[Federal Register Volume 77, Number 214 (Monday, November 5, 2012)]
[Rules and Regulations]
[Pages 66375-66388]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-26805]
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FARM CREDIT ADMINISTRATION
12 CFR Part 652
RIN 3052-AC56
Federal Agricultural Mortgage Corporation Funding and Fiscal
Affairs; Farmer Mac Investment Management
AGENCY: Farm Credit Administration.
ACTION: Final rule.
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SUMMARY: The Farm Credit Administration (FCA, Agency, us, or we) issues
this final rule amending our regulations governing investment
management practices of the Federal Agricultural Mortgage Corporation
(Farmer Mac or Corporation). This final rule will help ensure that
Farmer Mac maintains safe and sound non-program investment management
practices in accordance with clearly articulated board-established
guidance, streamlines the process for handling investments that fail to
meet the eligibility criteria after purchase, and modifies the
allowable purposes of Farmer Mac's non-program investments to include
investments that would complement Farmer Mac's program activities. We
are also finalizing the significant reorganization of these regulations
that we proposed to make the regulations easier to follow.
DATES: This regulation will be effective 30 days after publication in
the Federal Register during which either or both Houses of Congress are
in session. We will publish a notice of the effective date in the
Federal Register.
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
Jennifer A. Cohn, Senior Counsel, Office of the General Counsel, Farm
Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703)
883-4020.
SUPPLEMENTARY INFORMATION:
I. Objective
The objective of this final rule is to ensure that Farmer Mac has
appropriate Board policies and operational procedures in place to
manage its non-program investment portfolio safely and soundly with
appropriate consideration of its public mission as a Government-
sponsored enterprise (GSE). This final rule will:
Revise the permissible purposes of non-program
investments;
Revise board policy requirements, including stress-testing
requirements;
Modify the non-program investment portfolio limit;
Reduce the regulatory burden associated with investments
that fail to meet eligibility criteria after purchase; and
Reorganize the regulations to make them easier to follow.
II. History of Rule
On May 19, 2010, we published an Advanced Notice of Proposed
Rulemaking that considered revisions to Farmer Mac's non-program
investment and liquidity requirements.\1\ On November 18, 2011, we
published a Notice of Proposed Rulemaking (NPRM) that would have
revised these non-program investment and liquidity requirements.\2\
After considering the comments we received on the NPRM, we now plan to
finalize the proposed provisions contained in the NPRM in phases.
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\1\ 75 FR 27951.
\2\ 76 FR 71798.
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This first phase of final regulations will substantively revise the
following regulations:
Sec. 652.10--Investment Management
Sec. 652.15--Non-Program Investment Purposes and Limitation
(renumbered from Sec. 652.25)
Sec. 652.25--Management of Ineligible Investments and
Reservation of Authority to Require Divestiture (renumbered from Sec.
652.45)
Sec. 652.30--Interest Rate Risk Management (renumbered from
Sec. 652.15)
Sec. 652.45--Temporary Regulatory Waivers or Modifications
for Extraordinary Situations (renumbered from Sec. 652.30)
These revisions will help ensure that Farmer Mac maintains safe and
sound non-program investment management practices in accordance with
clearly articulated board-established guidance. They also streamline
the process for handling investments that fail to meet the eligibility
criteria after purchase and modify the allowable purposes of Farmer
Mac's non-program investments to include investments that would
complement Farmer Mac's program activities.
We are also making minor technical changes to the following
provisions:
Sec. 652.1--Purpose
Sec. 652.5--Definitions
Sec. 652.20--Eligible Non-Program Investments (renumbered
from Sec. 652.35)
In addition, we are deleting existing Sec. 652.40, entitled
``Stress Tests for
[[Page 66376]]
Mortgage Securities,'' and incorporating its provisions into Sec.
652.10(f).
Lastly, we are finalizing the proposed reorganization of the
investment management and liquidity regulations to make the sequence of
the issues covered more logical.
We intend to address in one or more future rulemakings regulations
covering all the areas of the proposed rule not covered in this final
rule, including liquidity management and requirements and investment
eligibility (including revised creditworthiness requirements). The
regulations that we proposed to revise but that we are not issuing as
final at this time (except to renumber them and, in some instances, to
make minor technical changes) include:
Sec. 652.5--Definitions
Sec. 652.20--Eligible Non-Program Investments (renumbered
from Sec. 652.35)
Sec. 652.35--Liquidity Reserve Management and Requirements
(renumbered from Sec. 652.20)
III. Guiding Principle of Rule
The FCA is an independent agency in the executive branch of the
Federal Government that serves as the regulator of Farmer Mac, as well
as of the other institutions of the Farm Credit System (System)
including, in pertinent part, Farm Credit banks and direct lender
associations. The FCA regulates Farmer Mac through the Office of
Secondary Market Oversight (OSMO). Farmer Mac is a stockholder-owned
instrumentality of the United States, chartered by Congress to
establish a secondary market for agricultural real estate, rural
housing mortgage loans, and rural utilities loans. Farmer Mac also
provides a secondary market for USDA-guaranteed farm program and rural
development loans.
A guiding principle for FCA in establishing regulations governing
Farmer Mac is to maintain an appropriate balance between the
Corporation's mission achievement and risk. We aim to ensure continuity
of operations so that Farmer Mac can fulfill its mission during
stressful economic conditions that may require sufficient access to
secondary sources of liquidity. This final rule is intended to provide
a high degree of certainty that Farmer Mac will be able to continue to
serve its customers under a wide range of market or economic conditions
without the need to issue debt to the Department of Treasury or seek
any other form of Government financial assistance.\3\
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\3\ Under certain specific adverse circumstances, Farmer Mac is
authorized to issue debt to the Department of the Treasury to meet
obligations on guarantees. See section 8.13 of the Farm Credit Act
of 1971, as amended (Act) (12 U.S.C. 2279aa-13).
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IV. Discussion of Comments and Section-by-Section Analysis of Rule
We received comment letters from Farmer Mac and from the Farm
Credit Council (Council), which, in addition to submitting a comment
letter directly responding to the NPRM, also asked us to consider,
wherever applicable, comments it had submitted on FCA's similar
proposed rule pertaining to System banks and associations.\4\
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\4\ See 76 FR 51289, Aug. 18, 2011.
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In addition to its comments on specific proposed regulation
provisions, the Council generally encouraged us to adapt this rule to
more closely mirror the requirements for System banks and associations.
Although the two final rules continue to differ where appropriate,
changes were made to both this rule and the System banks and
associations rule to make the requirements more similar.\5\
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\5\ In the interests of consistency, the FCA Board adopted the
final rule governing the investment management of System banks and
associations at the same time it adopted this final rule. That final
rule is also published in today's issue of the Federal Register.
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We will address each specific comment received in our discussion of
the regulation provision to which the comment relates. Some of the
minor changes we proposed received no comment. Unless otherwise
discussed in this preamble, we are finalizing those provisions as
proposed without further explanation. Interested persons are directed
to our NPRM for a discussion of those changes. Throughout this
regulation, we make minor technical, clarifying, and non-substantive
language changes that we do not specifically discuss in this preamble.
A. Reorganization of Rule
We are finalizing the rule's reorganization much the way we
proposed it. We provide the following table to orient the reader to the
reorganization. The left column of the table contains the existing
rule's section headings, and the right column contains the proposed
reorganization of section sequence and heading changes.
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Existing regulations Final reorganization
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Sec. 652.1 Purpose................... Sec. 652.1 Purpose.
Sec. 652.5 Definitions............... Sec. 652.5 Definitions.
Sec. 652.10 Investment management and Sec. 652.10 Investment
requirements. management.
Sec. 652.15 Interest rate risk Sec. 652.15 Non-program
management and requirements. investment purposes and
limitation.
Sec. 652.20 Liquidity reserve Sec. 652.20 Eligible non-
management and requirements. program investments.
Sec. 652.25 Non-program investment Sec. 652.25 Management of
purposes and limitation. ineligible investments.
Sec. 652.30 Temporary regulatory Sec. 652.30 Interest rate
waivers or modifications for risk management.
extraordinary situations.
Sec. 652.35 Eligible non-program Sec. 652.35 Liquidity reserve
investments. management and requirements.
Sec. 652.40 Stress tests for mortgage Sec. 652.40 [Reserved].
securities.
Sec. 652.45 Divestiture of ineligible Sec. 652.45 Temporary
non-program investments. regulatory waivers or
modifications for
extraordinary situations.
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Generally, the reorganization is meant to address sequentially and
as completely as possible the three major categories of management
governed in the rule: Investment management; interest rate risk
management; and liquidity management.
