Federal Register, Volume 77 Issue 214 (Monday, November 5, 2012)

[Federal Register Volume 77, Number 214 (Monday, November 5, 2012)]
[Rules and Regulations]
[Pages 66362-66375]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-26806]

[[Page 66362]]

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FARM CREDIT ADMINISTRATION

12 CFR Part 615

RIN 3052-AC50

Funding and Fiscal Affairs, Loan Policies and Operations, and
Funding Operations; Investment Management

AGENCY: Farm Credit Administration.

ACTION: Final rule.

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SUMMARY: The Farm Credit Administration (FCA, Agency, us, our, or we)
issues this final rule to amend our regulations governing investments
held by institutions of the Farm Credit System (FCS or System), as well
as related regulations. This final rule strengthens our regulations
governing investment management and interest rate risk management;
reduces regulatory burden for investments that fail to meet eligibility
criteria after purchase; and makes other changes that will enhance the
safety and soundness of System institutions.

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:

Timothy T. Nerdahl, Senior Financial Analyst, Office of Regulatory
Policy, Farm Credit Administration, McLean, VA 22102-5090, (952) 854-
7151 extension 5035, TTY (952) 854-2239;

Jennifer A. Cohn, Senior Counsel, Office of General Counsel, Farm
Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703)
883-4020.

SUPPLEMENTARY INFORMATION:

I. Objectives

The objectives of this rule are to:
Ensure that Farm Credit banks \1\ hold sufficient high-
quality, readily marketable investments to provide sufficient liquidity
to continue operations and pay maturing obligations in the event of
market disruption;
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\1\ Section 619.9140 of FCA regulations defines Farm Credit bank
to include Farm Credit Banks, agricultural credit banks, and banks
for cooperatives.
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Strengthen the safety and soundness of System
institutions;
Reduce regulatory burden with respect to investments that
fail to meet eligibility criteria after purchase; and
Enhance the ability of the System to supply credit to
agriculture and aquatic producers by ensuring adequate availability to
funds.

II. Background

Congress created the System as a Government-sponsored enterprise
(GSE) to provide a permanent, stable, and reliable source of credit and
related services to American agricultural and aquatic producers. Farm
Credit banks obtain funds that they and System associations use to
provide credit and related services primarily through the issuance of
Systemwide debt securities.\2\ If access to the debt market becomes
temporarily impeded, Farm Credit banks must have enough readily
available funds to continue operations and pay maturing obligations.
Subpart E of part 615 imposes comprehensive requirements regarding the
investments of System institutions in order to ensure continuity of
operations.
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\2\ Farm Credit banks use the Federal Farm Credit Banks Funding
Corporation (Funding Corporation) to issue and market Systemwide
debt securities. The Funding Corporation is owned by the Farm Credit
banks.
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III. History of Rule

We adopted our last major revisions to our investment regulations
in 1999 and amended them in a more limited manner in 2005. Since 1999,
the marketplace pertaining to investments has changed significantly.
Innovations in investment products have led to their increasing
complexity, and investors need to have greater expertise to fully
understand them. In addition, the financial crisis that began in 2007
resulted in numerous investment downgrades and the loss of billions of
dollars by financial institutions. While System banks suffered
considerably less stress during the crisis than many other financial
institutions, they did experience numerous downgrades and some losses
on individual investments.
In 2010, we issued FCA Bookletter BL-064, which provided
clarification and guidance regarding our regulations and expectations
with respect to the key elements of a robust investment asset
management framework that institutions should establish to prudently
manage their investments in changing markets.\3\ The issuance of this
bookletter was an interim measure towards strengthening our investment
regulations.
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\3\ FCA Bookletter BL-064, Farm Credit System Investment Asset
Management (December 9, 2010). This Bookletter may be viewed at
www.fca.gov. Under Quick Links, click on Bookletters.
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On August 18, 2011, we published a proposed rule to amend FCA's
regulations governing System investments.\4\ Our intention was to
strengthen and enhance board governance and controls and clarify our
expectations over investment management practices, while reducing
regulatory burden in several areas. After considering the comments we
received on the proposed rule, we now plan to finalize the proposed
provisions contained in the proposed rule in installments.
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\4\ 76 FR 51289.
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This first installment of final regulations will revise the
following regulations:
Sec. 615.5131--Definitions;
Sec. 615.5132--Investment Purposes;
Sec. 615.5133--Investment Management;
Sec. 615.5136--Emergencies Impeding Normal Access of Farm
Credit Banks to Capital Markets;
Sec. 615.5143--Management of Ineligible Investments and
Reservation of Authority to Require Divestiture;
Sec. 615.5174--Farmer Mac Securities;
Sec. 615.5180--Bank Interest Rate Risk Management
Program; and
615.5182--Interest Rate Risk Management by Associations
and Other Farm Credit System Institutions Other Than Banks.
In addition, we are making minor technical conforming revisions to
Sec. 615.5140 and to Sec. 615.5201, which is the Definitions section
in our capital adequacy regulations.
Finally, we are deleting the following existing provisions:
Sec. 615.5135--Management of Interest Rate Risk (we are
incorporating its provisions, as amended, into Sec. 615.5180);
Sec. 615.5141--Stress Tests for Mortgage Securities (we
are incorporating its provisions, as amended, into Sec. Sec.
615.5133(f)(1)(iii) and 615.5133(f)(4)); and
Sec. 615.5181--Bank Interest Rate Risk Management Program
(we are incorporating its provisions, as amended, into Sec. 615.5180).
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 investment eligibility (including revised
creditworthiness requirements) and association investments. The
regulations that we proposed to revise but that we are not revising at
this time include:
Sec. 615.5140--Eligible Investments (except for minor
technical changes); and
Sec. 615.5142--Association Investments.
This final regulation codifies much of the guidance that was
contained in BL-064. In many areas, however, the regulation imposes
requirements that go beyond the Bookletter's guidance. Although the
Bookletter may continue to provide useful guidance, institutions must
be sure that they are complying with the requirements in this
regulation.

[[Page 66363]]

Because we are not at this time finalizing revisions to Sec.
615.5142, governing association investments, the guidance on
association investments in BL-064, which clarifies existing Sec.
615.5142, will continue to be relevant. In addition, institutions
should be mindful of our Informational Memorandum on Association
Investments dated May 16, 2012, which reminds banks and associations of
their obligations under Sec. 615.5142.

IV. Discussion of Comment Letters and Section-by-Section Analysis of
Final Rule

FCA received comment letters from two Farm Credit banks--CoBank,
ACB and the Farm Credit Bank of Texas. FCA also received comment
letters from four Farm Credit associations--Colonial Farm Credit, ACA,
FCS Financial, ACA, Farm Credit Services of Mid-America, ACA, and
AgStar Financial Services, ACA. In addition, the Farm Credit Council
(Council) submitted comments that were developed with input from a
workgroup that includes financial officers from several associations,
all Farm Credit banks, and the Federal Farm Credit Banks Funding
Corporation (Funding Corporation). Finally, we also considered a
comment letter the Council submitted to FCA on a similar proposed rule
governing the Federal Agricultural Mortgage Corporation (Farmer Mac)
\5\ that generally encouraged us to make the requirements of the two
rules more similar. Although the two final rules continue to differ
where appropriate, changes were made to both this rule and the Farmer
Mac rule to make the requirements more similar.\6\
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\5\ 76 FR 71798 (November 18, 2011).
\6\ In the interest of consistency, the FCA Board adopted the
final rule governing Farmer Mac's investment management 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 received many constructive comments on the proposed rule. In
general, the commenters stated that several of the provisions would
enhance investment management at System institutions. They also stated,
however, that many provisions of the proposed rule were inordinately
and unnecessarily prescriptive.
The Council also commented generally that the rule is unnecessary
in light of FCA Bookletter BL-064. In response, we believe it is
prudent to codify the bookletter's guidance into regulation. In
addition, as stated above, in many areas the regulation imposes
requirements that go beyond the bookletter's guidance. Accordingly,
this regulation is necessary notwithstanding FCA Bookletter BL-064.
We will address each specific comment received in our discussion of
the regulation provision to which the comment relates. Those areas of
the proposed rule not receiving comment or receiving positive comments
are finalized as proposed unless otherwise discussed in this preamble.
Throughout this regulation, we make minor technical, clarifying, and
non-substantive language changes that we do not specifically discuss in
this preamble.

