[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

[[Page 27954]]

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

[[Page 27955]]

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?
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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