Federal Agricultural Mortgage Corporation Governance and Federal Agricultural Mortgage Corporation Funding and Fiscal Affairs; Risk-Based Capital Requirements, 23459-23469 [2011-10172]
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Federal Register / Vol. 76, No. 81 / Wednesday, April 27, 2011 / Rules and Regulations
■ d. By adding the OMB citation
‘‘(Approved by the Office of
Management and Budget under control
number 0579–0369)’’ at the end of the
section.
§ 301.76–7 Additional conditions for
issuance of certificates and limited permits
for regulated articles moved interstate from
areas quarantined for citrus greening.
(a) Additional conditions for the
issuance of a certificate; regulated
nursery stock produced within a nursery
located in the quarantined area. In
addition to the general conditions for
issuance of a certificate contained in
§ 301.76–5(a), an inspector or person
operating under a compliance
agreement may issue a certificate for
interstate movement of regulated
nursery stock to any State if all of the
following conditions are met:
(1) The nursery in which the nursery
stock is produced has entered into a
compliance agreement with APHIS in
which it agrees to meet the relevant
construction standards, sourcing and
certification requirements, cleaning,
disinfecting, and safeguarding
requirements, labeling requirements,
and recordkeeping and inspection
requirements specified in a PPQ
protocol document. The protocol
document will be provided to the
person at the time he or she enters into
the compliance agreement.5 The
compliance agreement may also specify
additional conditions determined by
APHIS to be necessary in order to
prevent the dissemination of citrus
greening under which the nursery stock
must be grown, maintained, and
shipped in order to obtain a certificate
for its movement. The compliance
agreement will also specify that APHIS
may amend the agreement.
(2) An inspector has determined that
the nursery has adhered to all terms and
conditions of the compliance agreement.
(3) The nursery stock is completely
enclosed in a sealed container that is
clearly labeled with the certificate and
is moved interstate in that container.
(4) A copy of the certificate is
attached to the consignee’s copy of the
accompanying waybill.
*
*
*
*
*
§ 301.76–8
[Amended]
10. Section 301.76–8 is amended as
follows:
■ a. In paragraph (b), by adding the
words ‘‘, or any term or condition of the
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■
5 The protocol document is also available on the
Internet at https://www.aphis.usda.gov/
plant_health/plant_pest_info/citrus/index.shtml
and may be obtained from local Plant Protection
and Quarantine offices, which are listed in
telephone directories.
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compliance agreement itself’’ after the
words ‘‘with this subpart’’.
■ b. In the OMB citation at the end of
the section, by removing the words
‘‘number 0579–0363’’ and adding the
words ‘‘numbers 0579–0363 and 0579–
0369’’ in their place.
§ 301.76–9
[Amended]
11. Section 301.76–9 is amended by
removing the words ‘‘All regulated
nursery stock treated with soil drenches
or in-ground granular applications and
foliar sprays prior to interstate
movement from an area quarantined
only for Asian citrus psyllid, but not for
citrus greening, as well as all’’ and
adding the word ‘‘All’’ in their place.
■
Done in Washington, DC, this 21st day of
April 2011.
Edward M. Avalos,
Under Secretary for Marketing and Regulatory
Programs.
[FR Doc. 2011–10092 Filed 4–26–11; 8:45 am]
BILLING CODE 3410–34–P
FARM CREDIT ADMINISTRATION
12 CFR Parts 651 and 652
Federal Agricultural Mortgage
Corporation Governance and Federal
Agricultural Mortgage Corporation
Funding and Fiscal Affairs; Risk-Based
Capital Requirements
Farm Credit Administration.
ACTION: Final rule.
AGENCY:
The Farm Credit
Administration (FCA, Agency, us, or
we) issues this final rule amending our
regulations on the Risk-Based Capital
Stress Test (RBCST or model) used by
the Federal Agricultural Mortgage
Corporation (Farmer Mac). This
rulemaking updates the model to ensure
that it continues to appropriately reflect
risk in a manner consistent with
statutory requirements for calculating
Farmer Mac’s regulatory minimum
capital level under a risk-based capital
stress test. This rule updates the model
to estimate the capital requirements
associated with Farmer Mac’s statutory
authority to finance rural utility loans
and to revise the treatment of certain
secured general obligations held by
Farmer Mac as program investments.
This rule also revises the treatment of
counterparty risk on non-program
investments in the model by adjusting
the haircuts applied to those
investments to keep the model
internally consistent with revisions
made to stressed historical corporate
bond default and recovery rates.
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Effective date: This regulation
will be effective 30 days after
publication in the Federal Register
during which either or both Houses of
Congress are in session. We will publish
a notice of the effective date in the
Federal Register.
Compliance date: Compliance with
the changes to the model must be
achieved by the first day of the fiscal
quarter following the effective date of
the rule. All other provisions require
compliance on the effective date of this
rule.
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:
DATES:
I. Objective
RIN 3052–AC51
SUMMARY:
23459
The objective of this final rule is to
ensure that the RBCST for Farmer Mac
continues to determine regulatory
capital requirements in a manner
consistent with statutory requirements.
II. Background
The FCA is an independent agency in
the executive branch of the Federal
Government that, in part, serves as the
safety and soundness regulator of
Farmer Mac. The FCA regulates Farmer
Mac through the Office of Secondary
Market Oversight (OSMO). Farmer Mac
is a stockholder-owned instrumentality
of the United States, chartered by
Congress to establish a secondary
market for agricultural real estate, rural
housing mortgage loans, and rural
utilities loans. Farmer Mac also
facilitates the capital markets funding
for USDA-guaranteed farm program and
rural development loans. Section 5406
of the Food, Conservation and Energy
Act of 2008 (2008 Farm Bill) 1 amended
the definition of ‘‘qualified loan’’ in Title
VIII of the Farm Credit Act of 1971, as
amended, (Act) 2 to include rural utility
loans. This change gave Farmer Mac the
authority to purchase and guarantee
securities backed by loans to rural
electric and telephone utility
cooperatives as program business. The
1 Public Law 110–246, 122 Stat. 1651 (June 18,
2008) (repealing and replacing Pub. L. 110–234).
2 Public Law 92 181, 85 Stat. 583 (December 10,
1971).
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2008 Farm Bill further directed FCA to
estimate the credit risk on the portfolio
covered by this new authority at a rate
of default and severity reasonably
related to the risks in rural electric and
telephone facility loans. The existing
RBCST (Version 3.0) for Farmer Mac is
contained in part 652, subpart B, and is
used to determine the minimum level of
regulatory capital Farmer Mac must
hold to maintain positive capital during
a 10-year period, as characterized by
stressful credit and interest rate
conditions. Version 3.0 of the RBCST
was developed according to the
provisions of section 8.32 of the Act
before Farmer Mac was given rural
utility authority and thus lacks a
component to directly recognize the
credit risk on such loans.3 The updated
version of the RBCST will be identified
as Version 4.0.
On January 22, 2010, we published a
proposed rule (75 FR 3647) to enhance
the RBCST for Farmer Mac and to add
a component addressing Farmer Mac’s
recently acquired authority to purchase
and guarantee securities backed by
loans to rural electric and telephone
utility cooperatives. The comment
period closed on April 22, 2010.4 This
rulemaking finalizes policies proposed
prior to the passage of the Dodd-Frank
Wall Street Reform and Consumer
Protection Act of 2010 (Dodd-Frank
Act).5 Section 939A of the Dodd-Frank
Act requires federal agencies to review
all regulatory references to Nationally
Recognized Statistical Ratings
Organization (NRSRO) credit ratings by
July 21, 2011, and, as a result of this
review, to remove those references.
While this rule maintains existing
reliance on NRSRO credit ratings, the
Agency intends to begin a rulemaking
initiative immediately following this
one to address the requirements of the
Dodd-Frank Act.
III. Comments and Our Response
We received several comments on the
proposed rule from Farmer Mac and one
comment letter from the Farm Credit
Council (FCC), acting for its
membership and each of the five Farm
Credit banks. The FCC expressed
support for using a more conservative
approach to loss rate estimation in the
AgVantage portfolio. It also noted its
belief that capital standards for Farmer
Mac should be equivalent to those of
Farm Credit System (FCS or System)
lenders. The FCC was also generally
3 FCA currently treats Farmer Mac’s portfolio of
investments in rural utility loans as non-program
investments.
4 75 FR 13682 (March 23, 2010).
5 Public Law 111–203, 124 Stat. 1376, (H.R. 4173),
July 21, 2010.
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supportive of the proposed
characterization of credit risk in the
rural utility portfolio, but noted that the
approach requires vigilant oversight of
Farmer Mac’s guarantee fee-pricing
procedures.
While we appreciate the FCC’s
comment, the Act provides for a
different treatment of capital than that
of the other System institutions. As
such, the FCC’s suggestion to make the
capital standards equivalent to those of
other FCS lenders is outside the scope
of this rulemaking. Farmer Mac
submitted comments on three aspects of
the proposed rule—the method of
characterizing credit losses on rural
utility loans, the stress factor applied to
the general obligation adjustment (GOA)
to estimated losses in the AgVantage
portfolio, and the concentration risk
adjustment to the GOA factors. Farmer
Mac stated that the proposed method of
characterizing losses in the rural utility
loans is not consistent across different
market environments because it was too
high relative to both the historical loss
experience in that sector as well as
levels that could be reasonably applied
to agricultural mortgages. Farmer Mac
also commented that the multiplier
selected to stress GOA factors was too
high, and the concentration risk
adjustment to the GOA factors was
unwarranted and duplicative to the use
of credit ratings in the base GOA factors.
Farmer Mac asked that the
concentration risk be reversed in its
impact to reflect a reduction in Farmer
Mac’s risk exposure in light of the
counterparty’s relative portfolio
diversification.
We discuss the comments specific to
our proposed rule and our responses
below. For purposes of responding to
the comments made regarding GOA
factors, we will be using the following
terms to distinguish between the
existing ‘‘base GOA’’ factors to refer to
those set forth in Version 3.0, which are
based solely on historical corporate
bond default and recovery rates, and
‘‘stressed GOA’’ factors to refer Version
4.0 where base GOA factors are
increased by a multiple of 3. Those
areas of the proposed rule not receiving
comment are finalized as proposed
unless otherwise discussed in this
preamble.
A. Credit Loss Estimation on Rural
Utility Loans [§§ 652.50 and 652.65(b);
Appendix A to Part 652]
1. Guarantee Fee
We proposed amending § 652.50 by
adding a definition for guarantee fees
charged on rural utility loans to
distinguish treatment of these fees from
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those assessed against all other loans
guaranteed by Farmer Mac. We
explained ‘‘rural utility guarantee fee,’’
as it pertains to funded volume, means
the gross spread over cost of funds, not
a subset of that spread. Farmer Mac
requested that we clarify whether or not
the definition of ‘‘rural utility guarantee
fee’’ is meant to reflect a subset of the
term ‘‘pricing spread.’’
We apply the term ‘‘rural utility
guarantee fee’’ as a standalone term and
not as a subset of pricing spread, and
therefore, no component of the pricing
spread should be netted. The rule
defines ‘‘rural utility guarantee fee’’ as
the actual guarantee fee charged for offbalance sheet volume and the earnings
spread over Farmer Mac’s funding costs
for on-balance sheet volume on rural
utility loans.6 As explained in the
proposed rulemaking, we use the phrase
‘‘earnings spread’’ in the guarantee fee
definition to represent the incoming
cashflow rate minus Farmer Mac’s total
funding rate associated with that
volume. We expect Farmer Mac to
maintain records of these spreads when
they are established for each
transaction. We do not consider this an
overly burdensome expectation given
Farmer Mac’s current practice of
documenting such approvals of such
spreads. Thus, the guarantee fee is the
gross spread over cost of funds, not a
subset of that spread. We are finalizing
the definition as proposed. As a
conforming technical change, we
finalize amendments to sections 1.0.a.,
4.1.b., 4.2.b.(2), and 4.2.b.(3) of the
model in Appendix A of part 652 to add
rural utility guarantee fees.
2. Credit Risk
We proposed amending the model in
Appendix A of part 652 to include rural
utility program volume by using a
stylized approach to characterizing
credit risk for rural utility program
volume by multiplying the dollarweighted average rural utility guarantee
fee by a factor of two to characterize
stressed annual loss rates.7 We also
proposed clarifying the applicability of
individual sections of the model to the
6 For purposes of the mechanics within the
spreadsheets of RBCST Version 4.0, on-balance
sheet volume will, if necessary, be divided into
those with AgVantage Plus-type structures and
those that are outright loan purchases similar in
structure to Farmer Mac’s cash window for
agricultural mortgages.
7 In the proposed rule, in this context, we used
the phrase ‘‘average annual loss rates.’’ We believe
the phrase ‘‘stressed annual loss rates’’ is clearer.
What we intend to convey is that while agricultural
lifetime loss rates are calculated by the model and
then distributed on a front-loaded basis, we
characterize rural utility loss rates as equal annual
loss rates, or what could be referred to as average
loss rates over a period of worst case stress.
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rural utility portfolio and adding new
sections 2.6, 4.1.e., and 4.3.e. to
calculate losses for rural utility loans.
Farmer Mac objected to the proposed
approach on the grounds that it results
in projected stressed credit losses on
rural utility loans that are inconsistent
across different market environments
and exceed both the historical
experience in the rural utility sector and
levels that could be reasonably applied
to agricultural mortgages. Farmer Mac
explained that the stressed credit loss
characterizations on rural utility loans
will be inconsistent across different
market environments because it would
be subject to inaccuracy due to potential
volatility in the pricing by Farmer Mac
of similar exposures under varying
market conditions through time. In
other words, investor risk tolerances
vary with changes in perceived levels of
overall risk in the market, and such
changes could enable Farmer Mac to
charge higher rates on rural utility loans
despite no change in the underlying
fundamentals of the sector or the
specific loans it guarantees. We disagree
with the suggestion that the stressed
credit loss characterizations on rural
utility loans will be inconsistent across
different market environments. We used
a multiple of the Farmer Mac rural
utility guarantee fee as a proxy for
stressed loss rates because the data on
historical losses are not suitable for the
development of a more statistically
reliable estimate. We elected not to
decompose the guarantee fee and
earnings spreads into their component
parts (including required versus
‘‘excess’’ spread) as that approach would
have: (1) Required significant
assumptions regarding what portion
might be attributable to Farmer Mac’s
perception of market conditions versus
credit risk; and (2) added a level of
calculation complexity that is
disproportionate to the coarse level of
precision achievable given the data
limitations. In other words, we take the
view that the market clearing price
reflects the market consensus of risk at
a point in time.
Farmer Mac asserts that the proposed
approach is also incongruous because it
characterizes losses of on- and offbalance sheet rural utility volume
identically, though the rural utility
guarantee fee would be inherently
different. Farmer Mac suggests that the
earnings spread on on-balance sheet
volume might be larger than the
guarantee fee on off-balance sheet
volume. Farmer Mac clarified this
comment by explaining that the return
on equity component of the earnings
spread would be larger for on-balance
sheet volume ‘‘[i]f the return on equity
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pricing is determined using current
statutory minimum capital requirements
(or any other capital requirements set
using a differential approach to capital
allocation).’’ The comment references
the statutory minimum requirements for
on-balance sheet exposure (2.75
percent) and off-balance sheet exposure
(0.75 percent) of outstanding principal.
