[Federal Register Volume 79, Number 171 (Thursday, September 4, 2014)]
[Proposed Rules]
[Pages 52814-52908]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-19179]
[[Page 52813]]
Vol. 79
Thursday,
No. 171
September 4, 2014
Part II
Farm Credit Administration
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12 CFR Parts 607, 614, 615, et al.
Regulatory Capital Rules: Regulatory Capital, Implementation of Tier 1/
Tier 2 Framework; Proposed Rule
Federal Register / Vol. 79 , No. 171 / Thursday, September 4, 2014 /
Proposed Rules
[[Page 52814]]
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FARM CREDIT ADMINISTRATION
12 CFR Parts 607, 614, 615, 620 and 628
RIN 3052-AC81
Regulatory Capital Rules: Regulatory Capital, Implementation of
Tier 1/Tier 2 Framework
AGENCY: Farm Credit Administration.
ACTION: Proposed rule.
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SUMMARY: The Farm Credit Administration (FCA or we) is seeking comments
on this proposed rule that would revise our regulatory capital
requirements for Farm Credit System (System) institutions to include
tier 1 and tier 2 risk-based capital ratio requirements (replacing core
surplus and total surplus requirements), a tier 1 leverage requirement
(replacing a net collateral requirement for System banks), a capital
conservation buffer, revised risk weightings, and additional public
disclosure requirements. The revisions to the risk weightings would
include alternatives to the use of credit ratings, as required by
section 939A of the Dodd-Frank Wall Street Reform and Consumer
Protection Act.
DATES: You may send us comments by January 2, 2015.
ADDRESSES: For accuracy and efficiency reasons, please submit comments
by email or through the FCA's Web site. We do not accept comments
submitted by facsimile (fax), as faxes are difficult for us to process
in compliance with section 508 of the Rehabilitation Act. Please do not
submit your comment multiple times via different methods. You may
submit comments by any of the following methods:
Email: Send us an email at [email protected].
FCA Web site: http://www.fca.gov. Select ``Public
Commenters,'' then ``Public Comments,'' and follow the directions for
``Submitting a Comment.''
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Mail: Barry F. Mardock, Deputy Director, Office of
Regulatory Policy, Farm Credit Administration, 1501 Farm Credit Drive,
McLean, VA 22102-5090.
You may review copies of all comments we receive at our office in
McLean, Virginia, or from our Web site at http://www.fca.gov. Once you
are in the Web site, select ``Public Commenters,'' then ``Public
Comments,'' and follow the directions for ``Reading Submitted Public
Comments.'' We will show your comments as submitted, but for technical
reasons we may omit items such as logos and special characters.
Identifying information you provide, such as phone numbers and
addresses, will be publicly available. However, we will attempt to
remove email addresses to help reduce Internet spam.
FOR FURTHER INFORMATION CONTACT: J.C. Floyd, Senior Capital Markets
Specialist and FCA Examiner, Office of Examination, Farm Credit
Administration, McLean, VA 22102-5090, (720) 213-0924, TTY (703) 883-
4056; or Rebecca S. Orlich, Senior Counsel, or Jennifer A. Cohn, Senior
Counsel, Office of General Counsel, Farm Credit Administration, McLean,
VA 22102-5090, (703) 883-4020, TTY (703) 883-4056.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Objectives of Proposed Rule
B. Overview of Proposed Rule
C. List of Questions Asked and Comments Requested in This
Preamble
D. Key Provisions of the Proposed Rule
E. The History and Cooperative Structure of the Farm Credit
System
1. Capital Structure of System Institutions
2. Member Stock--Association Level
3. Member Stock--System Bank Level
4. Allocated Equities
5. Unallocated Retained Earnings (URE) and URE Equivalents
F. The FCA's Current Capital Regulations
G. Prior FCA Advance Notices of Proposed Rulemaking (ANPRMs) on
the Basel Capital Standards
II. Minimum Regulatory Capital Ratios, Additional Capital
Requirements, and Overall Capital Adequacy
A. Minimum Risk-Based Capital Ratios and Other Regulatory
Capital Provisions
B. Leverage Ratio
C. Capital Conservation Buffer
D. Supervisory Assessment of Overall Capital Adequacy
III. Definition of Capital
A. Capital Components and Eligibility Criteria for Regulatory
Capital Instruments
1. Common Equity Tier 1 (CET1) Capital
a. Criteria
b. Accumulated Other Comprehensive Income (AOCI) and Minority
Interests
2. Additional Tier 1 (AT1) Capital
a. Criteria
b. FCA's Current Capital Regulations
3. Tier 2 Capital
4. FCA Approval of Capital Elements
5. FCA Prior Approval Requirements for Cash Patronage,
Dividends, and Redemptions; Safe Harbor
B. Regulatory Adjustments and Deductions
1. Regulatory Deductions From CET1 Capital
a. Goodwill and Other Intangibles (Other than Mortgage Servicing
Assets)
b. Gain-on-Sale Associated With a Securitization Exposure
c. Defined Benefit Pension Fund Net Assets
d. A System Institution's Allocated Equity Investment in Another
System Institution
e. ``Haircut'' Deduction for Redemption of Equities Included in
CET1 Capital Less Than 10 Years After Issuance or Allocation
2. The Corresponding Deduction Approach for Purchased Equities
3. Netting of Deferred Tax Liabilities Against Deferred Tax
Assets and Other Deductible Assets
C. Limits on Inclusion of Third-Party Capital
IV. Standardized Approach for Risk-Weighted Assets
A. Calculation of Standardized Total Risk-Weighted Assets
B. Risk-Weighted Assets for General Credit Risk
1. Exposures to Sovereigns
2. Exposures to Certain Supranational Entities and Multilateral
Development Banks
3. Exposures to Government-Sponsored Enterprises
4. Exposures to Depository Institutions, Foreign Banks, and
Credit Unions
5. Exposures to Public Sector Entities
6. Corporate Exposures
7. Residential Mortgage Exposures
8. High Volatility Commercial Real Estate Exposures
9. Past Due Exposures
10. Other Assets
11. Exposures to Other System Institutions
12. Risk-Weighting for Specialized Exposures
C. Off-Balance Sheet Items
1. Credit Conversion Factors
2. Credit-Enhancing Representations and Warranties
D. Over-the-Counter Derivative Contracts
E. Cleared Transactions
1. Definition of Cleared Transaction
2. Risk Weighting for Cleared Transactions
F. Credit Risk Mitigation
1. Guarantees and Credit Derivatives
a. Eligibility Requirements
b. Substitution Approach
c. Maturity Mismatch Haircut
d. Adjustment for Credit Derivatives Without Restructuring as a
Credit Event
e. Currency Mismatch Adjustment
f. Multiple Credit Risk Mitigants
2. Collateralized Transactions
a. Eligible Collateral
b. Risk Management Guidance for Recognizing Collateral
c. Simple Approach
d. Collateral Haircut Approach
e. Standard Supervisory Haircuts
f. Own Estimates of Haircuts
G. Unsettled Transactions
H. Risk-Weighted Assets for Securitization Exposures
1. Overview of the Securitization Framework and Definitions
2. Operational Requirements
a. Due Diligence Requirements
b. Operational Requirements for Traditional Securitizations
c. Operational Requirements for Synthetic Securitizations
d. Clean-Up Calls
3. Risk-Weighted Asset Amounts for Securitization Exposures
[[Page 52815]]
a. Exposure Amount of a Securitization Exposure
b. Gains-On-Sale and Credit-Enhancing Interest-Only Strips
c. Exceptions Under the Securitization Framework
d. Overlapping Exposures
e. Servicer Cash Advances
f. Implicit Support
4. Simplified Supervisory Formula Approach
5. Gross-Up Approach
6. Alternative Treatments for Certain Types of Securitization
Exposures
7. Credit Risk Mitigation for Securitization Exposures
8. N\th\-to-Default Credit Derivatives
I. Equity Exposures
1. Definition of Equity Exposure and Exposure Measurement
2. Equity Exposure Risk Weights
3. 100-Percent Risk Weight
4. Hedged Transactions
5. Measures of Hedge Effectiveness
6. Equity Exposures to Investment Funds
a. Full Look-Through Approach
b. Simple Modified Look-Through Approach
c. Alternative Modified Look-Through Approach
V. Market Discipline and Disclosure Requirements
A. Proposed Disclosure Requirements
B. Location and Frequency of Disclosures
C. Proprietary and Confidential Information
D. Specific Public Disclosure Requirements
VI. Conforming Changes
VII. Proposed Timeframe for Implementation
VIII. Abbreviations
IX. Regulatory Flexibility Act
Addendum: Discussion of This Proposed Rule
I. Introduction
A. Objectives of Proposed Rule
The FCA's objectives in proposing this rule are:
To modernize capital requirements while ensuring that
institutions continue to hold enough regulatory capital to fulfill
their mission as a Government-sponsored enterprise (GSE);
To ensure that the System's capital requirements are
comparable to the Basel III framework and the standardized approach
that the Federal banking regulatory agencies have adopted, but also to
ensure that the rules take into account the cooperative structure and
the organization of the System;
To make System regulatory capital requirements more
transparent; and
To meet the requirements of section 939A of the Dodd-Frank
Wall Street Reform and Consumer Protection Act.
B. Overview of Proposed Rule
The FCA is seeking public comment on a proposed rule that would
revise our capital requirements governing System banks,\1\ System
associations, Farm Credit Leasing Services Corporation, and any other
FCA-chartered institution the FCA determines should be subject to this
rule (collectively, System institutions). The proposed rule, where
appropriate, is comparable to the capital rules adopted in October 2013
and April 2014 by the Federal banking regulatory agencies \2\ for the
banking organizations they regulate.\3\ Those rules follow the Basel
Committee on Banking Supervision's (BCBS or Basel Committee) document
entitled ``Basel III: A Global Regulatory Framework for More Resilient
Banks and Banking Systems'' (Basel III), including subsequent changes
to the BCBS's capital standards and BCBS consultative papers, and our
proposed rule follows Basel III as appropriate for cooperatives.\4\
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\1\ For purposes of this preamble and proposed part 628, as well
as some of the regulations in which we are proposing conforming
changes and other existing regulations, the term ``System bank''
includes Farm Credit Banks, agricultural credit banks, and banks for
cooperatives. It has the same meaning as Farm Credit bank, which is
defined in Sec. 619.9140 and which would continue to be used in
some of the regulations in which we are proposing conforming changes
as well as in other existing regulations. The Farm Credit Act of
1971, as amended (Farm Credit Act), uses the term ``System bank'' in
a number of its provisions.
\2\ The Federal regulatory banking agencies are the Office of
the Comptroller of the Currency (OCC), the Board of Governors of the
Federal Reserve System (FRB), and the Federal Deposit Insurance
Corporation (FDIC).
\3\ 78 FR 62018 (October 11, 2013) (final rule of the OCC and
the FRB); 79 FR 20754 (April 14, 2014) (final rule of the FDIC).
\4\ Basel III was published in December 2010 and revised in June
2011. The text is available at http://www.bis.org/publ/bcbs189.htm.
The BCBS was established in 1974 by central banks with bank
supervisory authorities in major industrial countries. The BCBS
develops banking guidelines and recommends them for adoption by
member countries and others. BCBS documents are available at http://www.bis.org. The FCA does not have representation on the Basel
Committee, as do the Federal banking regulatory agencies, and is not
required by law to follow the Basel standards.
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The FCA believes this proposed rule would improve the quality and
quantity of System institutions' capital and enhance risk sensitivity
in calculating risk-weighted assets. It would also provide a more
transparent picture of System institutions' capital to the investment-
banking sector, which could facilitate System institutions' securities
offerings to third-party investors. In addition, to comply with section
939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act
of 2010 (Dodd-Frank Act),\5\ we propose alternatives to credit ratings
for calculating risk-weighted assets for certain exposures that are
currently based on the ratings of nationally recognized statistical
rating organizations (NRSROs).
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\5\ Pub. L. 111-203, 124 Stat. 1376 (2010).
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After the worldwide financial crisis that began in the past decade,
the BCBS issued Basel III and has continued to issue additional
standards, with the goal of strengthening the capital of financial
organizations. The capital rules recently adopted by the Federal
banking regulatory agencies reflect Basel III as well as aspects of
Basel II and other BCBS standards. The provisions of the banking
agencies' rules that are not specifically included in the Basel III
framework are generally consistent with the goals of the framework.
The FCA's proposed rule is comparable to the standardized approach
rules of the Federal banking regulatory agencies to the extent
appropriate for the System's cooperative structure and status as a GSE
with a mission to provide a dependable source of credit and related
services for agriculture and rural America. Like the banking agencies'
rules, the FCA's proposed rule incorporates key aspects of the Basel
III tier 1 and tier 2 framework and includes a leverage ratio as well
as a capital conservation buffer to enhance the resilience of System
institutions. The capital conservation buffer would be phased in over 3
years, but we are not proposing to incorporate any of the other
transition periods in Basel III and the Federal regulatory banking
agencies' rules.
The proposed rule would impose some new patronage and redemption
restrictions, including FCA prior approvals, on System institutions in
order to ensure the stability and permanence of the capital includable
in the tier 1 and tier 2 capital ratios, especially regarding the
equities held by the cooperative members of the institutions (common
cooperative equities). The proposed rule would also require additional
recordkeeping and disclosures by System institutions. We believe that
the benefits to the System of these proposed rules would more than
outweigh the restrictions and additional responsibilities we would
require.
The FCA also proposes changes to its risk-based capital rules for
determining risk-weighted assets--that is, the calculation of the
denominator of a System institution's risk-based capital ratios. This
proposed rule would eliminate the credit ratings of NRSROs from risk-
weights for certain exposures, consistent with section 939A of the
Dodd-Frank Act. As an alternative, FCA proposes to include
methodologies for determining risk-weighted assets for exposures to
sovereigns, foreign banks, and public sector entities, securitization
[[Page 52816]]
exposures, and counterparty credit risk. The rule includes new risk
weights for cleared transactions, guarantees including credit
derivatives, collateralized financial transactions, unsettled
transactions, and securitization exposures. In addition, there are
proposed new disclosure requirements for all System banks related to
regulatory capital instruments.
We generally do not propose risk weightings for exposures that
System institutions have no authority to acquire.\6\ In some but not
all cases, we discuss in this preamble this variance from the rules of
the Federal banking regulatory agencies. In addition, we do not propose
risk weightings for certain exposures that are both complex and
unlikely; in the unlikely event that a System institution did acquire
such an exposure, we would address it on a case-by-case basis using the
reservation of authority that we propose. We generally discuss these
exposures in this preamble.
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\6\ However, we do propose risk weighting for exposures that
System institutions are not permitted to acquire under their
investment authorities, because such exposures could be acquired
through foreclosure on collateral or similar transactions.
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We remind System institutions that the presence of a particular
risk weighting does not itself provide authority for a System
institution to have an exposure to that asset or item. System
authorities to acquire exposures are contained in other provisions of
our regulations and in the Farm Credit Act.
We are not proposing to adopt the ``advanced approaches''
regulatory capital rules because no System institution has the volume
of assets or foreign exposures that would subject it to those
approaches if it were regulated by a Federal banking regulatory
agency.\7\ We also do not propose the market risk requirements, because
no System institution has significant exposure to market risk, and we
propose to require all System institutions to exclude Accumulated Other
Comprehensive Income (AOCI) from regulatory capital.
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\7\ In general, the advanced approaches rule applies to banks
with consolidated total assets of at least $250 billion or with
foreign exposures of $10 billion or more. Only two System
institutions have total assets in excess of $50 billion, and foreign
exposures are negligible.
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We propose to place the tier 1 and tier 2 risk-weighted and
leverage capital requirements in a new part 628 of FCA regulations in
Title 12 of the Code of Federal Regulations. We would rescind the risk-
weighting provisions in subpart H of part 615 and the core surplus,
total surplus, and net collateral requirements in subpart K of part
615. We would retain in part 615 the requirements for the numerator of
the permanent capital ratio, a measure that is mandated by the Farm
Credit Act, but the risk weightings for the denominator of the
permanent capital ratio would be the risk weightings in new part 628.
We also propose conforming changes in several other FCA regulations.
In this proposed rule, we have used the general format and the
section and paragraph numbering system of the Federal banking
regulatory agencies' rules to the extent possible. In many cases, we
have retained the numbering system by reserving sections and paragraphs
where we are not proposing parallel provisions. We have done so in
order to facilitate the comparison of the proposal with the banking
agencies' rules.
C. List of Questions Asked and Comments Requested in This Preamble
We welcome comments on every aspect of this proposed regulation,
but there are certain areas where we are specifically seeking comment.
We ask specific questions in these areas throughout this preamble, but
for the convenience of commenters we provide below a list all of our
specific questions and requests for comment. We also ask generally for
comments that suggest how we could simplify the rule while retaining
the improved capital framework that is our goal.
(1) Alternatives to Including Common Cooperative Equities in CET1 or
Tier 2 Capital
We seek comment on using alternative terms or conditions that FCA
could apply to common cooperative equities. Is a 10-year revolvement
cycle long enough to reduce the expectation of redemption and increase
the permanence of such equity instruments so that they may be included
in CET1 capital?
(2) Capital Treatment of MSAs
We seek comment on whether FCA should risk weight MSAs at 100
percent or require deduction of MSAs from CET1, as we propose to do for
non-mortgage servicing rights. At the present time, FCA does not
consider any type of servicing asset material to a System institution's
or the System's consolidated balance sheet.
(3) Accounting for Defined Benefit Pension Fund Assets
Given System institutions' differing methods of reporting defined
benefit pension fund assets, what is the best way to require
adjustments for defined benefit pension fund assets in the CET1 capital
computation?
(4) Third-Party Capital Limits
We seek comment on alternative third-party limits to ensure that
System institutions remain capitalized primarily by their member
borrowers.
(5) Risk-Weighting--Exposures to OFIs
We seek comment on our proposed capital treatment of exposures to
OFIs. Specifically, what factors or other information would be relevant
if we consider assigning an intermediate risk-weight to a System
institution's exposure to an OFI, recognizing that the same exposure to
the same OFI would receive a 100-percent risk weight from a banking
organization regulated by a Federal banking regulatory agency?
(6) Risk-Weighting--Exposures to Certain Electrical Cooperative Assets
We seek comment as to whether we should retain this risk weighting
[for exposures to certain electrical cooperative assets], being mindful
of the Dodd-Frank Act section 939A requirement that we must eliminate
the credit rating criteria.
(7) Credit Conversion Factors for Off-Balance Sheet Items--Exposure
Amount of a System Bank's Commitment to an Association
We invite comment on this determination [regarding our
determination of the exposure amount of a System bank's commitment to
an association].
(8) System Institution Acting as Clearing Member
We invite comment as to whether we should adopt such provisions
[contemplating that System institutions would act as clearing members].
(9) Collateralized Transactions--Own Estimate of Haircuts
We seek comment on whether we should adopt a regulation that would
permit the use of an institution's own estimates.
(10) Exposures to Asset-Backed Commercial Paper (ABCP) Programs
We seek comment as to whether we should include provisions in our
risk-based capital rules regarding ABCP programs that are comparable to
those adopted by the Federal banking regulatory agencies.
(11) Disclosures
We invite comment on the appropriate application of these proposed
disclosure requirements to System banks.
[[Page 52817]]
D. Key Provisions of the Proposed Rule
Table 1--Summary of Key Provisions of the Tier 1/Tier 2 Capital Items
and Standardized Approach Risk Weights
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Minimum capital ratios Proposed treatment
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Tier 1/Tier 2--Capital Items
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Common equity tier 1 (CET1) capital A minimum requirement of 4.5
ratio (Sec. 628.10). percent.
Tier 1 capital ratio (Sec. 628.10)... A minimum requirement of 6.0
percent.
Total capital ratio (Sec. 628.10).... A minimum requirement of 8.0
percent.
Tier 1 Leverage ratio (Sec. 628.10).. A minimum tier 1 leverage ratio
requirement of 5.0 percent of
which at least 1.5 percent
must consist of unallocated
retained earnings and
unallocated retained earnings
equivalents. Applies to all
System institutions.
Components of Capital and Eligibility Describes the eligibility
Criteria for Regulatory Capital criteria for regulatory
Instruments (Sec. Sec. 628.20, capital instruments and adds
628.21, and 628.22). certain adjustments to and
deductions from regulatory
capital, including increased
deductions for mortgage
servicing assets (MSAs) and
deferred tax assets (DTAs).
Capital Conservation Buffer (Sec. A 2.5-percent capital
628.11). conservation buffer of CET1
capital above the minimum risk-
based capital requirements,
which must be maintained to
avoid restrictions on capital
distributions and certain
discretionary bonus payments.
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Risk-Weighted Assets--Standardized Approach
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Credit exposures to:................... Remains unchanged from existing
regulations:
U.S. government and its agencies... 0 percent.
U.S. depository institutions and 20 percent.
credit unions (including those
that are OFIs).
U.S. public sector entities, such 20 percent--general
as states and municipalities. obligations.
50 percent--revenue
obligations.
Cash............................... 0 percent.
Cash items in the process of 20 percent.
collection.
Exposures to other System 100 percent.
institutions that are not deducted
from capital.
Assets not specifically assigned to 100 percent.
a risk weight category and not
deducted from capital (Sec.
628.32).
Exposures to certain supranational Risk weight reduced from 20
entities and multilateral development percent to 0 percent.
banks (Sec. 628.32).
Exposures to Government-sponsored Risk weight for preferred stock
enterprises (Sec. 628.32). increased from 20 percent to
100 percent. Risk weight for
all other exposures (except
equity exposures, which are
discussed below) remains at 20
percent.
Credit exposures to:................... Introduces a risk-sensitive
Foreign sovereigns..................... treatment using the Country
Foreign banks.......................... Risk Classification measure
Foreign public sector entities (Sec. produced by the Organization
628.32). for Economic Cooperation and
Development instead of
determining risk weight based
on OECD membership status.
Corporate exposures (Sec. 628.32).... Assigns a 100-percent risk
weight to corporate exposures,
including exposures to OFIs
that do not satisfy the
criteria for a 20-percent risk
weight and agricultural
borrowers.
Residential mortgage exposures (Sec. 50 percent for first lien
628.32). residential mortgage exposures
that satisfy specified
underwriting criteria. 100
percent otherwise.
High volatility commercial real estate Introduces a 150-percent risk
exposures (Sec. 628.32). weight for certain credit
facilities that finance the
acquisition, development, or
construction of real property.
Past due exposures (Sec. 628.32)..... Introduces a 150-percent risk
weight for exposures that are
past due, unless they are
residential mortgage exposures
or they are guaranteed or
secured by financial
collateral.
Off-balance Sheet Items (Sec. 628.33) Certain credit conversion
factors (CCF) revised,
including the CCF for short-
term commitments that are not
unconditionally cancellable,
which is increased from 0
percent to 20 percent.
OTC Derivative Contracts (does not Modifies derivative matrix
include cleared transactions) (Sec. table slightly. Recognizes
628.34). credit risk mitigation of
collateralized OTC derivative
contracts.
Cleared Transactions (Sec. 628.35)... Provides preferential capital
requirements for cleared
derivative and repo-style
transactions (as compared to
requirements for non-cleared
transactions) with central
counterparties that meet
specified standards.
Guarantees and Credit Derivatives (Sec. Provides a more comprehensive
628.36). recognition of guarantees.
Collateralized Transactions (Sec. Recognizes financial
628.37). collateral.
Unsettled Transactions (Sec. 628.38). Risk weight depends on number
of business days past
settlement date.
Securitization Exposures (Sec. Sec. Replaces the ratings-based
628.41, 628.42, 628.43, 628.44, and approach with either the
628.45). standardized supervisory
formula approach (SSFA) or the
gross-up approach for
determining a securitization
exposure's risk weight based
on the underlying assets and
exposure's relative position
in the securitization's
structure.
[[Page 52818]]
Equity exposures (Sec. Sec. 628.51, Establishes a more risk-
628.52, and 628.53). sensitive treatment for equity
exposures.
Disclosure Requirements (Sec. Sec. Establishes qualitative and
628.61, 628.62, and 628.63). quantitative disclosure
requirements, including
regarding regulatory capital
instruments, for all System
banks.
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Existing FCA Regulatory Capital
------------------------------------------------------------------------
Minimum Capital Ratios:
Permanent capital ratio (Sec. Sec. Numerator calculation remains
615.5201 and 615.5205). unchanged, but risk weights
(denominator) are revised as
described in this proposal.
Total surplus ratio (Sec. Sec. Eliminated.
615.5301(i) and 615.5330(a)).
Core surplus ratio (Sec. Sec. Eliminated.
615.5301(b) and 615.5330(b)).
Net collateral Ratio (banks only) (Sec. Eliminated.
Sec. 615.5301(d) and 615.5335).
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E. The History and Cooperative Structure of the Farm Credit System
The System is a federally chartered network of four banks and 78
associations that are borrower-owned lending cooperatives, as well as
their related service organizations.\8\ Cooperatives are organizations
that are owned and controlled by their members who use the
cooperatives' products or services. The mission of the System is to
provide sound and dependable credit to its member borrowers, who are
American farmers, ranchers, producers or harvesters of aquatic
products, their cooperatives, and certain farm-related businesses and
rural utility cooperatives. The System was created by Congress in 1916
as a farm real estate lender and was the first GSE; in subsequent
years, Congress expanded the System to include production credit,
cooperative, rural housing, and other types of lending. The System's
enabling statute is the Farm Credit Act.\9\
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\8\ This is the System's structure as of December 31, 2013. The
Federal Agricultural Mortgage Corporation (Farmer Mac), which is a
federally chartered instrumentality, is also an institution in the
System. The FCA has a separate set of capital regulations that apply
to Farmer Mac, and this proposed rule does not pertain to Farmer
Mac's regulations.
\9\ 12 U.S.C. 2001-2279cc. The Act is available at www.fca.gov
under ``FCA Handbook.''
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System associations are direct retail lenders; Farm Credit Banks
(FCBs) are primarily wholesale lenders to the associations, and the
agricultural credit bank (CoBank or ACB) makes retail loans to
cooperatives as well as wholesale loans to affiliated associations.
Each System bank has a district, or lending territory, which includes
the territories of the affiliated associations that it funds; CoBank,
in addition, lends to cooperatives nationwide. There are generally two
types of associations: Agricultural credit associations (ACAs) and
Federal land credit associations (FLCAs). In general, ACAs make short,
intermediate, and long-term operating loans, real estate mortgage
loans, and rural housing loans.\10\ FLCAs make only long-term real
estate mortgage and rural housing loans.
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\10\ ACAs may have a production credit association subsidiary
that makes short and intermediate-term loans and a FLCA subsidiary
that makes long-term loans.
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The System banks own the Federal Farm Credit Banks Funding
Corporation (Funding Corporation), which is the fiscal agent for the
banks and is responsible for issuing and marketing System-wide debt
securities in domestic and global capital markets. The banks use the
proceeds from the securities to fund their lending and other
operations, and the banks are jointly and severally liable on the debt.
The FCA is the System's independent Federal regulator that examines
and regulates System institutions for safety and soundness and mission
compliance. The Farm Credit System Insurance Corporation (FCSIC) is an
independent, U.S. Government-controlled corporation whose purpose is to
ensure the timely payment of principal and interest on insured System-
wide debt obligations issued on behalf of the System banks. The members
of the FCA Board also serve as the members of the FCSIC Board. The
FCSIC administers a $3.5 billion Insurance Fund and collects insurance
premiums from System banks.
1. Capital Structure of System Institutions
A System institution's cooperative capital consists of member-
borrower stock, allocated equities, and unallocated retained earnings.
System institutions, like all businesses, need capital to absorb losses
in times of financial adversity and provide a source of funds to
stabilize earnings and finance growth. Capital also carries ownership
rights of members, which reflect the System's cooperative nature.
Members, both past and current, helped build almost all the capital of
System institutions.\11\
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\11\ A small amount of regulatory capital comes from the
purchase by third-party investors of preferred stock and qualifying
subordinated debt.
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Member stock and allocated equities are the common equity classes
of System institutions. As discussed above, this proposed rule refers
to member stock and allocated equity collectively as ``common
cooperative equity.'' After the URE of an institution is depleted, all
categories of common cooperative equities are subject to impairment
before preferred stock and other non-cooperative equities of the
institution are impaired. This impairment of common cooperative
equities by category differs somewhat from the common stock of a joint-
stock bank, whose common equities are all impaired on a pro rata basis.
However, the FCA considers the impairment by category to be
substantially the same, as the common cooperative equities protect
other equities and obligations of the institution to the same extent
common equities of a joint-stock bank protect non-common equities and
obligations.
Table 2 compares the capital of System institutions, as
cooperatives, and joint-stock companies.
[[Page 52819]]
Table 2--Capital Instrument Comparison
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Joint-stock
System institution company
------------------------------------------------------------------------
Capital Stock................... Preferred Stock Preferred Stock
(outside (member
investors). investors)
Preferred Stock
(member
investors)..
Member-Borrower Common Stock.
Stock and
Participation
Certificates.
Allocated Stock
\1\.
Earned Net Worth................ Allocated Surplus Retained Earnings.
\1\.
Unallocated
Retained Equity
and URE
equivalents.
------------------------------------------------------------------------
\1\ Allocated equities include both stock and surplus. System banks
generally allocate equity as stock, and System associations generally
allocate equity as surplus. Allocated equities in this context may be
redeemed at the discretion of the institution.
2. Member Stock--Association Level
A retail borrower of a System association or of the ACB is required
to purchase voting stock or non-voting participation certificates
(depending on the status of the borrower \12\) as a condition of
obtaining a loan \13\ and becoming a member of the institution. For
purposes of this discussion, the FCA uses the term ``member stock'' to
refer to both voting stock and participation certificates.
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\12\ Only members engaged in agriculture and aquaculture may
hold voting stock in associations. Except for the ACB, only System
associations may hold voting stock in their affiliated bank. The
ACB's voting members are its affiliated associations as well as its
agricultural and rural utility cooperative borrowers. Other
borrowers, such as rural homeowners who are not farmers and other
financing institutions, buy participation certificates as a
condition of getting a loan or service.
\13\ A member may also purchase preferred stock as an investment
in the association if the association offers such stock. Such
preferred stock is not a common cooperative equity.
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Member stock is redeemable at book value, not to exceed par, only
at the discretion of the association's board of directors and subject
to the association's compliance with capital adequacy requirements.
When these requirements are met, associations routinely retire member
stock within some timeframe after the member has repaid the loan.
System associations are authorized to pay dividends on member stock but
do not currently do so.
Currently, all associations set their member stock purchase
requirements at the Farm Credit Act's minimum of the lesser of $1,000
or 2 percent of the loan amount,\14\ regardless of the member's loan
volume. Thus, while association stock purchased by borrowers embodies a
key cooperative principle, it is not a significant source of
association capital.
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\14\ Section 4.3A(c)(1)(E)(i) of the Act.
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3. Member Stock--System Bank Level
By contrast, member stock purchased by associations in their
affiliated System bank plays an important role in capitalizing System
banks. Each System bank sets a ``required investment'' for its
affiliated associations based on a percentage of each association's
loan volume funded by the bank. System bank advances fund the stock
purchases, and the associations' repayments of these advances reduce
their retained earnings.\15\ As an association's loan volume grows, the
bank requires the association periodically to acquire additional stock
to maintain the required stock investment. When an association's loan
volume decreases, the bank either pays a return on what the bank deems
``excess'' stock through an interest credit or an increased patronage
refund distribution, or the bank retires such stock. Tying the amount
of the required investment to the amount of the loan results in each
association's bearing the cost and risks of bank capital relative to
the association's share of bank debt, but this practice also makes the
stock less permanent because the bank routinely issues or redeems the
stock.
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\15\ System banks and associations' accounting systems and wire
transfer systems are highly coordinated if not the same within
districts; therefore, a reduction in retained earnings would be
equivalent to cash repayment of an advance.
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The ACB's capitalization program sets a ``targeted investment'' for
its members based on loan volume and allows its members to accumulate
the targeted investment through the bank's payment of stock patronage
refunds, or to purchase stock to fulfill the entire investment
requirement. The ACB's affiliated associations have all chosen to meet
the target through stock purchases rather than through accumulations of
allocated equities.
4. Allocated Equities
As discussed above, some System institutions provide cooperative
benefits to their borrowers by paying patronage refunds to their member
borrowers based on net income. Patronage refunds may be paid in cash or
allocated equities \16\ (stock or surplus) or a combination of both.
When institutions pay patronage refunds as allocated equity, they
actually retain the allocated equity thus effectively increasing a
borrower's equity investment in the institution. For tax purposes, a
System institution that declares a patronage refund must provide the
borrower with a written notice of allocation evidencing the amount paid
in cash and the amount of allocated equity.\17\ In this context, FCA is
describing allocated equities that the institution determines are
subject to redemption. Those allocated equities that an institution
determines are not subject to redemption will be discussed later.
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\16\ The FCA uses the term ``allocated equity'' to mean
patronage refunds retained as both allocated stock and allocated
surplus.
\17\ Under Subchapter T of the Internal Revenue Code, there are
two types of allocated equities: Qualified and nonqualified. Their
Federal income Tax treatment differs. See 26 U.S.C. 1381-1388.
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Allocated equities have certain rights and features in common with
member stock. Allocated equities are redeemable at book value, not to
exceed face value, only at a board's discretion and subject to
compliance with regulatory and supervisory capital requirements.
5. Unallocated Retained Earnings (URE) and URE Equivalents
URE consists of current and retained earnings not allocated to a
member or distributed through patronage refunds or dividends.\18\ It is
free from any specific ownership claim or expectation of allocation,
and it absorbs losses before other forms of surplus and stock. For the
past two decades, System associations have retained their earnings
primarily in the form of URE. One distinction between URE and allocated
equity is whether the institution provides a written notice of
allocation to the borrower. If the System institution does not provide
a written notice of allocation to the borrower, the equity is URE.
However, many System institutions keep ``memo'' records so that URE may
be attributed to a borrower if liquidation occurs.\19\
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\18\ Under GAAP, a System institution may include allocated
equity not subject to retirement in its URE.
\19\ A limited amount of System URE stems from non-patronage
sources and, under the bylaws of most System institutions, would be
distributed at liquidation among past and present patrons.
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In a liquidation, current and past members may have a fixed and
limited
[[Page 52820]]
claim on URE (except allocated equity not subject to retirement that is
treated as URE under generally accepted accounting principles (GAAP)).
The FCA has considered certain nonqualified allocated equities to
be the equivalent of URE when a System institution has provided a
written notice of allocation to members stating the equities are not
subject to redemption except upon liquidation or dissolution. To treat
these nonqualified allocated equities as URE in the core surplus ratio,
the FCA has required System institutions to adopt bylaw provisions that
the nonqualified allocated equity cannot be:
Redeemed other than in a liquidation or dissolution of the
institution;
Considered by the institution as satisfying any borrower
requirement to capitalize the entity; and
Offset against the specified borrower's loan in the event
of a loan loss on the specified borrower's account.
F. The FCA's Current Capital Regulations
The FCA currently has three risk-based minimum capital standards:
(1) A 3.5-percent core surplus ratio (CSR); (2) a 7-percent total
surplus ratio (TSR); and (3) a 7-percent permanent capital ratio
(PCR).\20\ Congress added a definition of ``permanent capital'' to the
Farm Credit Act in 1988 and required the FCA to adopt risk-based
permanent capital standards for System institutions. The FCA adopted
permanent capital regulations in 1988 and, in 1997, added core surplus
and total surplus capital standards for banks and associations, as well
as a non-risk-based net collateral ratio (NCR) for banks.\21\ Since
then, we have made only minor changes to these regulations.
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\20\ See 12 CFR 615.5201-615.5216 and 615.5301-615.5336.
\21\ See 53 FR 39229 (October 6, 1988) and 63 FR 39229 (July 22,
1998).
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Permanent capital is defined in the Farm Credit Act to include
current earnings, unallocated and allocated earnings,\22\ stock (other
than stock retireable on repayment of the holder's loan or at the
discretion of the holder, and certain stock issued before October
1988), surplus less allowance for loan losses (ALL), and other debt or
equity instruments that the FCA determines appropriate to be considered
permanent capital. Allocated equities shared by a bank and each
affiliated association--that is, equities that a bank has allocated to
an affiliated association--appear on the books of both institutions but
can be counted in only one institution's permanent capital pursuant to
a capital allotment agreement between the two institutions.
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\22\ In this preamble, ``unallocated and allocated earnings''
would be equivalent to ``unallocated retained earnings and allocated
equities''. Additionally ``surplus'' would be ``unallocated retained
earnings''.
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Core surplus is high-quality capital similar (but not identical) to
Basel I's tier 1 capital and generally consists of URE, certain
allocated surplus, and noncumulative perpetual preferred stock. In
calculating core surplus, an association must deduct its net investment
in its affiliated bank; the bank may not include in its core surplus
the equities it has issued or distributed to its affiliated
associations. At least 1.5 percent of the minimum 3.5-percent core
surplus requirement must consist of URE and noncumulative perpetual
preferred stock. We did not include equities held by one System
institution in another institution because we wanted institutions to
have sufficient high-quality capital on a standalone basis in the event
the other System institution became severely weakened.
Total surplus generally contains most of the components of
permanent capital but excludes stock held by members as a condition of
obtaining a loan and certain other instruments that are routinely and
frequently retired by institutions.
G. Prior FCA Advance Notices of Proposed Rulemaking (ANPRMs) on the
Basel Capital Standards
In October 2007, the FCA published an advance notice of proposed
rulemaking (ANPRM) on the risk weighting of assets--the denominator in
our risk-based core surplus, total surplus, and permanent capital
ratios--a possible leverage ratio, and a possible early intervention
framework.\23\ A comment letter we received in December 2008 from the
Funding Corporation on behalf of the System focused primarily on the
numerators of those regulatory capital ratios.\24\ The System urged us
to replace the core surplus and total surplus capital standards with a
``Tier 1/Tier 2'' capital framework consistent with the Basel Accord
(Basel I and Basel II) and the other Federal banking regulatory
agencies' guidelines. The comment letter stated that, ``because the
System's growth has required the use of external equity capital, the
System is in regular contact with the financial community, including
rating agencies and investors. Obtaining capital at competitive terms,
conditions, and rates requires these parties [to] understand the
System's and individual institution's financial position, making
consistency with approaches used by other regulators, rating agencies,
and investment firms a requirement to enhance the capacity of the
System to achieve its mission. For the System to achieve its mission,
the System must be able to compete with other lenders. Therefore, FCA's
capital regulations must result in a regulatory framework that provides
for a level playing field, in addition to safe and sound operations.''
Furthermore, the System recommended that we replace our NCR, which is
applicable only to banks, with a non-risk-based leverage ratio
applicable to all System institutions.
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\23\ 72 FR 61568 (October 31, 2007).
\24\ Comment letter dated December 19, 2008, from Jamie Stewart,
President and CEO, Funding Corporation, on behalf of the System.
---------------------------------------------------------------------------
In December 2009, the Basel Committee published a consultative
document that proposed fundamental reforms to the current tier 1/tier 2
capital framework.\25\ The Basel Committee's primary aims were to
improve the banking sector's ability to absorb shocks arising from
financial and economic stress, to mitigate spillover risk from the
financial sector to the broader economy, and to increase bank
transparency and disclosures. The FCA issued another ANPRM in July 2010
seeking comments on a tier 1/tier 2 regulatory capital structure that
would be similar to the capital tiers delineated in the Basel
consultative document and the then-existing guidelines of the Federal
regulatory banking agencies. We received two comment letters, one from
a System institution and one from a trade association on behalf of the
System. Both commenters strongly supported the FCA's adoption of a
capital framework that was as similar as possible to the capital
guidelines of the Federal regulatory banking agencies as revised to
implement the Basel III standards. In particular, they asserted that
consistency of FCA capital requirements with those of the Federal
regulatory banking agencies and transparency would allow investors,
shareholders, and others to better understand the financial strength
and risk-bearing capacity of the System. The FCA decided to delay
issuing a proposed rule until the Basel Committee had issued its new
framework and the Federal regulatory banking agencies had
[[Page 52821]]
proposed rules to implement that framework.
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\25\ ``Basel Consultative Proposals to Strengthen the Resilience
of the Banking Sector,'' December 17, 2009. The document is
available at http://www.bis.org/publ/bcbs164.htm.
---------------------------------------------------------------------------
After soliciting comments on its December 2009 consultative
document, the Basel Committee issued the new Basel III capital
standards in December 2010 (revised June 2011). In 2012, the Federal
regulatory banking agencies issued proposed rules to implement those
standards and adopted final rules in October 2013 and April 2014.
The FCA agrees generally with the System's position that a tier 1
and tier 2 regulatory capital framework comparable to Basel III and the
Federal regulatory banking agencies' new rules would be beneficial to
System institutions, their members, the investment community, and other
interested parties. It would also facilitate the issuance of equities
and subordinated debt to third-party investors. In addition, we believe
it necessary and appropriate to update the denominator risk weightings
that have been revised based on the lessons learned in the 2008 global
financial crisis.
When we adopted the core surplus, total surplus and the net
collateral ratios in 1997, transparency to the investment community was
not a significant consideration because the capital in the System
institutions was held by or generated by their members. The goal of
those regulations was to ensure that each System institution built
sufficient high-quality capital, especially URE and URE equivalents, to
serve the needs of all qualifying eligible borrowers and to withstand
downturns in the agricultural sector as well as adversities at other
System institutions. The FCA continues to believe a significant amount
of URE and URE equivalents is necessary to achieve and maintain that
goal but also believes common cooperative equities may be included in
the higher quality capital measures to a larger extent than they are
included in our current regulations. This position is based on a number
of factors, including the reduction of the member stock requirement at
most institutions to the statutory minimum and the institutions'
evolving allocated equity redemption practices.
Through the 1990s and to the present day, a strong agricultural
economy together with sound business practices has enabled System
institutions to build higher quality capital while at the same time
growing the System's total assets from $64.8 billion in 1993 to $260.8
billion at the end of 2013.
II. Minimum Regulatory Capital Ratios, Additional Capital Requirements,
and Overall Capital Adequacy
A. Minimum Risk-Based Capital Ratios and Other Regulatory Capital
Provisions
The FCA is proposing the following minimum capital ratios: (1) A
common cooperative equity tier 1 (CET1) capital ratio of 4.5 percent;
(2) a tier 1 capital ratio of 6 percent; (3) a total capital ratio of 8
percent; and (4) a tier 1 capital leverage ratio of 5 percent, of which
at least 1.5 percent must be composed of URE and URE equivalents. Tier
1 capital would equal the sum of CET1 and AT1 capital. Total capital
would consist of CET1, AT1, and tier 2 capital. As noted above, the
FCA's existing core surplus, total surplus, and net collateral
requirements would be rescinded, but the minimum permanent capital
requirements would be retained.
In addition, each System institution would be subject to a capital
conservation buffer in excess of the risk-based capital requirements
that would impose limitations on its capital distributions and certain
discretionary bonuses, as described in section C below. The capital
conservation buffer would not be considered a minimum capital
requirement.
The FCA will continue to hold each System institution accountable
to maintain sufficient capital commensurate with the level and nature
of the risks to which it is exposed. This may require capital
significantly above the minimum requirements, depending on the
institution's activities and risk profile. Section D below describes
the requirement for overall capital adequacy of System institutions and
the supervisory assessment of an institution's capital adequacy.
Consistent with the FCA's authority under the Farm Credit Act and
current capital regulations, proposed Sec. 628.10(d) confirms FCA's
authority to require an institution to hold a different amount of
regulatory capital from what would otherwise be required under the
proposal, if we determine that the institution's regulatory capital is
not commensurate with its credit, operational, or other risks.
