Farm credit system: Funding and fiscal affairs, loan policies and operations, and funding operations— Capital adequacy; Basel Accord, 34191-34197 [E7-11990]
Agencies
[Federal Register: June 21, 2007 (Volume 72, Number 119)]
[Proposed Rules]
[Page 34191-34197]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr21jn07-6]
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FARM CREDIT ADMINISTRATION
12 CFR Part 615
RIN 3052-AC25
Funding and Fiscal Affairs, Loan Policies and Operations, and
Funding Operations; Capital Adequacy--Basel Accord
AGENCY: Farm Credit Administration.
ACTION: Advance notice of proposed rulemaking (ANPRM).
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SUMMARY: The Farm Credit Administration (FCA or we) is considering
revisions to our risk-based capital rules to more closely align minimum
capital requirements with risks taken by Farm Credit System (FCS or
System) institutions. We are seeking comments to facilitate the
development of a proposed rule that would increase the risk sensitivity
of the regulatory capital framework without unduly increasing
regulatory burden. This ANPRM addresses possible modifications to our
risk-based capital rules that are similar to the recent proposals of
the other Federal financial regulatory agencies. We are also seeking
comments on other aspects of our regulatory capital framework.
DATES: You may send comments on or before November 19, 2007.
ADDRESSES: We offer several methods for the public to submit comments.
For accuracy and efficiency reasons, commenters are encouraged to
submit comments by e-mail or through the Agency's Web site or the
Federal eRulemaking Portal. 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 reg-comm@fca.gov.
Agency Web site: https://www.fca.gov. Select ``Legal
Info,'' then ``Pending Regulations and Notices.''
Federal eRulemaking Portal: https://www.regulations.gov.
Follow the instructions for submitting comments.
Mail: Gary K. Van Meter, Deputy Director, Office of
Regulatory Policy, Farm Credit Administration, 1501 Farm Credit Drive,
McLean, VA 22102-5090.
Fax: (703) 883-4477. Posting and processing of faxes may
be delayed, as faxes are difficult for us to process and achieve
compliance with section 508 of the Rehabilitation Act. Please consider
another means to comment, if possible.
You may review copies of comments we receive at our office in
McLean, Virginia, or on our Web site at https://www.fca.gov. Once you
are in the Web site, select ``Legal Info,'' and then select ``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: Laurie Rea, Associate Director, Office
of Regulatory Policy, Farm Credit Administration, McLean, VA 22102-
5090, (703) 883-4232, TTY (703) 883-4434, or Wade Wynn, Policy Analyst,
Office of Regulatory Policy, Farm Credit Administration, McLean, VA
22102-5090, (703) 883-4262, TTY (703) 883-4434, or Rebecca Orlich,
Senior Counsel, Office of General Counsel, Farm Credit Administration,
McLean, VA 22102-5090, (703) 883-4020, TTY (703) 883-4020.
SUPPLEMENTARY INFORMATION:
I. Objectives
The objective of this ANPRM is to gather information to facilitate
the development of a comprehensive proposal that would:
1. Promote safe and sound banking practices and a prudent level of
regulatory capital;
2. Improve the risk sensitivity of our regulatory capital
requirements while avoiding undue regulatory burden;
3. To the extent appropriate, minimize differences in regulatory
capital requirements between System institutions and other federally
regulated banking organizations; \1\ and
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\1\ Banking organizations include commercial banks, savings
associations, and their respective bank holding companies.
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4. Foster economic growth in agriculture and rural America through
the effective allocation of System capital.
II. Background
The FCA's risk-based capital framework is based, in part, on the
[[Page 34192]]
``International Convergence of Capital Measurement and Capital
Standards'' (Basel I) as published by the Basel Committee on Banking
Supervision (Basel Committee) \2\ and is broadly consistent with the
capital requirements of the other Federal financial regulatory
agencies.\3\ We first adopted a risk-based capital framework for the
System as part of our 1988 regulatory capital revisions \4\ required by
the Agricultural Credit Act of 1987 \5\ and made subsequent revisions
in 1997,\6\ 1998 \7\ and 2005.\8\ Under the current capital framework,
each on- and off-balance sheet credit exposure is assigned to one of
five broad risk-weighting categories to determine the risk-adjusted
asset base, which is the denominator for computing the permanent
capital, total surplus, and core surplus ratios. Our minimum regulatory
capital requirements are contained in subparts H and K of part 615 of
our regulations.\9\
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\2\ The Basel Committee on Banking Supervision was established
in 1974 by central banks with bank supervisory authorities in major
industrialized countries. The Basel Committee formulates standards
and guidelines related to banking and recommends them for adoption
by member countries and others. All Basel Committee documents are
available at https://www.bis.org.
\3\ We refer collectively to the Office of the Comptroller of
the Currency, the Board of Governors of the Federal Reserve System,
the Federal Deposit Insurance Corporation, and the Office of Thrift
Supervision as the ``other Federal financial regulatory agencies.''
\4\ See 53 FR 39229 (October 6, 1988).
\5\ Pub. L. 100-233 (January 6, 1988), section 301. The 1987 Act
amended many provisions of the Farm Credit Act of 1971, as amended,
which is codified at 12 U.S.C. 2001 et seq.
