[Federal Register Volume 70, Number 221 (Thursday, November 17, 2005)]
[Proposed Rules]
[Pages 69692-69709]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-22730]
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FARM CREDIT ADMINISTRATION
12 CFR Parts 652 and 655
RIN 3052-AC17
Federal Agricultural Mortgage Corporation Funding and Fiscal
Affairs; Federal Agricultural Mortgage Corporation Disclosure and
Reporting Requirements; Risk-Based Capital Requirements
AGENCY: Farm Credit Administration.
ACTION: Proposed rule.
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SUMMARY: The Farm Credit Administration (FCA, Agency, us, or we) is
proposing to amend regulations governing the Federal Agricultural
Mortgage Corporation (Farmer Mac or the Corporation). Analysis of the
Farmer Mac risk-based capital stress test (RBCST or the model) in the 3
years since its first official submission as of June 30, 2002, has
identified several opportunities to update the model in response to
changing financial markets, new business practices and the evolution of
the loan portfolio at Farmer Mac, as well as continued development of
best-industry practices among leading financial institutions. The
proposed rule focuses on improvements to the RBSCT by modifying
regulations found at 12 CFR part 652, subpart B. The effect of the
proposed rule is intended to be a more accurate reflection of risk in
the model in order to improve the model's output--Farmer Mac's
regulatory minimum capital level. The proposed rule also makes one
clarification relating to Farmer Mac's reporting requirements at 12 CFR
655.50(c).
DATES: You may send us comments by February 15, 2006.
ADDRESSES: Send us your comments by electronic mail to [email protected], through the Pending Regulations section of our Web site
at http://www.fca.gov, or through the Government-wide Web site http://www.regulations.gov. You may also submit your comments in writing to
Robert Coleman, Director, Office of Secondary Market Oversight, Farm
Credit Administration, 1501 Farm Credit Drive, McLean, VA 22102-5090,
or by facsimile transmission to (703) 883-4477.
You may review copies of comments we receive at our office in
McLean, Virginia, or from our Web site at http://www.fca.gov. Once you
are in the Web site, select ``Legal Info,'' and then select ``Public
Comments.'' We will show your comments as submitted, but for technical
reasons we may omit items such as logos and special characters.
Identifying information you provide, such as phone numbers and
addresses, will be publicly available. However, we will attempt to
remove electronic-mail addresses to help reduce Internet spam.
FOR FURTHER INFORMATION CONTACT:
Joseph T. Connor, Associate Director for Policy and Analysis, Office of
Secondary Market Oversight, Farm Credit Administration, McLean, VA
22102-5090, (703) 883-4280, TTY (703) 883-4434; or
Joy Strickland, Senior Counsel, Office of the General Counsel, Farm
Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703)
883-4020.
SUPPLEMENTARY INFORMATION:
I. Purpose
The purpose of this proposed rule is to revise the risk-based
capital (RBC) regulations that apply to Farmer Mac. The substantive
issues addressed in this
[[Page 69693]]
proposed rule are: Miscellaneous income estimates, operating expense
estimates, counterparty risk on non-program investments, the resolution
timing for troubled loans and associated carrying costs, the treatment
for income related to gain on sale of agricultural mortgage-backed
securities (AMBS), the treatment of certain loan data for modeling
purposes,\1\ and the estimation of credit risk in the Long-Term Standby
Purchase Commitment (Standby) portfolio.
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\1\ This includes loan data where certain origination data are
not collected by Farmer Mac as well as other data anomalies or
ambiguous loan data.
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The RBC rule contains language that anticipates the need for
continuing changes to the model over time in an effort to adapt the
model to Farmer Mac's actual operations on an on-going basis to the
extent practicable. The Office of Secondary Market Oversight (OSMO) is
also interested in updating the model in future rulemakings to respond
to opportunities created by the continued evolution in techniques
available for modeling risk-based capital requirements.
Further, consistent with the FCA Chairman and Chief Executive
Officer's (CEO) letter to Congress on actions taken or to be taken in
response to the Government Accountability Office (GAO) report entitled,
``Farmer Mac: Some Progress Made, but Greater Attention to Risk
Management, Mission, and Corporate Governance Is Needed'' (Report),\2\
the regulatory development process also included consideration of all
comments and recommendations in the Report pertaining to the RBCST.
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\2\ United States General Accounting Office, Farmer Mac: Some
Progress Made, but Greater Attention to Risk Management, Mission,
and Corporate Governance Is Needed, GAO-04-116 (2003). At the time
of the report's publication, the GAO was known as the General
Accounting Office.
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II. Background
Analysis of the Farmer Mac RBCST since its first official
submission as of June 30, 2002, has identified several opportunities to
update the model in response to changing financial markets, new
business practices and from the evolution of the loan portfolio at
Farmer Mac, as well as continued development of best-industry practices
among leading financial institutions. We have divided the changes into
two broad categories that we label ``technical'' and ``substantive.''
Technical changes are those we may implement without rulemaking and
that do not require FCA Board action. We incorporated several such
technical changes in December 2002, June 2004, and August 2005, and
implemented them as Versions 1.1, 1.2, and 1.25 of the RBCST,
respectively. These technical changes, and other Call Report-related
changes, are detailed later in this preamble. This proposed rule makes
substantive changes that require formal rulemaking procedures and FCA
Board approval to implement.
III. Objectives
The FCA, through this proposed rule, seeks to update and refine the
RBCST. Our goal is to ensure that the RBCST reflects changes in the
Corporation's business structure and loan portfolio that have occurred
since the model was originally developed by FCA, while complying with
the statutory requirements and constraints on the model's design.
IV. Overview
The changes are summarized below.
A. Modify the RBCST's treatment of loans for which Farmer Mac does
not collect certain loan origination data required by the model because
of the loan product type and related underwriting requirements (e.g.,
seasoned and fast-track loans). The proposed revision would use loan
proxy data to estimate loan level losses rather than applying state-
level average loss rates to such loans. The proposed revision also
includes the use of data proxies when certain data anomalies are
identified or other ambiguous data conditions are present.
B. Revise the treatment of Standby loans for which loan origination
data needed by the model are available. Currently, the model treats all
Standby loans as if they are seasoned loans for which the loan
origination data needed for RBCST purposes are not available. Average
loss rates by-state estimated from other loans are applied to Standby
loans located in the same state. The proposed rule would improve the
loss estimation method applied to Standby loans by applying an approach
similar to that applied to the rest of the loan portfolio.
C. Change the method used to estimate future years' miscellaneous
income from a fixed rate of 2 basis points of total assets to the 3-
year average of the annualized actual miscellaneous income for each
quarter as a percent of the sum of: Cash, investments, guaranteed
securities, and loans held for investment. This change is consistent
with the regulation's goal to reflect Farmer Mac's actual operations,
as much as practicable.
D. Revise the variables in the regression formula used to calculate
operating expense coefficients to more completely reflect Farmer Mac's
cost. Operating expense coefficients are used to estimate future years'
operating expenses.
E. Revise the model's estimate of gain on sale of AMBS from a fixed
rate of 0.75 percent of new Farmer Mac I program volume to a rolling 3-
year weighted average of actual gain levels experienced by Farmer Mac.
F. Change the model's assumption concerning loan loss resolution
timing. The proposed revision reflects the stress associated with
carrying costs on non-performing loans based on Farmer Mac's actual
experience resolving troubled loans.
G. Adjust the model's estimate of income on non-program investments
to reflect counterparty risk. We propose the application of discounts
or ``haircuts'' to the yields on individual investments, scaled
according to their credit ratings. FCA's consideration of such an
adjustment was suggested in the October 2003 GAO Report.
H. Publish all prior technical changes, including those implemented
in December 2002 (RBCST Version 1.1), June 2004 (RBCST Version 1.2),
and August 2005 (RBCST Version 1.25).
I. Make other technical changes including improved formatting and
clarity of labeling in certain cells of the RBCST worksheets and
deletion of Sec. 652.100 which is no longer relevant as it dealt with
the date the original final rule on the RBCST became effective.
V. Issues, Options Considered, and Proposed Revisions
We have identified several items that require regulatory attention
to amend or clarify the final rule published on April 12, 2001 (66 FR
19048). Below is a detailed explanation of all changes considered and
proposed.
1. Treatment of Loans for Which Origination Data Are Not Collected by
Farmer Mac
There is a significant portion of Farmer Mac's portfolio for which
loan origination data required by the model are not collected by Farmer
Mac under its underwriting requirements. The RBCST was designed to use
loan data at origination. While not always necessary for underwriting
purposes, loan origination data is important to the functioning of the
model.
The RBCST uses a predictive equation to estimate the probability of
default (PD) for each loan held or securitized by Farmer Mac as well as
those underlying Standby contracts. The predictive equation is based on
variables representing data at loan origination for each loan's debt-
to-asset ratio, current ratio, loan-to-value ratio (LTV), and debt
service coverage ratio, as well as
[[Page 69694]]
inflation-adjusted loan size and worst-case rates of decline in
farmland values. The PD estimated for each loan is combined with a
loss-given-default estimate and loan size to determine expected loss.
The loan loss is then adjusted for seasoning to account for a decline
in PD as a loan ages. The RBCST then processes losses, together with
other factors, to determine Farmer Mac's risk-based capital
requirement. This approach to estimating PDs requires data at loan
origination for the financial variables associated with each loan.
Currently, the RBCST separates Farmer Mac's portfolio into two
groups referred to as ``Cash Window'' loans and Standby loans. Cash
Window loans are loans held for investment and loans that underlie
guaranteed securities, and Standby loans are loans that underlie
Standby contracts. This segmentation was originally made to reflect
Farmer Mac's business and loan underwriting practices when FCA
developed the RBCST. At that time, Cash Window loans were newly
originated full-time farm loans on which origination underwriting data
were consistently available. Standby loans, on the other hand, were
primarily highly seasoned Farm Credit System loans for which
origination underwriting data were not available. Similarly, the
business processes that pertain to Cash Window and Standby loans
differed. Cash Window loans were generally processed by Farmer Mac on a
loan-by-loan basis and held in a loan pool until sufficient volume was
attained to permit securitization as an AMBS. Standby loans were
largely underwritten on a pool basis and subject to a due diligence
review. Therefore, the RBCST's portfolio segmentation was designed to
treat Cash Window loans and Standby loans differently to reflect their
operational differences. In versions 1.25 and earlier, the RBCST
directly applies the estimated loss rates to individual Cash Window
loans. For Standby loans, the RBCST indirectly applies these rates to
individual loans following the specialized treatment discussed below.
During initial development of the RBCST in 1998, origination
financial data were available on a majority (approximately 88 percent)
of Farmer Mac's Cash Window loans, excluding pre-1996 loans. Since
then, Farmer Mac's loan portfolio has evolved such that several of its
loan products do not require collection of origination financial data.
For instance, Farmer Mac has established specialized underwriting
standards for Fast Track (i.e., reduced documentation loans), seasoned,
and part-time farm loans that exclude the collection of certain
origination loan data used for RBCST purposes in recognition of
acceptable alternative underwriting criteria. Total growth in these
loan types, especially seasoned loans, has outpaced other types in the
years since the model was first designed. Due to this growth, the
proportion of loans with incomplete underwriting data has increased. As
a result, the current treatment of applying average state-level loss
rates estimated from other loans within the portfolio is applied to a
significant proportion of the total loan portfolio. We recognize that
collecting origination financial data used for RBCST purposes on all
loan products may be impractical. Therefore, we propose modifying the
current treatment of such loans to apply loan data proxies that
conservatively reflect Farmer Mac's underwriting criteria and
practices.
In describing the revisions, we will first discuss revisions for
Cash Window loans and address Standby loans in the following section of
this preamble as a separate improvement to the RBCST.
Under this proposed rule, the RBCST would substitute conservative
proxies when the necessary loan origination data is unavailable. The
conservative proxies reflect the higher end of the range of acceptable
LTV and debt-to-asset ratios, and the lower end of the range of
acceptable debt service coverage (DSC) ratios according to Farmer Mac's
underwriting criteria. The proxy values to be applied are as follows:
Debt-to-asset ratio of 0.60, LTV ratio of 0.70, and DSC ratio of 1.20.
The conservative proxies relate directly to Farmer Mac's
underwriting standards thereby serving as another aspect of the
proposed rule that draws on Farmer Mac's actual operations to enhance
the RBCST. Using conservative proxy data preserves the theoretical and
structural integrity of the RBCST and maintains consistency with
statutory requirements for a stressful, worst-case scenario.
In addition, we propose application of the proxy data to data
anomalies that occasionally occur in large sets of loan level data.
Several conditions under which an anomaly would be identified are
described in section 4.1, paragraph d.(3)(A) of the Technical Appendix
to this proposed rule along with the proxy data that would be applied
in each case.