B. Section 652.1--Purpose
We received no comments on our proposal to delete the first
sentence of this section as unnecessary, and we adopt the revision as
proposed.
C. Section 652.5--Definitions
Many of the definitions we proposed relate to revisions to
regulations that will not be finalized until a later installment of
this rulemaking, and we will not finalize those definitions until we
finalize the regulations to which they relate. We received no comments
[[Page 66377]]
on the proposed technical clarification to the definition of FCA or the
proposed definition of OSMO as FCA's Office of Secondary Market
Oversight that we proposed, and we adopt these revisions as proposed.
We proposed technical clarifications to the definitions of
``Government agency'' and ``Government-sponsored agency.'' We are
finalizing definitions for these terms with additional technical
clarifications.
The Council commented that our existing definition of non-program
investments, which we did not propose to revise, is overly broad and
allows for the holding of investments beyond the regulatory objectives
of ensuring safety and soundness and continuity of funding as outlined
in Sec. 652.1. It suggested that we modify the definition to clarify
that non-program investments are those held for the investment purposes
authorized by revised and renumbered Sec. 652.25. We note that as
proposed and as discussed above, this final rule deletes the sentence
in Sec. 652.1 to which the comment refers. Moreover, the definition of
non-program investments does not itself allow for the holding of
investments. Rather, Farmer Mac may hold non-program investments only
for the permissible investment purposes. Accordingly, we do not change
this definition.
D. Section 652.10--Investment Management
Farmer Mac commented that several of the proposed changes to the
rule go well beyond establishing a framework for safety and soundness
and instead impose FCA's judgment on proper business operations. Our
general response is that we revised some of the proposed requirements
in the final rule to make them less prescriptive but that we retain
some of the proposed requirements, with clarifications. We respond to
the comments on specific provisions below.
The Council requested that FCA follow a similar structure and
approach for Farmer Mac as it proposed for the System banks and
associations in their investment management rule. In the final rule, we
revise the structure and approach of this rule. In addition, the
structure and approach of the rule governing System banks and
associations has also been revised. We believe the structure and
approach of the two rules are now more similar; although, where
appropriate, differences still exist.
1. Sec. 652.10(a)--Responsibilities of the Board of Directors
The Council commented that the proposed requirement that the board
must annually review and ``affirmatively validate'' the sufficiency of
its investment policies is overly prescriptive, burdensome, and
unclear. We agree that a requirement of annual board review is
sufficient and delete ``affirmatively validate'' from the final rule.
With the exception of a few minor technical, clarifying, and non-
substantive changes, this paragraph is unchanged from the existing
rule.
2. Sec. 652.10(b)--Investment Policies--General Requirements
The Council commented that the requirement (an existing requirement
for Farmer Mac that had been proposed for System banks and
associations) that Farmer Mac must document in its ``records or
minutes'' any analyses used in formulating investment policies or
amendments is burdensome and does not enhance the investment management
process. We agree that specifying minutes as a possible location for
this documentation is unnecessary. Accordingly, we are deleting ``or
minutes'' from the final rule.
We are moving the requirement (most of which is contained in
existing Sec. 652.10(f)(1)) that Farmer Mac's investment policies must
fully address the extent of pre-purchase analysis that management must
perform for various types, classes, and structure of investments from
proposed Sec. 652.10(f)(1)(i) to this paragraph because it is a more
logical location.
With these exceptions, we are adopting Sec. 652.10(b) as proposed,
including several minor technical and clarifying changes. A discussion
of these minor changes may be found in the preamble to the proposed
rule.\6\
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\6\ See 76 FR 71801, Nov. 18, 2011.
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3. Sec. 652.10(c)--Investment Policies--Risk Tolerance
Proposed Sec. 652.10(c) would have required Farmer Mac's
investment policies to ensure that the Corporation maintains prudent
diversification of its investment portfolio and that its asset
allocations and investment portfolio strategies do not expose its
capital or earnings to excessive risk of loss. In final Sec.
652.10(c), we revise this requirement to provide that Farmer Mac's
investment policies must include concentration limits to ensure prudent
diversification of credit, market, and liquidity risks in its
investment portfolio. We believe this language is more specific, better
reflects requirements that are necessary for safety and soundness, and
provides consistency with the rule governing System banks and
associations. We emphasize, however, that the objective of this
requirement remains ensuring that Farmer Mac's asset allocations and
investment portfolio strategies do not expose its capital or earnings
to excessive risk of loss.
In addition, our proposed rule, as well as our existing rule,
provides that risk limits must be based on Farmer Mac's objectives,
capital position, and risk tolerance. In the final rule, we further
specify that risk limits must be based on all relevant factors,
including Farmer Mac's objectives, capital position, earnings, and
quality and reliability of risk management systems.
Existing Sec. 652.10(c)(1)(ii) requires Farmer Mac's board (or a
designated subcommittee) to review annually the criteria for selecting
securities firms and the board to approve any changes to the criteria.
It also requires that the board (or subcommittee) review annually the
existing relationships with securities firms and be notified before any
changes to securities firms are made.
In our NPRM, we proposed clarifying changes to these requirements
but did not intend a significant change in the meaning. Both Farmer Mac
and the Council objected to the existing requirement that the board
must review existing relationships and be notified before changes are
made to these relationships. The Council commented that this
requirement is confusing, creates an excessive burden, and results in
an unnecessary distraction for the board.
We agree that as long as Farmer Mac's board (or a designated
committee) reviews the selection criteria on an annual basis, and the
board approves any changes to the criteria, the board does not need to
be involved in the approval of relationships. Accordingly, we have
deleted the existing and proposed requirement that the board (or a
subcommittee) must review existing relationships and be notified before
changes are made to these relationships.
We adopt several other minor technical, clarifying, and non-
substantive changes in this paragraph.
4. Sec. 652.10(e)--Internal Controls
Existing Sec. 652.10(e)(2) requires Farmer Mac to establish and
maintain a separation of duties and supervision between personnel who
execute investment transactions and personnel who approve, revaluate,
and oversee investments. Proposed Sec. 651.10(e)(2) would have added
to the list of
[[Page 66378]]
personnel whose duties and supervision would have had to be separated
from personnel who execute investment transactions. These additional
personnel would have been those who post accounting entries, reconcile
trade confirmations, and report compliance with investment policy.
Both Farmer Mac and the Council objected to this proposed revision
as overly prescriptive. Rather than itemizing all of the possible
personnel functions, final Sec. 652.10(e)(2) provides that Farmer Mac
must establish and maintain a separation of duties between personnel
who supervise or execute investment transactions and personnel who
supervise or engage in all other investment-related functions. These
other investment-related functions include those itemized in the list
in the proposed rule, as well as any other functions that are
investment related. This regulation does not prohibit one person from
performing or supervising more than one investment-related function
(other than executing, or supervising the execution of, investment
transactions), if appropriate controls are in place as warranted by the
complexity and risk of Farmer Mac's investment operations.
Proposed section 652.10(e)(4) would have added a new requirement
that Farmer Mac must implement an effective internal audit program to
review, at least annually, its investment controls, processes, and
compliance with FCA regulations and other regulatory guidance. The
internal audit program would have had to specifically include a review
of its process for ensuring all investments were eligible and suitable
for purchase under its board's investment policies.
Both Farmer Mac and the Council commented that this requirement was
too prescriptive and eliminated the flexibility that is necessary for
Farmer Mac's internal auditors to establish their own risk-based
approach to audits. Final Sec. 652.10(e)(4) requires Farmer Mac to
implement an effective internal audit program to review, at least
annually, its investment management functions, controls, processes, and
compliance with FCA regulations. The scope of the annual review must be
appropriate for the size, risk, and complexity of the investment
portfolio.
5. Sec. 652.10(f)--Due Diligence
We made a number of minor technical and non-substantive changes
throughout this paragraph to clarify the requirements and to more
closely match up with the language of the rule governing the System
banks and associations. We do not identify these minor changes here.
Below we discuss our responses to the comments we received, including
the changes we make in response to those comments.
Proposed Sec. 652.10(f)(1)(i) would have required Farmer Mac,
before it purchased an investment, to conduct sufficient due diligence
to determine whether the investment was eligible and suitable under its
board-approved investment policies and to document this determination.
This proposed requirement is retained in new Sec. 652.10(f)(1)(i),
with minor clarifications. Since we had used the term ``suitable'' to
mean an investment complied with Farmer Mac's board-approved investment
policies, we simplify the regulation by eliminating that term and
instead requiring Farmer Mac to determine whether an investment
complies with those policies. We also clarify that Farmer Mac must
determine whether an investment is for an authorized purpose.