We understand the comment to indicate
that program investment decisions, i.e.,
capital allocations, might be made on
the basis of some required equity return
margin over the associated statutory
minimum capital requirements rather
than on the basis of the risk and expense
characteristics of the investments. We
disagree with this premise. We are
aware of no reason to base return on
equity requirements on fixed statutory
minimum capital requirements or to use
such minimum capital requirements as
a proxy for capital allocated to specific
program investments. We reject the
suggestion that such fixed minimums
could be appropriately used as a basis
to justify differential return on equity
requirements on investments that have
otherwise exactly the same risk and
expense characteristics.
Farmer Mac also commented that a
multiple of two times the rural utility
guarantee fee would not be consistent
with FCA’s stated position that the
agriculture sector is generally more
risky than the rural utility sector.
Farmer Mac used a hypothetical
example to demonstrate its comment. In
this example, the cumulative annual
loss rate characterization on rural utility
volume over the 10 years of the
modeling horizon slightly exceeded the
estimated lifetime loss rate on newly
originated, agricultural loans
underwritten according to Farmer Mac’s
minimum standards. Farmer Mac
modified the example to create a
situation where the two sets of loans
were equally seasoned and concluded
that the cumulative loss rate for
electrical loans in such cases would
always exceed that of the agricultural
real estate loans. Farmer Mac explained
that the example demonstrated that the
rule’s approach would not be consistent
with the statute’s authorizing language
requiring modeled loss rates to be
‘‘reasonably related to risks’’ in rural
electric and telephone facility loans.
Farmer Mac instead suggests that
cumulative loss rates should, at the very
least, be no greater than those for
comparably sized agricultural mortgage
loans. While Farmer Mac noted that the
multiplier of two could be reduced, it
instead asked FCA to adopt a credit risk
estimate supported by historical loss
and recovery rate trends.
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23461
We disagree with the commenter’s use
of FCA Bookletter BL–053, ‘‘Revised
Regulatory Capital Treatment for Certain
Electric Cooperative Assets,’’ to support
the contention that the proposed
treatment is inconsistent with the
bookletter’s conclusion that the electric
cooperative sector has a lower risk
profile than the agricultural sector.8
While under normal conditions an
average dollar of exposure to a rural
electric cooperative is viewed as a lower
credit risk than an average dollar of
agricultural real estate mortgage
exposure, the purpose of the RBCST is
to represent a worst-case loss scenario
for program-related assets. We view the
concept of ‘‘worst case’’ in the rural
utility cooperative sector as
fundamentally different from the
agriculture sector. The rule’s approach
inherently reflects our expectation that
worst-case losses in the rural utility
sector will occur far less frequently than
worst-case losses in the agriculture
sector—but when they occur, can be far
more severe. While the average annual
loss rate over the long term may be
viewed as likely to be lower in the rural
utility sector due to the infrequent
occurrence of loss events, in a scenario
where worst-case losses do occur, they
will involve much greater loss rates than
worst-case losses in agriculture. Further,
the relationship between the two
cumulative 10-year loss rates
(agricultural versus rural utility) is not
instructive, as the sector with the higher
cumulative rate will vary depending on
rural utility guarantee fee rates and the
credit risk characteristics of the
agriculture portfolio at any given time.
Thus, in attempting to characterize both
sectors’ worst-case scenarios in the
RBCST over a 10-year modeling
horizon, having 10 years of loss rates
that do not always sum to lower
cumulative rate in the rural utility
portfolio is not inconsistent with the
general tenet that the electric
cooperative sector typically has a lower
risk profile.
Notwithstanding our position on this
comment, using the suggested approach,
it would be more appropriate to
compare cumulative loss rates only to
the modeling year at which the model
indicates capital would approach its
limit of zero (the zero-year) because
losses recognized by the model in
subsequent modeling years do not
impact the calculation of the minimum
capital requirement. Expanding on
8 While BL–053 pertains to Farm Credit System
banks and associations, and not to Farmer Mac, we
believe the general tenets set forth in it apply to
those same certain loan types in Farmer Mac’s
portfolio.
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Farmer Mac’s example, if the zero-year
occurred at year three, cumulative
losses over those 3 years in agriculture
portfolio would be 9.87 percent versus
4.2 percent in the rural utility portfolio.
Seasoning could further affect the
relative impacts of credit risk in the
model. Given our stated view of the
fundamentally different concepts of
‘‘worst-case’’ in the two sectors, this fact
does not contradict the Agency’s stated
position.
Farmer Mac’s comment goes on to
suggest various approaches to achieve
the ‘‘result’’ recommended (that
cumulative losses projected in the
RBCST for rural utilities loans should
be, on a relative basis, no greater than
those for comparably sized agricultural
mortgage loans). Farmer Mac notes that
this result could be achieved by
reducing the multiplier of two, but
suggests instead that we abandon the
proposed approach of applying a
multiplier to Farmer Mac pricing factors
in favor of an approach that references
historical loss trends. In the proposed
rule’s preamble, we discussed in detail
the insufficiency of historical lost trend
data, as well as other alternatives to the
proposed approach that were
considered and why they were rejected.
Farmer Mac also stated that the
proposed approach was inconsistent
with historical loss trends. We disagree
because the comment is based on the
premise that appropriate historical loss
trend information is available. As
discussed in the proposed rulemaking,
we determined that a data set suitable
to build a reliable default probability
loss function is not available due to the
fact that historical losses in the electric
cooperative sub-sector of the utilities
industry have been extremely rare and
dissimilar.9 We also note that historical
instances of default appear largely
unrelated to specific underwriting
decisions. Further, even among the few
historical instances of non-performing
loans in the data we obtained,
restructured credit defaults have in
many instances become more profitable
than the original loan in terms of
interest income, while others were
never fully resolved despite
exceptionally long periods of time since
initial default. For those reasons, an
empirical frequency-based analog for
estimating credit risk, as was used to
arrive at the model’s approach to
estimating agricultural loan risks, was
9 In
evaluating the suitability of empirical data
sources, we examined historical loan performance
data of the U.S. Department of Agriculture’s (USDA)
loan programs and interviewed market participants
including the National Rural Utility Cooperative
Financing Corporation, CoBank, and USDA’s Rural
Utility Service.
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not feasible for rural utilities. Instead,
the rule characterizes credit risk on
rural utility loans using the stylized
approach of multiplying the dollarweighted average rural utility guarantee
fee by a factor of two to characterize
stressed annual loss rates.
Finally, Farmer Mac commented that
the proposed approach to characterizing
credit losses in the rural utility portfolio
is inconsistent with the Act. We
disagree with this assessment because
the Act does not require us to use any
particular statistical methodology. The
Act, at section 8.32(a)(1)(B), requires us
to estimate credit loss risk ‘‘at a rate of
default and severity reasonably related
to risks in electric and telephone facility
loans * * * as determined by the
Director [of OSMO].’’ The proposed
rulemaking explained in some detail the
reason behind selecting the method of
identifying rural utilities credit loss risk,
and Farmer Mac has offered no evidence
to demonstrate that our method does not
reasonably relate to actual risks in the
rural utilities sector.
We selected a method that relies
directly on the notion that the
assessment of relative risk would be
reflected in differences in priced
guarantee fees charged by Farmer Mac.
These fees represent Farmer Mac’s
estimate of likely long-term average
annual losses on an investment, in
addition to fee loads to cover operating
costs and return-on-equity
requirements. We selected the
combination of the total earnings spread
with a lower stress multiple because the
total spread also represents agreement
on the value of the transaction between
at least two parties: Farmer Mac and its
counterparty (i.e., a market clearing
price).
For these reasons, we finalize this
section and the conforming changes as
proposed to reflect the treatment of the
rural utility authority. As we gain more
experience and data in this sector, the
Agency may revisit this approach.
B. Modification of the Treatment of
Loans Backed by an Obligation of the
Counterparty and Loans for Which
Pledged Loan Collateral Volume
Exceeds Farmer Mac-Guaranteed
Volume [§§ 652.50 and 652.65(d);
Appendix A to Part 652]
We are amending sections 2.4.b.3,
2.4.b.4, 4.1.f., and 4.2.b. of the model in
Appendix A of part 652 to increase the
GOA factors, address counterparty
concentration risks, and ensure
AgVantage Plus volume maturities are
recognized in the model.
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1. GOA Factors—Treatment of Loan
Volume
We proposed revising the GOA factors
by stressing the historical corporate
bond loss rates to levels intended to
represent stressed conditions instead of
average conditions. We accomplish this
in the model by modifying the GOA
factors through the application of
increases (or ‘‘haircuts’’) to the estimated
historical loss rates by whole-letter
credit rating category using a multiple of
three.
Farmer Mac commented that our
selection of three as the multiplier
appeared to be much too high based on
data in reports issued by Moody’s
Investor Services. Farmer Mac
explained that the multiple and its
implied assumption of a coefficient of
variation (CV) equal to one lacked
empirical support or theoretical
justification. Farmer Mac askedthat the
implied underlying CV ratio be much
lower than one and that separate
multipliers, scaled by whole-letter
credit rating, be applied based on the
historical variability over time of each
whole-letter credit rating. Farmer Mac
based this request on Moody’s data on
the standard deviations for 10-year
cumulative default rates. Farmer Mac
recommends these data be used to
derive empirically based multiples of
GOA factors to represent stress on issuer
counterparties.
We disagree with the
recommendation as we believe it to be
based on a mistaken reliance on CVs of
average default rates within credit rating
categories over time, rather than crosssectional CVs of the individual issuer
defaults within each period.10 The longterm average rate of the annual average
default rate combined with the standard
deviation of those average default rates
do not convey a reasonable measure of
‘‘worst-case’’ default risk, but rather, as
identified in the Moody’s report, are
primarily related to sample size used in
construction of the estimated average
loss rates. We believe our approach
places the adjusted corporate bond loss
estimate in a range that provides a
meaningfully stressful representation,
given limited data, and reflects
generally accepted statistical principles
and relationships. We selected the
multiplier of three on the basis that it
was a reasonable policy position given
that the most accurate alternative to the
selected multiple using statistical theory
to establish the limits on probability
from the sample variance (i.e.,
Chebychev’s theorem as discussed in
10 In the proposed rule, we used a CV of one in
an example to demonstrate a point and not as a
factual premise of this rulemaking.
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the proposed rule) would have yielded
a proposed multiple many times higher
than three. We continue to believe that
use of the limit of probability
established through limited sample
information to require too extreme a
multiple, and instead maintain our more
moderate treatment through the use of
our proposed value of three.
We further disagree that one can
accurately infer individual variability
directly from the variance of a set of
pooled experiences (aggregate annual
default rates) through time. The primary
purpose of the cited report, as explained
by Moody’s in the report, appears
fundamentally different from its use in
the comment letter. Moody’s report
explicitly states its purpose is to present
confidence intervals around historical
average cumulative default rates and, as
warning against interpretation as a
cross-sectional variance, the report
indicates that standard errors around
estimated long-run average default rates
‘‘should not be confused with the much
greater bands of uncertainty associated
with the expected performance of
particular cohorts of issuers formed at
specific points in time (cross
section).’’ 11
We finalize this provision as
proposed.
WReier-Aviles on DSKGBLS3C1PROD with RULES
2. GOA Factors—Concentration Ratios
We proposed modifying GOA factors
to recognize the risk associated with a
counterparty’s (also referred to as the
AgVantage Plus issuer) loan portfolio
concentration in the industry sector
used in an AgVantage Plus issuance. We
also proposed modifying section
2.4.b.3.A. of Appendix A to allow the
Director of OSMO to make final
determinations of concentration ratios
on a case-by-case basis by using
publicly reported data on counterparty
portfolios, non-public data submitted
and certified by Farmer Mac as part of
its RBCST submissions, and generally
recognizing two rural utility sectors—
rural electric cooperatives and rural
telephone cooperatives.
Farmer Mac objected to the GOA
modifications because it believes the
change creates redundancy in two ways:
(1) The level of an issuer’s loan portfolio
concentration is already captured in the
NRSRO’s credit rating and therefore
already captured in the level of the base
GOA factor (prior to the proposed
concentration risk adjustment), and (2)
base GOA factors already capture stress
associated with ‘‘tail’’ events according
11 Cantor, R; Hamilton, D.; Tennant, J.
‘‘Confidence Intervals for Corporate Default Rates’’,
Moody’s Investor Services, Global Credit Research:
Special Comment, April 2007; p. 1–2.
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to the newly proposed stressed
corporate bond loss-rate multiple.
Farmer Mac suggests instead that the
new GOA factors be adjusted to reflect
a reduction in risk due to the level of
diversification of the issuer, not an
increase in risk due to the issuer’s
portfolio concentration.
Farmer Mac further commented that
the proposed methodology is vague and
might oversimplify industry
concentration. Farmer Mac asked that at
least two sub-sectors of rural electric
utilities be recognized in the
concentration adjustment: Distribution
cooperatives and generation and
transmission (G&T) cooperatives.
Farmer Mac explained that the
magnitude of the concentration riskadjusted GOA (CRAGOA) factors are
driven more by the concentration risk
adjustment than by the stressed
historical corporate bond default and
recovery rates (stressed GOA factors).
Farmer Mac states that this is
counterintuitive to the concept of the
GOA because it associates more of the
final effect of the CRAGOA adjustment
with the issuer’s portfolio structure than
is warranted. Farmer Mac illustrates this
point using the example of a sovereign
issuer without credit risk. In this
scenario, the CRAGOA factor would
equal the concentration ratio, due to the
mathematical relationship between the
stressed GOA (pre-concentration risk
adjustment) and the CRAGOA (i.e.,
1¥(1–GOA) (1-concentration ratio),
where GOA = 0)). If that concentration
ratio were one, then no risk-mitigation
would be recognized in the general
obligation of the sovereign issuer even
if the issuer were rated AAA. Farmer
Mac views this as placing an overly
heavy emphasis on the issuer’s portfolio
concentration.
Farmer Mac contends that our
approach is inherently deficient
because, in the example, the percentage
increase in the GOA factor after
adjustment for concentration risk is
much greater for the AAA issuer (1,800
percent) than it is for the BBB issuer
(300 percent), though the magnitudes of
change stated in percentage terms are
actually artifacts of the scale of
remaining credit risk within each
whole-letter rating category, as we
discuss in depth below. Farmer Mac
commented that the concentration risk
adjustment should, if it has any impact
at all, reduce risk rather than increase
risk. Farmer Mac suggested replacing
the mathematical relationship we had
proposed with a multiplicative
relationship—i.e., because the
concentration ratio will frequently be
less than one, that the stressed GOA
factor should be reduced for any level
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23463
of issuer portfolio diversification, rather
than increased for any level of portfolio
concentration. Farmer Mac suggests the
following formula: CRAGOA = stressed
GOA * CR.