Other loan data adjustments would be made in response to certain
unique situations. These deal with rare instances where an origination
date field might be blank, purchase or commitment date fields are
blank, or the original loan balance is less than the current scheduled
loan balance. For example, if the original loan balance field is blank
or is less than the scheduled loan balance, the RBCST will use the
scheduled (current) loan balance for modeling purposes. In such cases,
when alternative loan balance data are used, the RBCST will substitute
the ``cut-off'' date (i.e., the date the loan was guaranteed or placed
under a Standby agreement) for the origination date for that loan for
purposes of the seasoning adjustment. In addition, the model uses the
cut-off date when the loan origination date field is blank for lack of
any other data to use in the model's seasoning adjustment. Because it
would not be possible to compile an exhaustive list of data anomalies,
the proposed rule reserves FCA's authority to require an explanation
from Farmer Mac on other data anomalies and to apply the proxy data to
such data until the anomaly is addressed by Farmer Mac.
2. Revise the Treatment of Standby Loans
As discussed in the previous section, loans underlying a Standby
agreement receive specialized treatment by the RBCST Versions 1.25 and
earlier. Rather than modeling loan-specific data, the average state-
level loss rates determined from the Cash Window loan portfolio are
applied to Standby loans based on the state in which the property is
located. The loans are then seasoned based on their age from
origination date. We adopted this treatment in response to the
characteristics of Standby loans at the time the RBCST was developed.
At that time, nearly all Standby loans were seasoned and origination
financial data were not readily or consistently available from the
originating FCS institution. Because the volume of the Standby program
was not high at the time we developed the RBCST, and because the
Standby loans were generally highly seasoned, it was deemed appropriate
to establish a separate treatment for Standby loans that based losses
on loans estimated using the Cash Window portfolio. However, given the
availability of the newly proposed data proxies described above, it is
now deemed more appropriate to treat Standby loans in a similar manner
to Cash Window loans when estimating credit risk. In addition, Farmer
Mac's Standby portfolio now includes more unseasoned loans for which
loan origination data are available but are not currently used to
estimate losses under the model's current treatment of Standby loans.
We propose to remove the specialized treatment of Standby loans and
treat these loans in the same manner as Cash Window loans with the
exception of seasoned Standby loans. Loans for
[[Page 69695]]
which origination data are available would be processed using those
data. Standby loans for which origination data are not available or
where data anomalies are identified would receive the same proxy data
used for Cash Window loans. Seasoned Standby loans where data are
available will receive the proxy data in light of Farmer Mac's practice
of populating origination data fields with ``cut off'' data for such
loans. ``Cut off'' data are data as of the date the loan was taken into
Farmer Mac's portfolio. As a result, the RBCST would apply the loss-
frequency model and loss-severity factor to all loans both Standby and
Cash Window. This change would yield a more complete measure of credit
risk of unseasoned Standby loans and compensate for the uncertainty
associated with missing data on Standby loans.
3. Revise the Treatment of Miscellaneous Income
Currently, the RBCST estimates Farmer Mac's miscellaneous income
over the 10 years of the model's time horizon as 2 basis points of
total assets. This estimate was considered adequate because it
approximated the historical average over the years prior to the model's
development. Moreover, the amounts estimated were not significant. We
propose to change the estimate of future years' miscellaneous income to
the 3-year weighted average of actual miscellaneous income in each
quarter divided by that quarter's actual sum of: Cash, investments,
guaranteed securities, and loans held for investment. This change is
consistent with the goal to reflect, as much as practicable, Farmer
Mac's actual operations on an on-going basis, as it will be updated
quarterly with Farmer Mac's most recent actual miscellaneous income
experience.
The benefits of this proposed change are that it will:
(1) Build in an on-going adjustment to the estimate based on recent
experience;
(2) Be easily understood;
(3) Add transparency to the miscellaneous income estimate; and
(4) Be consistent with the current rule's intent to simulate Farmer
Mac's operations to the maximum extent practicable.
4. Revise the Treatment of Gain on Sale of AMBS
The proposed rule revises the methodology used to estimate future
years' gains on the sale of AMBS, thus improving the model's ability to
reflect Farmer Mac's current operations on an on-going basis.
Previously, the model credited Farmer Mac with income of 0.75 percent
of new Farmer Mac I program volume as estimated by the backfilling of
loan volume in accordance with the steady-state scenario. However,
recent trends in Farmer Mac's operations demonstrate that AMBS sales
are more sporadic. The revised approach reflects the gain rates most
recently experienced in Farmer Mac's operations by establishing a new
input in the Data Inputs worksheet for ``Gain Rate on AMBS Sales'' and
applying that gain rate factor (expressed as the actual gain as a
percentage of the par value of the AMBS sold) to the dollar amount of
AMBS sold during the most recent 4 quarters. Applying the 3-year gain
rate factor to the most recent 4 quarters of activity appropriately
smoothes the variability in Farmer Mac's sales of AMBS for RBCST
purposes.
5. Revise the Operating Expense Regression Equation
The RBCST currently uses a regression equation to estimate
operating expenses in future years that relates historic Farmer Mac
operating expenses to a constructed variable reflecting loan and
investment volumes. The goal is to accurately reflect costs associated
with operating Farmer Mac as its program balances and investment levels
change without being overly influenced by random variations that can
reasonably occur in any given quarter. The structural model for
estimating operating expenses was developed soon after the 1996
legislation that resulted in Farmer Mac's current business structure.
As a result, the historic data can be divided into two time periods--
with one time period representing activity prior to their ability to
pool whole loans and hold loans on their balance sheet, and a second
period with their business activities focused more directly and
actively on loan-based activities. The data from the latter period had
much higher cost structures than the former. To accommodate the data
structure while retaining the longest sample period possible, a
specification was adopted that included pre-1996 data with a dummy
variable that permitted an intercept shift or, equivalently, as two
segments of the regression with a ``jump'' in the fitted line at the
point of the changes in cost structure related to the 1996 legislation.
Additionally, it seemed reasonable to consider a structure that
recognized economies of scale, assuming incremental business additions
could be underwritten at lower marginal costs. As a result, a structure
was adopted relating the logarithm of the sum of loans and investments
to actual operating expenses with a dummy variable separating the pre-
and post-1996 data periods.
Considerable data have accumulated since the operating expense
regression was developed. Therefore, it is appropriate to develop a
more complete representation of Farmer Mac's business activities at
this point. We have considered: (a) The appropriate historic data
period, (b) specific business segments and activities to include as
explanatory variables, (c) the potential for seasonality in the expense
structure, (d) the potential automation of the estimation of the
coefficients within the RBCST, and (e) the need to utilize existing
data structures and accounting conventions to the degree reasonable
(i.e., the potential difficulty with reconstructing some historic data
series related to changed business segments).
The Agency believes that a more complete characterization of the
expense structure of Farmer Mac can be specified by separating the
business activities that contribute to variation in annualized expenses
into:
(i) On-balance sheet investments,
(ii) On-balance sheet guaranteed securities,
(iii) The sum of off-balance sheet loans in the Farmer Mac I and
Farmer Mac II programs, and
(iv) Gross real estate owned (REO).
The use of the multiple regressors obviates the need for the dummy
variable. The inclusion of REO captures a possible high-cost segment of
their business and provides a direct linkage between problem loans and
higher operating costs. To reflect economies of scale, the independent
variables are expressed on a logarithmic scale. The proposed
specification and attendant revision in the RBCST utilize the following
expression:
Expensest = [alpha] + [beta]1ln(OnFt)
+ [beta]2ln(OnGSt) +
[beta]3ln(OnIt + OffIIt) +
[beta]4ln(OnREOt)
Where ``t'' indicates time period in the model, ``OnF'' represents on-
balance sheet investments, ``OnGS'' represents on-balance sheet
guaranteed securities, ``OffI'' and ``OffII'' represent off-balance
sheet Farmer Mac I and II program loans, respectively, and ``REO''
represents gross real-estate owned. The in-sample fit is improved with
this specification relative to the previously required approach for
comparable data periods. Tests of the appropriate sample period for
estimation are roughly comparable when using either complete available
sample period data or data from quarters after the 1996 legislation and
the establishment of the RBC
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requirement. As under the current RBCST, Farmer Mac must re-estimate
the coefficients quarterly and supply the coefficients and worksheet as
part of its quarterly submission.
6. Improve Estimates of Carrying Costs of Troubled Loans by Revising
Assumptions Regarding Loan Loss Resolution Timing
The RBCST was developed with a loss-severity estimate that assumes
it would take Farmer Mac 1 year to work through problem loans from the
point of default through final disposition. At the time of development
of the RBCST, historical problem loan resolution timing data from
Farmer Mac were not available. Farmer Mac data now indicate that
problem loans may take longer to resolve than the 1 year assumed in the
model's loss-severity rate.\3\ If the time interval is longer than the
current model's assumption, the capital needs for carrying non-
performing assets in the model are likely understated in the current
model. Therefore, we propose to reflect costs associated with any
additional loan loss resolution time (LLRT) period (i.e., the period
beyond the 1-year period assumed in the loss-severity rate) in the
model.\4\
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\3\ Farmer Mac provided data on historical problem loan
resolution timing which were used by FCA to estimate the time
interval for problem loan resolution. As additional data become
available, FCA may recalculate the LLRT interval.
\4\ The LLRT period is equal to the period of time in excess of
the portion of carrying costs already assumed in the RBCST's loss-
severity rate. The loss-severity rate is assumed to incorporate
losses associated with a period of 1 year of carrying defaulted
loans and, thus, the LLRT period is equal to the FCA-determined
actual period minus one.
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With the exception of the 1-year period assumed in the loss-
severity rate, the current RBCST under a steady-state scenario requires
backfilling of problem loan volume with like assets, without
recognizing any additional cost associated with carrying loans as non-
earning, but funded, assets. Under the proposed rule, the RBCST will
now reflect costs associated with the LLRT period. The change would be
incorporated into the RBCST as follows. Off-balance sheet loans
associated with losses are assumed to be purchased from the Standby
portfolio and fully funded at the short-term cost of funds rate used in
the model, and no associated guarantee fee is generated. The short-term
cost of funds (adjusted to incorporate interest rate shock effects) is
used to estimate this additional funding cost in recognition of Farmer
Mac's actual business practices. On-balance sheet loans generating
losses are also removed from the interest earnings calculations and
continue to generate interest expense at the blended cost of long- and
short-term funds (again adjusted to incorporate interest rate shock
effects) for the LLRT period. The model would continue to backfill new
loans at the point of loan resolution to retain its steady-state
specification.
The proposed revisions involve two principal changes from the
current RBCST. First, the date of backfill would be moved to a point in
time that more accurately reflects Farmer Mac's actual experience. The
model would then capture the additional costs of carrying loans in a
non-interest earning category on the balance sheet. Second, the
guarantee fee income would only be generated on performing loan
guarantees and commitments. The LLRT becomes a line item in the Data
Inputs worksheet. The initial LLRT will be set by FCA based on Farmer
Mac historical data. The Corporation has not had a significant number
of problem loans that have gone through the full resolution process
from which to determine the LLRT for RBCST purpose. Nevertheless, the
Agency has consistently designed the RBCST to reflect Farmer Mac data
and its actual experience when available. The proposed treatment
reflects the data currently available from Farmer Mac on the resolution
of troubled loans. If Farmer Mac establishes a pattern of faster or
slower resolution of troubled loans in the future, we will consider
adjustments to the LLRT at that time.
The proposed LLRT revisions are forward-looking only. In other
words, actual loans that defaulted in year zero and are in their second
year of non-performing status in year 1 of the model's 10-year time
horizon are not included in the proposed LLRT revision, and therefore
no adjustment to restate current balance sheet amounts is required. An
approach involving such a restatement was considered but deemed to add
an unnecessary degree of complexity to the model. We note that the
revision to more accurately reflect the carrying cost of non-performing
loans results in less additional stress under a down-rate interest rate
shock than under an up-rate shock. This result is logical as it would
be less costly to fund non-performing loans when interest rates are
relatively low.
One further calculation is necessary to complete the proposed LLRT
revision. Implementation of the LLRT revision requires an estimate of
loan amortization to estimate the additional carrying cost associated
with the LLRT period by applying the appropriate cost of funds to a
loan's remaining balance at the time of default. We use the portfolio
average principal amortization to make this adjustment (i.e., total
portfolio current scheduled principal balance divided by total
origination balance). The LLRT scaling factor is calculated in the
Credit Loss Module as the ratio of total portfolio current scheduled
principal balance divided by total origination balance divided by the
loss-severity factor (0.209). This approach results in the calculation
of a stressed level of nonperforming loan volume based on the credit
losses estimated by the RBCST.
7. Add a Component To Reflect Counterparty Risk
Currently, the RBCST does not include a component to reflect
counterparty risk on Farmer Mac's portfolio of investment securities,
and derivatives. We propose adopting a system of haircuts to the yields
on investment securities, scaled according to credit ratings--with
greater haircuts applied to lower credit ratings. The risk-based
capital regulations of the Office of Federal Housing Enterprise
Oversight (OFHEO) (12 CFR part 1750) established a precedent for the
levels of such haircuts. OFHEO defines five levels of credit ratings
from ``AAA'' to ``below BBB and unrated.'' They assign each of the
nationally recognized statistical rating organizations' (NRSRO) rating
categories to one of the four OFHEO general rating categories. With
these definitions specified, rate haircuts are applied by OFHEO to the
securities in the investment and derivatives portfolios of its
regulated enterprises.