\6\ See 62 FR 4429 (January 30, 1997).
\7\ See 63 FR 39219 (July 22, 1998).
\8\ See 70 FR 35336 (June 17, 2005).
\9\ 12 CFR part 615, subparts H and K.
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The financial services industry has changed significantly since we
adopted the Basel I-based capital framework for the System. Financial
markets have become increasingly global and interconnected.
Deregulation and consolidation have created larger, more complex
financial institutions. Technological innovation has enabled such
institutions to create increasingly sophisticated and complex financial
products and services. Risk management and measurement techniques have
also vastly improved. Financial regulators and industry participants
agree that Basel I is no longer the best regulatory capital framework
for many of the larger, more complex financial institutions and should
be modernized to better reflect recent developments in banking and
capital market practices.
For a number of years, the Basel Committee has worked to develop a
new accord to incorporate the recent advancements in the financial
services industry. In June 2004, it published the ``International
Convergence of Capital Measurement and Capital Standards: A Revised
Framework'' (Basel II) to promote improved risk measurement and
management processes and more closely align capital requirements with
risk.\10\ In September 2006, the other Federal financial regulatory
agencies issued an interagency notice of proposed rulemaking for
implementing Basel II in the United States (U.S. Basel II).\11\ U.S.
Basel II would require core banks \12\ and permit opt-in banks \13\
(collectively referred to as Basel II banking organizations) to
implement the new framework using the advanced internal ratings-based
approach \14\ to calculate the regulatory capital requirement for
credit risk and the advanced measurement approach \15\ to calculate the
regulatory capital requirement for operational risk.\16\
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\10\ See https://www.bis.org/publ/bcbsca.htm for the 2004 Basel
II Accord as well as updates in 2005 and 2006.
\11\ See 71 FR 55830 (September 25, 2006). This document is at
https://www.federalreserve.gov/generalinfo/base12/USImplementation.htm
.
\12\ Core banks are banking organizations that have consolidated
total assets of $250 billion or more or have consolidated on-balance
sheet foreign exposures of $10 billion or more.
\13\ Opt-in banks are banking organizations that do not meet the
definition of a core bank but have the risk management and
measurement capabilities to voluntarily implement the advanced
approaches of Basel II with supervisory approval.
\14\ A banking organization computes internal estimates of
certain key risk parameters for each credit exposure or pool of
exposures and feeds the results into regulatory formulas to
determine the risk-based capital requirement for credit risk.
\15\ Internal operational risk management systems and processes
are used to compute risk-based capital requirements for operational
risk.
\16\ The proposed rule seeks comments on whether Basel II
banking organizations should be permitted to use other credit and
operational risk approaches.
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Given the complexity and cost associated with adopting the advanced
approaches, most U.S. banking organizations (collectively referred to
as non-Basel II banking organizations) will not be required to
implement, or choose to implement, U.S. Basel II. As a result, a
bifurcated regulatory capital framework would be created in the United
States, which could result in different regulatory capital charges for
similar products offered by Basel II and non-Basel II banking
organizations. Financial regulators, banking organizations, trade
associations and other interested parties have raised concerns that the
bifurcated structure could create a competitive disadvantage for non-
Basel II banking organizations.
In December 2006, the other Federal financial regulatory agencies
addressed these concerns by issuing an interagency notice of proposed
rulemaking (Basel IA) to improve the risk sensitivity of the existing
Basel I-based capital framework for non-Basel II banking
organizations.\17\ Basel IA is intended to help minimize the potential
differences in the regulatory minimum capital requirements of Basel II
and non-Basel II banking organizations. The proposal would allow non-
Basel II banking organizations the option of adopting all the revisions
of Basel IA or continuing to use the existing Basel I-based capital
framework.\18\ Proposed Basel IA would: (1) Increase the number of
risk-weight categories to which credit exposures may be assigned; (2)
expand the use of external credit ratings to risk weight certain
exposures; (3) expand the range of recognized collateral and eligible
guarantors; (4) employ loan-to-value ratios to determine the risk
weight of most residential mortgages; (5) increase the credit
conversion factor for some commitments with an original maturity of 1
year or less; (6) assess a risk-based capital charge for early
amortizations in securitizations of revolving exposures; and (7) remove
the 50-percent limit on the risk weight for certain derivative
transactions.\19\
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\17\ 71 FR 77446 (December 26, 2006). This document is at https://www.federalreserve.gov/generalinfo/basel2/USImplementation.htm
.
\18\ A banking organization that chooses to adopt Basel IA can
return to the Basel I-based capital framework, provided the change
is approved by its primary Federal regulator and is not for the
purpose of capital arbitrage. The other Federal financial regulatory
agencies have stated that they do not expect banking organizations
to alternate between the Basel I and Basel IA risk-based capital
rules.
\19\ Neither the U.S. Basel II nor the Basel IA proposed rules
would affect the existing leverage ratio or prompt corrective action
standards.