A. Section 615.5131--Definitions

We proposed to amend Sec. 615.5131 to add definitions for the
terms Government agency and Government-sponsored agency. The Council
noted that FCA had already defined these terms in our capital adequacy
regulation at Sec. 615.5201. The Council stated that FCA and the other
banking regulators ``essentially define these terms identically'' for
capital purposes, and it asked us to conform the definitions.
We note that the definitions of these terms in the capital
regulations of FCA and of other banking regulators such as the Federal
Reserve Board (FRB), the Federal Deposit Insurance Corporation (FDIC),
and the Office of the Comptroller of the Currency (OCC) contain
technical differences from one another.\7\ In an effort to bring
additional clarity to these definitions, the definitions we proposed in
this rulemaking also differed in technical ways from any of these other
definitions. In the absence of definitive common definitions, we
believe our technical differences from the other regulators are
warranted. We agree, however, that FCA's definitions should be
consistent among themselves. Accordingly, we are finalizing the Sec.
615.5131 definitions as proposed with minor technical changes and, as
discussed below, we are revising the definitions in Sec. 615.5201 to
conform.
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\7\ See, e.g., 12 CFR Part 208, App. A (FRB); 12 CFR Part 225,
App. A (FRB); 12 CFR Part 325, App. A (FDIC); 12 CFR Part 3, App. A
(OCC).
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Section 615.5131 defines Government agency as the United States
Government 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. Section 615.5131
defines Government-sponsored agency as 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. This definition includes GSEs such as the
Federal National Mortgage Association (Fannie Mae) and the Federal Home
Loan Mortgage Corporation (Freddie Mac), as well as Federal agencies,
such as the Tennessee Valley Authority, that issue obligations that are
not explicitly guaranteed by the Government of the United States' full
faith and credit.

B. Section 615.5132--Investment Purposes

Section 615.5132 permits each Farm Credit bank to hold eligible
investments, for specified purposes,\8\ in an amount not to exceed 35
percent of its total outstanding loans. We remind banks that generating
earnings is not an authorized investment purpose, although it is
permissible if the earnings are incidental to one or more of the
specified investment purposes.\9\
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\8\ The specified purposes are maintaining a liquidity reserve,
managing surplus short-term funds, and managing interest rate risk.
\9\ We also remind associations that, pursuant to Sec.
615.5142, which we are not amending today, their only authorized
investment purposes are reducing interest rate risk and managing
surplus short-term funds. One association commenter suggested that
it holds investments to augment income. As with banks, augmenting
income through investments is permissible only if such income is
incidental to one or more of the authorized investment purposes.
Under Sec. 611.1135(a), service corporations may hold investments
for the purposes authorized for their organizers.
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In our proposed rule, we asked whether the 35-percent investment
limit should be raised. Commenters responded that this limit was
appropriate, as long as our regulations permitted the exclusion of
certain investments. We discuss these comments, and our responses,
below.
1. Exclusion of Investments Pledged To Meet Margin Requirements for
Derivative Transactions
In Sec. 615.5132(b)(1), we adopt as final our proposal to permit
Farm Credit banks to exclude investments pledged to meet margin
requirements for derivative transactions (collateral) when calculating
the 35-percent investment limit under paragraph (a). We note that
investments that are pledged as collateral do not count toward a Farm
Credit bank's compliance with its liquidity requirements.\10\ We make
this change because derivatives are used as a hedging tool against
interest rate risk and liquidity risk. Farm Credit banks use derivative
products as an integral part of their interest rate risk

[[Page 66364]]

management activities and as a supplement to the issuance of debt
securities in the capital markets. We recognize that banks are required
to post collateral to counterparties resulting from entering into
derivative transactions, and we believe banks should not be discouraged
from implementing appropriate risk management practices. We received
positive comments on this proposal from the Council and a bank.
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\10\ Under Sec. 615.5134(b), all investments that a bank holds
for the purpose of meeting the liquidity reserve requirement must be
free of lien.
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2. Exclusion of Other Investments
Some commenters requested that we also exclude certain other
investments from the 35-percent limit. They 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. These commenters stated that
including these securities in the 35-percent limit would require a bank
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.
Commenters also requested that we exclude Treasury securities from
the 35-percent limit. They stated that including Treasury securities in
the limit crowds out other higher-yielding, high-quality liquid
investments. Thus, their inclusion in the limit creates an economic
constraint and disincentive to holding Treasury securities, even though
they are the most liquid and marketable investment. They requested that
we treat Treasury securities like cash and exclude them from the 35-
percent limit.
Finally, the Council 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 that provides cash for
operations without the issuance of new Federal Farm Credit Banks debt
obligations. Under Sec. 615.5134(b), these investments may not be
counted in the liquidity reserve because they are not unencumbered. The
Council asserts that excluding pledged securities 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
on a blanket basis. We view these types of transactions as part of a
Farm Credit bank's normal cash management operations. Thus, under
normal conditions, we expect each Farm Credit bank to manage the level
of its investments within FCA's portfolio size limits to ensure
regulatory compliance. As discussed below, however, we are providing
additional flexibility to each bank in the management of its investment
portfolio by revising the regulation to allow compliance with the limit
on a 30-day average daily balance (ADB) basis rather than on a daily
basis; this change will enable a bank to exceed the investment limit
temporarily, as long as its 30-day ADB is below the limit. Moreover,
final Sec. 615.5132(b)(2) permits the exclusion from the investment
limit of other investments as FCA determines is appropriate.
3. Revision to Calculation
In order to provide Farm Credit banks with additional flexibility
to manage their investment portfolio, we are modifying how the 35-
percent investment limit is calculated in paragraph (a).
The numerator (investments) will be calculated as a 30-day ADB of
investments measured at amortized cost, excluding interest and net of
all collateral pledged for derivative purposes and any other
investments for which FCA has approved exclusions. The calculation of
the denominator (total outstanding loans) remains unchanged, although
the regulation makes explicit our existing interpretation that total
loans include accrued interest and do not include allowance for loan
loss.\11\ Compliance will only be measured at month end.
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\11\ Section 615.5131 provides that loans are calculated
quarterly (as of the last day of March, June, September, and
December) by using the ADB of loans during the quarter.

Example of the January 31, 2012 calculation: 30-day ADB of
investments as of January 31, 2012 divided by the 90-day ADB of
total outstanding loans as of December 31, 2011.
Example of the March 31, 2012 calculation: 30-day ADB of
investments as of March 31, 2012 divided by the 90-day ADB of total
outstanding loans as of March 31, 2012.

We believe this modification of the 35-percent calculation will
provide additional flexibility for Farm Credit banks in managing their
investment portfolios. Because FCA will evaluate compliance at month
end and on a 30-day ADB rather than the actual daily balance, a bank
that receives a large amount of returned collateral that temporarily
increases its investment portfolio above 35 percent on a particular
day, for example, should still be below the 35-percent ADB--unless it
is managing its investment portfolio too close to the 35-percent limit.