B. Leverage Ratio
The FCA is proposing a tier 1 leverage ratio for all System
institutions of 5 percent, of which at least 1.5 percent of non-risk-
weighted total assets must be URE and URE equivalents. This would
replace the net collateral ratio requirement for System banks. System
associations do not currently have a leverage ratio requirement. The
proposed ratio differs from the Federal regulatory banking agencies'
leverage ratio in two respects: There is no minimum URE and URE
equivalents requirement in their leverage ratio, and their minimum
requirement is 4 percent.
A leverage ratio constrains the build-up of leverage in the System,
which the risk-based regime is not designed to do. It reinforces the
risk-based requirements with a non-risk-based backstop--that is, if the
computation of the risk-weighted assets does not accurately reflect the
true underlying risk inherent in a System institution, the leverage
ratio serves as a floor that prevents the institution from decreasing
its capital below a certain percentage of total assets. Furthermore, it
represents a standardized measure that can be used to make comparison
among System institutions over time.
The 5-percent leverage ratio takes into consideration the fact that
System institutions are financially and operationally interconnected,
member-owned cooperatives, and monoline lenders that currently provide
credit to approximately 41 percent of the United States agriculture
sector. They have a business model and risk profile that are
substantially different from traditional banking organizations.
The higher 5-percent leverage ratio also helps to ensure that
System institutions continue to have sufficient systemic loss-absorbing
capital to withstand a severely adverse economic event while continuing
to provide a steady flow of credit to U.S. agriculture in view of the
System's unique GSE mission.
For associations, the proposed 5-percent minimum leverage ratio
would differ little from their proposed tier 1 risk-based capital
requirement. Most associations' on-balance sheet assets are risk
weighted at 100 percent, and the associations do not have significant
off-balance sheet items. This is not the case for System banks,
however. While System banks do have off-balance sheet items that would
have to be risk weighted--especially unfunded commitments in this
proposal--the banks also have a large portion of instruments in the 20-
percent risk-weighting category, primarily the direct loans to their
affiliated associations, and the 0-percent risk-weighting category. We
believe it is important for System banks to hold enough capital to
protect against risks other than credit risk (e.g. interest rate risk,
liquidity risk, premium risk, operational risk, etc.).
The 1.5-percent minimum URE and URE equivalents requirement is
similar in some respects to our current requirement that at least 1.5
percent of
[[Page 52822]]
an institution's core surplus must consist of URE and URE equivalents
and noncumulative perpetual preferred stock. For associations, the
great majority of which have not issued noncumulative perpetual
preferred stock, compliance with the proposed 1.5-percent URE and URE
equivalents requirement would differ little from the compliance with
their existing 1.5 percent of core surplus requirement. By contrast,
all banks have noncumulative perpetual preferred stock outstanding that
is included in their 1.5-percent core surplus requirement but would not
be included in the proposed 1.5-percent URE and URE equivalents minimum
standard. The FCA believes that it is especially important for System
banks to hold sufficient URE and URE equivalents to cushion the third-
party and common cooperative equities that make up the rest of tier 1
capital. URE and URE equivalents, when depleted, do not result in
losses to a System's institution's members. URE protects against the
interconnected risk that exists between System banks and associations;
it protects association members against association losses,
associations against bank losses, and the System against financial
contagion. We are proposing to make the URE and URE equivalents a part
of the leverage ratio because a URE minimum tied to risk-adjusted
assets may not be sufficient for the banks, which have a greater
disparity between risk-adjusted assets and total assets.
C. Capital Conservation Buffer
Consistent with Basel III and the Federal regulatory banking
agencies' rules, we are proposing a capital conservation buffer to
enhance the resilience of System institutions throughout financial
cycles. To avoid restrictions on cash payments for patronage,
redemptions, and dividends (collectively, capital distributions) or
discretionary executive bonuses, an institution's risk-weighted
regulatory capital ratios would have to be at least 2.5 percent above
the minimums when the buffer is fully phased in. The buffer would
provide an incentive for institutions to hold capital well above the
minimum required levels to ensure that they would meet the regulatory
minimums even during stressful conditions.
The capital conservation buffer would consist of tier 1 capital and
would be the lowest of the following risk-weighted measures:
The institution's CET1 ratio minus its minimum CET1 ratio;
The institution's tier 1 ratio minus its minimum tier 1
ratio; and
The institution's total capital ratio minus its minimum
total capital ratio.
If any of the institution's risk-weighted ratios were at or below the
minimum required ratios, the institution's capital conservation buffer
would be zero.
The maximum payout ratio would be the percentage of eligible
retained income that a System institution would be allowed to pay out
in capital distributions and discretionary bonuses during the current
calendar quarter and would be determined by the amount of the capital
conservation buffer held by the institution during the previous
calendar quarter. Eligible retained income would be defined as the
institution's net income as reported in its quarterly call reports to
the FCA for the four calendar quarters preceding the current calendar
quarter, net of any capital distributions, certain discretionary bonus
payments, and associated tax effects not already reflected in net
income.
A System institution's maximum payout amount for the current
calendar quarter would be equal to its eligible retained income
multiplied by the applicable maximum payout ratio in accordance with
table 1 in Sec. 628.11. An institution with a capital conservation
buffer that is greater than 2.5 percent would not be subject to a
maximum payout amount under this provision (although distributions
without FCA prior approval may be restricted by other provisions in
this proposed rule). If an institution's CET1, tier 1, or total capital
ratio is 2.5 percent or less above the minimum ratio, the maximum
payout ratio would also decline. The institution would remain subject
to payout restrictions until it raises its capital conservation buffer
above 2.5 percent. In addition, a System institution would not
generally be able to make capital distributions or pay discretionary
bonuses during the current calendar quarter if its eligible retained
income is negative and its capital conservation buffer is less than 2.5
percent as of the end of the previous quarter.
The capital conservation buffer is divided into quartiles, with
greater restrictions on capital distributions and discretionary bonus
payments as the capital conservation buffer falls closer to 0 percent.
When the buffer is fully phased in, payouts would be restricted to 60
percent of eligible retained income if the buffer is above 1.875
percent but at or below 2.5 percent. When the buffer is above 1.25
percent but less than or equal to 1.875 percent, the payout would be
restricted to 40 percent of eligible retained income. When the buffer
is above 0.625 percent but equal to or below 1.25 percent, the payout
would be restricted to 20 percent of eligible retained income. A
capital conservation buffer of 0.625 percent or below would result in a
0-percent payout.
The FCA proposes to define a capital distribution as:
A reduction of tier 1 capital through the repurchase or
redemption of a tier 1 capital instrument or by other means, unless the
redeemed capital is replaced in the same quarter by tier 1 qualifying
capital;
A reduction of tier 2 capital through the repurchase, or
redemption prior to maturity, of a tier 2 capital instrument or by
other means, unless the redeemed capital is replaced in the same
quarter by qualifying tier 1 or tier 2 capital;
A dividend declaration or payment on any tier 1 capital
instrument;
A dividend declaration or interest payment on any tier 2
capital instrument if the institution has full discretion to suspend
such payments permanently or temporarily without triggering an event of
default;
A cash patronage refund declaration or payment;
A patronage refund declaration in the form of allocated
equities that do not qualify as tier 1 or tier 2 capital; \26\ or
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\26\ A patronage refund declaration or payment in the form of
allocated equities that qualify as tier 1 capital is not a reduction
in tier 1 capital. It is merely a reclassification from one tier 1
capital element into a different tier 1 capital element.
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Any similar transaction that the FCA determines to be in
substance a distribution of capital.\27\
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\27\ We note that the Federal regulatory banking agencies
replaced the term ``capital distribution'' with ``distribution'' in
their final rule. We have decided to use the term ``capital
distribution'' to avoid potential confusion with other types of
distributions that do not meet the definition for purposes of
applying the capital conservation buffer.
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The FCA proposes to define a discretionary bonus payment as a
payment made to a senior officer of a System institution, where:
The System institution retains discretion whether to pay
the bonus and how much to pay until it awards the payment to the senior
officer;
The System institution determines the amount of the bonus
without prior promise to, or agreement with, the senior officer; and
The senior officer has no express or implied contractual
right to the bonus payment.
The term ``senior officer'' is already defined in Sec. 619.9310 as
``[t]he Chief Executive Officer, the Chief Operations Officer, the
Chief Financial Officer, and the General Counsel, or persons in
[[Page 52823]]
similar positions; and any other person responsible for a major policy-
making function.'' \28\
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\28\ The FCA considers this definition substantively identical
to the definition of ``executive officer'' used in the Federal
regulatory banking agencies' rules on the capital conservation
buffer.
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The purpose of limiting restrictions on discretionary bonus
payments to senior officers is to focus these measures on the
individuals within an institution who could expose the institution to
the greatest risk. We note that the institution may otherwise be
subject to limitations on capital distributions under other provisions
in this rule. In addition, we retain authority to approve a capital
distribution or bonus payment if we determine that the payment would
not be contrary to the purposes of the capital conservation buffer or
the safety and soundness of the institution.
D. Supervisory Assessment of Overall Capital Adequacy
System institutions should have internal processes to assess
capital adequacy that reflect a full understanding of risks and to
ensure sufficient capital is held. Our supervisory assessment of
capital adequacy must take account of the internal processes for
capital adequacy, as well as risks and other factors that can affect an
institution's financial condition, including the level and severity of
problem assets and total surplus exposure to operational and interest
rate risk. For this reason, a supervisory assessment of capital
adequacy may differ significantly from conclusions that might be drawn
solely from the level of the institution's risk-based capital ratios.
The FCA expects System institutions generally to operate with
capital levels well above the minimum risk-based ratios and to hold
capital commensurate with the level and nature of the exposed risk. For
example, System institutions that are growing or that anticipate growth
in the near future should maintain strong capital levels substantially
above the minimums and should not allow significant diminution of
financial strength below such levels to fund their growth. System
institutions with high levels of risk are also expected to operate with
capital well above the minimum levels. The supervisory assessment also
evaluates the quality and trends in an institution's capital
composition, including the share of common cooperative equities and URE
and equivalents.
Section 628.10(d) of the proposal would maintain and reinforce
these supervisory expectations by requiring that a System institution
maintain capital commensurate with the level and nature of all risks to
which it is exposed and that the institution have a process for
assessing its overall capital adequacy in relation to its risk profile,
as well as a comprehensive strategy for maintaining an appropriate
level of capital.
The supervisory assessment may include such factors as whether the
institution has merged recently, entered new activities, or introduced
new products. It would also consider whether an institution is
receiving special supervisory attention from FCA, has or is expected to
have losses resulting in capital inadequacy, has significant exposure
due to risks from concentrations in credit or nontraditional
activities, or has significant exposure to interest rate risk,
operational risk, or could be adversely affected by the activities or
condition of an affiliated System institution.
The supervisory assessment would also evaluate the
comprehensiveness and effectiveness of a System institution's capital
as required by Sec. Sec. 615.5200 and 618.8440 of existing FCA
regulations. We are proposing to revise Sec. 615.5200 to require the
planning to include the new ratios in this proposed rule. An effective
capital planning process would require a System institution to assess
its risk exposures, develop strategies for mitigating those risks, and
set capital adequacy goals relative to its risks, and prospective
economic conditions. Evaluation of an institution's capital adequacy
process would be commensurate with the institution's size,
sophistication, and risk profile.
III. Definition of Capital
A. Capital Components and Eligibility Criteria for Regulatory Capital
Instruments
1. Common Cooperative Equity Tier 1 (CET1) Capital
Under the proposed rule, a System institution's CET1 would be the
sum of URE and common cooperative equities, minus the regulatory
adjustments and deductions described in Sec. 628.22. We have adapted
the criteria for the common cooperative equities in accordance with
footnote 12 of Basel III, which states that the criteria for non-joint
stock companies, including mutuals and cooperatives, should take into
account their legal structure and constitution.\29\ The footnote
provides that the CET1 criteria ``should preserve the quality of the
instruments by requiring that they are deemed fully equivalent to
common shares . . . as regards loss absorption and do not possess
features which could cause the condition of the [non-joint stock] bank
to be weakened as a going concern during periods of market stress.''
The Federal regulatory banking agencies' rules have decided to apply
the same criteria to the mutual financial institutions they regulate
and to their joint-stock banking organizations.
---------------------------------------------------------------------------
\29\ Basel III framework footnote 12 to ``Criteria for
classification as common shares for regulatory capital purposes''.
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Basel III established 14 criteria a banking organization must meet
to include an instrument in CET1 capital; the Federal regulatory
banking agencies' rules have 13 criteria. These criteria are intended
to ensure that the instrument will be available to absorb losses at the
banking organization on a going-concern basis. Several of the criteria
provide that the instrument must represent the most subordinated claim
in liquidation, is entitled to a claim on residual assets proportional
to its share of issued capital, and must take the first and
proportionately greatest share of any losses as they occur.
Unlike joint-stock banks, System institutions have priorities of
impairment among the various classes of member stock and allocated
equities, and typically all current and former members are entitled to
the residual assets, based on historic patronage, in a liquidation of
the institution. However, all common cooperative equities are impaired
and depleted before all other instruments. Therefore, we are replacing
these criteria with criteria providing that the instrument must
represent a claim subordinated to all other equities of an institution
in a liquidation, and the holder receives payment only after all
general creditors and debt holders are paid.
Another CET1 criterion of Basel III and the Federal regulatory
banking agencies is that the banking organization does nothing to
create an expectation at issuance that the instrument will be redeemed,
nor do the statutory or contractual terms provide any feature that
might give rise to such an expectation. In the System, institutions
issue or distribute some common cooperative equities that are never
retired and that do not give rise to redemption expectations by
members. Other common cooperative equities, by contrast, are routinely
and frequently redeemed. Through this practice, System institutions can
create expectations on the part of their members that these purchased
and allocated equities will be redeemed. Consequently, we believe that
the
[[Page 52824]]
``expectation'' requirement of Basel III and the Federal regulatory
banking agencies' rules could reasonably be interpreted to disallow
common cooperative equities redeemed by System institutions from CET1.
However, it is important for the current members of a cooperative to
provide capital to the cooperative and for current and former members
of the cooperative eventually to receive a return of their capital.
Therefore, we have decided to recognize this key cooperative principle
by including in CET1 purchased and allocated equities that meet the
requirements described below.
The FCA is proposing to include in CET1 an amount of member stock
equal to the minimum stock purchase requirement set forth in the Farm
Credit Act. That minimum amount is the lesser of $1,000 or 2 percent of
the member's loan or loans. The FCA has reviewed the 2013 regulatory
technical standards of the European Banking Authority (EBA) regarding
the standards for CET1 for cooperatives, mutuals, the other non-joint
stock banks.\30\ European cooperative banks do not issue allocated
equities; therefore, the technical regulations have little application
to the treatment of System institutions' allocated equities. However,
we have adapted the EBA document's treatment of minimum required
amounts of purchased cooperative equities to allow System institutions
to include purchased member stock in their CET1.
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\30\ European Banking Authority, EBA Final Draft Regulatory
Technical Standards on Own Funds [Part 1] Under Regulation (EU) No.
575/2013 Capital Requirements Regulation--CRR), Title II, ch. 1,
art. 7.
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Purchased member capital is routinely funded directly or indirectly
by European cooperative banks, and the same is true for System
institutions. The CET1 criteria for Basel III and the Federal
regulatory banking agencies' rules do not permit joint-stock banks to
include in CET1 any equities whose purchase is directly or indirectly
funded by the bank. However, the EBA document permits cooperatives to
include directly or indirectly funded member stock (called a
subscription) if the amount of the subscription is not material, the
purpose of the cooperative's loan to the member is not the purchase of
an institution's capital instrument, and the member stock purchase is
necessary in order for the beneficiary of the loan to become a member
of the cooperative. The required minimum stock purchase requirements in
System institutions mirror these characteristics.
Some countries in the European Union require the redemption of the
member's subscription when the member pays off the loan. That is not
the case with respect to System institutions. They may, but are not
required to, redeem the member's required stock when a loan is paid. As
a general matter, the FCA has not given favorable treatment to member
stock in its capital regulations because of the widespread and routine
redemptions of member stock when the member's loan is paid off.
Notwithstanding these concerns, because the repayment of the member's
loan reduces the level of assets that the System institution must
capitalize and because of the similar characteristics with EBA
provisions, we have determined that including an amount equal to the
minimum stock purchase requirement appropriately recognizes the
cooperative structure of the System and is acceptable from a safety and
soundness standpoint. For this minimum amount of stock, the institution
would not have to obtain the prior approval of the FCA before redeeming
it and would not be required to keep it outstanding for a minimum
period. In other words, the institution could redeem the member's
minimum required stock according to its current redemption practices.
The FCA is also proposing to include other member-purchased common
cooperative equities and allocated equities of System institutions that
adopt a capitalization bylaw providing that the institution will not
redeem the equities for at least 10 years (for CET1 capital) and for at
least 5 years (for tier 2 capital) after issuance or distribution, will
not offset such equities against a member's loan in default, and will
not redeem the equities without the FCA's prior approval unless the
redemption falls within the ``safe harbor'' provision described below.
System institutions typically have allocated equity revolvement
periods ranging from 4 to 10 years, and perhaps longer, for their
allocated equities. We believe allocated equities with shorter
revolvement periods have higher member expectations of redemption than
allocated equities that are held longer. Such expectations may put
stress on System institutions to continue to redeem equities even when
the institution's financial health is deteriorating. Institutions'
boards of directors generally prefer to revolve allocated equities on a
regular basis. This aids in the capital planning process and can help
manage the revolvement expectations of the members. While the
regularity of redemptions results in a rise in member expectations, we
believe a longer revolvement period has the effect of moderating these
expectations--that is, if a member is not expecting equities allocated
in 2015 to be redeemed before 2025, the member is less likely to count
on the cash redemption of those equities in the member's own capital
planning. Therefore, we are retaining an ``expectation'' criterion
similar to that in Basel III and the Federal regulatory banking
agencies' rules, but we are providing that equities held by an
institution for at least 10 years will not be considered to create an
expectation. Cash payment of patronage refunds, dividends, and
redemption of allocated equities normally are paid from current year
net income, and an institution must ensure it generates sufficient net
income to cover these expected cash outlays from capital. A shorter
revolvement or redemption cycle places more strain than a longer
revolvement or redemption cycle on an institution's ability to generate
a return to stockholders and capitalize growth.
Under this proposal, all System institutions would be able to
include an amount equal to the minimum stock purchase requirements of
their members in CET1 capital, as well as purchased stock or allocated
equities that the institution never retires. System institutions that
have a member stock purchase requirement that is higher than the
statutory minimum and that revolve allocated equities would be able to
include all such equities in CET1 capital if they ensure that the
purchased stock and allocated equities are not redeemed for at least 10
years. Member stock in excess of the statutory minimum and allocated
equities that are retained for at least 5 years are includable in tier
2 capital; if retained for less than 5 years, such equities are not
includable in tier 1 or tier 2.
a. Criteria
The FCA proposes to require that the common cooperative equities
included in CET1 satisfy all the following criteria:
(1) The instrument is issued directly by the System institution and
represents a claim subordinated to all preferred stock, all
subordinated debt, and all liabilities in a receivership, insolvency,
liquidation, or similar proceeding of the System institution;
(2) If the holder of the instrument is entitled to a claim on the
residual assets of the System institution, the claim will be paid only
after all general creditors, subordinated debt holders, and preferred
stock claims have been satisfied in a receivership, insolvency,
liquidation, or similar proceeding;
[[Page 52825]]
(3) The instrument has no maturity date, can be redeemed only at
the discretion of the System institution and with the prior approval of
FCA, and does not contain any term or feature that creates an incentive
to redeem;
(4) The System institution did not create, through any action or
communication, an expectation that it will buy back, cancel, revolve,
or redeem the instrument, and the instrument does not include any term
or feature that might give rise to such an expectation, except that the
establishment of a revolvement period of 10 years or more, or the
practice of revolving or redeeming the instrument no less than 10 years
after issuance or allocation, will not be considered to create such an
expectation;
(5) Any cash dividend payments on the instrument are paid out of
the System institution's net income or unallocated retained earnings,
and are not subject to a limit imposed by the contractual terms
governing the instrument;
(6) The System institution has full discretion at all times to
refrain from paying any dividends without triggering an event of
default, a requirement to make a payment-in-kind, or an imposition of
any other restrictions on the System institution;
(7) Dividend payments and other distributions related to the
instrument may be paid only after all legal and contractual obligations
of the System institution have been satisfied, including payments due
on more senior claims;
(8) The holders of the instrument bear losses as they occur before
any losses are borne by holders of preferred stock claims on the System
institution and holders of any other claims with priority over common
cooperative equity instruments in a receivership, insolvency,
liquidation, or similar proceeding;
(9) The instrument is classified as equity under GAAP;
(10) The System institution, or an entity that the System
institution controls, did not purchase or directly or indirectly fund
the purchase of the instrument, except that where there is an
obligation for a member of the institution to hold an instrument in
order to receive a loan or service from the System institution, an
amount of that loan equal to the minimum borrower stock requirement
under section 4.3A of the Farm Credit Act will not be considered as a
direct or indirect funding where:
(a) The purpose of the loan is not the purchase of capital
instruments of the System institution providing the loan; and
(b) The purchase or acquisition of one or more member equities of
the institution is necessary in order for the beneficiary of the loan
to become a member of the System institution;
(11) The instrument is not secured, not covered by a guarantee of
the System institution, and is not subject to any other arrangement
that legally or economically enhances the seniority of the instrument;
(12) The instrument is issued in accordance with applicable laws
and regulations and with the institution's capitalization bylaws;
(13) The instrument is reported on the System institution's
regulatory financial statements separately from other capital
instruments; and
(14) The System institution's capitalization bylaws provide that it
will not redeem the instrument for a period of at least 10 years after
issuance, or if allocated equities at least 10 years after allocation
to a member, or reduce the original revolvement period to less than 10
years without the prior approval of the FCA, except that the minimum
statutory borrower stock described under paragraph (b)(1)(x) of this
section may be redeemed without a minimum period outstanding after
issuance and without the prior approval of the FCA.
b. Accumulated Other Comprehensive Income (AOCI) and Minority Interests
The FCA is not proposing to include minority interests in CET1 or
in any other component of regulatory capital because System
institutions have few or no minority equity interests in unconsolidated
subsidiaries.
The FCA is not proposing to include AOCI in CET1 capital, which is
different from Basel III and the Federal banking regulatory agencies'
final rules. As a result, we are proposing no adjustments to CET1 for
AOCI.
Under the FCA's current risk-based capital rules, most of the
components of AOCI included in GAAP equity are not included in a System
institution's regulatory capital. Under GAAP, AOCI includes unrealized
gains and losses on certain assets and liabilities that are not
included in net income. AOCI includes unrealized gains and losses on
available-for-sale (AFS) securities; ``other than temporary impairment
on securities'' reported as held to maturity (HTM) that are not credit
related; cumulative gains and losses on cash-flow hedges; foreign
currency translation adjustments; and amounts attributed to defined
benefit post retirement plans resulting from the initial and subsequent
application of the relevant GAAP standards that pertain to such plans.
The Federal banking regulatory agencies include in CET1 capital any
net unrealized losses on AFS equity securities and any foreign currency
translation adjustments. System institutions carry all equity
investments in other System institutions at par or book value. Current
investment regulations restrict equity investment outside the System.
Therefore, it would be rare for a System institution to have any net
unrealized losses or gains because of AFS equity securities. Only one
System institution, CoBank, would have a need to hold foreign currency,
and only in an amount to facilitate its lending activities. As a
result, the FCA is not proposing to include any AOCI item in CET1
capital, as it does not believe AFS equity securities or foreign
currency translation adjustments would ever be material to CET1
capital.
We note that, while the Federal regulatory banking agencies'
proposed rule would have required all banking organizations to include
most elements of AOCI in CET1 capital, the agencies' final rule permits
banking organizations using the standardized approach to make a one-
time election not to include most elements of AOCI in their regulatory
capital. The preamble to the final rule states that the agencies
received a significant number of comments expressing concern about the
potential volatility of AOCI inclusion on a banking organization's
capital and made other assertions about the negative effect the
proposed treatment would have on an organization's ability to manage
liquidity and interest rate risk. Under the FCA's proposed AOCI
treatment, the exclusion of AOCI from CET1 capital would be comparable
to the AOCI exclusions of the banking organizations that make an
election not to include AOCI in their CET1 capital.
We seek comment on using alternative terms or conditions that FCA
could apply to common cooperative equities. Is a 10-year revolvement
cycle long enough to reduce the expectation of redemption and increase
the permanence of such equity instruments so that they may be included
in CET1 capital?
2. Additional Tier 1 (AT1) Capital
The proposed criteria for AT1 are comparable to Basel III and the
Federal regulatory banking agencies' rules. AT1 would include primarily
noncumulative perpetual preferred stock issued by System institutions
and would be subject to certain adjustments and deductions. Qualifying
instruments would primarily be stock issued by
[[Page 52826]]
System banks to third-party investors, though all System institutions
have authority to issue such stock. AT1 would not include common
cooperative equities.
a. Criteria
The criteria for inclusion in AT1 capital are:
(1) The instrument is issued and paid-in;
(2) The instrument is subordinated to general creditors and
subordinated debt holders of the System institution in a receivership,
insolvency, liquidation, or similar proceeding;
(3) The instrument is not secured, not covered by a guarantee of
the System institution and not subject to any other arrangement that
legally or economically enhances the seniority of the instrument;
(4) The instrument has no maturity date and does not contain a
dividend step-up or any other term or feature that creates an incentive
to redeem;
(5) If callable by its terms, the instrument may be called by the
System institution only after a minimum of 5 years following issuance,
except that the terms of the instrument may allow it to be called
earlier than 5 years upon the occurrence of a regulatory event that
precludes the instrument from being included in AT1 capital, or a tax
event. In addition:
(a) The System institution must receive prior approval from FCA to
exercise a call option on the instrument.
(b) The System institution does not create at issuance of the
instrument, through any action or communication, an expectation that
the call option will be exercised.
(c) Prior to exercising the call option, or immediately thereafter,
the System institution must either: Replace the instrument to be called
with an equal amount of instruments that meet the criteria for a CET1
or AT1 capital instrument; \31\ or demonstrate to the satisfaction of
FCA that following redemption, the System institution will continue to
hold capital commensurate with its risk;
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\31\ Replacement can be concurrent with redemption of existing
AT1 capital instruments.
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(6) Redemption or repurchase of the instrument requires prior
approval from FCA;
(7) The System institution has full discretion at all times to
cancel dividends or other distributions on the instrument without
triggering an event of default, a requirement to make a payment-in-
kind, or an imposition of other restrictions on the System institution
except in relation to any distributions to holders of common
cooperative equity instruments or other instruments that are pari passu
with the instrument.
(8) Any distributions on the instrument are paid out of the System
institution's net income, unallocated retained earnings, or surplus
related to other AT1 capital instruments and are not subject to a limit
imposed by the contractual terms governing the instrument;
(9) The instrument does not have a credit-sensitive feature, such
as a dividend rate that is reset periodically based in whole or in part
on the System institution's credit quality, but may have a dividend
rate that is adjusted periodically independent of the System
institution's credit quality, in relation to general market interest
rates or similar adjustments;
(10) The paid-in amount is classified as equity under GAAP;
(11) The System institution did not purchase or directly or
indirectly fund the purchase of the instrument;
(12) The instrument does not have any features that would limit or
discourage additional issuance of capital by the System institution,
such as provisions that require the System institution to compensate
holders of the instrument if a new instrument is issued at a lower
price during a specified timeframe; and
(13) The System institution's capitalization bylaws provide that it
will not redeem the instrument without the prior approval of the FCA.
Notwithstanding the criteria for AT1 capital instruments referenced
above, an instrument with terms that provide that the instrument may be
called earlier than 5 years upon the occurrence of a rating agency
event does not violate the minimum 5-year issuance requirement provided
that the instrument was issued and included in a System institution's
core surplus capital prior to the effective date of the final rule, and
that such instrument satisfies all other criteria under this Sec.
628.20(c).
b. FCA's Current Capital Regulations
Under the FCA's current regulatory capital regulations, the
outstanding noncumulative perpetual preferred stock issued by System
institutions to third parties is included in core surplus and is
included in the minimum required 1.5 percent of core surplus that is
other than allocated equities routinely redeemed. Such preferred stock
would continue to receive favorable regulatory capital treatment in
tier 1 capital. However, consistent with the objective of Basel III and
the Federal regulatory banking agencies' rules that banking
organizations' common equities comprise at least 4.5 percent of risk-
based capital, the preferred stock would not be included in CET1.
3. Tier 2 Capital
The FCA proposes to include in tier 2 capital the sum of tier 2
capital instruments that satisfy the applicable criteria, plus ALL up
to 1.25 percent of risk-weighted assets, less any applicable
adjustments and deductions. The criteria are similar to those in Basel
III and the Federal regulatory banking agencies' rules, except that
common cooperative equities that are not includable in CET1 may be
included in tier 2 if they meet the applicable criteria.
The criteria for instruments (plus related surplus) included in
tier 2 capital are:
(1) The instrument is issued and paid-in, is a common cooperative
equity, or is member equity purchased in accordance with Sec.
628.20(d)(1)(viii) of the proposed rule;
(2) The instrument is subordinated to general creditors of the
System institution;
(3) The instrument is not secured, not covered by a guarantee of
the System institution and not subject to any other arrangement that
legally or economically enhances the seniority of the instrument in
relation to more senior claims;
(4) The instrument has a minimum original maturity of at least 5
years. At the beginning of each of the last 5 years of the life of the
instrument, the amount that is eligible to be included in tier 2
capital is reduced by 20 percent of the original amount of the
instrument (net of redemptions) and is excluded from regulatory capital
when the remaining maturity is less than 1 year. In addition, the
instrument must not have any terms or features that require, or create
significant incentives for, the System institution to redeem the
instrument prior to maturity; \32\
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\32\ An instrument that by its terms automatically converts into
a tier 1 capital instrument prior to 5 years after issuance complies
with the 5-year maturity requirement of this criterion.
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(5) The instrument, by its terms, may be called by the System
institution only after a minimum of 5 years following issuance, except
that the terms of the instrument may allow it to be called sooner upon
the occurrence of an event that would preclude the instrument from
being included in tier 2 capital, or a tax event. In addition:
(a) The System institution must receive the prior approval of FCA
to exercise a call option on the instrument.
[[Page 52827]]
(b) The System institution does not create at issuance, through
action or communication, an expectation the call option will be
exercised.
(c) Prior to exercising the call option, or immediately thereafter,
the System institution must either: Replace any amount called with an
instrument that is of equal or higher quality regulatory capital under
this section; \33\ or demonstrate to the satisfaction of FCA that
following redemption, the System institution would continue to hold an
amount of capital that is commensurate with its risk;
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\33\ A System institution may replace tier 2 or tier 1 capital
instruments concurrent with the redemption of existing tier 2
capital instruments.
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(6) The holder of the instrument must have no contractual right to
accelerate payment of principal, dividends, or interest on the
instrument, except in the event of a receivership, insolvency,
liquidation, or similar proceeding of the System institution;
(7) The instrument has no credit-sensitive feature, such as a
dividend or interest rate that is reset periodically based in whole or
in part on the System institution's credit standing, but may have a
dividend rate that is adjusted periodically independent of the System
institution's credit standing, in relation to general market interest
rates or similar adjustments;
(8) The System institution has not purchased and has not directly
or indirectly funded the purchase of the instrument, except that where
common cooperative equity instruments are held by a member of the
institution in connection with a loan, and the institution funds the
acquisition of such instruments, that loan shall not be considered as a
direct or indirect funding where:
(a) The purpose of the loan is not the purchase of capital
instruments of the System institution providing the loan;
(b) The purchase or acquisition of one or more capital instruments
of the institution is necessary in order for the beneficiary of the
loan to become a member of the System institution; and
(c) The capital instruments are in excess of the statutory minimum
stock purchase amount;
(9) Redemption of the instrument prior to maturity or repurchase is
at the discretion of the System institution and requires the prior
approval of the FCA; and
(10) If the instrument is a common cooperative equity, the System
institution's capitalization bylaws provide that it will not, except
with the prior approval of the FCA, redeem such equity included in tier
2 capital for a period of at least 5 years after allocating it to a
member.
4. FCA Approval of Capital Elements
Proposed Sec. 628.20(e) would require a System institution to
obtain prior approval to include a new capital element in its CET1
capital, AT1 capital, or tier 2 capital unless the element is
equivalent, in terms of capital quality and ability to absorb losses
with respect to all material terms, to a regulatory element the FCA has
already determined may be included in regulatory capital. After the FCA
determines that an institution may include an element in regulatory
capital, it will make its decision publicly available.
5. FCA Prior Approval Requirements for Cash Patronage, Dividends, and
Redemptions; Safe Harbor
As described above, the proposed rule would require FCA prior
approval for the redemption of equities included in tier 1 and tier 2,
consistent with Basel III and the Federal regulatory banking agencies'
rules. The proposed rule would also require FCA prior approval of cash
dividends and cash patronage, which is not a requirement of the Basel
III framework but is a requirement imposed by statute or regulation on
the federally chartered banking organizations regulated by the Federal
regulatory banking agencies. In Sec. 628.20(f), we are also proposing
a ``safe harbor'' to permit institutions to pay cash dividends and
patronage and to redeem equities with ``deemed'' FCA prior approval if
the payments are within the specified parameters.
Before a Federal savings association declares a dividend, it must
send a notice, or application for approval, of the action to the Office
of the Comptroller of the Currency (OCC). Whether OCC approval is
required or a mere notice will suffice depends on a number of factors.
For example, an application for approval is required if the proposed
declaration (together with all other capital distributions) for the
applicable calendar year exceeds the savings association's net income
for the current year plus the retained net income for the 2 preceding
years.\34\ A national bank must obtain OCC approval to declare a
dividend if the total amount of all common and preferred dividends,
including the proposed dividend, declared in any current year exceeds
the total of the national bank's net income of the current year to
date, combined with the retained net income of the previous 2
years.\35\
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\34\ 12 CFR 163.140-163.46.
\35\ 12 U.S.C. 60(b).
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The FCA's proposed rule would not require System institutions to
obtain prior approval to retire member stock up to an amount equal to
the Farm Credit Act's minimum member stock requirement of $1,000 or 2
percent of the loan, whichever is less. In addition, subject to any
restrictions on cash payouts under the capital conservation buffer
provision in Sec. 628.11, the proposed safe harbor would provide that
FCA prior approval is deemed to be granted for cash distributions to
pay dividends, patronage, or revolvements and redemptions of common
cooperative equities provided that:
For revolvements or redemptions of common cooperative
equities included in CET1 capital, such equities were issued or
distributed at least 10 years ago;
For revolvements or redemptions of common cooperative
equities included in tier 2 capital, such equities were issued or
distributed at least 5 years ago;
After such cash distributions, the dollar amount of the
System institution's CET1 capital equals or exceeds the dollar amount
of CET1 capital on the same date in the previous calendar year; and
After such cash distributions, the System institution
continues to comply with all regulatory capital requirements and
supervisory or enforcement actions.
System institutions do not generally have to obtain FCA prior
approval before paying patronage or dividends or redeeming equities
under current regulations, nor does the Farm Credit Act require prior
approval. However, it is a fundamental principle of the regulatory
capital requirements for U.S. banking organizations regulated by the
Federal regulatory banking agencies. In order for the regulatory
capital framework that applies to System institutions to be comparable
to the regulatory capital framework that applies to U.S. banking
organizations, we believe it is necessary to include these prior
approval requirements in our proposed rule. We believe that, most of
the time, most System institutions will be able to pay cash patronage
and dividends and redeem equities to the same extent that they do
currently.
B. Regulatory Adjustments and Deductions
1. Regulatory Deductions From CET1 Capital
Under the proposal, a System institution must deduct from CET1
[[Page 52828]]
capital the items described in Sec. 628.22 of the proposed rule. A
System institution would exclude these deductions from its total risk-
weighted assets and leverage exposure. These deductions are:
a. Goodwill and Other Intangibles (Other Than Mortgage Servicing
Assets)
Consistent with Basel III and the Federal regulatory banking
agencies' rules, the FCA proposes to exclude goodwill and other
intangible assets from regulatory capital because of the uncertainty
that a System institution may realize value from these assets under
adverse financial conditions. An institution would deduct goodwill and
``non-mortgage'' servicing assets, net of associated deferred tax
liabilities (DTLs), from CET1 capital. (The FCA's current capital
regulations require goodwill to be deducted from regulatory capital.)
While intangible assets include mortgage servicing assets (MSAs), the
MSAs are subject to a different treatment from other intangible assets
under Basel III and the Federal banking regulatory agencies' rules. In
Basel III and the agencies' rules, the MSAs, along with two other
items--significant investments in the common shares of unconsolidated
financial institutions and deferred tax assets (DTAs) that arise from
temporary differences--are given limited recognition in a banking
organization's CET1, with recognition capped at 10 percent of CET1 for
each item (i.e., a ``threshold deduction'' of 10 percent). There is
also a threshold deduction of 15 percent on the aggregate of the three
items, and any included MSAs are risk weighted at 250 percent.
The FCA is not proposing to implement the threshold deductions for
these three items. We believe that no System institution's MSAs would
meet the 10- and 15-percent thresholds. The proposed rule would require
System institutions to assign a risk weight to MSAs of 100 percent, as
they do in current FCA regulations. Traditionally, System institutions
follow the make-and-hold philosophy when it comes to its loan assets.
As a result, only a few System institutions have sold loans to Farmer
Mac or other parties for securitization. Should the levels of MSAs held
by System institutions increase significantly in the future, the FCA
may reconsider the appropriateness of this proposed treatment.
The FCA is not proposing the threshold deduction in Basel III and
the Federal regulatory banking agencies' rules for investments in other
financial institutions because it is proposing that System institutions
deduct their investments in other System institutions from their
regulatory capital, as described below. Other equity investments will
be risk weighted according to Sec. 628.51.
We do not believe DTAs that are risk weighted in this section would
represent material items on a System institution's balance sheet
because of System institutions' tax status. The FCBs and FLCAs are
exempt from Federal, state, municipal, and local taxation.\36\ Most
other System institutions' net income arises from both non-taxable and
taxable sources. The production and cooperative lending business lines
are taxable, but the ACB and taxable System associations may reduce
taxes by following Subchapter T provisions of the Internal Revenue
Code. Therefore, we do not expect large amounts of DTAs and deferred
tax liabilities (DTLs) on a System institution's balance sheet. Should
the levels of DTAs held by System institutions increase significantly
in the future, the FCA may reconsider the appropriateness of this
proposed treatment.
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\36\ They are subject to taxes on real estate held to the same
extent, according to its value, as other similar property held by
other persons is taxed. See 12 U.S.C. 2023 and 2098.
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We seek comment on whether FCA should risk weight MSAs at 100
percent or require deduction of MSAs from CET1, as we propose to do for
non-mortgage servicing rights. At the present time, FCA does not
consider any type of servicing asset material to a System institution's
or the System's consolidated balance sheet.
b. Gain-on-Sale Associated With a Securitization Exposure
A System institution would deduct from CET1 capital any after-tax
gain-on-sale associated with a securitization exposure. Under GAAP, any
gain-on-sale from a traditional securitization would increase a System
institution's CET1 capital. However, if a System institution received
cash from the sale of the securitization exposure and the MSA, it would
not deduct such amount from its CET1 capital. Any sale of loans to a
securitization structure that creates a gain may include an MSA that
also meets the proposed definition of ``gain-on-sale.'' A System
institution must exclude any portion of a gain-on-sale reported as an
MSA on FCA's Call Report.
c. Defined Benefit Pension Fund Net Assets
A System institution must deduct from CET1 capital a defined
benefit pension fund asset (an overfunded pension), net of any
associated DTLs, because of the uncertainty of realizing any of the
value from such assets. This proposed rule recognizes under GAAP the
amount of a defined benefit pension fund liabilities (an underfunded
pension) on the balance sheet of the institution, would be the same
amount included as CET1 capital. Therefore, a System institution must
not increase its CET1 capital by the derecognition of these defined
pension fund liabilities.
Currently, FCA regulations do not require the deduction of the
defined benefit pension fund net assets in the regulatory capital
calculations. Additionally, our call report does not collect defined
benefit pension fund assets. To implement this regulation, FCA will
develop a call report schedule and require each System institution to
report its individual yearend transactions for defined benefit pension
assets on their individual call report schedule. At this time, some
System institutions report their yearend transactions for defined
benefit pension assets on their institution-only shareholder reports.
Others, however, collectively report their yearend transactions for
defined benefit pension assets in the district-wide shareholder report.
Comparable to Basel III, a System institution would not be required
to deduct defined benefit pension fund assets to which the System
institution has unrestricted and unfettered access. In this case, the
System institution would assign risk weights to such assets as if the
institution directly owned them. Under this proposal, unrestricted and
unfettered access would mean that an institution is not required to
request and receive specific approval from pension beneficiaries each
time it would access funds in the plan.
Any portion of the defined benefit pension fund net assets not
deducted by an institution must be risk-weighted as if the System
institution directly held a proportional ownership share of each
exposure in the defined benefit pension fund. For example, assume that:
(1) The institution has a defined benefit pension fund net asset of
$10; and (2) the institution has unfettered and unrestricted access to
the assets of the defined benefit pension fund. Also, assume that 20
percent of the defined benefit pension fund is risk-weighted at 100
percent and 80 percent is risk-weighted at 300 percent. The institution
would risk weight $2 at 100 percent and $8 at 300 percent. This
treatment would be consistent with the full look-through approach
described in Sec. 628.53(b) of the proposed rule.
[[Page 52829]]
Given System institutions' differing methods of reporting defined
benefit pension fund assets, what is the best way to require
adjustments for defined benefit pension fund assets in the CET1 capital
computation?
d. A System Institution's Allocated Equity Investment in Another System
Institution
The proposed rule would require a System institution to deduct any
allocated equity investment in another System institution \37\ from its
CET1 capital pursuant to Sec. 628.22(a). Later in this preamble, we
will discuss deducting a System institution's purchased investment in
another System institution using the corresponding deduction approach
in Sec. 628.22(c). Other equity exposures are covered in Sec. 628.52.
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\37\ An example would be an association's equity investment in
its System bank.
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The FCA is proposing a different equity elimination method from the
Federal banking regulatory agencies' rules. We believe the method
proposed is more conservative than the banking agencies' rules but is
more appropriate for System institutions and is consistent with the
principles of Basel III. It is also simpler to calculate. System
associations, as members of a cooperative network, have equity
investments in their affiliated banks. System institutions also have
equity investments in other System institutions but few outside the
System. As we have discussed earlier in the preamble, the investments
that System institutions have in other System institutions are counted
in their GAAP financial statements as equity of the issuing or
allocating institution and as assets of the recipient institution. The
FCA continues to believe, as we have stated numerous times previously,
that equities should be counted in the regulatory capital of the
institution that has control of the equities. The allocating
institutions alone have discretion whether to allocate equities and
when, if ever, to distribute those equities. Therefore, under this
proposal, the allocating institutions would include in their CET1
capital the equities they have allocated to their members, provided
those equities meet the criteria for inclusion in CET1 capital. The
institutions that have received allocated equities from other
institutions must deduct those equities from their CET1 capital.
Under the proposed rule, System institutions will be able to
include allocated equities in CET1 capital that are excluded from core
surplus under current regulations. The proposed deductions apply only
to investments in other System institutions because, for the most part,
our investment regulations restrict equity investments outside the
System.
e. ``Haircut'' Deduction for Redemption of Equities Included in CET1
Capital Less Than 10 Years After Issuance or Allocation
Section 628.22(f) of the proposed rule would provide that, if a
System institution redeems equities included in CET1 capital that the
institution issued or allocated less than 10 years before, and the
institution did not receive prior FCA approval, the institution must
exclude 30 percent of the remaining purchased and allocated equities
otherwise includable in CET1 capital. That amount must be excluded from
CET1 for the next 3 years; during those 3 years the amount excluded
from CET1 may be included in tier 2 capital if it otherwise qualifies
for tier 2 capital. This haircut would not be imposed on allocated
equities that are URE equivalents unless such equities redeemed without
FCA approval were URE equivalents, nor would it be imposed for
redemptions of a member's minimum borrower stock requirement.