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FCA's objective is to develop a proposed rule that better reflects
recent advances in banking and capital market practices, minimizes
potential competitive distortions that could result from a bifurcated
regulatory capital framework in the United States, and more closely
aligns our minimum capital requirements with the relative risk factors
inherent in the System. We are considering whether we should modify our
risk-based capital rules so that they are consistent with Basel IA
where appropriate. However, we are also considering how the
modifications should be tailored to fit the System's distinct borrower-
owned lending cooperative structure and Government-sponsored enterprise
(GSE) mission.\20\
[[Page 34193]]
We seek comments from all interested parties to help us develop a
comprehensive proposal that would enhance our regulatory capital
framework and increase the risk sensitivity of our risk-based capital
rules without unduly increasing regulatory burden.
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\20\ The System was created by Congress in 1916 and is the
oldest GSE in the United States. System institutions provide credit
and financially related services to farmers, ranchers, producers or
harvesters of aquatic products, and farmer-owned cooperatives. They
also make credit available for agricultural processing and marketing
activities, rural housing, certain farm-related businesses,
agricultural and aquatic cooperatives, rural utilities, and foreign
and domestic entities in connection with international agricultural
trade.
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III. Questions
When addressing the following questions, we ask commenters to
consider the overarching objectives of Basel II and Basel IA to more
closely align capital with the specific risks taken by the financial
institution rather than relying on a ``one-size-fits-all'' approach for
determining regulatory minimum risk-based capital requirements. The
System is a specialized lender to agriculture and rural America with a
unique structure and risk profile. One of our objectives is to create a
more dynamic risk-based capital framework that is more sensitive to the
relative risks inherent in System lending and other mission-related
activities. We seek comments on specific criteria that might be used to
determine appropriate risk weights that meet this objective without
creating undue burden. Specifically, we ask that you support your
comments and recommendations with data, to the extent possible, in
response to our questions.\21\
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\21\ Please note that any data you submit will be made available
to the public in our rulemaking file.
\22 \ FCA's risk-weight categories are set forth in 12 CFR
615.5211.
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A. Increase the Number of Risk-Weight Categories
Our existing risk-based capital rules assign exposures to one of
five risk-weight categories: 0, 20, 50, 100, and 200 percent.\22\ Basel
IA proposes to add three new risk-weight categories to allow for
greater differentiation of credit risk and solicits comment on whether
a 10-percent risk-weight category would be appropriate for very low
risk assets. The proposed risk-weight categories are 35, 75, and 150
percent. The 35 and 75 percent risk-weight categories would provide the
opportunity to increase the risk sensitivity for those exposures that
are currently assigned a higher risk-based capital charge than may be
warranted. The 150-percent risk-weight category would provide a more
appropriate risk-based capital charge for higher risk exposures than is
currently permitted under our existing capital rules.
Question 1: We seek comment on what additional risk-weight
categories, if any, we should consider for assigning risk weights to
System institutions' on- and off-balance sheet exposures. If additional
risk-weight categories are added, what assets should be included in
each new risk-weight category?
B. Use of External Credit Ratings to Risk-Weight Exposures
1. Direct Exposures
In recent years, the FCA has permitted System institutions to use
external ratings to assign risk weights to certain credit exposures
linked to nationally recognized statistical rating organizations
(NRSROs) ratings.\23\ For example, in March 2003, we adopted an interim
final rule that permitted System institutions to use NRSRO ratings to
risk-weight highly rated investments in non-agency asset-backed
securities (ABS) and mortgage-backed securities (MBS) to the 20-percent
risk-weight category.\24\ In April 2004, we expanded the use of NRSRO
ratings to assign risk weights to loans to other financing
institutions.\25\ In June 2005, we adopted a ratings-based approach to
assign risk weights to recourse obligations, direct credit substitutes
(DCS), residual interests (other than credit-enhancing interest-only
strips), and other ABS and MBS investments.\26\ Furthermore, we
recently permitted the use of NRSRO ratings to assign risk weights to
certain electric cooperative credit exposures.\27\
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\23\ An NRSRO is a credit rating organization that is recognized
by and registered with the Securities and Exchange Commission (SEC)
as a nationally recognized statistical rating organization. See 12
CFR 615.5201. See also Pub. L. 109-291.
\24\ See 68 FR 15045 (March 28, 2003).
\25\ Other financing institutions are non-System financial
institutions that borrow from System banks. See 69 FR 29852 (May 26,
2004).)
\26\ These changes are consistent with those of the other
Federal financial regulatory agencies. See 70 FR 35336 (June 17,
2005).
\27\ See ``Revised Regulatory Capital Treatment for Certain
Electric Cooperatives Assets,'' FCA Bookletter BL-053 (February 12,
2007).
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Basel IA proposes to expand the use of NRSRO ratings to determine
the risk-based capital charge for exposures to sovereign entities,\28\
non-sovereign entities,\29\ and securitizations, as displayed in Table
1 (long-term exposures) and Table 2 (short-term exposures) set forth
below. External ratings for direct exposures to sovereign entities
would be based on the external rating of the exposure or the sovereign
entity's issuer rating if the exposure is unrated. Direct exposures to
non-sovereign entities and securitizations would be based only on the
external rating of the exposure.
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\28\ A sovereign entity is defined as a central government,
including its agencies, departments, ministries, and the central
bank. A sovereign entity does not include state, provincial, or
local governments, or commercial enterprises owned by a central
government.