C. Section 615.5133--Investment Management

Effective investment management requires financial institutions to
establish policies that include risk limits, approved mechanisms for
identifying, measuring, and reporting exposures, and strong corporate
governance. The recent crisis and its lingering effects have re-
emphasized the importance of sound investment management, and we
believe that strengthened regulation would further ensure the safe and
sound management of investments. Accordingly, we are making significant
changes to Sec. 615.5133, which governs investment management.
One association commented that the economic impact of certain
proposals on small associations could be profound, because they cannot
afford a bank's level of investment management expertise. The
association recognizes that association boards and management have a
fiduciary duty to manage investments in a safe and sound manner, but it
stated that it depends on its funding bank, in its approval role, to
provide advice regarding unwise investment decisions. In addition,
according to the association commenter, requiring associations to add
unnecessary investment management committees, policies, analyses, and
reports increases expenses and decreases the benefits of investments.
Revised Sec. 615.5133(b), which we discuss in greater detail
below, requires investment policies to be sufficiently detailed,
consistent with, and appropriate for the amounts, types, and risk
characteristics of an institution's investments.\12\ As we stated in
1999 and have repeated since that time, bank oversight does not absolve
an association's board and managers of their fiduciary responsibilities
to manage investments in a safe and sound manner. The fiduciary
responsibilities of association boards obligate them to develop
appropriate investment management policies and practices to manage the
risks associated with investment activities. Moreover, each
association's investment managers must fully understand the risks of
its investments and make independent and

[[Page 66365]]

objective evaluations of investments prior to purchase. An association
must comply with all the requirements in Sec. 615.5133 if the level or
type of its investments could expose its capital to material loss.
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\12\ The existing language imposes similar requirements.
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A bank's approval serves as an additional safeguard for an
association's investments, but the association must nevertheless have
the requisite expertise to manage the investments that it holds.
1. Section 615.5133(a)--Responsibilities of Board of Directors
The Council commented that the proposed requirement that the board
(or a designated committee of the board) must, at least annually,
review and ``affirmatively validate'' the sufficiency of its investment
policies is overly prescriptive, burdensome, and unclear. We agree that
a review requirement is sufficient and delete ``affirmatively
validate'' from the final rule.
We also move to this section and clarify a documentation
requirement that we had proposed in Sec. 615.5133(b). We had proposed
to require institutions to document in their records or board minutes
any analyses used in formulating their policies or amendments to the
policies. The Council stated that suggesting board minutes as a place
to document this analysis is burdensome and does not enhance the
investment management process. We do not agree that suggesting board
minutes as an optional location for documentation is burdensome.
Nevertheless, we revise the last sentence of Sec. 615.5133(a) to
require that any changes to the policies must be documented, without
specifying a location.
The revisions in this paragraph are otherwise unchanged from the
proposed rule. All other comments supported the proposed revisions in
this provision.
2. Section 615.5133(b)--Investment Policies--General Requirements
The Council commented that the revisions in this proposed paragraph
appeared reasonable overall. We move from Sec. 615.5133(f)(1) a
sentence requiring investment policies to fully address the extent of
pre-purchase analysis that management must perform for various classes
of investments. Otherwise, except for several minor non-substantive
technical changes, the revisions in this paragraph are unchanged from
the proposed rule.
3. Section 615.5133(c)--Investment Policies--Risk Tolerance
We received comment on the clarity of the proposed language in this
provision. Accordingly, we are clarifying the requirements in final
Sec. 615.5133(c) to require that investment policies must include
concentration limits to ensure prudent diversification of credit,
market, and liquidity risk in the investment portfolio.
In addition, our proposed rule, as well as our existing rule,
provides that risk limits must be based on an institution's
institutional objectives, capital position, and risk tolerance. In the
final rule, we are requiring that risk limits be based on all relevant
factors, including an institution's institutional objectives, capital
position, earnings, and quality and reliability of risk management
systems. In addition, in light of our relocation of our interest rate
risk management requirements to another subpart of these regulations
(discussed below), we are making explicit that risk limits must also
consider the interest rate risk management program required for banks
and associations.
a. Section 615.5133(c)(1)--Credit Risk
Existing Sec. 615.5133(c)(1)(ii) requires an institution's board
to review annually the investment policy criteria for selecting
securities firms and to determine whether to continue the institution's
existing relationships with them. To reduce regulatory burden, we
proposed to permit a designated committee of the board to review the
criteria and to determine whether to continue existing relationships,
but the board would have had to approve any changes to the criteria or
to the existing relationships.
Both the Council and a bank objected to the existing requirement
that the board must determine whether to continue an institution's
existing relationships with securities firms. They 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 an institution'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 the relationships. Accordingly, we have
deleted the existing and proposed requirements of board involvement in
an institution's relationships with securities firms.
Existing Sec. 615.5133(c)(1)(iii) requires investment policies to
establish collateral margin requirements on repurchase agreements. We
proposed to require institutions to regularly mark the collateral to
market and ensure appropriate controls are maintained over collateral
held. We received positive comments on this provision and adopt it as
proposed.
b. Section 615.5133(c)(2)--Market Risk
Existing Sec. 615.5133(c)(2) requires an institution's board to
establish market risk limits in accordance with our regulations and
other policies. In our proposed rule, we specifically identified these
other regulations as those governing stress testing and interest rate
risk.
The Council objected to the proposed revision, stating that it did
not appear to add a new requirement but that it could be used to impose
duplicative requirements. In addition, the Council vigorously objected
to the proposed and existing reference to ``other policies''; because
these policies have not been subject to notice and comment rulemaking,
we cannot require compliance with them in this regulation.
In response to these comments, the final regulation, like the
existing regulation, requires investment policies to set market risk
limits for specific types of investments and for the investment
portfolio.\13\ We believe this requirement is sufficient and the
reference to our ``regulations and * * * other policies'' is not
needed.
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\13\ We adopt our proposed technical changes to this provision.
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4. Section 615.5133(e)--Internal Controls
Existing Sec. 615.5133(e)(2) requires System institutions 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.
615.5133(e)(2) would have added to the list of 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 the Council and a bank objected to this proposed revision as
overly prescriptive. In response, rather than itemizing all of the
possible personnel functions, final Sec. 615.5133(e)(2) provides that
System institutions 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

[[Page 66366]]