We appreciate Farmer Mac’s concern
that the two sub-sectors of rural electric
utilities be recognized. However, we
believe the rule provides for recognition
of those sub-sectors and others on a
case-by-case basis. We recognize Farmer
Mac’s authority to finance four industry
sectors: Agriculture (including farms
and agribusiness), rural electric
distribution cooperatives, rural electric
G&T cooperatives, and rural telephone
cooperatives. The modifications to
section 2.4.b.3.A. of Appendix A will
allow the Director of OSMO (Director) to
make final determinations of
concentration ratios, including
recognizing two rural utility sectors—
rural electric cooperatives and rural
telephone cooperatives. However, we
disagree that the GOA factors contain
redundancy. While NRSRO’s may
consider the extent of diversification of
assets generally in their credit ratings,
they do not do so in a worst-case
context. Nor would the NRSRO’s
consideration of diversification always
specifically include the impact of the
issuer’s relative exposure to industry
sectors that Farmer Mac is authorized to
finance. Agriculture and rural utility
cooperative exposures are often
combined with other sector exposures
in publicly reported documents—
including sectors that Farmer Mac is not
authorized to finance. While it’s
possible that an NRSRO might require
the issuer to disaggregate that
information, its rating determination
would not specifically focus on the
degree of exposure to the Farmer Macauthorized sectors. Hence, credit ratings
do not provide the level of granularity
of information needed. Nor does an
NRSRO rating necessarily consider the
issuer’s exposure to the specific
industry sector involved in the specific
AgVantage Plus pool being modeled as
this approach does. We do not believe
that consideration of these specific risk
components to the modeling of
AgVantage Plus volume is sufficiently
reflected in credit ratings to use them as
suggested. For example, an NRSRO
rating on a 100-percent concentrated
issuer (e.g., a single-sector lender) says
little or nothing about its ability to
guarantee the credit on loan volume that
it would pledge to Farmer Mac. In a
worst-case loss scenario in that single
sector, the issuer’s ability to liquidate its
unpledged assets to fulfill its general
obligation to Farmer Mac at a price near
the outstanding principal would be
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severely reduced. This rule effectively
evaluates the degree of that reduced
ability at 100 percent. In other words,
we do not believe it to be plausible that
an issuer whose unpledged assets are
experiencing worst-case losses would be
able to continue as a going concern if it
were forced to liquidate a significant
volume of those unpledged, but highly
impaired assets in order to fulfill its
general obligation to Farmer Mac.
Farmer Mac asked that we define the
sectors but did not suggest any
definition with the request. We decline
to do so because we believe the general
understanding of what these sectors
include is sufficient for setting a
parameter but flexible enough to allow
the Director to use his discretion in a
manner appropriate to each case
presented. In addition, we do not view
the fact that the concentration risk
adjustment has a significant impact on
the CRAGOA as counterintuitive. We
believe it is logically consistent to view
the concentration ratio as potentially a
more significant driver of the value of
the issuer’s general obligation than the
estimated corporate bond loss rate. We
view the concentration risk adjustment
as a critical component of the CRAGOA
because it reflects the ability of the
specific counterparty to augment the
more generalized component derived
from stressed corporate bond default
rates by whole-letter credit rating.
Farmer Mac’s comment included an
example of a sovereign (credit-risk-free)
issuer and AgVantage Plus counterparty.
We believe this example is too extreme
to be applicable even for illustrative
purposes. As a risk-free issuer, the
hypothetical sovereign issuer in the
example would be guaranteeing the
credit risk on the subject loan volume,
thus making the transaction more akin
to the Farmer Mac II program than to the
AgVantage Plus product.12 The RBCST
already contains an approach on this
type of transaction, i.e., it does not
recognize credit risk and therefore
would it not be appropriate to model
this volume using the treatment for
AgVantage Plus. Such transactions
would result in a gross loss estimate of
zero to which the CRAGOA (equal to the
concentration ratio as previously
discussed) would be applied for a net
loss estimate of zero. However, to the
more general point outside of this
extreme case, i.e., a single-sector AAA
issuer, we believe it reasonably and
logically consistent for the single sector
characteristic to weigh most heavily in
A
the CRAGOA. The discussion and tables
below further describe these
relationships.
Farmer Mac argued that our approach
is inherently deficient due to the fact
that the CRAGOA factor increases
(relative to the stressed GOA) so much
more for the AAA issuer (18 times) than
it does for the BBB issuer (three times).
We disagree and use the following
tables to illustrate the ultimate effects of
the CRA across a set of cases that we
believe provide a more meaningful
context for interpretation of the effects
of its application.
The table is organized in three panels
across base Pre-GOA probability of
default rates (PD) of 1, 3, and 6 percent
(i.e., examples of loss rates as would be
determined by the RBCST credit loss
module or from the rural utility
guarantee fee). The stressed GOA (GOA
Pre-CRA) is applied to each case and a
pre-concentration risk adjusted loss rate
provided in column D (Pre-CRA loss
rate). The first table assumes a 25percent concentration ratio (CR) and
provides associated final loss rates in
column F after the CRA. Column G
reproduces the multiples of change
cited by Farmer Mac in its comment.
B
C
D
E
F
G
Pre-GOA
PD
(percent)
GOA
Pre-CRA
(percent)
Pre-CRA
loss rate
(percent)
CR
(percent)
Loss rate
postCRAGOA
(percent)
= F/D
1
1
1
1
1
1.41
3.70
5.13
11.48
44.52
0.0141
0.0370
0.0513
0.1148
0.4452
25
25
25
25
25
0.261
0.278
0.288
0.336
0.584
18.48
7.51
5.62
2.93
1.31
AAA ..................................................................................
AA ....................................................................................
A .......................................................................................
BBB ..................................................................................
< BBB ...............................................................................
3
3
3
3
3
1.41
3.70
5.13
11.48
44.52
0.0423
0.1110
0.1539
0.3444
1.3356
25
25
25
25
25
0.782
0.833
0.865
1.008
1.752
18.48
7.51
5.62
2.93
1.31
AAA ..................................................................................
AA ....................................................................................
A .......................................................................................
BBB ..................................................................................
< BBB ...............................................................................
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AAA ..................................................................................
AA ....................................................................................
A .......................................................................................
BBB ..................................................................................
< BBB ...............................................................................
6
6
6
6
6
1.41
3.70
5.13
11.48
44.52
0.0846
0.2220
0.3078
0.6888
2.6712
25
25
25
25
25
1.563
1.667
1.731
2.017
3.503
18.48
7.51
5.62
2.93
1.31
As the table indicates, assuming a
counterparty concentration ratio of 25
percent and a loss rate estimate of 1
percent before any adjustment for
general obligation credit enhancement,
the proportional changes are as
provided in Farmer Mac’s comment
letter—the AAA issuer’s post-CRAGOA
loss rate increases by a factor of 18.48,
whereas the BBB issuer’s loss rate
increases only 2.93 times after
considering the concentration risk. We
consider the increase differential
consistent with the logic that when a
structure is backed by a high-quality
issuer’s general obligation, there is
effectively more risk-mitigation value to
lose if that issuer happens to be highly
concentrated in the same sector as the
underlying loans and the magnitude of
that loss is appropriate and
proportionate to the concentration risk
at the issuer. Despite this difference in
CRA impact, the loss rate post-CRAGOA
for a AAA issuer is still less than half
the stressed loss rate applied to a BBB
issuer, and this relationship is not
12 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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affected by the level of the pre-GOA PD
(i.e., the 3-percent and 6-percent PreGOA PD scenarios reflect the same
magnitude of change post-CRAGOA).
When there is little credit risk, there is
less risk to mitigate with the GOA.
However, in the ‘‘below-BBB and
unrated’’ cases, the magnitude of the
reduction in credit risk is far greater
than in the case of the higher rated
initial exposures. For example, observe
the last two rows in column C with
11.48-percent and 44.52-percent ‘‘GOA
Pre-CRA’’ factors. Prior to the CRA, the
stressed GOA would have reduced
initial PD losses by 88.52 percent (1–
0.1148) and 55.48 percent (1–0.4452),
respectively. The magnitude of
difference among these changes to the
initial PD is reduced by the application
of the CRA, which is the same for each
of them. The percentage reduction in
the initial PD post-CRA is 73.94 percent
(down 24.65 percentage points) in the
AAA case, 66.39 percent (down 22.13
percentage points) and 41.61 percent
(down 13.67 percentage points) in the
‘‘BBB’’ and ‘‘< BBB’’ cases, respectively—
down 25 percent from the Pre-CRA PD
risk mitigation levels. We consider this
result consistent with reasonable
depictions of final credit exposure
relationships.
The next table provides comparable
information, but with a concentration
ratio of 50 percent rather than 25
A
23465
percent. As can be seen in the table, a
consistent and appropriate
proportionality remains as the multiples
of change become much larger due to
increases in the concentration ratio—
that is, the loss rate post-CRA GOA for
a AAA issuer is still less than the
stressed loss rate applied to a BBB
issuer, though by increasingly smaller
margins as concentration ratios rise.
This is logical and intentional because
as the concentration ratio approaches
one, risk-mitigation value of the
CRAGOA approaches zero for all
categories of issuer leaving Pre-GOA
PDs unadjusted for the general
obligation of the issuer.
B
C
D
E
F
G
Pre-GOA
PD
(percent)
GOA
Pre-CRA
(percent)
Pre-CRA
loss rate
(percent)
CR
(percent)
Loss Rate
post-CRA
GOA
(percent)
= F/D
1
1
1
1
1
1.41
3.70
5.13
11.48
44.52
0.0141
0.0370
0.0513
0.1148
0.4452
50
50
50
50
50
0.507
0.519
0.526
0.557
0.723
35.96
14.01
10.25
4.86
1.62
AAA ..................................................................................
AA ....................................................................................
A .......................................................................................
BBB ..................................................................................
< BBB ...............................................................................
3
3
3
3
3
1.41
3.70
5.13
11.48
44.52
0.0423
0.1110
0.1539
0.3444
1.3356
50
50
50
50
50
1.521
1.556
1.577
1.672
2.168
35.96
14.01
10.25
4.86
1.62
AAA ..................................................................................
AA ....................................................................................
A .......................................................................................
BBB ..................................................................................
< BBB ...............................................................................
WReier-Aviles on DSKGBLS3C1PROD with RULES
AAA ..................................................................................
AA ....................................................................................
A .......................................................................................
BBB ..................................................................................
< BBB ...............................................................................
6
6
6
6
6
1.41
3.70
5.13
11.48
44.52
0.0846
0.2220
0.3078
0.6888
2.6712
50
50
50
50
50
0.030
3.111
3.154
3.344
4.336
35.96
14.01
10.25
4.86
1.62
Finally, Farmer Mac suggested using
the formula: CRAGOA = stressed GOA
* CR to recognize increased risk
associated with counterparty
concentrations. As we previously
explained, we intend to recognize the
increased risk associated with
counterparty concentrations and do not
consider Farmer Mac’s suggestion to
adequately factor the impact of
increased concentration on effective
credit exposure. The concentration risk
adjustment is a critical component of
the CRAGOA because it tightens the
focus on this key risk characteristic of
the specific counterparty to complement
the more generalized component
derived from stressed corporate bond
default rates by whole-letter credit
rating—which, we do not believe
adequately captures this information.
We finalize as proposed all changes
on this subject matter but revise our
stated interpretation of the proposed
methodology as it is applied to rural
electric utility cooperative issuers to
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recognize two sectors, electric
distribution cooperatives and electric
generation and transmission
cooperatives.
3. Technical Changes
We proposed amending § 652.50 by
adding a definition for ‘‘AgVantage Plus’’
to clarify that, while ‘‘AgVantage Plus’’
is a product name used by Farmer Mac,
we are applying it throughout this
subpart to refer both specifically to
AgVantage Plus volume currently in
Farmer Mac’s portfolio as well as other
similarly structured program volume
that Farmer Mac might finance in the
future under other names. We described
‘‘AgVantage Plus’’ as a program created
by Farmer Mac in 2006 to provide
guarantees on timely repayment of
principal and interest on notes issued
by the counterparty. The notes are
secured by obligations of issuer, which
obligations are, in turn, backed by
Farmer Mac eligible loan assets. We also
proposed conforming changes to the
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model at Appendix A of part 652 to
replace the term ‘‘Off-Balance Sheet
AgVantage’’ with ‘‘AgVantage Plus.’’
Farmer Mac suggested we reduce the
complexity in the rule by referring to all
AgVantage products by the term
‘‘AgVantage Plus,’’ but exclude pools
with an initial principal amount under
$25 million. We agree and have revised
that definition to include any
AgVantage program investment over $25
million to avoid unnecessary
complexity on small deals. Only those
AgVantage issuers under the original
AgVantage program structure (as
opposed to what we have been referring
to as ‘‘AgVantage Plus’’) identified in the
original RBCST, (64 FR 61740,
November 12, 1999) will be excluded
from the RBCST loss calculation.
In January 2010, Farmer Mac adopted
new Financial Accounting Standards
Board guidance related to the
consolidation of variable interest
entities (Accounting Standards Update,
December 23, 2009). The adoption
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required consolidation of a significant
volume of previously off-balance sheet
program volume onto the balance sheet.
As this change impacts only the
presentation of this volume and has no
impact on the risk or cashflows
associated with this volume, we have
made minor mechanical adjustments in
data inputs to nullify the impact of the
adoption within the RBCST. These
include creating a new asset line item
for the affected consolidated volume
and an offsetting line item in the
liabilities section.
We finalize as proposed all other
changes on this subject matter.
C. Revise Haircuts on Non-Program
Investments
[Appendix A to Part 652]
We proposed changing the haircut
levels for non-program investments in
existing section 4.1.e. of Appendix A,
renumbering the section as 4.1.f., to the
same loss rate adjustment factors
proposed for application on loans
underlying guaranteed notes (i.e.,
AgVantage Plus) as discussed in section
III.B.1 of this preamble. The proposed
investment haircuts to recognize
counterparty risk were:
Whole letter credit rating
AAA .............................................
AA ...............................................
A .................................................
BBB .............................................
Below BBB and Unrated ............
rulemaking mistakenly used paragraph
(b) instead of (c), and Congress later
renumbered paragraph (c)(13) as
1.41 (c)(14).13 Both rulemakings clearly
3.70
5.13 discuss the contents of section 8.3(c)(14)
11.48 of the Act, so we are correcting the
44.52 citations now.
Haircut
(percent)
We likewise proposed annually
updating these figures, or as often as an
updated version of the Moody’s report
on Default and Recovery Rates of
Corporate Bond Issuers becomes
available.
We received no comments on this
proposal and finalize as proposed all
changes on this subject matter.
