[Federal Register Volume 76, Number 116 (Thursday, June 16, 2011)]
[Proposed Rules]
[Pages 35138-35141]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-14985]


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FARM CREDIT ADMINISTRATION

12 CFR Part 652

RIN 3052-AC70


Federal Agricultural Mortgage Corporation Funding and Fiscal 
Affairs; Farmer Mac Risk-Based Capital Stress Test, Version 5.0

AGENCY: Farm Credit Administration.

ACTION: Advance notice of proposed rulemaking.

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SUMMARY: In this advance notice of proposed rulemaking (ANPRM), the 
Farm Credit Administration (FCA, we, us, our) is requesting comments on 
alternatives to using credit ratings issued by nationally recognized 
statistical ratings organizations (NRSRO or credit rating agency) in 
regulations addressing the Risk-Based Capital Stress Test (RBCST or 
stress test) for the Federal Agricultural Mortgage Corporation (Farmer 
Mac or FAMC). Recent legislation requires every Federal agency to 
remove any references to credit ratings from its regulations and to 
substitute them with other standards of creditworthiness considered 
appropriate. Additionally, in response to this same legislative 
emphasis on ensuring appropriate prudential oversight of derivatives 
transactions, we are considering whether the RBCST should include a 
more explicit and comprehensive capital charge for counterparty risk 
stemming from derivative transactions. Lastly, through the ANPRM we are 
seeking public input on how we might revise the operational and 
strategic business planning requirements for FAMC to place greater 
emphasis on diversity and inclusion.

DATES: You may send comments on or before August 15, 2011.

ADDRESSES: We offer a variety of methods for you to submit comments. 
For accuracy and efficiency reasons, commenters are encouraged to 
submit comments by e-mail or through the FCA's Web site. As facsimiles 
(fax) are difficult for us to process and achieve compliance with 
section 508 of the Rehabilitation Act, we no longer accept 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: Laurie A. Rea, Director, 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, including any 
supporting data provided, 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) 883-4434,
 Or
Laura McFarland, Senior Counsel, Office of the General Counsel, Farm 
Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703) 
883-4020.

SUPPLEMENTARY INFORMATION:

I. Objective

    The purpose of this ANPRM is to gather public input on how FCA 
might:
     Revise existing Farmer Mac RBCST regulations to replace 
data from credit rating agencies.
     Comprehensively address derivative counterparty exposure 
in the RBCST; and
     Revise operational and strategic business planning 
requirements to place greater emphasis on diversity and inclusion.

II. Background

    Farmer Mac is an institution of the Farm Credit System, regulated 
by FCA through the FCA Office of Secondary Market Oversight (OSMO). 
Farmer Mac was established and chartered by Congress to create a 
secondary market for agricultural real estate mortgage loans, rural 
housing mortgage loans, and rural utilities loans, and it is a 
stockholder-owned instrumentality of the United States. Title VIII of 
the Farm Credit Act of 1971, as amended, (Act) governs Farmer Mac.\1\
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    \1\ Public Law 92 181, 85 Stat. 583, 12 U.S.C. 2001 et seq. 
(December 10, 1971).
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    On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer 
Protection Act of 2010 (Dodd-Frank Act) was enacted.\2\ Section 939A of 
the Dodd-Frank Act requires Federal agencies to review all regulatory 
references to NRSRO credit ratings and replace those references with 
other appropriate standards for determining creditworthiness. The Dodd-
Frank Act

[[Page 35139]]

further provides that, to the extent feasible, agencies should adopt a 
uniform standard of creditworthiness for use in regulations, taking 
into account the entities regulated and the purposes for which such 
regulated entities would rely on the creditworthiness standard.
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    \2\ Public Law 111-203, 124 Stat. 1376, (H.R. 4173), July 21, 
2010.
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    The FCA uses credit rating agency data in its RBCST regulations for 
Farmer Mac. Section 8.32 of the Act required FCA to establish a risk-
based capital stress test for Farmer Mac's portfolio.\3\ This stress 
test determines the level of regulatory capital necessary for Farmer 
Mac to maintain positive capital during a 10-year period where 
stressful credit and interest rate conditions occur. We first published 
regulations on the stress test, and other requirements related to 
section 8.32 of the Act, in the Federal Register at 66 FR 19048 (April 
12, 2001). Since then, we revised the stress test several times, most 
recently to capture capital requirements for Farmer Mac's rural 
utilities authorities. The existing RBCST for Farmer Mac is contained 
in 12 CFR part 652, subpart B, and it currently relies, in part, on 
NRSRO credit ratings when calculating regulatory minimum capital 
requirements.
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    \3\ 12 U.S.C. 2279bb-1.
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    We have comprehensively reviewed our regulations that use or rely 
on credit ratings, including other sections in part 652 which govern 
Farmer Mac's non-program investments and liquidity reserve 
requirements. This ANPRM is one of several notices and proposed rules 
on which we will be seeking public input relating to use of credit 
ratings in our rules.