include those itemized in the list in the proposed rule, as well as any
other functions that are investment-related. Examples of those items in
the proposed rule include but are not limited to posting accounting
entries and reconciling trade confirmations. This regulation does not
prohibit one person from performing or supervising more than one
investment-related function, except that the same person cannot
supervise or execute investment transactions and at the same time
supervise or engage in any other investment-related function. Each
institution must maintain appropriate controls as warranted by the
complexity and risk of its investment operations.
Proposed Sec. 615.5133(e)(4) would have added a new requirement
that System institutions must implement effective internal audit
programs to review, at least annually, their investment controls,
processes, and compliance with FCA regulations and other regulatory
guidance. Internal audit programs would have had to specifically
include a review of the process for ensuring all investments, at the
time of purchase, were eligible and suitable for purchase under the
boards' investment policies.
The Council and both bank commenters stated that this requirement
was too prescriptive and eliminated the flexibility that is necessary
for an institution's internal auditors to establish its own risk-based
approach to audits. An association encouraged FCA to set a de minimis
investment portfolio amount relative to an association's total assets
or total capital; investment portfolios under this amount would not be
subject to annual risk assessments.
Final Sec. 615.5133(e)(4) requires institutions to implement
effective internal audit programs to review, at least annually, their
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. Thus, while the final rule retains the annual audit
requirement, it provides flexibility in determining the scope of the
audit.
While the final rule allows for flexibility depending on the nature
of an institution's investment portfolio, there is no bright line de
minimis portfolio size that would permit an institution not to engage
in risk assessment. As stated above, an association must comply with
all the requirements in Sec. 615.5133 if the level or type of its
investments could expose its capital to material loss. Each association
must have the ability to manage the investments that it holds.
In addition to the regulatory requirements in Sec. 615.5133(e)(4),
the guidance provided in BL-064 continues to be relevant for
institutions in their development of internal audit processes.
5. Section 615.5133(f)--Due Diligence
As proposed, the final rule adds a new Sec. 615.5133(f) that
covers due diligence. This provision combines in one location the
requirements governing securities valuation and those governing stress
testing that are in existing Sec. 615.5133(f) and Sec. 615.5141,
respectively.
In addition to the substantive changes to specific provisions,
which we discuss below, we make extensive organizational and technical
changes to make the structure and approach of this rule more similar to
the rule governing Farmer Mac. We also make a number of minor technical
and non-substantive changes to clarify the requirements.
a. Section 615.5133(f)(1)(i)--Eligibility, Purpose, and Compliance with
Investment Policies
Proposed Sec. 615.5133(f)(1) would have required a System
institution, before it purchased an investment, to conduct sufficient
due diligence to determine whether the investment was eligible and
``suitable'' for purchase under its board's investment policies. The
institution would have been required to document this assessment.
This proposed requirement is retained in new Sec.
615.5133(f)(1)(i), with minor clarifications. Since we had used the
term ``suitable'' to mean an investment complied with the board's
investment policies, we simplify the regulation by eliminating that
term and instead requiring that an institution determine whether an
investment complies with those policies. We also clarify that an
institution must determine whether an investment is for an authorized
purpose.
The Council and a bank 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 they requested clarification that these pre-
purchase assessments may be defined for segments or classes of
securities that meet appropriate criteria rather than on a security-by-
security basis. We note that the regulation does not prohibit the
establishment of criteria for various classes or segments of
investments, as long as an institution adequately documents its
assessments.
We also added a sentence to Sec. 615.5133(f)(1)(i) specifically
authorizing an institution, 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.\14\ This provision does not authorize the board to
approve investments that do not comply with our regulatory eligibility
requirements and purpose limitations.
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\14\ This authority incorporates and broadens proposed Sec.
615.5133(f)(2)(i), which would have permitted an institution, with
board approval, to purchase an investment that exceeds the stress-
test parameters defined in its board policy.
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b. Section 615.5133(f)(1)(ii)--Valuation
Existing Sec. 615.5133(f)(1) requires a System institution 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 no
substantive changes to the requirement.
The Council objected to this existing requirement, commenting that
verifying value from an independent source is not realistic for
investments of tranches of collateralized mortgage obligations,
including planned amortization class 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,
institutions need not seek third party pre-purchase valuation for new
issues.
This valuation requirement and exclusion for new issues is retained
in new Sec. 615.5133(f)(1)(ii).
c. Section 615.5133(f)(1)(iii)--Risk Assessment
Like proposed Sec. 615.5133(f)(1), new Sec. 615.5133(f)(1)(iii)
provides that an institution's assessment of each investment at the
time of purchase must at a minimum include an evaluation of credit
risk, liquidity risk, market risk, interest rate risk, and the
underlying collateral of the investment.
The Council, a bank, and an association commented that while a
comprehensive level of due diligence is appropriate for more risky and
complex instruments such as mortgage-backed securities (MBS), such due
diligence would be excessive and burdensome for instruments such as
Treasury securities, federal funds investments, short-term commercial
paper, discount notes, bullet bonds, and other less complex

[[Page 66367]]

and less risky securities. To ensure that we do not require more due
diligence than is necessary, we add a provision that an institution's
risk assessment must be commensurate with the complexity and risk in
the investment.
The final rule specifies the risks that must be assessed but does
not specify how these risks must be assessed. We explain in this
preamble our expectations for how System institutions should assess
their risk.
In their assessment of credit risk, System institutions should
consider the nature and type of underlying collateral, credit
enhancements, complexity of structure, and any other available
indicators of the risk of default.
In their assessment of liquidity risk, System institutions should
consider the investment structure, depth of the market, and ability to
liquidate the position under a variety of economic scenarios and market
conditions.
In their assessment of market risk, System institutions should
consider how various market stress scenarios including, at a minimum,
potential changes in interest rates and market conditions (such as
market perceptions of creditworthiness), are likely to affect the cash
flow and price of the instrument.
Proposed Sec. 615.5133(f)(2) had required institutions to stress
test all investments at the time of purchase. Commenters stated that
while a pre-purchase stress-testing requirement is appropriate for
complex securities such as MBS, asset-backed securities (ABS), and
other non-Government guaranteed investments, it is inappropriate to
require pre-purchase stress testing on instruments with low price
sensitivity, such as Government-guaranteed investments and non-
amortizing, bullet-type investments maturing within 1 year. Moreover,
an association requested the establishment of a de minimis limit for
stress testing even of higher-risk, more complex securities.
We agree that stress testing lower risk, less complex investments,
such as overnight securities and commercial paper, may not provide
value and may create excessive burden. Accordingly, final Sec.
615.5133(f)(1)(iii) requires an institution to stress test before
purchase only investments that are structured or that have uncertain
cash flows, including all MBS and ABS. The stress test must be
commensurate with the risk and complexity of the investment and must
enable the institution to determine that the investment does not expose
its capital, earnings, and liquidity to risks that exceed the risks
specified in its investment policies.\15\ The stress testing must
comply with the requirements governing quarterly stress testing, which
are discussed below.
---------------------------------------------------------------------------

\15\ As part of reorganizing the final rule, we relocated this
requirement from proposed Sec. 615.5133(f)(2)(iii).
---------------------------------------------------------------------------

We do not establish a de minimis amount below which stress testing
need not be performed, because we believe that all high-risk, complex
instruments must be stress tested. We note that final Sec.
615.5133(f)(4) requires stress tests to be comprehensive and
appropriate for the risk profile of each institution. Moreover, that
provision also requires that the methodology an institution uses be
appropriate for the complexity, structure, and cash flow of the
investments in its portfolio.
d. Section 615.5133(f)(2)--Ongoing Value Determination
We retain the requirements of the first sentence of existing Sec.
615.5133(f)(2), with slight wording changes.
e. Section 615.5133(f)(3)--Ongoing Analysis of Credit Risk
We move the second sentence of existing Sec. 615.5133(f)(2) to
Sec. 615.5133(f)(3), with several changes. First, we delete the
existing ongoing requirement to evaluate price sensitivity to market
interest rates because that is adequately addressed in final Sec.
615.5180(c)(3). Second, rather than requiring institutions to evaluate
credit quality, we are requiring institutions to establish and maintain
processes to monitor and evaluate changes in credit quality. Finally,
we are retaining the existing requirement that institutions must
analyze credit risk on an ongoing basis, rather than monthly, as we had
proposed.
An association stated that it supported the proposed requirement to
evaluate the credit quality of investments, provided fixed-rate,
Government-guaranteed investments are excluded. We do not exclude these
investments from this requirement because, like any other investments,
the credit quality of Government-guaranteed investments can change over
time.
f. Section 615.5133(f)(4)--Quarterly Stress Testing
Final Sec. 615.5133(f)(4)(i) imposes requirements regarding
quarterly stress testing. The technical changes we made from proposed
Sec. 615.5133(f)(2)(ii) are not material. These changes consist of
clarifying the language and relocating language from proposed Sec.
615.5133(f)(2)(iii) that is more logically located here.
One of the bank commenters agreed that a properly structured and
documented quarterly stress test can provide useful information on
capital, earnings, and liquidity risk relative to changes in market
value of the entire portfolio, and it stated that the parameters an
individual institution sets for the quarterly stress-testing analysis
of its entire investment portfolio as a whole should be sufficient to
analyze the level of risk contributed by investments.
We do not believe that stress testing an institution's entire
portfolio as a whole is sufficient to analyze the risk of investments.
It is critical to know individual results. Otherwise, risks could be
offsetting each other, resulting in a portfolio-wide test that shows
little risk, yet has pockets of investments that may exhibit
significant risk. Accordingly, both proposed Sec. 615.5133(f)(2)(ii)
and final Sec. 615.5133(f)(4)(i) require institutions to stress test
their entire investment portfolio, including stress tests of all
investments individually and stress tests of the portfolio as a whole.
Final Sec. 615.5133(f)(4)(ii) sets forth a methodology that
applies to both pre-purchase and quarterly stress testing. Except for
minor technical changes, it is identical to proposed Sec.
615.5133(f)(2)(iii).
As proposed, because all banks currently use the alternative stress
test and the Council believes that they have the capability and
sophistication to develop their own stress test processes, we eliminate
the existing standardized stress test option.
g. Section 615.5133(f)(5)--Presale Value Verification
We redesignate existing Sec. 615.5133(f)(3) as Sec.
615.5133(f)(5) and change the word ``security'' to ``investment.''
6. Section 615.5133(g)--Reports to the Board of Directors
We proposed revisions to Sec. 615.5133(g), which specifies
information that management must report to the board or a board
committee each quarter. Proposed Sec. 615.5133(g)(1) retained the
general quarterly reporting requirements from existing Sec.
615.5133(g) but added to and modified them to strengthen the overall
reporting requirements.
The Council and a bank commented that the board reporting
requirements were exceedingly prescriptive and limiting of the board's
authority to direct management, and they requested that the provisions
be generalized and simply require that the board receive a