D. Other Miscellaneous Changes
[§§ 651.1(b) and 652.5]
In the process of this rulemaking, we
noted citations that were not updated in
prior rulemakings and make those
corrections now. In a 1994 rulemaking,
a definition for ‘‘affiliate’’ was added to
§ 651.1(b). This definition was later
duplicated in § 652.5 as part of a 2005
rulemaking. The definition in both
locations references section 8.3(b)(13) of
the Act; this citation should read
‘‘section 8.3(c)(14).’’ The original
IV. Quantitative Impact of Changes on
Required Capital
We received one comment from a
Farm Credit System institution that
understood the proposed rule to reflect
only incremental capital requirements
on rural utility loan volume. We are
clarifying that the substantive changes
to the RBCST contained in this final
rulemaking involve more components of
the model than simply the incremental
capital requirements on rural utility
volume, including changes to GOA
factors applied to all AgVantage Plustype volume and changes to investment
haircuts. Due to the stated confusion by
Farmer Mac regarding our intended
meaning of ‘‘rural utility guarantee fee’’
(see Farmer Mac’s request for
definitional clarification above), we are
providing further clarification in the
estimated impacts table below:
CALCULATED REGULATORY MINIMUM CAPITAL
[$ in thousands]
6/30/2010
WReier-Aviles on DSKGBLS3C1PROD with RULES
0
1
2
3
4
All
RBCST Version 3.0 ................................................................................................................
Revised Haircuts on Investments ..........................................................................................
Tripling of Version 3.0 GOA Factors .....................................................................................
Credit Risk on Rural Utility Loans ..........................................................................................
Concentration Risk Adjustment with Rural Utility Credit Risk ...............................................
RBCST Version 4.0 Effects ....................................................................................................
30,434
30,739
30,525
32,564
79,924
82,270
9/30/2010
36,743
37,053
36,969
37,694
92,844
94,966
12/31/2010
42,105
42,358
42,816
79,997
123,304
125,498
The impact amounts on line ‘‘1’’
reflect only the change associated with
the revised haircuts on non-program
investments. The impact amounts on
line ‘‘2’’ reflect only the change
associated with the tripling of general
obligation adjustment factors with all
else equal in the RBC Version 3.0 (i.e.,
it does not reflect rural utility credit-loss
characterization). The impact amounts
on line ‘‘3’’ reflect only the change
associated with the credit loss
characterization on rural utility volume
(i.e., it does not reflect the application
of the tripling GOA factors to rural
utility AgVantage Plus volume or
agricultural AgVantage Plus volume).
The impact amounts on line ‘‘4’’ reflect
the concentration adjustment to the
general obligation adjustment factor on
all AgVantage Plus volume, both rural
utility and agricultural, (i.e., it does not
reflect the application of the tripling
GOA factors to rural utility or
agricultural AgVantage Plus volume, but
it does include the rural utility loss
estimates isolated in line ‘‘3’’). The
individual estimated impacts do not
have an additive relationship to the total
impact on the model output. This is due
to the interrelationship of the changes
with one another when they are
combined in Version 4.0 (proposed). It
is worth noting that the marginal effects
are also not constant rate effects, but
depend on the starting conditions and
earnings spread of Farmer Mac and the
magnitude of the effect considered. For
example, as the volume in the rural
utility category is increased, the rate of
increase in the marginal minimum riskbased capital requirement begins to
increase as the downward-pressure on
that rate exerted by earnings from other
activities are further diluted as those
earnings become increasingly smaller in
proportion to total estimated losses. The
same effect is evident in other ways as
risk increases and the offsetting effect of
earnings is diminished relative to
increased risk. For example, this effect
would be observed, all else equal, with
lower initial earnings spreads or higher
AgVantage Plus counterparty
concentrations, updated (and higher)
Moody’s base corporate bond default
rates, or ratings downgrades. Thus, the
13 Section 8.3 is found at 12 U.S.C. 2279aa–3 and
discusses the powers of Farmer Mac and its board.
Amendments to the Act made in the Food,
Agriculture, Conservation, and Trade Act
Amendments of 1991 [Pub. L. 102–237] gave
Farmer Mac the authority to establish, acquire, and
maintain affiliates under applicable state law. This
1991 amendment led to the inclusion of the term
in § 651.1. Subsequently, a 1996 amendment to the
Act [Pub. L. 104–105] redesignated paragraph
(c)(13) as (c)(14).
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values in the table above are illustrative
of the relative effects of the revisions in
this rulemaking, given the conditions as
of each quarter end, but can be
materially affected by changes in
starting conditions or risk compositions
through time. Moreover, due to the
substitutability allowed within certain
loan pools and ability of AgVantage
counterparties to vary the level of
overcollateral submitted in each quarter
of a pool’s life, the risk characteristics
of an individual pool are subject to
change quarter to quarter.
Our tests indicate that changes related
to credit losses on rural utility loans
combined with the concentration risk
adjustment to the GOA would have the
most significant impact on risk-based
capital calculated by the model.
PART 652—FEDERAL AGRICULTURAL
MORTGAGE CORPORATION FUNDING
AND FISCAL AFFAIRS
3. The authority citation for part 652
continues to read as follows:
■
Authority: Secs. 4.12, 5.9, 5.17, 8.11, 8.31,
8.32, 8.33, 8.34, 8.35, 8.36, 8.37, 8.41 of the
Farm Credit Act (12 U.S.C. 2183, 2243, 2252,
2279aa–11, 2279bb, 2279bb–1, 2279bb–2,
2279bb–3, 2279bb–4, 2279bb–5, 2279bb–6,
2279cc); sec. 514 of Pub. L. 102–552, 106
Stat. 4102; sec. 118 of Pub. L. 104–105, 110
Stat. 168.
Subpart A—Investment Management
4. Section 652.5 is amended by
revising the definition for ‘‘affiliate’’ to
read as follows:
■
§ 652.5
V. Regulatory Flexibility Act
Pursuant to section 605(b) of the
Regulatory Flexibility Act (5 U.S.C. 601
et seq.), FCA hereby certifies the final
rule will not have a significant
economic impact on a substantial
number of small entities. Farmer Mac
has assets and annual income over the
amounts that would qualify it as a small
entity. Therefore, Farmer Mac is not
considered a ‘‘small entity’’ as defined in
the Regulatory Flexibility Act.
*
*
*
*
Affiliate means any entity established
under authority granted to the
Corporation under section 8.3(c)(14) of
the Farm Credit Act of 1971, as
amended.
*
*
*
*
*
Subpart B—Risk-Based Capital
Requirements
5. Amend § 652.50 by adding
alphabetically the following definitions:
■
List of Subjects
§ 652.50
12 CFR Part 651
*
Agriculture, Banks, Banking, Conflicts
of interest, Rural areas.
12 CFR Part 652
Agriculture, Banks, Banking, Capital,
Investments, Rural areas.
For the reasons stated in the
preamble, parts 651 and 652 of chapter
VI, title 12 of the Code of Federal
regulations are amended to read as
follows:
PART 651—FEDERAL AGRICULTURAL
MORTGAGE CORPORATION
GOVERNANCE
1. The authority citation for part 651
continues to read as follows:
■
WReier-Aviles on DSKGBLS3C1PROD with RULES
Definitions.
*
Authority: Secs. 4.12, 5.9, 5.17, 8.11, 8.31,
8.32, 8.33, 8.34, 8.35, 8.36, 8.37, 8.41 of the
Farm Credit Act (12 U.S.C. 2183, 2243, 2252,
2279aa–11, 2279bb, 2279bb–1, 2279bb–2,
2279bb–3, 2279bb–4, 2279bb–5, 2279bb–6,
2279cc); sec. 514 of Pub. L. 102–552, 106
Stat. 4102; sec. 118 of Pub. L. 104–105, 110
Stat. 168.
§ 651.1
[Amended]
2. Amend § 651.1(b) by removing the
reference, ‘‘section 8.3(b)(13)’’ and
adding in its place the reference,
‘‘section 8.3(c)(14)’’.
■
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Definitions.
*
*
*
*
AgVantage Plus means both the
product by that name used by Farmer
Mac and other similarly structured
program volume that Farmer Mac might
finance in the future under other names.
Those AgVantage securities with initial
principal amounts under $25 million
and whose issuers were part of the
original AgVantage program are
excluded from this definition.
*
*
*
*
*
Rural utility guarantee fee means the
actual guarantee fee charged for offbalance sheet volume and the earnings
spread over Farmer Mac’s funding costs
for on-balance sheet volume on rural
utility loans.
■ 6. Amend § 652.65 by:
■ a. Redesignating paragraphs (b)(5) and
(6) as paragraphs (b)(6) and (7);
■ b. Adding a new paragraph (b)(5);
■ c. Revising newly redesignated
paragraph (b)(6) and paragraph (d)(2) to
read as follows:
§ 652.65
Risk-based capital stress test.
*
*
*
*
*
(b) * * *
(5) You will calculate loss rates on
rural utility loans as further described in
Appendix A.
(6) You will further adjust losses for
loans that collateralize the general
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23467
obligation of AgVantage Plus volume,
and for loans where the program loan
counterparty retains a subordinated
interest in accordance with Appendix A
to this subpart.
*
*
*
*
*
(d) * * *
(2) You must use model assumptions
to generate financial statements over the
10-year stress period. The major
assumption is that cashflows generated
by the risk-based capital stress test are
based on a steady-state scenario. To
implement a steady-state scenario, when
on- and off-balance sheet assets and
liabilities amortize or are paid down,
you must replace them with similar
assets and liabilities (AgVantage Plus
volume is not replaced when it
matures). Replace amortized assets from
discontinued loan programs with
current loan programs. In general, keep
assets with small balances in constant
proportions to key program assets.
*
*
*
*
*
■ 7. Amend Appendix A of subpart B,
part 652 by:
■ a. Revising the table of contents;
■ b. Revising the last sentence of section
1.0.a.;
■ c. Adding a new fourth sentence to
section 2.0;
■ d. Adding the words ‘‘for All Types of
Loans, Except Rural Utility Loans’’ at the
end of each heading for sections 2.1, 2.2,
2.3, and 2.5;
■ e. Revising section 2.4.b.3
introductory text, b.3.A., and b.4
introductory text;
■ f. Adding a new section 2.6;
■ g. Renumbering the footnote in
section 3.0 from ‘‘15’’ to ‘‘16’’;
■ h. Revising section 4.1.b.,
redesignating section 4.1.e. as section
4.1.f., adding a new section 4.1.e., and
revising newly redesignated section
4.1.f.;
■ i. Revising section 4.2.b. introductory
text, paragraphs b.(1)(A)(v), b.(1)(A)(vi),
adding paragraph b.(1)(A)(vii), revising
the last sentence of paragraph b.(1)(B),
the first sentence of paragraph b.(2), and
the last sentence of paragraph b.(3)
introductory text;
■ j. Adding section 4.3.e.; and,
■ k. Revising the second sentence of
section 4.4.
The revisions and additions read as
follows:
Appendix A—Subpart B of Part 652—
Risk-Based Capital Stress Test
1.0
2.0
2.1
Introduction.
Credit Risk.
Loss-Frequency and Loss-Severity
Models for All Types of Loans, Except
Rural Utility Loans.
2.2 Loan-Seasoning Adjustment for All
Types of Loans, Except Rural Utility
Loans.
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2.3
2.4
2.5
2.6
3.0
3.1
4.0
4.1
4.2
4.3
4.4
4.5
4.6
4.7
5.0
5.1
*
Federal Register / Vol. 76, No. 81 / Wednesday, April 27, 2011 / Rules and Regulations
Example Calculation of Dollar Loss on
One Loan for All Types of Loans, Except
Rural Utility Loans.
Treatment of Loans Backed by an
Obligation of the Counterparty and
Loans for Which Pledged Loan Collateral
Volume Exceeds Farmer Mac-Guaranteed
Volume.
Calculation of Loss Rates for Use in the
Stress Test for All Types of Loans,
Except Rural Utility Loans.
Calculation of Loss Rates on Rural
Utility Volume for Use in the Stress Test.
Interest Rate Risk.
Process for Calculating the Interest Rate
Movement.
Elements Used in Generating Cashflows.
Data Inputs.
Assumptions and Relationships.
Risk Measures.
Loan and Cashflow Accounts.
Income Statements.
Balance Sheets.
Capital.
Capital Calculations.
Method of Calculation.
*
*
*
*
1.0
example, multiply the estimated dollar losses
remaining after adjustments in ‘‘1.’’ and ‘‘2.’’
above by the appropriate general obligation
adjustment (GOA) factor based on the
counterparty’s whole-letter issuer credit
rating by a nationally recognized statistical
rating organization (NRSRO) and the ratio of
the counterparty’s concentration of risk in
the same industry sector as the loans backing
the AgVantage Plus volume, as determined
by the Director.
A. The Director will make final
determinations of concentration ratios on a
case-by-case basis by using publicly reported
data on counterparty portfolios, non-public
data submitted and certified by Farmer Mac
as part of its RBCST submissions, and will
generally recognize rural electric
cooperatives and rural telephone
cooperatives as separate rural utility sectors.
The following table sets forth the GOA
factors and their components by whole-letter
credit rating (Adjustment Factor = Default
Rate × Severity Rate × 3), which may be
further adjusted for industry sector
concentration by the Director.15
Introduction
a. * * * The stress test also uses historic
agricultural real estate mortgage performance
data, rural utility guarantee fees, relevant
economic variables, and other inputs in its
calculations of Farmer Mac’s capital needs
over a 10-year period.
*
*
2.0
*
*
*
Credit Risk
* * * Loss rates discussed in this section
apply to all loans, unless otherwise
indicated. * * *
*
*
*
*
*
2.4 Treatment of Loans Backed by an
Obligation of the Counterparty, and Loans for
Which Pledged Loan Collateral Volume
Exceeds Farmer Mac-Guaranteed Volume
*
*
*
*
*
b. * * *
3. Loans with a positive loss estimate
remaining after adjustments in ‘‘1.’’ and ‘‘2.’’
above are further adjusted for the security
provided by the general obligation of the
counterparty. To make this adjustment in our
A
B
C
D
E
F
G
Whole-letter
rating
Default rate
(percent)
Severity rate
(percent)
V3.0 GOA factor
(percent)
V4.0 GOA
factors (D × 3)
(percent)
Concentration
ratio (e.g., 25%)
(percent)
Factor with
concentration
adjustment 1¥
((1¥E) × (1¥F))
(percent)
25.00
25.00
25.00
25.00
25.00
26.06
27.78
28.84
33.61
58.39
AAA ..................................
AA ....................................
A .......................................
BBB ..................................
Below BBB and Unrated ..
*
*
*
*
0.897
2.294
2.901
7.061
26.827
*
4. Continuing the previous example, the
pool contains two loans on which Farmer
Mac is guaranteeing a total of $2 million and
with total submitted collateral of 110 percent
of the guaranteed amount. Of the 10-percent
54
54
54
54
54
0.48
1.24
1.57
3.82
14.50
total overcollateral, 5 percent is contractually
required under the terms of the transaction.
The pool consists of two loans of slightly
over $1 million. Total overcollateral is
$200,000 of which $100,000 is contractually
required. The counterparty has a single ‘‘A’’
1.41
3.70
5.13
11.48
44.52
credit rating, a 25-percent concentration
ratio, and after adjusting for contractually
required overcollateral, estimated losses are
greater than zero. The net loss rate is
calculated as described in the steps in the
table below.