In assessing the counterparty risk associated with non-program
investments, OFHEO examined Depression-era default rates (1929 to 1931)
\5\ and a study completed for the National Bureau of Economic Research
(NBER) in the 1950's.\6\ OFHEO's haircut levels recognize recoveries on
defaulted instruments, an adjustment that was also based on Depression-
era data. Thus, haircut levels were derived based on default rates
multiplied by severity rates. For all counterparties, the default rates
used were 5 percent for AAA, 12.5 percent for AA, 20 percent for A, 40
percent for BBB and 100 percent for below BBB or unrated. Severity
rates used were 70 percent for nonderivative securities, yielding net
haircuts of 3.5 percent, 8.75 percent, 14.0 percent, and 28.0 percent
for ratings AAA through
[[Page 69697]]
BBB, respectively. One hundred percent haircuts are applied to the
``BBB or unrated'' category. The haircuts are applied on a weighted-
average basis as reductions in the weighted-average yields of non-
program investment categories.
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\5\ Keenan, S., Carty L., Shtogrin I., ``Historical Default
Rates of Corporate Bond Issuers, 1920-1997,'' published by Moody's
Investor's Services, February 1998.
\6\ Hickman, W. Braddock, ``Corporate Bond Quality and Investor
Experience,'' A Study by the National Bureau of Economic Research,
Princeton University Press, Princeton, 1955.
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We also considered OFHEO's phase-in of the haircuts and believe
such a phase-in is appropriate for the RBCST as well. The rationale for
the phase-in is based on the assumption that defaults on investments in
response to a general downturn in the economy would not be
instantaneous but on a more random basis through time. Therefore, the
Agency proposes to phase-in the haircuts on a linear basis over the
RBCST's 10-year time horizon. Further, we elected not to assign the
rating of a parent company to its unrated subsidiary. This treatment is
consistent with the OFHEO rule, which defends this policy on the basis
that (a) NRSROs will not impute a corporate parent's rating to a
derivative or credit enhancement counterparty in the context of a
securities transaction, and (b) to extend that rating to the unrated
subsidiary would be tantamount to the regulator rating the subsidiary.
We propose to apply these haircuts on a weighted-average basis by
investment categories established in the ``Data Inputs'' worksheet of
the RBCST, e.g., commercial paper, corporate debt and asset-backed
securities, agency mortgaged-backed securities and collateralized
mortgage obligations. This proposal requires the Corporation to
calculate the weighted-average haircut by investment category to be
applied to the weighted-average yields for each investment category and
input the haircuts into the ``Data Inputs'' worksheet. The proposed
haircuts are set forth in the Table in paragraph e. of section 4.1 in
the Technical Appendix.
Stress that impacts Farmer Mac would reasonably be expected to
affect its terms of access to the swap market. Therefore, we considered
adopting a similar haircut on derivative securities.\7\ However, while
the OFHEO regulation applies haircuts to derivatives, we do not propose
to do so at this time. Our reasoning is based on our preference for a
different approach to haircutting derivatives that reflects lost
payments from derivative securities in a net-receive position, as well
as the additional expense associated with the replacement of derivative
positions when the counterparty has defaulted and the market value of
the derivative has increased since the date the defaulted derivative
contract was executed. Such an increased market value would be to
Farmer Mac's benefit when the counterparty does not default, but to its
detriment when it does. The Agency will address this risk in future
revisions of the RBCST and specifically requests comment on the most
appropriate approach to incorporate such ``replacement cost'' risk into
the RBCST.
---------------------------------------------------------------------------
\7\ The term ``derivative'' refers to over-the-counter financial
derivative instruments used by Farmer Mac to hedge interest rate
risk and synthetically extend the term structure of its debt to
reduce funding costs.
---------------------------------------------------------------------------
8. Provide Public Notice of Technical Changes to the RBCST
In December 2002, the Agency modified the RBCST with four technical
changes. The changes resulted in the release of FARMER MAC RBCST
Version 1.1.xls, which was uploaded for public access on the FCA Web
site in the same month and first used by Farmer Mac for its December
31, 2002, submission. FARMER MAC RBCST Version 1.2 incorporates an
individual change to the calculation of regulatory capital held by
Farmer Mac and was implemented in June 2004. FARMER MAC RBCST Version
1.25 completed the changes in Version 1.2 to fully accommodate the
format of Farmer Mac's balance sheet after its adoption of FASB
Financial Interpretation 45 (FIN 45) in August 2005. The changes are
summarized below.
(i) Added two line items in the Data Inputs worksheet for Real
Estate Owned (REO), one for ``gross'' REO and the other ``net'' of
allowances for losses on REO assets. This change in the RBCST balance
sheet was made to adapt the model to the new balance sheet reporting
format in Farmer Mac's financial statements. The change also corrects
the amount of REO that is captured in assets-subject-to-loss on the
Loan and Cashflows worksheet. Gross REO, not net REO, is now added into
assets-subject-to-loss.
(ii) Corrected the ``base-case'' interest rate used in measuring
interest rate risk on the Risk Measures worksheet. The Act requires
that the model apply ``shocks'' to current interest rates at the lesser
of 600 basis points or 50 percent of average interest rates on Treasury
obligations in order to gauge Farmer Mac's sensitivity to interest rate
risk. Previously, the model's base-case was calculated applying the
shock to the 12-month average Constant Maturity Treasury rate (CMT)
instead of the 3-month average CMT as required by the regulation. The
change makes the model more consistent with the language in the
original regulation.
(iii) Added the line item for ``Gain/Loss on Available for Sale
Assets'' in the balance sheet. The RBCST ignores these gains and losses
for purposes of calculating income because they do not represent actual
cash flows. However, they must be presented in the balance sheet to
maintain balanced financial statements and for accuracy of disclosure.
This changes only the presentation of the model's balance sheet and has
no impact on the regulatory capital requirement.
(iv) Corrected the method of distributing credit losses over time.
The formula to distribute losses on new loan volume previously
allocated the impact of those losses over all 10 years of the model's
projected time horizon. For example, a small portion of losses on new
loan volume in year 5 was recognized in years 1, 2, 3, and 4 of Version
1.0. The change correctly associates losses on each year's estimated
new loan originations across the remaining years in the 10-year period.
(v) Recently, Farmer Mac changed the reporting format of its
balance sheet in order to adopt the Financial Accounting Standards
Board Interpretation No. 45 (FIN 45). The change resulted in the RBCST
misstating Farmer Mac's regulatory capital held. To correct this, we
inserted a new data element for Farmer Mac to submit in the Data Inputs
worksheet of the RBCST, ``Contingent obligation for probable losses
under FIN 45.'' The new data input, combined with a new line item in
the balance sheet for the contra-asset account ``Allowance for Loan
Losses,'' will permit the RBCST to correctly gross up Farmer Mac's
generally accepted accounting principles (GAAP) equity to calculate its
regulatory capital held as follows:
RCapital = EquityGAAP - OCI + R + ALL + C
Where:
RCapital = Regulatory Capital Held
EquityGAAP = Equity according to GAAP
OCI = Other Comprehensive Income
R = Reserves for Loan Losses
ALL = Allowance for Loan Losses
C = Contingent obligation for Probable Losses under FIN45
This change was implemented in June 2004 as FARMER MAC RBCST
Version 1.2.
(vi) FARMER MAC RBCST Version 1.25 was implemented to complete the
modifications necessary as a result of Farmer Mac's reporting format
changes after the adoption of FIN 45. It ensures that the income
generator references the appropriate fractions of all relevant balance
sheet accounts for purposes of projecting income over the model's 10-
year time horizon.
[[Page 69698]]
(vii) Currently Sec. 652.85(d) requires the RBCST to be submitted
quarterly not later than the last business day of April for the quarter
ended March 31, July for the quarter ended June 30, October for the
quarter ended September 30, and January for the quarter ended December
31. OSMO recently formally incorporated the RBCST submission into the
Farmer Mac Call Report, which is due by the date of Farmer Mac's filing
of its quarterly Form 10-Q, or annual Form 10-K, with the Securities
and Exchange Commission. Therefore, we propose to revise the rule by
changing the RBCST submission deadline as follows. The RBCST submission
will be due on the date of the filing of Farmer Mac's SEC Form 10-Q or
10-K, but no later than the 40th day after the quarter's ending March
31, June 30, and September 30, and the 60th day after the quarter
ending on December 30. This technical change was implemented in the
Call Report submitted for the first quarter of 2004.
9. Stressed-Based Cost of Funds Increment
It is reasonable to assume that a crisis in the agriculture sector
that generates worst-case historical loan loss levels would have an
impact on Farmer Mac's cost of funds. We considered alternative
approaches to reflect the possible impact on funding spreads of
significant stress to FAMC. For example, the cost of funds data used in
the RBCST could be adjusted to correspond to the maximum spreads over
U.S. Treasury securities of comparable maturity that were experienced
by the Farm Credit System during the worst-case credit risk conditions
of the 1980s. According to findings of Duncan and Singer, the worst-
case historical stressful spreads over treasuries for comparable
maturity Farm Credit System issuances were 138 basis points for 6-month
securities, 130 basis points for 1-year securities, 115 basis points
for 3-year securities, and 95 basis points for 5-year securities.\8\
---------------------------------------------------------------------------
\8\ Duncan, D. and M. Singer, ``The Farm Credit System Crisis
and Agency Security Yield-Spread Response'' Agricultural Finance
Review, 1992: 30-42.
---------------------------------------------------------------------------
The spreads in the RBCST could reflect these increased levels with
an adjustment to account for Farmer Mac's current holdings of non-
program investments relative to those held by the FCS institutions at
the time of maximum stress.
FCA requests specific comments on an appropriate methodology to add
stress to funding spreads in the RBCST. In particular, we request
suggestions on how best to incorporate differences in the relative risk
in the portfolios of the FCS and Farmer Mac as it relates to expected
cost of funds differences between the two entities, including how one
might scale the on-going changes in the risk of Farmer Mac's portfolio
to moderate or amplify the stressful cost of funds spread.
10. Recognition of Risk on AgVantage Bonds
We considered applying the haircuts on non-program investments to
AgVantage bonds because, despite their status as program assets, they
exhibit many characteristics of investment securities. The model does
not currently recognize risk associated with these assets or the loan
collateral associated with them. We rejected that approach because
AgVantage bonds are securities representing an interest in a pool of
qualified loans. The statute requires losses on such loans to be
estimated in a manner similar to the credit risk on other program
assets.
AgVantage bonds are secured by either a general pledge of
collateral that constitutes a representation and warranty of the
availability of unencumbered qualified loan assets, or a specific
pledge of qualified loans which, however, may be freely substituted at
any time. Submitting loan-level data on AgVantage loan collateral for
loss estimation is either not possible for lack of specifically
identified loans, or subject to inaccuracy due to specific loans being
replaced at any time, or simply impractical in terms of cost. The
AgVantage program accounts for a very small portion of total program
loan volume, and the proposed rule makes no change to the treatment of
AgVantage assets. However, we specifically request comment on the
question of how best to modify the RBCST in future rulemakings to
consider the risk of AgVantage bonds.
11. Impact of Proposed Changes on Required Capital
We evaluated the impact of the proposed changes to the currently
active version of the model, Version 1.25. Our tests indicated that
changes related to the data proxies, the treatment of Standby loan
portfolio, and the LLRT would have the most significant impact on
minimum regulatory capital calculated by the model. The table below
provides an indication of the impact of the revisions in the quarter
ended June 30, 2005. Lines 1 through 6 present the impacts if only that
revision were made to the current version and the column labeled
``Difference'' calculates the impact of that individual change for the
quarter ended June 30, 2005, compared to the minimum requirement
calculated using the currently active Version 1.25. Line 7 presents the
impact of all proposed revisions in Version 2.0. As the table shows,
the individual change 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 2.0.
------------------------------------------------------------------------
------------------------------------------------------------------------
Calculated Regulatory Minimum Capital 6/30/2005 Difference
-----------------------------------------
RBCST Version 1.25 (calculated as of 6/ 49,605 ..............
30/2005)
-----------------------------------------
RBCST 2.0 Individual Change Impacts:
(1) CLM Changes: Data Proxies and 75,665 26,060
Standby Treatment..................
(2) Miscellaneous Income Treatment.. 45,468 (4,137)
(3) Gain on Sale of AMBS............ 49,605 ..............
(4) Investment Haircuts............. 51,737 2,131
(5) Loan Loss Resolution Timing 76,956 27,350
(LLRT).............................
(6) Operating Expenses.............. 59,063 9,458
(7) Total RBCST Version 2.0 Impact.. 123,529 73,924
------------------------------------------------------------------------
As shown in the table, implementation of the LLRT carrying costs
and application of the data proxies result in the greatest impact on
the calculated risk-based capital requirements. The impact of using
loan data proxies reflects the conservative nature of the proxies and
to the modeling of all loans in the portfolio
[[Page 69699]]
compared to the current approach of applying state-level loss estimated
from certain loans to loan where loan origination data are unavailable.
The table also indicates that increases in the LLRT period result in
greater capital needs to offset the income and expense effects of
carrying nonperforming loan volume. The other proposed changes create a
more comprehensive representation of Farmer Mac operations for RBCST
purposes, though they are not as significant in their impact.