[[Page 66368]]

quarterly report containing information on the investment portfolio as
the board deems appropriate.
With one exception that we discuss below and minor technical
changes, we are finalizing all of the general quarterly reporting
requirements of Sec. 615.5133(g)(1) (redesignated as Sec.
615.5133(g)) that we proposed. We believe this level of reporting is
necessary to ensure an institution's board has the information it needs
about the institution's investments. The one proposed requirement that
we are not adopting in final Sec. 615.5133(g) is that we are not
requiring institutions to report on the results of their quarterly
stress tests. We expect, however, that institutions will report on
stress tests results that do not comply with their investment policies.
We are including in final Sec. 615.5133(g) the reporting
requirements that were contained in proposed Sec. 615.5143(c),
governing management of ineligible investments, because we believe it
is more logical to have all board reporting requirements in one
provision of the regulations. We make technical, but not substantive,
changes to these requirements.
Proposed Sec. 615.5133(g)(2) would have required an institution to
provide immediate notification to its board of directors or to a
designated board committee if its portfolio exceeded the quarterly
stress-test parameters defined in its board policy. The Council
expressed concern that the term ``immediate'' is vague, and it
requested that FCA require notification to be completed ``in a
reasonable manner'' as the board may direct.
Since exceeding a board policy's stress test parameters is not a
regulatory violation, we have decided not to require board notification
if this occurs. Nevertheless, we encourage each institution's board to
require that it be notified of such a situation, because it could lead
to serious risk exposures for the institution.
7. Investment Plan and Investment Oversight Committee
Our proposed rule recommended, but did not propose to require, that
institutions develop an investment plan and an investment oversight
committee. Three commenters opposed a requirement for an investment
plan or investment committee, stating that institutions' current
practices already achieve the purposes of the plans and committees.
Because this may be true for some institutions, we do not impose these
as requirements. We continue to believe, however, that each institution
that maintains an investment portfolio should consider whether it could
benefit from the development of an investment plan and the
establishment of an investment committee. The preamble to our proposed
rule discusses the benefits of these plans and committees. We also note
that the Federal Reserve published a proposed rule (77 FR 594, January
5, 2012) that would require publicly traded bank holding companies with
total consolidated assets of $10 billion or more to establish and
maintain an enterprise-wide risk committee of the board of directors.
Some System banks have already begun to or have implemented such
committees.

D. Section 615.5135--Management of Interest Rate Risk

We are relocating the requirements of existing Sec. 615.5135 to
revised Sec. 615.5180 in part 615 subpart G of our regulations,
because we had other interest rate risk requirements in subpart G and
it was logical to locate all of these requirements together. We will
discuss the changes made to Sec. 615.5180, and to other provisions in
subpart G, below.

E. Section 615.5136--Emergencies Impeding Normal Access of Farm Credit
Banks to Capital Markets

Final Sec. 615.5136, which is very similar to what we proposed,
provides that an emergency shall be deemed to exist whenever a
financial, economic, agricultural, or national defense, or other crisis
could impede the normal access of Farm Credit banks to the capital
markets. Whenever the FCA determines, after consultations with the
Funding Corporation to the extent practicable, that such an emergency
exists, the FCA Board may, in its sole discretion, adopt a resolution
that:
Modifies the amount, qualities, and types of eligible
investments that banks are authorized to hold pursuant to Sec.
615.5132;
Modifies or waives the liquidity requirement(s) in Sec.
615.5134; and/or
Authorizes other actions as deemed appropriate.
The revisions in our proposal, which we itemized in the preamble to
the proposed rule, provide additional flexibility to the resolution
that the FCA Board may adopt. The Council supported these revisions.
The final rule adds the catch-all ``other crisis'' that could impede
normal access to the capital markets.

F. Section 615.5140--Eligible Investments

We make only minor technical changes to this provision. We delete
the reference to divestiture in existing Sec. 615.5140(a)(4), 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. 615.5143(a). We also delete the
references to stress testing mortgage securities in existing Sec.
615.5140(a)(5), because new Sec. 615.5133(f) sets forth stress-testing
requirements for investments. Finally, we make a slight formatting
change to Sec. 615.5140(a) to clarify its requirements.

G. Section 615.5141--Stress Tests for Mortgage Securities

As proposed, we remove this stand-alone, stress-testing section
from our regulations, because we have included stress-testing
requirements in final Sec. 615.5133(f)(1)(iii) and (f)(4).

H. Section 615.5143--Management of Ineligible Investments and
Reservation of Authority To Require Divestiture

Existing Sec. 615.5143 requires an institution to dispose of an
investment that is ineligible\16\ within 6 months unless we approve, in
writing, a plan that authorizes the institution to divest the
instrument over a longer period of time.
---------------------------------------------------------------------------

\16\ Under existing Sec. 615.5140.
---------------------------------------------------------------------------

New Sec. 615.5143(b) no longer requires a System institution to
divest of (or to receive approval of a divestiture plan for) an
investment that was eligible when purchased but no longer satisfies the
eligibility criteria.\17\ Rather, the institution must notify the FCA
within 15 calendar days of determining that the investment no longer
satisfies eligibility criteria. This approach provides institutions
with greater flexibility to manage their positions and mitigate losses
as compared with a forced divestiture during a specified time period.
Two commenters supported this change to our overall approach.
---------------------------------------------------------------------------

\17\ Such an investment would no longer be considered
``ineligible.''
---------------------------------------------------------------------------

The proposed rule would have required an institution to notify FCA
``promptly'' if an investment no longer satisfies the eligibility
criteria. 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 the FCA's examination function. If FCA retained
this requirement, the Council suggested a 60-day calendar notice.
In response to this comment, we make the notification period 15
calendar days after the System institution determines