Loan A
1
Guaranteed Volume ...................................................................................................................................................
2
3
4
5
6
Origination Balance of 2-Loan Portfolio .....................................................................................................................
Age-Adjusted Loss Rate ............................................................................................................................................
Estimated Age-Adjusted Losses ................................................................................................................................
Guarantee Volume Scaling Factor .............................................................................................................................
Losses Adjusted for Total Overcollateral ...................................................................................................................
WReier-Aviles on DSKGBLS3C1PROD with RULES
7 Contractually Required Overcollateral on Pool (5%) .................................................................................................
8 Net Losses on Pool Adjusted for Contractually Required Overcollateral ..................................................................
9 GOA Factor for ‘‘A’’ Issuer with 25% Concentration Ratio ........................................................................................
10 Losses Adjusted for ‘‘A’’ General Obligation ...........................................................................................................
11 Loss Rate Input in the RBCST for this Pool ............................................................................................................
Loan B
$2,000,000
$1,080,000
7%
$75,600
90.91%
$68,727
$1,120,000
5%
$56,000
90.91%
$50,909
$100,000
$19,636
28.84%
$5,664
0.28%
You must submit the outstanding
principal, maturity date of the loan, maturity
*
*
*
*
15 Emery, K., Ou S., Tennant, J., Kim F., Cantor
R., ‘‘Corporate Default and Recovery Rates, 1920—
2007,’’ published by Moody’s Investors Service,
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date of the AgVantage Plus contract (if
applicable), and the rural utility guarantee
fee percentage for each loan in Farmer Mac’s
rural utility loan portfolio on the date at
February 2008—the most recent edition as of March
2008; Default Rates, page 24, Recovery Rates
(Severity Rate = 1 minus Senior Unsecured Average
Recovery Rate) page 20.
2.6 Calculation of Loss Rates on Rural
Utility Volume for-Use in the Stress Test
*
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which the stress test is conducted. You must
multiply the rural utility guarantee fee by
two to calculate the loss rate on rural utility
loans under stressful economic conditions
and then multiply the loss rate by the total
outstanding principal. To arrive at the net
rural utility loan losses, you must next apply
the steps ‘‘5’’ through ‘‘11’’ of section 2.4.b.4
of this Appendix. For loans under an
AgVantage Plus-type structure, the calculated
losses are distributed over time on a straightline basis. For loans that are not part of an
AgVantage Plus-type structure, losses are
distributed over the 10-year modeling
horizon, consistent with other nonAgVantage Plus loan volume.
*
*
4.1
*
*
*
*
*
*
Data Inputs
*
*
b. Cashflow Data for Asset and Liability
Account Categories. The necessary cashflow
data for the spreadsheet-based stress test are
book value, weighted average yield, weighted
average maturity, conditional prepayment
rate, weighted average amortization, and
weighted average guarantee fees and rural
utility guarantee fees. The spreadsheet uses
this cashflow information to generate starting
and ending account balances, interest
earnings, guarantee fees, rural utility
guarantee fees, and interest expense. Each
asset and liability account category identified
in this data requirement is discussed in
section 4.2 ‘‘Assumptions and Relationships.’’
*
*
*
*
*
e. Loan-Level Data for All Rural Utility
Program Volume. The stress test requires
loan-level data for all rural utility program
volume. The specific loan data fields
required for calculating the credit risk are
outstanding principal, maturity date of the
loan, maturity date of the AgVantage Plus
contract (if applicable), and the rural utility
guarantee fee percentage for each loan in
Farmer Mac’s rural utility loan portfolio on
the date at which the stress test is conducted.
23469
f. Weighted Haircuts for Non-Program
Investments. For non-program investments,
the stress test adjusts the weighted average
yield data referenced in section 4.1.b. to
reflect counterparty risk. Non-program
investments are defined in § 652.5. The
Corporation must calculate the haircut to be
applied to each investment based on the
lowest whole-letter credit rating the
investment received from an NRSRO using
the haircut levels in effect at the time.
Haircut levels shall be the same amounts
calculated for the GOA factor in section
2.4.b.3 above. The first table provides the
mappings of NRSRO ratings to whole-letter
ratings for purposes of applying haircuts.
Any ‘‘+’’ or ‘‘¥’’ signs appended to NRSRO
ratings that are not shown in the table should
be ignored for purposes of mapping NRSRO
ratings to FCA whole-letter ratings. The
second table provides the haircut levels by
whole-letter rating category.
FCA WHOLE-LETTER CREDIT RATINGS MAPPED TO RATING AGENCY CREDIT RATINGS
FCA Ratings Category .........
Standard & Poor’s LongTerm.
Fitch Long-Term ..................
Standard & Poor’s ShortTerm.
Fitch Short-Term ..................
Moody’s ................................
AAA .............................
AAA .............................
AA ...............................
AA ...............................
A ..................................
A ..................................
BBB .............................
BBB .............................
Below BBB and Unrated.
Below BBB and Unrated.
AAA .............................
A–1+ ............................
SP–1+ .........................
F–1+ ............................
.....................................
A ..................................
A–2 ..............................
SP–2 ...........................
F–2 ..............................
Prime-2 MIG2 VMIG2
BBB .............................
A–3 ..............................
F–3 ..............................
Prime-3 MIG3 VMIG3
Below BBB and Unrated.
SP–3, B, or Below and
Unrated.
Below F–3 and Unrated.
Not Prime, SG and Unrated.
Fitch Bank Ratings ..............
A ..................................
Moody’s Bank Financial
Strength Rating.
A ..................................
AA ...............................
A–1 ..............................
SP–1 ...........................
F–1 ..............................
Prime-MIG12 ...............
VMIg1 ..........................
B ..................................
A/B ..............................
B ..................................
C .................................
B/C ..............................
C .................................
D .................................
C/D ..............................
D .................................
E.
D/E.
E.
FARMER MAC RBCST MAXIMUM
HAIRCUT BY RATINGS CLASSIFICATION
Non-program
investment
counterparties
(excluding
derivatives)
(percent)
Ratings classification
Cash .................................
AAA ...................................
AA .....................................
A .......................................
BBB ...................................
Below BBB or Unrated .....
*
4.2
WReier-Aviles on DSKGBLS3C1PROD with RULES
*
*
*
*
0.00
1.41
3.70
5.13
11.48
44.52
*
Assumptions and Relationships
*
*
*
*
b. From the data and assumptions, the
stress test computes pro forma financial
statements for 10 years. The stress test must
be run as a ‘‘steady state’’ with regard to
program balances (with the exception of
AgVantage Plus volume, in which case
maturities are recognized by the model), and
where possible, will use information gleaned
from recent financial statements and other
data supplied by Farmer Mac to establish
earnings and cost relationships on major
program assets that are applied forward in
time. As documented in the stress test,
entries of ‘‘1’’ imply no growth and/or no
change in account balances or proportions
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relative to initial conditions with the
exception of pre-1996 loan volume being
transferred to post-1996 loan volume. The
interest rate risk and credit loss components
are applied to the stress test through time.
The individual sections of that worksheet
are:
(1) * * *
(A) * * *
(v) Loans held for securitization;
(vi) Farmer Mac II program assets; and
(vii) Rural Utility program volume on
balance sheet.
(B) * * * The exceptions are that expiring
pre-1996 Act program assets are replaced
with post-1996 Act program assets and
AgVantage Plus volume maturities are
recognized by the model.
(2) Elements related to other balance sheet
assumptions through time. As well as interest
earning assets, the other categories of the
balance sheet that are modeled through time
include interest receivable, guarantee fees
receivable, rural utility guarantee fees
receivable, prepaid expenses, accrued
interest payable, accounts payable, accrued
expenses, reserves for losses (loans held and
guaranteed securities), and other off-balance
sheet obligations. * * *
(3) Elements related to income and
expense-assumptions. * * * These
parameters are the gain on agricultural
mortgage-backed securities (AMBS) sales,
miscellaneous income, operating expenses,
reserve requirement, guarantee fees, rural
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utility guarantee fees, and loan loss
resolution timing.
*
4.3
*
*
*
*
*
Risk Measures
*
*
*
*
e. The credit loss exposure on rural utility
volume, described in section 2.6,
‘‘Calculation of Loss Rates on Rural Utility
Volume for Use in the Stress Test,’’ is entered
into the ‘‘Risk Measures’’ worksheet applied
to the volume balance. All losses arising from
rural utility loans are expressed as annual
loss rates and distributed over the weighted
average maturity of the rural utility
AgVantage Plus Volume, or as annual loss
across the full 10-year modeling horizon in
the case of rural utility Cash Window loans.
*
4.4
*
*
*
*
Loan and Cashflow Accounts
* * * The steady-state formulation results
in account balances that remain constant
except for the effects of discontinued
programs, maturing AgVantage Plus
positions, and the LLRT adjustment. * * *
*
*
*
*
*
Dated: April 21, 2011.
Mary Alice Donner,
Acting Secretary, Farm Credit Administration
Board.
[FR Doc. 2011–10172 Filed 4–26–11; 8:45 am]
BILLING CODE 6705–01–P
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]]>Agencies
[Federal Register Volume 76, Number 81 (Wednesday, April 27, 2011)]
[Rules and Regulations]
[Pages 23459-23469]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-10172]
=======================================================================
-----------------------------------------------------------------------
FARM CREDIT ADMINISTRATION
12 CFR Parts 651 and 652
RIN 3052-AC51
Federal Agricultural Mortgage Corporation Governance and Federal
Agricultural Mortgage Corporation Funding and Fiscal Affairs; Risk-
Based Capital Requirements
AGENCY: Farm Credit Administration.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The Farm Credit Administration (FCA, Agency, us, or we) issues
this final rule amending our regulations on the Risk-Based Capital
Stress Test (RBCST or model) used by the Federal Agricultural Mortgage
Corporation (Farmer Mac). This rulemaking updates the model to ensure
that it continues to appropriately reflect risk in a manner consistent
with statutory requirements for calculating Farmer Mac's regulatory
minimum capital level under a risk-based capital stress test. This rule
updates the model to estimate the capital requirements associated with
Farmer Mac's statutory authority to finance rural utility loans and to
revise the treatment of certain secured general obligations held by
Farmer Mac as program investments. This rule also revises the treatment
of counterparty risk on non-program investments in the model by
adjusting the haircuts applied to those investments to keep the model
internally consistent with revisions made to stressed historical
corporate bond default and recovery rates.
DATES: Effective date: This regulation will be effective 30 days after
publication in the Federal Register during which either or both Houses
of Congress are in session. We will publish a notice of the effective
date in the Federal Register.
Compliance date: Compliance with the changes to the model must be
achieved by the first day of the fiscal quarter following the effective
date of the rule. All other provisions require compliance on the
effective date of this rule.
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 objective of this final rule is to ensure that the RBCST for
Farmer Mac continues to determine regulatory capital requirements in a
manner consistent with statutory requirements.
II. Background
The FCA is an independent agency in the executive branch of the
Federal Government that, in part, serves as the safety and soundness
regulator of Farmer Mac. The FCA regulates Farmer Mac through the
Office of Secondary Market Oversight (OSMO). Farmer Mac is a
stockholder-owned instrumentality of the United States, chartered by
Congress to establish a secondary market for agricultural real estate,
rural housing mortgage loans, and rural utilities loans. Farmer Mac
also facilitates the capital markets funding for USDA-guaranteed farm
program and rural development loans. Section 5406 of the Food,
Conservation and Energy Act of 2008 (2008 Farm Bill) \1\ amended the
definition of ``qualified loan'' in Title VIII of the Farm Credit Act
of 1971, as amended, (Act) \2\ to include rural utility loans. This
change gave Farmer Mac the authority to purchase and guarantee
securities backed by loans to rural electric and telephone utility
cooperatives as program business. The
[[Page 23460]]
2008 Farm Bill further directed FCA to estimate the credit risk on the
portfolio covered by this new authority at a rate of default and
severity reasonably related to the risks in rural electric and
telephone facility loans. The existing RBCST (Version 3.0) for Farmer
Mac is contained in part 652, subpart B, and is used to determine the
minimum level of regulatory capital Farmer Mac must hold to maintain
positive capital during a 10-year period, as characterized by stressful
credit and interest rate conditions. Version 3.0 of the RBCST was
developed according to the provisions of section 8.32 of the Act before
Farmer Mac was given rural utility authority and thus lacks a component
to directly recognize the credit risk on such loans.\3\ The updated
version of the RBCST will be identified as Version 4.0.
---------------------------------------------------------------------------
\1\ Public Law 110-246, 122 Stat. 1651 (June 18, 2008)
(repealing and replacing Pub. L. 110-234).
\2\ Public Law 92 181, 85 Stat. 583 (December 10, 1971).
\3\ FCA currently treats Farmer Mac's portfolio of investments
in rural utility loans as non-program investments.
---------------------------------------------------------------------------
On January 22, 2010, we published a proposed rule (75 FR 3647) to
enhance the RBCST for Farmer Mac and to add a component addressing
Farmer Mac's recently acquired authority to purchase and guarantee
securities backed by loans to rural electric and telephone utility
cooperatives. The comment period closed on April 22, 2010.\4\ This
rulemaking finalizes policies proposed prior to the passage of the
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
(Dodd-Frank Act).\5\ Section 939A of the Dodd-Frank Act requires
federal agencies to review all regulatory references to Nationally
Recognized Statistical Ratings Organization (NRSRO) credit ratings by
July 21, 2011, and, as a result of this review, to remove those
references. While this rule maintains existing reliance on NRSRO credit
ratings, the Agency intends to begin a rulemaking initiative
immediately following this one to address the requirements of the Dodd-
Frank Act.
---------------------------------------------------------------------------
\4\ 75 FR 13682 (March 23, 2010).
\5\ Public Law 111-203, 124 Stat. 1376, (H.R. 4173), July 21,
2010.
---------------------------------------------------------------------------
III. Comments and Our Response
We received several comments on the proposed rule from Farmer Mac
and one comment letter from the Farm Credit Council (FCC), acting for
its membership and each of the five Farm Credit banks. The FCC
expressed support for using a more conservative approach to loss rate
estimation in the AgVantage portfolio. It also noted its belief that
capital standards for Farmer Mac should be equivalent to those of Farm
Credit System (FCS or System) lenders. The FCC was also generally
supportive of the proposed characterization of credit risk in the rural
utility portfolio, but noted that the approach requires vigilant
oversight of Farmer Mac's guarantee fee-pricing procedures.
While we appreciate the FCC's comment, the Act provides for a
different treatment of capital than that of the other System
institutions. As such, the FCC's suggestion to make the capital
standards equivalent to those of other FCS lenders is outside the scope
of this rulemaking. Farmer Mac submitted comments on three aspects of
the proposed rule--the method of characterizing credit losses on rural
utility loans, the stress factor applied to the general obligation
adjustment (GOA) to estimated losses in the AgVantage portfolio, and
the concentration risk adjustment to the GOA factors. Farmer Mac stated
that the proposed method of characterizing losses in the rural utility
loans is not consistent across different market environments because it
was too high relative to both the historical loss experience in that
sector as well as levels that could be reasonably applied to
agricultural mortgages. Farmer Mac also commented that the multiplier
selected to stress GOA factors was too high, and the concentration risk
adjustment to the GOA factors was unwarranted and duplicative to the
use of credit ratings in the base GOA factors. Farmer Mac asked that
the concentration risk be reversed in its impact to reflect a reduction
in Farmer Mac's risk exposure in light of the counterparty's relative
portfolio diversification.