The FCA is proposing this deduction to ensure proper management by
System institutions of their members' expectations of redemption and
also to ensure that institutions are vigilant in their recordkeeping of
the issuance and allocation dates of CET1 capital. For most System
institutions that redeem equities on a regular basis, the 10-year
minimum retention requirement will result in a longer revolvement
period, especially for allocated equities, and will likely require some
member education about the longer period. It is important that members
know they cannot reasonably expect redemption of the equities that
their institution includes in CET1 capital in a shorter timeframe than
10 years.
2. The Corresponding Deduction Approach for Purchased Equities
Section 628.22(c) of this proposal incorporates the Basel III
corresponding deduction approach for a System institution's purchased
equity investment in another System institution. The corresponding
deduction approach does not apply to allocated equity investments in
another System institution. Under the proposal, a System institution
would be required to deduct an amount from the same component of
capital for which the underlying instrument would qualify as if the
System institution had issued the instrument itself. If a System
institution did not have a sufficient amount of the specific component
of regulatory capital for the entire deduction, then it would deduct
the remaining portion from the next higher (more subordinated) capital
component. Should a System institution not have enough AT1 capital to
satisfy the required deduction, the shortfall would be deducted from
CET1 capital elements.
3. Netting of Deferred Tax Liabilities Against Deferred Tax Assets and
Other Deductible Assets
In this proposed rule, FCA would simplify the netting of DTLs
against DTAs and other deductible assets for deductions of DTAs. This
proposal differs from the Federal banking regulatory agencies' final
rules for deductions of DTAs. For System institutions, this proposal
also represents a change from our existing DTAs deduction regulation.
Under the proposal, System institutions would adjust CET1 capital under
Sec. 628.22(b) of the proposed rule net of any associated deferred tax
effects. In addition, System institutions would deduct from CET1
capital elements under Sec. 628.22(a) and (c) of the proposed rule net
of associated DTLs, pursuant to Sec. 628.22(e).
Currently System institution deduct DTAs according to Sec.
615.5209 of FCA regulations. A System institution must deduct an amount
of DTAs from its assets and its total capital that is equal to the
greater of the two following conditions: (1) An amount of DTAs that is
dependent on future income; or (2) an amount of DTAs that is dependent
on future income in excess of 10 percent of the amount of core
surplus.\38\
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\38\ That exists before the deduction of any deferred-tax
assets.
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For this proposed regulation, FCA categorized DTAs into three
types. First, there are DTAs that arise from temporary differences that
a System institution could realize through a net loss carryback.\39\
Since System institutions have recognized or projected to realize these
temporary differences in current income, a System institution would
assign these DTAs a risk weight of 100 percent. Second, there are DTAs
that arise from temporary differences that a System institution could
not realize through net loss carryback.\40\ And third, there are DTAs
that arise from operating loss and tax credit carryforwards.\41\ A
System
[[Page 52830]]
institution would deduct the latter two DTAs subject to Sec.
628.22(c).
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\39\ Net of any valuation allowances.
\40\ Net of any valuation allowances.
\41\ Net of any valuation allowances.
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Under the proposal, System institutions making regulatory capital
deductions under Sec. 628.22 would net DTLs against assets to which
they are associated (other than DTAs). Should the asset to which the
DTL is associated become impaired or derecognized under GAAP, the
System institution would extinguish the DTL. Likewise, System
institutions may only use the same DTL once for netting purposes. This
practice is consistent with the netting DTLs against goodwill.
System institutions would net DTLs against DTAs that arise from
temporary differences that a System institution could not realize
through net loss carrybacks,\42\ and DTAs that arise from operating
loss and tax credit carryforwards \43\ provided certain conditions
exist: (1) A System institution would net only DTLs and DTAs related to
taxes levied by the same taxation authority and eligible for offsetting
by that authority; and (2) the amount of DTLs that a System institution
would be able to net against DTAs that arise from loss
carryforwards,\44\ and against DTAs arising from temporary differences
that could not be realized through loss carrybacks,\45\ would be
allocated in proportion to the amount of DTAs that arise from loss
carryforwards \46\ and of DTAs arising from temporary differences that
could not be realized through net operating loss carrybacks.\47\
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\42\ Net of any valuation allowances.
\43\ Net of any valuation allowances.
\44\ Net of any valuation allowances.
\45\ Net of any valuation allowances.
\46\ Net of any valuation allowances, but before any offsetting
of DTLs.
\47\ Net of any valuation allowances, but before any offsetting
of DTLs.
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GAAP requires quarterly adjustment for some DTA and DTL items, such
as DTAs and DTLs associated with certain gains and losses included in
AOCI. Therefore, the FCA expects System institutions to use for
regulatory capital calculations the DTA and DTL amounts reported in the
regulatory reports. The proposed rule does not require System
institutions to perform these calculations more often than would be
required to meet quarterly regulatory reporting requirements.
The FCA would allow System institutions to treat future taxes
payable included in valuing a leveraged lease portfolio as a reversing
taxable temporary difference available to support recognizing DTAs.\48\
The proposed rule allows a System institution to use the DTLs embedded
in the carrying value of a leveraged lease to reduce the amount of DTAs
consistent with Sec. 628.22(e).
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\48\ Temporary differences arise when financial events or
transactions are recognized in one period for financial reporting
purposes and in another period, or periods, for tax purposes. A
reversing taxable temporary difference is a temporary difference
that produces additional taxable income in future periods.
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The FCA recognizes that, if the tax laws of the relevant state and
local jurisdictions do not differ significantly from Federal income tax
laws, then under GAAP the calculation of deferred tax expense can be
made in the aggregate considering the combination of Federal, state,
and local income tax rates. The rate used should consider whether
amounts paid in one jurisdiction are deductible in another
jurisdiction. For example, since state and local taxes are deductible
for Federal income tax purposes, the aggregate combined rate would
generally be (1) The Federal income tax rate plus (2) the state and
local tax rates, minus (3) the Federal tax effect of the deductibility
of the state and local taxes at the Federal tax rate. In addition, for
financial reporting purposes, consistent with GAAP, the FCA allows
System institutions to offset DTAs (net of valuation allowance) and
DTLs related to a particular tax jurisdiction. Moreover, for regulatory
reporting purposes, consistent with GAAP, the FCA requires separate
calculations of income taxes, both current and deferred amounts, for
each tax jurisdiction. Accordingly, System institutions must calculate
DTAs and DTLs on a state-by-state basis for financial reporting
purposes under GAAP and for regulatory reporting purposes.
Under the proposed rule, a System institution must assign a risk
weight of 100 percent under Sec. 628.30 for DTAs that arise from
temporary differences that a System institution may realize through net
operating loss carrybacks. By this proposal, the FCA would allow System
institutions to include in regulatory capital some or all of their DTAs
resulting from timing differences that are realizable through net
operating loss carrybacks. In this regard, we believe the proposed rule
strikes an appropriate balance between prudential concerns and
practical considerations about the ability of System institutions to
realize DTAs.
C. Limits on Inclusion of Third-Party Capital
The proposed rule would impose limits on System institution
issuances of third-party capital--that is, capital issued to entities
that are not System institutions or members of System institutions--in
regulatory capital.\49\ The FCA currently imposes limits on the
inclusion of third-party capital in core surplus, total surplus, and
net collateral on a case-by-case basis in connection with our clearance
of disclosure documents and regulatory capital determinations. The FCA
has imposed this restriction to ensure that cooperative ownership
continues to predominate in all System institutions, in order to
maintain the status of the System as a member-controlled GSE that is
owned by and primarily benefits its members.
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\49\ The FCA notes that System institution members could hold
third-party equities that are issued to groups of persons such as
individual accredited investors, if they are qualified to purchase
the stock and are not prohibited to do so under conditions imposed
by FCA. We use the term ``third-party'' to refer to a class of stock
other than the classes of stock that only a System institution's
members are eligible to purchase.
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The proposed rule would provide that third-party capital when
issued, together with any already outstanding third-party capital in
tier 1 capital, may be included in tier 1 capital in an amount up to 33
percent of all other tier 1 capital (i.e., 25 percent of all tier 1
capital including third-party capital). It may be included in total
capital in an amount equal to the lesser of 40 percent of total capital
or 100 percent of tier 1 capital.
The two formulas are:
1. ALTPC = min (40 percent TC, 100 percent T1),
where,
ALTPC = Aggregate limit on third-party capital
TC = Total capital (tier 1 Capital + tier 2 Capital)
T1 = Tier 1 capital
[GRAPHIC] [TIFF OMITTED] TP04SE14.000
[[Page 52831]]
where
CLNPPS = current limit on noncumulative perpetual preferred stock in
tier 1 capital, calculated this quarter
ELNPPS = existing limit on noncumulative perpetual preferred stock
in tier 1 capital, calculated the previous quarter,
NPPS = noncumulative perpetual preferred stock included in tier 1
capital,
T1 = tier 1 capital, and
n = 4 previous quarters, 1-4
We seek comment on alternative third-party limits to ensure that
System institutions remain capitalized primarily by their member
borrowers.
IV. Standardized Approach for Risk-Weighted Assets
A. Calculation of Standardized Total Risk-Weighted Assets
Similar to the FCA's current risk-based capital rules, under this
proposal a System institution would calculate its total risk-weighted
assets by adding together its on- and off-balance sheet risk-weighted
asset amounts and making any relevant adjustments to incorporate
required capital deductions.\50\ Risk-weighted asset amounts generally
would be determined by assigning on-balance sheet assets to broad risk-
weight categories according to the counterparty or, if relevant, the
guarantor or collateral. Similarly, risk-weighted asset amounts for
off-balance sheet items would be calculated using a two-step process:
(1) Multiplying the amount of the off-balance sheet exposure \51\ by a
credit conversion factor (CCF) to determine a credit equivalent amount;
and (2) assigning the credit equivalent amount to a relevant risk-
weight category.
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\50\ See generally the FCA's regulations at part 615, subpart H.
\51\ The term ``exposure,'' which would be defined as an amount
at risk, is used throughout the proposed rule and preamble.
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A System institution would determine its standardized total risk-
weighted assets by calculating the sum of its risk-weighted assets for
general credit risk, cleared transactions, unsettled transactions,
securitization exposures, and equity exposures, each as defined below,
less the System institution's allowance for loan losses (ALL) that is
not included in tier 2 capital (as described in Sec. 628.20 of the
proposal). The sections below describe in more detail how a System
institution would determine the risk-weighted asset amounts for its
exposures.
B. Risk-Weighted Assets for General Credit Risk
Under this proposed rule, total risk-weighted assets for general
credit risk is the sum of the risk-weighted asset amounts as calculated
under Sec. 628.31(a) of the proposal. As proposed, general credit risk
exposures would include a System institution's on-balance sheet
exposures (other than cleared transactions, securitization exposures,
and equity exposures, each as defined in Sec. 628.2 of the proposed
rule), exposures to over-the-counter (OTC) derivative contracts, off-
balance sheet commitments, trade and transaction-related contingencies,
guarantees, repo-style transactions, financial standby letters of
credit, forward agreements, or other similar transactions. Proposed
Sec. 628.32 describes the risk weights that would apply to sovereign
exposures; exposures to certain supranational entities and multilateral
development banks (MDBs); exposures to Government-sponsored enterprises
(GSEs); exposures to depository institutions, foreign banks, and credit
unions (including certain exposures to other financing institutions
(OFIs) owned or controlled by these entities); exposures to public
sector entities (PSEs); corporate exposures (including certain
exposures to OFIs); residential mortgage exposures; high volatility
commercial real estate (HVCRE) exposures; past due exposures; other
assets (including cash, gold bullion, certain MSAs and DTAs); and loans
from System banks to associations.
Generally, the exposure amount for the on-balance sheet component
of an exposure would be the System institution's carrying value for the
exposure as determined under generally accepted accounting principles
(GAAP). Because all System institutions use GAAP to prepare their
financial statements and regulatory reports, we believe that using GAAP
to determine the amount and nature of an exposure provides a consistent
framework that System institutions can easily apply. Using GAAP for
this purpose would reduce the potential burden that could otherwise
result from requiring System institutions to comply with a separate set
of accounting and measurement standards for risk-based capital
calculation purposes under non-GAAP standards, such as regulatory
accounting practices or legal classification standards.
For purposes of the definition of exposure amount for available-
for-sale (AFS) or held-to-maturity (HTM) debt securities and AFS
preferred stock not classified as equity under GAAP, the exposure
amount is the System institution's carrying value (including net
accrued but unpaid interest and fees) for the exposure, less any net
unrealized gains, and plus any net unrealized losses. For purposes of
the definition of exposure amount for AFS preferred stock classified as
an equity security under GAAP, the exposure amount is the System
institution's carrying value (including net accrued but unpaid interest
and fees) for the exposure, less any net unrealized gains that are
reflected in such carrying value but excluded from the System
institution's regulatory capital.\52\
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\52\ Although System banks often classify their securities as
AFS, associations almost always classify their securities, to the
extent they hold any, as HTM.
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In most cases, the exposure amount for an off-balance sheet
component of an exposure would typically be determined by multiplying
the notional amount of the off-balance sheet component by the
appropriate CCF as determined under Sec. 628.33 of the proposed rule.
The exposure amount for an OTC derivative contract or cleared
transaction that is a derivative would be determined under Sec. 628.34
of the proposed rule, whereas exposure amounts for collateralized OTC
derivative contracts, collateralized cleared transactions that are
derivatives, repo-style transactions, and eligible margin loans would
be determined under Sec. 628.37 of the proposal.
1. Exposures to Sovereigns
Under the proposal, a sovereign would be defined as a central
government (including the U.S. Government) or an agency, department,
ministry, or central bank of a central government (for the U.S.
Government, the central bank is the Federal Reserve). The FCA proposes
to retain the current rules' risk weights for exposures to and claims
directly and unconditionally guaranteed by the U.S. Government or its
agencies.\53\ Accordingly, exposures to the U.S. Government, the
Federal Reserve, or a U.S. Government agency, and the portion of an
exposure that is directly and unconditionally guaranteed by the U.S.
Government, the Federal Reserve, or a U.S. Government agency would
receive a 0-percent risk weight.\54\ Consistent with the current risk-
based capital rules, the portion of a deposit insured by the Federal
Deposit Insurance Corporation (FDIC) or the National Credit Union
Administration (NCUA) would also be assigned a 0- percent risk weight.
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\53\ A U.S. Government agency would be defined in the proposal
as an instrumentality of the U.S. Government whose obligations are
fully guaranteed as to the timely payment of principal and interest
by the full faith and credit of the U.S. Government.
\54\ Similar to the FCA's current risk-based capital rules, a
claim would not be considered unconditionally guaranteed by a
central government if the validity of the guarantee is dependent
upon some affirmative action by the holder or a third party.
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[[Page 52832]]
An exposure conditionally guaranteed by the U.S. Government, the
Federal Reserve, or a U.S. Government agency would receive a 20-percent
risk weight.\55\ This would include an exposure that is conditionally
guaranteed by the FDIC or the NCUA.
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\55\ Because of the issues such an exposure would raise, the FCA
would determine the risk-weight of any System institution exposures
that has a Farm Credit System Insurance Corporation (FCSIC)
guarantee, whether conditional or unconditional, on a case-by-case
basis.
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The FCA's existing risk-based capital rules generally assign risk
weights to direct exposures to sovereigns and exposures directly
guaranteed by sovereigns based on whether the sovereign is a member of
the Organization for Economic Cooperation and Development (OECD) and,
as applicable, whether the exposure is unconditionally or conditionally
guaranteed by the sovereign.\56\
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\56\ Section 615.5211.
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The OECD assigns Country Risk Classifications (CRCs) to many
countries as an assessment of their credit risk. CRCs are used to set
interest rate charges for transactions covered by the OECD arrangement
on export credits. The OECD uses a scale of 0 to 7 with 0 being the
lowest possible risk and 7 being the highest possible risk. The OECD no
longer assigns CRCs to certain high-income countries that are members
of the OECD and that have previously received a CRC of 0. These
countries exhibit a similar degree of country risk as that of a
jurisdiction with a CRC of 0.\57\
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\57\ For more information on the OECD country risk
classification methodology, see generally OECD, ``Country Risk
Classification,'' available at http://www.oecd.org/tad/xcred/crc.htm.
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Under the proposed rule, the risk weight for exposures to countries
with CRCs would be determined based on the CRCs. Exposures to OECD
member countries that do not have CRCs would be risk-weighted at 0-
percent. Exposures to non-OECD members with no CRC would be risk-
weighted at 100-percent.\58\ The OECD regularly updates CRCs and makes
the assessments publicly available on its Web site. Accordingly, the
FCA believes that the CRC approach should not represent undue burden to
System institutions.
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\58\ This proposed rule, like the capital rules of the Federal
banking regulatory agencies, permits a lower risk weighting for
sovereign exposures if certain conditions are met, including that
the exposure is denominated in the sovereign's currency. Although
the investment eligibility regulation applicable to System
institutions require that all investments must be denominated in
U.S. dollars (see Sec. 615.5140(a) of our regulations), this lower
risk weight could be used if a System institution were to foreclose
on collateral in the form of such a sovereign exposure.
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The FCA believes that use of CRCs in the proposal is permissible
under section 939A of the Dodd-Frank Act and that section 939A was not
intended to apply to assessments of creditworthiness by organizations
such as the OECD. Section 939A is part of Subtitle C of Title IX of the
Dodd-Frank Act, which, among other things, enhances regulation by the
U.S. Securities and Exchange Commission (SEC) of credit rating
agencies, including Nationally Recognized Statistical Rating
Organizations (NRSROs) registered with the SEC. Section 939A requires
agencies to remove references to credit ratings and NRSROs from Federal
regulations. In the introductory ``findings'' section to Subtitle C,
which is entitled ``Improvements to the Regulation of Credit Ratings
Agencies,'' Congress characterized credit rating agencies as
organizations that play a critical ``gatekeeper'' role in the debt
markets and perform evaluative and analytical services on behalf of
clients, and whose activities are fundamentally commercial in
character.\59\ Furthermore, the legislative history of section 939A
focuses on the conflicts of interest of credit rating agencies in
providing credit ratings to their clients, and the problem of
government ``sanctioning'' of the credit rating agencies' credit
ratings by having them incorporated into Federal regulations. The OECD
is not a commercial entity that produces credit assessments for fee-
paying clients, nor does it provide the sort of evaluative and
analytical services as credit rating agencies. Additionally, the FCA
notes that the use of the CRCs is limited in the proposal. The FCA
considers CRCs to be a reasonable alternative to credit ratings for
sovereign exposures and the proposed CRC methodology to be more
granular and risk sensitive than the current risk-weighting methodology
based solely on OECD membership.
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\59\ See Dodd-Frank Act, section 931 (15 U.S.C. 78o-7 note).
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The FCA also proposes to require a System institution to apply a
150-percent risk weight to sovereign exposures immediately upon
determining that an event of sovereign default has occurred or if an
event of sovereign default has occurred during the previous 5 years.
Sovereign default would be defined as a noncompliance by a sovereign
with its external debt service obligations or the inability or
unwillingness of a sovereign government to service an existing loan
according to its original terms, as evidenced by failure to pay
principal or interest fully and on a timely basis, arrearages, or
restructuring. A default would include a voluntary or involuntary
restructuring that results in a sovereign not servicing an existing
obligation in accordance with the obligation's original terms.
Table 3--Risk Weights for Sovereign Exposures
------------------------------------------------------------------------
Risk weight
(in
percent)
------------------------------------------------------------------------
CRC:
0-1.................................................... 0
2...................................................... 20
3...................................................... 50
4-6.................................................... 100
7...................................................... 150
OECD Member with No CRC.................................... 0
Non-OECD Member with No CRC................................ 100
Sovereign Default.......................................... 150
------------------------------------------------------------------------
2. Exposures to Certain Supranational Entities and Multilateral
Development Banks
Under the FCA's existing risk-based capital rules, exposures to
certain supranational entities and multilateral development banks
(MDBs) receive a 20-percent risk weight. Consistent with the Basel
framework's treatment of exposures to supranational entities, the FCA
proposes to apply a 0-percent risk weight to exposures to the Bank for
International Settlements, the European Central Bank, the European
Commission, and the International Monetary Fund.
Similarly, the FCA proposes to apply a 0-percent risk weight to
exposures to an MDB. The proposal would define an MDB to include the
International Bank for Reconstruction and Development, the Multilateral
Investment Guarantee Agency, the International Finance Corporation, the
Inter-American Development Bank, the Asian Development Bank, the
African Development Bank, the European Bank for Reconstruction and
Development, the European Investment Bank, the European Investment
Fund, the Nordic Investment Bank, the Caribbean Development Bank, the
Islamic Development Bank, the Council of Europe Development Bank, and
any other multilateral lending institution or regional development bank
in which the U.S. Government is a shareholder or contributing member or
which the FCA determines poses comparable credit risk.
The FCA believes this treatment is appropriate in light of the
generally high-credit quality of MDBs, their strong shareholder
support, and a shareholder structure comprised of a significant
proportion of sovereign entities with
[[Page 52833]]
strong creditworthiness. Exposures to regional development banks and
multilateral lending institutions that are not covered under the
definition of MDB generally would be treated as corporate exposures and
would receive a 100-percent risk weight.
3. Exposures to Government-Sponsored Enterprises
The System is a GSE, and the definition of GSE adopted by the
Federal banking regulatory agencies includes the System in their
definition of GSE.\60\ Those agencies view the System, and the other
GSEs, as potential counterparties to the entities that they regulate.
In contrast, we regulate System institutions rather than viewing them
as potential counterparties. It is too confusing for the System to be
included in a definition that is intended to refer to counterparties.
Accordingly, we propose for the purpose of these capital regulations at
part 628 to exclude institutions of the System (other than the Federal
Agricultural Mortgage Corporation (Farmer Mac)) from the definition of
GSE.\61\ Throughout these capital regulations, we will refer to System
institutions specifically as necessary.
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\60\ The definition of GSE adopted by the Federal banking
regulatory agencies includes the Federal National Mortgage
Association (Fannie Mae), the Federal Home Loan Mortgage Corporation
(Freddie Mac), the System, and the Federal Home Loan Bank System.
\61\ Farmer Mac would remain included in the FCA's definition of
GSE, because this regulation would view Farmer Mac as a counterparty
rather than as a regulated entity.
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The FCA is proposing to assign a 20-percent risk weight to
exposures to GSEs that are not equity exposures and a 100-percent risk
weight to preferred stock issued by a GSE.\62\ This risk weighting
would represent a change to the FCA's existing risk-based capital
rules, which currently allow a System institution to apply a 20-percent
risk weight to GSE preferred stock.\63\
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\62\ As discussed below, System institutions would be required
to deduct from capital preferred stock (and all other equities)
issued by other System institutions, and therefore we do not propose
a risk weight for these exposures.
\63\ Section 615.5211(b)(6).
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4. Exposures to Depository Institutions, Foreign Banks, and Credit
Unions
The FCA's existing risk-based capital rules assign a 20-percent
risk weight to all exposures to U.S. depository institutions and
foreign banks incorporated in an OECD country. Short-term exposures to
foreign banks incorporated in a non-OECD country receive a 20-percent
risk weight and long-term exposures to such entities receive a 100-
percent risk weight.
Under the proposal, exposures to U.S. depository institutions and
credit unions would be assigned a 20-percent risk weight.\64\ This risk
weight would apply to a System bank exposure to an OFI that is owned
and controlled by a U.S. or state depository institution or credit
union that guarantees the exposure. If the OFI exposure did not satisfy
these requirements, it would be assigned a 100-percent risk weight as a
corporate exposure pursuant to Sec. 628.32(f)(2).
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\64\ A depository institution is defined in section 3 of the
Federal Deposit Insurance Act (12 U.S.C. 1813(c)(1)). Under this
proposal, a credit union refers to an insured credit union as
defined under the Federal Credit Union Act (12 U.S.C. 1752(7)).
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Our existing OFI rules assign a 20-percent risk weight to a claim
on an OFI that is an OECD bank or is owned and controlled by an OECD
bank that guarantees the claim or if the OFI or its parent has a
sufficiently high credit rating.\65\ Our proposal would impose the same
risk weight for OFI exposures of the same nature, except that we
propose to eliminate the credit rating alternative in accordance with
section 939A of the Dodd-Frank Act.
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\65\ Sec. 615.5211(b)(16).
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Under this proposal, an exposure to a foreign bank would receive a
risk weight one category higher than the risk weight assigned to a
direct exposure to the foreign bank's home country, based on the
assignment of risk weights by CRC, as discussed above.\66\ Exposures to
a foreign bank in a country that does not have a CRC but that is a
member of the OECD would receive a 20-percent risk weight. A System
institution would assign a 100-percent risk weight to an exposure to a
foreign bank in a non-OECD member country that does not have a CRC,
except that the institution could assign a 20-percent risk weight to
self-liquidating, trade-related contingent items that arise from the
movement of goods and that have a maturity of 3 months or less.
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\66\ Foreign bank means a foreign bank as defined in section
211.2 of the Federal Reserve Board's Regulation K (12 CFR 211.2),
that is not a depository institution. For purposes of the proposal,
home country meant the country where an entity is incorporated,
chartered, or similarly established.
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A System institution would be required to assign a 150-percent risk
weight to an exposure to a foreign bank immediately upon determining
that an event of sovereign default has occurred in the bank's home
country, or if an event of sovereign default has occurred in the
foreign bank's home country during the previous 5 years.
Both the Basel capital framework and our existing regulation treat
exposures to securities firms that meet certain requirements like
exposures to depository institutions.\67\ However, like the Federal
banking regulatory agencies, the FCA no longer believes that the risk
profile of these firms is sufficiently similar to depository
institutions to justify that treatment. Accordingly, the FCA proposes
to require System institutions to treat exposures to securities firms
as corporate exposures, with a 100-percent risk weight.
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\67\ See Sec. 615.5211(b)(14) and (b)(15).
Table 4--Risk Weights for Exposures to Foreign Banks
------------------------------------------------------------------------
Risk weight
(in
percent)
------------------------------------------------------------------------
Sovereign CRC
0-1.................................................... 20
2...................................................... 50
3...................................................... 100
4-7.................................................... 150
OECD Member with no CRC.................................... 20
Non-OECD Member with no CRC................................ 100
Sovereign Default.......................................... 150
------------------------------------------------------------------------
5. Exposures to Public Sector Entities
The FCA's existing risk-based capital rules assign a 20-percent
risk weight to general obligations of states and other political
subdivisions of OECD countries.\68\ Exposures that rely on repayment
from specific projects (for example, revenue bonds) are assigned a risk
weight of 50 percent. Other exposures to state and political
subdivisions of OECD countries (including industrial revenue bonds) and
exposures to political subdivisions of non-OECD countries receive a
risk weight of 100 percent. The risk weights assigned to revenue
obligations are higher than the risk weight assigned to general
obligations because repayment of revenue obligations depends on
specific projects, which present more risk relative to a general
repayment obligation of a state or political subdivision of a
sovereign.
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\68\ Political subdivisions of the United States would include a
state, county, city, town or other municipal corporation, a public
authority, and generally any publicly owned entity that is an
instrument of a state or municipal corporation.
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The FCA is proposing to apply the same risk weights to exposures to
U.S. states and municipalities as the existing risk-based capital rules
apply. Under the proposal, these political subdivisions would be
included in the definition of ``public sector entity'' (PSE).
Consistent with both the current rules and the Basel capital framework,
the FCA proposes to define a PSE as a state, local authority, or other
governmental subdivision below the level of a sovereign. This
definition would
[[Page 52834]]
include U.S. states and municipalities and would not include
government-owned commercial companies that engage in activities
involving trade, commerce, or profit that are generally conducted or
performed in the private sector.
Under the proposal, a System institution would assign a 20-percent
risk weight to a general obligation exposure to a PSE that is organized
under the laws of the United States or any state or political
subdivision thereof and a 50-percent risk weight to a revenue
obligation exposure to such a PSE. A general obligation would be
defined as a bond or similar obligation that is backed by the full
faith and credit of a PSE. A revenue obligation would be defined as a
bond or similar obligation that is an obligation of a PSE, but which
the PSE is committed to repay with revenues from a specific project
financed rather than general tax funds.
Similar to the Basel framework's use of home country risk weights
to assign a risk weight to a PSE exposure, the FCA proposes to require
a System institution to apply a risk weight to an exposure to a non-
U.S. PSE based on (1) The CRC applicable to the PSE's home country or,
if the home country has no CRC, whether it is a member of the OECD, and
(2) whether the exposure is a general obligation or a revenue
obligation, in accordance with Table 5.
The risk weights assigned to revenue obligations would be higher
than the risk weights assigned to a general obligation issued by the
same PSE, as set forth, for non-U.S. PSEs, in Table 5. Similar to
exposures to a foreign bank, exposures to a non-U.S. PSE in a country
that does not have a CRC rating would receive a 100-percent risk
weight. Exposures to a non-U.S. PSE in a country that has defaulted on
any outstanding sovereign exposure or that has defaulted on any
sovereign exposure during the previous 5 years would receive a 150-
percent risk weight. Table 5 illustrates the proposed risk weights for
exposures to non-U.S. PSEs.
Table 5--Proposed Risk Weights for Exposures to Non-U.S. PSE General
Obligations and Revenue Obligations
[in percent]
------------------------------------------------------------------------
Risk weight Risk weight
for for
exposures exposures
to non-U.S. to non-U.S.
PSE general PSE revenue
obligations obligations
------------------------------------------------------------------------
Sovereign CRC:
0-1....................................... 20 50
2......................................... 50 100
3......................................... 100 100
4-7....................................... 150 150
OECD Member with No CRC....................... 20 50
Non-OECD Member with No CRC................... 100 100
Sovereign Default............................. 150 150
------------------------------------------------------------------------
The FCA proposes to allow a System institution to apply a risk
weight to an exposure to a non-U.S. PSE according to the risk weight
that the foreign banking organization supervisor allows to be assigned
to it. In no event, however, may the risk weight for an exposure to a
non-U.S. PSE be lower than the risk weight assigned to direct exposures
to that PSE's home country.
6. Corporate Exposures
Under the FCA's existing risk-based capital rules, credit exposures
to companies that are not depository institutions or securitization
vehicles generally are assigned to the 100-percent risk weight
category. A 20-percent risk weight is assigned to claims on, or
guaranteed by, a securities firm incorporated in an OECD country that
satisfies certain conditions.
The proposed requirements would be generally consistent with the
existing risk-based capital rules and require System institutions to
assign a 100-percent risk weight to all corporate exposures. The
proposal would define a corporate exposure as an exposure to a company
that is not an exposure to a sovereign, the Bank for International
Settlements, the European Central Bank, the European Commission, the
International Monetary Fund, an MDB, a depository institution, a
foreign bank, or a credit union, a PSE, a GSE, a residential mortgage
exposure, an HVCRE exposure, a cleared transaction, a securitization
exposure, an equity exposure, or an unsettled transaction. This
definition captures all exposures that are not otherwise included in
another specific exposure category and is not limited to exposures to
corporations.
Accordingly, this category would include borrower loans such as
agricultural loans and consumer loans, regardless of the corporate form
of the borrower, unless those loans qualify for different risk weights
(such as a 50-percent risk weight for residential mortgage exposures)
under other provisions. This category would also include premises,
fixed assets, and other real estate owned.
Because they are corporate exposures, this category includes all
OFI exposures that do not qualify for the 20-percent depository
institution risk weight provided in Sec. 628.32(d) and discussed
above. Our existing rules also contain a default 100-percent risk
weight category.\69\ But our existing regulations also contain an
intermediate, 50-percent risk weight category for claims on OFIs that
do not satisfy the requirements for a 20-percent risk weight but that
otherwise meet similar capital, risk identification and control, and
operational standards or that carry an investment grade credit
rating.\70\ Only if an OFI does not satisfy these standards does a
claim on it receive a 100-percent risk weighting.
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\69\ Sec. 615.5211(d)(11).
\70\ Sec. 615.5211(c)(5).
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This 50-percent risk weighting for what would otherwise be a
corporate exposure is inconsistent with our treatment of other
corporate exposures. In addition, the Federal banking regulatory
agencies would assign a 100-percent risk weight to these exposures.
Accordingly, we propose to eliminate the 50-percent risk weight for
OFIs and to assign a 100-percent risk weight to exposures to OFIs that
do not satisfy the requirements for a 20-percent risk weight because
they are not depository institutions.
We seek comment on our proposed capital treatment of exposures to
OFIs. Specifically, what factors or other information would be relevant
if we consider assigning an intermediate risk weight to a System
institution's exposure to an OFI, recognizing that the same exposure to
the same OFI would receive a 100-percent risk weight from a banking
organization regulated by a Federal banking regulatory agency?
In contrast to the FCA's existing risk-based capital rules, all
securities firms would be subject to the same treatment as corporate
exposures.
7. Residential Mortgage Exposures
The FCA's existing risk-based capital rules assign ``qualified
residential loans'' to the 50-percent risk-weight category.\71\
Qualified residential loans
[[Page 52835]]
include both rural home loans authorized under Sec. 613.3030 and
single-family residential loans to bona fide farmers, ranchers, and
producers and harvesters of aquatic products. Qualified residential
loans must have been approved in accordance with prudent underwriting
standards suitable for residential property and must not be past due 90
days or more or carried in nonaccrual status.\72\ If the loan does not
satisfy these safety and soundness standards, or the property is not
characteristic of residential property, the loan receives a 100-percent
risk weight.
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\71\ Sec. 615.5211(c)(2).
\72\ See definition of qualified residential loan in Sec.
615.5201. In addition to these credit risk standards, qualified
residential loans must also satisfy a number of criteria designed to
ensure that the property is residential in nature. The conditions
for a loan to be considered nonaccrual are set forth in Sec.
621.6(a) of the FCA's regulations. This rule proposes no changes to
that provision.
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In general, although our rule is structured differently, our
existing safety and soundness standards are very similar to the risk-
weighting requirements of the Federal banking regulatory agencies for
residential mortgage exposures.\73\ The major differences between the
two sets of rules are the FCA's criteria regarding the characteristics
of residential property, which the Federal banking regulatory agencies
do not have.
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\73\ These agencies retained their existing risk-weighting
requirements for residential mortgage exposures when they adopted
their new capital rules.
---------------------------------------------------------------------------
In the interest of consistency, we now propose to structure our
rule the same way as the Federal banking regulatory agencies do.
Moreover, we propose to adopt the safety and soundness standards of the
Federal banking regulatory agencies. As mentioned above, and as
discussed below, although these standards are already very similar,
there would be a few changes to our rule. Finally, while we would
retain two of our existing requirements regarding the characteristics
of residential property, we propose to eliminate the rest of these
requirements as unnecessary and burdensome.\74\
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\74\ Although we are proposing to delete the specific
requirements in this area, FCA examiners will continue to verify
that residential property securing an exposure risk-weighted as a
residential mortgage exposure does in fact exhibit characteristics
of residential rather than agricultural property. If examiners
determine that the property is agricultural in nature, they will
require appropriate adjustment of the risk-based capital treatment.
---------------------------------------------------------------------------
We would define a residential mortgage exposure as an exposure
(other than a securitization exposure or equity exposure) that is
primarily secured by a first or subsequent lien on one-to-four family
residential property, provided that the dwelling (including attached
components such as garages, porches, and decks) represents at least 50
percent of the total appraised value of the collateral secured by the
first or subsequent lien.\75\
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\75\ To ensure that the collateral is primarily residential
rather than agricultural in nature, we propose to revise the
definition adopted by the Federal banking regulatory agencies to
include the requirement regarding the appraised value of the
dwelling relative to the value of the collateral as a whole.
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The proposed rule would assign a residential mortgage exposure to
the 50-percent risk-weight category if the property is either owner-
occupied or rented \76\ and if the exposure was made in accordance with
prudent underwriting standards suitable for residential property,
including standards relating to the loan amount as a percentage of the
appraised value of the property; \77\ is not 90 days or more past due
or carried in non-accrual status; and is not restructured or
modified.\78\
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\76\ The FCA's risk-weighting provisions would not expand the
lending authorities of System institutions.
\77\ The requirement that the underwriting standards be suitable
for residential property is the other requirement we propose to add
to ensure that the collateral is primarily residential rather than
agricultural in nature.
\78\ The FCA's existing regulation does not prohibit loans that
have been restructured or modified from receiving a 50-percent risk
weight. The other proposed requirements carry over from our existing
regulation.
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A System institution must assign a 100-percent risk weight to all
residential mortgage exposures that do not satisfy the criteria for a
50-percent risk weight.
The proposed rule would maintain the current risk-based capital
treatment for residential mortgage exposures that are guaranteed by the
U.S. Government or U.S. Government agencies. Accordingly, residential
mortgage exposures that are unconditionally guaranteed by the U.S.
Government or a U.S. Government agency would receive a 0-percent risk
weight, and residential mortgage exposures that are conditionally
guaranteed by the U.S. Government or a U.S. Government agency would
receive a 20-percent risk weight.
Under the proposal, a residential mortgage exposure may be assigned
to the 50-percent risk-weight category only if it is not restructured
or modified. We believe this new restriction on System institution risk
weighting, which the Federal banking regulatory agencies adopted, is
appropriate based on risk.
However, a residential mortgage exposure modified or restructured
on a permanent or trial basis solely pursuant to the U.S. Treasury's
Home Affordable Mortgage Program (HAMP) would not be considered to be
restructured or modified and would continue to receive a 50-percent
risk weighting. Treating mortgage loans modified pursuant to HAMP in
this manner is appropriate in light of the special and unique incentive
features of HAMP, and the fact that the program is offered by the U.S.
Government to achieve the public policy objective of promoting
sustainable loan modifications for homeowners at risk of foreclosure in
a way that balances the interests of borrowers, servicers, and
lenders.\79\
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\79\ The rules of the Federal banking regulatory agencies
establish risk weights for ``pre-sold residential construction
loans'' and ``statutory multifamily mortgages.'' These are loans
that are authorized by statutes that do not apply to System
institutions, and therefore we do not propose risk weights for them.
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System institutions should be mindful that the residential mortgage
market is likely to change in the future, in part because of
regulations the CFPB is adopting to improve the quality of mortgage
underwriting and to reduce the associated credit risk and in part for
market-driven or other reasons. The FCA may propose changes in the
treatment of residential mortgage exposures in the future. If so, we
intend to take into consideration structural and product market
developments, other relevant regulations, and potential issues with
implementation across various product types.
8. High Volatility Commercial Real Estate Exposures
Certain acquisition, development, and construction (ADC) loans
(which are a subset of commercial real estate exposures) present
particular risks and warrant the holding of additional capital beyond
the 100-percent risk weight that would otherwise apply. Accordingly,
the FCA is proposing a 150-percent risk weight for these HVCRE
exposures.
The proposed definition of HVCRE would be a credit facility that,
prior to conversion to permanent financing, finances or has financed
the acquisition, development, or construction of real property. The
financing of four kinds of property is excluded from this definition:
One-to-four family residential properties;
Real property that the FCA has authorized as an investment
pursuant to Sec. 615.5140(e) (this provision authorizes System
institutions to purchase and hold investments as approved by the FCA);
The purchase or development of agricultural land, which
includes all land known to be used or usable for
[[Page 52836]]
agricultural purposes (such as crop and livestock production), provided
that the valuation of the agricultural land is based on its value for
agricultural purposes and the valuation does not take into
consideration any potential use of the land for non-agricultural
commercial development or residential development; or
Commercial real estate projects that meet certain
prudential criteria, including with respect to the LTV ratio and
capital contributions or expense contributions of the borrower.
A commercial real estate loan that is not an HVCRE exposure,
including permanent financing after the life of the ADC project
concludes, would be treated as a corporate exposure.
There may be overlap between HVCRE exposures and exposures to land
in transition--agricultural land in the path of development. FCA
Bookletter BL-058 (BL-058) explains that while System institutions may
finance land in transition, they may not provide development financing
that converts agricultural land to non-agricultural land, except in
very rare instances. BL-058 provides guidance on how a System
institution making a loan to purchase or refinance land in transition
should ensure compliance with the FCA's eligibility and scope of
financing regulations. System institutions contemplating land in
transition financing must review and understand BL-058 and must ensure
they are in full compliance with all FCA regulations in that area.
9. Past Due Exposures
Under the FCA's existing risk-based capital rules, the risk weight
of a loan does not change if the loan becomes past due, with the
exception of certain residential mortgage loans. The FCA believes,
however, that a higher risk weight is appropriate for past due
exposures (such as past due agricultural or other borrower loans) to
reflect the increased risk associated with such exposures.
To reflect the impaired credit quality of such exposures, the FCA
proposes to require a System institution to assign a risk weight of 150
percent to an exposure that is not guaranteed or is not secured by
financial collateral (and that is not a sovereign exposure or a
residential mortgage exposure) if it is 90 days or more past due or
recognized as nonaccrual.\80\ We believe this risk weight is
appropriate and that any increased capital burden, potential rise in
procyclicality, or impact on lending associated with the increased risk
weight is justified given the overall objective of capturing the risk
associated with the impaired credit quality of these exposures.
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\80\ A loan is considered nonaccrual if it meets any of the
conditions specified in Sec. 621.6(a).
---------------------------------------------------------------------------
Moreover, the increased risk weight would not double-count the risk
of a past due exposure, even though the ALL would already be reflected
in the risk-based capital numerator, because the ALL is intended to
cover estimated, incurred losses as of the balance sheet date, not
unexpected losses. The higher risk weight on past due exposures would
ensure sufficient regulatory capital for the increased probability of
unexpected losses on these exposures.
A System institution would be permitted to assign a risk weight to
the portion of a past due exposure that is collateralized by financial
collateral or that is guaranteed if the financial collateral,
guarantee, or credit derivative meets the proposed requirements for
recognition described in Sec. 628.36 and Sec. 628.37.\81\
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\81\ As discussed below, proposed Sec. 628.2 would define
financial collateral as collateral in the form of, in pertinent
part, cash, investment grade debt instruments that are not
resecuritization exposures, publicly traded equity securities and
convertible bonds, and mutual fund (including money market fund)
shares if a price is publicly quoted daily, in which the System
institution has a perfected, first-priority security interest
(except for cash). Financial collateral would not include collateral
such as real estate (whether agricultural or not) or chattel.
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10. Other Assets
Generally consistent with our existing risk-based capital rules,
the FCA proposes the risk weights described below for the following
exposures:
(1) A 0-percent risk weight to cash owned and held in all offices
of the System institution, in transit, or in accounts at a depository
institution or a Federal Reserve Bank; to gold bullion held in a
depository institution's vaults on an allocated basis to the extent
gold bullion assets are offset by gold bullion liabilities; and to
exposures that arise from the settlement of cash transactions (such as
equities, fixed income, spot foreign exchange and spot commodities)
with a central counterparty where there is no assumption of ongoing
counterparty credit risk by the central counterparty after settlement
of the trade;
(2) A 20-percent risk weight to cash items in the process of
collection; and
(3) A 100-percent risk weight to DTAs arising from temporary
differences that a System institution could realize through net
operating loss carrybacks;
(4) A 100-percent risk weight to all MSAs; and
(5) A 100-percent risk weight to all assets not specifically
assigned a different risk weight under this proposed rule (other than
exposures that would be deducted from tier 1 or tier 2 capital pursuant
to proposed Sec. 628.22).
As discussed above, the FCA is proposing, unlike the Federal
banking regulatory agencies, to deduct from capital all DTAs, other
than those arising from temporary differences that a System institution
could realize through net operating loss carrybacks. In addition,
because System institutions have such little exposure to MSAs, we are
proposing to simplify the capital treatment as adopted by the Federal
banking regulatory agencies. Accordingly, we are proposing to risk
weight DTAs and MSAs as stated above and to eliminate the capital
treatment, including the 250-percent risk weight, adopted by the
Federal banking regulatory agencies.\82\
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\82\ If a System institution were to increase significantly its
exposures to MSAs, we would consider exercising our authority to
require a higher risk weight.