12. Change to Disclosure Regulations
We are also proposing one change to the disclosure regulations in
Sec. 655.50(c). We propose to remove the word ``should'' and replace
it with ``must'' to clarify that Farmer Mac must provide FCA with a
copy of substantive correspondence it files with the Securities and
Exchange Commission.
VI. Regulatory Flexibility Act
Pursuant to section 605(b) of the Regulatory Flexibility Act (5
U.S.C. 601 et seq.), FCA hereby certifies the 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 them as small entities. Therefore, Farmer Mac is not considered
a ``small entity'' as defined in the Regulatory Flexibility Act.
List of Subjects
12 CFR Part 652
Agriculture, Banks, Banking, Capital, Investments, Rural areas.
12 CFR Part 655
Accounting, Agriculture, Banks, Banking, Accounting and reporting
requirements, Disclosure and reporting requirements, Rural areas.
For the reasons stated in the preamble, parts 652 and 655 of
chapter VI, title 12 of the Code of Federal Regulations are proposed to
be amended as follows:
PART 652--FEDERAL AGRICULTURAL MORTGAGE CORPORATION FUNDING AND
FISCAL AFFAIRS
1. 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.
2. Add subpart B to part 652 to read as follows:
Subpart B--Risk-Based Capital Requirements
Sec.
652.50 Definitions.
652.55 General.
652.60 Corporation board guidelines.
652.65 Risk-based capital stress test.
652.70 Risk-based capital level.
652.75 Your responsibility for determining the risk-based capital
level.
652.80 When you must determine the risk-based capital level.
652.85 When to report the risk-based capital level.
652.90 How to report your risk-based capital determination.
652.95 Failure to meet capital requirements.
652.100 Audit of the risk-based capital stress test.
Appendix A--Subpart B of Part 652--Risk-Based Capital Stress Test
Sec. 652.50 Definitions.
For purposes of this subpart, the following definitions will apply:
Farmer Mac, Corporation, you, and your means the Federal
Agricultural Mortgage Corporation and its affiliates as defined in
subpart A of this part.
Our, us, or we means the Farm Credit Administration.
Regulatory capital means the sum of the following as determined in
accordance with generally accepted accounting principles:
(1) The par value of outstanding common stock;
(2) The par value of outstanding preferred stock;
(3) Paid-in capital, which is the amount of owner investment in
Farmer Mac in excess of the par value of stock;
(4) Retained earnings; and,
(5) Any allowances for losses on loans and guaranteed securities.
Risk-based capital means the amount of regulatory capital
sufficient for Farmer Mac to maintain positive capital during a 10-year
period of stressful conditions as determined by the risk-based capital
stress test described in Sec. 652.65.
Sec. 652.55 General.
You must hold risk-based capital in an amount determined in
accordance with this subpart.
Sec. 652.60 Corporation board guidelines.
(a) Your board of directors is responsible for ensuring that you
maintain total capital at a level that is sufficient to ensure
continued financial viability and provide for growth. In addition, your
capital must be sufficient to meet statutory and regulatory
requirements.
(b) No later than 65 days after the beginning of Farmer Mac's
planning year, your board of directors must adopt an operational and
strategic business plan for at least the next 3 years. The plan must
include:
(1) A mission statement;
(2) A review of the internal and external factors that are likely
to affect you during the planning period;
(3) Measurable goals and objectives;
(4) Forecasted income, expense, and balance sheet statements for
each year of the plan; and
(5) A capital adequacy plan.
(c) The capital adequacy plan must include capital targets
necessary to achieve the minimum, critical and risk-based capital
standards specified by the Act and this subpart as well as your capital
adequacy goals. The plan must address any projected dividends, equity
retirements, or other action that may decrease your capital or its
components for which minimum amounts are required by this subpart. You
must specify in your plan the circumstances in which stock or equities
may be retired. In addition to factors that must be considered in
meeting the statutory and regulatory capital standards, your board of
directors must also consider at least the following factors in
developing the capital adequacy plan:
(1) Capability of management;
(2) Strategies and objectives in your business plan;
(3) Quality of operating policies, procedures, and internal
controls;
(4) Quality and quantity of earnings;
(5) Asset quality and the adequacy of the allowance for losses to
absorb potential losses in your retained mortgage portfolio, securities
guaranteed as to principal and interest, commitments to purchase
mortgages or securities, and other program assets or obligations;
(6) Sufficiency of liquidity and the quality of investments; and,
(7) Any other risk-oriented activities, such as funding and
interest rate risks, contingent and off-balance sheet liabilities, or
other conditions warranting additional capital.
Sec. 652.65 Risk-based capital stress test.
You will perform the risk-based capital stress test as described in
summary form below and as described in detail in Appendix A to this
subpart. The risk-based capital stress test spreadsheet is also
available electronically at http://www.fca.gov. The risk-based capital
stress test has five components:
(a) Data requirements. You will use the following data to implement
the risk-based capital stress test.
(1) You will use Corporation loan-level data to implement the
credit risk component of the risk-based capital stress test.
[[Page 69700]]
(2) You will use Call Report data as the basis for Corporation data
over the 10-year stress period supplemented with your interest rate
risk measurements and tax data.
(3) You will use other data, including the 10-year Constant
Maturity Treasury (CMT) rate and the applicable Internal Revenue
Service corporate income tax schedule, as further described in Appendix
A to this subpart.
(b) Credit risk. The credit risk part estimates loan losses during
a period of sustained economic stress.
(1) For each loan in the Farmer Mac I portfolio, you will determine
a default probability by using the logit functions specified in
Appendix A to this subpart with each of the following variables:
(i) Borrower's debt-to-asset ratio at loan origination;
(ii) Loan-to-value ratio at origination, which is the loan amount
divided by the value of the property;
(iii) Debt-service-coverage ratio at origination, which is the
borrower's net income (on- and off-farm) plus depreciation, capital
lease payments, and interest, less living expenses and income taxes,
divided by the total term debt payments;
(iv) The origination loan balance stated in 1997 dollars based on
the consumer price index; and,
(v) The worst-case percentage change in farmland values (23.52
percent).
(2) You will then calculate the loss rate by multiplying the
default probability for each loan by the estimated loss-severity rate,
which is the average loss of the defaulted loans in the data set (20.9
percent).
(3) You will calculate losses by multiplying the loss rate by the
origination loan balances stated in 1997 dollars.
(4) You will adjust the losses for loan seasoning, based on the
number of years since loan origination, according to the functions in
Appendix A to this subpart.
(5) The losses must be applied in the risk-based capital stress
test as specified in Appendix A to this subpart.
(c) Interest rate risk. (1) During the first year of the stress
period, you will adjust interest rates for two scenarios, an increase
in rates and a decrease in rates. You must determine your risk-based
capital level based on whichever scenario would require more capital.
(2) You will calculate the interest rate stress based on changes to
the quarterly average of the 10-year CMT. The starting rate is the 3-
month average of the most recent CMT monthly rate series. To calculate
the change in the starting rate, determine the average yield of the
preceding 12 monthly 10-year CMT rates. Then increase and decrease the
starting rate by:
(i) 50 percent of the 12-month average if the average rate is less
than 12 percent; or
(ii) 600 basis points if the 12-month average rate is equal to or
higher than 12 percent.
(3) Following the first year of the stress period, interest rates
remain at the new level for the remainder of the stress period.
(4) You will apply the interest rate changes scenario as indicated
in Appendix A to this subpart.
(5) You may use other interest rate indices in addition to the 10-
year CMT subject to our concurrence, but in no event can your risk-
based capital level be less than that determined by using only the 10-
year CMT.
(d) Cashflow generator. (1) You must adjust your financial
statements based on the credit risk inputs and interest rate risk
inputs described above to generate pro forma financial statements for
each year of the 10-year stress test. The cashflow generator produces
these financial statements. You may use the cashflow generator
spreadsheet that is described in Appendix A to this subpart and
available electronically at http://www.fca.gov. You may also use any
reliable cashflow program that can develop or produce pro forma
financial statements using generally accepted accounting principles and
widely recognized financial modeling methods, subject to our
concurrence. You may disaggregate financial data to any greater degree
than that specified in Appendix A to this subpart, subject to our
concurrence.
(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. 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.
(3) You must simulate annual pro forma balance sheets and income
statements in the risk-based capital stress test using Farmer Mac's
starting position, the credit risk and interest rate risk components,
resulting cashflow outputs, current operating strategies and policies,
and other inputs as shown in Appendix A to this subpart and the
electronic spreadsheet available at http://www.fca.gov.
(e) Calculation of capital requirement. The calculations that you
must use to solve for the starting regulatory capital amount are shown
in Appendix A to this subpart and in the electronic spreadsheet
available at http://www.fca.gov.
Sec. 652.70 Risk-based capital level.
The risk-based capital level is the sum of the following amounts:
(a) Credit and interest rate risk. The amount of risk-based capital
determined by the risk-based capital test under Sec. 652.65.
(b) Management and operations risk. Thirty (30) percent of the
amount of risk-based capital determined by the risk-based capital test
in Sec. 652.65.
Sec. 652.75 Your responsibility for determining the risk-based
capital level.
(a) You must determine your risk-based capital level using the
procedures in this subpart, Appendix A to this subpart, and any other
supplemental instructions provided by us. You will report your
determination to us as prescribed in Sec. 652.90. At any time,
however, we may determine your risk-based capital level using the
procedures in Sec. 652.65 and Appendix A to this subpart, and you must
hold risk-based capital in the amount we determine is appropriate.
(b) You must at all times comply with the risk-based capital levels
established by the risk-based capital stress test and must be able to
determine your risk-based capital level at any time.
(c) If at any time the risk-based capital level you determine is
less than the minimum capital requirements set forth in section 8.33 of
the Act, you must maintain the statutory minimum capital level.
Sec. 652.80 When you must determine the risk-based capital level.
(a) You must determine your risk-based capital level at least
quarterly, or whenever changing circumstances occur that have a
significant effect on capital, such as exposure to a high volume of, or
particularly severe, problem loans or a period of rapid growth.
(b) In addition to the requirements of paragraph (a) of this
section, we may require you to determine your risk-based capital level
at any time.
(c) If you anticipate entering into any new business activity that
could have a significant effect on capital, you must determine a pro
forma risk-based capital level, which must include the new business
activity, and report this pro forma determination to the Director,
[[Page 69701]]
Office of Secondary Market Oversight, at least 10-business days prior
to implementation of the new business program.
Sec. 652.85 When to report the risk-based capital level.
(a) You must file a risk-based capital report with us each time you
determine your risk-based capital level as required by Sec. 652.80.
(b) You must also report to us at once if you identify in the
interim between quarterly or more frequent reports to us that you are
not in compliance with the risk-based capital level required by Sec.
652.70.
(c) If you make any changes to the data used to calculate your
risk-based capital requirement that cause a material adjustment to the
risk-based capital level you reported to us, you must file an amended
risk-based capital report with us within 5-business days after the date
of such changes;
(d) You must submit your quarterly risk-based capital report for
the last day of the preceding quarter not later than the last business
day of April, July, October, and January of each year.
Sec. 652.90 How to report your risk-based capital determination.
(a) Your risk-based capital report must contain at least the
following information:
(1) All data integral for determining the risk-based capital level,
including any business policy decisions or other assumptions made in
implementing the risk-based capital test;
(2) Other information necessary to determine compliance with the
procedures for determining risk-based capital as specified in Appendix
A to this subpart; and,
(3) Any other information we may require in written instructions to
you.
(b) You must submit each risk-based capital report in such format
or medium, as we require.
Sec. 652.95 Failure to meet capital requirements.
(a) Determination and notice. At any time, we may determine that
you are not meeting your risk-based capital level calculated according
to Sec. 652.65, your minimum capital requirements specified in section
8.33 of the Act, or your critical capital requirements specified in
section 8.34 of the Act. We will notify you in writing of this fact and
the date by which you should be in compliance (if applicable).
(b) Submission of capital restoration plan. Our determination that
you are not meeting your required capital levels may require you to
develop and submit to us, within a specified time period, an acceptable
plan to reach the appropriate capital level(s) by the date required.
Sec. 652.100 Audit of the risk-based capital stress test.
You must have a qualified, independent external auditor review your
implementation of the risk-based capital stress test every 3 years and
submit a copy of the auditor's opinion to us.