\29\ Non-sovereign entities include securities firms, insurance
companies, bank holding companies, savings and loan holding
companies, multilateral lending and regional development
institutions, partnerships, limited liability companies, business
trusts, special purpose entities, associations and other similar
organizations.
\30\ 71 FR 77452 (December 26, 2006).
Table 1.--Basel IA Proposed Risk Weights Based on External Ratings for Long-Term Exposures\30\
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Securitization
Sovereign risk Non-sovereign exposure* risk
Long-term rating category Example weight (in risk weight weight (in
percent) (in percent) percent)
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Highest investment grade rating........ AAA.................... 0 20 20
Second highest investment grade rating. AA..................... 20 20 20
Third highest investment grade rating.. A...................... 20 35 35
Lowest investment grade rating-plus.... BBB+................... 35 50 50
Lowest investment grade rating......... BBB.................... 50 75 75
Lowest investment grade rating-minus... BBB-................... 75 100 100
One category below investment grade.... BB+, BB................ 75 150 200
One category below investment grade- BB-.................... 100 200 200
minus.
Two or more categories below investment B, CCC................. 150 200 (*)
grade.
[[Page 34194]]
Unrated**.............................. n/a.................... 200 200 (*)
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* A securitization exposure includes ABS and MBS, recourse obligations, DCS, and residuals (other than a credit-
enhancing interest-only strip). For long-term securitization exposures that are externally rated more than one
category below investment grade, short-term exposures that are rated below investment grade, or any unrated
securitization exposures, the existing risk-based capital treatment as described in the agencies' recourse
rule would be used.
** Unrated sovereign exposures and unrated debt securities issued by non-sovereigns would receive the risk
weight indicated in Tables 1 and 2. Other unrated exposures, for example, unrated loans to non-sovereigns,
would continue to be risk weighted under the existing risk-based capital rules.
Table 2.--Basel IA Proposed Risk Weights Based on External Ratings for Short-Term Exposures \31\
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Non-
Sovereign sovereign Securitization
Short-term rating category Example risk weight risk weight exposure*
(in (in risk weight
percent) percent) (in percent)
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Highest investment grade rating......... A-1, P-1.................... 0 20 20
Second-highest investment grade rating.. A-2, P-2.................... 20 35 35
Lowest investment grade................. A-3, P-3.................... 50 75 75
Unrated**............................... n/a......................... 100 100 *
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* A securitization exposure includes ABS and MBS, recourse obligations, DCS, and residuals (other than a credit-
enhancing interest-only strip). For long-term securitization exposures that are externally rated more than one
category below investment grade, short-term exposures that are rated below investment grade, or any unrated
securitization exposures, the existing risk-based capital treatment as described in the agencies' recourse
rule would be used.
** Unrated sovereign exposures and unrated debt securities issued by non-sovereigns would receive the risk
weight indicated in Tables 1 and 2. Other unrated exposures, for example, unrated loans to non-sovereigns,
would continue to be risk-weighted under the existing risk-based capital rules.
System institutions provide financing to agriculture and rural
America through a variety of lending \32\ and investment \33\ products.
They also hold highly rated liquid investments to manage liquidity,
short-term surplus funds, and interest rate risk. Our existing risk-
based capital rules assign most agricultural and rural business \34\
loans and mission-related investment assets to the 100-percent risk-
weight category unless the risk exposure is mitigated by an acceptable
guarantee or collateral. The FCA is considering the expanded use of
NRSRO ratings to assign risk weights to other externally rated credit
exposures in the System, such as corporate debt securities and loans.
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\31\ 71 FR 77452 (December 26, 2006).
\32\ The Farm Credit Banks provide wholesale funding to their
affiliated associations who, in turn, make retail loans to eligible
borrowers. CoBank, ACB, provides both wholesale funding to its
affiliated associations and retail loans to cooperatives and other
eligible borrowers.
\33\ System banks and associations are permitted to make
mission-related investments to agriculture and rural America. See
``Investments in Rural America--Pilot Investment Programs,'' FCA
Informational Memorandum (January 11, 2005).
\34\ Agricultural businesses include farmer-owned cooperatives,
food and fiber processors and marketers, manufacturers and
distributors of agricultural inputs and services, and other
agricultural-related businesses. Rural businesses include electric
utilities and other energy-related businesses, communication
companies, water and waste disposal businesses, ethanol plants, and
other rural-related businesses.
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Question 2: We seek comments on all aspects of the appropriateness
of using NRSRO ratings to assign risk weights to credit exposures. If
we expand the use of external ratings, how should we align the risk-
weight categories with NRSRO ratings to determine the appropriate
capital charge for externally rated credit exposures? Should any
externally rated positions be excluded from this new ratings-based
approach?
2. Recognized Financial Collateral
Our current risk-based capital rules assign lower risk weights to
exposures collateralized by: (1) Cash held by a System institution or
its funding bank; (2) securities issued or guaranteed by the U.S.
Government, its agencies or Government-sponsored agencies; (3)
securities issued or guaranteed by central governments in other OECD
\35\ countries; (4) securities issued by certain multilateral lending
or regional development institutions; or (5) securities issued by
qualifying securities firms.