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11. Exposures to Other System Institutions
We propose to retain the existing 20-percent risk weight for loans
from System banks to associations (direct loans).
Under proposed Sec. 628.22(c), all equities (including preferred
stock) a System institution has invested in another System institution
would be deducted from the investing institution's regulatory capital,
and therefore we do not propose a risk weighting for these exposures.
These exposures would include an association's investment in its System
bank, a System bank's purchase of nonvoting stock or participation
certificates of an affiliated association pursuant to Sec. 615.5171,
and the purchase of a System association's preferred stock by a System
bank, association, or service corporation pursuant to Sec. 615.5175.
In the past, System institutions (generally System banks) have
entered into loss-sharing agreements with other System institutions
(generally, affiliated associations) under Sec. 614.4340. In the
future, if System institutions enter into a loss-sharing agreement, the
FCA would assign a risk weight for any associated exposures at that
time, using our reservation of authority.
12. Risk-Weighting for Specialized Exposures
By FCA Bookletter BL-052, dated January 25, 2006, the FCA permitted
loans recorded before January 1, 2006 that are supported by Tobacco
Buyout assignments to be risk weighted at 20
[[Page 52837]]
percent.\83\ These loans mature no later than 2015. Although we do not
propose to include it in this rule, the FCA intends to continue to
permit a 20-percent risk weight for these loans. If necessary, we will
issue revised guidance on this capital treatment when we adopt our
final capital rule.
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\83\ Such loans recorded after this date must be risk-weighted
at 100 percent.
---------------------------------------------------------------------------
By FCA Bookletter BL-053, dated February 27, 2007, the FCA
permitted System institutions to assign a lower risk than would
otherwise apply to certain electrical cooperative assets, based on the
unique characteristics and lower risk profile of this industry segment.
Exposures to certain electrical cooperative assets that satisfy
specified conditions receive a 50-percent rather than a 100-percent
risk weight. Furthermore, exposures to these assets receive a 20-
percent risk weight if the assets have a AAA or AA credit rating.
We do not propose this favorable risk weighting for these assets in
this rule, but we seek comment as to whether we should retain this risk
weighting, being mindful of the Dodd-Frank Act section 939A requirement
that we must eliminate the credit rating criteria. If we do retain this
capital treatment, we will issue revised guidance on the risk weighting
when we adopt our final capital rule.
C. Off-Balance Sheet Items
1. Credit Conversion Factors
Under this proposed rule, as under our existing risk-based capital
rules, a System institution would calculate the exposure amount of an
off-balance sheet item by multiplying the off-balance sheet component,
which is usually the contractual amount, by the applicable credit
conversion factor (CCF). This treatment would apply to off-balance
sheet items, such as commitments (including a System bank's commitment
to an association, discussed below), contingent items, guarantees,
certain repo-style transactions, financial standby letters of credit,
and forward agreements.
We propose to determine the exposure amount of a System bank's
commitment to an association as the difference between the
association's maximum credit limit with the System bank (as established
by the general financing agreement or promissory note, as required by
Sec. 614.4125(d)) and the amount the association has borrowed from the
System bank. For example, if a System bank has a $100 maximum credit
limit to an association and the association has $80 outstanding on its
direct note, the System bank's exposure amount on its commitment would
be $20.
Determining a System bank's exposure amount in this manner would
result in what could be viewed as double counting of commitment
exposures (although, as discussed below, we disagree). Continuing the
example above, the association that has borrowed $80 from its System
bank could have $60 in outstanding loans to its borrowers and $15 in
commitments to its borrowers.\84\ The System bank would be required to
hold capital against its $20 commitment exposure amount, and the
association would be required to hold capital against its $15
commitment exposure amount, which it would fund by drawing on its
commitment with the System bank.
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\84\ The association could use the $5 difference to fund its
operations and investments.
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We do not believe this treatment results in double counting
commitment exposures. This treatment is consistent with the way we
treat loan exposures; we require a System bank to hold capital against
the outstanding balance of its loan to an association, and we also
require an association to hold capital against its loans to borrowers
(even though the association's loaned funds come from its loan with the
System bank). As with loan exposures, we believe that there are
separate risks involved in System bank commitment exposures and
association commitment exposures.\85\ Accordingly, we do not propose to
net association commitments against System bank commitments. We invite
comment on this determination.
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\85\ To illustrate the difference, we note that an association
could use money it borrowers from the bank not only to establish and
expand commitments and loans to borrowers but also to invest, hedge
risk, replace equipment, or fund new facilities and services.
---------------------------------------------------------------------------
Similar to the current risk-based capital rules, a System
institution would apply a 0-percent CCF to the unused portion of
commitments that are unconditionally cancelable by the institution. For
purposes of this proposed rule, a commitment would mean any legally
binding arrangement that obligates a System institution to extend
credit or to purchase assets. Unconditionally cancelable would mean a
commitment that a System institution may, at any time, with or without
cause, refuse to extend credit under the commitment (to the extent
permitted under applicable law). In the case of an operating line of
credit, a System institution would be deemed able to unconditionally
cancel the commitment if it can, at its option, prohibit additional
extensions of credit, reduce the credit line, and terminate the
commitment to the full extent permitted by applicable law. If a System
institution provides a commitment that is structured as a syndication,
it would only be required to calculate the exposure amount for its pro
rata share of the commitment.
The FCA proposes to maintain the current 20-percent CCF for self-
liquidating, trade-related contingencies with an original maturity of
14 months or less.\86\ In addition, the FCA proposes to increase the
CCF from 0 percent to 20 percent for commitments with an original
maturity of 14 months or less that are not unconditionally cancelable
by a System institution.
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\86\ As under our existing rules, we propose a 14-month rather
than a 12-month original maturity because the agricultural
production cycle and related marketing efforts typically extend
beyond 12 months. A 14-month maturity would allow a commitment for
an operating loan to cover an entire cycle. A new commitment would
be issued for the next cycle. Allowing a more favorable risk weight
for a 14-month rather than a 12-month commitment does not materially
raise risk in the portfolios of System institutions.
---------------------------------------------------------------------------
As under our existing risk-based capital rules, a System
institution would apply a 50-percent CCF to commitments with an
original maturity of more than 14 months that are not unconditionally
cancelable by the institution and to transaction-related contingent
items, including performance bonds, bid bonds, warranties, and
performance standby letters of credit.
Under this proposed rule, a System institution would be required to
apply a 100-percent CCF to off-balance sheet guarantees, repurchase
agreements, credit-enhancing representations and warranties that are
not securitization exposures, securities lending and borrowing
transactions, financial standby letters of credit, forward agreements,
and other similar exposures. The off-balance sheet component of a
repurchase agreement would equal the sum of the current fair values of
all positions the System institution has sold subject to repurchase.
The off-balance sheet component of a securities lending transaction
would be the sum of the current fair values of all positions the System
institution has lent under the transaction. For securities borrowing
transactions, the off-balance sheet component would be the sum of the
current fair values of all non-cash positions the institution has
posted as collateral under the transaction. In certain circumstances, a
System institution may instead determine the exposure amount of the
transaction as described in Sec. 628.37 of the proposed rule.
[[Page 52838]]
In contrast to our existing risk-based capital rules, which require
capital for securities lending and borrowing transactions and
repurchase agreements only if they generate an on-balance sheet
exposure, the proposed rule would require a System institution to hold
risk-based capital against all repo-style transactions (that is,
repurchase agreements, reverse repurchase agreements, securities
lending transactions, and securities borrowing transactions),
regardless of whether they generate on-balance sheet exposures, as
described in Sec. 628.37 of the proposed rule. For example, capital is
required against the cash receivable that a System institution
generates when it borrows a security and posts cash collateral to
obtain the security. We propose this approach because System
institutions face counterparty credit risk when engaging in repo-style
transactions, even if those transactions do not generate on-balance
sheet exposures, and thus these transactions should not be exempt from
risk-based capital requirements.
2. Credit-Enhancing Representations and Warranties
Consistent with our existing risk-based capital rules, under the
proposed rule a System institution would be subject to a risk-based
capital requirement when it provides credit-enhancing representations
and warranties on assets sold or otherwise transferred to third
parties, as such positions are considered recourse arrangements.\87\
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\87\ Sec. Sec. 615.5201 and 615.5210.
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A System institution would be required to hold capital only for the
maximum contractual amount of its exposure under the representations
and warranties, not against the value of the underlying loan. Moreover,
a System institution would have to hold capital for the life of a
credit-enhancing representation and warranty, but not after its
expiration, regardless of the maturity of the underlying loan.
D. Over-the-Counter Derivative Contracts
Under the proposed rule, a System institution is required to hold
risk-based capital for counterparty credit risk for an OTC derivative
contract. As defined in proposed Sec. 628.2, a derivative contract is
a financial contract whose value is derived from the values of one or
more underlying assets, reference rates, or indices of asset values or
reference rates. A derivative contract includes interest rate, exchange
rate, equity, commodity, credit, and any other derivative contract that
poses similar counterparty credit risks. Derivative contracts also
include unsettled securities, commodities, and foreign exchange
transactions with a contractual settlement or delivery lag that is
longer than the lesser of the market standard for the particular
instrument or 5 business days. This applies, for example, to mortgage-
backed securities (MBS) transactions that the GSEs conduct in the To-
Be-Announced market.
Under the proposed rule, an OTC derivative contract does not
include a derivative contract that is a cleared transaction, which is
subject to a specific treatment as described elsewhere in this
preamble.
To determine the risk-weighted asset amount for an OTC derivative
contract under the proposed rule, a System institution would first
determine its exposure amount for the contract and then apply to that
amount a risk weight based on the counterparty, eligible guarantor, or
recognized collateral.
For a single OTC derivative contract that is not subject to a
qualifying master netting agreement (as defined further below in this
section), the proposed rule would require the exposure amount to be the
sum of: (1) The System institution's current credit exposure, which
would be the greater of the fair value or 0; and (2) potential future
exposure (PFE), which would be calculated by multiplying the notional
principal amount of the OTC derivative contract by the appropriate
conversion factor, in accordance with Table 6 below.
Under the proposed rule, the conversion factor matrix would include
the categories of OTC derivative contracts as illustrated in Table 6.
For an OTC derivative contract that does not fall within one of the
specified categories in Table 6, the proposed rule would require PFE to
be calculated using the ``other'' conversion factor.
[[Page 52839]]
[GRAPHIC] [TIFF OMITTED] TP04SE14.001
For multiple OTC derivative contracts subject to a qualifying
master netting agreement, a System institution would calculate the
exposure amount by adding the net current credit exposure and the
adjusted sum of the PFE amounts for all OTC derivative contracts
subject to the qualifying master netting agreement. Under the proposed
rule, the net current credit exposure would be the greater of 0 and the
net sum of all positive and negative fair values of the individual OTC
derivative contracts subject to the qualifying master netting
agreement. The adjusted sum of the PFE amounts would be calculated as
described in Sec. 628.34(a)(2)(ii) of the proposed rule.
Under the proposed rule, to recognize the netting benefit of
multiple OTC derivative contracts, the contracts would have to be
subject to a qualifying master netting agreement. The proposed rule
would define a qualifying master netting agreement as any written,
legally enforceable netting agreement that creates a single legal
obligation for all individual transactions covered by the agreement
upon an event of default (including receivership, insolvency,
liquidation, or similar proceeding) provided that certain conditions
set forth in Sec. 628.3 of the proposed rule are met.\88\ These
conditions include
[[Page 52840]]
requirements with respect to the System institution's right to
terminate the contract and liquidate collateral and meeting certain
standards with respect to legal review of the agreement to ensure it
meets the criteria in the definition.
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\88\ Section 628.3 of the proposed rule organizes substantive
requirements related to cleared transactions, eligible margin loans,
qualifying master netting agreements, and repo-style transactions in
a central place to assist System institutions in determining their
legal responsibilities.
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The required legal review must be sufficient so that the System
institution may conclude with a well-founded basis that, among other
things, the contract would be found legal, binding, and enforceable
under the law of the relevant jurisdiction and that the contract meets
the other requirements of the definition. In some cases, the legal
review requirement could be met by reasoned reliance on a commissioned
legal opinion or an in-house counsel analysis.
In other cases, for example, those involving certain unfamiliar
derivative transactions or derivative counterparties in jurisdictions
where a System institution has little experience, the institution would
be expected to obtain an explicit, written legal opinion from external
or internal legal counsel addressing the particular situation.
Under the proposed rule, if an OTC derivative contract is
collateralized by financial collateral,\89\ a System institution would
first have to determine the exposure amount of the OTC derivative
contract as described in this section of the preamble. Next, to
recognize the credit risk mitigation benefits of the financial
collateral, a System institution could use the simple approach for
collateralized transactions as described in Sec. 628.37(b) of the
proposed rule. Alternatively, if the financial collateral is marked-to-
market on a daily basis and subject to a daily margin maintenance
requirement, a System institution could adjust the exposure amount of
the contract using the collateral haircut approach described in Sec.
628.37(c) of the proposed rule.
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\89\ As discussed below, proposed Sec. 628.2 would define
financial collateral as collateral in the form of, in pertinent
part, cash, investment grade debt instruments that are not
resecuritization exposures, publicly traded equity securities and
convertible bonds, and mutual fund (including money market fund)
shares if a price is publicly quoted daily, in which the System
institution has a perfected, first-priority security interest
(except for cash). Financial collateral would not include collateral
such as real estate (whether agricultural or not) or chattel.
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Similarly, if a System institution purchased a credit derivative
that would be recognized under Sec. 628.36 of the proposed rule as a
credit risk mitigant, it would not be required to compute a separate
counterparty credit risk capital requirement for the credit derivative,
provided it does so consistently for all such credit derivative
contracts. Further, where these credit derivative contracts are subject
to a qualifying master netting agreement, the System institution would
be required to either include them all or exclude them all from any
measure used to determine the counterparty credit risk exposure to all
relevant counterparties for risk-based capital purposes.
Under the proposed rule, a System institution would have to treat
an equity derivative contract as an equity exposure and compute its
risk-weighted asset amount according to the simple risk-weight approach
(SRWA) described in Sec. 628.52. If the System institution risk
weighted a contract under the SRWA described in Sec. 628.52, it could
choose not to hold risk-based capital against the counterparty risk of
the equity contract, so long as it made this choice for all such
contracts. Where the OTC equity contracts are subject to a qualified
master netting agreement, a System institution would either include or
exclude all of the contracts from any measure used to determine
counterparty credit risk exposures.\90\
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\90\ It would be unusual for a System institution to have such
an exposure, but it could occur, for example, through foreclosure of
collateral.
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If a System provided protection through a credit derivative, it
would have to treat the credit derivative as an exposure to the
underlying reference asset and compute a risk-weighted asset amount for
the credit derivative under Sec. 628.32 of the proposed rule. The
System institution would not be required to compute a counterparty
credit risk capital requirement for the credit derivative, as long as
it did so consistently for all such OTC credit derivative contracts.
Further, where these credit derivative contracts are subject to a
qualifying master netting agreement, the System institution would
either have to include all or exclude all such credit derivatives from
any measure used to determine counterparty credit risk exposure to all
relevant counterparties for risk-based capital purposes.
Under the proposed rule, the risk weight for OTC derivative
transactions is not subject to any specific ceiling, consistent with
the Basel capital framework.
E. Cleared Transactions
Like the BCBS and the Federal banking regulatory agencies, the FCA
supports incentives designed to encourage clearing of derivative and
repo-style transactions \91\ through a central counterparty (CCP)
wherever possible in order to promote transparency, multilateral
netting, and robust risk management practices. Although there are some
risks associated with CCPs, as discussed below, we believe that CCPs
generally help improve the safety and soundness of the derivatives and
repo-style transactions markets through the multilateral netting of
exposures, establishment, and enforcement of collateral requirements,
and the promotion of market transparency.
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\91\ See Sec. 628.2 of the proposed rule for the definition of
a repo-style transaction.
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1. Definition of Cleared Transaction
Under the proposal, a System institution would be required to hold
risk-based capital for all of its cleared transactions. In any such
transaction, the System institution would act as a clearing member
client (defined as a party to a cleared transaction associated with a
CCP in which a clearing member acts either as a financial intermediary
with respect to the party or guarantees the performance of the party to
the CCP).\92\
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\92\ The Federal banking regulatory agencies adopted regulatory
provisions contemplating that their regulated banking organizations
could act as clearing members as well as clearing member clients.
Because of the complexity, we believe System institutions will not
want to act as clearing members, and we therefore do not propose
comparable provisions. We invite comment as to whether we should
adopt such provisions. In their absence, if a System institution did
choose to act as a clearing member, we could address risk-weighting
issues on a case-by-case basis.
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The proposed rule would define a cleared transaction as an exposure
associated with an outstanding derivative contract or repo-style
transaction that a System institution or clearing member has entered
into with a CCP (that is, a transaction that a CCP has accepted).\93\
Cleared transactions would include the following: (1) A transaction
between a clearing member client System institution and a clearing
member where the clearing member acts as a financial intermediary on
behalf of the client and enters into an offsetting
[[Page 52841]]
transaction with a CCP; and (2) a transaction between a clearing member
client System institution and a CCP where a clearing member guarantees
the performance of the client to the CCP. Such transactions would also
have to satisfy additional criteria provided in Sec. 628.3 of the
proposed rule, including bankruptcy remoteness of collateral,
transferability criteria, and portability of the clearing member
client's position.
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\93\ For example, we expect that a transaction with a
derivatives clearing organization (DCO) would meet the proposed
criteria for a cleared transaction. A DCO is a clearinghouse,
clearing association, clearing corporation, or similar entity that
enables each party to an agreement, contract, or transaction to
substitute, through novation or otherwise, the credit of the DCO for
the credit of the parties; arranges or provides, on a multilateral
basis, for the settlement or netting of obligations; or otherwise
provides clearing services or arrangements that mutualize or
transfer credit risk among participants. To qualify as a DCO, an
entity must be registered with the U.S. Commodity Futures Trading
Commission and comply with all relevant laws and procedures.
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Derivative transactions that are not cleared transactions because
they do not meet all the criteria would be OTC derivative transactions.
For example, if a transaction submitted to a CCP is not accepted by a
CCP because the terms of the transaction submitted by the clearing
members do not match or because other operational issues were
identified by the CCP, the transaction would not meet the definition of
a cleared transaction and would be an OTC derivative transaction. If
the counterparties to the transaction resolved the issues and
resubmitted the transaction and it was accepted, the transaction would
then be a cleared transaction.
2. Risk Weighting for Cleared Transactions
Under the proposed rule, to determine the risk-weighted asset
amount for a cleared transaction, a clearing member client System
institution would multiply the trade exposure amount for the cleared
transaction by the appropriate risk weight, determined as described
below. The trade exposure amount would be calculated as follows:
(1) For a cleared transaction that is either a derivative contract
or a netting set of derivative contracts, the trade exposure amount
would equal the exposure amount for the derivative contract or netting
set of derivative contracts, calculated using the current exposure
method (CEM) for OTC derivative contracts (described in Sec. 628.34 of
the proposed rule), plus the fair value of the collateral posted by the
clearing member client System institution and held by the CCP or
clearing member in a manner that is not bankruptcy remote; \94\ and
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\94\ Under this proposal, bankruptcy remote, with respect to an
entity or asset, would mean that the entity or asset would be
excluded from an insolvent entity's estate in a receivership,
insolvency, or similar proceeding.
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(2) For a cleared transaction that is a repo-style transaction or a
netting set of repo-style transactions, the trade exposure amount would
equal the exposure amount calculated under the collateral haircut
approach (described in Sec. 628.37(c) of the proposed rule) plus the
fair value of the collateral posted by the clearing member client
System institution that is held by the CCP or clearing member in a
manner that is not bankruptcy remote.
The trade exposure amount would not include any collateral posted
by a clearing member client System institution that is held by a
custodian in a manner that is bankruptcy remote from the CCP, clearing
member, other counterparties of the clearing member, and the custodian
itself. In addition to the capital requirement for the cleared
transaction, the System institution would remain subject to a capital
requirement for any collateral provided to a CCP, a clearing member, or
a custodian in connection with a cleared transaction in accordance with
Sec. 628.32 of the proposal.
The risk weight for a cleared transaction would depend on whether
the CCP is a qualifying CCP (QCCP). Central counterparties that are
designated financial market utilities (FMUs) and foreign entities
regulated and supervised in a manner equivalent to designated FMUs
would be QCCPs. In addition, a CCP could be a QCCP if it were in sound
financial condition and met certain standards that are set forth in the
proposed QCCP definition.
A System institution that is a clearing member client would apply a
2-percent risk weight to its trade exposure amount to a QCCP only if:
(1) The collateral posted by the clearing member client System
institution to the QCCP or clearing member is subject to an arrangement
that prevents any losses to the clearing member client due to the joint
default or a concurrent insolvency, liquidation, or receivership
proceeding of the clearing member and any other clearing member clients
of the clearing member; and
(2) The clearing member client System institution has conducted
sufficient legal review to conclude with a well-founded basis (and
maintains sufficient written documentation of that legal review) that
in the event of a legal challenge (including one resulting from default
or a liquidation, insolvency, or receivership proceeding) the relevant
court and administrative authorities would find the arrangements to be
legal, valid, binding, and enforceable under the law of the relevant
jurisdiction.
If the criteria above are not met, a clearing member client System
institution would apply a risk weight of 4 percent to the trade
exposure amount.
For a cleared transaction with a CCP that is not a QCCP, a clearing
member client System institution would risk weight the trade exposure
amount to the CCP according to the treatment for the CCP under Sec.
628.32 of the proposal (generally 100 percent). Collateral posted by a
clearing member client System institution that is held by a custodian
in a manner that is bankruptcy remote from the CCP, clearing member,
and other clearing member clients of the clearing member would not be
subject to a capital requirement for counterparty credit risk.
The diagrams below demonstrate the various potential transactions
and exposure treatment in the proposed rule. Table 7 sets out how the
transactions illustrated in the diagrams below are risk-weighted under
the proposed rule.
In the diagram, ``T'' refers to a transaction, and the arrow
indicates the direction of the exposure. The diagram describes the
appropriate risk weight treatment for exposures from the perspective of
a System institution entering into cleared transactions as a client of
a clearing member (T1 and T2). Table 7 shows for
each trade whom the exposure is to, a description of the type of trade,
and the risk weight that would apply based on the risk of the
counterparty.
System Institution Client--Clearing Member(CM) Trade
Financial Intermediary with offsetting transaction to QCCP
[GRAPHIC] [TIFF OMITTED] TP04SE14.002
[[Page 52842]]
Agency with guarantee of client performance
[GRAPHIC] [TIFF OMITTED] TP04SE14.003
Table 7--Risk Weights for Various Cleared Transactions
----------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------
T1................................... CM..................... CM financial 2% or 4% risk weight on
intermediary with trade exposure amount.
offsetting trade to
QCCP.
T2................................... QCCP................... CM agent with guarantee 2% or 4% risk weight on
of client performance. trade exposure amount.
----------------------------------------------------------------------------------------------------------------
F. Credit Risk Mitigation
System institutions use a number of techniques to mitigate credit
risks. For example, a System institution may collateralize exposures
with cash or securities; a third party may guarantee an exposure; a
System institution may buy a credit derivative to offset an exposure's
credit risk; or a System institution may net exposures with a
counterparty under a netting agreement. This section of the preamble
describes how the proposed rule would allow System institutions to
recognize the risk-mitigation effects of guarantees, credit
derivatives, and collateral for risk-based capital purposes.
Under the proposed rule, a System institution generally would be
able to use a substitution approach to recognize the credit risk
mitigation effect of an eligible guarantee from an eligible guarantor
and the simple approach to recognize the effect of collateral. To
recognize credit risk mitigants, a System institution would have to
implement operational procedures and risk-management processes that
ensure that all documentation used in collateralizing or guaranteeing a
transaction is legal, valid, binding, and enforceable under applicable
law in the relevant jurisdictions. A System institution would be
expected to conduct sufficient legal review to reach a well-founded
conclusion that the documentation meets this standard as well as
conduct additional reviews as necessary to ensure continuing
enforceability.
Although the use of credit risk mitigants may reduce or transfer
credit risk, it simultaneously may increase other risks, including
operational, liquidity, or market risk. Accordingly, a System
institution would be expected to employ robust procedures and processes
to control risks, including roll-off and concentration risks, and
monitor and manage the implications of using credit risk mitigants for
the institution's overall credit risk profile.
1. Guarantees and Credit Derivatives
a. Eligibility Requirements
Our existing risk-based capital rules generally recognize third-
party guarantees provided by central governments, GSEs, PSEs in the
OECD countries, multilateral lending institutions and regional
development banking organizations, U.S. depository institutions,
foreign banks, and qualifying securities firms in OECD countries.\95\
The FCA proposes to revise this listing of eligible guarantors to
expressly include sovereigns, the Bank for International Settlements,
the International Monetary Fund, the European Central Bank, the
European Commission, Federal Home Loan Banks (FHLB), Federal
Agricultural Mortgage Corporation (Farmer Mac), MDBs, depository
institutions, bank holding companies, savings and loan holding
companies, credit unions, and foreign banks. Entities not expressly
included in the above list would be eligible guarantors if they have
issued and outstanding unsecured debt securities without credit
enhancement that are investment grade, if their creditworthiness is not
positively correlated with the credit risk of the exposures for which
it has provided guarantees, and if they meet certain other
requirements.\96\
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\95\ Section 615.5211.
\96\ Our proposed definition of eligible guarantor is comparable
to that adopted by the Federal banking regulatory agencies. A System
institution would not satisfy the definition of eligible guarantor.
System institutions are not included in the express listing of
eligible guarantors. Moreover, individual System institutions do not
meet the eligible guarantor criteria because of the positive
correlation of the creditworthiness of a System institution with the
credit risk of the System exposures for which it would provide
guarantees. Accordingly, a System institution that received a
guarantee from another System institution would not be able to
recognize the guarantee for credit risk mitigation purposes.
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Guarantees and credit derivatives would be required to meet
specific eligibility requirements to be recognized for credit risk
mitigation purposes. Under the proposal, an eligible guarantee would be
defined as a guarantee from an eligible guarantor that is written and
meets certain standards and conditions, including with respect to its
enforceability. An eligible credit derivative would be defined as a
credit derivative in the form of a credit default swap (CDS), n\th\-to-
default swap, total return swap, or any other form of credit derivative
approved by the FCA, provided that the instrument meets the standards
and conditions set forth in the proposed definition. See the proposed
definitions of ``eligible guarantee'' and ``eligible credit
derivative'' in Sec. 628.2 of the proposed rule.
Under this proposed rule, a System institution would be permitted
to recognize the credit risk mitigation benefits of an eligible credit
derivative that hedges an exposure that is different from the credit
derivative's reference exposure used for determining the derivative's
cash settlement value, deliverable obligation, or occurrence of a
credit event if:
(1) The reference exposure ranks pari passu with or is subordinated
to the hedged exposure;
[[Page 52843]]
(2) The reference exposure and the hedged exposure are to the same
legal entity; and
(3) Legally enforceable cross-default or cross-acceleration clauses
are in place to assure payments under the credit derivative are
triggered when the issuer fails to pay under the terms of the hedged
exposure.
When a System institution has a group of hedged exposures with
different residual maturities that are covered by a single eligible
guarantee or eligible credit derivative, the System institution would
treat each hedged exposure as if it were fully covered by a separate
eligible guarantee or eligible credit derivative.
b. Substitution Approach
Under the proposed substitution approach, if the protection amount
(as defined below) of an eligible guarantee or eligible credit
derivative is greater than or equal to the exposure amount of the
hedged exposure, a System institution would substitute the risk weight
applicable to the guarantor or credit derivative protection provider
for the risk weight assigned to the hedged exposure.
If the protection amount of the eligible guarantee or eligible
credit derivative is less than the exposure amount of the hedged
exposure, a System institution would treat the hedged exposure as two
separate exposures (protected and unprotected) to recognize the credit
risk mitigation benefit of the guarantee or credit derivative. In such
cases, a System institution would calculate the risk-weighted asset
amount for the protected exposure under Sec. 628.36 of the proposed
rule (using a risk weight applicable to the guarantor or credit
derivative protection provider and an exposure amount equal to the
protection amount of the guarantee or credit derivative). The System
institution would calculate its risk-weighted asset amount for the
unprotected exposure under Sec. 628.32 of the proposed rule (using the
risk weight assigned to the exposure and an exposure amount equal to
the exposure amount of the original hedged exposure minus the
protection amount of the guarantee or credit derivative).
The protection amount of an eligible guarantee or eligible credit
derivative would mean the effective notional amount of the guarantee or
credit derivative reduced to reflect any maturity mismatch, lack of
restructuring coverage, or currency mismatch as described below. The
effective notional amount for an eligible guarantee or eligible credit
derivative would be the lesser of the contractual notional amount of
the credit risk mitigant or the exposure amount of the hedged exposure,
multiplied by the percentage coverage of the credit risk mitigant. For
example, the effective notional amount of a guarantee that covers, on a
pro rata basis, 40 percent of any losses on a $100 bond would be $40.
c. Maturity Mismatch Haircut
Under the proposed requirements, a System institution that
recognizes an eligible guarantee or eligible credit derivative would
have to adjust the effective notional amount of the credit risk
mitigant to reflect any maturity mismatch between the hedged exposure
and the credit risk mitigant. A maturity mismatch occurs when the
residual maturity of a credit risk mitigant is less than that of the
hedged exposure(s).\97\
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\97\ As noted above, when a System institution has a group of
hedged exposures with different residual maturities that are covered
by a single eligible guarantee or eligible credit derivative, a
System institution would treat each hedged exposure as if it were
fully covered by a separate eligible guarantee or eligible credit
derivative. To determine whether any of the hedged exposures has a
maturity mismatch with the eligible guarantee or credit derivative,
the System institution would assess whether the residual maturity of
the eligible guarantee or eligible credit derivative is less than
that of any of the hedged exposures.
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The residual maturity of a hedged exposure would be the longest
possible remaining time before the obligated party of the hedged
exposure is scheduled to fulfill its obligation on the hedged exposure.
A System institution would be required to take into account any
embedded options that may reduce the term of the credit risk mitigant
so that the shortest possible residual maturity for the credit risk
mitigant would be used to determine the potential maturity mismatch. If
a call is at the discretion of the protection provider, the residual
maturity of the credit risk mitigant would be at the first call date.
If the call is at the discretion of the System institution purchasing
the protection, but the terms of the arrangement at origination of the
credit risk mitigant contain a positive incentive for the institution
to call the transaction before contractual maturity, the remaining time
to the first call date would be the residual maturity of the credit
risk mitigant. Under this proposed rule, a System institution would be
permitted to recognize a credit risk mitigant with a maturity mismatch
only if its original maturity is greater than or equal to 1 year and
the residual maturity is greater than 3 months.
Assuming that the credit risk mitigant may be recognized, a System
institution would be required to apply the following adjustment to
reduce the effective notional amount of the credit risk mitigant to
recognize the maturity mismatch:
Pm = E x [(t -0.25)/(T -0.25)],
Where:
(1) Pm = effective notional amount of the credit risk mitigant,
adjusted for maturity mismatch;
(2) E = effective notional amount of the credit risk mitigant;
(3) t = the lesser of T or residual maturity of the credit risk
mitigant, expressed in years; and
(4) T = the lesser of 5 or the residual maturity of the hedged
exposure, expressed in years.
d. Adjustment for Credit Derivatives Without Restructuring as a Credit
Event
Under the proposal, a System institution that seeks to recognize an
eligible credit derivative that does not include a restructuring of the
hedged exposure as a credit event under the derivative would have to
reduce the effective notional amount of the credit derivative
recognized for credit risk mitigation purposes by 40 percent. For
purposes of the proposed credit risk mitigation framework, a
restructuring would involve forgiveness or postponement of principal,
interest, or fees that result in a credit loss event (that is, a
charge-off, specific provision, or other similar debit to the profit
and loss account). In these instances, the System institution would be
required to apply the following adjustment to reduce the effective
notional amount of the credit derivative: Pr = PM
x 0.60,
Where:
(1) Pr = effective notional amount of the credit risk
mitigant, adjusted for lack of a restructuring event (and maturity
mismatch, if applicable); and
(2) Pm = effective notional amount of the credit risk
mitigant (adjusted for maturity mismatch, if applicable).
e. Currency Mismatch Adjustment
Under this proposal, if a System institution recognizes an eligible
guarantee or eligible credit derivative that is denominated in a
currency different from that in which the hedged exposure is
denominated, the institution would apply the following formula to the
effective notional amount of the guarantee or credit derivative:
Pc = Pr x (1 - Hfx),
Where:
(1) Pc = effective notional amount of the credit risk
mitigant, adjusted for currency mismatch (and maturity mismatch and
lack of restructuring event, if applicable);
(2) Pr = effective notional amount of the credit risk
mitigant (adjusted for
[[Page 52844]]
maturity mismatch and lack of restructuring event, if applicable);
and
(3) Hfx = haircut appropriate for the currency mismatch
between the credit risk mitigant and the hedged exposure.
A System institution would be required to use a standard
supervisory haircut of 8 percent for Hfx (based on a 10-
business day holding period and daily marking-to-market and
remargining). The System institution is required to scale the haircut
up using the square root of time formula if the institution revalues
the guarantee or credit derivative less frequently than once every 10
business days. The applicable haircut HM is calculated using
the following square root of time formula:
[GRAPHIC] [TIFF OMITTED] TP04SE14.004
Tm equals the greater of 10 or the number of days between
revaluation.
f. Multiple Credit Risk Mitigants
If multiple credit risk mitigants cover a single exposure, a System
institution would be able to disaggregate the exposure into portions
covered by each credit risk mitigant (for example, the portion covered
by each guarantee) and calculate separately a risk-based capital
requirement for each portion. In addition, when a single credit risk
mitigant covers multiple exposures, a System institution would have to
treat each hedged exposure as covered by a single risk mitigant and
must calculate separate risk-weighted asset amounts for each exposure
using the substitution approach described in Sec. 628.36(c) of the
proposed rule.
2. Collateralized Transactions
a. Eligible Collateral
We propose to recognize a range of financial collateral as credit
risk mitigants that may reduce the risk-based capital requirements
associated with a collateralized transaction, similar to the Basel
capital framework and the rules of the Federal banking regulatory
agencies.
As proposed, financial collateral would mean collateral in the form
of:
(1) Cash on deposit at a depository institution, or Federal Reserve
Bank (including cash held for the System institution by a third-party
custodian or trustee);
(2) Gold bullion;
(3) Short- and long-term debt securities that are not
resecuritization exposures \98\ and that are investment grade;
---------------------------------------------------------------------------
\98\ References to resecuritization exposures in this preamble,
and the presence of risk weights related to resecuritization
exposures in this proposed rule, do not grant any authorities to
System institutions related to resecuritization exposures.
---------------------------------------------------------------------------
(4) Equity securities that are publicly traded;
(5) Convertible bonds that are publicly traded; or
(6) Money market fund shares and other mutual fund shares if a
price for the shares is publicly quoted daily.\99\ With the exception
of cash on deposit at a depository institution, or Federal Reserve
Bank, the System institution would also be required to have a
perfected, first-priority security interest or, outside of the United
States, the legal equivalent thereof, notwithstanding the prior
security interest of any custodial agent. A System institution would be
permitted to recognize partial collateralization of an exposure.
---------------------------------------------------------------------------
\99\ This definition of financial collateral would exclude
collateral such as real estate or chattel. We note that publicly
traded equity securities and convertible bonds are not eligible
investments for System institutions, but they could be acquired as
foreclosed collateral.
---------------------------------------------------------------------------
Under this proposed rule, a System institution would be able to
recognize the risk-mitigating effects of financial collateral using the
simple approach, described below, where: (1) The collateral is subject
to a collateral agreement for at least the life of the exposure; (2)
the collateral is revalued at least every 6 months; and (3) the
collateral (other than gold) and the exposure are denominated in the
same currency. For repo-style transactions, eligible margin loans,
collateralized derivative contracts, and single-product netting sets of
such transactions, a System institution could alternatively use the
collateral haircut approach described below. A System institution would
be required to use the same approach for similar exposures or
transactions.
b. Risk Management Guidance for Recognizing Collateral
Before a System institution recognized collateral for credit risk
mitigation purposes, it would have to: (1) Conduct sufficient legal
review to ensure, at the inception of the collateralized transaction
and on an ongoing basis, that all documentation used in the transaction
is binding on all parties and legally enforceable in all relevant
jurisdictions; (2) consider the correlation between risk of the
underlying direct exposure and collateral risk in the transaction; and
(3) fully take into account the time and cost needed to realize the
liquidation proceeds and the potential for a decline in collateral
value over this time period.
A System institution also would have to ensure that the legal
mechanism under which the collateral is pledged or transferred provides
the institution the right to liquidate or take legal possession of the
collateral in a timely manner in the event of the default, insolvency,
or bankruptcy (or other defined credit event) of the counterparty and,
where applicable, the custodian holding the collateral.
In addition, a System institution would have to ensure that it has:
(1) Taken all steps necessary to fulfill any legal requirements to
secure its interest in the collateral so that it has and maintains an
enforceable security interest;
(2) Set up and implemented clear and robust procedures to comply
with any legal conditions required for declaring the default of the
borrower and prompt liquidation of the collateral in the event of
default;
(3) Established and implemented procedures and practices for
conservatively estimating, on a regular ongoing basis, the fair value
of the collateral, taking into account factors that could affect that
value (for example, the liquidity of the market for the collateral and
obsolescence or deterioration of the collateral); and
(4) Established systems in place for promptly requesting and
receiving additional collateral for transactions whose terms require
maintenance of collateral values at specified thresholds.
c. Simple Approach
Under the proposed simple approach, the collateralized portion of
the exposure would receive the risk weight applicable to the
collateral. The collateral would be required to meet the definition of
financial collateral. For repurchase agreements, reverse repurchase
agreements, and securities lending and borrowing transactions, the
collateral would be the instruments, gold, and cash that a System
institution has borrowed, purchased subject to resale, or taken as
collateral from the counterparty under the transaction. As noted above,
in all cases:
(1) The collateral would have to be subject to a collateral
agreement for at least the life of the exposure;
(2) The System institution would be required to revalue the
collateral at least every 6 months; and
(3) The collateral (other than gold) and the exposure would be
required to be denominated in the same currency.
Generally, the risk weight assigned to the collateralized portion
of the exposure would be no less than 20
[[Page 52845]]
percent. However, OTC derivative contracts that are marked-to-fair
value on a daily basis and subject to a daily margin maintenance
agreement could receive:
(1) A 0-percent risk weight to the extent that they are
collateralized by cash on deposit; or
(2) A 10-percent risk weight to the extent that the contracts are
collateralized by an exposure to a sovereign that qualifies for a 0-
percent risk weight under Sec. 628.32 of the proposal.
In addition, a System institution may assign a 0-percent risk
weight to the collateralized portion of an exposure where:
(i) The financial collateral is cash on deposit; or
(ii) The financial collateral is an exposure to a sovereign that
qualifies for a 0-percent risk weight under Sec. 628.32 of the
proposal and the System institution has discounted the fair value of
the collateral by 20 percent.
d. Collateral Haircut Approach
The proposed rule would permit a System institution to use a
collateral haircut approach to recognize the credit risk mitigation
benefits of financial collateral that secures an eligible margin loan,
a repo-style transaction, collateralized derivative contract, or
single-product netting set of such transactions.
To apply the collateral haircut approach, a System institution
would determine the exposure amount and the relevant risk weight for
the counterparty or guarantor.
The exposure amount for an eligible margin loan, repo-style
transaction, collateralized derivative contract, or a netting set of
such transactions is equal to the greater of 0 or the sum of the
following three quantities:
(1) The value of the exposure less the value of the collateral. For
eligible margin loans, repo-style transactions and netting sets
thereof, the value of the exposure is the sum of the current fair
values of all instruments, gold, and cash the System institution has
lent, sold subject to repurchase, or posted as collateral to the
counterparty under the transaction or netting set. For collateralized
OTC derivative contracts and netting sets thereof, the value of the
exposure is the exposure amount that is calculated under Sec. 628.34
of the proposal. The value of the collateral would equal the sum of the
current fair values of all instruments, gold and cash the System
institution has borrowed, purchased subject to resale, or taken as
collateral from the counterparty under the transaction or netting set;
(2) The absolute value of the net position in a given instrument or
in gold (where the net position in a given instrument or in gold equals
the sum of the current fair values of the instrument or gold the System
institution has lent, sold subject to repurchase, or posted as
collateral to the counterparty minus the sum of the current fair values
of that same instrument or gold that the System institution has
borrowed, purchased subject to resale, or taken as collateral from the
counterparty) multiplied by the market price volatility haircut
appropriate to the instrument or gold; and
(3) The absolute values of the net position of instruments and cash
in a currency that is different from the settlement currency (where the
net position in a given currency equals the sum of the current fair
values of any instruments or cash in the currency the System
institution has lent, sold subject to repurchase, or posted as
collateral to the counterparty minus the sum of the current fair values
of any instruments or cash in the currency the System institution has
borrowed, purchased subject to resale, or taken as collateral from the
counterparty) multiplied by the haircut appropriate to the currency
mismatch.
For purposes of the collateral haircut approach, a given instrument
would include, for example, all securities with the same Committee on
Uniform Securities Identification Procedures (CUSIP) number and would
not include securities with different CUSIP numbers, even if issued by
the same issuer with the same maturity date.
e. Standard Supervisory Haircuts
Under this proposed rule, a System institution would apply a
haircut for price market volatility and foreign exchange rates,
determined using standard supervisory market price volatility haircuts
and a standard haircut for exchange rates.
The standard supervisory market price volatility haircuts would set
a specified market price volatility haircut for various categories of
financial collateral. These standard haircuts are based on the 10-
business-day holding period for eligible margin loans and derivative
contracts. For repo-style transactions, a System institution would
multiply the standard supervisory haircuts by the square root of \1/2\
to scale them for a holding period of 5 business days.
The FCA proposes standard supervisory market price volatility
haircuts in accordance with Table 8 below. These haircuts reflect the
collateral's credit quality and an appropriate differentiation based on
the collateral's residual maturity.
A System institution would be required to use an 8-percent haircut
for each currency mismatch for transactions subject to a 10-day holding
period, as adjusted for different required holding periods.
Table 8--Standard Supervisory Market Price Volatility Haircuts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Haircut (in percent) assigned based on:
------------------------------------------------------------------------------ Investment-
Sovereign issuers risk weight under Non-sovereign issuers risk weight grade
Residual maturity Sec. 628.32 \2\ under Sec. 628.32 securitization
------------------------------------------------------------------------------ exposures (in
Zero 20 or 50 100 20 50 100 percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than or equal to 1 year.............................. 0.5 1.0 15.0 1.0 2.0 4.0 4.0
Greater than 1 year and less than or equal to 5 years..... 2.0 3.0 15.0 4.0 6.0 8.0 12.0
Greater than 5 years...................................... 4.0 6.0 15.0 8.0 12.0 16.0 24.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
Main index equities (including convertible bonds) and gold.........................15.0..........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Other publicly traded equities (including convertible bonds).......................25.0..........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Mutual funds...................................................Highest haircut applicable to any security in
which the fund can invest.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[[Page 52846]]
Cash collateral held.................................................................0...........
--------------------------------------------------------------------------------------------------------------------------------------------------------
Other exposure types...............................................................25.0..........
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The market price volatility haircuts in Table 8 are based on a 10-business-day holding period.
\2\ Includes a foreign PSE that receives a 0-percent risk weight.