Appendix A--Subpart B of Part 652--Risk-Based Capital Stress Test
1.0 Introduction.
2.0 Credit Risk.
2.1 Loss-Frequency and Loss-Severity Models.
2.2 Loan-Seasoning Adjustment.
2.3 Example Calculation of Dollar Loss on One Loan.
2.4 Calculation of Loss Rates for Use in the Stress Test.
3.0 Interest Rate Risk.
3.1 Process for Calculating the Interest Rate Movement.
4.0 Elements Used in Generating Cashflows.
4.1 Data Inputs.
4.2 Assumptions and Relationships.
4.3 Risk Measures.
4.4 Loan and Cashflow Accounts.
4.5 Income Statements.
4.6 Balance Sheets.
4.7 Capital.
5.0 Capital Calculations.
5.1 Method of Calculation.
1.0 Introduction
a. Appendix A provides details about the risk-based capital
stress test (stress test) for Farmer Mac. The stress test calculates
the risk-based capital level required by statute under stipulated
conditions of credit risk and interest rate risk. The stress test
uses loan-level data from Farmer Mac's agricultural mortgage
portfolio or proxy data as described in section 4.1d.(3) below, as
well as quarterly Call Report and related information to generate
pro forma financial statements and calculate a risk-based capital
requirement. The stress test also uses historic agricultural real
estate mortgage performance data, relevant economic variables, and
other inputs in its calculations of Farmer Mac's capital needs over
a 10-year period.
b. Appendix A establishes the requirements for all components of
the stress test. The key components of the stress test are:
Specifications of credit risk, interest rate risk, the cashflow
generator, and the capital calculation. Linkages among the
components ensure that the measures of credit and interest rate risk
pass into the cashflow generator. The linkages also transfer
cashflows through the financial statements to represent values of
assets, liabilities, and equity capital. The 10-year projection is
designed to reflect a steady state in the scope and composition of
Farmer Mac's assets.
2.0 Credit Risk
Loan loss rates are determined by applying loss-frequency and
loss-severity equations to Farmer Mac loan-level data. From these
equations, you must calculate loan losses under stressful economic
conditions assuming Farmer Mac's portfolio remains at a ``steady
state.'' Steady state assumes the underlying characteristics and
risks of Farmer Mac's portfolio remain constant over the 10 years of
the stress test. Loss rates are computed from estimated dollar
losses for use in the stress test. The loan volume subject to loss
throughout the stress test is then multiplied by the loss rate.
Lastly, the stress test allocates losses to each of the 10 years
assuming a time pattern for loss occurrence as discussed in section
4.3, ``Risk Measures.''
2.1 Loss-Frequency and Loss-Severity Models
a. Credit risks are modeled in the stress test using historical
time series loan-level data to measure the frequency and severity of
losses on agricultural mortgage loans. The model relates loss
frequency and severity to loan-level characteristics and economic
conditions through appropriately specified regression equations to
account explicitly for the effects of these characteristics on loan
losses. Loan losses for Farmer Mac are estimated from the resulting
loss-frequency equation combined with the loss-severity factor by
substituting the respective values of Farmer Mac's loan-level data
or proxy data as described in section 4.1d.(3) below, and applying
stressful economic inputs.
b. The loss-frequency equation and loss-severity factor were
estimated from historical agricultural real estate mortgage loan
data from the Farm Credit Bank of Texas (FCBT). Due to Farmer Mac's
relatively short history, its own loan-level data are insufficiently
developed for use in estimating the default frequency equation and
loss-severity factor. In the future, however, expansions in both the
scope and historic length of Farmer Mac's lending operations may
support the use of its data in estimating the relationships.
c. To estimate the equations, the data used included FCBT loans,
which satisfied three of the four underwriting standards Farmer Mac
currently uses (estimation data). The four standards specify: (1)
The debt-to-assets ratio (D/A) must be less than 0.50, (2) the loan-
to-value ratio (LTV) must be less than 0.70, (3) the debt-service-
coverage ratio (DSCR) must exceed 1.25, (4) and the current ratio
(current assets divided by current liabilities) must exceed 1.0.
Furthermore, the D/A and LTV ratios were restricted to be less than
or equal to 0.85.
d. Several limitations in the FCBT loan-level data affect
construction of the loss-frequency equation. The data contained
loans that were originated between 1979 and 1992, but there were
virtually no losses during the early years of the sample period. As
a result, losses attributable to specific loans are only available
from 1986 through 1992. In addition, no prepayment information was
available in the data.
e. The FCBT data used for estimation also included as performing
loans, those loans that were re-amortized, paid in full, or merged
with a new loan. Including these loans may lead to an understatement
of loss-frequency probabilities if some of the re-amortized, paid,
or merged loans experience default or incur losses. In contrast,
when the
[[Page 69702]]
loans that are re-amortized, paid in full, or merged are excluded
from the analysis, the loss-frequency rates are overstated if a
higher proportion of loans that are re-amortized, paid in full, or
combined (merged) into a new loan are non-default loans compared to
live loans.\1\
---------------------------------------------------------------------------
\1\ Excluding loans with defaults, 11,527 loans were active and
7,515 loans were paid in full, re-amortized or merged as of 1992. A
t-test \2\ of the differences in the means for the group of
defaulted loans and active loans indicated that active loans had
significantly higher D/A and LTV ratios, and lower current ratios
than defaulted loans where loss occurred. These results indicate
that, on average, active loans have potentially higher risk than
loans that were re-amortized, paid in full, or merged.
---------------------------------------------------------------------------
f. The structure of the historical FCBT data supports estimation
of loss frequency based on origination information and economic
conditions. Under an origination year approach, each observation is
used only once in estimating loan default. The underwriting
variables at origination and economic factors occurring over the
life of the loan are then used to estimate loan-loss frequency.
g. The final loss-frequency equation is based on origination
year data and represents a lifetime loss-frequency model. The final
equation for loss frequency is:
p = 1/(1 + exp (-(BX))
Where:
BX = (-12.62738) + 1.91259 [middot] X1 + (-0.33830)
[middot] X2/ (1 + 0.0413299)\Periods\ + (-0.19596)
[middot] X3 + 4.55390
[middot] (1-exp ((-0.00538178) [middot] X4) + 2.49482
[middot] X5
Where:
p is the probability that a loan defaults and has positive
losses (Pr (Y=1 [bond] x));
X1 is the LTV ratio at loan origination raised
to the power 5.3914596; \2\
---------------------------------------------------------------------------
\2\ Loss probability is likely to be more sensitive to changes
in LTV at higher values of LTV. The power function provides a
continuous relationship between LTV and defaults.
---------------------------------------------------------------------------
X2 is the largest annual percentage decline in
FCBT farmland values during the life of the loan dampened with a
factor of 0.0413299 per year; \3\
---------------------------------------------------------------------------
\3\ The dampening function reflects the declining effect that
the maximum land value decline has on the probability of default
when it occurs later in a loan's life.
---------------------------------------------------------------------------
X3 is the DSCR at loan origination
X4 is 1 minus the exponential of the product of
negative 0.00538178 and the original loan balance in 1997 dollars
expressed in thousands; and
X5 is the D/A ratio at loan origination.
h. The estimated logit coefficients and p-values are: \4\
---------------------------------------------------------------------------
\4\ The nonlinear parameters for the variable transformations
were simultaneously estimated using SAS version 8e NLIN procedure.
The NLIN procedure produces estimates of the parameters of a
nonlinear transformation for LTV, dampening factor, and loan-size
variables. To implement the NLIN procedure, the loss-frequency
equation and its variables are declared and initial parameter values
supplied. The NLIN procedure is an iterative process that uses the
initial parameter values as the starting values for the first
iteration and continues to iterate until acceptable parameters are
solved. The initial values for the power function and dampening
function are based on the proposed rule. The procedure for the
initial values for the size variable parameter is provided in an
Excel spreadsheet posted at http://www.fca.gov.
The Gauss-Newton method is the selected iterative solving
process. As described in the preamble, the loss-frequency function
for the nonlinear model is the negative of the log-likelihood
function, thus producing maximum likelihood estimates. In order to
obtain statistical properties for the loss-frequency equation and
verify the logistic coefficients, the estimates for the nonlinear
transformations are applied to the FCBT data and the loss-frequency
model is re-estimated using the SAS Logistic procedure. The SAS
procedures, output reports and Excel spreadsheet used to estimate
the parameters of the loss-frequency equation are located on the Web
site http://www.fca.gov.
------------------------------------------------------------------------
Coefficients p-value
------------------------------------------------------------------------
Intercept................................... -12.62738 <0.0001
X1: LTV variable............................ 1.91259 0.0001
X2: Max land value decline variable......... 0.33830 <0.0001
X3: DSCR.................................... -0.19596 0.0002
X4: Loan size variable...................... 4.55390 <0.0001
X5: D/A ratio............................... 2.49482 <0.0000
------------------------------------------------------------------------
i. The low p-values on each coefficient indicate a highly
significant relationship between the probability ratio of loan-loss
frequency and the respective independent variables. Other goodness-
of-fit indicators are:
Hosmer and Lemeshow goodness-of-fit p-value--0.1718
Max-rescaled R \2\--0.2015
Concordant--85.2%
Disconcordant--12.0%
Tied--2.8%
j. These variables have logical relationships to the incidence
of loan default and loss, as evidenced by the findings of numerous
credit-scoring studies in agricultural finance.\5\ Each of the
variable coefficients has directional relationships that
appropriately capture credit risk from underwriting variables and,
therefore, the incidence of loan-loss frequency. The frequency of
loan loss was found to differ significantly across all of the loan
characteristics and lending conditions. Farmland values represent an
appropriate variable for capturing the effects of exogenous economic
factors. It is commonly accepted that farmland values at any point
in time reflect the discounted present value of expected returns to
the land.\6\ Thus, changes in land values, as expressed in the loss-
frequency equation, represent the combined effects of the level and
growth rates of farm income, interest rates, and inflationary
expectations--each of which is accounted for in the discounted,
present value process.
---------------------------------------------------------------------------
\5\ Splett, N.S., P. J. Barry, B. Dixon, and P. Ellinger. ``A
Joint Experience and Statistical Approach to Credit Scoring,''
Agricultural Finance Review, 54(1994):39-54.
\6\ Barry, P. J., P. N. Ellinger, J. A. Hopkin, and C. B. Baker.
Financial Management in Agriculture, 5th ed., Interstate Publishers,
1995.
---------------------------------------------------------------------------
k. When applying the equation to Farmer Mac's portfolio, you
must get the input values for X1, X3,
X4, and X5 for each loan in Farmer Mac's
portfolio on the date at which the stress test is conducted, using
either submitted data or proxy data as described in section 4.1
d.(3) below. For the variable X2, the stressful input
value from the benchmark loss experience is -23.52 percent. You must
apply this input to all Farmer Mac loans subject to loss to
calculate loss frequency under stressful economic conditions.\7\ The
maximum land value decline from the benchmark loss experience is the
simple average of annual land value changes for Iowa, Illinois, and
Minnesota for the years 1984 and 1985.\8\
---------------------------------------------------------------------------
\7\ On- and off-balance sheet Farmer Mac I agricultural mortgage
program assets booked after the 1996 Act amendments are subject to
the loss calculation.
\8\ While the worst-case losses, based on origination year,
occurred during 1983 and 1984, this benchmark was determined using
annual land value changes that occurred 2 years later.
---------------------------------------------------------------------------
l. Forecasting with data outside the range of the estimation
data requires special treatment for implementation. While the
estimation data embody Farmer Mac values for various loan
characteristics, the maximum farmland price decline experienced in
Texas was -16.69 percent, a value below the benchmark experience of
-23.52 percent. To control for this effect, you must apply a
procedure that restricts the slope of all the independent variables
to that observed at the maximum land value decline observed in the
estimation data. Essentially, you must approximate the slope of the
loss-frequency equation at the point -16.69 percent in order to
adjust the probability of loan default and loss occurrence for data
beyond the range in the estimating data. The adjustment procedure is
shown in step 4 of section 2.3 entitled, ``Example Calculation of
Dollar Loss on One Loan.''
m. Loss severity was not found to vary systematically and was
considered constant across the tested loan characteristics and
lending conditions. Thus, the simple weighted average by loss volume
of 20.9 percent is used in the stress test.\9\ You must
[[Page 69703]]
multiply loss severity with the probability estimate computed from
the loss-frequency equation to determine the loss rate for a loan.
---------------------------------------------------------------------------
\9\ We calculated the weighted-average loss severity from the
estimation data.
---------------------------------------------------------------------------
n. Using original loan balance results in estimated
probabilities of loss frequency over the entire life of a loan. To
account for loan seasoning, you must reduce the loan-loss exposure
by the cumulative probability of loss already experienced by each
loan as discussed in section 2.2 entitled, ``Loan-Seasoning
Adjustment.'' This subtraction is based on loan age and reduces the
loss estimated by the loss-frequency and loss-severity equations.
The result is an age-adjusted lifetime dollar loss that can be used
in subsequent calculations of loss rates as discussed in section
2.4, ``Calculation of Loss Rates for Use in the Stress Test.''
2.2 Loan-Seasoning Adjustment.
a. You must use the seasoning function supplied by FCA to adjust
the calculated probability of loss for each Farmer Mac loan for the
cumulative loss exposure already experienced based on the age of
each loan. The seasoning function is based on the same data used to
determine the loss-frequency equation and an assumed average life of
14 years for agricultural mortgages. If we determine that the
relationship between the loss experience in Farmer Mac's portfolio
over time and the seasoning function can be improved, we may augment
or replace the seasoning function.
b. The seasoning function is parameterized as a beta
distribution with parameters of p = 4.288 and q = 5.3185.\10\ How
the loan-seasoning distribution is used is shown in Step 7 of
section 2.3, ``Example Calculation of Dollar Loss on One Loan.''
---------------------------------------------------------------------------
\10\ We estimated the loan-seasoning distribution from portfolio
aggregate charge-off rates from the estimation data. To do so, we
arrayed all defaulting loans where loss occurred according to the
time from origination to default. Then, a beta distribution,
[Beta](p, q), was fit to the estimation data scaled to the maximum
time a loan survived (14 years).