The Council commented that eligibility and the other pre-purchase
assessments are often established for a class or segment of securities
by specifying the criteria (credit risk, liquidity, market risk, etc.)
that make a class of securities eligible and suitable per se, and it
requested clarification that these pre-purchase assessments may be
defined for segments or classes of securities that meet appropriate
criteria rather on a security-by-security basis. We note that the
regulation does not prohibit Farmer Mac from establishing criteria for
various classes or segments of investments; nonetheless, Farmer Mac
must continue to adequately document its evaluation and assessments of
investments being purchased.
We also added a sentence to Sec. 652.10(f)(1)(i) specifically
authorizing Farmer Mac, with board approval, to hold investments that
do not comply with its investment policies. This addition recognizes
that such decisions are within the discretion of the board's business
judgment. We emphasize that this provision does not authorize the board
to approve investments that do not comply with our regulatory
eligibility requirements and purpose limitations.
Existing Sec. 652.10(f)(1) requires Farmer Mac to verify the value
of a security that it plans to purchase, other than a new issue, with a
source that is independent of the broker, dealer, counterparty, or
other intermediary to the transaction. We proposed to relocate this
requirement to Sec. 652.10(f)(1)(ii) but proposed no substantive
changes to the requirement.\7\
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\7\ The proposed requirement read: ``Prior to purchase, you must
verify the value of the investment (unless it is a new issue) with a
source that is independent of the broker, dealer, counterparty, or
other intermediary to the transaction.''
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Both Farmer Mac and the Council objected to this existing
requirement. The Council commented that verifying value from an
independent source is not realistic for investments of tranches of
collateralized mortgage obligations (CMOs), including planned
amortization class (PAC) bonds, purchased in the primary market. The
Council stated that these securities are generally unique in nature and
their value, when newly created, will be impossible to verify with a
third party prior to purchase.
In response, we reiterate that the third-party, pre-purchase
valuation requirement explicitly excludes new issues. Accordingly,
Farmer Mac need not seek third-party, pre-purchase valuation for new
issues.
Proposed Sec. 652.10(f)(1)(iii) would have contained extensive
risk-assessment evaluation and documentation requirements. Both Farmer
Mac and the Council objected to these requirements. The Council
commented that the detail and prescriptiveness of this paragraph was
unnecessary, burdensome, and redundant to the proposed investment
policy requirements. The Council also stated that the proposed rule
governing System banks and associations, while still excessive, was
more ``streamlined'' and consistent with the overall objectives of the
regulations.
In response, we have revised the requirements of final Sec.
652.10(f)(1)(iii) to be much less detailed than those in the NPRM as
well as more similar, but not identical, to those in the final rule
governing System banks and associations. The final rule specifies the
risks that must be assessed but, other than stress-testing
requirements, which are discussed below, it does not specify how these
risks must be assessed. We explain in this preamble our expectations
for how Farmer Mac should assess its risk. These expectations were
stated as requirements in the proposed rule.
In its assessment of credit risk, Farmer Mac should consider the
nature and type of underlying collateral, credit enhancements,
complexity of the structure, and any other available indicators of the
risk of default.
In its assessment of liquidity risk, Farmer Mac should consider the
investment structure, depth of the market, and ability to liquidate the
[[Page 66379]]
position under a variety of economic scenarios and market conditions.
In its assessment of market risk, Farmer Mac should consider how
various market stress scenarios including, at a minimum, potential
changes in interest rates and market conditions (such as changes in
market perceptions of creditworthiness), are likely to affect the cash
flow and price of the instrument.
The proposed rule would have required Farmer Mac, in conducting its
market risk assessment, to use reasonable and appropriate methodologies
for stress testing for the type or class of instrument to ensure the
investment complies with risk limits established in its investment and
interest rate risk policies. Although we intended that this stress-
testing requirement would encompass structured instruments and those
with uncertain cash flows, such as mortgage-backed securities and
asset-backed securities, the proposed rule did not expressly specify
what types or classes of instruments must be stress tested.
The Council commented that this proposal was more lenient than the
provisions that were proposed for System banks and associations, which
would have expressly required stress testing of all instruments prior
to purchase. In response to the Council's comment, and to clarify our
intentions in our proposed regulation, final Sec. 651.10(f)(1)(iii)
expressly requires Farmer Mac to stress test all investments that are
structured or that have uncertain cash flows, including specifically
mortgage-backed securities and asset-backed securities, prior to their
purchase. The stress test must be commensurate with the risk and
complexity of the investment.
Existing Sec. 652.10(f)(2) requires Farmer Mac, at least monthly,
to determine the fair market value of each security in its portfolio
and the fair market value of its whole investment portfolio. In doing
so, Farmer Mac must also evaluate the credit quality and price
sensitivity to the change in market interest rates of each security in
its portfolio and its whole investment portfolio. We had proposed to
delete the entire second sentence. Final Sec. 652.10(f)(3) requires
Farmer Mac to establish and maintain processes to monitor and evaluate
changes in the credit quality of each security in its portfolio and its
whole investment portfolio on an ongoing basis. We delete the price
sensitivity evaluation requirement because that is addressed in our
final interest rate risk management regulation at Sec. 652.30(c)(3).
Final Sec. 652.10(f)(4)(i) requires Farmer Mac to stress test its
entire investment portfolio, including stress tests of all investments
individually and stress tests of the portfolio as a whole, at the end
of each quarter. The stress test must enable Farmer Mac to determine
that its investment securities, both individually and on a portfolio-
wide basis, do not expose its capital, earnings, or liquidity to risks
that exceed the risk tolerance specified in its investment policies.
These requirements combine and clarify the existing Sec. 652.40(a)
requirement that Farmer Mac be able to identify individual securities
that expose it to a high level of risk with the portfolio-wide stress
testing required by proposed Sec. 652.10(f)(3)(i).
The Council commented that the stress-testing requirements in
proposed Sec. 652.10(f)(3)(ii) differed in subtle but important ways
from what was proposed for System banks and associations, and it stated
that this inconsistency was not supported by any business difference
between Farmer Mac and System banks and associations. The Council did
not, however, either specify the differences or explain why the
differences were important. We have made a few minor changes in the
final rule. We believe the final rule is substantially similar to the
final rule governing the System banks and associations; any differences
are not intended to be material.
6. Sec. 652.10(g)--Reports to the Board of Directors
Farmer Mac commented that the board reporting requirements in
proposed Sec. 652.10(g) go beyond establishing a framework for safety
and soundness and instead effectively supplant Farmer Mac's business
judgment with FCA's, but the Corporation provided no specific comments
on the requirements. The Council, commenting on the proposed rule
governing System banks and associations--which was somewhat more
detailed than the proposed rule governing Farmer Mac--stated that the
board reporting requirements were exceedingly prescriptive and limiting
of the board's authority to direct management, and it requested that
the provisions be generalized and simply require that the board receive
a quarterly report containing information on the investment portfolio
as the board deems appropriate.
We are finalizing Sec. 651.10(g) as proposed. We believe this
level of reporting is necessary to ensure the board has the information
it needs about Farmer Mac's investments.
E. Section 652.15--Non-Program Investment Purposes and Limitation
We are finalizing our proposal to renumber existing Sec. 652.25 as
Sec. 652.15.
We proposed in Sec. 652.15(a) to add a new permissible purpose for
Farmer Mac's non-program investments--investments that complement
program business activities. In the preamble to the proposed rule, we
stated that this purpose would recognize that certain investments, such
as investments with a rural focus that are backed by the full faith and
credit of the United States Government, could advance Farmer Mac's
mission by complementing its program business activities. We believe
that even if an investment is not held for the purposes of complying
with interest rate risk management requirements, complying with
liquidity requirements, or managing surplus short-term funds, mission
advancement could nevertheless be an appropriate purpose for which to
hold investments.\8\
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\8\ FCA has also approved mission-related investments for System
banks and associations on a case-by-case basis.
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Section 8.3(c)(12) of the Act permits Farmer Mac to ``purchase or
sell any securities or obligations * * * necessary and convenient to
the business of the Corporation.'' We believe this proposed broadening
of investment purposes is compatible with Farmer Mac's statutory
mandate and consistent with congressional intent.
We emphasized in the preamble to the proposed rule that this
provision would not add any new eligible investments to our authorized
list; Farmer Mac would still need to seek FCA's prior approval for any
investments not explicitly authorized on the list of eligible
investments.