The proposed rule would require that a System institution increase
the standard supervisory haircut for transactions involving large
netting sets. During the financial crisis, many financial institutions
experienced significant delays in settling or closing out
collateralized transactions, such as repo-style transactions and
collateralized OTC derivatives. Accordingly, for netting sets where:
(1) The number of trades exceeds 5,000 at any time during the
quarter; \100\
---------------------------------------------------------------------------
\100\ The 5,000-trade threshold applies to a netting set, which
by definition means a group of transactions with a single
counterparty that are subject to a qualifying master netting
agreement.
---------------------------------------------------------------------------
(2) One or more trades involves illiquid collateral posted by the
counterparty; or
(3) The netting set includes any OTC derivatives that cannot be
easily replaced, this proposed rule would require a System institution
to assume a holding period of 20 business days for the collateral under
the collateral haircut approach. The formula and methodology for
increasing the haircut to reflect this longer holding period is
described in Sec. 628.37(c) of the proposed rule. A System institution
is not required to adjust the holding period upward for cleared
transactions. When determining whether collateral is illiquid or an OTC
derivative cannot be easily replaced for these purposes, a System
institution should assess whether, during a period of stressed market
conditions, it could obtain multiple price quotes within 2 days or less
for the collateral or OTC derivative that would not move the market or
represent a market discount (in the case of collateral) or a premium
(in the case of an OTC derivative.)
In addition, the proposed rule would require a System institution
to increase the holding period for a netting set if over the two
previous quarters more than two margin disputes on a netting set have
occurred that lasted longer than the holding period.
Margin disputes may occur when the System institution and its
counterparty do not agree on the value of collateral or on the
eligibility of the collateral provided. Margin disputes also can occur
when the System institution and its counterparty disagree on the amount
of margin that is required, which could result from differences in the
valuation of a transaction, or from errors in the calculation of the
net exposure of a portfolio, for instance, if a transaction is
incorrectly included or excluded from the portfolio.
The determination as to whether a dispute constitutes a margin
dispute for purposes of this rule would depend on whether resolution of
the dispute occurs within the time period required under an agreement.
Where a dispute is subject to a recognized industry dispute resolution
protocol, the dispute period would be considered to begin after a
third-party dispute resolution mechanism has failed.
A System institution would not be required to adjust the holding
period upward for cleared transactions.
f. Own Estimates of Haircuts
Unlike the Federal banking regulatory agencies, the FCA does not
propose to permit System institutions to calculate market price
volatility and foreign exchange volatility using their own internal
estimates. We believe, due to the complexity of developing and using
these estimates, that no System institution is likely to use its own
estimates of haircuts. We seek comment on whether we should adopt a
regulation that would permit the use of an institution's own estimates.
We note that even if we do not adopt such a provision, we would be able
to permit a System institution to use its own estimates in the future
on a case-by-case basis, using standards similar to those contained in
the final rule of the Federal banking regulatory agencies.\101\
---------------------------------------------------------------------------
\101\ The final rules of the Federal banking regulatory agencies
permit a banking organization to use such haircuts only after
satisfying specified minimum standards and receiving prior approval
from its primary Federal supervisor.
---------------------------------------------------------------------------
G. Unsettled Transactions
The FCA proposes to provide for a separate risk-based capital
requirement for transactions involving securities, foreign exchange
instruments, and commodities that have a risk of delayed settlement or
delivery. The proposed capital requirement would not, however, apply to
certain types of transactions, including:
(1) Cleared transactions that are marked-to-market daily and
subject to daily receipt and payment of variation margin;
(2) Repo-style transactions, including unsettled repo-style
transactions;
(3) One-way cash payments on OTC derivative contracts; or
(4) Transactions with a contractual settlement period that is
longer than the normal settlement period (which the proposal defines as
the lesser of the market standard for the particular instrument or 5
business days).\102\
---------------------------------------------------------------------------
\102\ Such transactions would be treated as derivative contracts
as provided in Sec. 628.34 or Sec. 628.35 of the proposal.
---------------------------------------------------------------------------
Under the proposal, in the case of a system-wide failure of a
settlement, clearing system, or central counterparty, the FCA may waive
risk-based capital requirements for unsettled and failed transactions
until the situation is rectified.
This rule proposes separate treatments for delivery-versus-payment
(DvP) and payment-versus-payment (PvP) transactions with a normal
settlement period, and non-DvP/non-PvP transactions with a normal
settlement period. A DvP transaction would refer to a securities or
commodities transaction in which the buyer is obligated to make payment
only if the seller has made delivery of the securities or commodities
and the seller is obligated to deliver the securities or commodities
only if the buyer has made payment. A PvP transaction would mean a
foreign exchange transaction in which each counterparty is obligated to
make a final transfer of one or more currencies only if the other
counterparty
[[Page 52847]]
has made a final transfer of one or more currencies.
A System institution would be required to hold risk-based capital
against a DvP or PvP transaction with a normal settlement period if the
institution's counterparty has not made delivery or payment within 5
business days after the settlement date. The System institution would
determine its risk-weighted asset amount for such a transaction by
multiplying the positive current exposure of the transaction for the
institution by the appropriate risk weight in Table 9. The positive
current exposure from an unsettled transaction of a System institution
would be the difference between the transaction value at the agreed
settlement price and the current market price of the transaction, if
the difference results in a credit exposure of the institution to the
counterparty.
Table 9--Proposed Risk Weights for Unsettled DvP and PvP Transactions
------------------------------------------------------------------------
Risk weight to be
applied to
Number of business days after contractual settlement positive current
date exposure (in
percent)
------------------------------------------------------------------------
From 5 to 15......................................... 100.0
From 16 to 30........................................ 625.0
From 31 to 45........................................ 937.5
46 or more........................................... 1,250.0
------------------------------------------------------------------------
A System institution would hold risk-based capital against any non-
DvP/non-PvP transaction with a normal settlement period if the
institution delivered cash, securities, commodities, or currencies to
its counterparty but has not received its corresponding deliverables by
the end of the same business day. The System institution would continue
to hold risk-based capital against the transaction until it has
received the corresponding deliverables. From the business day after
the System institution has made its delivery until 5 business days
after the counterparty delivery is due, the institution would calculate
the risk-weighted asset amount for the transaction by risk weighting
the current fair value of the deliverables owed to the institution,
using the risk weight appropriate for an exposure to the counterparty
in accordance with Sec. 628.32. If a System institution has not
received its deliverables by the 5th business day after the
counterparty delivery due date, the institution would assign a 1,250-
percent risk weight to the current fair value of the deliverables owed.
H. Risk-Weighted Assets for Securitization Exposures
Under the FCA's existing risk-based capital rules, a System
institution may use external ratings issued by NRSROs to assign risk
weights to certain recourse obligations, residual interests, direct
credit substitutes, and asset-backed securities (ABS) and MBS. We
propose to significantly revise the risk-based capital framework for
securitization exposures. These proposed revisions include removing
references to and reliance on credit ratings to determine risk weights
for these exposures and using alternative standards of
creditworthiness, as required by section 939A of the Dodd-Frank Act. In
addition, we propose to update the terminology for the securitization
framework, include a definition of a securitization exposure that
encompasses a wider range of exposures with similar risk
characteristics, and implement new due diligence requirements for
securitization exposures.
1. Overview of the Securitization Framework and Definitions
The proposed securitization framework is designed to address the
credit risk of exposures that involve the tranching of the credit risk
of one or more underlying financial exposures.\103\ The proposed rule
would define a securitization exposure as an on- or off-balance sheet
credit exposure (including credit-enhancing representations and
warranties) that arises from a traditional or synthetic securitization
(including a resecuritization), or an exposure that directly or
indirectly references a securitization exposure.
---------------------------------------------------------------------------
\103\ Only those MBS that involve tranching of credit risk would
be securitization exposures. As discussed below, mortgage-backed
pass-through securities (for example, those guaranteed by Freddie
Mac or Fannie Mae) that feature various maturities but do not
involve tranching of credit risk would not meet the proposed
definition of a securitization exposure. These securities are risk
weighted in accordance with the general risk-weighting provisions.
---------------------------------------------------------------------------
A traditional securitization would be defined, in part, as a
transaction in which credit risk of one or more underlying exposures
has been transferred to one or more third parties (other than through
the use of credit derivatives or guarantees), where the credit risk
associated with the underlying exposures has been separated into at
least two tranches reflecting different levels of seniority. The
proposed definition includes certain other conditions, such as
requiring all or substantially all of the underlying exposures to be
financial exposures.
Both the designation of exposures as securitization exposures (or
resecuritization exposures, as described below) and the calculation of
risk-based capital requirements for securitization exposures under the
proposed rule are guided by the economic substance of a transaction
rather than its legal form. Provided there is tranching of credit risk,
securitization exposures could include, among other things, ABS and
MBS, loans, lines of credit, liquidity facilities, financial standby
letters of credit, credit derivatives and guarantees, loan servicing
assets, servicer cash advance facilities, reserve accounts, credit-
enhancing representations and warranties, and credit-enhancing
interest-only strips (CEIOs). Securitization exposures would also
include assets sold with retained tranches.
Requiring all or substantially all of the underlying exposures of a
securitization to be financial exposures creates an important boundary
between the general credit risk framework and the securitization
framework. Examples of financial exposures include loans, commitments,
credit derivatives, guarantees, receivables, asset-backed securities,
MBS, other debt securities, or equity securities. Based on their cash
flow characteristics, for purposes of this proposal, asset classes such
as lease residuals and royalty income would also be considered
financial assets.
The securitization framework is designed to address the tranching
of the credit risk of financial exposures and is not designed, for
example, to apply to tranched credit exposures to commercial or
industrial companies or nonfinancial assets or to amounts deducted from
capital in Sec. 628.22 of the proposal. In other words, a loan backed
by nonfinancial assets (such as facilities, objects, or commodities
that are being financed), even if the credit exposure is tranched,
would not be a securitization exposure.
Under the proposal, an operating entity would not fall under the
definition of a traditional securitization (even if substantially all
of its assets are financial exposures). For purposes of the proposed
definition of a traditional securitization, operating entities
generally would refer to companies that are established to conduct
business with clients with the intention of earning a profit in their
own right and that generally produce goods or provide services beyond
the business of investing, reinvesting, holding, or
[[Page 52848]]
trading in financial assets.\104\ Under the proposal, a System
institution's equity investment in an operating entity generally would
be an equity exposure.\105\ However, investment firms that generally do
not produce goods or provide services beyond the business of investing,
reinvesting, holding, or trading in financial assets, would not be
operating entities for purposes of this proposal and would not qualify
for this general exclusion from the definition of traditional
securitization.
---------------------------------------------------------------------------
\104\ Under this definition, all System banks, associations, and
service corporations, and all UBEs, are operating entities and are
not traditional securitizations.
\105\ A System institution's equity investment in an operating
entity that is another System institution (a System bank,
association, or service corporation), however, would be deducted
from capital pursuant to Sec. 628.22 rather than being risk
weighted as an equity exposure.
---------------------------------------------------------------------------
Paragraph (10) of the proposed definition of traditional
securitization (in Sec. 628.2) would specifically exclude exposures to
investment funds (as defined in the proposed rule), collective
investment funds, and pension plans (both terms as defined in relevant
regulations set forth in the proposed definition); and exposures that
are registered with the SEC under the Investment Company Act of 1940 or
foreign equivalents. These specific exemptions serve to narrow the
potential scope of the securitization framework. These entities and
transactions are exempted because they are regulated and subject to
strict leverage requirements. The capital requirements for an extension
of credit to, or an equity holding in, these entities and transactions
are more appropriately calculated under the rules for corporate and
equity exposures.
To address the treatment of investment firms that are not
specifically excluded from the securitization framework, the proposed
rule provides discretion to the FCA to exclude from the definition of a
traditional securitization those transactions in which the underlying
exposures are owned by an investment firm that exercises substantially
unfettered control over the size and composition of its assets,
liabilities, and off-balance sheet exposures.
In determining whether to exclude an investment firm from the
securitization framework, the FCA would consider a number of factors,
including the assessment of the transaction's leverage, risk profile,
and economic substance. This supervisory exclusion would give the FCA
discretion to distinguish structured finance transactions, to which the
securitization framework was designed to apply, from those of flexible
investment firms such as certain hedge funds and private equity funds.
Only investment firms that can easily change the size and
composition of their capital structure, as well as the size and
composition of their assets and off-balance sheet exposures, would be
eligible for the exclusion from the definition of traditional
securitization under this provision. The FCA does not consider managed
collateralized debt obligation vehicles, structured investment
vehicles, and similar structures, which allow considerable management
discretion regarding asset composition but are subject to substantial
restrictions regarding capital structure, to have substantially
unfettered control. Thus, such transactions would meet the definition
of traditional securitization.
The line between securitization exposures and non-securitization
exposures may be difficult to draw in some circumstances. In addition
to the supervisory exclusion from the definition of traditional
securitization described above, the FCA may expand the scope of the
securitization framework to include other transactions if doing so is
justified by the economics of the transaction. Similar to the analysis
for excluding an investment firm from treatment as a traditional
securitization, the FCA would consider the economic substance,
leverage, and risk profile of transactions to ensure the appropriate
risk-based capital treatment. The FCA would consider a number of
factors when assessing the economic substance of a transaction
including, for example, the amount of equity in the structure, overall
leverage (whether on- or off-balance sheet), whether redemption rights
attach to the equity investor, and the ability of the junior tranches
to absorb losses without interrupting contractual payments to more
senior tranches.
Under the proposal, a synthetic securitization would mean a
transaction in which:
(1) All or a portion of the credit risk of one or more underlying
exposures is retained or transferred to one or more third parties
through the use of one or more credit derivatives or guarantees (other
than a guarantee that transfers only the credit risk of an individual
retail exposure);
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different levels
of seniority;
(3) Performance of the securitization exposures depends upon the
performance of the underlying exposures; and
(4) All or substantially all of the underlying exposures are
financial exposures (such as loans, commitments, credit derivatives,
guarantees, receivables, asset-backed securities, MBS, other debt
securities, or equity securities).
Mortgage-backed pass-through securities (for example, those
guaranteed by Freddie Mac or Fannie Mae) that feature various
maturities but do not involve tranching of credit risk would not meet
the proposed definition of a securitization exposure. Only those MBS
that involve tranching of credit risk would be securitization
exposures.
This proposed rule would define a resecuritization exposure as an
on- or off-balance sheet exposure to a resecuritization; or an exposure
that directly or indirectly references a resecuritization exposure. A
resecuritization would mean a securitization which has more than one
underlying exposure and in which one or more of the underlying
exposures is a securitization exposure. A resecuritization would not
include exposures comprised of a single asset that has been retranched,
such as a resecuritization of a real estate mortgage investment conduit
(Re-REMIC). A resecuritization also would not include pass-through
securities that have been pooled together and effectively reissued as
tranched securities, because the pass-through securities do not tranche
credit protection and would therefore not be considered securitization
exposures.
In their rules, the Federal banking regulatory agencies excluded
certain exposures to asset-backed commercial paper (ABCP) programs from
the definition of resecuritization exposure. Their rules defined an
ABCP program as a program established primarily for the purpose of
issuing commercial paper that is investment grade and backed by
underlying exposures held in a bankruptcy-remote special purpose
entity. The System has access to the capital markets through the
Funding Corporation; we believe it unlikely that a System institution
would establish an ABCP program, because if the Funding Corporation's
ability to issue debt ever was impeded, we believe the ability of an
ABCP program to issue commercial paper would face the same
difficulties. Accordingly, in the interest of simplifying our
regulations where possible, we propose to make no reference to ABCP
programs. We seek comment as to whether we should include provisions in
our risk-based capital rules regarding ABCP programs that are
comparable to those adopted by the Federal banking regulatory agencies.
[[Page 52849]]
2. Operational Requirements
a. Due Diligence Requirements
The FCA, like the Federal banking regulatory agencies, notes that
during the recent financial crisis, many banking organizations relied
exclusively on NRSRO ratings and did not perform their own credit
analysis of the securitization exposures.\106\ As the Federal banking
regulatory agencies have required in their rules, we propose that
System institutions satisfy specific due diligence requirements for
securitization exposures. Specifically, a System institution would be
required to demonstrate, to the FCA's satisfaction, a comprehensive
understanding of the features of a securitization exposure that would
materially affect the exposure's performance. The System institution's
analysis would be required to be commensurate with the complexity of
the exposure and the materiality of the exposure in relation to capital
of the institution. On an on-going basis (no less frequently than
quarterly), the System institution would be required to evaluate,
review, and update as appropriate the analysis required under Sec.
628.41(c)(1) of the proposed rule for each securitization exposure. The
pre- and periodic post-acquisition analysis of the exposure's risk
characteristics would have to consider:
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\106\ 78 FR 62017, 62114, Oct. 11, 2013.
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(1) Structural features of the securitization that would materially
affect the performance of the exposure, for example, the contractual
cash flow waterfall, waterfall-related triggers, credit enhancements,
liquidity enhancements, fair value triggers, the performance of
organizations that service the position, and deal-specific definitions
of default;
(2) Relevant information regarding the performance of the
underlying credit exposure(s), for example, the percentage of loans 30,
60, and 90 days past due; default rates; prepayment rates; loans in
foreclosure; property types; occupancy; average credit score or other
measures of creditworthiness; average LTV ratio; and industry and
geographic diversification data on the underlying exposure(s);
(3) Relevant market data on the securitization, for example, bid-
ask spread, most recent sales price and historical price volatility,
trading volume, implied market rating, and size, depth and
concentration level of the market for the securitization; and
(4) For resecuritization exposures, performance information on the
underlying securitization exposures, for example, the issuer name and
credit quality, and the characteristics and performance of the
exposures underlying the securitization exposures.
If the System institution is not able to meet these due diligence
requirements and demonstrate a comprehensive understanding of a
securitization exposure to the FCA's satisfaction, the institution
would be required to assign a risk weight of 1,250 percent to the
exposure.
b. Operational Requirements for Traditional Securitizations
In a traditional securitization, an originating banking
organization typically transfers a portion of the credit risk of
underlying exposures (such as loans) to third parties by selling those
exposures to a third party (which could include, but is not limited to,
a securitization special purpose entity).\107\ The proposed rule would
define ``originating System institution,'' with respect to a
securitization, as a System institution that directly or indirectly
originated the underlying exposures included in a securitization.\108\
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\107\ The proposal would define a securitization SPE as a
corporation, trust, or other entity organized for the specific
purpose of holding underlying exposures of a securitization, the
activities of which are limited to those appropriate to accomplish
this purpose, and the structure of which is intended to isolate the
underlying exposures held by the entity from the credit risk of the
seller of the underlying exposures to the entity.
\108\ Note that in the definition of originating System
institution, ``originating'' refers to originating the underlying
exposures (such as loans) that are included in a securitization, not
to originating the securitization. We remind System institutions
that nothing in these capital rules authorizes them to engage in
activities that are not otherwise authorized.
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Under the proposed rule, a System institution that transfers
exposures it has originated or purchased to a third party in connection
with a traditional securitization can exclude the underlying exposures
from the calculation of risk-weighted assets only if each of the
following conditions are met: (1) The exposures are not reported on the
System institution's consolidated balance sheet under GAAP; (2) the
System institution has transferred to one or more third parties credit
risk associated with the underlying exposures; and (3) any clean-up
calls relating to the securitization are eligible clean-up calls (as
discussed below).
An originating System institution that meets these conditions must
hold risk-based capital against any credit risk it retains or acquires
in connection with the securitization. An originating System
institution that fails to meet these conditions is required to hold
risk-based capital against the transferred exposures as if they had not
been securitized and must deduct from CET1 capital any after-tax gain-
on-sale resulting from the transaction.
In addition, if a securitization: (1) Includes one or more
underlying exposures in which the borrower is permitted to vary the
drawn amount within an agreed limit under a line of credit; and (2)
contains an early amortization provision, the originating System
institution is required to hold risk-based capital against the
transferred exposures as if they had not been securitized and deduct
from CET1 capital any after-tax gain-on-sale resulting from the
transaction.\109\ We believe that this treatment is appropriate given
the lack of risk transference in securitizations of revolving
underlying exposures with early amortization provisions.
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\109\ Many securitizations of revolving credit facilities
contain provisions that require the securitization to be wound down
and investors to be repaid if the excess spread falls below a
certain threshold. This decrease in excess spread may, in some
cases, be caused by deterioration in the credit quality of the
underlying exposures. An early amortization event could increase a
System institution's capital needs if new draws on the revolving
credit facilities need to be financed by the System institution
using on-balance sheet sources of funding. The payment allocations
used to distribute principal and finance charge collections during
the amortization phase of these transactions also could expose a
System institution to a greater risk of loss than in other
securitization transactions. The proposed rule would define an early
amortization provision as a provision in a securitization's
governing documentation that, when triggered, causes investors in
the securitization exposures to be repaid before the original stated
maturity of the securitization exposure, unless the provision: (1)
Is solely triggered by events not related to the performance of the
underlying exposures or the originating System institution (such as
material changes in tax laws or regulations); or (2) leaves
investors fully exposed to future draws by borrowers on the
underlying exposures even after the provision is triggered.
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c. Operational Requirements for Synthetic Securitizations
System institutions are authorized to use synthetic securitizations
as risk management tools to reduce their overall credit risk exposure
relating to certain referenced loan pools. The use of synthetic
securitizations enables System institutions to increase their risk-
based capital ratios without moving assets off their balance sheets.
For synthetic securitizations, an originating System institution
would recognize for risk-based capital purposes the use of a credit
risk mitigant to hedge underlying exposures only if each of the
conditions in the proposed definition of ``synthetic securitization''
is satisfied.
Failure to meet these operational requirements for a synthetic
securitization would prevent a System institution that has purchased
tranched
[[Page 52850]]
credit protection referencing one or more of its exposures from using
the proposed securitization framework with respect to the reference
exposures and would require the institution to hold risk-based capital
against the underlying exposures as if they had not been synthetically
securitized.
A System institution that holds a synthetic securitization as a
result of purchasing credit protection may use the securitization
framework to determine the risk-based capital for its exposure.
Alternatively, it may instead choose to disregard the credit protection
and use the general risk weights under Sec. 628.32.
A System institution that provides tranched credit protection in
the form of a synthetic securitization or credit protection to a
synthetic securitization must use the securitization framework to
compute risk-based capital requirements for its exposures to the
synthetic securitization even if the originating System institution
fails to meet one or more of the operational requirements for a
synthetic securitization.
d. Clean-Up Calls
To satisfy the operational requirements for securitizations and
enable an originating System institution to exclude the underlying
exposures from the calculation of its risk-based capital requirements,
any clean-up call associated with a securitization would need to be an
eligible clean-up call. The proposal would define a clean-up call as a
contractual provision that permits an originating System institution or
servicer to call securitization exposures before their stated maturity
or call date. In the case of a traditional securitization, a clean-up
call generally is accomplished by repurchasing the remaining
securitization exposures once the amount of underlying exposures or
outstanding securitization exposures falls below a specified level. In
the case of a synthetic securitization, the clean-up call may take the
form of a clause that extinguishes the credit protection once the
amount of underlying exposures has fallen below a specified level.
Under the proposal, an eligible clean-up call would be a clean-up
call that:
(1) Is exercisable solely at the discretion of the originating
System institution or servicer;
(2) Is not structured to avoid allocating losses to securitization
exposures held by investors or otherwise structured to provide credit
enhancement to the securitization (for example, to purchase non-
performing underlying exposures); and
(3) For a traditional securitization, is only exercisable when 10
percent or less of the principal amount of the underlying exposures or
securitization exposures (determined as of the inception of the
securitization) is outstanding; or, for a synthetic securitization, is
only exercisable when 10 percent or less of the principal amount of the
reference portfolio of underlying exposures (determined as of the
inception of the securitization) is outstanding.
Where a securitization SPE is structured as a master trust, a
clean-up call with respect to a particular series or tranche issued by
the master trust would meet criterion (3) of the definition of
``eligible clean-up call'' as long as the outstanding principal amount
in that series was 10 percent or less of its original amount at the
inception of the series.
3. Risk-Weighted Asset Amounts for Securitization Exposures
Under the proposed securitization framework, a System institution
generally would calculate a risk-weighted asset amount for a
securitization exposure by applying either: (1) The simplified
supervisory formula approach (SSFA), described elsewhere in this
preamble; or (2) a gross-up approach. A System institution would be
required to apply either the gross-up approach or the SSFA consistently
across all of its securitization exposures. However, a System
institution could choose to apply a 1,250-percent risk weight to any
securitization exposure. While the FCA does not propose to restrict the
ability of System institutions to switch from the SSFA to the gross-up
approach, we do not anticipate there should be a need for frequent
changes in methodology by an institution absent significant change in
the nature of its securitization activities, and we would expect
institutions would be able to provide the FCA's Office of Examination,
upon request, with their rationale for changing methodologies.
The SSFA may be somewhat complex for some System institutions to
use, although it might also result in lower risk-weighting
requirements. The gross-up approach may involve less operational
burden, but it may also result in higher risk-weighting
requirements.\110\
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\110\ Requirements under either approach would likely be lower
than the 1,250-percent risk weight.
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The proposal provides for alternative treatment of securitization
exposures to certain gains-on-sale and CEIO exposures. Specifically,
the proposed rule would include a minimum 100-percent risk weight for
interest-only MBS and exceptions to the securitization framework for
certain small business loans and certain derivatives as described
below. A System institution could use the securitization credit risk
mitigation rules to adjust the capital requirement under the
securitization framework for an exposure to reflect certain collateral,
credit derivatives, and guarantees, as described in more detail below.
a. Exposure Amount of a Securitization Exposure
Under this proposal, the exposure amount of an on-balance sheet
securitization exposure that is not a repo-style transaction, eligible
margin loan, OTC derivative contract or derivative that is a cleared
transaction would generally be the System institution's carrying value
of the exposure. The exposure amount of an on-balance sheet
securitization exposure that is an available-for-sale debt security or
an available-for-sale debt security transferred to held-to-maturity
would be the System institution's carrying value (including net accrued
but unpaid interest and fees), less any net unrealized gains on the
exposure and plus any net unrealized losses on the exposure.
The exposure amount of an off-balance sheet securitization exposure
that is not a repo-style transaction, an eligible margin loan, an OTC
derivative contract (other than a credit derivative), or a derivative
that is a cleared transaction (other than a credit derivative) would be
the notional amount of the exposure. The proposed treatment for OTC
credit derivatives is described in more detail below.\111\
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\111\ The rules of the Federal banking regulatory agencies
address how to calculate the exposure amount of an off-balance sheet
exposure to an ABCP securitization exposure. As discussed above, we
do not propose any provisions relating to ABCPs.
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Under the proposed rule, the exposure amount of a securitization
exposure that is a repo-style transaction, eligible margin loan, an OTC
derivative contract (other than a purchased credit derivative), or
derivative that is a cleared transaction (other than a purchased credit
derivative) would be the exposure amount of the transaction as
calculated in Sec. 628.34 or Sec. 628.37, as applicable.
b. Gains-On-Sale and Credit-Enhancing Interest-Only Strips
Under this proposed rule, a System institution would deduct from
CET1 capital any after-tax gain-on-sale
[[Page 52851]]
resulting from a securitization and would apply a 1,250-percent risk
weight to the portion of a CEIO that does not constitute an after-tax
gain-on-sale.
c. Exceptions Under the Securitization Framework
We propose several exceptions to the general provisions in the
securitization framework. First, a System institution would be required
to assign a risk weight of at least 100 percent to an interest-only
MBS. The FCA believes that a minimum risk weight of 100 percent is
prudent in light of the uncertainty implied by the substantial price
volatility of these securities. Second, as in the capital regulations
of the Federal banking regulatory agencies, a special set of rules
would apply to securitizations of small business loans and leases on
personal property transferred with retained contractual exposure by
System institutions. Finally, if a securitization exposure is an OTC
derivative contract or derivative contract that is a cleared
transaction (other than a credit derivative) that has a first priority
claim on the cash flows from the underlying exposures (notwithstanding
amounts due under interest rate or currency derivative contracts, fees
due, or other similar payments), a System institution may choose to set
the risk-weighted asset amount of the exposure equal to the amount of
the exposure.
d. Overlapping Exposures
This proposed rule includes provisions to limit the double counting
of risks in situations involving overlapping securitization exposures.
If a System institution has multiple securitization exposures that
provide duplicative coverage to the underlying exposures of a
securitization the institution would not be required to hold
duplicative risk-based capital against the overlapping position.
Instead, the System institution would apply to the overlapping position
the applicable risk-based capital treatment under the securitization
framework that results in the highest risk-based capital requirement.
e. Servicer Cash Advances
A traditional securitization typically employs a servicing banking
organization (which could be a System institution) that, on a day-to-
day basis, collects principal, interest, and other payments from the
underlying exposures of the securitization and forwards such payments
to the securitization SPE or to investors in the securitization.
Servicing banking organizations often provide a facility to the
securitization under which the servicing banking organization may
advance cash to ensure an uninterrupted flow of payments to investors
in the securitization, including advances made to cover foreclosure
costs or other expenses to facilitate the timely collection of the
underlying exposures. These servicer cash advance facilities are
securitization exposures.
Under the proposed rule, a System institution would either apply
the SSFA or the gross-up approach, as described below, or a 1,250-
percent risk weight to a servicer cash advance facility exposure. The
treatment of the undrawn portion of the facility would depend on
whether the facility is an eligible servicer cash advance facility. An
eligible servicer cash advance facility would be defined as a servicer
cash advance facility in which:
(1) The servicer is entitled to full reimbursement of advances,
except that a servicer may be obligated to make non-reimbursable
advances for a particular underlying exposure if any such advance is
contractually limited to an insignificant amount of the outstanding
principal balance of that exposure;
(2) The servicer's right to reimbursement is senior in right of
payment to all other claims on the cash flows from the underlying
exposures of the securitization; and
(3) The servicer has no legal obligation to, and does not make,
advances to the securitization if the servicer concludes the advances
are unlikely to be repaid.
Under the proposal, a System institution that is a servicer under
an eligible servicer cash advance facility would not be required to
hold risk-based capital against potential future cash advanced payments
that it may be required to provide under the contract governing the
facility. A System institution that is a servicer under a non-eligible
servicer cash advance facility would be required to hold risk-based
capital against the amount of all potential future cash advance
payments that it may be contractually required to provide during the
subsequent 12-month period under the contract governing the facility.
f. Implicit Support
This proposed rule would require a System institution that provides
support to a securitization in excess of its predetermined contractual
obligation (implicit support) to include in risk-weighted assets all of
the underlying exposures associated with the securitization as if the
exposures had not been securitized, and deduct from CET1 any after-tax
gain-on-sale resulting from the securitization. In addition, the System
institution would have to disclose publicly (i) that it has provided
implicit support to the securitization, and (ii) the risk-based capital
impact to the institution of providing such implicit support. Under the
proposed reservations of authority, the FCA also could require the
System institution to hold risk-based capital against all the
underlying exposures associated with some or all the institution's
other securitizations as if the exposures had not been securitized, and
to deduct from CET1 any after-tax gain-on-sale resulting from such
securitizations.
4. Simplified Supervisory Formula Approach
This rule proposes a SSFA as one option for assigning risk weights
to securitization exposures.\112\ The proposed SSFA starts with a
baseline derived from the capital requirements that apply to all
exposures underlying a securitization and then assigns risk weights
based on the subordination level of an exposure. The proposed SSFA
would apply relatively higher capital requirements to the more risky
junior tranches of a securitization that are the first to absorb
losses, and relatively lower requirements to the most senior exposures.
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\112\ As discussed above, we propose a gross-up approach as
another option for assigning risk weights to securitization
exposures.
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The SSFA methodology would apply a 1,250-percent risk weight to
securitization exposures that absorb losses up to the amount of capital
that would be required for the underlying exposures if those exposures
were held directly by a System institution. In addition, the FCA is
proposing a supervisory risk-weight floor, or minimum risk weight, of
20 percent for each securitization exposure. This floor is prudent
given the performance of many securitization structures during the
recent crisis.
At the inception of a securitization, the SSFA would require more
capital on a transaction-wide basis than would be required if the
underlying assets had not been securitized. That is, if the System
institution held every tranche of a securitization, its overall capital
charge would be greater than if the institution held the underlying
assets in portfolio. This overall outcome is important in reducing the
likelihood of regulatory capital arbitrage through securitizations.
Data used by a System institution to determine SSFA parameters
would have to be the most currently available data. For exposures that
feature payments on
[[Page 52852]]
a monthly or quarterly basis, the data would have to be no more than 91
calendar days old.
To use the SSFA, a System institution would have to obtain or
determine the weighted-average risk weight of the underlying exposures
(KG), as well as the attachment and detachment points for
the System institution's position within the securitization structure.
``KG'' would be calculated using the risk-weighted asset
amounts and would be expressed as a decimal value between 0 and 1 (that
is, an average risk weight of 100 percent would mean that KG
would equal 0.08). The System institution could recognize the relative
seniority of the exposure, as well as all cash funded enhancements, in
determining attachment and detachment points. In addition, a System
institution would have to determine the credit performance of the
underlying exposures.
To make the SSFA more risk sensitive and forward-looking, the
parameter KG would be modified based on delinquencies among
the underlying assets of the securitization. The resulting adjusted
parameter is labeled KA. KA is set equal to the weighted average of the
KG value and a fixed parameter equal to 0.5.
Under the proposal, the W parameter would equal the ratio of the
sum of the dollar amounts of any underlying exposures of the
securitization that are 90 days or more past due, subject to a
bankruptcy or insolvency proceeding, in the process of foreclosure,
held as real estate owned, in default, or have contractually deferred
interest for 90 days or more divided by the ending balance, measured in
dollars, of the underlying exposures.
The numerator of parameter W explicitly excludes loans with
deferral of principal or interest for: (1) Federally guaranteed student
loans, in accordance with the terms of those programs; or (2) consumer
loans, including non-federally guaranteed student loans, provided that
such payments are deferred pursuant to provisions included in the
contract at the time funds are disbursed that provide for period(s) of
deferral that are not initiated based on changes in the
creditworthiness of the borrower. Moreover, the calculation of
parameter W includes all underlying exposures of a securitization
transaction.
The entire specification of the SSFA in the proposed rule is as
follows:
[GRAPHIC] [TIFF OMITTED] TP04SE14.005
KSSFA is the risk-based capital requirement for the securitization
exposure and is a function of three variables, labeled a, u, and 1. The
constant e is the base of the natural logarithms (which is
approximately equal to 2.71828). The variables a, u, and 1, and have
the following definitions:
[GRAPHIC] [TIFF OMITTED] TP04SE14.006
The values of A and D denote the attachment and detachment points,
respectively, for the tranche. Specifically, A is the attachment point
for the tranche that contains the securitization exposure and
represents the threshold at which credit losses will first be allocated
to the exposure. This input is the ratio, as expressed as a decimal
value between 0 and 1, of the dollar amount of the securitization
exposures that are subordinated to the tranche that contains the
securitization exposure held by the System institution to the current
dollar amount of all underlying exposures.
Parameter D is the detachment point for the tranche that contains
the securitization exposure and represents the threshold at which
credit losses of principal allocated to the securitization exposure
would result in a total loss of principal. This input, which is a
decimal value between 0 and 1, equals the value of A plus the ratio of
the dollar amount of the exposures that are pari passu with the System
institution's securitization exposure (that is, have equal seniority
with respect to credit risk) to the current dollar amount of all
underlying exposures. The SSFA specification is completed by the
constant term p, which is set equal to 0.5 for securitization exposures
that are not resecuritizations, or 1.5 for resecuritization exposures,
and the variable KA, which is described above.
When parameter D for a securitization exposure is less than or
equal to KA, the exposure must be assigned a risk weight of 1,250
percent. When parameter A for a securitization exposure is greater than
or equal to KA, the risk weight of the exposure, expressed as a
percent, would equal KSSFA times 1,250. When parameter A is less than
KA and D is greater than KA, the applicable risk weight is a
weighted average of 1,250 percent and 1,250 percent times KSSFA. The
risk weight would be determined according to the following formula:
[GRAPHIC] [TIFF OMITTED] TP04SE14.007
For resecuritizations, System institutions must use the SSFA to
measure the underlying securitization exposure's contribution to KG.
For example, consider a hypothetical securitization tranche that has an
attachment point at 0.06 and a detachment point at 0.07. Then assume
that 90 percent of the underlying pool of assets of the
resecuritization were mortgage loans that qualified for a 50-percent
risk weight and that the remaining 10 percent of the pool was a tranche
of a separate securitization (where the underlying 7 exposures
consisted of mortgages that also qualified for a 50-percent weight). An
exposure to this hypothetical tranche would meet the definition of a
resecuritization exposure. Next, assume that the attachment point A of
the securitization that is the 10-percent share of the resecuritization
is 0.06 and the detachment point D is 0.08. Finally, assume that none
of the underlying mortgage exposures of either the hypothetical tranche
or the underlying securitization exposure meet the proposed definition
of ``delinquent.''
The value of KG for the resecuritization exposure would equal the
weighted average of the two distinct KG values. For the mortgages that
qualify for the 50-percent risk weight and represent 90 percent of the
resecuritization, KG equals 0.04 (that is, 50 percent of the 8-percent
risk-based capital standard).
[[Page 52853]]
[GRAPHIC] [TIFF OMITTED] TP04SE14.008
To calculate the value of KG, securitization a System institution
would use the attachment and detachment points of 0.06 and 0.08,
respectively. Applying those input parameters to the SSFA (together
with p = 0.5 and KG = 0.04) results in a KG, securitization equal to
0.2325.
Substituting this value into the equation yields:
[GRAPHIC] [TIFF OMITTED] TP04SE14.009
This value of 0.05925 for KG, resecuritization, would then be used
in the calculation of the risk-based capital requirement for the
tranche of the resecuritization (where A = 0.06, B = 0.07, p = 1.5).
The result is a risk-weight of 1,172 percent for the tranche that runs
from 0.06 to 0.07. Given that the attachment point is very close to the
value of KG, resecuritization, the capital charge is nearly equal to
the maximum risk weight of 1,250 percent.
To apply the securitization framework to a single tranched exposure
that has been re-tranched, such as some Re-REMICs, a System institution
must apply the SSFA or gross-up approach to the retranched exposure as
if it were still part of the structure of the original securitization
transaction. Therefore, a System institution implementing the SSFA or
the gross-up approach would calculate parameters for those approaches
that would treat the retranched exposure as if it were still embedded
in the original structure of the transaction while still recognizing
any added credit enhancement provided by retranching. For example,
under the SSFA a System institution would calculate the approach using
hypothetical attachment and detachment points that reflect the
seniority of the retranched exposure within the original deal
structure, as well as any additional credit enhancement provided by
retranching of the exposure. Parameters that depend on pool-level
characteristics, such as the W parameter under the SSFA, would be
calculated based on the characteristics of the total underlying
exposures of the initial securitization transaction, not just the
retranched exposure.
5. Gross-up Approach
As an alternative to the SSFA, System institutions may assign risk-
weighted asset amounts to securitization exposures by implementing the
gross-up approach described in Sec. 628.43 of the proposal. If a
System institution chooses to apply the gross-up approach, it would be
required to apply this approach to all of its securitization exposures,
except as otherwise provided for certain securitization exposures under
Sec. Sec. 628.44 and 628.45 of the proposal.
The gross-up approach assigns risk-weighted asset amounts based on
the full amount of the credit-enhanced assets for which the System
institution directly or indirectly assumes credit risk. To calculate
risk-weighted assets under the gross-up approach, a System institution
would determine four inputs: the pro rata share A, the exposure amount
C, the enhanced amount B, and the applicable risk weight RW. The pro
rata share A is the par value of the System institution's exposure X as
a percentage of the par value of the tranche Y in which the
securitization exposure resides A = \x/y\. The enhanced amount B is the
value of all the tranches that are more senior to the tranche in which
the exposure resides. The applicable risk weight RW is the weighted-
average risk weight of the underlying exposures in the securitization
(for example, 100 percent for a corporate exposure).
Under the gross-up approach, a System institution would be required
to calculate the credit equivalent amount CEA, which equals the sum of
(1) the exposure of the System institution's securitization exposure
and (2) the pro rata share multiplied by the enhanced amount CEA = C +
(A x B). To calculate risk-weighted assets RWA for a securitization
exposure under the gross-up approach, a System institution would be
required to assign the applicable risk weight to the gross-up credit
equivalent amount RWA = RW x CEA. As noted above, in all cases, the
minimum risk weight for securitization exposures would be 20 percent.
6. Alternative Treatments for Certain Types of Securitization Exposures
Under the proposed rule, a System institution generally would
assign a 1,250-percent risk weight to all securitization exposures to
which the institution does not apply the SSFA or the gross-up approach.
However, the proposed rule provides alternative treatments for certain
types of securitization exposures described below, provided that the
System institution knows the composition of the underlying exposures at
all times.
7. Credit Risk Mitigation for Securitization Exposures
Under the proposed rule, the treatment of credit risk mitigation
for securitization exposures would differ slightly from the treatment
for other exposures. To recognize the risk-mitigating effects of
financial collateral or an eligible guarantee or an eligible credit
derivative from an eligible guarantor, a System institution that
purchased credit protection would use the approaches for collateralized
transactions under Sec. 628.37 of the proposed rule or the
substitution treatment for guarantees and credit derivatives described
in Sec. 628.36 of the proposed rule.
In cases of maturity or currency mismatches, or, if applicable,
lack of a restructuring event trigger, the institution would have to
make any applicable adjustments to the protection amount of an eligible
guarantee or credit derivative as required by Sec. 628.36 for any
hedged securitization exposure. In addition, for synthetic
securitizations, when an eligible guarantee or eligible credit
derivative covers multiple hedged exposures that have different
residual maturities, the System institution would have to use the
longest residual maturity of any of the hedged exposures as the
residual maturity of all the hedged exposures. A System institution
would not be required to compute a counterparty credit risk capital
requirement for the credit derivative provided that this treatment is
applied consistently for all of its OTC credit derivatives.
A System institution that purchases an OTC credit derivative (other
than an nth-to-default credit derivative) that is recognized as a
credit risk mitigant for a securitization exposure would not be
required to compute a separate counterparty credit risk capital
requirement provided that the institution makes this choice
consistently for all such credit derivatives. The System institution
would have to either include all or
[[Page 52854]]
exclude all such credit derivatives that are subject to a qualifying
master netting agreement from any measure used to determine
counterparty credit risk exposure to all relevant counterparties for
risk-based capital purposes.
If a System institution could not, or chose not to, recognize a
credit derivative that is a securitization exposure as a credit risk
mitigant, the institution would have to determine the exposure amount
of the credit derivative under the treatment for OTC derivatives in
Sec. 628.34. If the System institution purchased the credit protection
from a counterparty that is a securitization, the institution would
have to determine the risk weight for counterparty credit risk
according to the securitization framework. If the System institution
purchased credit protection from a counterparty that is not a
securitization, the institution would have to determine the risk weight
for counterparty credit risk according to general risk weights under
Sec. 628.32. A System institution that believes it is authorized to
and wishes to provide protection in the form of a guarantee or credit
derivative (other than an nth-to-default credit derivative) that covers
the full amount or a pro rata share of a securitization exposure's
principal and interest should seek guidance from the FCA on risk
weighting and other issues. We do not propose the capital treatment
adopted by the Federal banking regulatory agencies, because we would
want the opportunity to fully consider any contemplated transaction
before assigning a risk weighting.
8. Nth-to-Default Credit Derivatives
A System institution that believes it is authorized to and wishes
to provide credit protection through an nth-to-default credit
derivative or second-or-subsequent-to default credit derivative should
seek guidance from the FCA on risk weighting and other issues. As with
the capital treatment for providing credit protection discussed above,
we do not propose the capital treatment adopted by the Federal banking
regulatory agencies for these derivatives, because we would want the
opportunity to fully consider any contemplated transaction before
assigning a risk weighting.
A System institution could obtain credit protection on a group of
underlying exposures through a first-to-default credit derivative.