A. Farmer Mac Programs

    Under the Farmer Mac I program, FAMC guarantees prompt payment of 
principal and interest on securities representing interests in, or 
obligations backed by, mortgage loans secured by first liens on 
agricultural real estate or rural housing. It also purchases, or 
commits to purchase, qualified loans or securities backed by qualified 
loans directly from lenders. Under the Farmer Mac II program, FAMC 
purchases and securitizes portions of certain loans guaranteed by the 
U.S. Department of Agriculture, including farm ownership and operating 
loans and rural business and community development loans. Farmer Mac 
also guarantees the timely payment of principal and interest on the 
securities created from these loans. In 2008, Congress granted Farmer 
Mac the authority to purchase and guarantee securities backed by loans 
to rural electric and telephone utility cooperatives as program 
business.\4\ Farmer Mac also provides a secondary market for USDA-
guaranteed farm program and rural development loans.
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    \4\ Section 5406 of Public Law 110-246, 122 Stat. 1651 (June 18, 
2008) (repealing and replacing Pub. L. 110-234).
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B. Risk-Based Capital and Credit Ratings

    Under our rules, Farmer Mac's regulatory capital must be sufficient 
so that it would remain positive during the 10-year time horizon of the 
stress test. One component of the RBCST accounts for the risk of loss 
on specific types of program investments (i.e., investments backed by 
agricultural real estate mortgage loans, rural housing loans, or rural 
utility cooperative loans) that include credit enhancement features. In 
this context, credit risk is adjusted downward based on the whole-
letter credit rating of the counterparty on AgVantage and similarly 
structured assets. The adjustment is made to recognize the risk-
reducing strength of the counterparty's general obligation backing of 
these securities. These securities are further backed by eligible loan 
collateral.
    Another component of the RBCST estimates counterparty risk 
associated with non-program investments, e.g., corporate debt, asset-
backed securities and mortgage-related securities. In this context, the 
RBCST reduces earnings at rates related to the cumulative historical 
default and recovery rates of corporate debt by whole-letter credit 
rating category as published by Moody's Investor Services.\5\ The 
RBCST's calculations in each of these two components use five whole-
letter rating categories. It then assigns counterparties into these 
categories by referencing ratings issued by an NRSRO for the 
counterparty. The regulations, in turn, specify the change in expected 
cash flows during the stress period to reflect the risk of default by a 
counterparty based in part on the assigned ratings category. The 
changes in cash flows decrease projected losses on program assets and 
decrease earnings on non-program investments, which then translate to 
changes in equity over the modeling horizon and affect the required 
minimum regulatory capital calculated by the stress test.
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    \5\ Emery K., Ou S., Tennant, J., Kim F., Cantor R., ``Corporate 
Default and Recovery Rates, 1920-2009,'' published by Moody's 
Investors Service, February 2010.
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    FCA initially chose to use NRSRO ratings in the RBCST as a source 
of objective and neutral third-party assessments of the credit risk for 
particular instruments and counterparties. We used ratings because they 
were readily and publicly available. The use of NRSRO ratings was also, 
at the time, believed to offer enhanced consistency in credit 
evaluation across different components of the RBCST. In 2010, the Dodd-
Frank Act addressed, in part, the structure of credit rating agencies, 
requiring revisions and imposing other requirements in an effort to 
resolve the conflicts of interest and other difficulties believed to be 
at the center of the 2008-2009 financial market crisis. The Dodd-Frank 
Act also questioned the value of these ratings when used as the primary 
data source in the assessment of the creditworthiness of a security or 
money market instrument. In connection with that, the Dodd-Frank Act 
requires every Federal agency to remove any reference to, or reliance 
on, credit rating agencies in its regulations and replace any such 
reference with an alternative standard of credit worthiness considered 
appropriate for the regulatory purpose. As a result, we are seeking 
suggestions on what alternative data sources would be most appropriate 
for the RBCST.