In addition, we stated in the preamble to the proposed rule that
neither the proposed purpose nor any of the three existing purposes
authorize Farmer Mac to accumulate investment portfolios for arbitrage
activities or to engage in trading for speculative or primarily capital
gains purposes. We stated that realizing gains on sales before
investments mature is not a regulatory violation as long as the profits
are incidental to the specified permissible investment purposes. And we
emphasized that Farmer Mac's internal controls must ensure that
eligible investments clearly fulfill one or more of the authorized
investment purposes.
The Council strongly objected to the proposed purpose, stating that
FCA ``specifically states'' that the purpose will allow Farmer Mac to
use non-program investments as a business strategy to enhance returns
for investors.
[[Page 66380]]
The Council stated that this purpose would authorize Farmer Mac to
assume additional risk in its non-program investments and that Farmer
Mac's authorized investment purposes should be the same as those for
System banks. The Council also expressed concern that FCA did not
define what constitutes ``business activities.'' The Council asked us
to delete this proposed purpose entirely.
We adopt this provision as proposed. We specifically state that
this new purpose is to advance Farmer Mac's mission by complementing
Farmer Mac's program business activities--not to enhance returns to
investors. Positive returns are permissible only if they are incidental
to this purpose or to one of the three existing purposes. FCA will use
its supervisory authorities to ensure that all investments held for
this purpose actually do complement Farmer Mac's program business
activities and that the risk and return characteristics of such
investments are appropriate.
As stated above, Farmer Mac may hold only investments that are
already on the list of eligible investments unless it seeks FCA's prior
approval. In determining whether to grant approval, FCA will consider
the risk of the investment and whether it actually does complement
Farmer Mac's program business activities; where appropriate, we may
impose conditions on the approval. Although System banks do not have
such a purpose authorized by regulation, FCA has approved many mission-
related investments for System banks and associations. We further
emphasize that Farmer Mac's investments held for any of the four
permissible purposes will be subject to the 35-percent investment limit
in Sec. 652.15(b). We believe this limitation will help ensure that
Farmer Mac's mission achievement continues to be centered on providing
a source of liquidity and credit support for agriculture and rural
lenders directly through its secondary market and guarantee programs.
Investments that complement program business activities should have an
agricultural or rural focus.
We adopt as final our proposal to change the current regulatory
maximum non-program investment parameters in paragraph (b) to delete
the alternate maximum of a fixed $1.5 billion. While we continue to
believe that excessive or inappropriate use of non-program investments
is not consistent with the Corporation's statutory mission and status
as a Government-sponsored enterprise (GSE), we believe the maximum
investment parameter of 35 percent of program volume alone is
sufficient and that there is no longer a need for the $1.5-billion
ceiling on that maximum calculation. This change is based on Farmer
Mac's growth since the $1.5 billion ceiling was established in 2005. We
received no comment on this proposal.
Also in paragraph (b), we adopt as final our proposal to permit
Farmer Mac to exclude investments pledged to meet margin requirements
for derivative transactions (collateral) when calculating the 35-
percent investment limit under paragraph (b).\9\ We note that
investments that are pledged as collateral do not count toward Farmer
Mac's compliance with its liquidity requirements.\10\ We make this
change because the Dodd-Frank Act may result in additional margin
requirements for Farmer Mac, and we want to avoid the unintended
consequence of discouraging the use of derivatives as an appropriate
risk management tool. We received positive comments on this proposal
from the Council.
---------------------------------------------------------------------------
\9\ Paragraph (b) permits Farmer Mac to hold eligible non-
program investments, for specified purposes, up to 35 percent of
program volume.
\10\ Under new Sec. 652.35(b) (renumbered from existing Sec.
652.20(b)), all investments held for the purpose of meeting the
liquidity reserve requirement must be free of liens or other
encumbrances.
---------------------------------------------------------------------------
The Council requested that we also exclude various other
investments from the investment limit calculation. The Council
requested that we exclude securities purchased and designated for the
primary purpose of posting collateral for derivative positions, even if
the collateral is returned or the securities are never posted. The
Council stated that including these securities in the limit would
require Farmer Mac to maintain a cushion under the limit to accommodate
the possibility of return, thereby limiting the amount of other
investments it can hold to manage its liquidity position and derivative
counterparty exposures.
Both Farmer Mac and the Council asked that Treasury securities also
be excluded from the 35-percent limit. Farmer Mac stated that the
proposed rule would require it to hold significant amounts of Treasury
securities to meet FCA's liquidity requirements, thereby utilizing a
large portion of its liquidity and investment portfolio capacity. The
Council stated that the 35-percent limit creates an economic constraint
and disincentive to holding Treasury securities, even though they are
the most liquid and marketable investment.
Finally, the Council also requested that investment securities
pledged in secured borrowing relationships be excluded from the 35-
percent limit. The Council cited State Ag-Linked lending programs and
repurchase agreements as examples of these secured borrowing
relationships. Under both arrangements, according to the Council, the
pledging of securities acts as an alternative means of obtaining cash
for operations. Under Sec. 652.35(b) (renumbered from Sec.
652.20(b)), these investments may not be counted in the liquidity
reserve because they are not unencumbered. The Council asserts that
excluding securities pledged in secured borrowing relationships from
the 35-percent limit would be consistent with use of the securities as
an alternative method to secure financing and their treatment under the
FCA regulatory liquidity measurement.
We decline to exclude these investments from the investment limit.
We view these types of transactions as part of Farmer Mac's normal cash
management operations. Thus, under normal conditions, we expect Farmer
Mac to manage the level of its investments within FCA's portfolio size
limits to ensure regulatory compliance. If, in unusual business
environments, Farmer Mac were to experience the unexpected need for a
significant increase in pledgeable assets, and that increase could
result in a short-term need for regulatory flexibility regarding the
35-percent maximum limit, Sec. 652.45 of this regulation provides for
FCA discretion to allow that flexibility.
F. Section 652.20--Eligible Non-Program Investments
As proposed, we renumber existing Sec. 652.35, Eligible Non-
Program Investments, as Sec. 652.20. We delete the reference to
divestiture that was contained in Sec. 652.35(a)(5), because we no
longer require divestiture of investments that were eligible when
purchased, and the treatment of investments that were ineligible when
purchased is specified in Sec. 652.25(a). We also delete the
references to stress-testing mortgage securities that were contained in
Sec. 652.35(a)(6), because new Sec. 652.10(f) sets forth stress-
testing requirements for investments. We are reprinting this provision
because of these changes, but we are making no other changes to the
provision.
G. Section 652.25--Management of Ineligible Investments and Reservation
of Authority To Require Divestiture
As proposed, we delete existing Sec. 652.45 and replace it with
new Sec. 652.25. Existing Sec. 652.45(a)(2) requires Farmer Mac to
dispose of an investment that is ineligible \11\ within 6 months
[[Page 66381]]
unless we approve, in writing, a plan that authorizes divestment over a
longer period of time. An acceptable divestiture plan generally must
require Farmer Mac to dispose of the ineligible investment as quickly
as possible without substantial financial loss. Until it actually
disposes of the ineligible investment, Farmer Mac must report on
specified matters to its board of directors and to FCA at least
quarterly.
---------------------------------------------------------------------------
\11\ Under existing Sec. 652.35.
---------------------------------------------------------------------------
New Sec. 652.25(b) no longer requires Farmer Mac to divest of (or
to receive approval of a divestiture plan for) an investment that was
eligible \12\ when purchased but that no longer satisfies the
eligibility criteria.\13\ Rather, Farmer Mac would be required to
notify the OSMO within 15 calendar days of determining that the
investment no longer satisfies the eligibility criteria, and the
investment would be subject to specified requirements that are
discussed below. This approach provides the Corporation with greater
flexibility to manage its position and mitigate losses as compared with
a forced divestiture during a specific time period (or the need to
devote resources to developing and submitting a divestiture plan for
FCA to consider).
---------------------------------------------------------------------------
\12\ Under renumbered Sec. 652.20.
\13\ Such an investment would no longer be considered
``ineligible.''
---------------------------------------------------------------------------
The proposed rule would have required Farmer Mac to notify the OSMO
``promptly'' if an investment no longer satisfied the eligibility
criteria. Farmer Mac commented that the term ``prompt'' leaves
significant room for interpretation as to practical application, and it
requested a specific timeframe. The Council commented that it was
unsure what ``prompt'' meant in the context of the rule, and it stated
that notification is redundant and unnecessary given the requirements
of the regulation and the ongoing nature of FCA's examination function.
If FCA retained this requirement, the Council suggested a 60-calendar-
day notice period.
In response to these comments, we make the notification period 15
calendar days after Farmer Mac determines that the investment no longer
satisfies the eligibility criteria. We believe this notification period
is adequate, since the timeframe does not begin until Farmer Mac makes
the determination. Moreover, notification can be as simple as a
telephone call or an email.