We discuss the comments specific to our proposed rule and our
responses below. For purposes of responding to the comments made
regarding GOA factors, we will be using the following terms to
distinguish between the existing ``base GOA'' factors to refer to those
set forth in Version 3.0, which are based solely on historical
corporate bond default and recovery rates, and ``stressed GOA'' factors
to refer Version 4.0 where base GOA factors are increased by a multiple
of 3. Those areas of the proposed rule not receiving comment are
finalized as proposed unless otherwise discussed in this preamble.
A. Credit Loss Estimation on Rural Utility Loans [Sec. Sec. 652.50 and
652.65(b); Appendix A to Part 652]
1. Guarantee Fee
We proposed amending Sec. 652.50 by adding a definition for
guarantee fees charged on rural utility loans to distinguish treatment
of these fees from those assessed against all other loans guaranteed by
Farmer Mac. We explained ``rural utility guarantee fee,'' as it
pertains to funded volume, means the gross spread over cost of funds,
not a subset of that spread. Farmer Mac requested that we clarify
whether or not the definition of ``rural utility guarantee fee'' is
meant to reflect a subset of the term ``pricing spread.''
We apply the term ``rural utility guarantee fee'' as a standalone
term and not as a subset of pricing spread, and therefore, no component
of the pricing spread should be netted. The rule defines ``rural
utility guarantee fee'' as the actual guarantee fee charged for off-
balance sheet volume and the earnings spread over Farmer Mac's funding
costs for on-balance sheet volume on rural utility loans.\6\ As
explained in the proposed rulemaking, we use the phrase ``earnings
spread'' in the guarantee fee definition to represent the incoming
cashflow rate minus Farmer Mac's total funding rate associated with
that volume. We expect Farmer Mac to maintain records of these spreads
when they are established for each transaction. We do not consider this
an overly burdensome expectation given Farmer Mac's current practice of
documenting such approvals of such spreads. Thus, the guarantee fee is
the gross spread over cost of funds, not a subset of that spread. We
are finalizing the definition as proposed. As a conforming technical
change, we finalize amendments to sections 1.0.a., 4.1.b., 4.2.b.(2),
and 4.2.b.(3) of the model in Appendix A of part 652 to add rural
utility guarantee fees.
---------------------------------------------------------------------------
\6\ For purposes of the mechanics within the spreadsheets of
RBCST Version 4.0, on-balance sheet volume will, if necessary, be
divided into those with AgVantage Plus-type structures and those
that are outright loan purchases similar in structure to Farmer
Mac's cash window for agricultural mortgages.
---------------------------------------------------------------------------
2. Credit Risk
We proposed amending the model in Appendix A of part 652 to include
rural utility program volume by using a stylized approach to
characterizing credit risk for rural utility program volume by
multiplying the dollar-weighted average rural utility guarantee fee by
a factor of two to characterize stressed annual loss rates.\7\ We also
proposed clarifying the applicability of individual sections of the
model to the
[[Page 23461]]
rural utility portfolio and adding new sections 2.6, 4.1.e., and 4.3.e.
to calculate losses for rural utility loans.
---------------------------------------------------------------------------
\7\ In the proposed rule, in this context, we used the phrase
``average annual loss rates.'' We believe the phrase ``stressed
annual loss rates'' is clearer. What we intend to convey is that
while agricultural lifetime loss rates are calculated by the model
and then distributed on a front-loaded basis, we characterize rural
utility loss rates as equal annual loss rates, or what could be
referred to as average loss rates over a period of worst case
stress.
---------------------------------------------------------------------------
Farmer Mac objected to the proposed approach on the grounds that it
results in projected stressed credit losses on rural utility loans that
are inconsistent across different market environments and exceed both
the historical experience in the rural utility sector and levels that
could be reasonably applied to agricultural mortgages. Farmer Mac
explained that the stressed credit loss characterizations on rural
utility loans will be inconsistent across different market environments
because it would be subject to inaccuracy due to potential volatility
in the pricing by Farmer Mac of similar exposures under varying market
conditions through time. In other words, investor risk tolerances vary
with changes in perceived levels of overall risk in the market, and
such changes could enable Farmer Mac to charge higher rates on rural
utility loans despite no change in the underlying fundamentals of the
sector or the specific loans it guarantees. We disagree with the
suggestion that the stressed credit loss characterizations on rural
utility loans will be inconsistent across different market
environments. We used a multiple of the Farmer Mac rural utility
guarantee fee as a proxy for stressed loss rates because the data on
historical losses are not suitable for the development of a more
statistically reliable estimate. We elected not to decompose the
guarantee fee and earnings spreads into their component parts
(including required versus ``excess'' spread) as that approach would
have: (1) Required significant assumptions regarding what portion might
be attributable to Farmer Mac's perception of market conditions versus
credit risk; and (2) added a level of calculation complexity that is
disproportionate to the coarse level of precision achievable given the
data limitations. In other words, we take the view that the market
clearing price reflects the market consensus of risk at a point in
time.
Farmer Mac asserts that the proposed approach is also incongruous
because it characterizes losses of on- and off-balance sheet rural
utility volume identically, though the rural utility guarantee fee
would be inherently different. Farmer Mac suggests that the earnings
spread on on-balance sheet volume might be larger than the guarantee
fee on off-balance sheet volume. Farmer Mac clarified this comment by
explaining that the return on equity component of the earnings spread
would be larger for on-balance sheet volume ``[i]f the return on equity
pricing is determined using current statutory minimum capital
requirements (or any other capital requirements set using a
differential approach to capital allocation).'' The comment references
the statutory minimum requirements for on-balance sheet exposure (2.75
percent) and off-balance sheet exposure (0.75 percent) of outstanding
principal. We understand the comment to indicate that program
investment decisions, i.e., capital allocations, might be made on the
basis of some required equity return margin over the associated
statutory minimum capital requirements rather than on the basis of the
risk and expense characteristics of the investments. We disagree with
this premise. We are aware of no reason to base return on equity
requirements on fixed statutory minimum capital requirements or to use
such minimum capital requirements as a proxy for capital allocated to
specific program investments. We reject the suggestion that such fixed
minimums could be appropriately used as a basis to justify differential
return on equity requirements on investments that have otherwise
exactly the same risk and expense characteristics.
Farmer Mac also commented that a multiple of two times the rural
utility guarantee fee would not be consistent with FCA's stated
position that the agriculture sector is generally more risky than the
rural utility sector. Farmer Mac used a hypothetical example to
demonstrate its comment. In this example, the cumulative annual loss
rate characterization on rural utility volume over the 10 years of the
modeling horizon slightly exceeded the estimated lifetime loss rate on
newly originated, agricultural loans underwritten according to Farmer
Mac's minimum standards. Farmer Mac modified the example to create a
situation where the two sets of loans were equally seasoned and
concluded that the cumulative loss rate for electrical loans in such
cases would always exceed that of the agricultural real estate loans.
Farmer Mac explained that the example demonstrated that the rule's
approach would not be consistent with the statute's authorizing
language requiring modeled loss rates to be ``reasonably related to
risks'' in rural electric and telephone facility loans. Farmer Mac
instead suggests that cumulative loss rates should, at the very least,
be no greater than those for comparably sized agricultural mortgage
loans. While Farmer Mac noted that the multiplier of two could be
reduced, it instead asked FCA to adopt a credit risk estimate supported
by historical loss and recovery rate trends.
We disagree with the commenter's use of FCA Bookletter BL-053,
``Revised Regulatory Capital Treatment for Certain Electric Cooperative
Assets,'' to support the contention that the proposed treatment is
inconsistent with the bookletter's conclusion that the electric
cooperative sector has a lower risk profile than the agricultural
sector.\8\ While under normal conditions an average dollar of exposure
to a rural electric cooperative is viewed as a lower credit risk than
an average dollar of agricultural real estate mortgage exposure, the
purpose of the RBCST is to represent a worst-case loss scenario for
program-related assets. We view the concept of ``worst case'' in the
rural utility cooperative sector as fundamentally different from the
agriculture sector. The rule's approach inherently reflects our
expectation that worst-case losses in the rural utility sector will
occur far less frequently than worst-case losses in the agriculture
sector--but when they occur, can be far more severe. While the average
annual loss rate over the long term may be viewed as likely to be lower
in the rural utility sector due to the infrequent occurrence of loss
events, in a scenario where worst-case losses do occur, they will
involve much greater loss rates than worst-case losses in agriculture.
Further, the relationship between the two cumulative 10-year loss rates
(agricultural versus rural utility) is not instructive, as the sector
with the higher cumulative rate will vary depending on rural utility
guarantee fee rates and the credit risk characteristics of the
agriculture portfolio at any given time. Thus, in attempting to
characterize both sectors' worst-case scenarios in the RBCST over a 10-
year modeling horizon, having 10 years of loss rates that do not always
sum to lower cumulative rate in the rural utility portfolio is not
inconsistent with the general tenet that the electric cooperative
sector typically has a lower risk profile.
---------------------------------------------------------------------------
\8\ While BL-053 pertains to Farm Credit System banks and
associations, and not to Farmer Mac, we believe the general tenets
set forth in it apply to those same certain loan types in Farmer
Mac's portfolio.
---------------------------------------------------------------------------
Notwithstanding our position on this comment, using the suggested
approach, it would be more appropriate to compare cumulative loss rates
only to the modeling year at which the model indicates capital would
approach its limit of zero (the zero-year) because losses recognized by
the model in subsequent modeling years do not impact the calculation of
the minimum capital requirement. Expanding on
[[Page 23462]]
Farmer Mac's example, if the zero-year occurred at year three,
cumulative losses over those 3 years in agriculture portfolio would be
9.87 percent versus 4.2 percent in the rural utility portfolio.
Seasoning could further affect the relative impacts of credit risk in
the model. Given our stated view of the fundamentally different
concepts of ``worst-case'' in the two sectors, this fact does not
contradict the Agency's stated position.
Farmer Mac's comment goes on to suggest various approaches to
achieve the ``result'' recommended (that cumulative losses projected in
the RBCST for rural utilities loans should be, on a relative basis, no
greater than those for comparably sized agricultural mortgage loans).
Farmer Mac notes that this result could be achieved by reducing the
multiplier of two, but suggests instead that we abandon the proposed
approach of applying a multiplier to Farmer Mac pricing factors in
favor of an approach that references historical loss trends. In the
proposed rule's preamble, we discussed in detail the insufficiency of
historical lost trend data, as well as other alternatives to the
proposed approach that were considered and why they were rejected.
Farmer Mac also stated that the proposed approach was inconsistent
with historical loss trends. We disagree because the comment is based
on the premise that appropriate historical loss trend information is
available. As discussed in the proposed rulemaking, we determined that
a data set suitable to build a reliable default probability loss
function is not available due to the fact that historical losses in the
electric cooperative sub-sector of the utilities industry have been
extremely rare and dissimilar.\9\ We also note that historical
instances of default appear largely unrelated to specific underwriting
decisions. Further, even among the few historical instances of non-
performing loans in the data we obtained, restructured credit defaults
have in many instances become more profitable than the original loan in
terms of interest income, while others were never fully resolved
despite exceptionally long periods of time since initial default. For
those reasons, an empirical frequency-based analog for estimating
credit risk, as was used to arrive at the model's approach to
estimating agricultural loan risks, was not feasible for rural
utilities. Instead, the rule characterizes credit risk on rural utility
loans using the stylized approach of multiplying the dollar-weighted
average rural utility guarantee fee by a factor of two to characterize
stressed annual loss rates.
---------------------------------------------------------------------------
\9\ In evaluating the suitability of empirical data sources, we
examined historical loan performance data of the U.S. Department of
Agriculture's (USDA) loan programs and interviewed market
participants including the National Rural Utility Cooperative
Financing Corporation, CoBank, and USDA's Rural Utility Service.
---------------------------------------------------------------------------
Finally, Farmer Mac commented that the proposed approach to
characterizing credit losses in the rural utility portfolio is
inconsistent with the Act. We disagree with this assessment because the
Act does not require us to use any particular statistical methodology.
The Act, at section 8.32(a)(1)(B), requires us to estimate credit loss
risk ``at a rate of default and severity reasonably related to risks in
electric and telephone facility loans * * * as determined by the
Director [of OSMO].'' The proposed rulemaking explained in some detail
the reason behind selecting the method of identifying rural utilities
credit loss risk, and Farmer Mac has offered no evidence to demonstrate
that our method does not reasonably relate to actual risks in the rural
utilities sector.
We selected a method that relies directly on the notion that the
assessment of relative risk would be reflected in differences in priced
guarantee fees charged by Farmer Mac. These fees represent Farmer Mac's
estimate of likely long-term average annual losses on an investment, in
addition to fee loads to cover operating costs and return-on-equity
requirements. We selected the combination of the total earnings spread
with a lower stress multiple because the total spread also represents
agreement on the value of the transaction between at least two parties:
Farmer Mac and its counterparty (i.e., a market clearing price).
For these reasons, we finalize this section and the conforming
changes as proposed to reflect the treatment of the rural utility
authority. As we gain more experience and data in this sector, the
Agency may revisit this approach.
B. Modification of the Treatment of Loans Backed by an Obligation of
the Counterparty and Loans for Which Pledged Loan Collateral Volume
Exceeds Farmer Mac-Guaranteed Volume [Sec. Sec. 652.50 and 652.65(d);
Appendix A to Part 652]
We are amending sections 2.4.b.3, 2.4.b.4, 4.1.f., and 4.2.b. of
the model in Appendix A of part 652 to increase the GOA factors,
address counterparty concentration risks, and ensure AgVantage Plus
volume maturities are recognized in the model.
1. GOA Factors--Treatment of Loan Volume
We proposed revising the GOA factors by stressing the historical
corporate bond loss rates to levels intended to represent stressed
conditions instead of average conditions. We accomplish this in the
model by modifying the GOA factors through the application of increases
(or ``haircuts'') to the estimated historical loss rates by whole-
letter credit rating category using a multiple of three.
Farmer Mac commented that our selection of three as the multiplier
appeared to be much too high based on data in reports issued by Moody's
Investor Services. Farmer Mac explained that the multiple and its
implied assumption of a coefficient of variation (CV) equal to one
lacked empirical support or theoretical justification. Farmer Mac
askedthat the implied underlying CV ratio be much lower than one and
that separate multipliers, scaled by whole-letter credit rating, be
applied based on the historical variability over time of each whole-
letter credit rating. Farmer Mac based this request on Moody's data on
the standard deviations for 10-year cumulative default rates. Farmer
Mac recommends these data be used to derive empirically based multiples
of GOA factors to represent stress on issuer counterparties.