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\35\ OECD stands for the Organization for Economic Cooperation
and Development. The OECD is an international organization of
countries that are committed to democratic government and the market
economy. An up-to-date listing of member countries is available at
https://www.oecd.org or https://www.oecdwash.org._____________________________________-
The banking industry has suggested that regulators recognize a
wider variety of collateral types for the purpose of reducing risk-
based capital requirements. In response, the other Federal financial
regulatory agencies have proposed to expand the types of eligible
collateral for risk-weighting purposes. Basel IA assigns lower risk
weights to exposures collateralized by: (1) Securities issued or
guaranteed by sovereigns that are externally rated at least investment
grade by an NRSRO (e.g., BBB- or Baa3) or the sovereign entity's issuer
rating if the security is not rated; or (2) securities issued by non-
sovereign entities that are externally rated at least investment grade
by an NRSRO (e.g., BBB or Baa2). The collateralized portion of the
exposure would be assigned a risk weight (as listed in Table 1 and
Table 2) according to the external rating of the collateral. The
uncollateralized portion of the exposure would be assigned a risk
weight according to the external rating of the exposure (or a sovereign
entity's issuer rating where applicable).
Question 3: We seek comment on whether recognizing additional types
of eligible collateral would improve the risk sensitivity of our risk-
based capital rules without being overly burdensome.
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We also seek comment on what additional types of collateral, if any, we
should consider and what effect the collateral should have on the risk
weighting of System exposures.
3. Eligible Guarantors
Our existing capital rules permit the use of third party guarantees
to lower the risk weight of certain exposures. Guarantors include: (1)
The U.S. Government, its agencies or Government-sponsored agencies; (2)
U.S. state and local governments; (3) central governments and banks in
OECD countries; (4) central governments in non-OECD countries (local
currency exposures only); (5) banks in non-OECD countries (short-term
claims only); (6) certain multilateral lending and regional development
institutions; and (7) qualifying securities firms.
Basel IA proposes to include guarantees from any entity that has
long-term senior debt (without credit enhancements) rated at least
investment grade by an NRSRO or, if the entity is a sovereign, an
issuer rating that is at least investment grade (e.g., BBB- or Baa3 for
sovereigns and BBB or Baa2 for non-sovereigns).\36\ The guaranteed
portion of the exposure would be assigned a risk weight (as detailed in
Table 1) according to the NRSRO rating of the eligible guarantor's
long-term senior debt or, if the guarantor is a sovereign and its long-
term debt is not rated, then the exposure would be assigned a risk
weight according to the NRSRO rating of the sovereign. Non-guaranteed
portions of the exposure would be assigned to the external rating of
the exposure (or a sovereign entity's issuer rating where applicable).
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\36\ See 71 FR 77453 (December 26, 2006). A recognized third
party guarantee would have to: (1) Be written and unconditional, and
if the third party is a sovereign, be backed by the full faith and
credit of the sovereign; (2) cover all or a pro rata portion of
contractual payments of the obligor on the reference exposure; (3)
give the beneficiary a direct claim against the protection provider;
(4) be non-cancelable by the protection provider for reasons other
than the breach of the contract by the beneficiary; (5) be legally
enforceable against the protection provider in a jurisdiction where
the protection provider has sufficient assets against which a
judgment may be attached and enforced; and (6) require the
protection provider to make payment to the beneficiary on the
occurrence of a default (as defined in the guarantee) of the obligor
on the reference exposure without first requiring the beneficiary to
demand payment from the obligor.
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Question 4: We seek comment on what additional types of third party
guarantees, if any, we should recognize and what effect such guarantees
should have on the risk weighting of System exposures.
C. Direct Loans to System Associations
The FCA is considering ways to better align our risk-based capital
requirements for direct loans with System associations. System banks
make direct loans to their affiliated associations who, in turn, make
retail loans to eligible borrowers. Our current risk-based capital
rules assign a 20-percent risk weight to direct loans at the bank level
and another risk weight (depending upon the type of loan) to retail
loans at the association level.\37\ The 20-percent risk weight is
intended to recognize the risks to the banks associated with lending to
their affiliated associations. The other Federal financial regulatory
agencies also assign a 20-percent risk weight to similar GSE and OECD
depository institution exposures.\38\ We are exploring methods to
improve the risk sensitivity of our risk-based capital rules by
assigning different risk weights to direct loan exposures based on the
System association's distinct risk profile.
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\37\ Our risk-based capital rules also assign a 20-percent risk
weight to similar GSE and OECD depository institution exposures.
\38\ Basel IA would retain the 20-percent risk weight for these
types of exposures. See 71 FR 77451 and 77454 (December 26, 2006).
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Question 5: We seek comment on what evaluative criteria or methods
we might use to assign risk weights to direct loans to System
associations. How should the criteria be used to adjust the risk weight
as the quality of the direct loan changes over time?