Provided the rules of recognition for guarantees and credit derivatives
under Sec. 628.36(b) were met, the System institution would determine
its risk-based capital requirement for the underlying exposures as if
the institution synthetically securitized the underlying exposure with
the smallest risk-weighted asset amount and had obtained no credit risk
mitigant on the other underlying exposures. A System institution would
calculate a risk-based capital requirement for counterparty credit risk
according to Sec. 628.34 for a first-to-default credit derivative that
does not meet the rules of recognition of Sec. 628.36(b).
A System institution could obtain credit protection on a group of
underlying exposures through a nth-to-default credit derivative.
Provided the rules of recognition of Sec. 628.36(b) (other than a
first-to-default credit derivative) were met, the System institution
could recognize the credit risk mitigation benefits of the derivative
only if the institution also had obtained credit protection on the same
underlying exposures in the form of first-through-(n-1)-to-default
credit derivatives; or if n-1 of the underlying exposures had already
defaulted. If a System institution satisfied these requirements, the
institution would determine its risk-based capital requirement for the
underlying exposures as if the institution had only synthetically
securitized the underlying exposure with the nth smallest risk-weighted
asset amount and had obtained no credit risk mitigant on the other
underlying exposures. For a nth-to-default credit derivative that did
not meet the rules of recognition of Sec. 628.36(b), a System
institution would calculate a risk-based capital requirement for
counterparty credit risk according to the treatment of OTC derivatives
under Sec. 628.34.
I. Equity Exposures
As discussed above, all equities (including preferred stock) issued
by other System institutions would be deducted from capital under Sec.
628.22. Accordingly, we do not propose a risk weighting for these
equity exposures. These intra-System equity exposures would include an
association's investment in its System bank, a System bank's purchase
of nonvoting stock or participation certificates of an affiliated
association pursuant to Sec. 615.5171, and the purchase of a System
institution's preferred stock by a System bank, association, or service
corporation pursuant to Sec. 615.5175.
Generally, System institutions have limited non-System equity
exposures. A System institution could, however, acquire limited non-
System equity exposures in several ways, including by investing in
rural business investment companies (RBICs), by making other equity
investments that the FCA approves,\113\ and by foreclosing on equity
exposures previously pledged as collateral.
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\113\ System institutions have no authority to make non-System
equity investments, other than in RBICs, unless they receive the
FCA's approval under Sec. 615.5140(e). Authority for System
institutions to invest in RBICs is governed by 7 U.S.C. 2009cc et
seq.; these investments do not require the FCA's approval. However,
as with any UBE investment, the FCA's approval is required for a
System institution to invest in a UBE organized for investing in an
RBIC.
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This proposal would significantly revise our existing risk-based
capital rules' treatment for non-System equity exposures. In
particular, the proposed rule would require a System institution to
apply the Simple Risk-Weight Approach (SRWA) for equity exposures that
are not exposures to an investment fund and apply certain look-through
approaches to assign risk-weighted asset amounts to equity exposures to
an investment fund. These approaches are discussed in detail below.
1. Definition of Equity Exposure and Exposure Measurement
Under the proposed rule, a System institution would be required to
determine the adjusted carrying value for each non-System equity
exposure based on the approaches described below:
(1) For an equity exposure classified as HTM \114\ the adjusted
carrying value would be a System institution's carrying value of the
exposure;
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\114\ As noted above, although System banks often classify their
securities as AFS, associations usually classify their securities;
to the extent, they hold any, as HTM.
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(2) For an equity exposure classified as AFS, the adjusted carrying
value of the exposure would be the System institution's carrying value
of the exposure less any net unrealized gains on the exposure that are
reflected in the carrying value but excluded from the System
institution's regulatory capital components;
(3) For a commitment to acquire an equity exposure that is
unconditional, the adjusted carrying value would be the effective
notional principal amount of the exposure multiplied by a 100-percent
conversion factor;
(4) For a commitment to acquire an equity exposure that is
conditional, the adjusted carrying value would be the effective
notional principal amount of the commitment multiplied by a conversion
factor. For a commitment with an original maturity of 14 months or
less, the conversion factor would be 20 percent, and for a commitment
with an original maturity greater than 14 months, the conversion factor
would be 50 percent; and
[[Page 52855]]
(5) For the off-balance sheet component of an equity exposure that
is not an equity commitment, the adjusted carrying value would be the
effective notional principal amount of the exposure. The size of the
exposure would be equivalent to a hypothetical on-balance sheet
position in the underlying equity instrument that would evidence the
same change in fair value (measured in dollars) for a given small
change in the price of the underlying equity instrument, minus the
adjusted carrying value of the on-balance sheet component of the
exposure.
The concept of the effective notional principal amount of the off-
balance sheet portion of an equity exposure is included to provide a
uniform method for System institutions to measure the on-balance sheet
equivalent of an off-balance sheet exposure. For example, if the value
of a derivative contract referencing the common stock of company X
changes the same amount as the value of 150 shares of common stock of
company X, for a small change (for example, 1.0 percent) in the value
of the common stock of company X, the effective notional principal
amount of the derivative contract is the current value of 150 shares of
common stock of company X, regardless of the number of shares the
derivative contract references. The adjusted carrying value of the off-
balance sheet component of the derivative is the current value of 150
shares of common stock of company X minus the adjusted carrying value
of any on-balance sheet amount associated with the derivative.
2. Equity Exposure Risk Weights
Under the proposed SRWA for equity exposures, a System institution
would determine the risk-weighted asset amount for an equity exposure,
other than an equity exposure to an investment fund, under Sec. 628.52
of the proposed rule. A System institution would calculate risk-
weighted asset amounts under Sec. 628.52 by multiplying the adjusted
carrying value of the equity exposure, or the effective and ineffective
portions of a hedge pair as described below, by the lowest applicable
risk weight in Sec. 628.52. A System institution would determine the
risk-weighted asset amount for an equity exposure to an investment fund
under Sec. 628.53 of the proposal. A System institution would sum
risk-weighted asset amounts for all of its equity exposures to
calculate its aggregate risk-weighted asset amount for its equity
exposures.
The proposed SRWA risk weights are summarized below in Table 10.
Table 10--Simple Risk-Weight Approach (SRWA)
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Risk Weight (in percent) Equity exposure
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0................................. An equity exposure to a sovereign,
the Bank for International
Settlements, the European Central
Bank, the European Commission, the
International Monetary Fund, an
MDB, and any other entity whose
credit exposures receive a 0-
percent risk weight under Sec.
628.32 of the proposal.
20................................ An equity exposure to a PSE or the
Federal Agricultural Mortgage
Corporation (Farmer Mac).
100............................... An equity exposure that the
FCA has authorized pursuant to Sec.
615.5140(e) for a purpose other
than those specified in Sec.
615.5132(a) (for System banks) or
Sec. 615.5142 (for associations),
unless the exposure is assigned a
different risk weight under this
section.
The effective portion of a
hedged pair.
Non-significant equity
exposures, to the extent that the
aggregate adjusted carrying value
of the exposures does not exceed 10
percent of total capital (tier 1
capital plus tier 2 capital).
600............................... An equity exposure to an investment
firm that (i) would meet the
definition of a traditional
securitization were it not for the
FCA's application of paragraph (8)
of that definition (in Sec.
628.2) and (ii) has greater than
immaterial leverage.
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3. 100-Percent Risk Weight
Under this proposed rule, a System institution would apply a 100-
percent risk weight to the following equity exposures:
An equity exposure that the FCA has authorized pursuant to
Sec. 615.5140(e) for a purpose other than those specified in Sec.
615.5132(a) (for System banks) or Sec. 615.5142 (for associations),
unless the equity exposure is assigned a different risk weight under
this section.
The effective portion of a hedge pair; and
Non-significant equity exposures.
Hedged transactions are discussed later in this preamble; the other
two equity exposures are discussed in this section.
Section Sec. 615.5132(a) of the FCA's regulations authorizes
System banks to invest in eligible securities (equity securities are
not eligible) for the purposes of complying with liquidity
requirements, managing surplus short-term funds, and managing interest
rate risk. Section Sec. 615.5142 authorizes associations to invest in
eligible securities (again, equity securities are not eligible) for the
purposes of reducing interest rate risk and managing surplus short-term
funds. Section 615.5140(e) authorizes System banks and associations,
with our approval, to purchase and hold investments that are not
otherwise eligible (such as equity investments) or that would be held
for a purpose not specified by regulation.
Under proposed Sec. 628.52, equity investments that the FCA
approves for a purpose other than those specified in Sec. 615.5132(a)
(for System banks) or Sec. 615.5142 (for associations) would be risk
weighted at 100 percent, unless the investments would qualify for a
different risk weight (for example, 0 percent or 20 percent) under this
section.
Under the proposed rule, a 100-percent risk weight would also apply
to certain non-System equity exposures deemed non-significant. The
following equity exposures, to the extent that their aggregate adjusted
carrying value of does not exceed 10 percent of the System
institution's total capital (tier 1 and tier 2), would be deemed non-
significant: \115\
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\115\ Non-significant equity exposures exclude exposures to an
investment firm that (1) would meet the definition of traditional
securitization were it not for the FCA's application of paragraph
(8) of the definition of a traditional securitization and (2) have
greater than immaterial leverage. These investment firm exposures
would be assigned a 600-percent risk weight.
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Equity exposures to unconsolidated unincorporated business
entities and equity exposures held through consolidated unincorporated
business entities, as authorized by subpart J of part 611;
Equity exposures that the FCA has authorized pursuant to
Sec. 615.5140(e) for a purpose specified in Sec. 615.5132(a) (for
System banks) or Sec. 615.5142 (for associations), unless the equity
exposures are assigned a different risk weight under this section; and
Equity exposures to an unconsolidated rural business
investment company and equity
[[Page 52856]]
exposures held through a consolidated rural business investment company
described in 7 U.S.C. 2009cc et seq.
Equity exposures to foreclosed collateral; these exposures
could be either publicly traded or non-publicly traded.\116\
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\116\ This proposal defines publicly traded as traded on: (1)
Any exchange registered with the SEC as a national securities
exchange under section 6 of the Securities Exchange Act of 1934 (15
U.S.C. 78f); or (2) any non-U.S.-based securities exchange that is
registered with, or approved by, a national securities regulatory
authority and that provides a liquid, two-way market for the
instrument in question. A two-way market would refer to a market
where there are independent bona fide offers to buy and sell so that
a price reasonably related to the last sales price or current bona
fide competitive bid and offer quotations can be determined within 1
day and settled at that price within a relatively short timeframe
conforming to trade custom.
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To compute the aggregate adjusted carrying value of a System
institution's equity exposures for determining their non-significance,
this proposal provides that the System institution may exclude: (1) The
equity exposure in a hedge pair with the smaller adjusted carrying
value; and (2) a proportion of each equity exposure to an investment
fund equal to the proportion of the assets of the investment fund that
are not equity exposures. If a System institution does not know the
actual holdings of the investment fund, the System institution may
calculate the proportion of the assets of the fund that are not equity
exposures based on the terms of the prospectus, partnership agreement,
or similar contract that defines the fund's permissible investments. If
the sum of the investment limits for all exposure classes within the
fund exceeds 100 percent, the System institution would assume that the
investment fund invests to the maximum extent possible in equity
exposures.
To determine which of a System institution's equity exposures
qualify for a 100-percent risk weight based on the 10 percent of
capital standard for non-significance, the System institution would
aggregate the exposures in the following order:
(1) Equity exposures to unconsolidated rural business investment
companies, or those held through consolidated rural business investment
companies described in 7 U.S.C. 2009cc et seq.;
(2) Equity exposures that the FCA has authorized pursuant to Sec.
615.5140(e) for a purpose specified in Sec. 615.5132(a) (for System
banks) or Sec. 615.5142 (for associations);
(3) Equity exposures to unconsolidated unincorporated business
entities and equity exposures held through consolidated unincorporated
business entities, as authorized by subpart J of part 611;
(4) Foreclosed collateral in the form of publicly traded equity
exposures (including those held indirectly through investment funds);
and
(5) Foreclosed collateral in the form of non-publicly traded equity
exposures (including those held indirectly through investment funds).
To the extent that any of these aggregated equity exposures exceed
10 percent of a System institution's total capital, the FCA will
determine their risk weighting.
4. Hedged Transactions
Under the proposal, to determine risk-weighted assets under the
SRWA, a System institution could identify hedge pairs, which would be
defined as two equity exposures that form an effective hedge, as long
as each equity exposure is publicly traded or has a return that is
primarily based on a publicly traded equity exposure. A System
institution would risk weight only the effective and ineffective
portions of a hedge pair rather than the entire adjusted carrying value
of each exposure that makes up the pair.
Under the proposed rule, two equity exposures form an effective
hedge if the exposures either have the same remaining maturity or each
has a remaining maturity of at least 3 months; the hedge relationship
is formally documented in a prospective manner (that is, before the
System institution acquires at least one of the equity exposures); the
documentation specifies the measure of effectiveness (E) the System
institution would use for the hedge relationship throughout the life of
the transaction; and the hedge relationship has an E greater than or
equal to 0.8. A System institution would measure E at least quarterly
and would use one of three measures of E described in the next section:
The dollar-offset method, the variability-reduction method, or the
regression method.
It is possible that only part of a System institution's exposure to
a particular equity instrument is part of a hedge pair. For example,
assume a System institution has equity exposure A with a $300 adjusted
carrying value and chooses to hedge a portion of that exposure with
equity exposure B with an adjusted carrying value of $100. Also assume
that the combination of equity exposure B and $100 of the adjusted
carrying value of equity exposure A form an effective hedge with an E
of 0.8. In this situation, the institution would treat $100 of equity
exposure A and $100 of equity exposure B as a hedge pair, and the
remaining $200 of its equity exposure A as a separate, stand-alone
equity position. The effective portion of a hedge pair would be
calculated as E multiplied by the greater of the adjusted carrying
values of the equity exposures forming the hedge pair. The ineffective
portion of a hedge pair would be calculated as (1-E) multiplied by the
greater of the adjusted carrying values of the equity exposures forming
the hedge pair. In the above example, the effective portion of the
hedge pair would be 0.8 x $100 = $80, and the ineffective portion of
the hedge pair would be (1 - 0.8) x $100 = $20.
5. Measures of Hedge Effectiveness
As stated above, a System institution could determine effectiveness
using any one of three methods--the dollar-offset method, the
variability-reduction method, or the regression method. Under the
dollar-offset method, a System institution would determine the ratio of
the cumulative sum of the changes in value of one equity exposure to
the cumulative sum of the changes in value of the other equity
exposure, termed the ratio of value change (RVC). If the changes in the
values of the two exposures perfectly offset each other, the RVC would
be -1. If RVC is positive, implying that the values of the two equity
exposures move in the same direction, the hedge is not effective and E
equals 0. If RVC is negative and greater than or equal to -1 (that is,
between 0 and -1), then E would equal the absolute value of RVC. If RVC
is negative and less than -1, then E would equal 2 plus RVC.
The variability-reduction method of measuring effectiveness
compares changes in the value of the combined position of the two
equity exposures in the hedge pair (labeled X in the equation below) to
changes in the value of one exposure as though that one exposure were
not hedged (labeled A). This measure of E expresses the time-series
variability in X as a proportion of the variability of A. As the
variability described by the numerator becomes small relative to the
variability described by the denominator, the measure of effectiveness
improves, but is bounded from above by a value of one. E would be
computed as:
[[Page 52857]]
[GRAPHIC] [TIFF OMITTED] TP04SE14.010
where
X1 = A1 - B1
A1 the value at time t of the one exposure in a hedge pair, and
B1 the value at time t of the other exposure in the hedge pair.
The value of t would range from 0 to T, where T is the length of
the observation period for the values of A and B, and is comprised of
shorter values each labeled t.
The regression method of measuring effectiveness is based on a
regression in which the change in value of one exposure in a hedge pair
is the dependent variable and the change in value of the other exposure
in the hedge pair is the independent variable. E would equal the
coefficient of determination of this regression, which is the
proportion of the variation in the dependent variable explained by
variation in the independent variable. However, if the estimated
regression coefficient is positive, then the value of E is 0.
Accordingly, E is higher when the relationship between the values of
the two exposures is closer.
6. Equity Exposures to Investment Funds
We propose three methods of assigning risk weights to equity
exposures to investment funds. Regardless of the method a System
institution chooses, the risk weight for an exposure to an investment
fund would have to be no less than 20 percent.\117\ System institutions
should keep in mind that the only investment funds they are authorized
to invest in are diversified investment funds; that is, shares of an
investment company registered under section 8 of the Investment Company
Act of 1940. The portfolio of the investment company must consist
solely of eligible investments authorized by our investment
regulations.\118\
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\117\ As with non-System equity exposures generally, System
institutions generally have limited equity exposures to investment
funds.
\118\ Section 615.5140(a)(8).
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As discussed further below, under the proposed rule, a System
institution would determine the risk-weighted asset amount for equity
exposures (except equity exposures that the FCA has authorized pursuant
to Sec. 615.5140(e) for a purpose other than those specified in Sec.
615.5132(a) (for System banks) or Sec. 615.5142 (for associations)) to
investment funds using one of three approaches--the full look-through
approach, the simple modified look-through approach, or the alternative
modified look-through approach. The risk-weighted asset amount for an
equity exposure that the FCA has authorized pursuant to Sec.
615.5140(e) for a purpose other than those specified in Sec.
615.5132(a) (for System banks) or Sec. 615.5142 (for associations) is
the exposure's adjusted carrying value. If a System institution did not
use the full look-through approach, and an equity exposure to an
investment fund was part of a hedge pair, the System institution would
have to use the ineffective portion of the hedge pair as the adjusted
carrying value for the equity exposure to the investment fund. The
risk-weighted asset amount of the effective portion of the hedge pair
would be equal to its adjusted carrying value. A System institution
could choose which approach to apply for each equity exposure to an
investment fund.
a. Full Look-Through Approach
A System institution could use the full look-through approach only
if the institution was able to calculate a risk-weighted asset amount
for each of the exposures held by the investment fund. Under the
proposal, a System institution using the full look-through approach
would be required to calculate the risk-weighted asset amount for its
proportional ownership shares of each of the exposures held by the
investment fund as if the proportionate ownership share of the adjusted
carrying value of each of the exposures were held directly by the
institution. The System institution's risk-weighted asset amount for
the fund would be equal to (1) The aggregate risk-weighted asset amount
of the exposures held by the fund as if they were held directly by the
System institution multiplied by (2) the System institution's
proportional ownership share of the fund.
b. Simple Modified Look-Through Approach
Under the proposed simple modified look-through approach, a System
institution would set the risk-weighted asset amount for its equity
exposure to an investment fund equal to the adjusted carrying value of
the equity exposure multiplied by the highest risk weight that applies
to an exposure the fund is permitted to hold under the prospectus,
partnership agreement, or similar agreement that defines the fund's
permissible investments. The System institution may exclude derivative
contracts held by the fund that are used for hedging, rather than for
speculative purposes, as long as they do not constitute a material
portion of the fund's exposures.
c. Alternative Modified Look-Through Approach
Under the proposed alternative modified look-through approach, a
System institution may assign the adjusted carrying value of an equity
exposure to an investment fund on a pro rata basis to different risk-
weight categories based on the investment limits in the fund's
prospectus, partnership agreement, or similar contract that defines the
fund's permissible investments.
The risk-weighted asset amount for the System institution's equity
exposure to the investment fund would be equal to the sum of each
portion of the adjusted carrying value assigned to an exposure type
multiplied by the applicable risk weight. If the sum of the investment
limits for all exposures within the fund exceeds 100 percent, the
System institution would assume that the fund invests to the maximum
extent permitted under its investment limits in the exposure type with
the highest applicable risk weight under the proposed requirements and
continues to make investments in the order of the exposure category
with the next highest risk weight until the maximum total investment
level is reached. If more than one exposure category applies to an
exposure, the System institution would use the highest applicable risk
weight. A System institution may exclude derivative contracts held by
the fund that are used for hedging, rather than for speculative
purposes, as long as they do not constitute a material portion of the
fund's exposures.
V. Market Discipline and Disclosure Requirements
A. Proposed Disclosure Requirements
Meaningful public disclosure by banking organizations is one of the
three pillars of the Basel framework. Public disclosure complements the
minimum capital requirements and the supervisory review process by
encouraging market discipline. The other Federal banking regulatory
agencies adopted disclosure requirements for the banking
[[Page 52858]]
organizations that they regulate with $50 billion or more in assets.
We propose similar disclosure requirements for System banks on a
bank-only basis (not on a consolidated, district-wide basis). We
believe these proposed disclosure requirements are appropriate for all
System banks--even those that currently have less than $50 billion in
assets--because they are jointly and severally liable for the
Systemwide debt obligations that they issue.\119\ A System bank's
exposure to risks and the techniques that it uses to identify, measure,
monitor, and control those risks are important factors that market
participants consider in their assessment of the bank. A System bank
would not, however, have to make any disclosures that do not apply to
it.\120\
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\119\ Nothing in this proposed regulation or preamble would
change any of our existing regulatory requirements, including those
in part 620 or part 621.
\120\ For example, Table 1 would require a System bank to make
certain disclosures about subsidiaries. If a System bank has no
subsidiaries, it would not have to make those disclosures.
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We believe this proposal strikes the proper balance between the
market benefits of disclosure and the burden of providing the
disclosures. We invite comment on the appropriate application of these
proposed disclosure requirements to System banks.
We propose to require each System bank to have a board-approved
disclosure policy that addresses the bank's approach for determining
the disclosures it will make. The policy would address the associated
internal controls, disclosure controls, and procedures. The board of
directors and senior management would ensure that disclosures are
reviewed appropriately and that effective internal controls, disclosure
controls, and procedures are maintained. The System bank's chief
executive officer, chief financial officer, and a designated board
member would have to attest that the disclosures meet the requirements
of these regulations.
A System bank would decide the relevant material disclosures.
Information would be regarded as material if its omission or
misstatement could influence the assessment or decision of a user
making investment decisions.
We would expect that disclosures of CET1, tier 1, and total capital
ratios would be tested by external auditors as part of the financial
statement audit in a manner similar to the testing that external
auditors perform on banking organizations regulated by the Federal
banking regulatory agencies.
B. Location and Frequency of Disclosures
This proposed rule would require that a System bank provide timely
public disclosures after each calendar quarter. However, qualitative
disclosures that provide a general summary of a System bank's risk-
management objectives and policies, reporting system, and definitions
may be disclosed annually after the end of the fourth calendar quarter,
provided any significant changes are disclosed in the interim.
The System bank would have to make these disclosures in its
quarterly and annual reports to shareholders that are required in part
620 of our regulations.\121\ We do not require a System bank to make
these disclosures in the exact format set out in the proposed
regulations, or in the same location in the report, as long as they
provide a summary table specifically indicating the location(s) of all
disclosures. This flexibility grants System banks discretion in how to
disclose the required information and to avoid duplication.
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\121\ Sections 620.2 and 620.4 of the FCA's regulations requires
each System institution to prepare, provide to the FCA and
shareholders, and make available to the public an annual report
after the end of each fiscal year. Sections 620.2 and 620.10
requires each System institution to prepare, provide to the FCA and
shareholders, and make available to the public a quarterly report
after the end of each fiscal quarter (except the fiscal quarter that
coincides with the end of the System institution's fiscal year).
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In some cases, management may determine that a significant change
has occurred, such that the most recent reported amounts do not reflect
the System bank's capital adequacy and risk profile. In those cases,
the System bank would need to disclose the general nature of these
changes and briefly describe how they are likely to affect public
disclosures going forward. A System bank would have to make these
interim disclosures as soon as practicable after the determination that
a significant change has occurred. This disclosure requirement may be
satisfied by providing a notice under Sec. 620.15.
The disclosures required by the proposal would have to be publicly
available (for example, included on a public Web site) for each of the
last 3 years or such shorter time period beginning when the System bank
becomes subject to the disclosure requirements. For example, a System
bank that began to make public disclosures in the first quarter of 2015
would have to make all of its required disclosures publicly available
until the first quarter of 2018, after which it would have to make its
required disclosures for the previous 3 years publicly available.
C. Proprietary and Confidential Information
The FCA believes that proposed disclosure requirements strike the
proper balance between the need for meaningful disclosure and the
protection of proprietary and confidential information.\122\
Accordingly, the FCA believes System banks would be able to provide all
of these disclosures without revealing proprietary and confidential
information. Only in rare circumstances might disclosure of certain
items of information required by the proposal compel a System bank to
reveal confidential and proprietary information. In these unusual
situations, if a System bank believes that disclosure of specific
commercial or financial information would compromise its position by
making public information that is either proprietary or confidential in
nature, the System bank would not be required to disclose those
specific items under the rule's periodic disclosure requirements.
Instead, the System bank would have to disclose more general
information about the subject matter of the requirement, together with
the fact that, and the reason why, the specific items of information
have not been disclosed. This provision would apply only to those
disclosures included in this proposed rule and would not apply to
disclosure requirements imposed by accounting standards or other FCA
regulations.
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\122\ Proprietary information encompasses information that, if
shared with competitors, would render a System bank's investment in
these products/systems less valuable, and, hence, could undermine
its competitive position. Information about customers is often
confidential, in that it is provided under the terms of a legal
agreement or counterparty relationship.
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D. Specific Public Disclosure Requirements
The public disclosure requirements are designed to provide
important information to market participants on the scope of
application, capital structure, risk exposures, risk assessment
processes, and the capital adequacy of the System institution. The
focus of the proposed disclosure requirements is the substantive
content of the tables, not the tables themselves. The table numbers
below refer to the table numbers in proposed Sec. 628.63. A System
bank would be required to make the disclosures described in Tables 1
through 10.\123\
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\123\ Other disclosure requirements, such as regulatory
reporting requirements, would continue to apply.
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[[Page 52859]]
Table 1 disclosures, ``Scope of Application,'' would provide the
basic context underlying regulatory capital calculations.
Table 2 disclosures, ``Capital Structure,'' would provide summary
information on the terms and conditions of the main features of
regulatory capital instruments, which would allow for an evaluation of
the quality of the capital available to absorb losses within a System
bank. A System bank also would disclose the total amount of CET1, tier
1, and total capital, with separate disclosures for deductions and
adjustments to capital. We believe that many of these disclosure
requirements would be captured in revised regulatory reports.
Table 3 disclosures, ``Capital Adequacy,'' would provide
information on a System bank's approach for categorizing and risk-
weighting its exposures, as well as the amount of total risk-weighted
assets. The table would also include CET1, and tier 1 and total risk-
based capital ratios.
Table 4 disclosures, ``Capital Conservation Buffer,'' would require
a System bank to disclose the capital conservation buffer, the eligible
retained income and any limitations on capital distributions and
certain discretionary bonus payments, as applicable.
Disclosures in Tables 5, ``Credit Risk: General Disclosures,'' 6,
``General Disclosure for Counterparty Credit Risk-Related Expenses,''
and 7, ``Credit Risk Mitigation,'' would relate to credit risk,
counterparty credit risk and credit risk mitigation, respectively, and
would provide market participants with insight into different types and
concentrations of credit risk to which a System bank is exposed and the
techniques it uses to measure, monitor, and mitigate those risks. These
disclosures are intended to enable market participants to assess the
credit risk exposures of the System bank without revealing proprietary
information.
Table 8 disclosures, ``Securitization,'' would provide information
to market participants on the amount of credit risk transferred and
retained by a System bank through securitization transactions, the
types of products involved in the System bank's securitizations, the
risks inherent in the System bank's securitized assets, the System
bank's policies regarding credit risk mitigation, and the names of any
entities that provide external credit assessments of a securitization.
These disclosures would provide a better understanding of how
securitization transactions impact the credit risk of a System bank.
For purposes of these disclosures (and these capital regulations), a
System bank would be considered to have securitized assets if assets
that it originated or purchased from third parties are included in a
securitization. Securitization transactions in which the originating
System bank does not retain any securitization exposure would be shown
separately and would only be reported for the year of inception of the
transaction.\124\
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\124\ A System bank is authorized to act as an ``originating
System institution,'' which the proposed regulation would define as
a System institution that directly or indirectly originated the
underlying exposures included in a securitization. A System bank is
not authorized to perform every role in a securitization, and
nothing in these capital rules authorizes a System bank to engage in
activities relating to securitizations that are not otherwise
authorized.
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Table 9 disclosures, ``Equities,'' would provide market
participants with an understanding of the types of equity securities
held by the System bank and how they are valued. The disclosures would
also provide information on the capital allocated to different equity
products and the amount of unrealized gains and losses. We understand
that System banks generally hold few equity securities; nevertheless,
we believe disclosure of these securities, when they are held, is
warranted.
Table 10 disclosures, ``Interest Rate Risk for Non-trading
Activities,'' would require a System bank to provide certain
quantitative and qualitative disclosures regarding the System bank's
management of interest rate risks.
VI. Conforming Changes
The FCA is proposing a number of conforming changes to current FCA
regulations as follows:
In Sec. 607.2(b), revision of the definition of ``average
risk-adjusted asset base'';
In Sec. 614.4351(a)(3), replacement of the reference to
total surplus with a reference to tier 2 capital;
In Sec. 615.5143(a), removal of references to the net
collateral ratio;
In Sec. 615.5200, removal of references to total capital,
surplus, core surplus, total surplus, and unallocated surplus; addition
of references to CET1, tier 1 capital, total capital, and tier 1
leverage ratio; and other minor nonsubstantive and technical changes;
In Sec. 615.5201, removal of definitions that would no
longer be used in part 615, subpart H, including ``bank,''
``commitment,'' ``credit conversion factor,'' ``credit derivative,''
``credit-enhancing interest-only strip,'' ``credit-enhancing
representations and warranties,'' ``deferred-tax assets that are
dependent on future income or future events,'' ``direct credit
substitute,'' ``direct lender institution,'' ``externally rated,''
``face amount,'' ``financial asset,'' ``financial standby letter of
credit,'' ``Government agency,'' ``Government-sponsored agency,''
``institution,'' ``nationally recognized statistical rating
organization,'' ``non-OECD bank,'' ``OECD,'' ``OECD bank,''
``performance-based standby letter of credit,'' ``qualified residential
loan,'' ``qualifying bilateral netting contract,'' ``qualifying
securities firm,'' ``recourse,'' ``residual interest,'' ``risk
participation,'' ``Rural Business Investment Company,''
``securitization,'' ``servicer cash advance,'' ``total capital,''
``traded position,'' and ``U.S. depository institution''; revision of
the definitions of ``permanent capital'' and ``risk-adjusted asset
base''; and addition of definitions of ``deferred tax assets'' and
``System institution'';
In Sec. Sec. 615.5206 and 615.5208, removal of references
to the Farm Credit System Financial Assistance Corporation in Sec.
615.5206(a); removal of Sec. Sec. 615.5206(d) and 615.5208(c), which
pertain to the Farm Credit System Financial Assistance Corporation; and
other minor nonsubstantive and technical changes;
In Sec. 615.5207, revisions in paragraph (f) (requiring
deduction of an investment in the Funding Corporation) and paragraph
(j) (elimination of exclusion of AOCI and requirement to exclude any
defined benefit pension fund net asset) to make the deductions from the
numerator of the permanent capital calculation uniform with the
deductions from the denominator;
Removal of Sec. Sec. 615.5209 through 615.5212, which
pertain to risk-weighting (the risk-weights for the permanent capital
ratio would be the same risk weights that would be used for the tier 1
and tier 2 capital ratios in part 628);
In Sec. 615.5220, minor nonsubstantive and technical
changes;
Revision of Sec. 615.5240 to add a reference to the
regulatory capital standards in proposed part 628;
Revision of Sec. 615.5250 to include references to the
regulatory capital standards in proposed part 628;
In Sec. 615.5255, the addition of part 628 capital
standards and minor nonsubstantive and technical changes;
In Sec. 615.5270, revision to incorporate restrictions
and limits on redemptions of equities would be included in tier 1 and
tier 2 capital in the proposed rule;
In Sec. 615.5290, minor nonsubstantive and technical
changes;
Removal of part 615, subpart K, which contains the
requirements for the
[[Page 52860]]
core surplus, total surplus, and net collateral standards;
In Sec. Sec. 615.5350, 615.5352, and 615.5355,
replacement of references to core surplus, total surplus, and net
collateral with references to tier 1 and tier 2 capital;
In Sec. 615.5357, addition of a reference to the capital
restoration plan in proposed Sec. 628.301; and
Revision of Sec. 620.17 to expand the stockholder
notification requirement to include the regulatory capital standards in
proposed part 628.
VII. Proposed Timeframe for Implementation
Basel III and the Federal regulatory banking agencies' rules have
numerous phase-in and transition periods for the capital regulations
lasting from 2014 (2015 for banking organizations not using the
advanced approaches rules) until 2019 or after. Many of these
transition provisions pertain to regulatory deductions and adjustments,
minority interests, and temporary inclusion of non-qualifying
instruments. There is also a transition period for the capital
conservation buffer.
The FCA is not proposing any transition or phase-in periods for
regulatory adjustments and deductions. The Federal regulatory banking
agencies' transition periods serve several purposes. The agencies,
which are members of the BCBS, are generally following the transition
and phase-in periods of Basel III and other countries' banking
regulations. Since the primary competitors of many U.S. banking
organizations are financial institutions that are regulated by foreign
countries that are also following Basel III, there will be a level
playing field among such competitors. In addition, the Federal
regulatory banking agencies note that the various transition periods
will give the banking organizations they regulate sufficient time to
build capital to meet the new minimum requirements.
The FCA believes multiple transition periods of varying lengths for
multiple adjustments and deductions could be unnecessarily burdensome
for System institutions and for the FCA. Instead of a single learning
curve and software re-tooling on the calculation of the new framework,
institutions and FCA staff would have a new learning curve every 4
quarters for the first 4 or more years after the rule becomes
effective.
We have analyzed every System institution's call report data, and
we project that all System institutions would meet all the proposed
minimum amounts for the CET1, tier 1 and total capital risk-based
ratios if those requirements were in effect today. In reviewing the
capital components, we assumed that all institutions would adopt
required bylaw provisions for inclusion of stock and allocated equities
in tier 1 and tier 2 capital. We also assumed that no institutions that
redeem allocated equities on a cycle of less than 10 years would extend
their patronage redemption periods in order to include those equities
in CET1 capital, but rather they would maintain existing patronage
redemption periods and qualify allocated equities as tier 2 capital.
For the risk weightings, we used a simple analysis. For System
associations, we assumed the proposed risk weightings would not be
materially different from existing risk weightings in the current
regulations. For System banks, we believe that certain new risk weights
or conversion factors could have a material impact but, taken
collectively, the impacts should net against each other. For instance,
System banks would need to hold additional capital for their
unconditionally cancelable unfunded commitments, but they would hold
less capital for their end-user derivative portfolios. In the proposed
rule, the banks may use credit risk mitigation for the collateral
posted to derivative counterparties that are not available to them
under current regulations.
All System institutions would meet the 5.0 minimum tier 1 leverage
ratio (including the 1.5-percent component of the ratio for URE and
equivalents) if the proposed requirement were effective today. Our
analysis indicates that the leverage ratio would not be a constraining
ratio for System associations because of their strong capital levels.
The leverage ratio for associations would be very similar to their tier
1 capital risk-based ratio because most of their assets are risk
weighted at 100 percent. If the proposed rule were effective today, the
current leverage ratios of System banks would, however, be closer to,
but above, the proposed 5.0-percent tier 1 and a 1.5-percent URE and
URE equivalents component of the minimum leverage ratio. The System
banks' tier 1 leverage ratios would be significantly lower than their
tier 1 risk-based ratios because a large portion of their loans are to
their affiliated associations and are risk-weighted at 20 percent.
The FCA has decided to propose a transition period for the capital
conservation buffer that would commence on January 1, 2016, with the
buffer fully phased in beginning January 1, 2019. Unlike the
adjustments and deductions transitions, the calculation of the capital
conservation buffer would not change over the transition period, and
there would not be an additional burden to revise the calculation each
year. Rather, the amount of the capital conservation buffer increases
every year until fully phased in. The Federal regulatory banking
agencies' capital conservation buffer rules also will be fully phased
in as of January 1, 2019, but their transition period will begin in
2015. We expect our final rule will become effective for the reporting
periods beginning in 2016.
In the event that some System institutions do not meet the tier 1
and tier 2 capital standards when the rules become effective, we are
proposing to permit them to comply by submitting a capital restoration
plan. The plan, which the institution would be required to submit
within 20 days of the quarterend during which the new capital standards
become effective, would describe how the institution proposes to
achieve and maintain compliance with the new requirements,
demonstrating progress towards meeting that goal. If the FCA did not
approve the plan, the institution would have to revise and re-submit
the plan. There is a list of factors in the proposed rule that the FCA
would consider in evaluating a plan. They include: (1) Circumstances
leading to the institution's decrease in capital and whether they were
caused by the institution or by circumstances beyond the institution's
control; (2) the institution's financial ratios (e.g., capital, adverse
assets, ALL) compared to those of its peers or industry norms; and (3)
the institution's previous compliance practices; and (4) the views of
the institution's directors and managers regarding the plan. If the
capital restoration plan is adopted by the institution and approved by
the FCA within 180 days of the quarterend in which the tier 1 and tier
2 capital requirements become effective, the institution will be deemed
to be in compliance with the requirements.\125\
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\125\ This proposed rule is modeled after current Sec.
615.5336, which was adopted in 1997 at the time the FCA adopted the
core surplus, total surplus, and net collateral requirements.
Several System institutions achieved initial compliance with those
requirements.
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VIII. Abbreviations
ABCP Asset-Backed Commercial Paper
ABS Asset-backed Security
ADC Acquisition, Development, or Construction
AFS Available For Sale
ALL Allowance for Loan Losses
AOC Accumulated Other Comprehensive Income
BCBS Basel Committee on Banking Supervision
BHC Bank Holding Company
CCF Credit Conversion Factor
[[Page 52861]]
CCP Central Counterparty
CDS Credit Default Swap
CEIO Credit-Enhancing Interest-Only Strip
CEM Current Exposure Method
CFR Code of Federal Regulations
CFPB Consumer Financial Protection Bureau
CFTC Commodity Futures Trading Commission
CPSS Committee on Payment and Settlement Systems
CRC Country Risk Classifications
CUSIP Committee on Uniform Securities Identification Procedures
DAC Deferred Acquisition Cost
DCO Derivatives Clearing Organizations
DTA Deferred Tax Asset
DTL Deferred Tax Liability
DvP Delivery-versus-Payment
E Measure of Effectiveness
EE Expected Exposure
ERISA Employee Retirement Income Security Act of 1974
FCA Farm Credit Administration
FDIC Federal Deposit Insurance Corporation
FDICIA Federal Deposit Insurance Corporation Improvement Act of 1991
FFIEC Federal Financial Institutions Examination Council
FHA Federal Housing Authority
FHLB Federal Home Loan Bank
FHLMC Federal Home Loan Mortgage Corporation
FIRREA Financial Institutions, Reform, Recovery and Enforcement Act
FMU Financial Market Utility
FNMA Federal National Mortgage Association
FR Federal Register
GAAP Generally Accepted Accounting Principles (U.S.)
GNMA Government National Mortgage Association
GSE Government-Sponsored Enterprise
HAMP Home Affordable Mortgage Program
HOLA Home Owners' Loan Act
HTM Held to Maturity
HVCRE High-Volatility Commercial Real Estate
IFRS International Financial Reporting Standards
IOSCO International Organization of Securities Commissions
LTV Loan-to-Value Ratio
MBS Mortgage-backed Security
MDB Multilateral Development Bank
MHC Mutual Holding Company
MSA Mortgage Servicing Assets
NRSRO Nationally Recognized Statistical Rating Organization
OCC Office of the Comptroller of the Currency
OECD Organization for Economic Cooperation and Development
OFI Other Financing Institution
OMB Office of Management and Budget
OTC Over-the-Counter
OTTI Other Than Temporary Impairment
PFE Potential Future Exposure
PMI Private Mortgage Insurance
PMSR Purchased Mortgage Servicing Right
PSE Public Sector Entities
PvP Payment-versus-Payment
QCCP Qualifying Central Counterparty
QIS Quantitative Impact Study
QM Qualified Mortgage
RBA Ratings-Based Approach
RBC Risk-Based Capital
REIT Real Estate Investment Trust
Re-REMIC Resecuritization of Real Estate Mortgage Investment Conduit
SAP Statutory Accounting Principles
SEC Securities and Exchange Commission
SFA Supervisory Formula Approach
SLHC Savings and Loan Holding Company
SPE Special Purpose Entity
SRWA Simple Risk-Weight Approach
SSFA Simplified Supervisory Formula Approach
U.S.C. United States Code
VA Department of Veterans Affairs
VOBA Value of Business Acquired
WAM Weighted Average Maturity
IX. 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 proposed rule
would not have a significant economic impact on a substantial number of
small entities. Each of the banks in the Farm Credit 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, Farm Credit System institutions are not ``small entities''
as defined in the Regulatory Flexibility Act.
Addendum: Discussion of This Proposed Rule
Overview
The FCA is issuing a proposed rule (proposal or proposed rule) to
update the capital rules for the System by adopting certain changes
comparable to those suggested by the Basel Committee on Banking
Supervision (BCBS) to the international regulatory capital framework,
the Federal banking regulatory agencies' regulations, and requirements
of the Dodd-Frank Act. Among other things, the proposed rule would:
Establish minimum risk-based CET1, tier 1, and total
capital ratio requirements;
Establish a minimum tier 1 leverage ratio requirement;
Establish a capital conservation buffer below which an
institution's discretionary cash distributions and bonuses would be
limited or prohibited without FCA approval;
Increase capital requirements for past-due loans, high
volatility commercial real estate exposures, and certain short-term
loan commitments;
Expand the recognition of collateral and guarantors in
determining risk-weighted assets;
Remove references to credit ratings;
Establish due diligence requirements for securitization
exposures; and
Increase required regulatory capital disclosures of System
banks.
This addendum summarizes this proposed rule. The FCA intends for
this addendum to act as a guide for System institutions to navigate the
proposed rule and identify the provisions that may be most relevant to
them, but it is not comprehensive. The FCA expects and encourages all
System institutions to review the proposed rule in its entirety.
We remind System institutions that the presence of a particular
risk weighting does not itself provide authority for a System
institution to have an exposure to that asset or item.
A. Capital Components
1. Common Equity Tier 1 Capital (CET1)
(a) Common cooperative equities (purchased member stock, purchased
participation certificates, and allocated equities) with the following
key criteria (among others):
Borrower stock (regardless of redemption or revolvement
period) up to the statutory minimum of $1000 or 2 percent of the loan
amount, whichever is less;
Equities are perpetual;
Equities subject to discretionary revolvement or
redemption are not retired for at least 10 years after issuance;
Equities can be retired only with FCA prior approval
(unless it is the statutory minimum borrower stock requirement or
unless the distribution meets ``safe harbor'' standards) and the System
institution has a capitalization bylaw providing that it must obtain
FCA approval prior to redeeming or revolving any equities it includes
in CET1 before the end of the 10-year period;
Equities represent a claim subordinated to all preferred
stock, all subordinated debt, and all liabilities of the institution in
a receivership, liquidation, or similar proceeding; and
(b) Unallocated retained earnings (URE).
The FCA is proposing to require System institutions to exclude AOCI
from CET1.
2. Additional Tier 1 Capital (AT1)
Equities other than common cooperative equities (i.e., equities
issued primarily to third-party investors) that meet most of the CET1
criteria, except that AT1 capital equities represent a claim that ranks
senior to all common cooperative equities in a receivership,
liquidation, or similar proceeding.
[[Page 52862]]
3. Tier 2 Capital
(a) Equities, which may be common cooperative equities or equities
held by third parties, not includable in Tier 1 with the following key
criteria:
Equities are perpetual or have an original maturity of at
least 5 years;
Equities subject to discretionary revolvement or
redemption are not retired for at least 5 years after issuance; and
Equities may not be redeemed or revolved prior to maturity
or the end of the stated revolvement period without FCA prior approval
(unless the distribution meets ``safe harbor'' standards);
(b) Subordinated debt that is not callable for at least 5 years and
not subject to acceleration except in the event of a receivership,
liquidation, or similar proceeding; and
(c) Allowance for losses (ALL) up to 1.25 percent of total risk-
weighted assets.