The proposed rule would also have required notification to the OSMO
when an investment that satisfied the regulatory eligibility criteria
was not suitable because it did not satisfy the risk tolerance
established in the institution's required board policy, and the
investment would have been subject to the same specified requirements
discussed below. We are deleting this notification requirement from the
final rule because we do not want to create a disincentive for Farmer
Mac to establish a risk tolerance that is stricter than FCA's
regulatory eligibility criteria. Under the final rule, Farmer Mac does
not have to notify the OSMO when an investment that satisfies FCA's
regulatory eligibility criteria does not satisfy its own risk
tolerance, nor is the investment subject to the other specified
requirements discussed below.
As we proposed, final Sec. 652.25(a) provides that an investment
that does not satisfy the regulatory eligibility criteria at the time
of purchase is ineligible. Under the final rule (as under the existing
regulation), Farmer Mac may not purchase ineligible investments. If
Farmer Mac does purchase an ineligible investment, it must notify the
OSMO within 15 calendar days after determining that the investment was
ineligible and must divest of the investment no later than 60 calendar
days after the determination unless we approved, in writing, a plan
that authorizes divestiture over a longer period of time.
Although it is not stated in the regulation, we clarify here that
an acceptable divestiture plan would have to require Farmer Mac to
dispose of the investment as quickly as possible without substantial
financial loss. The plan would also have to contain sufficient analysis
to support continued retention of the investment, including its effect
on the institution's capital, earnings, liquidity, and collateral
position. Our decision would not be based solely on financial loss and
would include consideration of all circumstances surrounding the
purchase. Until Farmer Mac divests of the investment, it would be
subject to the same specified requirements discussed below.
Furthermore, we emphasize that any purchase of an ineligible
investment would indicate weaknesses in Farmer Mac's internal controls
and due diligence and would trigger increased FCA oversight if it
occurs. We expect such a purchase to occur rarely, if ever. For this
reason, we are retaining the divestiture requirement from the existing
and proposed rules, despite the Council's request that we treat
investments that are ineligible when purchased in the same manner as we
treat investments that are eligible when purchased but that
subsequently fail to meet the eligibility criteria. Furthermore, in
response to the Council's comment that this provision essentially
authorizes Farmer Mac to purchase ineligible investments that could be
held for 60 calendar days, we emphasize that this provision does not
authorize such a purchase. As stated, if Farmer Mac makes such a
purchase, it should expect increased FCA oversight of its internal
controls and due diligence process, as well as other enforcement
actions as appropriate.
The specified requirements that apply to investments retained by
Farmer Mac that are ineligible or that no longer satisfy the
eligibility requirements are specified in Sec. 652.25(c). We believe
these specified requirements are warranted by safety and soundness
concerns.
Section 652.25(c)(1) contains reporting requirements. Each quarter,
Farmer Mac is required to report to FCA and to its board on the status
of all such investments. The report must demonstrate the effect that
the investments may have on the Corporation's capital, earnings, and
liquidity position. Additionally, the report must address how the
Corporation plans to reduce its risk exposure from these investments or
exit the position.
Section 652.25(c)(2) provides that the investments may not be used
to satisfy Farmer Mac's liquidity requirement(s) in Sec. 652.40 and
that they must continue to be included in the investment portfolio
limit calculation established in Sec. 652.15(b).
Finally, Sec. 652.25(d) reserves FCA's authority to require Farmer
Mac to divest of any investment at any time for failure to comply with
Sec. 652.15(a) or for safety and soundness purposes. Although we did
not propose failure to comply with the permissible investment purposes
specified in Sec. 652.15(a) as a basis for requiring divestiture, this
change makes explicit our authority to require divestiture of an
investment that does not comply with our investment regulations. The
timeframe FCA sets would consider the expected loss on the transaction
(or transactions) and the effect on Farmer Mac's financial condition
and performance. Because the final rule does not require automatic
divestiture of any investment that was eligible when purchased, FCA is
making express our authority to require divestiture of investments when
necessary.
H. Section 652.30--Interest Rate Risk Management
We renumber existing Sec. 652.15 as Sec. 652.30. No comments were
received on the proposed revisions to this section, and we finalize
them as
[[Page 66382]]
proposed, with a minor, non-substantive change. The preamble to our
proposed rule explains our changes.
I. Section 652.35--Liquidity Reserve Management and Requirements
As proposed, we renumber existing Sec. 652.20, Liquidity Reserve
Management and Requirements, as Sec. 652.35. We are reprinting this
provision because of this renumbering, but we are making no other
changes to the provision.
J. Section 642.40--Stress Tests for Mortgage Securities
As proposed, we remove this standalone section from our regulations
and incorporate its requirements into Sec. 652.10(f), as discussed
above.
K. Section 652.45--Temporary Regulatory Waivers or Modifications for
Extraordinary Situations
We adopt the proposed revisions to Sec. 652.45. We relocate
existing Sec. 652.30, which authorizes FCA to modify or waive
regulatory investment management and liquidity management requirements
in extraordinary situations, to new Sec. 652.45. We believe this
location is more appropriate for this provision.
In addition to the existing specific modifications and waivers the
provision authorizes, we amend Sec. 652.45 to authorize FCA to take
other actions as deemed appropriate. This added authority will give FCA
additional flexibility to address extraordinary situations.
We received no comments on this revision, and the Council was
supportive of similar changes in the proposed rule governing System
banks.
V. Regulatory Flexibility Act
Farmer Mac has assets and annual income in excess of the amounts
that would qualify it as a small entity. Therefore, Farmer Mac is not a
``small entity'' as defined in the Regulatory Flexibility Act. Pursuant
to section 605(b) of the Regulatory Flexibility Act (5 U.S.C. 601 et
seq.), the FCA hereby certifies that the final rule will not have a
significant economic impact on a substantial number of small entities.
List of Subjects in 12 CFR Part 652
Agriculture, Banks, banking, Capital, Investments, Rural areas.
For the reasons stated in the preamble, part 652 of chapter VI,
title 12 of the Code of Federal Regulations is amended as follows:
PART 652--FEDERAL AGRICULTURAL MORTGAGE CORPORATION FUNDING AND
FISCAL AFFAIRS
0
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.
0
2. Subpart A, consisting of Sec. Sec. 652.1 through 652.45, is revised
to read as follows:
Subpart A--Investment Management
Sec.
652.1 Purpose.
652.5 Definitions.
652.10 Investment management.
652.15 Non-program investment purposes and limitation.
652.20 Eligible non-program investments.
652.25 Management of ineligible investments and reservation of
authority.
652.30 Interest rate risk management.
652.35 Liquidity reserve management and requirements.
652.40 [Reserved]
652.45 Temporary regulatory waivers or modifications for
extraordinary situations.
Subpart A--Investment Management
Sec. 652.1 Purpose.
The purpose of this subpart is to ensure safety and soundness,
continuity of funding, and appropriate use of non-program investments
considering the Federal Agricultural Mortgage Corporation's (Farmer Mac
or Corporation) special status as a Government-sponsored enterprise
(GSE). The subpart contains requirements for Farmer Mac's board of
directors to adopt policies covering such areas as investment
management, interest rate risk, and liquidity reserves. The subpart
also requires Farmer Mac to comply with various reporting requirements.
Sec. 652.5 Definitions.
For purposes of this subpart, the following definitions will apply:
Affiliate means any entity established under authority granted to
the Corporation under section 8.3(c)(14) of the Farm Credit Act of
1971, as amended.
Asset-backed securities (ABS) mean investment securities that
provide for ownership of a fractional undivided interest or collateral
interests in specific assets of a trust that are sold and traded in the
capital markets. For the purposes of this subpart, ABS exclude mortgage
securities that are defined below.
Eurodollar time deposit means a non-negotiable deposit denominated
in United States dollars and issued by an overseas branch of a United
States bank or by a foreign bank outside the United States.
Farmer Mac, Corporation, you, and your means the Federal
Agricultural Mortgage Corporation and its affiliates.
FCA, our, us, or we means the Farm Credit Administration.
Final maturity means the last date on which the remaining principal
amount of a security is due and payable (matures) to the registered
owner. It does not mean the call date, the expected average life, the
duration, or the weighted average maturity.
General obligations of a state or political subdivision means:
(1) The full faith and credit obligations of a state, the District
of Columbia, the Commonwealth of Puerto Rico, a territory or possession
of the United States, or a political subdivision thereof that possesses
general powers of taxation, including property taxation; or
(2) An obligation that is unconditionally guaranteed by an obligor
possessing general powers of taxation, including property taxation.