D. Small Agricultural and Rural Business Loans
Our existing risk-based capital rules assign small agricultural and
rural business loans to the 100-percent risk-weight category unless the
credit risk is mitigated by an acceptable guarantee or acceptable
collateral. The other Federal financial regulatory agencies are
exploring options to permit small business loans to qualify for a 75-
percent risk weight.\39\ They are also considering criteria for short-
term loans that do not amortize, such as working capital loans and
other revolving lines of credit.\40\
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\39\ See 71 FR 77462-77463 (December 26, 2006). The agencies
suggest the following criteria for qualifying loans: (1) Total
credit exposure to the business must not exceed $1 million; (2)
loan(s) must be personally guaranteed by the owner(s) of the
business and fully collateralized by the assets of the business; (3)
loan(s) must be prudently underwritten, performing, and fully
amortize within 7 years; (4) businesses must maintain a minimum debt
service coverage ratio of 1.3; (5) loan(s) must not have been
restructured; and (6) proceeds are not to be used to service any
other outstanding loan obligation.
\40\ For example, loans or draws from a revolving line of credit
that mature in 18 months could forgo the amortization requirement
provided the loan is to be repaid from anticipated proceeds of
previously established financial transactions and the proceeds are
pledged for the repayment of the loan.
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Question 6: We seek comment on what approaches we might use to
improve the risk sensitivity of our risk-based capital rules for small
agricultural and rural business loans. More specifically, what
qualifying criteria might we use to assign small agricultural and rural
business loans to risk-weight categories of less than 100 percent?
E. Loans Secured by Liens on Real Estate
1. First-Lien Loans
The FCA is considering ways to use loan-to-value ratios (LTV) and
other criteria to determine the risk-based capital charges for farm
real estate and qualified residential loans. Our existing capital rules
assign farm real estate loans to the 100-percent risk-weight category
and qualified residential loans \41\ to the 50-percent risk-weight
category. Basel IA proposes to risk weight first-lien residential
mortgages, including mortgages held for sale and mortgages held in
portfolio, based on LTV as outlined in Table 3 (farm real estate loans
are not included in this table).\42\ Basel IA proposes to include the
risk-mitigating effects of loan-level private mortgage insurance in the
calculation of LTV, provided the loan-level insurer is not affiliated
with the banking organization and has long-term senior debt (without
credit enhancement) externally rated at least the third highest
investment grade by an NRSRO (e.g., AA or Aa2).
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\41\ Qualified residential loans are rural home loans (as
defined by 12 CFR 613.3030) and single-family residential loans to
bona fide farmers, ranchers, or producers or harvesters of aquatic
products that meet the requirements listed in 12 CFR 615.5201.
\42\ See 71 FR 77456 (December 26, 2006). Basel IA proposes to
require institutions to calculate LTV at origination using the lower
of the purchase price of the property or the value at origination in
conformance with appraisal regulations and real estate lending
guidelines. LTV would be updated quarterly to reflect any decrease
in the principal balance, or if a negative amortization loan, an
increase in the principal balance. Property values are updated only
if a mortgage is refinanced and the banking organization extends
additional funds.
\43\ See 71 FR 77455 (December 26, 2006).
Table 3.--Basel IA Proposed LTV and Risk Weights for 1-4 Family First
Liens \43\
------------------------------------------------------------------------
Risk weight
Loan-to-value ratio (in percent) (in
percent)
------------------------------------------------------------------------
60 or less................................................. 20
Greater than 60 and less than or equal to 80............... 35
[[Page 34196]]
Greater than 80 and less than or equal to 85............... 50
Greater than 85 and less than or equal to 90............... 75
Greater than 90 and less than or equal to 95............... 100
Greater than 95............................................ 150
------------------------------------------------------------------------
The other Federal financial regulatory agencies are also evaluating
approaches that would consider borrower creditworthiness in conjunction
with LTV to determine the appropriate risk weight for first-lien
mortgages.\44\ Borrowers would be grouped by credit history using
default odds obtained from credit reporting agencies' validation
charts. A banking organization would determine a borrower's default
odds by mapping the borrower's credit score to the credit reporting
agencies' validation charts.
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\44\ See 71 FR 77456 (December 26, 2006).
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Question 7: We seek comment on all aspects of using LTV to
determine the risk-based capital charge for farm real estate and
qualified residential loans. Specifically, we ask that you address farm
real estate and qualified residential loans separately when answering
the following questions:
How might we determine the value (e.g., the denominator of
the LTV) of the real estate at origination?
How should PMI or guarantees be treated in the calculation
of LTV?
How should LTV be adjusted over time?
How should LTV be mapped to risk-weight categories?
How might loan characteristics such as loan size,
availability of credit scores, and payment frequency be used in
conjunction with LTV?
How might borrower creditworthiness be used in conjunction
with LTV and how might they be mapped to risk-weight categories?
2. Junior-Lien Loans
Our existing regulations permit System institutions to make short-
and intermediate-term loans secured by a junior lien on a property as
long as the System institution also holds the first lien on the
property. Further, System institutions can make loans secured by stand-
alone junior liens, provided the financing is used exclusively for
repairs, remodeling, or other improvements to qualified rural
homes.\45\ Loans secured by junior liens are risk-weighted at 50
percent if the institution holds a first lien on a mortgage that is
classified as a qualified residential loan. All other loans secured by
junior liens are risk-weighted at 100 percent.
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\45\ See 12 CFR 614.4200(b)(4).
