conservatorships of both Fannie
Mae and Freddie Mac, is it appropriate to maintain a higher obligor
limit for Government-sponsored agencies?
F. Section 652.40--Stress Tests for Mortgage Securities
In the current rule, stress-testing requirements apply to one type
of asset--mortgage securities--and one type of stress--interest rate
risk.\15\ Is the scope of the stress-testing requirement adequate, or
should it be broadened to apply to the entire investment portfolio
(both individually and at a portfolio level)? Should the scope of the
stress-testing be expanded to include market price risks due to factors
other than interest rate changes? We refer to both firm-specific risks
and systemic risks. Firm-level risks include operational fraud,
deteriorating program asset quality, and negative media coverage.
Systemic risks include industry sector shocks such as occurred on
September 11, 2001, with payment system disruption, or asset class as
was seen in the financial services sector in 2007 and
[[Page 27956]]
2008. If the scope of required stress-testing is expanded, what types
and severity of liquidity event scenarios should be tested, and how
should forward-looking cash-flow projections be built around these
scenarios?
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\15\ By interest rate risk, we refer to the price sensitivity of
mortgage instruments over different interest rate/yield curve
scenarios, including prepayment and interest rate volatility
assumptions--as described in current Sec. 652.40.
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IV. List of Key Questions
To ensure an appropriate level of earnings performance
while limiting risk to an acceptable level, should our regulations
(and/or Farmer Mac board policy) specify earnings performance
benchmarks and some acceptable band of earnings performance above and
below such benchmarks? If so, how might Farmer Mac's liquidity
management policy establish limits around an investment portfolio
benchmark, either statically or dynamically, to reflect the potential
changes in investment value that can occur in stressful market or
economic environments?
Would it be appropriate for our regulations to require a
liquidity contingency funding plan? If so, how specific should the
regulation be regarding required components of the plan versus simply
requiring that the plan reasonably reflect current standards, for
example, those specified by the Basel Committee on Banking Supervision?
In light of the marginal funding instability that results
from relying primarily on shorter term debt--even when the maturity is
extended synthetically--would it be appropriate to require Farmer Mac
to establish a debt maturity management plan? If so, how might such a
requirement be structured?
Should the availability of a liquid market for Farmer
Mac's program investments be considered in the Corporation's liquidity
contingency funding plan?
Are there other metrics or approaches available that might
improve upon, augment, or appropriately replace days-of-liquidity as
currently used in Sec. 652.20(a)? For example, to recognize greater
differences in the liquidity value of different asset classes, and to
augment the minimum days-of-liquidity requirement, would it be
appropriate to establish a subcategory of the minimum days-of-liquidity
requirement that would include, for example, only cash or Treasury
securities in the definition of ``primary liquid assets'' but also set
a smaller minimum required number of days? If such a requirement is
warranted, what would be the appropriate number of minimum primary
days-of-liquidity, balancing the benefits gained from maintaining these
higher quality liquid assets against their higher cost?
Would it be appropriate to re-evaluate the discounts in
Sec. 652.20(c) in order to better reflect the risk of diminished
marketability of liquid investments under adverse conditions? If so,
which ones and what would be the appropriate degree of change? In
particular, we request public comment on whether the discount currently
applied on Farmer Mac II securities is appropriate. Would it be
appropriate to refine the schedule of discounts in Sec. 652.20(c)? For
example, there is no difference in the discounts applied to AAA-rated
versus AA-rated corporate debt securities.
Would the experience gained during the financial markets
crisis of 2008 and 2009 justify adjustments to many of the portfolio
limits in Sec. 652.35 to add conservatism to them and improve
diversification of the portfolio? We invite specific comments on
appropriate changes for each asset class, final maturity limit, credit
rating requirement, portfolio concentration limit, and other
restrictions.
Given that Farmer Mac might not always hold the ``on the run''
(i.e., highest liquidity) issuance of Treasury securities, would
imposing maximum maturity limitations enhance the resale value of these
investments in stressful conditions?
In light of the recent financial instability of Government-
sponsored agencies such as Fannie Mae and Freddie Mac, would it be
appropriate to revise this section to put concentration limits on
exposure to these entities in Sec. 652.35(a)(2)?
The requirements in Sec. 652.35(a)(3) carry the implied assumption
that general obligation bonds are always less risky than revenue bonds.
But is that always the case? Would it be more appropriate for our
regulation to limit both sub-categories equally?
We invite comment on whether it is appropriate to include mortgage
securities collateralized by ``jumbo'' mortgages as an eligible
liquidity investment.
Further, is it appropriate to allow investments in subordinated
debt as the current rule does? If so, is it appropriate that
subordinated debt receives discounts and investment limits at the same
level as more senior types of corporate debt?
Do the obligor limits in Sec. 652.35(d)(1) generally
provide for an adequate level of diversification? Specifically, in
light of the uncertainty associated with the current conservatorships
of both Fannie Mae and Freddie Mac, is it appropriate to maintain a
higher obligor limit for Government-sponsored agencies?
Is the scope of the stress-testing requirement adequate,
or should it be broadened to apply to the entire investment portfolio
(both individually and at a portfolio level)? Should the scope of the
stress-testing be expanded to include market price risks due to factors
other than interest rate changes? If the scope of required stress-
testing is expanded, what types and severity of liquidity event
scenarios should be tested, and how should forward-looking, cash flow
projections be built around these scenarios?
V. Conclusion
We welcome comments on all provisions of this notice, even if we
did not request specific comments on those provisions.
Dated: May 13, 2010.
Roland E. Smith,
Secretary, Farm Credit Administration Board.
[FR Doc. 2010-12012 Filed 5-18-10; 8:45 am]
BILLING CODE 6705-01-P