[[Page 66369]]

that the investment no longer satisfies the eligibility criteria. We
believe this notification period is adequate, since the timeframe does
not begin until the System institution makes the determination.
Moreover, notification can be as simple as a telephone call or email.
In addition, in the final rule as in the proposed, the institution
is subject to the following requirements:
It must not use the investment to satisfy its liquidity
requirement(s) under Sec. 615.5134;
It must continue to include the investment in the Sec.
615.5132 investment portfolio limit calculation;
It may continue to include the investment as collateral
under Sec. 615.5050 and net collateral under Sec. 615.5301(c) at the
lower of cost or market value; and
It must develop a plan to reduce the risk arising from the
investment.
The proposed rule would have required notification to FCA 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 requirements regarding exclusion from the liquidity
reserve, inclusion in the investment portfolio limit, inclusion in
collateral and net collateral, and the development of a risk reduction
plan. We are deleting this notification requirement, as well as the
other requirements, from the final rule because we do not want to
create a disincentive for a System institution to establish a risk
tolerance that is stricter than FCA's regulatory eligibility criteria.
Under the final rule, a System institution does not have to notify the
FCA 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 requirements.
As we proposed, final Sec. 615.5143(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), System institutions may not purchase ineligible
investments. If a System institution does purchase an ineligible
investment, it must notify the FCA 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 approve, in writing, a plan that authorizes divestiture over
a longer period of time. In addition, in the final rule as in the
proposed, until the institution divests of the investment:
It must not be used to satisfy the institution's liquidity
requirement(s) under Sec. 615.5134;
It must continue to be included in the Sec. 615.5132
investment portfolio limit calculation; and
It must be excluded as collateral under Sec. 615.5050 and
net collateral under Sec. 615.5301(c).
Although it is not stated in the regulation, we clarify here than
an acceptable divestiture plan would have to require a System
institution to dispose of the investment as quickly as possible without
substantial financial loss. The plan would also have to contain
sufficient analysis to support 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.
In addition, we emphasize that any purchase of an ineligible
investment would indicate weaknesses in a System institution'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 requirements from the existing
and proposed rules, despite the Council's and a bank commenter'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 System institutions 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 a
System institution makes such a purchase, it should expect increased
FCA oversight of its internal controls and due diligence process as
well as enforcement actions as appropriate.
Proposed Sec. 615.5143(c) would have required each institution to
report to its board at least quarterly regarding investments that were
ineligible when purchased and investments that were eligible when
purchased but that no longer satisfy the eligibility criteria. As
discussed above, we have moved these reporting requirements to Sec.
615.5133(g) so that all board reporting requirements for investments
are in one place.
Finally, Sec. 615.5143(d) reserves FCA's authority to require an
institution to divest of any investment at any time for failure to
comply with Sec. 615.5132(a) or Sec. 615.5142 (as applicable) or for
safety and soundness purposes. Although we did not propose failure to
comply with the permissible investment purposes specified in Sec.
615.5132(a) and Sec. 615.5142 as a basis for requiring divestiture,
this change merely makes explicit our implicit 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 a System
institution's financial condition and performance. Because the final
rule would not require divestiture of any investment that was eligible
when purchased, FCA is making express our authority to require
divestiture of investments when necessary. We received no comments on
our proposed reservation of authority.

I. Section 615.5174--Farmer Mac Securities

We proposed changes to Sec. 615.5174(d), governing stress testing
of Farmer Mac securities, which Farm Credit banks, associations, and
service corporations are permitted to purchase and hold for the purpose
of managing credit and interest rate risk and furthering their mission
to finance agriculture. For the reason discussed in the preamble to the
proposed rule, we proposed to remove the requirement that a System
institution must subject Farmer Mac securities backed by loans that the
institution originated to the stress testing applicable to investments.
If a System institution purchases a Farmer Mac security from another
System institution or from outside the System, however, the security
would remain subject to the stress testing applicable to investments.
Because we proposed to eliminate our divestiture requirement for other
investments that fail a stress test, we also proposed to eliminate that
divestiture requirement for those Farmer Mac securities that remain
subject to stress testing.
We also added a definition of the term ``you'' in new Sec.
615.5174(e), to clarify that the regulation applies to Farm Credit
banks, associations, and service corporations.
We received two comments on Sec. 615.5174, both supporting the
stress-testing change, and we are finalizing Sec. 615.5174 as
proposed.

J. Section 615.5180--Bank Interest Rate Risk Management Program

We are revising Sec. 615.5180 by moving the requirements of
existing Sec. 615.5135 and existing Sec. 615.5181 into this

[[Page 66370]]

section. Since all three existing sections govern interest rate risk
management of banks, it makes sense to combine them into one regulatory
provision.
Interest rate risk management is an important part of the overall
financial management of a Farm Credit bank. The potentially adverse
effects that interest rate risk may have on net interest income and the
market value of equity is of particular importance.
We believe that strong policy direction from a Farm Credit bank's
board of directors is essential to an effective interest rate risk
management program. Accordingly, final Sec. 615.5180(a) retains the
existing requirement, currently contained in Sec. 615.5180, that a
bank's board must develop and implement an interest rate risk
management program, tailored to the needs of the institution, that
establishes a risk management process that effectively identifies,
measures, monitors, and controls interest rate risk. Final Sec.
615.5180(a) also contains the requirement, currently contained in Sec.
615.5181(a), that the bank's board of directors must be knowledgeable
of the nature and level of interest rate risk taken by the institution.
Final Sec. 615.5180(b) contains the requirement, currently in
Sec. 615.5181(b), that senior management is responsible for ensuring
that interest rate risk is properly managed on both a long-range and a
day-to-day basis.
Final Sec. 615.5180(c), which requires the board of directors of
each bank to adopt an interest rate risk management section of an
asset/liability management policy that establishes interest rate risk
exposure limits as well as the criteria to determine compliance with
these limits, contains the requirements we had proposed in Sec.
615.5135, as revised. Final Sec. 615.5180(c) requires, in addition to
the existing requirements that carry over, that the interest rate risk
management section must establish policies and procedures for the bank
to:
Address the purpose and objectives of interest rate risk
management;
Consider the effect of investments on interest rate risk
based on the results of the required stress testing; \18\
---------------------------------------------------------------------------

\18\ Existing Sec. 615.5135 already requires banks to include
investments in their interest rate shock analysis.
---------------------------------------------------------------------------

Identify exception parameters and approvals needed for any
exceptions to the requirements of the board's policies;
Describe delegations of authority;
Describe reporting requirements, including exceptions to
limits contained in the board's policies; and
Consider the nature and purpose of derivative contracts
and establish counterparty risk thresholds and limits for derivatives.
We delete several existing requirements because similar
requirements are also contained in the board reporting requirements of
Sec. 615.5133(g).
We are finalizing our proposal to require that management of each
bank must report at least quarterly to its board of directors, or to a
designated committee of the board, describing the nature and level of
interest rate risk exposure. Any deviations from the board's policies
on interest rate risk must be specifically identified in the report and
approved by the board or a designated committee of the board.
The Council generally supported the proposed changes to the rule,
but it was concerned that FCA would implement the additional
requirements in a way that results in additional burden in areas where
such burden is not supported by identified weaknesses in current System
interest rate risk management practices. The Council stated that this
area has functioned exceedingly well over the years, including
throughout the recent financial market crisis, and it asked that FCA
recognize this effectiveness.
We recognize that overall, the System has implemented effective
interest rate risk management practices. We believe our revisions to
this rule will further strengthen these practices. We do not intend to
impose additional burden in implementation unless that burden is
warranted.

K. Section 615.5181--Bank Interest Rate Risk Management Program

We remove this section from our regulations, because we have
included these requirements in final Sec. 615.5180.

L. Section 615.5182--Interest Rate Risk Management by Associations and
Other Farm Credit System Institutions Other Than Banks

We made minor technical, non-substantive changes to this provision.