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Basel IA proposes to risk-weight junior-lien mortgages based on a
combined LTV.\46\ For example, if a banking organization holds a first
lien on a property, then the junior lien loan would be added to the
first lien to determine the combined LTV and assigned the appropriate
risk weight as outlined in Table 3.\47\ For stand-alone junior liens,
the banking organization would follow the same procedures, except the
junior-lien loan would be combined with all senior-lien loans (all
principal amounts outstanding would be aggregated) to determine the LTV
and assigned the appropriate risk weight as outlined in Table 4.
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\46\ See 71 FR 77458-77459 (December 26, 2006).
\47\ The steps for determining the risk-adjusted value of the
unfunded portion of a junior-lien loan (e.g., a line of credit)
would be as follows: (1) The unfunded commitment is multiplied by
the appropriate credit conversion factor to determine the on-balance
sheet credit equivalent; (2) the on-balance sheet credit equivalent
is added to the first lien and the funded portion of the junior-lien
loan to determine the combined LTV; and (3) the combined LTV is
assigned the appropriate risk weight as outlined in Table 3. The
unfunded commitment would be adjusted accordingly as the borrower
utilizes the junior-lien loan.
\48\ See 71 FR 77459 (December 26, 2006).
Table 4.--Basel IA Proposed LTV and Risk Weights for 1-4 Family Junior
Liens \48\
------------------------------------------------------------------------
Risk weight
Loan-to-value ratio (in percent) (in
percent)
------------------------------------------------------------------------
60 or less................................................. 75
Greater than 60 and less than or equal to 90............... 100
Greater than 90............................................ 150
------------------------------------------------------------------------
Question 8: We seek comment on all aspects of using combined LTV to
risk-weight junior-lien loans. Specifically, how should combined LTV be
calculated at origination and adjusted over time? How should the
combined LTVs be used to assign stand-alone junior-lien loans to risk-
weight categories?
F. Short- and Long-Term Commitments
Under Sec. 615.5212, off-balance sheet commitments are generally
risk-weighted in two steps: (1) The off-balance sheet commitment is
multiplied by a credit conversion factor (CCF)\49\ to determine its on-
balance sheet credit equivalent; and (2) the on-balance sheet credit
equivalent is assigned to the appropriate risk-weight category in Sec.
615.5211 according to the obligor, after considering any applicable
collateral and guarantees.\50\ Basel IA proposes to retain the zero-
percent CCF for commitments that are unconditionally cancelable\51\ but
assign a 10-percent CCF to all other short-term commitments. Further,
Basel IA seeks comment on alternative approaches that would apply a
single CCF of 20 percent to all short- and long-term commitments that
are not unconditionally cancelable.
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\49\ A CCF is a number by which an off-balance sheet item is
multiplied to obtain a credit equivalent before placing the item in
a risk-weight category.
\50\ 50 Our existing regulations assign a zero-percent CCF to
unused commitments with an original maturity of 14 months or less.
Unused commitments with an original maturity of greater that 14
months can also receive a zero-percent CCF provided the commitment
is unconditionally cancelable and the System institution has the
contractual right to make a separate credit decision before each
drawing under the lending arrangement. All other unused commitments
with an original maturity of greater than 14 months are assigned a
50-percent CCF.
\51\ An unconditionally cancelable commitment is one that can be
canceled for any reason at any time without prior notice.
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Question 9: We seek comment on what approaches we might use to risk
weight short- and long-term commitments that are not unconditionally
cancelable.
G. Adjusting Risk Weights on Exposures Over Time
The FCA welcomes comment on additional approaches or criteria
(other than NRSRO credit ratings and LTVs addressed in previous
sections) that might be used to adjust the risk weight of exposures
throughout the life of the asset. Our existing risk-based capital rules
assign a static risk weight to assets within a given asset class
without allowing for risk-weight adjustments as asset quality improves
or deteriorates. For example, most loans to System borrowers are risk-
weighted at 100 percent throughout the life of the loan without making
risk-weight adjustments based on credit classifications or other credit
performance factors.
Question 10: We seek comment on what methods we might use to adjust
the risk weight of credit exposures as the asset quality or default
probability changes over time.
H. Capital Charge for Operational Risk
The FCA welcomes comments on possible approaches for determining a
capital charge for operational risk. The broad risk-weighting
categories under our existing capital rules are intended to implicitly
cover operational and other types of risks. As we move to a more risk-
sensitive capital framework, it may be more appropriate to apply an
explicit capital charge for operational risk, especially to cover risks
associated with
[[Page 34197]]
off-balance sheet activity. Basel IA is designed to implicitly cover
risks other than credit risk, and therefore, does not propose an
explicit capital charge for operational risk.
Question 11: We seek comment on whether we should consider a risk-
based capital charge for operational risk.
I. Capital Leverage Ratio
We are considering whether we should supplement our existing risk-
based capital rules with a minimum capital leverage ratio requirement
for all FCS institutions to further promote the safety and soundness of
the System. Our existing capital regulations require System banks to
maintain a minimum net collateral ratio (NCR) \52\ of 103 percent \53\
but do not impose a capital leverage ratio on System associations. The
NCR provides a level of protection for operating and other forms of
risk at System banks, but it does not differentiate higher quality from
lower quality capital. The other Federal financial regulatory agencies
currently supplement their risk-based capital rules with a leverage
ratio of Tier 1 capital to total assets (Tier 1 leverage ratio).\54\
The Tier 1 leverage ratio consists of only the most reliable and
permanent forms of capital such as common stock, non-cumulative
perpetual preferred stock, and retained earnings. Neither the U.S.