---------------------------------------------------------------------------
2.3 Example Calculation of Dollar Loss on One Loan.
Here is an example of the calculation of the dollar losses for
an individual loan with the following characteristics and input
values:\11\
---------------------------------------------------------------------------
\11\ In the examples presented we rounded the numbers, but the
example calculation is based on a larger number of significant
digits. The stress test uses additional digits carried at the
default precision of the software.
------------------------------------------------------------------------
------------------------------------------------------------------------
Loan Origination Year................................... 1996
Loan Origination Balance................................ $1,250,000
LTV at Origination...................................... 0.5
D/A at Origination...................................... 0.5
DSCR at Origination..................................... 1.3984
Maximum Percentage Land Price Decline (MAX)............. -23.52
------------------------------------------------------------------------
Step 1: Convert 1996 Origination Value to 1997 dollar value
(LOAN) based on the consumer price index and transform as follows:
$1,278,500 = $1,250,000 [middot] 1.0228
0.998972 = 1 - exp((-.00538178) [middot] $1,278,500 / 1000)
Step 2: Calculate the default probabilities using -16.64 percent
and -16.74 percent land value declines as follows: \12\
---------------------------------------------------------------------------
\12\ This process facilitates the approximation of slope needed
to adjust the loss probabilities for land value declines greater
than observed in the estimation data.
---------------------------------------------------------------------------
Where,
Z1 = (-12.62738) + 1.91259 [middot]
LTV5.3914596 - 0.33830 [middot] (-16.6439443) - 0.19596
[middot] DSCR + 4.55390 [middot] 0.998972 + 2.49482 [middot] DA = (-
1.428509)
Default Loss Frequency at (-16.64%) = 1 / 1 +
exp - (-1.428509) = 0.19333111
And
Z1 = (-12.62738) + 1.91259 [middot]
LTV5.3914596 - 0.33830 [middot] (-16.7439443) - 0.19596
[middot] DSCR + 4.55390 [middot] 0.998972 + 2.49482 [middot] DA = (-
1.394679)
Loss Frequency Probability at (-16.74%) = 1 / 1 +
exp-(-1.394679) = 0.19866189
Step 3: Calculate the slope adjustment. You must calculate slope
by subtracting the difference between ``Loss-Frequency Probability
at -16.64 percent'' and ``Loss-Frequency Probability at -16.74
percent'' and dividing by -0.1 (the difference between -16.64
percent and 16.74 percent as follows:
0.05330776 = (0.19333111 - 0.19866189) / -0.1
Step 4: Make the linear adjustment. You make the adjustment by
increasing the loss-frequency probability where the dampened
stressed farmland value input is less than -16.69 percent to reflect
the stressed farmland value input, appropriately discounted. As
discussed previously, the stressed land value input is discounted to
reflect the declining effect that the maximum land value decline has
on the probability of default when it occurs later in a loan's
life.\13\ The linear adjustment is the difference between -16.69
percent land value decline and the adjusted stressed maximum land
value decline input of -23.52 multiplied by the slope estimated in
Step 3 as follows:
---------------------------------------------------------------------------
\13\ The dampened period is the number of years from the
beginning of the origination year to the current year (i.e., January
1, 1996 to January 1, 2000 is 4 years).
Loss Frequency at -16.69 percent =
Z1 = (-12.62738) + (1.91259) (LTV5.3914596) -
(0.33830) (-16.6939443) - (0.19596) (DSCR) + (4.55390) (0.998972) +
(2.49482) (DA) = -1.411594
And
1 / 1 + exp(-1.411594) = 0.19598279
Dampened Maximum Land Price Decline = (-20.00248544) = (-23.52)
(1.0413299)-4
Slope Adjustment = 0.17637092 = 0.053312247 [middot] (-16.6939443 -
(-20.00248544))
Loan Default Probability = 0.37235371 = 0.19598279 + 0.17637092
Step 5: Multiply loan default probability times the average
severity of 0.209 as follows:
0.077821926 = 0.37235371 [middot] 0.209
Step 6: Multiply the loss rate times the origination loan
balance as follows:
$97,277 = $1,250,000 [middot] 0.077821926
Step 7: Adjust the origination based dollar losses for 4 years
of loan seasoning as follows:
$81,987 = $97,277 - $97,277 [middot] (0.157178762) \14\
---------------------------------------------------------------------------
\14\ The age adjustment of 0.157178762 is determined from the
beta distribution for a 4-year-old loan.
---------------------------------------------------------------------------
2.4 Calculation of Loss Rates for Use in the Stress Test
a. You must compute the loss rates by state as the dollar
weighted average seasoned loss rates from the Cash Window and
Standby loan portfolios by state. The spreadsheet entitled, ``Credit
Loss Module.XLS'' can be used for these calculations. This
spreadsheet is available for download on our Web site, http://www.fca.gov, or will be provided upon request. The blended loss
rates for each state are copied from the ``Credit Loss Module'' to
the stress test spreadsheet for determining Farmer Mac's regulatory
capital requirement.
b. The stress test use of the blended loss rates is further
discussed in section 4.3, ``Risk Measures.''
3.0 Interest Rate Risk
The stress test explicitly accounts for Farmer Mac's
vulnerability to interest rate risk from the movement in interest
rates specified in the statute. The stress test considers Farmer
Mac's interest rate risk position through the current structure of
its balance sheet, reported interest rate risk shock-test
results,\15\ and other financial activities. The stress test
calculates the effect of interest rate risk exposure through market
value changes of interest-bearing assets, liabilities, and off-
balance sheet transactions, and thereby the effects to equity
capital. The stress test also captures this exposure through the
cashflows on rate-sensitive assets and liabilities. We discuss how
to calculate the dollar impact of interest rate risk in section 4.6,
``Balance Sheets.''
---------------------------------------------------------------------------
\15\ See paragraph c. of section 4.1 entitled, ``Data Inputs,''
for a description of the interest rate risk shock-reporting
requirement.
---------------------------------------------------------------------------
3.1 Process for Calculating the Interest Rate Movement
a. The stress test uses the 10-year Constant Maturity Treasury
(10-year CMT) released by the Federal Reserve in HR. 15, ``Selected
Interest Rates.'' The stress test uses the 10-year CMT to generate
earnings yields on assets, expense rates on liabilities, and changes
in the market value of assets and liabilities. For stress test
purposes, the starting rate for the 10-year CMT is the 3-month
average of the most recent monthly rate series published by the
Federal Reserve. The 3-month average is calculated by summing the
latest monthly series of the 10-year CMT and dividing by three. For
instance, you would calculate the initial rate on June 30, 1999, as:
------------------------------------------------------------------------
10-year
CMT
Month end monthly
series
------------------------------------------------------------------------
04/1999...................................................... 5.18
05/1999...................................................... 5.54
[[Page 69704]]
06/1999...................................................... 5.90
Average...................................................... 5.54
------------------------------------------------------------------------
b. The amount by which the stress test shocks the initial rate
up and down is determined by calculating the 12-month average of the
10-year CMT monthly series. If the resulting average is less than 12
percent, the stress test shocks the initial rate by an amount
determined by multiplying the 12-month average rate by 50 percent.
However, if the average is greater than or equal to 12 percent, the
stress test shocks the initial rate by 600 basis points. For
example, determine the amount by which to increase and decrease the
initial rate for June 30, 1999, as follows:
------------------------------------------------------------------------
10-year
CMT
Month end monthly
series
------------------------------------------------------------------------
07/1998...................................................... 5.46
08/1998...................................................... 5.34
09/1998...................................................... 4.81
10/1998...................................................... 4.53
11/1998...................................................... 4.83
12/1998...................................................... 4.65
01/1999...................................................... 4.72
02/1999...................................................... 5.00
03/1999...................................................... 5.23
04/1999...................................................... 5.18
05/1999...................................................... 5.54
06/1999...................................................... 5.90
----------
12-Month Average......................................... 5.10
------------------------------------------------------------------------
------------------------------------------------------------------------
-------------------------------------------------------------------------
Calculation of Shock Amount
Multiply the 12-Month Average by: 50%
Shock in basis points equals: 255
------------------------------------------------------------------------
c. You must run the stress test for two separate changes in
interest rates: (i) An immediate increase in the initial rate by the
shock amount; and (ii) immediate decrease in the initial rate by the
shock amount. The stress test then holds the changed interest rate
constant for the remainder of the 10-year stress period. For
example, at June 30, 1999, the stress test would be run for an
immediate and sustained (for 10 years) upward movement in interest
rates to 8.09 percent (5.54 percent plus 255 basis points) and also
for an immediate and sustained (for 10 years) downward movement in
interest rates to 2.99 percent (5.54 percent minus 255 basis
points). The movement in interest rates that results in the greatest
need for capital is then used to determine Farmer Mac's risk-based
capital requirement.
4.0 Elements Used in Generating Cashflows
a. This section describes the elements that are required for
implementation of the stress test and assessment of Farmer Mac
capital performance through time. An Excel spreadsheet named FAMC
RBCST, available at http://www.fca.gov, contains the stress test,
including the cashflow generator. The spreadsheet contains the
following seven worksheets:
(1) Data Input;
(2) Assumptions and Relationships;
(3) Risk Measures (credit risk and interest rate risk);
(4) Loan and Cash Flow Accounts;
(5) Income Statements;
(6) Balance Sheets; and
(7) Capital.
b. Each of the components is described in further detail below
with references where appropriate to the specific worksheets within
the Excel spreadsheet. The stress test may be generally described as
a set of linked financial statements that evolve over a period of 10
years using generally accepted accounting conventions and specified
sets of stressed inputs. The stress test uses the initial financial
condition of Farmer Mac, including earnings and funding
relationships, and the credit and interest rate stressed inputs to
calculate Farmer Mac's capital performance through time. The stress
test then subjects the initial financial conditions to the first
period set of credit and interest rate risk stresses, generates
cashflows by asset and liability category, performs necessary
accounting postings into relevant accounts, and generates an income
statement associated with the first interval of time. The stress
test then uses the income statement to update the balance sheet for
the end of period 1 (beginning of period 2). All necessary capital
calculations for that point in time are then performed.
c. The beginning of the period 2 balance sheet then serves as
the departure point for the second income cycle. The second period's
cashflows and resulting income statement are generated in similar
fashion as the first period's except all inputs (i.e., the periodic
loan losses, portfolio balance by category, and liability balances)
are updated appropriately to reflect conditions at that point in
time. The process evolves forward for a period of 10 years with each
pair of balance sheets linked by an intervening set of cashflow and
income statements. In this and the following sections, additional
details are provided about the specification of the income-
generating model to be used by Farmer Mac in calculating the risk-
based capital requirement.
4.1 Data Inputs
The stress test requires the initial financial statement
conditions and income generating relationships for Farmer Mac. The
worksheet named ``Data Inputs'' contains the complete data inputs
and the data form used in the stress test. The stress test uses
these data and various assumptions to calculate pro forma financial
statements. For stress test purposes, Farmer Mac is required to
supply:
a. Call Report Schedules RC: Balance Sheet and RI: Income
Statement. These schedules form the starting financial position for
the stress test. In addition, the stress test calculates basic
financial relationships and assumptions used in generating pro forma
annual financial statements over the 10-year stress period.
Financial relationships and assumptions are in section 4.2,
``Assumptions and Relationships.''
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. The spreadsheet uses this cashflow
information to generate starting and ending account balances,
interest earnings, 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.''
c. Interest Rate Risk Measurement Results. The stress test uses
the results from Farmer Mac's interest rate risk model to represent
changes in the market value of assets, liabilities, and off-balance
sheet positions during upward and downward instantaneous shocks in
interest rates of 300, 250, 200, 150, and 100 basis points. The
stress test uses these data to calculate a schedule of estimated
effective durations representing the market value effects from a
change in interest rates. The stress test uses a linear
interpolation of the duration schedule to relate a change in
interest rates to a change in the market value of equity. This
calculation is described in section 4.4 entitled, ``Loan and
Cashflow Accounts,'' and is illustrated in the referenced worksheet
of the stress test.
d. Loan-Level Data for All Farmer Mac I Program Assets.
(1) The stress test requires loan-level data for all Farmer Mac
I program assets to determine lifetime age-adjusted loss rates. The
specific loan data fields required for running the credit risk
component are:
Farmer Mac I program loan data fields
------------------------------------------------------------------------
-------------------------------------------------------------------------
Loan Number.
Ending Scheduled Balance.
Group.
Pre/Post Act.
Property State.
Product Type.
Origination Date.
Loan Cutoff Date.
Original Loan Balance.
Original Scheduled P&I.
Original Appraised Value.
Loan-to-Value Ratio.
Debt-to-Assets Ratio.
Current Assets.
Current Liabilities.
Total Assets.
Total Liabilities.
Gross Farm Revenue.
Net Farm Income.
Depreciation.
Interest on Capital Debt.
Capital Lease Payments.
Living Expenses.
Income & FICA Taxes.
Net Off-Farm Income.
Total Debt Service.
Guarantee/Commitment Fee.
Seasoned Loan Flag.