Government agency means the United States or an agency,
instrumentality, or corporation of the United States Government whose
obligations are fully and explicitly insured or guaranteed as to the
timely repayment of principal and interest by the full faith and credit
of the United States Government.
Government-sponsored agency means an agency, instrumentality, or
corporation chartered or established to serve public purposes specified
by the United States Congress but whose obligations are not fully and
explicitly insured or guaranteed by the full faith and credit of the
United States Government, including but not limited to any Government-
sponsored enterprise.
Liquid investments are assets that can be promptly converted into
cash without significant loss to the investor. A security is liquid if
the spread between its bid price and ask price is narrow and a
reasonable amount can be sold at those prices promptly.
Long-Term Standby Purchase Commitment (LTSPC) is a commitment by
Farmer Mac to purchase specified eligible loans on one or more
undetermined future dates. In consideration for Farmer Mac's assumption
of the credit risk on the specified loans underlying an LTSPC, Farmer
Mac receives an annual commitment fee on the outstanding
[[Page 66383]]
balance of those loans in monthly installments based on the outstanding
balance of those loans.
Market risk means the risk to your financial condition because the
value of your holdings may decline if interest rates or market prices
change. Exposure to market risk is measured by assessing the effect of
changing rates and prices on either the earnings or economic value of
an individual instrument, a portfolio, or the entire Corporation.
Maturing obligations means maturing debt and other obligations that
may be expected, such as buyouts of long-term standby purchase
commitments or repurchases of agricultural mortgage securities.
Mortgage securities means securities that are either:
(1) Pass-through securities or participation certificates that
represent ownership of a fractional undivided interest in a specified
pool of residential (excluding home equity loans), multifamily or
commercial mortgages, or
(2) A multiclass security (including collateralized mortgage
obligations and real estate mortgage investment conduits) that is
backed by a pool of residential, multifamily or commercial real estate
mortgages, pass-through mortgage securities, or other multiclass
mortgage securities.
(3) This definition does not include agricultural mortgage-backed
securities guaranteed by Farmer Mac itself.
Nationally recognized statistical rating organization (NRSRO) means
a rating organization that the Securities and Exchange Commission
recognizes as an NRSRO.
Non-program investments means investments other than those in:
(1) ``Qualified loans'' as defined in section 8.0(9) of the Farm
Credit Act of 1971, as amended; or
(2) Securities collateralized by ``qualified loans.''
OSMO means FCA's Office of Secondary Market Oversight.
Program assets means on-balance sheet ``qualified loans'' as
defined in section 8.0(9) of the Farm Credit Act of 1971, as amended.
Program obligations means off-balance sheet ``qualified loans'' as
defined in section 8.0(9) of the Farm Credit Act of 1971, as amended.
Regulatory capital means your core capital plus an allowance for
losses and guarantee claims, as determined in accordance with generally
accepted accounting principles.
Revenue bond means an obligation of a municipal government that
finances a specific project or enterprise, but it is not a full faith
and credit obligation. The obligor pays a portion of the revenue
generated by the project or enterprise to the bondholders.
Weighted average life (WAL) means the average time until the
investor receives the principal on a security, weighted by the size of
each principal payment and calculated under specified prepayment
assumptions.
Sec. 652.10 Investment management.
(a) Responsibilities of the board of directors. Your board of
directors must adopt written policies for managing your non-program
investment activities. Your board must also ensure that management
complies with these policies and that appropriate internal controls are
in place to prevent loss. At least annually, your board, or a
designated committee of the board, must review the sufficiency of these
investment policies. Any changes to the policies must be adopted by the
board. You must report any changes to these policies to the OSMO within
10 business days of adoption.
(b) Investment policies--general requirements. Your investment
policies must address the purposes and objectives of investments, risk
tolerance, delegations of authority, internal controls, due diligence,
and reporting requirements. Moreover, your investment policies must
fully address the extent of pre-purchase analysis that management must
perform for various types, classes, and structure of investments.
Furthermore, the policies must include reporting requirements and
approvals needed for exceptions to the board's policies. Investment
policies must be sufficiently detailed, consistent with, and
appropriate for the amounts, types, and risk characteristics of your
investments. You must document in the Corporation's records any
analyses used in formulating your policies or amendments to the
policies.
(c) Investment policies--risk tolerance. Your investment policies
must establish risk limits for the various types, classes, and sectors
of eligible investments. These policies must include concentration
limits to ensure prudent diversification of credit, market, and
liquidity risks in the investment portfolio. Risk limits must be based
on all relevant factors, including the Corporation's objectives,
capital position, earnings, and quality and reliability of risk
management systems. Your policies must identify the types and quantity
of investments that you will hold to achieve your objectives and
control credit, market, liquidity, and operational risks. Your policies
must establish risk limits for the following four types of risk:
(1) Credit risk. Your investment policies must establish:
(i) Credit quality standards, limits on counterparty risk, and risk
diversification standards that limit concentrations in a single or
related counterparty(ies), geographical areas, industry sectors, and
asset classes or obligations with similar characteristics.
(ii) Criteria for selecting brokers, dealers, and investment
bankers (collectively, securities firms). You must buy and sell
eligible investments with more than one securities firm. As part of
your review of your investment policies required under paragraph (a) of
this section, your board of directors, or a designated committee of the
board, must review the criteria for selecting securities firms. Any
changes to the criteria must be approved by the board.
(iii) Collateral margin requirements on repurchase agreements. You
must regularly mark the collateral to market and ensure appropriate
controls are maintained over collateral held.
(2) Market risk. Your investment policies must set market risk
limits for specific types of investments and for the investment
portfolio.
(3) Liquidity risk. Your investment policies must describe the
liquidity characteristics of eligible investments that you will hold to
meet your liquidity needs and the Corporation's other objectives.
(4) Operational risk. Investment policies must address operational
risks, including delegations of authority and internal controls in
accordance with paragraphs (d) and (e) of this section.
(d) Delegation of authority. All delegations of authority to
specified personnel or committees must state the extent of management's
authority and responsibilities for investments.
(e) Internal controls. You must:
(1) Establish appropriate internal controls to detect and prevent
loss, fraud, embezzlement, conflicts of interest, and unauthorized
investments.
(2) Establish and maintain a separation of duties between personnel
who supervise or execute investment transactions and personnel who
supervise or engage in all other investment-related functions.
(3) Maintain records and management information systems that are
appropriate for the level and complexity of your investment activities.
(4) Implement an effective internal audit program to review, at
least annually, your investment management functions, controls,
processes, and compliance with FCA regulations. The scope of the annual
review must be appropriate for the size, risk, and complexity of the
investment portfolio.
[[Page 66384]]
(f) Due diligence--(1) Pre-purchase analysis--(i) Objective,
eligibility, and compliance with investment policies. Before you
purchase an investment, you must conduct sufficient due diligence to
determine whether the investment is eligible under Sec. 652.20, is for
an authorized purpose under Sec. 652.15(a), and complies with your
board-approved investment policies. You must document its eligibility,
purpose, and investment policy compliance and your investment
objective. Your investment policies must fully address the extent of
pre-purchase analysis that management must perform for various types,
classes, and structure of investments. Your board must approve your
decision to hold an investment that does not comply with your written
investment policy requirements.
(ii) Valuation. Prior to purchase, you must verify the value of the
investment (unless it is a new issue) with a source that is independent
of the broker, dealer, counterparty or other intermediary to the
transaction.
(iii) Risk assessment. Your risk assessment must be documented and,
at a minimum, include an evaluation of credit risk, market risk, and
liquidity risk and the underlying collateral of the investment. You
must conduct stress testing before you purchase any investment that is
structured or that has uncertain cash flows, including all mortgage-
backed securities or asset-backed securities. The stress testing must
be commensurate with the risk and complexity of the investments and
must comply with the requirements of paragraph (f)(4) of this section.
(2) Monthly fair value determination. At least monthly, you must
determine the fair market value of each investment in your portfolio
and the fair market value of your whole investment portfolio.
(3) Ongoing analysis of credit risk. You must establish and
maintain processes to monitor and evaluate changes in the credit
quality of each security and the whole investment portfolio on an
ongoing basis.
(4) Quarterly stress testing. (i) You must stress test your entire
investment portfolio, including stress tests of all investments
individually and stress tests of the portfolio as a whole, at the end
of each quarter. The stress tests must enable you to determine that
your investment securities, both individually and on a portfolio-wide
basis, do not expose your capital, earnings, or liquidity to risks that
exceed the risk tolerance specified in your investment policies. If
your portfolio risk exceeds your investment policy limits, you must
develop a plan to reduce risk and comply with your investment policy
limits.