C. Considerations and Objectives for a New Approach to Quantifying 
Relative Creditworthiness

    FCA believes that any new standard of creditworthiness should 
distinguish between different levels of credit risk, in an accurate and 
timely manner, and be transparent in its approach. We believe it should 
also be applied consistently across the multiple components of the 
RBCST and be reasonably simple, while not unduly burdensome to apply 
and not be easily subject to manipulation. FCA recognizes that any 
resulting system will likely involve trade-offs among these objectives, 
e.g., simple versus accurate and timely, accurate and timely versus not 
burdensome to apply.
    To eliminate the use of NRSRO ratings in calculating risk-based 
capital requirements for Farmer Mac, we need to develop an alternative 
basis to assess counterparty risk. One approach may be to identify 
objective criteria that Farmer Mac could apply to categorize credit 
exposures into different risk classes and assess counterparty risk 
accordingly. The criteria may be broadly designated. For example, 
credit exposures could be divided into government and non-government, 
secured and unsecured, or other categories, such as maturity. Such a 
broad approach, however, may not be able to sufficiently and 
consistently account for difference in relative risk among exposures 
that fall into the same category. FCA may also consider adopting 
criteria that reference certain

[[Page 35140]]

financial or other metrics related to the obligor or counterparty. To 
be meaningful, the criteria would need to account for or bear a 
reasonable correlation to the potential riskiness of default among 
different obligors or counterparties. Any criteria would also need to 
be readily obtainable for all relevant counterparties by FCA, Farmer 
Mac and the public or it might not be sufficiently transparent and 
objective. The standards would need to ensure that the investment or 
position is not speculative, and carries credit risk appropriate for 
Farmer Mac's risk profile and the authorized purposes for non-program 
investments. As any new counterparty risk evaluation approach is 
initiated, there is the potential for increased risk as the new system 
is implemented.
    FCA might also consider an approach that builds on Farmer Mac's 
internal credit review process and allows it to assign risk ratings to 
various categories and assess risk based on qualitative and 
quantitative standards set by FCA regulations. For example, FCA could 
assign loss rate estimates based on Farmer Mac's internal ratings or 
some modification of such, as reviewed or approved by FCA--or simply 
review or approve Farmer Mac's mapping of its assigned risk ratings to 
estimated loss rates. This approach would be more subjective than the 
alternative discussed above but could allow FCA to leverage the data 
collection and analysis already performed by Farmer Mac. Under this 
approach, FCA would likely rely heavily on the supervisory process to 
make sure that Farmer Mac is strictly following its internal guidelines 
and not assuming high levels of credit risk.
    Questions (1) through (11) of Section III of this ANPRM address 
this topic.

D. Counterparty Risk on Derivatives

    As part of our Dodd-Frank Act review and the increasing emphasis by 
the financial industry on ensuring appropriate prudential oversight of 
derivatives transactions, we are also considering whether the RBCST 
should include a more explicit and comprehensive capital charge for 
counterparty risk stemming from derivative transactions.
    The RBCST produces a single comprehensive capital requirement for 
Farmer Mac by modeling changes in cash flows under a specific statutory 
stress scenario. We believe there may be opportunities to revise the 
RBCST to add a representation of counterparty default exposure on 
derivatives transactions by considering both net replacement cost as 
well as current exposure to individual cash flows based on an 
assessment of the counterparty's creditworthiness.
    Questions (12) and (13) of Section III. of this ANPRM address this 
topic.

E. Capital and Business Planning

    As part of this ANPRM, we are seeking input on how we might revise 
Sec.  652.60(b) on operational and strategic business planning 
requirements to place greater emphasis on diversity and inclusion in 
both Farmer Mac's personnel as well as the borrowers and lenders who 
benefit from its secondary market activities.
    We believe an integral part of promoting and achieving inclusion 
and diversity can be accomplished through an effective operational plan 
that includes strategies to seek out qualified loans from a diverse 
group of sources and provides rural lenders with financing products 
that serve a diverse array of borrowers, such as small, beginning, new, 
disabled, female, and minority farmers, ranchers, and rural homeowners, 
as well as cooperatives with diversity of ownership. We believe 
promotion of inclusion and diversity should also extend to non-
traditional agricultural producers, such as local food systems, organic 
or specialty crop farmers, and community-supported agriculture.
    Additionally, we are considering whether Farmer Mac's operational 
and strategic plans should include strategies and actions to achieve 
diversity and inclusion within FAMC's workforce, management, and 
governance structure, as well as an assessment of the progress FAMC has 
made in this area. We are also contemplating whether the plans should 
describe FAMC's succession programs.
    Questions (14) and (15) of Section III. of this ANPRM address this 
topic.