------------------------------------------------------------------------
(2) From the loan-level data, you must identify the geographic
distribution by state of Farmer Mac's loan portfolio and enter the
[[Page 69705]]
current loan balance for each state in the ``Data Inputs''
worksheet. The lifetime age-adjustment of origination year loss
rates was discussed in section 2.0, ``Credit Risk.'' The lifetime
age-adjusted loss rates are entered in the ``Risk Measures''
worksheet of the stress test. The stress test application of the
loss rates is discussed in section 4.3, ``Risk Measures.''
(3) Under certain circumstances, described below, you must
substitute the following data proxies for the variables LTV, DSCR,
and D/A: LTV = 0.70, DSCR = 1.20, and D/A = 0.60. The substitution
must be done whenever any of these data are missing, i.e., cells are
blank, or one or more of the conditions in the following table is
true.
----------------------------------------------------------------------------------------------------------------
Condition: Apply:
----------------------------------------------------------------------------------------------------------------
1. Total Assets = 0............................... Proxy D/A.
2. Total Liabilities = 0.......................... Proxy D/A.
3. Total assets less total liabilities <0......... Proxy D/A.
4. Total debt service = 0 or not calculable....... Proxy DSCR.
5. Net farm income = 0............................ Proxy DSCR.
6. LTV ratio = 0.................................. Proxy LTV.
7. Total assets less than original appraised value Proxy LTV, D/A.
8. Total liabilities less than the original loan Proxy D/A.
amount.
9. Total debt service is less than original Proxy DSCR.
scheduled principal and interest payment.
10. Depreciation, interest on capital debt, Proxy DSCR.
capital lease payments, or living expenses are
reported as less than zero.
11. Original Scheduled Principal and Interest is Proxy DSCR.
greater than Total Debt Service.
12. Calculated LTV (original loan amount divided The greater of the two LTV ratios.
by original appraised value) does not equal the
submitted greater of LTV ratio.
13. Any of the fields referenced in ``1.'' through Proxy all realted ratios.
``12.'' above are blank or contain spaces,
periods, zeros, negative amounts, or fonts
formatted to any setting ratios other than
numbers.
----------------------------------------------------------------------------------------------------------------
In addition, the following loan data adjustments must be made in
response to the situations listed below:
----------------------------------------------------------------------------------------------------------------
Situation: Data adjustment:
----------------------------------------------------------------------------------------------------------------
Original loan balance is less than scheduled loan Substitute scheduled balance for origination.
balance.
Purchase (commitment) date (a.k.a. ``cutoff'' Insert the quarter end ``as of'' date of the RBCST
date) field and Origination date field are both submission.
blank.
Origination date field is blank................... Model based on Cutoff date.
Seasoned Standby loans that include loan data..... Proxy data applied.\16\
----------------------------------------------------------------------------------------------------------------
Further, because it would not be possible to compile an
exhaustive list of loan data anomalies, FCA reserves the authority
to require an explanation on other data anomalies it identifies and
to apply the loan data proxies on such cases until the anomaly is
adequately addressed by the Corporation.
---------------------------------------------------------------------------
\16\ Application of proxy data recognizes that underwriting data
on seasoned standby loans are not reviewed by Farmer Mac in favor of
other criteria and frequently not origination data.
---------------------------------------------------------------------------
e. Weighted Haircuts for Non-Program Investments. For non-
program investments, the stress test adjusts the weighted average
yield data referenced in section 4.1b. to reflect counterparty risk.
Non-program investments are defined in 12 CFR 652.5. The haircuts
are applied by credit rating category. For this purpose, FCA credit
rating categories are mapped to the Nationally Recognized
Statistical Rating Organizations (NRSRO) ratings categories as set
forth in the following table.
Rating Agencies Mappings to FCA Ratings Categories
--------------------------------------------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------------------------------------------
FCA Ratings Category............. AAA............... AA............... A................ BBB.............. Below BBB and Unrated.
Standard & Poor's Long-Term...... AAA............... AA............... A................ BBB.............. Below BBB and Unrated.
Fitch Long-Term.................. AAA............... AA............... A................ BBB.............. Below BBB and Unrated.
Moody's Long-Term................ Aaa............... Aa............... A................ Baa.............. Below Baa and Unrated.
Standard & Poor's Short-Term..... A-1+.............. A-1.............. A-2.............. A-3.............. SP-3, B, or Below and Unrated.
SP-1+............. SP-1............. SP-2.............
Fitch Short-Term................. F-1+.............. F-1.............. F-2.............. F-3.............. Below F-3 and Unrated.
Moody's Short-Term \17\.......... .................. Prime-1.......... Prime-2.......... Prime-3.......... Not Prime, SG and Unrated.
MIG1............. MIG2............. MIG3.............
VMIG1............ VMIG2............ VMIG3............
Fitch Individual Bank Ratings.... A................. B................ C................ D................ E
A/B.............. B/C.............. C/D.............. D/E
Moody's Bank Financial Strength A................. B................ C................ D................ E
Rating.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[[Page 69706]]
The Corporation must calculate the haircut to be applied to each
investment based on the lowest credit rating the investment received
from NRSRO using the haircuts levels in the following table.
---------------------------------------------------------------------------
\17\ Any rating that appears in more than one category column is
assigned to the lower FCA rating category.
FARMER MAC RBCST Maximum Haircut by FCA Ratings Category
------------------------------------------------------------------------
Non-derivative
contract
FCA ratings category counterparties
or instruments
(percent)
------------------------------------------------------------------------
Cash.................................................... 0
AAA..................................................... 3.50
AA...................................................... 8.75
A....................................................... 14.00
BBB..................................................... 28.00
Below BBB and Unrated................................... 100.00
------------------------------------------------------------------------
Individual investment haircuts must then be aggregated into
weighted average haircuts by investment category and provided in the
``Data Inputs'' worksheet. The spreadsheet uses this information to
account for counterparty insolvency through reduced interest
earnings on these categories of investment according to a 10-year
linear phase-in. Each asset account category identified in this data
requirement is discussed in section 4.2, ``Assumptions and
Relationships.''
f. Other Data Requirements. Other data elements are taxes paid
over the previous 2 years, the corporate tax schedule, selected line
items from Schedule RS-C of the Call Report, and 10-year CMT
information as discussed in section 3.1 entitled, ``Process for
Calculating the Interest Rate Movement.'' The stress test uses the
corporate tax schedule and previous taxes paid to determine the
appropriate amount of taxes, including available loss carry-backs
and loss carry-forwards. Three line items found in sections Part
II.2.a. and 2.b. of Call Report Schedule RS-C Capital Calculation
must also be entered in the ``Data Inputs'' sheet. The two line
items found in Part II.2.a. contain the dollar volume off-balance
sheet assets relating to the Farmer Mac I and II programs. The off-
balance sheet program asset dollar volumes are used to calculate the
operating expense regression on a quarterly basis. The single-line
item found in Part II.2.b. provides the amount of other off-balance
sheet obligations and is presented in the balance sheet section of
the stress test for purposes of completeness. The 10-year CMT
quarterly average of the monthly series and the 12-month average of
the monthly series must be entered in the ``Data Inputs'' sheet.
These two data elements are used to determine the starting interest
rate and the level of the interest rate shock applied in the stress
test.
4.2 Assumptions and Relationships
a. The stress test assumptions are summarized on the worksheet
called ``Assumptions and Relationships.'' Some of the entries on
this page are direct user entries. Other entries are relationships
generated from data supplied by Farmer Mac or other sources as
discussed in section 4.1, ``Data Inputs.'' After current financial
data are entered, the user selects the date for running the stress
test. This action causes the stress test to identify and select the
appropriate data from the ``Data Inputs'' worksheet. The next
section highlights the degree of disaggregation needed to maintain
reasonably representative financial characterizations of Farmer Mac
in the stress test. Several specific assumptions are established
about the future relationships of account balances and how they
evolve.
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, 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 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) Elements related to cashflows, earnings rates, and
disposition of discontinued program assets.
(A) The stress test accounts for earnings rates by asset class
and cost rates on funding. The stress test aggregates investments
into the categories of: Cash and money market securities; commercial
paper; certificates of deposit; agency mortgage-backed securities
and collateralized mortgage obligations; and other investments. With
FCA's concurrence, Farmer Mac is permitted to further disaggregate
these categories. Similarly, we may require new categories for
future activities to be added to the stress test. Loan items
requiring separate accounts include the following:
(i) Farmer Mac I program assets post-1996 Act;
(ii) Farmer Mac I program assets post-1996 Act Swap balances;
(iii) Farmer Mac I program assets pre-1996 Act;
(iv) Farmer Mac I AgVantage securities;
(v) Loans held for securitization; and
(vi) Farmer Mac II program assets.
(B) The stress test also uses data elements related to
amortization and prepayment experience to calculate and process the
implied rates at which asset and liability balances terminate or
``roll off'' through time. Further, for each category, the stress
test has the capacity to track account balances that are expected to
change through time for each of the above categories. For purposes
of the stress test, all assets are assumed to maintain a ``steady
state'' with the implication that any principal balances retired or
prepaid are replaced with new balances. The exceptions are that
expiring pre-1996 Act program assets are replaced with post-1996 Act
program assets.
(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, prepaid expenses, accrued
interest payable, accounts payable, accrued expenses, reserves for
losses (loans held and guaranteed securities), and other off-balance
sheet obligations. The stress test is consistent with Farmer Mac's
existing reporting categories and practices. If reporting practices
change substantially, the above list will be adjusted accordingly.
The stress test has the capacity to have the balances in each of
these accounts determined based upon existing relationships to other
earning accounts, to keep their balances either in constant
proportions of loan or security accounts, or to evolve according to
a user-selected rule. For purposes of the stress test, these
accounts are to remain constant relative to the proportions of their
associated balance sheet accounts that generated the accrued
balances.
(3) Elements related to income and expense assumptions. Several
other parameters that are required to generate pro forma financial
statements may not be easily captured from historic data or may have
characteristics that suggest that they be individually supplied.
These parameters are the gain on agricultural mortgage-backed
securities (AMBS) sales, miscellaneous income, operating expenses,
reserve requirement, guarantee fees and loan loss resolution timing.
(A) The stress test applies the actual weighted average gain
rate on sales of AMBS over the most recent 3 years to the dollar
amount of AMBS sold during the most recent four quarters in order to
estimate gain on sale of AMBS over the stress period.
(B) The stress test assumes miscellaneous income at a level
equal to the average of the most recent 3-year's actual
miscellaneous income as a percent of the sum of; cash, investments,
guaranteed securities, and loans held for investment.
(C) The stress test assumes that short-term cost of funds is
incurred in relation to the amount of defaulting loans purchased
from off-balance sheet pools. The remaining UPB on this loan volume
is the origination amount reduced by the proportion of the total
portfolio that has amortized as of the end of the most recent
quarter. This volume is assumed to be funded at the short-term cost
of funds and this expense continues for a period equal to the loan
loss resolution timing period (LLRT) period minus 1. We will
calculate the LLRT period from Farmer Mac data. In addition, during
the LLRT period, all guarantee income associated with the loan
volume ceases.
(D) The stress test generates no interest income on the
estimated volume of defaulted on-balance sheet loan volume required
to be carried during the LLRT period, but continues to accrue
funding costs during the remainder of the LLRT period.
(E) The Agency will consider revising the LLRT period in
response to changes in the Corporation's actual experience.
(F) Operating costs are determined in the model through
application of the revised
[[Page 69707]]
operating expense equation which may be restated as:
Expenses = [alpha] + [beta]1ln(OnFt) +
[beta]2ln(OnGSt) +
[beta]3ln(OffIt + OffIIt) +
[beta]4ln(REOt)
Where t indicates time period in the model, OnF represents on-
balance sheet investments, OnGS represents on-balance sheet
guaranteed securities, OffI and OffII represent off balance sheet
Farmer Mac I and II program loans, respectively, REO represents
gross real-estate owned and the [beta]i coefficients are
taken from the operating expense regression equation which is to be
re-estimated quarterly by Farmer Mac, and the resulting coefficients
entered into the ``Assumptions and Relationships'' worksheet. As
additional data accumulate, the specification will be re-examined
and modified if we deem changing the specification results in a more
appropriate representation of operating expenses.
(G) To run the stress test, the operating expense regression
equation must be re-estimated using data from Farmer Mac's inception
to the most recent quarterly financial information and the resulting
coefficient entered into the ``Assumptions and
Relationships''worksheet.
(H) The reserve requirement as a fraction of loan assets can
also be specified. However, the stress test is run with the reserve
requirement set to zero. Setting the parameter to zero causes the
stress test to calculate a risk-based capital level that is
comparable to regulatory capital, which includes reserves. Thus, the
risk-based capital requirement contains the regulatory capital
required, including reserves. The amount of total capital that is
allocated to the reserve account is determined by GAAP. The
guarantee rates applied in the stress test are: post-1996 Farmer Mac
I assets (50 basis points, current weighted average of 42 basis
points); pre-1996 Farmer Mac I assets (25 basis points); and Farmer
Mac II assets (25 basis points).
(4) Elements related to earnings rates and funding costs.