M. Section 615.5201--Definitions

As discussed above, our capital adequacy regulation at Sec.
615.5201 defines the terms Government agency and Government-sponsored
agency. We agree with the Council's comment that FCA's definitions
should be consistent among themselves. Accordingly, we are revising the
definitions in Sec. 615.5201 to conform to the new definitions in
Sec. 615.5131.

IV. 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. Each of the banks in the System, considered together with its
affiliated associations, has assets and annual income in excess of the
amounts that would qualify them as small entities. Therefore, System
institutions are not ``small entities'' as defined in the Regulatory
Flexibility Act.

List of Subjects in 12 CFR Part 615

Accounting, Agriculture, Banks, banking, Government securities,
Investments, Rural areas.

For the reasons stated in the preamble, part 615 of chapter VI,
title 12 of the Code of Federal Regulations is amended as follows:

PART 615--FUNDING AND FISCAL AFFAIRS, LOAN POLICIES AND OPERATIONS,
AND FUNDING OPERATIONS

0
1. The authority citation for part 615 continues to read as follows:

Authority: Secs. 1.5, 1.7, 1.10, 1.11, 1.12, 2.2, 2.3, 2.4, 2.5,
2.12, 3.1, 3.7, 3.11, 3.25, 4.3, 4.3A, 4.9, 4.14B, 4.25, 5.9, 5.17,
6.20, 6.26, 8.0, 8.3, 8.4, 8.6, 8.7, 8.8, 8.10, 8.12 of the Farm
Credit Act (12 U.S.C. 2013, 2015, 2018, 2019, 2020, 2073, 2074,
2075, 2076, 2093, 2122, 2128, 2132, 2146, 2154, 2154a, 2160, 2202b,
2211, 2243, 2252, 2278b, 2278b-6, 2279aa, 2279aa-3, 2279aa-4,
2279aa-6, 2279aa-7, 2279aa-8, 2279aa-10, 2279aa-12); sec. 301(a) of
Pub. L. 100-233, 101 Stat. 1568, 1608.

0
2. Section 615.5131 is amended by:
0
a. Removing designations for paragraphs (a) through (l) and maintaining
alphabetical order;
0
b. Removing the reference to ``615.5131(h)'' from the definition for
``asset-backed securities (ABS)'' and adding in its place the words
``this section''; and
0
c. Adding in alphabetical order definitions for ``government agency''
and ``government-sponsored agency'' to read as follows:

Sec. 615.5131 Definitions.

[[Page 66371]]

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.
* * * * *

0
3. Section 615.5132 is revised to read as follows:

Sec. 615.5132 Investment purposes.

(a) Each Farm Credit bank may hold eligible investments, listed
under Sec. 615.5140, in an amount not to exceed 35 percent of its
total outstanding loans, to comply with its liquidity requirements in
Sec. 615.5134, manage surplus short-term funds, and manage interest
rate risk under Sec. 615.5180. To comply with this calculation, the
30-day average daily balance of investments is divided by loans.
Investments are calculated at amortized cost. Loans are calculated as
defined in Sec. 615.5131. For the purpose of this calculation, loans
include accrued interest and do not include any allowance for loan loss
adjustments. Compliance with the calculation is measured on the last
day of every month.
(b) The following investments may be excluded when calculating the
amount of eligible investments held by the Farm Credit bank pursuant to
Sec. 615.5132(a):
(1) Eligible investments listed under Sec. 615.5140 that are
pledged by a Farm Credit bank to meet margin requirements for
derivative transactions; and
(2) Any other investments FCA determines are appropriate for
exclusion.

0
4. Section 615.5133 is revised to read as follows:

Sec. 615.5133 Investment management.

(a) Responsibilities of board of directors. Your board of directors
must adopt written policies for managing your 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, the 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 and be documented.
(b) Investment policies--general requirements. Your board's written
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 classes of
investments. Furthermore, your investment policies must address the
means for reporting, and approvals needed for, exceptions to
established policies. Investment policies must be sufficiently
detailed, consistent with, and appropriate for the amounts, types, and
risk characteristics of your investments.
(c) Investment policies--risk tolerance. Your investment policies
must establish risk limits for the various types, classes, and sectors
of eligible investments and for the entire investment portfolio. 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 your institutional objectives, capital position,
earnings, and quality and reliability of risk management systems and
must take into consideration the interest rate risk management program
required by Sec. 615.5180 or Sec. 615.5182, as applicable. 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. Each association or service
corporation that holds significant investments and each bank must
establish risk limits in its investment policies for these four types
of risk.
(1) Credit risk. Investment policies must establish:
(i) Credit quality standards, limits on counterparty risk, and risk
diversification standards that limit concentrations. Limits must be set
for single or related counterparty(ies), a geographical area,
industries, 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. Investment policies must set market risk limits
for specific types of investments and for the investment portfolio.
(3) Liquidity risk. Investment policies must describe the liquidity
characteristics of eligible investments that you will hold to meet your
liquidity needs and other institutional 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 function, 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.
(f) Due diligence--(1) Pre-purchase analysis. (i) Eligibility,
purpose, and compliance with investment policies. Before you purchase
an investment, you must conduct sufficient due diligence to determine
whether it is eligible under Sec. 615.5140, is for an authorized
purpose under Sec. 615.5132 or Sec. 615.5142, as applicable, and
complies with your board's investment policies. You must document your
assessment and the information used in your assessment. Your board must
approve your decision to hold an investment that does not comply with
your investment policies.
(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 assessment of each investment at the
time of purchase must at a minimum include an evaluation of credit
risk, liquidity risk, market risk, interest rate risk, and the
underlying collateral of the investment. This assessment must be
commensurate with the complexity and risk in the

[[Page 66372]]

investment. You must perform stress testing on any investment that is
structured or that has uncertain cash flows, including all mortgage-
backed securities and asset-backed securities, before you purchase it.
The stress test must be commensurate with the risk and complexity of
the investment and must enable you to determine that the investment
does not expose your capital, earnings, or liquidity to risks that are
greater than those specified in your investment policies. The stress
testing must comply with the requirements in paragraph (f)(4)(ii) of
this section.
(2) Ongoing 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 investment in your portfolio and in your 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 comply with those limits.
(ii) Your stress tests must be defined in a board-approved policy
and must include defined parameters for the types of securities you
purchase. The stress tests must be comprehensive and appropriate for
the risk profile of your institution. 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. 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, your
management must report on the following to your board of directors or a
designated board committee:
(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 realized during
the quarter on individual investments 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 (must be specifically
identified);
(8) The status and performance of each investment described in
Sec. 615.5143(a) and (b) or that does not comply with your investment
policies; including the expected effect of these investments on your
capital, earnings, liquidity, and collateral position; and
(9) The terms and status of any required divestiture plan or risk
reduction plan.

Sec. 615.5135 [Removed]

0
5. Section 615.5135 is removed.

0
6. Section 615.5136 is revised to read as follows:

Sec. 615.5136 Emergencies impeding normal access of Farm Credit banks
to capital markets.

An emergency shall be deemed to exist whenever a financial,
economic, agricultural, national defense, or other crisis could impede
the normal access of Farm Credit banks to the capital markets. Whenever
the Farm Credit Administration determines, after consultation with the
Federal Farm Credit Banks Funding Corporation to the extent
practicable, that such an emergency exists, the Farm Credit
Administration Board may, in its sole discretion, adopt a resolution
that:
(a) Modifies the amount, qualities, and types of eligible
investments that Farm Credit banks are authorized to hold pursuant to
Sec. 615.5132 of this subpart;
(b) Modifies or waives the liquidity requirement(s) in Sec.
615.5134 of this subpart; and/or
(c) Authorizes other actions as deemed appropriate.

0
7. Section 615.5140 is amended by revising paragraph (a) to read as
follows:

Sec. 615.5140 Eligible investments.