4. Regulatory Adjustments and Deductions
(a) Deductions from CET1 capital.
Goodwill, intangible assets, gains-on-sale in connection
with a securitization exposure, and defined benefit pension fund net
assets, all of which are net of associated deferred tax liabilities;
and
The System institution's allocated equity investments in
another System institution.
(b) Deductions from regulatory capital using the corresponding
deduction approach.
A System institution's purchased equity investments in
other System institutions must be deducted using the corresponding
deduction approach.
This means that a System institution would make deductions from the
component of capital for which the underlying instrument qualified if
it were issued by the System institution itself.
5. FCA Prior Approval of Cash Patronage Refunds, Cash Dividend
Payments, and Allocated Equity Redemptions; ``Safe Harbor'' Treatment
for Certain Such Payments
FCA prior approval would be required for redemption of equities
included in tier 1 and tier 2, comparable to Basel III and the banking
agencies' rule. Prior approval is also required for cash dividends and
cash patronage in excess of a specified level, comparable to U.S.
banking law and regulations. An exception to the FCA prior approval
requirement is that System institutions could retire member stock up to
an amount equal to the Farm Credit Act's minimum member-borrower stock
requirement of $1,000 or 2 percent of the member's loan, whichever is
less. In addition, this amount of borrower stock would not have to be
outstanding for a minimum period of 10 years in order for the
institution to include it in CET1. However, redemptions of such amounts
of stock would be included in the calculation for the ``safe harbor''
in proposed Sec. 628.22(f)(5).
Under the proposed ``safe harbor,'' FCA prior approval is deemed to
be granted (i.e., a request for approval does not have to be made to
the FCA) for cash distributions to pay dividends, patronage, or
revolvements and redemptions of common cooperative equities provided
that:
(a) For revolvements or redemptions of common cooperative equities
included in CET1 capital, such equities were issued or allocated at
least 10 years ago;
(b) For revolvements or redemptions of common cooperative equities
included in Tier 2 capital, such equities were issued or allocated at
least 5 years ago;
(c) After such cash distributions, the dollar amount of the System
institution's CET1 capital equals or exceeds the dollar amount of CET1
capital on the same date of the previous calendar year; and
(d) After such cash distributions, the System institution continues
to comply with all minimum regulatory capital requirements and
supervisory or enforcement actions.
6. Capital Conservation Buffer
The capital conservation buffer of 2.5 percent provides a cushion
above regulatory capital minimums. The buffer's purpose is to restrict
an institution's discretionary distributions of earnings before that
institution reaches the minimum capital requirements.
If a System institution's CET1, tier 1 and total capital ratios
exceed minimum requirements, the capital conservation buffer is
proposed to be the lowest of the following:
The System institution's CET1 capital ratio minus the
System institution's minimum CET1 capital ratio of 4.5 percent;
The System institution's tier 1 capital ratio minus the
System institution's minimum tier 1 capital ratio of 6 percent; and
The System institution's total capital ratio minus the
System institution's minimum total capital ratio of 8 percent.
If the CET1 ratio, tier 1 ratio, or total capital ratio does not
exceed minimum requirements, then the capital conservation buffer would
be zero.
B. Risk Weightings
1. Zero-Percent (0%) Risk-Weighted Exposures
An exposure to the U.S. Government, its central bank, or a
U.S. Government agency--Sec. 628.32(a)(1)(i)(A);
The portion of an exposure that is directly and
unconditionally guaranteed by the U.S. Government, its central bank, or
a U.S. Government agency--Sec. 628.32(a)(1)(i)(B);
An exposure to a sovereign entity that meets certain
criteria (as discussed below)--Sec. 628.32(a) and Table 1;
Exposures to certain supranational entities and
multilateral development banks--Sec. 628.32(b);
Cash--Sec. 628.32(l);
Certain gold bullion--Sec. 628.32(l);
Certain exposures that arise from the settlement of cash
transactions with a central counterparty--Sec. 628.32(l);
An exposure to an OTC derivative contract that meets
certain criteria--Sec. 628.37(b)(3)(i);
The collateralized portion of an exposure with respect to
which the financial collateral meets certain criteria--Sec.
628.37(b)(3)(iii); and
An equity exposure to any entity whose credit exposures
receive a 0-percent risk weight--Sec. 628.52(b)(1).
2. Twenty-Percent (20%) Risk-Weighted Exposures
The portion of an exposure that is conditionally
guaranteed by the U.S. Government, its central bank, or a U.S.
Government agency--Sec. 628.32(a)(1)(ii);
An exposure to a sovereign entity that meets certain
criteria (as discussed below)--Sec. 628.32(a) and Table 1;
An exposure to a GSE, other than an equity exposure or
preferred stock--Sec. 628.32(c)(1);
Most exposures to U.S.- or state-organized depository
institutions or credit unions, including those that are OFIs--Sec.
628.32(d)(1);
An exposure to a foreign bank that meets certain criteria
(as discussed below)--Sec. 628.32(d)(2) and Table 2;
A general obligation exposure to a U.S. or state PSE--
Sec. 628.32(e)(1)(i);
An exposure to a non-U.S. PSE that meets certain criteria
(as discussed below)--Sec. 628.32(e)(2), (e)(3), and (e)(4)(i) and
Table 3;
Cash items in the process of collection--Sec.
628.32(l)(2);
A loan that a System bank makes to an association (a
direct loan)--Sec. 628.32(m); and
[[Page 52863]]
An equity exposure to a PSE or the Federal Agricultural
Mortgage Corporation (Farmer Mac)--Sec. 628.52(b)(2).
3. Fifty-Percent (50%) Risk-Weighted Exposures
An exposure to a sovereign entity that meets certain
criteria (as discussed below)--Sec. 628.32(a) and Table 1;
An exposure to a foreign bank that meets certain criteria
(as discussed below)--Sec. 628.32(d)(2) and Table 2;
A revenue obligation exposure to a U.S. or state PSE--
Sec. 628.32(e)(1)(ii);
An exposure to a non-U.S. PSE that meets certain criteria
(as discussed below)--Sec. 628.32(e)(2), (e)(3), (e)(4)(ii) and Tables
3 and 4; and
First lien residential mortgage exposures that meet
certain criteria--Sec. 628.32(g).
4. One Hundred-Percent (100%) Risk-Weighted Exposures
An exposure to a sovereign entity that meets certain
criteria (as discussed below)--Sec. 628.32(a) and Table 1;
Preferred stock issued by a GSE--Sec. 628.32(c)(2);
An exposure to a foreign bank that meets certain criteria
(as discussed below)--Sec. 628.32(d)(2) and Table 2;
An exposure to a non-U.S. PSE that meets certain criteria
(as discussed below)--Sec. 628.32(e)(2), (e)(3), (e)(5) and Tables 3
and 4;
All corporate exposures--Sec. 628.32(f). This category
would include the following:
[cir] Borrower loans such as agricultural loans and consumer loans,
regardless of the corporate form, of the borrower, unless those loans
qualify for different risk weights under other risk-weighting
provisions;
[cir] System bank exposures to OFIs that do not satisfy the
criteria for a 20-percent risk weight; and
[cir] Premises, fixed assets, and other real estate owned;
All residential mortgage exposures that do not satisfy the
criteria for a 50-percent risk weight--Sec. 628.32(g);
DTAs arising from temporary differences that could be
realized through net operating loss carrybacks--Sec. 628.32(l)(3);
All MSAs--Sec. 628.32(l)(4);
All assets that are not specifically assigned a different
risk weight and that are not deducted from tier 1 or tier 2 capital
pursuant to Sec. 628.22--Sec. 628.32(l)(5);
Certain equity exposures authorized under Sec.
615.5140(e)--Sec. 628.52(b)(3)(i);
The effective portion of a hedge pair--Sec.
628.52(b)(3)(ii); and
Non-significant equity exposures--Sec. 628.52(b)(3)(iii).
5. One Hundred Fifty-Percent (150%) Risk-Weighted Exposures
An exposure to a sovereign entity that meet certain
criteria (as discussed below)--Sec. 628.32(a) and Table 1;
A sovereign exposure, if an event of sovereign default has
occurred during the previous 5 years--Sec. 628.32(a)(6) and Table 1;
An exposure to a foreign bank, if an event of sovereign
default has occurred during the previous 5 years in the foreign bank's
home country--Sec. 628.32(d)(2)(iv) and Table 2;
An exposure to a non-U.S. PSE that meets certain criteria
(as discussed below)--Sec. 628.32(e)(2), (e)(3), (e)(5) and Tables 3
and 4;
An exposure to a PSE, if an event of sovereign default has
occurred during the previous 5 years in the PSE's home country--Sec.
628.32(e)(6) and Tables 3 and 4;
HVCRE exposures--Sec. 628.32(j); and
The portion of a past due exposure that is not guaranteed
or that is not secured by financial collateral (except for a sovereign
exposure or a residential mortgage exposure, both risk-weighted as
discussed above)--Sec. 628.32(k).
6. Six Hundred-Percent (600%) Risk-Weighted Exposures
An equity exposure to an investment firm, provided that
the investment firm meets specified conditions--Sec. 628.52(b).
7. One Thousand Two Hundred Fifty-Percent (1,250%) Risk-Weighted
Exposures
Certain high-risk securitization exposures, such as CEIO
strips--Sec. Sec. 628.41-628.45.
8. Past Due Exposures (90 Days or More Past Due or in Nonaccrual
Status)
One hundred (100) percent--residential mortgage
exposures--Sec. 628.32(g);
A System institution may assign a risk weight to the
guaranteed portion of a past due exposure based on the risk weight that
applies under Sec. 628.36 if the guarantee or credit derivative meets
the requirements of that section--Sec. 628.32(k)(2);
A System institution may assign a risk weight to the
portion of a past due exposure that is collateralized by financial
collateral based on the risk weight that applies under Sec. 628.37 if
the financial collateral meets the requirements of that section--Sec.
628.32(k)(3); and
One hundred fifty (150) percent--all other past due
exposures--Sec. 628.32(k).
9. Conversion Factors for Off-Balance Sheet Items--Sec. 628.33
Zero percent (0%)--the unused portion of a commitment that
is unconditionally cancellable by the System institution;
Twenty percent (20%)--
[cir] Commitment with an original maturity of 14 months or less
that is not unconditionally cancellable by the System institution; and
[cir] Self-liquidating, trade-related contingent items that arise
from the movement of goods, with an original maturity of 14 months or
less;
Fifty percent (50%)--
[cir] Commitments with an original maturity of more than 14 months
that are not unconditionally cancellable by the System institution; and
[cir] Transaction-related contingent items, including performance
bonds, bid bonds, warranties, and performance standby letters of
credit;
One hundred percent (100%)--
[cir] Guarantees;
[cir] Repurchase agreements (the off-balance sheet component of
which equals the sum of the current fair values of all positions the
System institution has sold subject to repurchase);
[cir] Credit-enhancing representations and warranties that are not
securitization exposures;
[cir] Off-balance sheet securities lending transactions (the off-
balance sheet component of which equals the sum of the current fair
values of all positions the System institution has lent under the
transaction);
[cir] Off-balance sheet securities borrowing transactions (the off-
balance sheet component of which equals the sum of the current fair
values of all non-cash positions the System institution has posted as
collateral under the transaction);
[cir] Financial standby letters of credit; and
[cir] Forward agreements.
10. Over-the-Counter (OTC) Derivative Contracts--Sec. 628.34
The System institution would determine the risk-based capital
requirement for a derivative contract by determining the exposure
amount and then assigning a risk weight based on the counterparty or
collateral. The exposure amount is the sum of current exposure plus
potential future credit exposure (PFE). The current credit exposure is
the greater of 0 or the mark-to-fair value of the derivative contract.
The PFE is generally the notional amount of the derivative contract
multiplied by a credit conversion factor for the type of derivative
contract. Table
[[Page 52864]]
1 to proposed Sec. 628.34 shows the credit conversion factors for
derivative contracts.
11. Treatment of Cleared Transactions--Sec. 628.35
The proposal introduces a specific capital treatment for exposures
to central counterparties (CCPs), including certain transactions
conducted through clearing members by System institutions that are not
themselves clearing members of a CCP. Proposed Sec. 628.35 describes
the capital treatment of cleared transactions and of default fund
exposures to CCPs, including more favorable capital treatment for
cleared transactions through CCPs that meet certain criteria.
12. Treatment of Guarantees--Sec. 628.36
The proposal would allow a System institution to substitute the
risk weight of an eligible guarantor for the risk weight otherwise
applicable to the guaranteed exposure. This treatment would apply only
to eligible guarantees and eligible credit derivatives, and it would
provide certain adjustments for maturity mismatches, currency
mismatches, and situations where restructuring is not treated as a
credit event. To be an eligible guarantee, the guarantee would be
required to be from an eligible guarantor (as defined in the proposal)
and would have to satisfy the definitional requirements of eligible
guarantee.
13. Treatment of Collateralized Transactions--Sec. 628.37
The proposal allows System institutions to recognize the risk-
mitigating benefits of financial collateral (as defined) in risk-
weighted assets. In all cases, the System institution would be required
to have a perfected, first priority interest in the financial
collateral.
Where the collateral satisfies specified criteria, a System
institution could use the simple approach--that is, it could apply a
risk weight to the portion of an exposure that is secured by the fair
value of financial collateral by using the risk weight of the
collateral. There is a general risk weight floor of 20 percent.
For repo-style transactions, eligible margin loans, collateralized
derivative contracts, and single-product netting sets of such
transactions, a System institution could instead use the collateral
haircut approach--that is, it could reduce the amount of exposure to be
risk weighted (rather than substituting the risk weight of the
collateral).
A System institution would be required to use the same approach for
similar exposures or transactions.
14. Unsettled Transactions--Sec. 628.38
The proposal provides for a separate risk-based capital requirement
for transactions involving securities, foreign exchange instruments,
and commodities that have a risk of delayed settlement or delivery. The
proposed capital requirement would not, however, apply to certain types
of transactions, including cleared transactions that are marked-to-
market daily and subject to daily receipt and payment of variation
margin. The proposal contains separate treatments for delivery-versus-
payment (DvP) and payment-versus-payment (PvP) transactions with a
normal settlement period, and non-DvP/non-PvP transactions with a
normal settlement period.
15. Securitization Exposures--Sec. Sec. 628.41-628.45
The proposed rule introduces due diligence and other requirements
for System institutions that own, originate, or purchase securitization
exposures and introduces a new definition of securitization exposure.
Under the proposed rule, a System institution that originates the
underlying exposures included in a securitization could have a
securitization exposure and, if so, would be subject to the
requirements.
Note that mortgage-backed pass-through securities (for example,
those guaranteed by FHLMC or FNMA) do not meet the proposed definition
of a securitization exposure because they do not involve a tranching of
credit risk. Rather, only those MBS that involve tranching of credit
risk would be securitization exposures.
16. Equity Exposures--Sec. Sec. 628.51-628.52
A System institution would apply a simple risk-weight approach
(SRWA) to determine the risk weight for equity exposures that are not
exposures to an investment fund.
17. Equity Exposures to Investment Funds--Sec. 628.53
The proposals described in this section would apply to equity
exposures to investment funds such as mutual funds, but not to hedge
funds or other leveraged investment funds. For exposures to investment
funds (other than certain equity exposures authorized under Sec.
615.5140(e), for which the risk-weighted asset amount is equal to their
adjusted carrying value for the fund), a System institution must use
one of three risk-weighting approaches: The full-look through approach;
the simple modified look-through approach; or the alternative modified
look-through approach.
18. Foreign Exposures--Sec. 628.32(a), (d), and (e), and Tables 1, 2,
3, and 4
Under the proposal a System institution would risk weight an
exposure to a foreign government, foreign public sector entity (PSE),
and a foreign bank based on the Country Risk Classification (CRC) that
is applicable to the foreign government, or the home country of the
foreign PSE or foreign bank. If a foreign country does not have a CRC,
the risk weighting for its government, PSEs, and banks would depend on
whether or not the country is a member of the Organization for Economic
Cooperation and Development (OECD). A sovereign exposure would be
assigned a 150-percent risk weight immediately upon determining that an
event of sovereign default has occurred, or if an event of sovereign
default has occurred during the previous 5 years.
The risk weights for foreign sovereigns, foreign banks, and foreign
PSEs are shown in the tables below:
Table 1--Risk Weights for Foreign Sovereign Exposures
------------------------------------------------------------------------
Risk weight
(in percent)
------------------------------------------------------------------------
Sovereign CRC:
0-1................................................. 0
2................................................... 20
3................................................... 50
4-6................................................. 100
7................................................... 150
OECD Member with no CRC................................. 0
Non-OECD Member with no CRC............................. 100
Sovereign Default....................................... 150
------------------------------------------------------------------------
Table 2--Risk Weights for Exposures to Foreign Banks
------------------------------------------------------------------------
Risk weight
(in percent)
------------------------------------------------------------------------
Sovereign CRC:
0-1................................................. 20
2................................................... 50
3................................................... 100
4-7................................................. 150
OECD Member with no CRC................................. 20
Non-OECD Member with no CRC............................. 100
Sovereign Default....................................... 150
------------------------------------------------------------------------
[[Page 52865]]
Table 3--Risk Weights for Foreign PSE General Obligations
------------------------------------------------------------------------
Risk weight
(in percent)
------------------------------------------------------------------------
Sovereign CRC:
0-1................................................. 20
2................................................... 50
3................................................... 100
4-7................................................. 150
OECD Member with no CRC................................. 20
Non-OECD Member with no CRC............................. 100
Sovereign Default....................................... 150
------------------------------------------------------------------------
Table 4--Risk Weights for Foreign PSE Revenue Obligations
------------------------------------------------------------------------
Risk weight
(in percent)
------------------------------------------------------------------------
Sovereign CRC:
0-1................................................. 50
2-3................................................. 100
4-7................................................. 150
OECD Member with no CRC................................. 50
Non-OECD Member with no CRC............................. 100
Sovereign Default....................................... 150
------------------------------------------------------------------------
Table 19--Summary Comparison of Current Risk-Weighting Rules Versus Proposed Risk-Weighting Rules
----------------------------------------------------------------------------------------------------------------
Current risk weight (in
Category general) Proposal Comments
----------------------------------------------------------------------------------------------------------------
Risk Weights for On-Balance Sheet Exposures Under Current and Proposed Rules
----------------------------------------------------------------------------------------------------------------
Cash................................. 0%..................... 0%.
Direct exposures to or 0%..................... 0%. .......................
unconditionally guaranteed by the
U.S. Government, its central bank,
or a U.S. Government agency.
Exposures to certain supranational 20%.................... 0%. .......................
entities and multilateral
development banks.
Cash items in the process of 20%.................... 20%. .......................
collection.
Conditional exposures to the U.S. 20%.................... 20%. A conditional exposure
Government. is one that requires
the satisfaction of
certain conditions,
for example, servicing
requirements.
Exposures to Government-sponsored 20% (including 20%--exposures other
entities (GSEs). preferred stock). than preferred stock
and equity exposures.
100%--preferred stock. .......................
Most exposures to U.S. depository 20%.................... 20%. .......................
institutions or credit unions
(including those that are OFIs).
Exposures to U.S. public sector 20%--general 20%--general
entities (PSEs). obligations. obligations.
50%--revenue 50%--revenue
obligations. obligations..
Exposures to other System 20%.................... 20%. .......................
institutions that are not deducted
from tier 1 or tier 2 capital.
Corporate exposures (including 100%................... 100%. .......................
exposures to OFIs that do not
satisfy the criteria for a lower
risk weight and agricultural
borrowers).
High volatility commercial real 100% (not specifically 150%. .......................
estate (HVCRE) loans. addressed).
Past due exposures................... Generally no change 100%--residential 90 days or more past
when an exposure is mortgage exposures. due or in nonaccrual.
past due.
Past due QRLs--100%.... 150%--all other .......................
exposures, for the
portion that is not
guaranteed or secured
by financial
collateral.
Servicing assets..................... 100% (not specifically 100%--MSAs. .......................
addressed).
mortgage servicing (Non-MSAs deducted from
assets (MSAs) and non- capital).
MSAs.
Deferred tax assets.................. Certain DTAs deducted 100%--DTAs arising from .......................
from capital. temporary differences
that could be realized
through net operating
carrybacks.
Other DTAs--100% (not (Other DTAs deducted
specifically from capital).
addressed).
[[Page 52866]]
Assets not specifically assigned to a 100%................... 100%................... Includes:
risk-weight category and not --borrower loans such
deducted from tier 1 or tier 2 as agricultural loans
capital. and consumer loans,
unless qualify for 50%
risk weighting.
--premises, fixed
assets, and other real
estate owned.
Exposures to foreign governments and 0% for direct and Risk weight depends on .......................
their central banks. unconditional claims Country Risk
on OECD governments. Classification (CRC)
20% for conditional applicable to the
claims on OECD sovereign. If there is
governments. no CRC, depends on
100% for claims on non- OECD membership. Risk
OECD governments. weights range between
0% and 150%. 150% for
a sovereign that has
defaulted within the
previous 5 years.
Exposures to foreign banks........... 20% for claims on banks Risk weight depends on .......................
in OECD countries. home country's CRC
20% for short-term rating. If there is no
claims on banks in non- CRC, depends on OECD
OECD countries. membership of home
100% for long-term country. Risk weights
claims on banks in non- range between 20% and
OECD countries. 150%.
150% in the case of a
sovereign default in
the bank's home
country.
Claims on foreign PSEs............... 20% for general Risk weight depends on
obligations of states the home country's
and political CRC. If there is no
subdivisions of OECD CRC, risk depends on
countries. OECD membership of
50% for revenue home country. Risk
obligations of states weights range between
and political 20% and 150% for
subdivisions of OECD general obligations
countries. and between 50% and
100% for all 150% for revenue
obligations of states obligations.
and political 150% for a PSE in a
subdivisions of non- home country with a
OECD countries. sovereign default.
MBS, ABS, and structured securities.. Ratings-based approach. Deduction for the after-
tax gain-on-sale of a
securitization.
1,250% risk weight for
a CEIO.
100% for interest-only
MBS that are not
credit-enhancing.
System institutions may
elect to follow a
gross up approach--
senior securitization
tranches are assigned
the risk weight
association with the
underlying exposures.
System institutions may
instead elect to
follow the simplified
supervisory formula
approach (SSFA)--
requires various data
inputs to a
supervisory formula
exposure.
Alternatively, System .......................
institutions may apply
a 1,250% risk weight
to any securitization.
Unsettled transactions............... Not addressed.......... 100%, 625%, 937.5%, and .......................
1,250% for DvP or PvP
transactions depending
on the number of
business days past the
settlement date.
1,250% for non-DvP, non-
PvP transactions more
than 5 days past the
settlement date.
[[Page 52867]]
The proposed capital
requirement for
unsettled transactions
would not apply to
cleared transactions
that are marked-to-
market daily and
subject to daily
receipt and payment of
variation margin.
Equity exposures..................... 100%................... 0% risk weight: equity .......................
exposures to any
entity whose credit
exposures receive a 0%
risk weight.
20%: Equity exposures
to a PSE or Farmer Mac.
100%: Certain equity
exposures authorized
under Sec.
615.5140(e), equity
exposures to effective
portions of hedge
pairs, and equity
exposures to non-
significant equity
investments.
600%: Equity exposures
to investment firms
that satisfy certain
conditions.
Equity exposures to investment funds. There is a 20% risk Except for certain
weight floor on mutual equity exposures
fund holdings. authorized under Sec.
615.5140(e), choose
among three
approaches: full look-
through; simple
modified look-through;
and alternative
modified look-through.
Full look-through: Risk
weight the assets of
the fund (as if owned
directly) multiplied
by the System
institution's
proportional ownership
in the fund.
Simple modified look-
through: Multiply the
System institution's
exposure by the risk
weight of the highest
risk weight asset in
the fund.
Alternative modified
look-through: Assign
risk weight on a pro
rata basis based on
the investment limits
in the fund's
prospectus.
For certain equity
exposures authorized
under Sec.
615.5140(e), risk-
weighted asset amount
= adjusted carrying
value.
----------------------------------------------------------------------------------------------------------------
Credit Conversion Factors (CCF) Under the Current and Proposed Rules
----------------------------------------------------------------------------------------------------------------
CCF for off-balance sheet items...... 0% for the unused 0% for the unused .......................
portion of a portion of a
commitment with an commitment that is
original maturity of unconditionally
14 months or less, or cancellable by the
which is System institution.
unconditionally
cancellable by the
System institution at
any time.
20% for short-term, 20% for the unused
self-liquidating, portion of a
trade-related commitment with an
contingent items. original maturity of
14 months or less that
is not unconditionally
cancellable by the
System institution.
50% for the unused 20% for self-
portion of a liquidating trade-
commitment with an related contingent
original maturity of items that arise from
more than 14 months the movement of goods,
that is not with an original
unconditionally maturity of 14 months
cancellable by the or less.
System institution.
[[Page 52868]]
50% for transaction- 50% for the unused
related contingent portion of a
items (performance commitment over 14
bonds, bid bonds, months that is not
warranties, and unconditionally
standby letters of cancellable by the
credit). System institution.
100% for guarantees, 50% for transaction-
repurchase agreements, related contingent
securities lending and items (performance
borrowing bonds, bid bonds,
transactions, warranties, and
financial standby standby letters of
letters of credit, and credit).
forward agreements.
100% for guarantees,
repurchase agreements,
securities lending and
borrowing
transactions,
financial standby
letters of credit, and
forward agreements.
OTC derivative contracts (except Calculation of off- Calculation of off-
cleared transactions). balance sheet credit balance sheet credit
equivalents based on equivalents amount
current exposure plus based on current
potential future exposure plus
exposure and a set of potential future
conversion factors. exposure and a revised
set of conversion
factors.
Recognition of credit
risk mitigation of
collateralized OTC
derivative contracts.
Cleared transactions................. Not specifically If collateral posted
addressed. with a qualified
central counterparty,
and subject to
specific requirements,
then assign 2 percent;
or
If requirements not
met, then assign 4
percent.
----------------------------------------------------------------------------------------------------------------
Credit Risk Mitigation Under the Current and Proposed Rules
----------------------------------------------------------------------------------------------------------------
Guarantees........................... Generally recognizes Recognizes guarantees Claims conditionally
guarantees provided by from eligible guaranteed by the U.S.
central governments, guarantors, as defined. government receive a
GSEs, PSEs in OECD Substitution treatment risk weight of 20
countries, allows the System percent.
multilateral lending institution to
institutions, regional substitute the risk
development weight of the
institutions, U.S. protection provider
depository for the risk weight
institutions, foreign ordinarily assigned to
banks, and qualifying the exposure.
securities firms in Applies only to
OECD countries. eligible guarantees
and eligible credit
derivatives, and
adjusts for maturity
mismatches, currency
mismatches, and where
restructuring is not
treated as a credit
event.
Collateralized transactions.......... No recognition......... For financial Financial collateral
collateral only, the does not include does
proposal provides two not include collateral
approaches. such as real estate or
chattel. In all cases
the System institution
must have a perfected,
1st priority interest.
1. Simple approach..... For the simple approach
A System institution there must be a
may apply a risk collateral agreement
weight to the portion for at least the life
of an exposure that is of the exposure;
secured by the fair collateral must be
value of collateral by revalued at least
using the risk weight every 6 months;
of the collateral-- collateral other than
with a general risk gold must be in the
weight floor of 20%. same currency.
2. Collateral haircut
approach.
A System institution
may use standard
supervisory haircuts
for eligible margin
loans, repo-style
transactions, and
collateralized
derivative contracts.
----------------------------------------------------------------------------------------------------------------
[[Page 52869]]
20. Disclosure Requirements--Sec. Sec. 628.61-628.63 (Including Tables
1-10)
The proposed rule would require each System bank, generally on a
quarterly basis, to make public disclosures related to its capital
requirements. Disclosures would be required as follows:
Table 1--Scope of Application--would provide the basic context
underlying regulatory capital calculations.
Table 2--Capital Structure--would provide summary information on
the terms and conditions of the main features of regulatory capital
instruments. Would also require disclosure of the total amount of CET1,
tier 1, and total capital, with separate disclosures for deductions and
adjustments to capital.
Table 3--Capital Adequacy--would provide information on a System
bank's approach for categorizing and risk-weighting its exposures, as
well as the amount of total risk-weighted assets.
Table 4--Capital Conservation Buffer--would require a System bank
to disclosure the capital conservation buffer, the eligible retained
income and any limitations on capital distributions and certain
discretionary bonus payments, as applicable.
Table 5--Credit Risk: General Disclosures--would require a System
bank to disclose information pertaining to its general credit risk.
Table 6--General Disclosure for Counterparty Credit Risk-Related
Exposures--would require a System bank to disclose information
pertaining to its counterparty credit risk.
Table 7--Credit Risk Mitigation--would require a System bank to
disclose information pertaining to credit risk mitigation.
Table 8--Securitization--would provide information to market
participants on the amount of credit risk transferred and retained by a
System bank through securitization transactions, the types of products
involved in the System bank's securitizations, the risks inherent in
the System bank's securitized assets, the System bank's policies
regarding credit risk mitigation, and the names of any entities that
provide external credit assessments of a securitization.\126\
Securitization transactions in which the originating System bank does
not retain any securitization exposure would be shown separately and
would only be reported for the year of inception of the
transaction.\127\
---------------------------------------------------------------------------
\126\ For purposes of these disclosures (and these capital
regulations), a System bank would be considered to have securitized
assets if assets that it originated or purchased from third parties
are included in a securitization.
\127\ A System bank is authorized to act as an ``originating
System institution,'' which the proposed regulation would define as
a System institution that directly or indirectly originated the
underlying exposures included in a securitization.
---------------------------------------------------------------------------
Table 9--Equities--would provide market participants with an
understanding of the types of equity securities held by the System bank
and how they are valued. Would also provide information on the capital
allocated to different equity products and the amount of unrealized
gains and losses.
Table 10--Interest Rate Risk for Non-Trading Activities--would
require a System bank to provide certain quantitative and qualitative
disclosures regarding the System bank's management of interest rate
risks.
List of Subjects
12 CFR Part 607
Accounting, Agriculture, Banks, banking, Reporting and
recordkeeping requirements, Rural areas.
12 CFR Part 614
Agriculture, Banks, banking, Foreign trade, Reporting and
recordkeeping requirements, Rural areas.
12 CFR Part 615
Accounting, Agriculture, Banks, banking, Government securities,
Investments, Rural areas.
12 CFR Part 620
Accounting, Agriculture, Banks, banking, Reporting and
recordkeeping requirements, Rural areas.
12 CFR Part 628
Accounting, Agriculture, Banks, banking, Capital, Government
securities, Investments, Rural areas.
For the reasons stated in the preamble, parts 607, 614, 615, 620,
and 628 of chapter VI, title 12 of the Code of Federal Regulations are
proposed to be amended as follows:
PART 607--ASSESSMENT AND APPORTIONMENT OF ADMINISTRATIVE EXPENSES
0
1. The authority citation for part 607 continues to read as follows:
Authority: Secs. 5.15, 5.17 of the Farm Credit Act (12 U.S.C.
2250, 2252) and 12 U.S.C. 3025.
0
2. Section 607.2 is amended by revising paragraph (b) introductory text
to read as follows:
Sec. 607.2 Definitions.
* * * * *
(b) Average risk-adjusted asset base means the average of the risk-
adjusted asset base (as defined in Sec. 615.5201 of this chapter) of
banks, associations, and designated other System entities, calculated
as follows:
* * * * *
PART 614--LOAN POLICIES AND OPERATIONS
0
3. The authority citation for part 614 continues to read as follows:
Authority: 42 U.S.C. 4012a, 4104a, 4104b, 4106, and 4128; secs.
1.3, 1.5, 1.6, 1.7, 1.9, 1.10, 1.11, 2.0, 2.2, 2.3, 2.4, 2.10, 2.12,
2.13, 2.15, 3.0, 3.1, 3.3, 3.7, 3.8, 3.10, 3.20, 3.28, 4.12, 4.12A,
4.13B, 4.14, 4.14A, 4.14C, 4.14D, 4.14E, 4.18, 4.18A, 4.19, 4.25,
4.26, 4.27, 4.28, 4.36, 4.37, 5.9, 5.10, 5.17, 7.0, 7.2, 7.6, 7.8,
7.12, 7.13, 8.0, 8.5 of the Farm Credit Act (12 U.S.C. 2011, 2013,
2014, 2015, 2017, 2018, 2019, 2071, 2073, 2074, 2075, 2091, 2093,
2094, 2097, 2121, 2122, 2124, 2128, 2129, 2131, 2141, 2149, 2183,
2184, 2201, 2202, 2202a, 2202c, 2202d, 2202e, 2206, 2206a, 2207,
2211, 2212, 2213, 2214, 2219a, 2219b, 2243, 2244, 2252, 2279a,
2279a-2, 2279b, 2279c-1, 2279f, 2279f-1, 2279aa, 2279aa-5); sec. 413
of Pub. L. 100-233, 101 Stat. 1568, 1639.
0
4. Section 614.4351 is amended by revising paragraph (a)(3) to read as
follows:
Sec. 614.4351 Computation of lending and leasing limit base.
(a) * * *
(3) Any amounts of preferred stock not eligible to be included in
tier 2 capital as defined in Sec. 628.2 must be deducted from the
lending limit base.
* * * * *
PART 615--FUNDING AND FISCAL AFFAIRS, LOAN POLICIES AND OPERATIONS,
AND FUNDING OPERATIONS
0
5. The authority citation for part 615 is revised 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),
Pub. L. 100-233, 101 Stat. 1568, 1608; sec. 939A, Pub. L. 111-203,
124 Stat. 1326, 1887 (15 U.S.C. 78o-7 note).
0
6. Section 615.5143 is amended by revising paragraphs (a)(3) and (b)(4)
to read as follows:
Sec. 615.5143 Management of ineligible investments and reservation of
authority to require divestiture.
(a) * * *
[[Page 52870]]
(3) It must be excluded as collateral under Sec. 615.5050.
(b) * * *
(4) You may continue to hold the investment as collateral under
Sec. 615.5050 at the lower of cost or market value.
* * * * *
0
7. Sections 615.5200 and 615.5201 are revised to read as follows:
Sec. 615.5200 Capital planning.
(a) The Board of Directors of each System institution shall
determine the amount of capital needed to assure the System
institution's continued financial viability and to provide for growth
necessary to meet the needs of its borrowers. The minimum capital
standards specified in this part and part 628 of this chapter are not
meant to be adopted as the optimal capital level in the System
institution's capital adequacy plan. Rather, the standards are intended
to serve as minimum levels of capital that each System institution must
maintain to protect against the credit and other general risks inherent
in its operations.
(b) Each Board of Directors shall establish, adopt, and maintain a
formal written capital adequacy plan as a part of the financial plan
required by Sec. 618.8440 of this chapter. The plan shall include the
capital targets that are necessary to achieve the System institution's
capital adequacy goals as well as the minimum permanent capital, common
equity tier 1 capital, tier 1 capital, total capital, and tier 1
leverage ratio (including the unallocated retained earnings (URE) and
URE equivalents minimum) standards. The plan shall address any
projected dividends, patronage distribution, equity retirements, or
other action that may decrease the System institution's capital or the
components thereof for which minimum amounts are required by this part.
The plan shall set forth the circumstances in which retirements or
revolvements of stock or equities may occur. In addition to factors
that must be considered in meeting the minimum standards, the board of
directors shall also consider at least the following factors in
developing the capital adequacy plan:
(1) Capability of management and the board of directors;
(2) Quality of operating policies, procedures, and internal
controls;
(3) Quality and quantity of earnings;
(4) Asset quality and the adequacy of the allowance for losses to
absorb potential loss within the loan and lease portfolios;
(5) Sufficiency of liquid funds;
(6) Needs of a System institution's customer base; and
(7) Any other risk-oriented activities, such as funding and
interest rate risks, potential obligations under joint and several
liability, contingent and off-balance-sheet liabilities or other
conditions warranting additional capital.
Sec. 615.5201 Definitions.
For the purpose of this subpart, the following definitions apply:
Nonagreeing association means an association that does not have an
allotment agreement in effect with a Farm Credit Bank or agricultural
credit bank pursuant to Sec. 615.5207(b)(2).
Permanent capital, subject to adjustments as described in Sec.
615.5207, includes:
(1) Current year earnings;
(2) Allocated and unallocated earnings (which, in the case of
earnings allocated in any form by a System bank to any association or
other recipient and retained by the bank, must be considered, in whole
or in part, permanent capital of the bank or of any such association or
other recipient as provided under an agreement between the bank and
each such association or other recipient);
(3) All surplus excluding accumulated other comprehensive income,
except defined benefits pension fund net assets as reported under GAAP;
(4) Stock issued by a System institution, except:
(i) Stock that may be retired by the holder of the stock on
repayment of the holder's loan, or otherwise at the option or request
of the holder;
(ii) Stock that is protected under section 4.9A of the Act or is
otherwise not at risk;
(iii) Farm Credit Bank equities required to be purchased by Federal
land bank associations in connection with stock issued to borrowers
that is protected under section 4.9A of the Act;
(iv) Capital subject to revolvement, unless:
(A) The bylaws of the System institution clearly provide that there
is no express or implied right for such capital to be retired at the
end of the revolvement cycle or at any other time; and
(B) The System institution clearly states in the notice of
allocation that such capital may only be retired at the sole discretion
of the board of directors in accordance with statutory and regulatory
requirements and that no express or implied right to have such capital
retired at the end of the revolvement cycle or at any other time is
thereby granted;
(5) [Reserved]
(6) Financial assistance provided by the Farm Credit System
Insurance Corporation that the FCA determines appropriate to be
considered permanent capital; and
(7) Any other debt or equity instruments or other accounts the FCA
has determined are appropriate to be considered permanent capital. The
FCA may permit one or more System institutions to include all or a
portion of such instrument, entry, or account as permanent capital,
permanently or on a temporary basis, for purposes of this part.
Preferred stock means stock that is permanent capital and has
dividend and/or liquidation preference over common stock.
Risk-adjusted asset base means standardized total risk-weighted
assets as defined in Sec. 628.2 of this chapter, adjusted in
accordance with Sec. 615.5207 and excluding the deduction for that
amount of the System institution's allowance for loan losses that is
not included in tier 2 capital.
Stock means stock and participation certificates.
System bank means a Farm Credit bank as defined in Sec. 619.9140
of this chapter, which includes Farm Credit Banks, agricultural credit
banks, and banks for cooperatives.
System institution means a System bank, an association of the Farm
Credit System, Farm Credit Leasing Services Corporation, and their
successors, and any other institution chartered by the FCA that the FCA
determines should be considered a System institution for the purposes
of this subpart.
Term preferred stock means preferred stock with an original
maturity of at least 5 years and on which, if cumulative, the board of
directors has the option to defer dividends, provided that, at the
beginning of each of the last 5 years of the term of the stock, the
amount that is eligible to be counted as permanent capital is reduced
by 20 percent of the original amount of the stock (net of redemptions).
0
8. Sections 615.5206, 615.5207, and 615.5208 are revised to read as
follows:
Sec. 615.5206 Permanent capital ratio computation.
(a) The System institution's permanent capital ratio is determined
on the basis of the financial statements of the System institution
prepared in accordance with generally accepted accounting principles.
(b) The System institution's asset base and permanent capital are
computed using average daily balances for the most recent 3 months.
[[Page 52871]]
(c) The System institution's permanent capital ratio is calculated
by dividing the System institution's permanent capital, adjusted in
accordance with Sec. 615.5207 (the numerator), by the risk-adjusted
asset base (the denominator) as defined in Sec. 615.5201, to derive a
ratio expressed as a percentage.
Sec. 615.5207 Capital adjustments and associated reductions to
assets.
For the purpose of computing the System institution's permanent
capital ratio, the following adjustments must be made prior to
assigning assets to risk-weight categories and computing the ratio:
(a) Where two System institutions have stock investments in each
other, such reciprocal holdings must be eliminated to the extent of the
offset. If the investments are equal in amount, each System institution
must deduct from its assets and its total capital an amount equal to
the investment. If the investments are not equal in amount, each System
institution must deduct from its total capital and its assets an amount
equal to the smaller investment. The elimination of reciprocal holdings
required by this paragraph must be made prior to making the other
adjustments required by this section.
(b) Where an association has an equity investment in a Farm Credit
bank, the double counting of capital is eliminated in the following
manner:
(1) For a purchased investment, each association must deduct its
investment in a System bank from its permanent capital. Each System
bank will consider all purchased stock investments as its permanent
capital.
(2) For an allocated investment, each System bank and each of its
affiliated associations may enter into an agreement that specifies, for
computing permanent capital, a dollar amount and/or percentage
allotment of the association's allocated investment between the bank
and the association. Section 615.5208 provides conditions for allotment
agreements or defines allotments in the absence of such agreements.
(c) A Farm Credit Bank or agricultural credit bank and a recipient,
other than an association, of allocated earnings from such bank may
enter into an agreement specifying a dollar amount and/or percentage
allotment of the recipient's allocated earnings in the bank between the
bank and the recipient. Such agreement must comply with the provisions
of paragraph (b) of this section, except that, in the absence of an
agreement, the allocated investment must be allotted 100 percent to the
allocating bank and 0 percent to the recipient. All equities of the
bank that are purchased by a recipient are considered as permanent
capital of the issuing bank.
(d) A bank for cooperatives or an agricultural credit bank and a
recipient of allocated earnings from such bank may enter into an
agreement specifying a dollar amount and/or percentage allotment of the
recipient's allocated earnings in the bank between the bank and the
recipient. Such agreement must comply with the provisions of paragraph
(b) of this section, except that, in the absence of an agreement, the
allocated investment must be allotted 100 percent to the allocating
bank and 0 percent to the recipient. All equities of a bank that are
purchased by a recipient shall be considered as permanent capital of
the issuing bank.
(e) Where a System institution has an equity investment in another
System institution to capitalize a loan participation interest, the
investing System institution must deduct from its permanent capital an
amount equal to its investment in the participating System institution.
(f) Where a System institution has an equity investment in a
service corporation chartered under section 4.25 of the Act or the
Funding Corporation chartered under section 4.9 of the Act, the
investing System institution must deduct from its permanent capital an
amount equal to its investment in the service corporation or the
Funding Corporation, respectively.
(g) Each System institution must deduct from its total capital an
amount equal to all goodwill, whenever acquired.
(h) To the extent a System institution has deducted its investment
in another System institution from its permanent capital, the
investment may be eliminated from its asset base.
(i) Where a Farm Credit bank and an association have an enforceable
written agreement to share losses on specifically identified assets on
a predetermined quantifiable basis, such assets must be counted in each
System institution's risk-adjusted asset base in the same proportion as
the System institutions have agreed to share the loss.
(j) The permanent capital of a System institution must exclude any
defined benefit pension fund net asset as reported under GAAP.
(k) For purposes of calculating capital ratios under this part,
deferred-tax assets are subject to the conditions, limitations, and
restrictions described in Sec. 628.22(a)(3) of this chapter.
(l) [Reserved]
Sec. 615.5208 Allotment of allocated investments.
(a) The following conditions apply to agreements that a System bank
enters into with an affiliated association pursuant to Sec.
615.5207(b)(2):
(1) The agreement must be for a term of 1 year or longer.
(2) The agreement must be entered into on or before its effective
date.
(3) The agreement may be amended according to its terms, but no
more frequently than annually except in the event that a party to the
agreement is merged or reorganized.
(4) On or before the effective date of the agreement, a certified
copy of the agreement, and any amendments thereto, must be sent to the
field office of the Farm Credit Administration responsible for
examining the System institution. A copy must also be sent within 30
calendar days of adoption to the bank's other affiliated associations.