(A) The stress test can accommodate numerous specifications of
earnings and funding costs. In general, both relationships are tied
to the 10-year CMT interest rate. Specifically, each investment
account, each loan item, and each liability account can be specified
as fixed rate, or fixed spread to the 10-year CMT with initial rates
determined by actual data. The stress test calculates specific
spreads (weighted average yield less initial 10-year CMT) by
category from the weighted average yield data supplied by Farmer Mac
as described earlier. For example, the fixed spread for Farmer Mac I
program post-1996 Act mortgages is calculated as follows:
Fixed Spread = Weighted Average Yield less 10-year CMT
0.014 = 0.0694 - 0.0554
(B) The resulting fixed spread of 1.40 percent is then added to
the 10-year CMT when it is shocked to determine the new yield. For
instance, if the 10-year CMT is shocked upward by 300 basis points,
the yield on Farmer Mac I program post-1996 Act loans would change
as follows:
Yield = Fixed Spread + 10-year CMT
.0994 = .014 + .0854
(C) The adjusted yield is then used for income calculations when
generating pro forma financial statements. All fixed-spread asset
and liability classes are computed in an identical manner using
starting yields provided as data inputs from Farmer Mac. The fixed-
yield option holds the starting yield data constant for the entire
10-year stress test period. You must run the stress test using the
fixed-spread option for all accounts except for discontinued program
activities, such as Farmer Mac I program loans made before the 1996
Act. For discontinued loans, the fixed-rate specification must be
used if the loans are primarily fixed-rate mortgages.
(5) Elements related to interest rate shock test. As described
earlier, the interest rate shock test is implemented as a single set
of forward interest rates. The stress test applies the up-rate
scenario and down-rate scenario separately. The stress test also
uses the results of Farmer Mac's shock test, as described in
paragraph c. of section 4.1, ``Data Inputs,'' to calculate the
impact on equity from a stressful change in interest rates as
discussed in section 3.0 titled, ``Interest Rate Risk.'' The stress
test uses a schedule relating a change in interest rates to a change
in the market value of equity. For instance, if interest rates are
shocked upward so that the percentage change is 262 basis points,
the linearly interpolated effective estimated duration of equity is
-6.7405 years given Farmer Mac's interest rate measurement results
at 250 and 300 basis points of -6.7316 and -6.7688 years,
respectively found on the effective duration schedule. The stress
test uses the linearly interpolated estimated effective duration for
equity to calculate the market value change by multiplying duration
by the base value of equity before any rate change from Farmer Mac's
interest rate risk measurement results with the percentage change in
interest rates.
4.3 Risk Measures
a. This section describes the elements of the stress test in the
worksheet named ``Risk Measures'' that reflect the interest rate
shock and credit loss requirements of the stress test.
b. As described in section 3.1, the stress test applies the
statutory interest rate shock to the initial 10-year CMT rate. It
then generates a series of fixed annual interest rates for the 10-
year stress period that serve as indices for earnings yields and
cost of funds rates used in the stress test. (See the ``Risk
Measures'' worksheet for the resulting interest rate series used in
the stress test.)
c. The Credit Loss Module's state-level loss rates, as described
in section 2.4 entitled, ``Calculation of Loss Rates for Use in the
Stress Test,'' are entered into the ``Risk Measures'' worksheet and
applied to the loan balances that exist in each state. The
distribution of loan balances by state is used to allocate new loans
that replace loan products that roll off the balance sheet through
time. The loss rates are applied both to the initial volume and to
new loan volume that replaces expiring loans. The total life of loan
losses that are expected at origination are then allocated through
time based on a set of user entries describing the time-path of
losses.
d. The loss rates estimated in the credit risk component of the
stress test are based on an origination year concept, adjusted for
loan seasoning. All losses arising from loans originated in a
particular year are expressed as lifetime age-adjusted losses
irrespective of when the losses actually occur. The fraction of the
origination year loss rates that must be used to allocate losses
through time are 43 percent to year 1, 17 percent to year 2, 11.66
percent to year 3, and 4.03 percent for the remaining years. The
total allocated losses in any year are expressed as a percent of
loan volume in that year to reflect the conversion to exposure year.
4.4 Loan and Cashflow Accounts
The worksheet labeled ``Loan and Cashflow Data'' contains the
categorized loan data and cashflow accounting relationships that are
used in the stress test to generate projections of Farmer Mac's
performance and condition. As can be seen in the worksheet, the
steady-state formulation results in account balances that remain
constant except for the effects of discontinued programs and the
LLRT adjustment. For assets with maturities under 1 year, the
results are reported for convenience as though they matured only one
time per year with the additional convention that the earnings/cost
rates are annualized. For the pre-1996 Act assets, maturing balances
are added back to post-1996 Act account balances. The liability
accounts are used to satisfy the accounting identity, which requires
assets to equal liabilities plus owner equity. In addition to the
replacement of maturities under a steady state, liabilities are
increased to reflect net losses or decreased to reflect resulting
net gains. Adjustments must be made to the long- and short-term debt
accounts to maintain the same relative proportions as existed at the
beginning period from which the stress test is run with the
exception of changes associated with the funding of defaulted loans
during the LLRT period. The primary receivable and payable accounts
are also maintained on this worksheet, as is a summary balance of
the volume of loans subject to credit losses.
4.5 Income Statements
a. Information related to income performance through time is
contained on the worksheet named ``Income Statements.'' Information
from the first period balance sheet is used in conjunction with the
earnings and cost-spread relationships from Farmer Mac supplied data
to generate the first period's income statement. The same set of
accounts is maintained in this worksheet as ``Loan and Cashflow
Accounts'' for consistency in reporting each annual period of the
10-year stress period of the test with the exception of the line
item labeled ``Interest reversals to carry loan losses'' which
incorporates the LLRT adjustment to earnings from the ``Risk
Measures'' worksheet. Loans that defaulted do not earn interest or
guarantee and commitment fees during LLRT period. The income from
each interest-bearing account is calculated, as are costs of
interest-bearing liabilities. In each case, these entries are the
associated interest rate for that period multiplied by the account
balances.
[[Page 69708]]
b. The credit losses described in section 2.0, ``Credit Risk,''
are transmitted through the provision account as is any change
needed to re-establish the target reserve balance. For determining
risk-based capital, the reserve target is set to zero as previously
indicated in section 4.2. Under the income tax section, it must
first be determined whether it is appropriate to carry forward tax
losses or recapture tax credits. The tax section then establishes
the appropriate income tax liability that permits the calculation of
final net income (loss), which is credited (debited) to the retained
earnings account.
4.6 Balance Sheets
a. The worksheet named ``Balance Sheets'' is used to construct
pro forma balance sheets from which the capital calculations can be
performed. As can be seen in the Excel spreadsheet, the worksheet is
organized to correspond to Farmer Mac's normal reporting practices.
Asset accounts are built from the initial financial statement
conditions, and loan and cashflow accounts. Liability accounts
including the reserve account are likewise built from the previous
period's results to balance the asset and equity positions. The
equity section uses initial conditions and standard accounts to
monitor equity through time. The equity section maintains separate
categories for increments to paid-in-capital and retained earnings
and for mark-to-market effects of changes in account values. The
process described below in the ``Capital'' worksheet uses the
initial retained earnings and paid-in-capital account to test for
the change in initial capital that permits conformance to the
statutory requirements. Therefore, these accounts must be maintained
separately for test solution purposes.
b. The market valuation changes due to interest rate movements
must be computed utilizing the linearly interpolated schedule of
estimated equity effects due to changes in interest rates, contained
in the ``Assumptions & Relationships'' worksheet. The stress test
calculates the dollar change in the market value of equity by
multiplying the base value of equity before any rate change from
Farmer Mac's interest rate risk measurement results, the linearly
interpolated estimated effective duration of equity, and the
percentage change in interest rates. In addition, the earnings
effect of the measured dollar change in the market value of equity
is estimated by multiplying the dollar change by the blended cost of
funds rate found on the ``Assumptions & Relationships'' worksheet.
Next, divide by 2 the computed earnings effect to approximate the
impact as a theoretical shock in the interest rates that occurs at
the mid-point of the income cycle from period t0 to
period t1. The measured dollar change in the market value
of equity and related earnings effect are then adjusted to reflect
any tax-related benefits. Tax adjustments are determined by
including the measured dollar change in the market value of equity
and the earnings effect in the tax calculations found in the
``Income Statements'' worksheet. This approach ensures that the
value of equity reflects the economic loss or gain in value of
Farmer Mac's capital position from a change in interest rates and
reflects any immediate tax benefits that Farmer Mac could realize.
Any tax benefits in the module are posted through the income
statement by adjusting the net taxes due before calculating final
net income. Final net income is posted to accumulated unretained
earnings in the shareholders' equity portion of the balance sheet.
The tax section is also described in section 4.5 entitled, ``Income
Statements.''
c. After one cycle of income has been calculated, the balance
sheet as of the end of the income period is then generated. The
``Balance Sheet'' worksheet shows the periodic pro forma balance
sheets in a format convenient to track capital shifts through time.
d. The stress test considers Farmer Mac's balance sheet as
subject to interest rate risk and, therefore, the capital position
reflects mark-to-market changes in the value of equity. This
approach ensures that the stress test captures interest rate risk in
a meaningful way by addressing explicitly the loss or gain in value
resulting from the change in interest rates required by the statute.
4.7 Capital
The ``Capital'' worksheet contains the results of the required
capital calculations as described below, and provides a method to
calculate the level of initial capital that would permit Farmer Mac
to maintain positive capital throughout the 10-year stress test
period.
5.0 Capital Calculation
a. The stress test computes regulatory capital as the sum of the
following:
(1) The par value of outstanding common stock;
(2) The par value of outstanding preferred stock;
(3) Paid-in capital;
(4) Retained earnings; and
(5) Reserve for loan and guarantee losses.
b. Inclusion of the reserve account in regulatory capital is an
important difference compared to minimum capital as defined by the
statute. Therefore, the calculation of reserves in the stress test
is also important because reserves are reduced by loan and guarantee
losses. The reserve account is linked to the income statement
through the provision for loan-loss expense (provision). Provision
expense reflects the amount of current income necessary to rebuild
the reserve account to acceptable levels after loan losses reduce
the account or as a result of increases in the level of risky
mortgage positions, both on- and off-balance sheet. Provision
reversals represent reductions in the reserve levels due to reduced
risk of loan losses or loan volume of risky mortgage positions. The
liabilities section of the ``Balance Sheets'' worksheet also
includes separate line items to disaggregate the Guarantee and
commitment obligation related to the Financial Accounting Standards
Board Interpretation No. 45 (FIN 45) Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This item is disaggregated to
permit accurate calculation of regulatory capital post-adoption of
FIN 45. When calculating the stress test, the reserve is maintained
at zero to result in a risk-based capital requirement that includes
reserves, thereby making the requirement comparable to the statutory
definition of regulatory capital. By setting the reserve requirement
to zero, the capital position includes all financial resources
Farmer Mac has at its disposal to withstand risk.
5.1 Method of Calculation
a. Risk-based capital is calculated in the stress test as the
minimum initial capital that would permit Farmer Mac to remain
solvent for the ensuing 10 years. To this amount, an additional 30
percent is added to account for managerial and operational risks not
reflected in the specific components of the stress test.
b. The relationship between the solvency constraint (i.e.,
future capital position not less than zero) and the risk-based
capital requirement reflects the appropriate earnings and funding
cost rates that may vary through time based on initial conditions.
Therefore, the minimum capital at a future point in time cannot be
directly used to determine the risk-based capital requirement. To
calculate the risk-based capital requirement, the stress test
includes a section to solve for the minimum initial capital value
that results in a minimum capital level over the 10 years of zero at
the point in time that it would actually occur. In solving for
initial capital, it is assumed that reductions or additions to the
initial capital accounts are made in the retained earnings accounts,
and balanced in the debt accounts at terms proportionate to initial
balances (same relative proportion of long- and short-term debt at
existing initial rates). Because the initial capital position
affects the earnings, and hence capital positions and appropriate
discount rates through time, the initial and future capital are
simultaneously determined and must be solved iteratively. The
resulting minimum initial capital from the stress test is then
reported on the ``Capital'' worksheet of the stress test. The
``Capital'' worksheet includes an element that uses Excel's
``solver'' or ``goal seek'' capability to calculate the minimum
initial capital that, when added (subtracted) from initial capital
and replaced with debt, results in a minimum capital balance over
the following 10 years of zero.
PART 655--FEDERAL AGRICULTURAL MORTGAGE CORPORATION DISCLOSURE AND
REPORTING REQUIREMENTS
3. The authority citation for part 655 continues to read as
follows:
Authority: Sec. 8.11 of the Farm Credit Act (12 U.S.C. 2279aa-
11).
Subpart B--Reports Relating to Securities Activities of the Federal
Agricultural Mortgage Corporation
Sec. 655.50 [Amended]
4. Section 655.50 is amended by removing the word ``should'' and
adding in its place, the word ``must'' in the second sentence of
paragraph (c).
[[Page 69709]]
Dated: November 10, 2005.
Jeanette Brinkley,
Secretary, Farm Credit Administration Board.
[FR Doc. 05-22730 Filed 11-16-05; 8:45 am]
BILLING CODE 6705-01-P