We disagree with the recommendation as we believe it to be based on
a mistaken reliance on CVs of average default rates within credit
rating categories over time, rather than cross-sectional CVs of the
individual issuer defaults within each period.\10\ The long-term
average rate of the annual average default rate combined with the
standard deviation of those average default rates do not convey a
reasonable measure of ``worst-case'' default risk, but rather, as
identified in the Moody's report, are primarily related to sample size
used in construction of the estimated average loss rates. We believe
our approach places the adjusted corporate bond loss estimate in a
range that provides a meaningfully stressful representation, given
limited data, and reflects generally accepted statistical principles
and relationships. We selected the multiplier of three on the basis
that it was a reasonable policy position given that the most accurate
alternative to the selected multiple using statistical theory to
establish the limits on probability from the sample variance (i.e.,
Chebychev's theorem as discussed in
[[Page 23463]]
the proposed rule) would have yielded a proposed multiple many times
higher than three. We continue to believe that use of the limit of
probability established through limited sample information to require
too extreme a multiple, and instead maintain our more moderate
treatment through the use of our proposed value of three.
---------------------------------------------------------------------------
\10\ In the proposed rule, we used a CV of one in an example to
demonstrate a point and not as a factual premise of this rulemaking.
---------------------------------------------------------------------------
We further disagree that one can accurately infer individual
variability directly from the variance of a set of pooled experiences
(aggregate annual default rates) through time. The primary purpose of
the cited report, as explained by Moody's in the report, appears
fundamentally different from its use in the comment letter. Moody's
report explicitly states its purpose is to present confidence intervals
around historical average cumulative default rates and, as warning
against interpretation as a cross-sectional variance, the report
indicates that standard errors around estimated long-run average
default rates ``should not be confused with the much greater bands of
uncertainty associated with the expected performance of particular
cohorts of issuers formed at specific points in time (cross section).''
\11\
---------------------------------------------------------------------------
\11\ Cantor, R; Hamilton, D.; Tennant, J. ``Confidence Intervals
for Corporate Default Rates'', Moody's Investor Services, Global
Credit Research: Special Comment, April 2007; p. 1-2.
---------------------------------------------------------------------------
We finalize this provision as proposed.
2. GOA Factors--Concentration Ratios
We proposed modifying GOA factors to recognize the risk associated
with a counterparty's (also referred to as the AgVantage Plus issuer)
loan portfolio concentration in the industry sector used in an
AgVantage Plus issuance. We also proposed modifying section 2.4.b.3.A.
of Appendix A to allow the Director of OSMO to make final
determinations of concentration ratios on a case-by-case basis by using
publicly reported data on counterparty portfolios, non-public data
submitted and certified by Farmer Mac as part of its RBCST submissions,
and generally recognizing two rural utility sectors--rural electric
cooperatives and rural telephone cooperatives.
Farmer Mac objected to the GOA modifications because it believes
the change creates redundancy in two ways: (1) The level of an issuer's
loan portfolio concentration is already captured in the NRSRO's credit
rating and therefore already captured in the level of the base GOA
factor (prior to the proposed concentration risk adjustment), and (2)
base GOA factors already capture stress associated with ``tail'' events
according to the newly proposed stressed corporate bond loss-rate
multiple. Farmer Mac suggests instead that the new GOA factors be
adjusted to reflect a reduction in risk due to the level of
diversification of the issuer, not an increase in risk due to the
issuer's portfolio concentration.
Farmer Mac further commented that the proposed methodology is vague
and might oversimplify industry concentration. Farmer Mac asked that at
least two sub-sectors of rural electric utilities be recognized in the
concentration adjustment: Distribution cooperatives and generation and
transmission (G&T) cooperatives. Farmer Mac explained that the
magnitude of the concentration risk-adjusted GOA (CRAGOA) factors are
driven more by the concentration risk adjustment than by the stressed
historical corporate bond default and recovery rates (stressed GOA
factors). Farmer Mac states that this is counterintuitive to the
concept of the GOA because it associates more of the final effect of
the CRAGOA adjustment with the issuer's portfolio structure than is
warranted. Farmer Mac illustrates this point using the example of a
sovereign issuer without credit risk. In this scenario, the CRAGOA
factor would equal the concentration ratio, due to the mathematical
relationship between the stressed GOA (pre-concentration risk
adjustment) and the CRAGOA (i.e., 1-(1-GOA) (1-concentration ratio),
where GOA = 0)). If that concentration ratio were one, then no risk-
mitigation would be recognized in the general obligation of the
sovereign issuer even if the issuer were rated AAA. Farmer Mac views
this as placing an overly heavy emphasis on the issuer's portfolio
concentration.
Farmer Mac contends that our approach is inherently deficient
because, in the example, the percentage increase in the GOA factor
after adjustment for concentration risk is much greater for the AAA
issuer (1,800 percent) than it is for the BBB issuer (300 percent),
though the magnitudes of change stated in percentage terms are actually
artifacts of the scale of remaining credit risk within each whole-
letter rating category, as we discuss in depth below. Farmer Mac
commented that the concentration risk adjustment should, if it has any
impact at all, reduce risk rather than increase risk. Farmer Mac
suggested replacing the mathematical relationship we had proposed with
a multiplicative relationship--i.e., because the concentration ratio
will frequently be less than one, that the stressed GOA factor should
be reduced for any level of issuer portfolio diversification, rather
than increased for any level of portfolio concentration. Farmer Mac
suggests the following formula: CRAGOA = stressed GOA * CR.
We appreciate Farmer Mac's concern that the two sub-sectors of
rural electric utilities be recognized. However, we believe the rule
provides for recognition of those sub-sectors and others on a case-by-
case basis. We recognize Farmer Mac's authority to finance four
industry sectors: Agriculture (including farms and agribusiness), rural
electric distribution cooperatives, rural electric G&T cooperatives,
and rural telephone cooperatives. The modifications to section
2.4.b.3.A. of Appendix A will allow the Director of OSMO (Director) to
make final determinations of concentration ratios, including
recognizing two rural utility sectors--rural electric cooperatives and
rural telephone cooperatives. However, we disagree that the GOA factors
contain redundancy. While NRSRO's may consider the extent of
diversification of assets generally in their credit ratings, they do
not do so in a worst-case context. Nor would the NRSRO's consideration
of diversification always specifically include the impact of the
issuer's relative exposure to industry sectors that Farmer Mac is
authorized to finance. Agriculture and rural utility cooperative
exposures are often combined with other sector exposures in publicly
reported documents--including sectors that Farmer Mac is not authorized
to finance. While it's possible that an NRSRO might require the issuer
to disaggregate that information, its rating determination would not
specifically focus on the degree of exposure to the Farmer Mac-
authorized sectors. Hence, credit ratings do not provide the level of
granularity of information needed. Nor does an NRSRO rating necessarily
consider the issuer's exposure to the specific industry sector involved
in the specific AgVantage Plus pool being modeled as this approach
does. We do not believe that consideration of these specific risk
components to the modeling of AgVantage Plus volume is sufficiently
reflected in credit ratings to use them as suggested. For example, an
NRSRO rating on a 100-percent concentrated issuer (e.g., a single-
sector lender) says little or nothing about its ability to guarantee
the credit on loan volume that it would pledge to Farmer Mac. In a
worst-case loss scenario in that single sector, the issuer's ability to
liquidate its unpledged assets to fulfill its general obligation to
Farmer Mac at a price near the outstanding principal would be
[[Page 23464]]
severely reduced. This rule effectively evaluates the degree of that
reduced ability at 100 percent. In other words, we do not believe it to
be plausible that an issuer whose unpledged assets are experiencing
worst-case losses would be able to continue as a going concern if it
were forced to liquidate a significant volume of those unpledged, but
highly impaired assets in order to fulfill its general obligation to
Farmer Mac.
Farmer Mac asked that we define the sectors but did not suggest any
definition with the request. We decline to do so because we believe the
general understanding of what these sectors include is sufficient for
setting a parameter but flexible enough to allow the Director to use
his discretion in a manner appropriate to each case presented. In
addition, we do not view the fact that the concentration risk
adjustment has a significant impact on the CRAGOA as counterintuitive.
We believe it is logically consistent to view the concentration ratio
as potentially a more significant driver of the value of the issuer's
general obligation than the estimated corporate bond loss rate. We view
the concentration risk adjustment as a critical component of the CRAGOA
because it reflects the ability of the specific counterparty to augment
the more generalized component derived from stressed corporate bond
default rates by whole-letter credit rating.
Farmer Mac's comment included an example of a sovereign (credit-
risk-free) issuer and AgVantage Plus counterparty. We believe this
example is too extreme to be applicable even for illustrative purposes.
As a risk-free issuer, the hypothetical sovereign issuer in the example
would be guaranteeing the credit risk on the subject loan volume, thus
making the transaction more akin to the Farmer Mac II program than to
the AgVantage Plus product.\12\ The RBCST already contains an approach
on this type of transaction, i.e., it does not recognize credit risk
and therefore would it not be appropriate to model this volume using
the treatment for AgVantage Plus. Such transactions would result in a
gross loss estimate of zero to which the CRAGOA (equal to the
concentration ratio as previously discussed) would be applied for a net
loss estimate of zero. However, to the more general point outside of
this extreme case, i.e., a single-sector AAA issuer, we believe it
reasonably and logically consistent for the single sector
characteristic to weigh most heavily in the CRAGOA. The discussion and
tables below further describe these relationships.
---------------------------------------------------------------------------
\12\ 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.
---------------------------------------------------------------------------
Farmer Mac argued that our approach is inherently deficient due to
the fact that the CRAGOA factor increases (relative to the stressed
GOA) so much more for the AAA issuer (18 times) than it does for the
BBB issuer (three times). We disagree and use the following tables to
illustrate the ultimate effects of the CRA across a set of cases that
we believe provide a more meaningful context for interpretation of the
effects of its application.
The table is organized in three panels across base Pre-GOA
probability of default rates (PD) of 1, 3, and 6 percent (i.e.,
examples of loss rates as would be determined by the RBCST credit loss
module or from the rural utility guarantee fee). The stressed GOA (GOA
Pre-CRA) is applied to each case and a pre-concentration risk adjusted
loss rate provided in column D (Pre-CRA loss rate). The first table
assumes a 25-percent concentration ratio (CR) and provides associated
final loss rates in column F after the CRA. Column G reproduces the
multiples of change cited by Farmer Mac in its comment.
----------------------------------------------------------------------------------------------------------------
A B C D E F G
----------------------------------------------------------------------------------------------------------------
GOA Pre- Pre-CRA Loss rate
Pre-GOA PD CRA loss rate CR post-CRAGOA = F/D
(percent) (percent) (percent) (percent) (percent)
----------------------------------------------------------------------------------------------------------------
AAA............................... 1 1.41 0.0141 25 0.261 18.48
AA................................ 1 3.70 0.0370 25 0.278 7.51
A................................. 1 5.13 0.0513 25 0.288 5.62
BBB............................... 1 11.48 0.1148 25 0.336 2.93
< BBB............................. 1 44.52 0.4452 25 0.584 1.31
----------------------------------------------------------------------------------------------------------------
AAA............................... 3 1.41 0.0423 25 0.782 18.48
AA................................ 3 3.70 0.1110 25 0.833 7.51
A................................. 3 5.13 0.1539 25 0.865 5.62
BBB............................... 3 11.48 0.3444 25 1.008 2.93
< BBB............................. 3 44.52 1.3356 25 1.752 1.31
----------------------------------------------------------------------------------------------------------------
AAA............................... 6 1.41 0.0846 25 1.563 18.48
AA................................ 6 3.70 0.2220 25 1.667 7.51
A................................. 6 5.13 0.3078 25 1.731 5.62
BBB............................... 6 11.48 0.6888 25 2.017 2.93
< BBB............................. 6 44.52 2.6712 25 3.503 1.31
----------------------------------------------------------------------------------------------------------------
As the table indicates, assuming a counterparty concentration ratio
of 25 percent and a loss rate estimate of 1 percent before any
adjustment for general obligation credit enhancement, the proportional
changes are as provided in Farmer Mac's comment letter--the AAA
issuer's post-CRAGOA loss rate increases by a factor of 18.48, whereas
the BBB issuer's loss rate increases only 2.93 times after considering
the concentration risk. We consider the increase differential
consistent with the logic that when a structure is backed by a high-
quality issuer's general obligation, there is effectively more risk-
mitigation value to lose if that issuer happens to be highly
concentrated in the same sector as the underlying loans and the
magnitude of that loss is appropriate and proportionate to the
concentration risk at the issuer. Despite this difference in CRA
impact, the loss rate post-CRAGOA for a AAA issuer is still less than
half the stressed loss rate applied to a BBB issuer, and this
relationship is not
[[Page 23465]]
affected by the level of the pre-GOA PD (i.e., the 3-percent and 6-
percent Pre-GOA PD scenarios reflect the same magnitude of change post-
CRAGOA). When there is little credit risk, there is less risk to
mitigate with the GOA. However, in the ``below-BBB and unrated'' cases,
the magnitude of the reduction in credit risk is far greater than in
the case of the higher rated initial exposures. For example, observe
the last two rows in column C with 11.48-percent and 44.52-percent
``GOA Pre-CRA'' factors. Prior to the CRA, the stressed GOA would have
reduced initial PD losses by 88.52 percent (1-0.1148) and 55.48 percent
(1-0.4452), respectively. The magnitude of difference among these
changes to the initial PD is reduced by the application of the CRA,
which is the same for each of them. The percentage reduction in the
initial PD post-CRA is 73.94 percent (down 24.65 percentage points) in
the AAA case, 66.39 percent (down 22.13 percentage points) and 41.61
percent (down 13.67 percentage points) in the ``BBB'' and ``< BBB''
cases, respectively--down 25 percent from the Pre-CRA PD risk
mitigation levels. We consider this result consistent with reasonable
depictions of final credit exposure relationships.
The next table provides comparable information, but with a
concentration ratio of 50 percent rather than 25 percent. As can be
seen in the table, a consistent and appropriate proportionality remains
as the multiples of change become much larger due to increases in the
concentration ratio--that is, the loss rate post-CRA GOA for a AAA
issuer is still less than the stressed loss rate applied to a BBB
issuer, though by increasingly smaller margins as concentration ratios
rise. This is logical and intentional because as the concentration
ratio approaches one, risk-mitigation value of the CRAGOA approaches
zero for all categories of issuer leaving Pre-GOA PDs unadjusted for
the general obligation of the issuer.