Basel II nor the Basel IA proposed rules would affect the existing
leverage ratio.
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\52\ The net collateral ratio is a bank's net collateral as
defined by 12 CFR 615.5301(c) divided by the bank's adjusted total
liabilities.
\53\ See 12 CFR 615.5335(a).
\54\ See 12 CFR 3.6(b) and (c); 12 CFR part 208, appendix B and
12 CFR part 225, appendix D; 12 CFR 325.3; and 12 CFR 567.8.
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Question 12: We seek comment on whether our capital rules should
include a minimum capital leverage ratio requirement for all System
institutions. We also seek comment on changes, if any, that should be
made to the existing regulatory minimum NCR requirement applicable to
System banks that would make it more comparable to the Tier 1 ratio
used by the other Federal financial regulatory agencies.
J. Regulatory Capital Directives \55\
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\55\ 12 CFR part 615, subpart M.
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We are considering whether we should modify our capital rules to
specify potential early intervention criteria for the issuance of
capital directives. Currently, FCA has the discretion to issue a
capital directive \56\ when an institution's capital is insufficient.
The FCA, however, has not defined capital or other financial early
intervention thresholds to require an institution to take corrective
action as described in Sec. 615.5355. Early intervention approaches
have been used in other contexts, including the System's Market Access
Agreement and the statutory requirements applicable to other regulated
financial institutions. An early intervention capital directive
framework could provide a clearer indication of when we would impose
additional and increasing supervisory oversight on an institution to
address continuing deterioration in its financial condition and capital
position from credit, interest rate, or other financial risks.
---------------------------------------------------------------------------
\56\ A capital directive is defined in Sec. 615.5355(a) as an
order issued to an institution that does not have or maintain
capital at or greater than the minimum ratios set forth in 12 CFR
615.5205, 615.5330, and 615.5335, or established under subpart L of
part 615, or by a written agreement under an enforcement or
supervisory action, or as a condition of approval of an application.
The FCA's authority is set forth in sections 4.3(b)(2) and 4.3A(e)
of the Farm Credit Act (12 U.S.C. 2154(b)(2) and 2154a(e)).
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Question 13: We seek comment on revising our current capital
directive regulations to include an early intervention framework. We
also seek comment on potential financial thresholds, such as capital
ratios or risk measures, that would trigger an FCA capital directive
action.
K. Multi-Dimensional Regulatory Structure
As stated above, one of FCA's objectives is to implement a revised
capital framework that improves the risk sensitivity of our capital
rules while avoiding undue regulatory burden. There are currently five
banks and 95 associations in the System with varying degrees of asset
size, complexity of operations, and sophistication in their risk
management practices. Some System institutions have the risk management
capabilities to apply more complex, risk-sensitive regulatory capital
requirements than other System institutions. It may be appropriate for
the FCA to adopt more than one set of capital rules to account for
these differences. However, this approach could result in different
capital requirements for the same type of transaction and increase
examination and oversight costs.
The other Federal financial regulatory agencies are proposing more
than one set of capital rules for the financial institutions they
regulate. For example, implementation of U.S. Basel II would be
limited, for the most part, to the largest, internationally active
banks that meet certain infrastructure requirements. Basel IA would
permit non-Basel II banking organizations the option of applying the
revised Basel IA-based capital framework or remaining subject to the
existing Basel I-based capital framework.\57\ Consequently, a
trifurcated regulatory capital framework would be created in the United
States.
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\57\ A banking organization that chooses to apply Basel IA must
do so in its entirety. However, a banking organization has the
option of risk weighting existing mortgage loans using the existing
Basel I-based capital rules. This option would apply only to those
mortgage loans that the banking organization owned at the time it
chose to apply Basel IA.
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While our expectation is to implement a revised capital framework
similar to Basel IA, we also recognize that some aspects of Basel II
may be appropriate for the larger, more complex System institutions.
However, we are still reviewing Basel II and its potential application
to the System. Therefore, we are not seeking comments on Basel II at
this time. Rather, we are considering the overall regulatory capital
framework for the System in light of the changes occurring in the
financial services industry such as the Basel II and Basel IA proposed
rules and recent best practices for economic capital modeling.
Question 14: We seek comment on the most appropriate risk-based
capital framework for the System and the reasons we should implement
one framework over another. Should we consider creating a uniform
regulatory capital structure for the System or a multi-dimensional
regulatory structure and allow each System institution the option of
choosing which capital framework it will apply? How might this new
risk-based capital framework increase the costs or regulatory burden to
the System? Would the increased costs be justified by improved risk
sensitivity, risk management, and more efficient capital allocation?
Question 15: Additionally, we seek comment on any other methods
that may be used to increase the risk sensitivity of our risk-based
capital rules.
Dated: June 15, 2007.
Roland E. Smith,
Secretary, Farm Credit Administration Board.
[FR Doc. E7-11990 Filed 6-20-07; 8:45 am]
BILLING CODE 6705-01-P
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