(ii) Your stress tests must be comprehensive and appropriate for
the risk profile of your investment portfolio and the Corporation. At a
minimum, the stress tests must be able to measure the price sensitivity
of investments over a range of possible interest rate/yield curve
scenarios. The methodology that you use to analyze investment
securities must be appropriate for the complexity, structure, and cash
flows of the investments in your portfolio. You must rely to the
maximum extent practicable on verifiable information to support all
your assumptions, including prepayment and interest rate volatility
assumptions, when you apply your stress tests. Your assumptions must be
prudent and based on sound judgment, and you must document the basis
for all assumptions that you use to evaluate the security and its
underlying collateral. You must also document all subsequent changes in
your assumptions.
(5) Presale value verification. Before you sell an investment, you
must verify its value with a source that is independent of the broker,
dealer, counterparty, or other intermediary to the transaction.
(g) Reports to the board of directors. At least quarterly,
executive management must report on the following to the board of
directors or a designated committee of the board:
(1) Plans and strategies for achieving the board's objectives for
the investment portfolio;
(2) Whether the investment portfolio effectively achieves the
board's objectives;
(3) The current composition, quality, and liquidity profile of the
investment portfolio;
(4) The performance of each class of investments and the entire
investment portfolio, including all gains and losses that you incurred
during the quarter on individual securities that you sold before
maturity and why they were liquidated;
(5) Potential risk exposure to changes in market interest rates as
identified through quarterly stress testing and any other factors that
may affect the value of your investment holdings;
(6) How investments affect your capital, earnings, and overall
financial condition;
(7) Any deviations from the board's policies. These deviations must
be formally approved by the board of directors.
Sec. 652.15 Non-program investment purposes and limitation.
(a) Farmer Mac is authorized to hold eligible non-program
investments listed under Sec. 652.20 for the purposes of enterprise
risk management, including complying with its interest rate risk
requirements in Sec. 652.30; complying with its liquidity requirements
in Sec. 652.40; managing surplus short-term funds; and complementing
program business activities.
(b) Non-program investments cannot exceed 35 percent of program
assets and program obligations, excluding 75 percent of the program
assets that are guaranteed by the United States Department of
Agriculture as described in section 8.0(9)(B) of the Farm Credit Act of
1971, as amended. When calculating the total amount of non-program
investments under this section, exclude investments pledged to meet
margin requirements on derivative transactions.
Sec. 652.20 Eligible non-program investments.
(a) You may hold only the types, quantities, and qualities of non-
program investments listed in the following Non-Program Investment
Eligibility Criteria Table. These investments must be denominated in
United States dollars.
Non-Program Investment Eligibility Criteria Table
----------------------------------------------------------------------------------------------------------------
Maximum percentage
Final maturity NRSRO issue or of total non-
Asset class limit issuer credit Other requirements program investment
rating requirement portfolio
----------------------------------------------------------------------------------------------------------------
(1) Obligations of the United None.............. NA................ None.............. None.
States.
Treasuries
[[Page 66385]]
Other obligations
(except mortgage securities)
fully insured or guaranteed by
the United States Government or
a Government agency.
(2) Obligations of Government- None.............. NA................ None.............. None.
sponsored agencies.
Government-sponsored
agency securities (except
mortgage securities).
Other obligations
(except mortgage securities)
fully insured or guaranteed by
Government-sponsored agencies.
(3) Municipal Securities:
General obligations.... 10 years.......... One of the two None.............. None.
highest.
Revenue bonds.......... 5 years for fixed Highest........... None.............. 15%.
rate bonds and 10
years for index/
floating rate
bonds.
(4) International and None.............. None.............. The United States None.
Multilateral Development Bank must be a voting
Obligations. shareholder.
(5) Money Market Instruments:
Federal funds.......... 1 day or One of the two None.............. None.
continuously highest short-
callable up to term.
100 days.
Negotiable certificates 1 year............ One of the two None.............. None.
of deposit. highest short-
term.
Bankers acceptances.... None.............. One of the two Issued by a None.
highest short- depository
term. institution.
Prime commercial paper. 270 days.......... Highest short-term None.............. None.
Non-callable term 100 days.......... Highest short-term None.............. 20%.
Federal funds and Eurodollar
time deposits.
Master notes........... 270 days.......... Highest short-term None.............. 20%.
Repurchase agreements 100 days.......... NA................ .................. None.
collateralized by eligible
investments or marketable
securities rated in the highest
credit rating category by an
NRSRO.
(6) Mortgage Securities:
Issued or guaranteed by None.............. NA................ .................. None.
the United States or a
Government agency.
Government-sponsored None.............. One of the two .................. 50%.
agency mortgage securities. highest.
Non-Government agency None.............. Highest........... .................. 15% combined.
or Government-sponsored agency
securities that comply with 15
U.S.C. 77d(5) or 15 U.S.C.
78c(a)(41).
Commercial mortgage- None.............. Highest........... Security
backed securities. must be backed by
a minimum of 100
loans.
Loans
from a single
mortgagor cannot
exceed 5% of the
pool..
Pool must
be geographically
diversified
pursuant to the
board's policy..
[[Page 66386]]
(7) Asset-Backed Securities None.............. Highest........... Maximum of 5-year 25% combined.
secured by: WAL for fixed
Credit card receivables rate or floating
Automobile loans....... rate ABS at their
Home equity loans...... contractual
Wholesale automobile interest rate
dealer loans. caps.
Student loans..........
Equipment loans........
Manufactured housing
loans.
(8) Corporate Debt Securities... 5 years........... One of the highest Cannot be 25%.
two for convertible to
maturities equity securities.
greater than 3
years, and one of
the highest three
for maturities of
three years or
less.
(9) Diversified Investment Funds NA................ NA................ The portfolio of None, if your
Shares of an investment company the investment shares in each
registered under section 8 of company must investment
the Investment Company Act of consist solely of company comprise
1940.. eligible less than 10% of
investments your portfolio.
authorized by Otherwise counts
this section. toward limit for
The investment each type of
company's risk investment.
and return
objectives and
use of
derivatives must
be consistent
with FCA guidance
and your
investment
policies..
----------------------------------------------------------------------------------------------------------------
Note: You must also comply with requirements of paragraphs (b), (c), and (d) of this section, and Sec. 651.40
when applicable. ``NA'' means not applicable.
(b) Rating of foreign countries. Whenever the obligor or issuer of
an eligible investment is located outside the United States, the host
country must maintain the highest sovereign rating for political and
economic stability by an NRSRO.
(c) Marketable investments. All eligible investments, except money
market instruments, must be readily marketable. An eligible investment
is marketable if you can sell it promptly at a price that closely
reflects its fair value in an active and universally recognized
secondary market. You must evaluate and document the size and liquidity
of the secondary market for the investment at time of purchase.
(d) Obligor limits. (1) You may not invest more than 25 percent of
your regulatory capital in eligible investments issued by any single
entity, issuer, or obligor. This obligor limit does not apply to
Government-sponsored agencies or Government agencies. You may not
invest more than 100 percent of your regulatory capital in any one
Government-sponsored agency. There are no obligor limits for Government
agencies.
(2) Obligor limits for your holdings in an investment company. You
must count securities that you hold through an investment company
toward the obligor limits of this section unless the investment
company's holdings of the security of any one issuer do not exceed 5
percent of the investment company's total portfolio.
(e) Preferred stock and other investments approved by the FCA. (1)
You may purchase non-program investments in preferred stock issued by
other Farm Credit System institutions only with our written prior
approval. You may also purchase non-program investments other than
those listed in the Non-Program Investment Eligibility Criteria Table
at paragraph (a) of this section only with our written prior approval.
(2) Your request for our approval must explain the risk
characteristics of the investment and your purpose and objectives for
making the investment.
Sec. 652.25 Management of ineligible investments and reservation of
authority.
(a) Investments ineligible when purchased. Investments that do not
satisfy the eligibility criteria set forth in Sec. 652.20 at the time
of purchase are ineligible. You must not purchase ineligible
investments. If you determine that you have purchased an ineligible
investment, you must notify the OSMO within 15 calendar days after such
determination. You must divest of the investment no later than 60
calendar days after the determination unless we approve, in writing, a
plan that authorizes you to divest of the investment over a longer
period of time.
(b) Investments that no longer satisfy eligibility criteria. If you
determine that an investment (that satisfied the eligibility criteria
set forth in Sec. 652.20 when purchased) no longer satisfies the
eligibility criteria, you must notify the OSMO within 15 calendar days
of the determination.