----------------------------------------------------------------------------------------------------------------
A B C D E F G
----------------------------------------------------------------------------------------------------------------
Loss Rate
Pre-GOA PD GOA Pre- Pre-CRA CR post-CRA
(percent) CRA loss rate (percent) GOA = F/D
(percent) (percent) (percent)
----------------------------------------------------------------------------------------------------------------
AAA............................... 1 1.41 0.0141 50 0.507 35.96
AA................................ 1 3.70 0.0370 50 0.519 14.01
A................................. 1 5.13 0.0513 50 0.526 10.25
BBB............................... 1 11.48 0.1148 50 0.557 4.86
< BBB............................. 1 44.52 0.4452 50 0.723 1.62
----------------------------------------------------------------------------------------------------------------
AAA............................... 3 1.41 0.0423 50 1.521 35.96
AA................................ 3 3.70 0.1110 50 1.556 14.01
A................................. 3 5.13 0.1539 50 1.577 10.25
BBB............................... 3 11.48 0.3444 50 1.672 4.86
< BBB............................. 3 44.52 1.3356 50 2.168 1.62
----------------------------------------------------------------------------------------------------------------
AAA............................... 6 1.41 0.0846 50 0.030 35.96
AA................................ 6 3.70 0.2220 50 3.111 14.01
A................................. 6 5.13 0.3078 50 3.154 10.25
BBB............................... 6 11.48 0.6888 50 3.344 4.86
< BBB............................. 6 44.52 2.6712 50 4.336 1.62
----------------------------------------------------------------------------------------------------------------
Finally, Farmer Mac suggested using the formula: CRAGOA = stressed
GOA * CR to recognize increased risk associated with counterparty
concentrations. As we previously explained, we intend to recognize the
increased risk associated with counterparty concentrations and do not
consider Farmer Mac's suggestion to adequately factor the impact of
increased concentration on effective credit exposure. The concentration
risk adjustment is a critical component of the CRAGOA because it
tightens the focus on this key risk characteristic of the specific
counterparty to complement the more generalized component derived from
stressed corporate bond default rates by whole-letter credit rating--
which, we do not believe adequately captures this information.
We finalize as proposed all changes on this subject matter but
revise our stated interpretation of the proposed methodology as it is
applied to rural electric utility cooperative issuers to recognize two
sectors, electric distribution cooperatives and electric generation and
transmission cooperatives.
3. Technical Changes
We proposed amending Sec. 652.50 by adding a definition for
``AgVantage Plus'' to clarify that, while ``AgVantage Plus'' is a
product name used by Farmer Mac, we are applying it throughout this
subpart to refer both specifically to AgVantage Plus volume currently
in Farmer Mac's portfolio as well as other similarly structured program
volume that Farmer Mac might finance in the future under other names.
We described ``AgVantage Plus'' as a program created by Farmer Mac in
2006 to provide guarantees on timely repayment of principal and
interest on notes issued by the counterparty. The notes are secured by
obligations of issuer, which obligations are, in turn, backed by Farmer
Mac eligible loan assets. We also proposed conforming changes to the
model at Appendix A of part 652 to replace the term ``Off-Balance Sheet
AgVantage'' with ``AgVantage Plus.''
Farmer Mac suggested we reduce the complexity in the rule by
referring to all AgVantage products by the term ``AgVantage Plus,'' but
exclude pools with an initial principal amount under $25 million. We
agree and have revised that definition to include any AgVantage program
investment over $25 million to avoid unnecessary complexity on small
deals. Only those AgVantage issuers under the original AgVantage
program structure (as opposed to what we have been referring to as
``AgVantage Plus'') identified in the original RBCST, (64 FR 61740,
November 12, 1999) will be excluded from the RBCST loss calculation.
In January 2010, Farmer Mac adopted new Financial Accounting
Standards Board guidance related to the consolidation of variable
interest entities (Accounting Standards Update, December 23, 2009). The
adoption
[[Page 23466]]
required consolidation of a significant volume of previously off-
balance sheet program volume onto the balance sheet. As this change
impacts only the presentation of this volume and has no impact on the
risk or cashflows associated with this volume, we have made minor
mechanical adjustments in data inputs to nullify the impact of the
adoption within the RBCST. These include creating a new asset line item
for the affected consolidated volume and an offsetting line item in the
liabilities section.
We finalize as proposed all other changes on this subject matter.
C. Revise Haircuts on Non-Program Investments
[Appendix A to Part 652]
We proposed changing the haircut levels for non-program investments
in existing section 4.1.e. of Appendix A, renumbering the section as
4.1.f., to the same loss rate adjustment factors proposed for
application on loans underlying guaranteed notes (i.e., AgVantage Plus)
as discussed in section III.B.1 of this preamble. The proposed
investment haircuts to recognize counterparty risk were:
------------------------------------------------------------------------
Haircut
Whole letter credit rating (percent)
------------------------------------------------------------------------
AAA......................................................... 1.41
AA.......................................................... 3.70
A........................................................... 5.13
BBB......................................................... 11.48
Below BBB and Unrated....................................... 44.52
------------------------------------------------------------------------
We likewise proposed annually updating these figures, or as often
as an updated version of the Moody's report on Default and Recovery
Rates of Corporate Bond Issuers becomes available.
We received no comments on this proposal and finalize as proposed
all changes on this subject matter.
D. Other Miscellaneous Changes [Sec. Sec. 651.1(b) and 652.5]
In the process of this rulemaking, we noted citations that were not
updated in prior rulemakings and make those corrections now. In a 1994
rulemaking, a definition for ``affiliate'' was added to Sec. 651.1(b).
This definition was later duplicated in Sec. 652.5 as part of a 2005
rulemaking. The definition in both locations references section
8.3(b)(13) of the Act; this citation should read ``section
8.3(c)(14).'' The original rulemaking mistakenly used paragraph (b)
instead of (c), and Congress later renumbered paragraph (c)(13) as
(c)(14).\13\ Both rulemakings clearly discuss the contents of section
8.3(c)(14) of the Act, so we are correcting the citations now.
---------------------------------------------------------------------------
\13\ Section 8.3 is found at 12 U.S.C. 2279aa-3 and discusses
the powers of Farmer Mac and its board. Amendments to the Act made
in the Food, Agriculture, Conservation, and Trade Act Amendments of
1991 [Pub. L. 102-237] gave Farmer Mac the authority to establish,
acquire, and maintain affiliates under applicable state law. This
1991 amendment led to the inclusion of the term in Sec. 651.1.
Subsequently, a 1996 amendment to the Act [Pub. L. 104-105]
redesignated paragraph (c)(13) as (c)(14).
---------------------------------------------------------------------------
IV. Quantitative Impact of Changes on Required Capital
We received one comment from a Farm Credit System institution that
understood the proposed rule to reflect only incremental capital
requirements on rural utility loan volume. We are clarifying that the
substantive changes to the RBCST contained in this final rulemaking
involve more components of the model than simply the incremental
capital requirements on rural utility volume, including changes to GOA
factors applied to all AgVantage Plus-type volume and changes to
investment haircuts. Due to the stated confusion by Farmer Mac
regarding our intended meaning of ``rural utility guarantee fee'' (see
Farmer Mac's request for definitional clarification above), we are
providing further clarification in the estimated impacts table below:
Calculated Regulatory Minimum Capital
[$ in thousands]
----------------------------------------------------------------------------------------------------------------
6/30/2010 9/30/2010 12/31/2010
----------------------------------------------------------------------------------------------------------------
0 RBCST Version 3.0............................................. 30,434 36,743 42,105
1 Revised Haircuts on Investments............................... 30,739 37,053 42,358
2 Tripling of Version 3.0 GOA Factors........................... 30,525 36,969 42,816
3 Credit Risk on Rural Utility Loans............................ 32,564 37,694 79,997
4 Concentration Risk Adjustment with Rural Utility Credit Risk.. 79,924 92,844 123,304
All RBCST Version 4.0 Effects................................... 82,270 94,966 125,498
----------------------------------------------------------------------------------------------------------------
The impact amounts on line ``1'' reflect only the change associated
with the revised haircuts on non-program investments. The impact
amounts on line ``2'' reflect only the change associated with the
tripling of general obligation adjustment factors with all else equal
in the RBC Version 3.0 (i.e., it does not reflect rural utility credit-
loss characterization). The impact amounts on line ``3'' reflect only
the change associated with the credit loss characterization on rural
utility volume (i.e., it does not reflect the application of the
tripling GOA factors to rural utility AgVantage Plus volume or
agricultural AgVantage Plus volume). The impact amounts on line ``4''
reflect the concentration adjustment to the general obligation
adjustment factor on all AgVantage Plus volume, both rural utility and
agricultural, (i.e., it does not reflect the application of the
tripling GOA factors to rural utility or agricultural AgVantage Plus
volume, but it does include the rural utility loss estimates isolated
in line ``3''). The individual estimated impacts do not have an
additive relationship to the total impact on the model output. This is
due to the interrelationship of the changes with one another when they
are combined in Version 4.0 (proposed). It is worth noting that the
marginal effects are also not constant rate effects, but depend on the
starting conditions and earnings spread of Farmer Mac and the magnitude
of the effect considered. For example, as the volume in the rural
utility category is increased, the rate of increase in the marginal
minimum risk-based capital requirement begins to increase as the
downward-pressure on that rate exerted by earnings from other
activities are further diluted as those earnings become increasingly
smaller in proportion to total estimated losses. The same effect is
evident in other ways as risk increases and the offsetting effect of
earnings is diminished relative to increased risk. For example, this
effect would be observed, all else equal, with lower initial earnings
spreads or higher AgVantage Plus counterparty concentrations, updated
(and higher) Moody's base corporate bond default rates, or ratings
downgrades. Thus, the
[[Page 23467]]
values in the table above are illustrative of the relative effects of
the revisions in this rulemaking, given the conditions as of each
quarter end, but can be materially affected by changes in starting
conditions or risk compositions through time. Moreover, due to the
substitutability allowed within certain loan pools and ability of
AgVantage counterparties to vary the level of overcollateral submitted
in each quarter of a pool's life, the risk characteristics of an
individual pool are subject to change quarter to quarter.
Our tests indicate that changes related to credit losses on rural
utility loans combined with the concentration risk adjustment to the
GOA would have the most significant impact on risk-based capital
calculated by the model.
V. Regulatory Flexibility Act
Pursuant to section 605(b) of the Regulatory Flexibility Act (5
U.S.C. 601 et seq.), FCA hereby certifies the final rule will not have
a significant economic impact on a substantial number of small
entities. Farmer Mac has assets and annual income over the amounts that
would qualify it as a small entity. Therefore, Farmer Mac is not
considered a ``small entity'' as defined in the Regulatory Flexibility
Act.
List of Subjects
12 CFR Part 651
Agriculture, Banks, Banking, Conflicts of interest, Rural areas.
12 CFR Part 652
Agriculture, Banks, Banking, Capital, Investments, Rural areas.
For the reasons stated in the preamble, parts 651 and 652 of
chapter VI, title 12 of the Code of Federal regulations are amended to
read as follows:
PART 651--FEDERAL AGRICULTURAL MORTGAGE CORPORATION GOVERNANCE
0
1. The authority citation for part 651 continues to read as follows:
Authority: Secs. 4.12, 5.9, 5.17, 8.11, 8.31, 8.32, 8.33, 8.34,
8.35, 8.36, 8.37, 8.41 of the Farm Credit Act (12 U.S.C. 2183, 2243,
2252, 2279aa-11, 2279bb, 2279bb-1, 2279bb-2, 2279bb-3, 2279bb-4,
2279bb-5, 2279bb-6, 2279cc); sec. 514 of Pub. L. 102-552, 106 Stat.
4102; sec. 118 of Pub. L. 104-105, 110 Stat. 168.
Sec. 651.1 [Amended]
0
2. Amend Sec. 651.1(b) by removing the reference, ``section
8.3(b)(13)'' and adding in its place the reference, ``section
8.3(c)(14)''.
PART 652--FEDERAL AGRICULTURAL MORTGAGE CORPORATION FUNDING AND
FISCAL AFFAIRS
0
3. The authority citation for part 652 continues to read as follows:
Authority: Secs. 4.12, 5.9, 5.17, 8.11, 8.31, 8.32, 8.33, 8.34,
8.35, 8.36, 8.37, 8.41 of the Farm Credit Act (12 U.S.C. 2183, 2243,
2252, 2279aa-11, 2279bb, 2279bb-1, 2279bb-2, 2279bb-3, 2279bb-4,
2279bb-5, 2279bb-6, 2279cc); sec. 514 of Pub. L. 102-552, 106 Stat.
4102; sec. 118 of Pub. L. 104-105, 110 Stat. 168.
Subpart A--Investment Management
0
4. Section 652.5 is amended by revising the definition for
``affiliate'' to read as follows:
Sec. 652.5 Definitions.
* * * * *
Affiliate means any entity established under authority granted to
the Corporation under section 8.3(c)(14) of the Farm Credit Act of
1971, as amended.
* * * * *
Subpart B--Risk-Based Capital Requirements
0
5. Amend Sec. 652.50 by adding alphabetically the following
definitions:
Sec. 652.50 Definitions.
* * * * *
AgVantage Plus means both the product by that name used by Farmer
Mac and other similarly structured program volume that Farmer Mac might
finance in the future under other names. Those AgVantage securities
with initial principal amounts under $25 million and whose issuers were
part of the original AgVantage program are excluded from this
definition.
* * * * *
Rural utility guarantee fee means the actual guarantee fee charged
for off-balance sheet volume and the earnings spread over Farmer Mac's
funding costs for on-balance sheet volume on rural utility loans.
0
6. Amend Sec. 652.65 by:
0
a. Redesignating paragraphs (b)(5) and (6) as paragraphs (b)(6) and
(7);
0
b. Adding a new paragraph (b)(5);
0
c. Revising newly redesignated paragraph (b)(6) and paragraph (d)(2) to
read as follows:
Sec. 652.65 Risk-based capital stress test.
* * * * *
(b) * * *
(5) You will calculate loss rates on rural utility loans as further
described in Appendix A.
(6) You will further adjust losses for loans that collateralize the
general obligation of AgVantage Plus volume, and for loans where the
program loan counterparty retains a subordinated interest in accordance
with Appendix A to this subpart.
* * * * *
(d) * * *
(2) You must use model assumptions to generate financial statements
over the 10-year stress period. The major assumption is that cashflows
generated by the risk-based capital stress test are based on a steady-
state scenario. To implement a steady-state scenario, when on- and off-
balance sheet assets and liabilities amortize or are paid down, you
must replace them with similar assets and liabilities (AgVantage Plus
volume is not replaced when it matures). Replace amortized assets from
discontinued loan programs with current loan programs. In general, keep
assets with small balances in constant proportions to key program
assets.
* * * * *
0
7. Amend Appendix A of subpart B, part 652 by:
0
a. Revising the table of contents;
0
b. Revising the last sentence of section 1.0.a.;
0
c. Adding a new fourth sentence to section 2.0;
0
d. Adding the words ``for All Types of Loans, Except Rural Utility
Loans'' at the end of each heading for sections 2.1, 2.2, 2.3, and 2.5;
0
e. Revising section 2.4.b.3 introductory text, b.3.A., and b.4
introductory text;
0
f. Adding a new section 2.6;
0
g. Renumbering the footnote in section 3.0 from ``15'' to ``16'';
0
h. Revising section 4.1.b., redesignating section 4.1.e. as section
4.1.f., adding a new section 4.1.e., and revising newly redesignated
section 4.1.f.;