(a) You may hold only the following types of investments listed in
the Investment Eligibility Criteria Table. These investments must be
denominated in United States dollars.

Investment Eligibility Criteria Table
----------------------------------------------------------------------------------------------------------------
Final maturity NRSRO Credit Investment
Asset class limit rating Other requirements portfolio limit
----------------------------------------------------------------------------------------------------------------
(1) Obligations of the United None.............. NA................ None.............. None.
States.
Treasuries.
Agency securities
(except mortgage securities).
Other obligations fully
insured or guaranteed by the
United States, its agencies,
instrumentalities and
corporations.

[[Page 66373]]

(2) Municipal Securities:
General obligations.... 10 years.......... One of the highest None.............. None.
two.
Revenue bonds.......... 5 years........... Highest........... At the time of 15%.
purchase, you
must document
that the issue is
actively traded
in an established
secondary market.
(3) International and None.............. None.............. The United States None.
Multilateral Development Bank must be a voting
Obligations. shareholder.
(4) 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.
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.............. None.
collateralized by eligible
investments or marketable
securities rated in the highest
credit rating category by an
NRSRO.
(5) Mortgage Securities:
Issued or guaranteed by None.............. NA................ None.............. None.
the United States.
Fannie Mae or Freddie None.............. NA................ None.............. 50%.
Mac mortgage securities.
Non-Agency securities None.............. Highest........... None.............. 15%.
that comply 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.
(6) Asset-Backed Securities None.............. Highest........... 5-year WAL for 20%.
secured by. fixed rate or
Credit card floating rate ABS
receivables.. at their
Automobile loans....... contractual
Home equity loans...... interest rate
Wholesale automobile caps.
dealer loans.. 7-year WAL for
Student loans.......... floating rate ABS
Equipment loans........ that remain below
Manufactured housing their contractual
loans.. interest rate
cap..
(7) Corporate Debt Securities... 5 years........... One of the two Cannot be 20%.
highest. convertible to
equity securities.

[[Page 66374]]

(8) 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 10% or less of
investments your portfolio.
authorized by Otherwise counts
Sec. Sec. toward limit for
615.5140 and each type of
615.5174. investment.
The investment
company's risk
and return
objectives and
use of
derivatives must
be consistent
with FCA guidance
and your
investment
policies..
----------------------------------------------------------------------------------------------------------------

* * * * *

Sec. 615.5141 [Removed]

0
8. Section 615.5141 is removed.

0
9. Section 615.5143 is revised to read as follows:

Sec. 615.5143 Management of ineligible investments and reservation of
authority to require divestiture.

(a) Investments ineligible when purchased. Investments that do not
satisfy the eligibility criteria set forth in Sec. 615.5140 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 us within 15 calendar days after the
determination. You must divest of the investment no later than 60
calendar days after you determine that the investment is ineligible
unless we approve, in writing, a plan that authorizes you to divest the
investment over a longer period of time. Until you divest of the
investment:
(1) It must not be used to satisfy your liquidity requirement(s)
under Sec. 615.5134;
(2) It must continue to be included in the Sec. 615.5132
investment portfolio limit calculation; and
(3) It must be excluded as collateral under Sec. 615.5050 and net
collateral under Sec. 615.5301(c).
(b) Investments that no longer satisfy eligibility criteria. If you
determine that an investment (that satisfied the eligibility criteria
set forth in Sec. 615.5140 when purchased) no longer satisfies the
eligibility criteria, you may continue to hold it, subject to the
following requirements:
(1) You must notify us within 15 calendar days after such
determination;
(2) You must not use the investment to satisfy your liquidity
requirement(s) under Sec. 615.5134;
(3) You must continue to include the investment in the Sec.
615.5132 investment portfolio limit calculation;
(4) You may continue to include the investment as collateral under
Sec. 615.5050 and net collateral under Sec. 615.5301(c) at the lower
of cost or market value; and
(5) You must develop a plan to reduce the investment's risk to you.
(c) Reservation of authority. FCA retains the authority to require
you to divest of any investment at any time for failure to comply with
Sec. 615.5132(a) or Sec. 615.5142 or for safety and soundness
reasons. The timeframe set by FCA will consider the expected loss on
the transaction (or transactions) and the effect on your financial
condition and performance.

0
10. Section 615.5174 is amended by:
0
a. Removing the reference ``615.5131(f)'' in paragraph (a) and adding
in its place, the reference ``615.5131'';
0
b. Revising paragraph (d); and
0
c. Adding paragraph (e).
The revision and addition read as follows:

Sec. 615.5174 Farmer Mac securities.

* * * * *
(d) Stress Test. You must perform stress tests, in accordance with
Sec. 615.5133(f)(1)(iii) and Sec. 615.5133(f)(4), on mortgage
securities, issued or guaranteed by Farmer Mac, that are backed by
loans that you did not originate.
(e) You. Means a Farm Credit bank, association, or service
corporation.

0
11. Section 615.5180 is revised to read as follows:

Sec. 615.5180 Bank interest rate risk management program.

(a) The board of directors of each Farm Credit bank must develop,
implement, and effectively oversee an interest rate risk management
program tailored to the needs of the institution. The program must
establish a risk management process that effectively identifies,
measures, monitors, and controls interest rate risk. The board of
directors of each Farm Credit bank must be knowledgeable of the nature
and level of interest rate risk taken by the institution.
(b) Senior management is responsible for ensuring that interest
rate risk is properly managed on both a long-range and a day-to-day
basis.
(c) The board of directors of each Farm Credit bank must adopt an
interest rate risk management section of an asset/liability management
policy that establishes interest rate risk exposure limits as well as
the criteria to determine compliance with these limits. At a minimum,
the interest rate risk management section must establish policies and
procedures for the bank to:
(1) Address the purpose and objectives of interest rate risk
management;
(2) Identify and analyze the causes of risks within its existing
balance sheet structure;
(3) Measure the potential effect of these risks on projected
earnings and market values by conducting interest rate shock tests and
simulations of multiple economic scenarios at least on a quarterly
basis and by considering the effect of investments on interest rate
risk based on the results of the stress testing required under Sec.
615.5133(f)(4);
(4) Describe and implement actions needed to obtain its desired
risk management objectives;
(5) Identify exception parameters and approvals needed for any
exceptions to the requirements of the board's policies;
(6) Describe delegations of authority;
(7) Describe reporting requirements, including exceptions to limits
contained in the board's policies;
(8) Consider the nature and purpose of derivative contracts and
establish counterparty risk thresholds and limits for derivatives.
(d) At least quarterly, management of each Farm Credit bank must
report to its board of directors, or a designated committee of the
board, describing the nature and level of interest rate risk

[[Page 66375]]

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 designated committee of the board.

Sec. 615.5181 [Removed]

0
12. Section 615.5181 is removed.

0
13. Section 615.5182 is revised to read as follows:

Sec. 615.5182 Interest rate risk management by associations and other
Farm Credit System institutions other than banks.

Any association or other Farm Credit System institution other than
Farm Credit banks, excluding the Federal Agricultural Mortgage
Corporation, with interest rate risk that could lead to significant
declines in net income or in the market value of capital must comply
with the requirements of Sec. 615.5180. The interest rate risk
management program required under Sec. 615.5180 must be commensurate
with the level of interest rate risk of the institution.

0
14. Section 615.5201 is amended by revising the definitions for
``government agency'' and ``government-sponsored agency'' to read as
follows:

Sec. 615.5201 Definitions.

* * * * *
Government agency means the United States Government 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.
* * * * *

Dated: October 25, 2012.
Dale L. Aultman,
Secretary, Farm Credit Administration Board.
[FR Doc. 2012-26806 Filed 11-2-12; 8:45 am]
BILLING CODE 6705-01-P