III. Request for Comments

    FCA regulations governing the Farmer Mac RBCST contain specific 
references to credit ratings issued by NRSROs for purposes of 
calculating regulatory minimum capital requirements. FCA is issuing 
this ANPRM to identify standards that may be appropriate replacements 
for credit ratings issued by NRSROs, which maintain compliance with 
statutory design requirements for the RBCST. Other regulatory agencies 
have also issued ANPRMs as part of their process to address references 
to credit ratings in their capital regulations and prudential 
standards.\6\ We encourage any interested person(s) to submit comments 
on the following questions and ask that you support your comments with 
relevant data or examples. We remind commenters that comments and data 
submitted in support of a comment are available to the public through 
our rulemaking files.
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    \6\ See 75 FR 49423 (Aug. 13, 2010), 75 FR 52283 (Aug. 25, 
2010), and 76 FR 5292 (Jan. 31, 2011).
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    1. What core principles would be most important in FCA's 
development of new standards of creditworthiness?
    2. What qualitative and quantitative standards would FCA need to 
set to implement an approach that relied on the Farmer Mac to generate 
internal estimates of counterparty risk exposures? What are the 
strengths and weaknesses of such an approach?
    3. Is it important that FCA's approach to replacing its reliance on 
credit rating agency data be consistent with that of other financial 
regulators or with those of other Farm Credit System institutions? If 
so, how important and why?
    4. What specific creditworthiness or investment criteria should FCA 
use in its RBCST regulation?
    5. What types of objective criteria should be used to differentiate 
credit exposures and apply meaningful counterparty risk estimates in 
the RBCST?
    6. Should different criteria be used for different broad classes of 
investments or exposures? If so, what perverse incentives or other 
unintended consequences could that lead to? For example, could criteria 
that are perceived to be more flexible or subjective for a given asset 
class incent the regulated entity to accept a proportion of exposure to 
that asset class relative to its entire program (or non-program) 
portfolio that it might deem excessive without that incentive?
    7. What approach would estimate a meaningful and consistent level 
of counterparty risk for a variety of exposures by employing publicly 
available qualitative and quantitative metrics, such as individual 
obligor credit spreads and/or financial ratio analysis to estimate 
probability of default and recovery rates?
    8. Alternatively, could such estimates be reasonably made at the 
level of the market (e.g., identifying an index of industry sector 
spreads and stratifying spreads into certain ranges) and mapped to loss 
rates set by FCA?
    9. How might a set of loss rates be developed for each spread 
stratum?
    10. Are there any existing objective tools or approaches that could 
readily replace references to ratings issued by NRSROs in the RBCST?
    11. What other approaches or methodologies not discussed above 
should FCA consider?

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    12. What methodologies or approaches should FCA consider to more 
explicitly incorporate a derivatives counterparty exposure charge into 
the RBCST?
    13. What is the best manner of evaluating minimum capital 
requirements on derivative counterparty exposures in the RBCST and 
should a pre-processing model be constructed (i.e., a sub-model used to 
derive inputs into the RBCST) to represent this risk--both in terms of 
missed individual contractual cash flows as well the replacement cost 
on defaulted derivatives? If so, how should replacement costs be 
estimated?
    14. Should Farmer Mac be required to include strategies in its 
marketing plans that address how its secondary market programs and 
products will be offered to all qualified borrowers, including:
    (a) Minorities, the disabled, and women;
    (b) Young, beginning, small, and family farms and cooperatives; or
    (c) Non-traditional agricultural producers, such as local food 
systems, organic or specialty crop farmers and the lenders who serve 
them? Why or why not?
    15. Should Farmer Mac's marketing plans set quantitative goals to 
increase purchases of, or commitments to purchase, loans to young, 
beginning, small, and family farms, and those owned or operated by 
minorities, the disabled, and women? If so, what would be the best 
method to apply such goals to rural utility cooperatives (e.g., 
minority-managed cooperatives or cooperatives that serve predominantly 
minority residential customers or minority-owned commercial customers)?
    16. To what extent should FCA regulations require Farmer Mac to 
develop a human capital plan as part of its strategic and operational 
business plan to foster diversity in its workforce and succession 
planning?

    Dated: June 10, 2011.
Mary Alice Donner,
Acting Secretary, Farm Credit Administration Board.
[FR Doc. 2011-14985 Filed 6-15-11; 8:45 am]
BILLING CODE 6705-01-P