(c) Requirements for investments that are ineligible or no longer
satisfy eligibility criteria--(1) Reporting requirements. Each quarter,
you must report to the OSMO and your board on the status of investments
identified in paragraph (a) or (b) of this section. Your report must
demonstrate the effect that these investments may have on the
Corporation's capital, earnings, and liquidity position. Additionally,
the report must address how the Corporation plans to reduce its risk
exposure from these investments or exit the position(s).
(2) Other requirements. Investments identified in paragraph (a) or
(b) of this section may not be used to satisfy the liquidity
requirement(s) in Sec. 652.40. These investments must continue to be
included in the investment portfolio
[[Page 66387]]
limit calculation established in Sec. 652.15(b).
(d) Reservation of authority. FCA retains the authority to require
you to divest of any investment at any time for failure to comply with
Sec. 652.15(a) or for safety and soundness reasons. The timeframe set
by FCA for such required divestiture will consider the expected loss on
the transaction (or transactions) and the effect on the Corporation's
financial condition and performance.
Sec. 652.30 Interest rate risk management.
(a) The board of directors of Farmer Mac must provide effective
oversight (direction, controls, and supervision) of interest rate risk
management and must be knowledgeable of the nature and level of
interest rate risk taken by Farmer Mac.
(b) The board of directors of Farmer Mac must adopt an interest
rate risk management policy that establishes appropriate interest rate
risk exposure limits based on the Corporation's risk-bearing capacity
and reporting requirements in accordance with paragraphs (c) and (d) of
this section. At least annually, the board of directors, or a
designated committee of the board, must review the policy. Any changes
to the policy must be approved by the board of directors. You must
report any changes to the policy to the OSMO within 10 business days of
adoption.
(c) The interest rate risk management policy must, at a minimum:
(1) Address the purpose and objectives of interest rate risk
management;
(2) Identify the causes of interest rate risk and set appropriate
quantitative limits consistent with a clearly articulated board risk
tolerance;
(3) Require management to establish and implement comprehensive
procedures to measure the potential effect of these risks on the
Corporation's projected earnings and market values by conducting
interest rate stress tests and simulations of multiple economic
scenarios at least quarterly. Your stress tests must gauge how interest
rate fluctuations affect the Corporation's capital, earnings, and
liquidity position. The methodology that you use must be appropriate
for the complexity of the structure and cash flows of your on- and off-
balance sheet positions, including the nature and purpose of derivative
contracts, and establish counterparty risk thresholds and limits for
derivatives. It must also ensure an appropriate level of consistency
with the stress-test scenarios considered under Sec. 652.10(f)(4).
Assumptions applied in stress tests must, to the maximum extent
practicable, rely on verifiable information. You must document the
basis for all assumptions that you use.
(4) Describe and authorize management to implement actions needed
to achieve Farmer Mac's desired risk management objectives;
(5) Ensure procedures are established to evaluate and document, at
least quarterly, whether actions taken have actually met the
Corporation's desired risk management objectives;
(6) Identify exception parameters and approvals needed for any
exceptions to the policy's requirements;
(7) Describe delegations of authority; and,
(8) Describe reporting requirements, including exceptions to policy
limits.
(d) At least quarterly, management must report to the Corporation's
board of directors, or a designated committee of the board, describing
the nature and level of interest rate risk exposure. Any deviations
from the board's policy on interest rate risk must be specifically
identified in the report and approved by the board, or a designated
committee of the board.
Sec. 652.35 Liquidity reserve management and requirements.
(a) Minimum liquidity reserve requirement. Within 24 months of this
rule becoming effective, and thereafter, Farmer Mac must hold cash,
eligible non-program investments under Sec. 652.35 of this subpart,
and/or on-balance sheet securities backed by portions of Farmer Mac
program assets (loans) that are guaranteed by the United States
Department of Agriculture as described in section 8.0(9)(B) of the Act
(in accordance with the requirements of paragraphs (b) and (c) of this
section), to maintain sufficient liquidity to fund a minimum of 60 days
of maturing obligations, interest expense, and operating expenses at
all times. You must document your compliance with this minimum reserve
requirement at least once each month as of the last day of the month
using month-end data. Liquid asset values must be marked to market. In
addition, you must have the capability and information systems in place
to be able to calculate the minimum reserve requirement on a daily
basis.
(b) Free of lien. All investments held for the purpose of meeting
the liquidity reserve requirement of this section must be free of liens
or other encumbrances.
(c) Discounts. The amount that may be counted to meet the minimum
liquidity reserve requirement is as follows:
(1) For cash and overnight investments, multiply the cash and
investments by 100 percent;
(2) For money market instruments with maturities of 5 business days
or less, multiply the instruments by 97 percent of market value;
(3) For money market instruments with maturities greater than 5
business days and floating-rate debt and preferred stock securities,
multiply the instruments and securities by 95 percent of market value;
(4) For diversified investment funds, multiply the individual
securities in the funds by the discounts that would apply to the
securities if held separately;
(5) For fixed-rate debt and preferred stock securities, multiply
the securities by 90 percent of market value;
(6) For securities backed by Farmer Mac program assets (loans)
guaranteed by the United States Department of Agriculture as described
in section 8.0(9)(B) of the Act, multiply the securities by 75 percent;
and
(7) We reserve the authority to modify or determine the appropriate
discount for any investment used to meet the minimum liquidity reserve
requirement if the otherwise applicable discount does not accurately
reflect the liquidity of that investment or if the investment does not
fit wholly within one of the specified investment categories. In making
any modification or determination, we will consider the liquidity of
the investment as well as any other relevant factors. We will provide
notice of at least 20 business days before any modified discounts will
take effect.
(d) Liquidity reserve policy--board responsibilities. Farmer Mac's
board of directors must adopt a liquidity reserve policy. The board
must also ensure that management uses adequate internal controls to
ensure compliance with the liquidity reserve policy standards,
limitations, and reporting requirements established pursuant to this
paragraph and to paragraphs (e), (f), and (g) of this section. At least
annually, the board of directors or a designated subcommittee of the
board must review and validate the liquidity policy's adequacy. The
board of directors must approve any changes to the policy. You must
provide a copy of the revised policy to FCA's Office of Secondary
Market Oversight within 10 business days of adoption.
(e) Liquidity reserve policy--content. Your liquidity reserve
policy must contain at a minimum the following:
(1) The purpose and objectives of liquidity reserves;
(2) A listing of specific assets, debt, and arrangements that can
be used to meet liquidity objectives;
[[Page 66388]]
(3) Diversification requirements of your liquidity reserve
portfolio;
(4) Maturity limits and credit quality standards for non-program
investments used to meet the minimum liquidity reserve requirement of
paragraph (a) of this section;
(5) The minimum and target (or optimum) amounts of liquidity that
the board believes are appropriate for Farmer Mac;
(6) The maximum amount of non-program investments that can be held
for meeting Farmer Mac's liquidity needs, as expressed as a percentage
of program assets and program obligations;
(7) Exception parameters and post approvals needed;
(8) Delegations of authority; and
(9) Reporting requirements.
(f) Liquidity reserve reporting--periodic reporting requirements.
At least quarterly, Farmer Mac's management must report to the
Corporation's board of directors or a designated subcommittee of the
board describing, at a minimum, liquidity reserve compliance with the
Corporation's policy and this section. Any deviations from the board's
liquidity reserve policy (other than requirements specified in Sec.
652.20(e)(5)) must be specifically identified in the report and
approved by the board of directors.
(g) Liquidity reserve reporting--special reporting requirements.
Farmer Mac's management must immediately report to its board of
directors any noncompliance with board policy requirements that are
specified in Sec. 652.20(e)(5). Farmer Mac must report, in writing, to
FCA's Office of Secondary Market Oversight no later than the next
business day following the discovery of any breach of the minimum
liquidity reserve requirement at Sec. 652.20(a).
Sec. 652.40 [Reserved]
Sec. 652.45 Temporary regulatory waivers or modifications for
extraordinary situations.
Whenever the FCA determines that an extraordinary situation exists
that necessitates a temporary regulatory waiver or modification, the
FCA may, in its sole discretion:
(a) Modify or waive the minimum liquidity reserve requirement in
Sec. 652.40 of this subpart;
(b) Modify the amount, qualities, and types of eligible investments
that you are authorized to hold pursuant to Sec. 652.20 of this
subpart; and/or
(c) Take other actions as deemed appropriate.
Dated: October 25, 2012.
Dale L. Aultman,
Secretary, Farm Credit Administration Board.
[FR Doc. 2012-26805 Filed 11-2-12; 8:45 am]
BILLING CODE 6705-01-P