(5) Unless the parties otherwise agree, if the System bank and the
association have not entered into a new agreement on or before the
expiration of an existing agreement, the existing agreement will
automatically be extended for another 12 months, unless either party
notifies the Farm Credit Administration in writing of its objection to
the extension prior to the expiration of the existing agreement.
(b) In the absence of an agreement between a System bank and one or
more associations, or in the event that an agreement expires and at
least one party has timely objected to the continuation of the terms of
its agreement, the following formula applies with respect to the
allocated investments held by those associations with which there is no
agreement (nonagreeing associations), and does not apply to the
allocated investments held by those associations with which the bank
has an agreement (agreeing associations):
(1) The allotment formula must be calculated annually.
(2) The permanent capital ratio of the System bank must be computed
as of the date that the existing agreement terminates, using a 3-month
average daily balance, excluding the allocated investment from
nonagreeing associations but including any allocated investments of
agreeing associations that are allotted to the bank under applicable
allocation agreements. The permanent capital ratio of each nonagreeing
association must be computed as of the same date using a 3-month
average daily balance, and must be computed excluding its allocated
investment in the bank.
(3) If the permanent capital ratio for the System bank calculated
in
[[Page 52872]]
accordance with Sec. 615.5208(b)(2) is 7 percent or above, the
allocated investment of each nonagreeing association whose permanent
capital ratio calculated in accordance with Sec. 615.5208(b)(2) is 7
percent or above must be allotted 50 percent to the bank and 50 percent
to the association.
(4) If the permanent capital ratio of the System bank calculated in
accordance with Sec. 615.5208(b)(2) is 7 percent or above, the
allocated investment of each nonagreeing association whose capital
ratio is below 7 percent must be allotted to the association until the
association's capital ratio reaches 7 percent or until all of the
investment is allotted to the association, whichever occurs first. Any
remaining unallotted allocated investment must be allotted 50 percent
to the bank and 50 percent to the association.
(5) If the permanent capital ratio of the System bank calculated in
accordance with Sec. 615.5208(b)(2) is less than 7 percent, the amount
of additional capital needed by the bank to reach a permanent capital
ratio of 7 percent must be determined, and an amount of the allocated
investment of each nonagreeing association must be allotted to the
System bank, as follows:
(i) If the total of the allocated investments of all nonagreeing
associations is greater than the additional capital needed by the bank,
the allocated investment of each nonagreeing association must be
multiplied by a fraction whose numerator is the amount of capital
needed by the bank and whose denominator is the total amount of
allocated investments of the nonagreeing associations, and such amount
must be allotted to the bank. Next, if the permanent capital ratio of
any nonagreeing association is less than 7 percent, a sufficient amount
of unallotted allocated investment must then be allotted to each
nonagreeing association, as necessary, to increase its permanent
capital ratio to 7 percent, or until all such remaining investment is
allotted to the association, whichever occurs first. Any unallotted
allocated investment still remaining must be allotted 50 percent to the
bank and 50 percent to the nonagreeing association.
(ii) If the additional capital needed by the bank is greater than
the total of the allocated investments of the nonagreeing associations,
all of the remaining allocated investments of the nonagreeing
associations must be allotted to the bank.
Sec. Sec. 615.5209, 615.5210, 615.5211, and 615.5212 [Removed and
reserved]
0
9. Sections 615.5209, 615.5210, 615.5211, and 615.5212 are removed and
reserved.
0
10. Section 615.5220 is revised to read as follows:
Sec. 615.5220 Capitalization bylaws.
(a) The board of directors of each System bank and association
shall, pursuant to section 4.3A of the Farm Credit Act of 1971 (Act),
adopt capitalization bylaws, subject to the approval of its voting
shareholders that set forth:
(1) Classes of equities and the manner in which they shall be
issued, transferred, converted and retired;
(2) For each class of equities, a description of the class(es) of
persons to whom such stock may be issued, voting rights, dividend
rights and preferences, and priority upon liquidation, including
rights, if any, to share in the distribution of the residual estate;
(3) The number of shares and par value of equities authorized to be
issued for each class of equities. However, the bylaws need not state a
number or value limit for these equities:
(i) Equities that are required to be purchased as a condition of
obtaining a loan, lease, or related service.
(ii) Non-voting stock resulting from the conversion of voting stock
due to repayment of a loan.
(iii) Non-voting equities that are issued to an association's
funding bank in conjunction with any agreement for a transfer of
capital between the association and the bank.
(iv) Equities resulting from the distribution of earnings.
(4) For Farm Credit Banks, agricultural credit banks (with respect
to loans other than to cooperatives), and associations, the percentage
or dollar amount of equity investment (which may be expressed as a
range within which the board of directors may from time to time
determine the requirement) that will be required to be purchased as a
condition for obtaining a loan, which amount shall be not less than, 2
percent of the loan amount or $1,000, whichever is less;
(5) For banks for cooperatives and agricultural credit banks (with
respect to loans to cooperatives), the percentage or dollar amount of
equity or guaranty fund investment (which may be expressed as a range
within which the board may from time to time determine the requirement)
that serves as a target level of investment in the bank for patronage-
sourced business, which amount shall not be less than, 2 percent of the
loan amount or $1,000, whichever is less;
(6) The manner in which equities will be retired, including a
provision stating that equities other than those protected under
section 4.9A of the Act are retireable at the sole discretion of the
board, provided minimum permanent capital adequacy standards
established in subpart H of this part are met;
(7) The manner in which earnings will be allocated and distributed,
including the basis on which patronage refunds will be paid, which
shall be in accord with cooperative principles; and
(8) For Farm Credit banks, the manner in which the capitalization
requirements of the Farm Credit bank shall be allocated and equalized
from time to time among its owners.
(b) The board of directors of each service corporation (including
the Farm Credit Leasing Services Corporation) shall adopt
capitalization bylaws, subject to the approval of its voting
shareholders, that set forth the requirements of paragraphs (a)(1),
(a)(2), and (a)(3) of this section to the extent applicable. Such
bylaws shall also set forth the manner in which equities will be
retired and the manner in which earnings will be distributed.
0
11. Section 615.5240 is revised to read as follows:
Sec. 615.5240 Capital requirements.
(a) The capitalization bylaws shall enable the institution to meet
the capital adequacy standards established under subpart H of this
part, part 628 of this chapter, and the capital requirements
established by the board of directors of the institution.
(b) In order to qualify as permanent capital, equities issued under
the bylaws must meet the following requirements:
(1) Retirement must be solely at the discretion of the board of
directors and not upon a date certain (other than the original maturity
date of preferred stock) or upon the happening of any event, such as
repayment of the loan, and not pursuant to any automatic retirement or
revolvement plan;
(2) Retirement must be at not more than book value;
(3) The institution must have made the disclosures required by this
subpart;
(4) For common stock and participation certificates, dividends must
be noncumulative and payable only at the discretion of the board; and
(5) For cumulative preferred stock, the board of directors must
have discretion to defer payment of dividends.
0
12. Sections 615.5250 and 615.5255 are revised to read as follows:
[[Page 52873]]
Sec. 615.5250 Disclosure requirements for sales of borrower stock.
(a) For sales of borrower stock, which for this subpart means
equities purchased as a condition for obtaining a loan, an institution
must provide a prospective borrower with the following documents prior
to loan closing:
(1) The institution's most recent annual report filed under part
620 of this chapter;
(2) The institution's most recent quarterly report filed under part
620 of this chapter, if more recent than the annual report;
(3) A copy of the institution's capitalization bylaws; and
(4) A written description of the terms and conditions under which
the equity is issued. In addition to specific terms and conditions, the
description must disclose:
(i) That the equity is an at-risk investment and not a compensating
balance;
(ii) That the equity is retireable only at the discretion of the
board of directors, consistent with the institution's bylaws, and only
if minimum capital standards established under subpart H of this part
and part 628 are met;
(iii) Whether the institution presently meets its minimum capital
standards established under subpart H of this part and part 628;
(iv) Whether the institution knows of any reason the institution
may not meet its capital standards on the next earnings distribution
date; and
(v) The rights, if any, to share in patronage distributions.
(b) Notwithstanding the provisions of paragraph (a) of this
section, no materials previously provided to a purchaser (except the
disclosures required by paragraph (a)(4) of this section) need be
provided again unless the purchaser requests such materials.
Sec. 615.5255 Disclosure and review requirements for sales of other
equities.
(a) A bank, association, or service corporation must submit a
proposed disclosure statement to the Farm Credit Administration (FCA)
for review and clearance prior to the proposed sale of any other
equities, which for this subpart means equities not purchased as a
condition for obtaining a loan.
(b) An institution may not offer to sell other equities until a
disclosure statement is reviewed and cleared by the FCA.
(c) A disclosure statement must include:
(1) All of the information required by part 620 of this chapter in
the annual report to shareholders as of a date within 135 days of the
proposed sale. An institution may incorporate by reference its most
recent annual report to shareholders and the most recent quarterly
report filed with the FCA in satisfaction of this requirement;
(2) The information required by Sec. 615.5250(a)(3) and (a)(4);
and
(3) A discussion of the intended use of the sale proceeds.
(d) An institution is not required to provide the materials
identified in paragraphs (c)(1) and (c)(2) of this section to a
purchaser who previously received them unless the purchaser requests
it.
(e) For any class of stock where each purchaser and each subsequent
transferee acquires at least $250,000 of the stock and meets the
definition of ``accredited investor'' or ``qualified institutional
buyer'' contained in 17 CFR 230.501 and 230.144A (or successor
provisions), a disclosure statement submitted pursuant to this section
is deemed reviewed and cleared by the FCA and an institution may treat
stock that meets all requirements of part 615 as permanent capital for
the purpose of meeting the minimum permanent capital standards
established under subpart H, unless the FCA notifies the institution to
the contrary within 30 days of receipt of a complete disclosure
statement submission. A complete disclosure statement submission
includes the proposed disclosure statement plus any additional
materials requested by the FCA.
(f) For all other issuances, a disclosure statement submitted
pursuant to this section is deemed cleared by the FCA, and an
institution may treat stock that meets all requirements of part 615 as
permanent capital for the purpose of meeting the minimum permanent
capital standards established under subpart H unless the FCA notifies
the institution to the contrary within 60 days of receipt of a complete
disclosure statement submission. A complete disclosure statement
submission includes the proposed disclosure statement plus any
additional materials requested by the FCA.
(g) Upon request, the FCA will inform the institution how it will
treat the proposed issuance for other regulatory capital ratios or
computations.
(h) No institution, officer, director, employee, or agent shall, in
connection with the sale of equities, make any disclosure, through a
disclosure statement or otherwise, that is inaccurate or misleading, or
omit to make any statement needed to prevent other disclosures from
being misleading.
(i) Each bank and association must establish a method to disclose
and make information on insider preferred stock purchases and
retirements readily available to the public. At a minimum, each
institution offering preferred stock must make this information
available upon request.
(j) The requirements of this section do not apply to the sale of
Farm Credit System institution equities to:
(1) Other Farm Credit System institutions,
(2) Other financing institutions in connection with a lending or
discount relationship, or
(3) Non-Farm Credit System lenders that purchase equities in
connection with a loan participation transaction.
(k) In addition to the requirements of this section, each
institution is responsible for ensuring its compliance with all
applicable Federal and state securities laws.
0
13. Section 615.5270 is revised to read as follows:
Sec. 615.5270 Retirement of other equities.
(a) Equities other than eligible borrower stock shall be retired at
not more than their book value.
(b) Subject to the redemption restrictions in part 628 of this
chapter, no equities shall be retired, except pursuant to Sec. Sec.
615.5280 and 615.5290 or term stock at its stated maturity, unless
after retirement the institution would continue to meet the minimum
permanent capital standards established under subpart H of this part.
(c) A bank, association, or service corporation board of directors
may delegate authority to retire at-risk stock to institution
management if:
(1) The board has determined that the institution's capital
position is adequate;
(2) All retirements are in accordance with applicable provisions of
part 628 of this chapter and the institution's capital adequacy plan or
capital restoration plan;
(3) The institution's permanent capital ratio will be in excess of
9 percent and the applicable capital conservation buffer set forth in
Sec. 628.11 of this chapter will be at or above 2.5 percent after any
retirements;
(4) The institution will continue to satisfy all applicable
regulatory capital standards after any retirements; and
(5) Management reports the aggregate amount and net effect of stock
purchases and retirements to the board of directors each quarter.
(d) Each board of directors of a bank, association, or service
corporation that issues preferred stock must adopt a written policy
covering the retirement of preferred stock that complies with this
paragraph and part 628 of this chapter
[[Page 52874]]
as applicable. The policy must, at a minimum:
(1) Establish any delegations of authority to retire preferred
stock and the conditions of delegation, which must meet the
requirements of paragraph (c) of this section and include minimum
levels for regulatory capital standards as applicable and commensurate
with the volatility of the preferred stock.
(2) Identify limitations on the amount of stock that may be retired
during a single quarterly (or shorter) time period;
(3) Ensure that all stockholder requests for retirement are treated
fairly and equitably;
(4) Prohibit any insider, including institution officers,
directors, employees, or agents, from retiring any preferred stock in
advance of the release of material non-public information concerning
the institution to other stockholders; and
(5) Establish when insiders may retire their preferred stock.
(e) The institution's board must review its policy at least
annually to ensure that it continues to be appropriate for the
institution's current financial condition and consistent with its long-
term goals established in its capital adequacy plan.
0
14. Section 615.5290 is revised to read as follows:
Sec. 615.5290 Retirement of capital stock and participation
certificates in event of restructuring.
(a) If a Farm Credit Bank or agricultural credit bank forgives and
writes off, under Sec. 617.7415 of this chapter, any of the principal
outstanding on a loan made to any borrower, where appropriate the
Federal land bank association of which the borrower is a member and
stockholder shall cancel the same dollar amount of borrower stock held
by the borrower in respect of the loan, up to the total amount of such
stock, and to the extent provided for in the bylaws of the Bank
relating to its capitalization, the Farm Credit Bank or agricultural
credit bank shall retire an equal amount of stock owned by the Federal
land bank association.
(b) If an association forgives and writes off, under Sec. 617.7415
of this chapter, any of the principal outstanding on a loan made to any
borrower, the association shall cancel the same dollar amount of
borrower stock held by the borrower in respect of the loan, up to the
total amount of such loan.
(c) Notwithstanding paragraphs (a) and (b) of this section, the
borrower shall be entitled to retain at least one share of stock to
maintain the borrower's membership and voting interest.
Subpart K [Removed and reserved]
0
15. Subpart K, consisting of Sec. Sec. 615.5301, 615.5330, 615.5335,
and 615.5336, is removed and reserved.
0
16. Section 615.5350 is amended by revising paragraph (a) to read as
follows:
Sec. 615.5350 General--applicability.
(a) The rules and procedures specified in this subpart are
applicable to a proceeding to establish required minimum capital ratios
that would otherwise be applicable to an institution under Sec. Sec.
615.5205 and 628.10 of this chapter. The Farm Credit Administration is
authorized to establish such minimum capital requirements for an
institution as the Farm Credit Administration, in its discretion, deems
to be necessary or appropriate in light of the particular circumstances
of the institution. Proceedings under this subpart also may be
initiated to require an institution having capital ratios greater than
those set forth in Sec. Sec. 615.5205 or 628.10 of this chapter to
continue to maintain those higher ratios.
* * * * *
0
17. Section 615.5352 is amended by revising paragraph (a) to read as
follows:
Sec. 615.5352 Procedures.
(a) Notice. When the Farm Credit Administration determines that
minimum capital ratios greater than those set forth in Sec. Sec.
615.5205 or 628.10 of this chapter are necessary or appropriate for a
particular institution, the Farm Credit Administration will notify the
institution in writing of the proposed minimum capital ratios and the
date by which they should be reached (if applicable) and will provide
an explanation of why the ratios proposed are considered necessary or
appropriate for the institution.
* * * * *
0
18. Section 615.5354 is revised to read as follows:
Sec. 615.5354 Enforcement.
An institution that does not have or maintain the minimum capital
ratios applicable to it, whether required in subpart H of this part and
part 628 of this chapter, in a decision pursuant to this subpart, in a
written agreement or temporary or final order under part C of title V
of the Act, or in a condition for approval of an application, or an
institution that has failed to submit or comply with an acceptable plan
to attain those ratios, will be subject to such administrative action
or sanctions as the Farm Credit Administration considers appropriate.
These sanctions may include the issuance of a capital directive
pursuant to subpart M of this part or other enforcement action,
assessment of civil money penalties, and/or the denial or condition of
applications.
0
19. Section 615.5355 is amended by revising paragraph (a) introductory
text to read as follows:
Sec. 615.5355 Purpose and scope.
(a) This subpart is applicable to proceedings by the Farm Credit
Administration to issue a capital directive under sections 4.3(b) and
4.3A(e) of the Act. A capital directive is an order issued to an
institution that does not have or maintain capital at or greater than
the minimum ratios set forth in Sec. Sec. 615.5205 and 628.10 of this
chapter; or established for the institution under subpart L of this
part, by a written agreement under part C of title V of the Act, or as
a condition for approval of an application. A capital directive may
order the institution to:
* * * * *
PART 620--DISCLOSURE TO SHAREHOLDERS
0
20. The authority citation for part 620 continues to read as follows:
Authority: Secs. 4.3, 4.3A, 4.19, 5.9, 5.17, 5.19 of the Farm
Credit Act (12 U.S.C. 2154, 2154a, 2207, 2243, 2252, 2254); sec. 424
of Pub. L. 100-233, 101 Stat. 1568, 1656; sec. 514 of Pub. L. 102-
552, 106 Stat. 4102.
0
21. Section 620.5 is amended by revising paragraph (d)(1)(ix) to read
as follows:
Sec. 620.5 Contents of the annual report to shareholders.
* * * * *
(d) * * *
(1) * * *
(ix) The statutory and regulatory restriction regarding retirement
of stock and distribution of earnings pursuant to Sec. 615.5215, and
any requirements to add capital under a plan approved by the Farm
Credit Administration pursuant to Sec. Sec. 615.5350, 615.5351,
615.5353, or 615.5357 of this chapter.
* * * * *
0
22. Section 620.17 is revised to read as follows:
Sec. 620.17 Special notice provisions for events related to
noncompliance with minimum regulatory capital ratios.
(a) For purposes of this section, ``regulatory capital ratios''
include the capital ratios specified in Sec. 628.10 of this chapter
and the permanent capital
[[Page 52875]]
standard prescribed under Sec. 615.5205 of this chapter.
(b) When a Farm Credit bank or association determines that it is
not in compliance with one or more applicable minimum regulatory
capital ratios, that institution must prepare and provide to its
shareholders and the FCA a notice stating that the institution has
initially determined it is not in compliance with the minimum
regulatory capital ratio or ratios. Such notice must be given within 30
days following the monthend.
(c) When notice is given under paragraph (b) of this section, the
institution must also notify its shareholders and the FCA when the
regulatory capital ratio or ratios that are the subject of such notice
decrease by one half of 1 percent or more from the level reported in
the original notice, or from that reported in a subsequent notice
provided under this paragraph. This notice must be given within 45 days
following the end of every quarter at which the institution's
regulatory capital ratio or ratios decreases as specified.
(d) Each institution required to prepare a notice under paragraph
(b) or (c) of this section shall provide the notice to shareholders or
publish it in any publication with circulation wide enough to be
reasonably assured that all of the institution's shareholders have
access to the information in a timely manner. The information required
to be included in this notice must be conspicuous, easily
understandable, and not misleading.
(e) A notice, at a minimum, shall include:
(1) A statement that:
(i) Briefly describes the regulatory capital ratios established by
the FCA and the notice requirement of paragraph (b) of this section;
(ii) Indicates the institution's current level of capital; and
(iii) Notifies shareholders that the institution's capital is below
the FCA minimum regulatory capital ratio or ratios.
(2) A statement of the effect that noncompliance has had on the
institution and its shareholders, including whether the institution is
currently prohibited by statute or regulation from retiring stock or
distributing earnings or whether the FCA has issued a capital directive
or other enforcement action to the institution.
(3) A complete description of any event(s) that may have
significantly contributed to the institution's noncompliance with the
minimum regulatory capital ratio or ratios.
(4) A statement that the institution is required by regulation to
provide another notice to shareholders within 45 days following the end
of any subsequent quarter at which the regulatory capital ratio or
ratios decrease by one half of 1 percent or more from the level
reported in the notice.
0
23. Part 628 is added to read as follows:
PART 628--CAPITAL ADEQUACY OF SYSTEM INSTITUTIONS
Subpart A--General Provisions
Sec.
628.1 Purpose, applicability, and reservations of authority.
628.2 Definitions.
628.3 Operational requirements for certain exposures.
628.4-628.9 [Reserved]
Subpart B--Capital Ratio Requirements and Buffers
628.10 Minimum capital requirements.
628.11 Capital conservation buffer.
628.12-628.19 [Reserved]
Subpart C--Definition of Capital
628.20 Capital components and eligibility criteria for regulatory
capital instruments.
628.21 [Reserved]
628.22 Regulatory capital adjustments and deductions.
628.23 Limits on third party capital.
628.24-628.29 [Reserved]
Subpart D--Risk-Weighted Assets--Standardized Approach
628.30 Applicability.
Risk-Weighted Assets for General Credit Risk
628.31 Mechanics for calculating risk-weighted assets for general
credit risk.
628.32 General risk weights.
628.33 Off-balance sheet exposures.
628.34 OTC derivative contracts.
628.35 Cleared transactions.
628.36 Guarantees and credit derivatives: substitution treatment.
628.37 Collateralized transactions.
Risk-Weighted Assets for Unsettled Transactions
628.38 Unsettled transactions.
628.39 through 628.40 [Reserved]
Risk-Weighted Assets for Securitization Exposures
628.41 Operational requirements for securitization exposures.
628.42 Risk-weighted assets for securitization exposures.
628.43 Simplified supervisory formula approach (SSFA) and the gross-
up approach.
628.44 Securitization exposures to which the SSFA and gross-up
approach do not apply.
628.45 Recognition of credit risk mitigants for securitization
exposures.
Risk-Weighted Assets for Equity Exposures
628.51 Introduction and exposure measurement.
628.52 Simple risk-weight approach (SRWA).
628.53 Equity exposures to investment funds.
628.54 through 628.60 [Reserved]
Disclosures
628.61 Purpose and scope.
628.62 Disclosure requirements.
628.63 Disclosures.
628.64 through 628.99 [Reserved]
Subpart E--[Reserved]
Subpart F--[Reserved]
Subpart G--Transition Provisions
628.300 Transitions.
628.301 Initial compliance and reporting requirements.
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),
Pub. L. 100-233, 101 Stat. 1568, 1608; sec. 939A, Pub. L. 111-203,
124 Stat. 1326, 1887 (15 U.S.C. 78o-7 note).
Subpart A--General Provisions
Sec. 628.1 Purpose, applicability, and reservations of authority.
(a) Purpose. This part establishes minimum capital requirements and
overall capital adequacy standards for System institutions. This part
includes methodologies for calculating minimum capital requirements,
public disclosure requirements related to the capital requirements, and
transition provisions for the application of this part.
(b) Limitation of authority. Nothing in this part limits the
authority of FCA to take action under other provisions of law,
including action to address unsafe or unsound practices or conditions,
deficient capital levels, or violations of law or regulation, under
part C of title V of the Farm Credit Act.
(c) Applicability. Subject to the requirements in paragraph (d) of
this section:
(1) Minimum capital requirements and overall capital adequacy
standards. Each System institution must calculate its minimum capital
requirements and meet the overall capital adequacy standards in subpart
B of this part.
(2) Regulatory capital. Each System institution must calculate its
regulatory capital in accordance with subpart C of this part.
(3) Risk-weighted assets. (i) Each System institution must use the
[[Page 52876]]
methodologies in subpart D of this part to calculate total risk-
weighted assets.
(ii) [Reserved]
(4) Disclosures. (i) All System banks must make the public
disclosures described in subpart D of this part.
(ii) [Reserved]
(iii) [Reserved]
(d) Reservation of authority--(1) Additional capital in the
aggregate. FCA may require a System institution to hold an amount of
regulatory capital greater than otherwise required under this part if
FCA determines that the System institution's capital requirements under
this part are not commensurate with the System institution's credit,
market, operational, or other risks according to part 615, subparts L
and M of this chapter.
(2) Regulatory capital elements. (i) If FCA determines that a
particular common equity tier 1 (CET1), additional tier 1 (AT1), or
tier 2 capital element has characteristics or terms that diminish its
permanence or its ability to absorb losses, or otherwise present safety
and soundness concerns, FCA may require the System institution to
exclude all or a portion of such element from CET1 capital, AT1
capital, or tier 2 capital, as appropriate.
(ii) Notwithstanding the criteria for regulatory capital
instruments set forth in subpart C of this part, FCA may find that a
capital element may be included in a System institution's CET1 capital,
AT1 capital, or tier 2 capital on a permanent or temporary basis
consistent with the loss absorption capacity of the element and in
accordance with Sec. 628.20(e).
(3) Risk-weighted asset amounts. If FCA determines that the risk-
weighted asset amount calculated under this part by the System
institution for one or more exposures is not commensurate with the
risks associated with those exposures, FCA may require the System
institution to assign a different risk-weighted asset amount to the
exposure(s) or to deduct the amount of the exposure(s) from its
regulatory capital.
(4) Total leverage. If FCA determines that the leverage exposure
amount, or the amount reflected in the System institution's reported
average total consolidated assets, for a balance sheet exposure
calculated by a System institution under Sec. 628.10 is inappropriate
for the exposure(s) or the circumstances of the System institution, FCA
may require the System institution to adjust this exposure amount in
the numerator and the denominator for purposes of the leverage ratio
calculations.
(5) [Reserved]
(6) Other reservation of authority. With respect to any deduction
or limitation required under this part, FCA may require a different
deduction or limitation, provided that such alternative deduction or
limitation is commensurate with the System institution's risk and
consistent with safety and soundness.
(e) Notice and response procedures. In making a determination under
this section, FCA will apply notice and response procedures in the same
manner as the notice and response procedures in Sec. 615.5352 of this
chapter.
(f) [Reserved]
Sec. 628.2 Definitions.
As used in this part:
Additional tier 1 capital (AT1) is defined in Sec. 628.20(c).
Allocated equities (stock or surplus) means a retained patronage
refund that a System institution has distributed to a borrower.\1\
---------------------------------------------------------------------------
\1\ System institutions as cooperatives are required to send
borrowers a written notice of allocation specifying the amount of
patronage refunds retained as equity pursuant to the Internal
Revenue Code section 1388. There are two types of allocated
equities: Qualified allocated equities and nonqualified allocated
equities. Allocated equities are redeemable at the System
institution board's discretion. Allocated equities contain no voting
rights and are generally subordinated to borrow stock in
receivership, insolvency, liquidation, or similar proceeding.
---------------------------------------------------------------------------
Allocated investment means earnings allocated but not paid in cash
by a System bank to an association or other recipient.
Allowances for loan losses (ALL) means valuation allowances that
have been established through a charge against earnings to cover
estimated credit losses on loans, lease financing receivables, or other
extensions of credit as determined in accordance with generally
accepted accounting principles (GAAP). For purposes of this part, ALL
includes allowances that have been established through a charge against
earnings to cover estimated credit losses associated with off-balance
sheet credit exposures as determined in accordance with GAAP.
Bank holding company means a bank holding company as defined in
section 2 of the Bank Holding Company Act.
Bank Holding Company Act means the Bank Holding Company Act of
1956, as amended (12 U.S.C. 1841 et seq.).
Bankruptcy remote means, with respect to an entity or asset, that
the entity or asset would be excluded from an insolvent entity's estate
in receivership, insolvency, liquidation, or similar proceeding.
Borrower stock means the capital investment a borrower holds in a
System institution in connection with a loan.
Call Report means reports of condition and performance, as
described in subpart D of part 621 of this chapter.
Carrying value means, with respect to an asset, the value of the
asset on the balance sheet of the System institution, determined in
accordance with GAAP.
Central counterparty (CCP) means a counterparty (for example, a
clearinghouse) that facilitates trades between counterparties in one or
more financial markets by either guaranteeing trades or novating
contracts.
CFTC means the U.S. Commodity Futures Trading Commission.
Clean-up call means a contractual provision that permits an
originating System institution or servicer to call securitization
exposures before their stated maturity or call date.
Cleared transaction means an exposure associated with an
outstanding derivative contract or repo-style transaction that a System
institution or clearing member has entered into with a central
counterparty (that is, a transaction that a central counterparty has
accepted).
(1) The following transactions are cleared transactions:
(i) [Reserved]
(ii) [Reserved]
(iii) A transaction between a clearing member client System
institution and a clearing member where the clearing member acts as a
financial intermediary on behalf of the clearing member client and
enters into an offsetting transaction with a CCP, provided that the
requirements set forth in Sec. 628.3(a) are met; or
(iv) A transaction between a clearing member client System
institution and a CCP where a clearing member guarantees the
performance of the clearing member client System institution to the CCP
and the transaction meets the requirements of Sec. 628.3(a)(2) and
(a)(3).
(2) [Reserved]
Clearing member means a member of, or direct participant in, a CCP
that is entitled to enter into transactions with the CCP.
Clearing member client means a party to a cleared transaction
associated with a CCP in which a clearing member either acts as a
financial intermediary with respect to the party or guarantees the
performance of the party to the CCP.
Collateral agreement means a legal contract that specifies the time
when, and circumstances under which, a counterparty is required to
pledge collateral to a System institution for a single financial
contract or for all
[[Page 52877]]
financial contracts in a netting set and confers upon the System
institution a perfected, first-priority security interest
(notwithstanding the prior security interest of any custodial agent),
or the legal equivalent thereof, in the collateral posted by the
counterparty under the agreement. This security interest must provide
the System institution with a right to close out the financial
positions and liquidate the collateral upon an event of default of, or
failure to perform by, the counterparty under the collateral agreement.
A contract would not satisfy this requirement if the System
institution's exercise of rights under the agreement may be stayed or
avoided under applicable law in the relevant jurisdictions, other than
in receivership, conservatorship, resolution under the Federal Deposit
Insurance Act, title II of the Dodd-Frank Act, under any similar
insolvency law applicable to GSEs, or under the Farm Credit Act.
Commitment means any legally binding arrangement that obligates a
System institution to extend credit or to purchase assets.
Commodity derivative contract means a commodity-linked swap,
purchased commodity-linked option, forward commodity-linked contract,
or any other instrument linked to commodities that gives rise to
similar counterparty credit risks.
Commodity Exchange Act means the Commodity Exchange Act of 1936 (7
U.S.C. 1 et seq.).
Common cooperative equity or equities means borrower stock,
participation certificates, and allocated equities issued or allocated
by a System institution to its members.
Common equity tier 1 capital (CET1) is defined in Sec. 628.20(b).
Company means a corporation, partnership, limited liability
company, depository institution, business trust, special purpose
entity, System institution, association, or similar organization.
Corporate exposure means an exposure to a company that is not:
(1) An exposure to a sovereign, the Bank for International
Settlements, the European Central Bank, the European Commission, the
International Monetary Fund, a multi-lateral development bank (MDB), a
depository institution, a foreign bank, a credit union, or a public
sector entity (PSE);
(2) An exposure to a GSE;
(3) A residential mortgage exposure;
(4) [Reserved];
(5) [Reserved];
(6) A high volatility commercial real estate (HVCRE) exposure;
(7) A cleared transaction;
(8) [Reserved];
(9) A securitization exposure;
(10) An equity exposure;
(11) An unsettled transaction; or
(12) An exposure to another System institution.
Country risk classification (CRC) with respect to a sovereign,
means the most recent consensus CRC published by the Organization for
Economic Cooperation and Development (OECD) as of December 31st of the
prior calendar year that provides a view of the likelihood that the
sovereign will service its external debt.
Credit derivative means a financial contract executed under
standard industry credit derivative documentation that allows one party
(the protection purchaser) to transfer the credit risk of one or more
exposures (reference exposure(s)) to another party (the protection
provider) for a certain period of time.
Credit-enhancing interest-only strip (CEIO) means an on-balance
sheet asset that, in form or in substance:
(1) Represents a contractual right to receive some or all of the
interest and no more than a minimal amount of principal due on the
underlying exposures of a securitization; and
(2) Exposes the holder of the CEIO to credit risk directly or
indirectly associated with the underlying exposures that exceeds a pro
rata share of the holder's claim on the underlying exposures, whether
through subordination provisions or other credit-enhancement
techniques.
Credit-enhancing representations and warranties means
representations and warranties that are made or assumed in connection
with a transfer of underlying exposures (including loan servicing
assets) and that obligate a System institution to protect another party
from losses arising from the credit risk of the underlying exposures.
Credit-enhancing representations and warranties include provisions to
protect a party from losses resulting from the default or
nonperformance of the counterparties of the underlying exposures or
from an insufficiency in the value of the collateral backing the
underlying exposures. Credit-enhancing representations and warranties
do not include:
(1) Early default clauses and similar warranties that permit the
return of, or premium refund clauses covering, 1-4 family residential
first mortgage loans that qualify for a 50-percent risk weight for a
period not to exceed 120 days from the date of transfer. These
warranties may cover only those loans that were originated within 1
year of the date of transfer;
(2) Premium refund clauses that cover assets guaranteed, in whole
or in part, by the U.S. Government, a U.S. Government agency or a
Government-sponsored enterprise (GSE), provided the premium refund
clauses are for a period not to exceed 120 days from the date of
transfer; or
(3) Warranties that permit the return of underlying exposures in
instances of misrepresentation, fraud, or incomplete documentation.
Credit risk mitigant means collateral, a credit derivative, or a
guarantee.
Credit union means an insured credit union as defined under the
Federal Credit Union Act (12 U.S.C. 1752 et seq.).
Current exposure means, with respect to a netting set, the larger
of 0 or the fair value of a transaction or portfolio of transactions
within the netting set that would be lost upon default of the
counterparty, assuming no recovery on the value of the transactions.
Current exposure is also called replacement cost.
Current exposure methodology means the method of calculating the
exposure amount for over-the-counter derivative contracts in Sec.
628.34(a).
Custodian means a company that has legal custody of collateral
provided to a CCP.
Depository institution means a depository institution as defined in
section 3 of the Federal Deposit Insurance Act.
Depository institution holding company means a bank holding company
or savings and loan holding company.
Derivative contract means a financial contract whose value is
derived from the values of one or more underlying assets, reference
rates, or indices of asset values or reference rates. Derivative
contracts include interest rate derivative contracts, exchange rate
derivative contracts, equity derivative contracts, commodity derivative
contracts, credit derivative contracts, and any other instrument that
poses similar counterparty credit risks. Derivative contracts also
include unsettled securities, commodities, and foreign exchange
transactions with a contractual settlement or delivery lag that is
longer than the lesser of the market standard for the particular
instrument or 5 business days.
Discretionary bonus payment means a payment made to a senior
officer of a System institution, where:
(1) The System institution retains discretion as to whether to
make, and the amount of, the payment until the payment is awarded to
the senior officer;
[[Page 52878]]
(2) The amount paid is determined by the System institution without
prior promise to, or agreement with, the senior officer; and
(3) The senior officer has no contractual right, whether express or
implied, to the bonus payment.
Dodd-Frank Act means the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (Pub. L. 111-203, 124 Stat. 1376).
Early amortization provision means a provision in the documentation
governing a securitization that, when triggered, causes investors in
the securitization exposures to be repaid before the original stated
maturity of the securitization exposures, unless the provision:
(1) Is triggered solely by events not directly related to the
performance of the underlying exposures or the originating System
institution (such as material changes in tax laws or regulations); or
(2) Leaves investors fully exposed to future draws by borrowers on
the underlying exposures even after the provision is triggered.
Effective notional amount means, for an eligible guarantee or
eligible credit derivative, the lesser of the contractual notional
amount of the credit risk mitigant and the exposure amount of the
hedged exposure, multiplied by the percentage coverage of the credit
risk mitigant.
Eligible clean-up call means a clean-up call that:
(1) Is exercisable solely at the discretion of the originating
System institution or servicer;
(2) Is not structured to avoid allocating losses to securitization
exposures held by investors or otherwise structured to provide credit
enhancement to the securitization; and
(3)(i) For a traditional securitization, is only exercisable when
10 percent or less of the principal amount of the underlying exposures
or securitization exposures (determined as of the inception of the
securitization) is outstanding; or
(ii) For a synthetic securitization, is only exercisable when 10
percent or less of the principal amount of the reference portfolio of
underlying exposures (determined as of the inception of the
securitization) is outstanding.
Eligible credit derivative means a credit derivative in the form of
a credit default swap, nth-to-default swap, total return swap, or any
other form of credit derivative approved by the FCA, provided that:
(1) The contract meets the requirements of an eligible guarantee
and has been confirmed by the protection purchaser and the protection
provider;
(2) Any assignment of the contract has been confirmed by all
relevant parties;
(3) If the credit derivative is a credit default swap or nth-to-
default swap, the contract includes the following credit events:
(i) Failure to pay any amount due under the terms of the reference
exposure, subject to any applicable minimal payment threshold that is
consistent with standard market practice and with a grace period that
is closely in line with the grace period of the reference exposure; and
(ii) Receivership, insolvency, liquidation, conservatorship or
inability of the reference exposure issuer to pay its debts, or its
failure or admission in writing of its inability generally to pay its
debts as they become due, and similar events;
(4) The terms and conditions dictating the manner in which the
contract is to be settled are incorporated into the contract;
(5) If the contract allows for cash settlement, the contract
incorporates a robust valuation process to estimate loss reliably and
specifies a reasonable period for obtaining post-credit event
valuations of the reference exposure;
(6) If the contract requires the protection purchaser to transfer
an exposure to the protection provider at settlement, the terms of at
least one of the exposures that is permitted to be transferred under
the contract provide that any required consent to transfer may not be
unreasonably withheld;
(7) If the credit derivative is a credit default swap or nth-to-
default swap, the contract clearly identifies the parties responsible
for determining whether a credit event has occurred, specifies that
this determination is not the sole responsibility of the protection
provider, and gives the protection purchaser the right to notify the
protection provider of the occurrence of a credit event; and
(8) If the credit derivative is a total return swap and the System
institution records net payments received on the swap as net income,
the System institution records offsetting deterioration in the value of
the hedged exposure (either through reductions in fair value or by an
addition to reserves).
Eligible guarantee means a guarantee from an eligible guarantor
that:
(1) Is written;
(2) Is either:
(i) Unconditional, or
(ii) A contingent obligation of the U.S. Government or its
agencies, the enforceability of which is dependent upon some
affirmative action on the part of the beneficiary of the guarantee or a
third party (for example, meeting servicing requirements);
(3) Covers all or a pro rata portion of all contractual payments of
the obligated party on the reference exposure;
(4) Gives the beneficiary a direct claim against the protection
provider;
(5) Is not unilaterally cancelable by the protection provider for
reasons other than the breach of the contract by the beneficiary;
(6) Except for a guarantee by a sovereign, is legally enforceable
against the protection provider in a jurisdiction where the protection
provider has sufficient assets against which a judgment may be attached
and enforced;
(7) Requires the protection provider to make payment to the
beneficiary on the occurrence of a default (as defined in the
guarantee) of the obligated party on the reference exposure in a timely
manner without the beneficiary first having to take legal actions to
pursue the obligor for payment; and
(8) Does not increase the beneficiary's cost of credit protection
on the guarantee in response to deterioration in the credit quality of
the reference exposure.
Eligible guarantor means:
(1) A sovereign, the Bank for International Settlements, the
International Monetary Fund, the European Central Bank, the European
Commission, a Federal Home Loan Bank, Federal Agricultural Mortgage
Corporation (Farmer Mac), a multilateral development bank (MDB), a
depository institution, a bank holding company, a savings and loan
holding company, a credit union, a foreign bank, or a qualifying
central counterparty; or
(2) An entity (other than a special purpose entity):
(i) That at the time the guarantee is issued or anytime thereafter,
has issued and outstanding an unsecured debt security without credit
enhancement that is investment grade;
(ii) Whose creditworthiness is not positively correlated with the
credit risk of the exposures for which it has provided guarantees; and
(iii) That is not an insurance company engaged predominately in the
business of providing credit protection (such as a monoline bond
insurer or re-insurer).
Eligible margin loan means:
(1) An extension of credit where:
(i) The extension of credit is collateralized exclusively by liquid
and readily marketable debt or equity securities, or gold;
(ii) The collateral is marked-to-fair value daily, and the
transaction is subject to daily margin maintenance requirements; and
[[Page 52879]]
(iii) The extension of credit is conducted under an agreement that
provides the System institution the right to accelerate and terminate
the extension of credit and to liquidate or set-off collateral promptly
upon an event of default, including upon an event of receivership,
insolvency, liquidation, conservatorship, or similar proceeding, of the
counterparty, provided that, in any such case, any exercise of rights
under the agreement will not be stayed or avoided under applicable law
in the relevant jurisdictions, other than in receivership,
conservatorship, resolution under the Federal Deposit Insurance Act,
Title II of the Dodd-Frank Act, under any similar insolvency law
applicable to GSEs, or under the Farm Credit Act.\2\
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\2\ This requirement is met where all transactions under the
agreement are (i) executed under U.S. law and (ii) constitute
``securities contracts'' under section 555 of the Bankruptcy Code
(11 U.S.C. 555) or qualified financial contracts under section
11(e)(8) of the Federal Deposit Insurance Act.
---------------------------------------------------------------------------
(2) In order to recognize an exposure as an eligible margin loan
for purposes of this subpart, a System institution must comply with the
requirements of Sec. 628.3(b) with respect to that exposure.
Eligible servicer cash advance facility means a servicer cash
advance facility in which:
(1) The servicer is entitled to full reimbursement of advances,
except that a servicer may be obligated to make non-reimbursable
advances for a particular underlying exposure if any such advance is
contractually limited to an insignificant amount of the outstanding
principal balance of that exposure;
(2) The servicer's right to reimbursement is senior in right of
payment to all other claims on the cash flows from the underlying
exposures of the securitization; and
(3) The servicer has no legal obligation to, and does not make
advances to the securitization if the servicer concludes the advances
are unlikely to be repaid.
Equity derivative contract means an equity-linked swap, purchased
equity-linked option, forward equity-linked contract, or any other
instrument linked to equities that gives rise to similar counterparty
credit risks.
Equity exposure means:
(1) A security or instrument (whether voting or non-voting) that
represents a direct or an indirect ownership interest in, and is a
residual claim on, the assets and income of a company, unless:
(i) The issuing company is consolidated with the System institution
under GAAP;
(ii) The System institution is required to deduct the ownership
interest from tier 1 or tier 2 capital under this part;
(iii) The ownership interest incorporates a payment or other
similar obligation on the part of the issuing company (such as an
obligation to make periodic payments); or
(iv) The ownership interest is a securitization exposure;
(2) A security or instrument that is mandatorily convertible into a
security or instrument described in paragraph (1) of this definition;
(3) An option or warrant that is exercisable for a security or
instrument described in paragraph (1) of this definition; or
(4) Any other security or instrument (other than a securitization
exposure) to the extent the return on the security or instrument is
based on the performance of a security or instrument described in
paragraph (1) of this definition.
ERISA means the Employee Retirement Income and Security Act of 1974
(29 U.S.C. 1001 et seq.).
Exchange rate derivative contract means a cross-currency interest
rate swap, forward foreign-exchange contract, currency option
purchased, or any other instrument linked to exchange rates that gives
rise to similar counterparty credit risks.
Exposure means an amount at risk.
Exposure amount means:
(1) For the on-balance sheet component of an exposure (other than
an available-for-sale or held-to-maturity security; an OTC derivative
contract; a repo-style transaction or an eligible margin loan for which
the System institution determines the exposure amount under Sec.
628.37; a cleared transaction; or a securitization exposure), the
System institution's carrying value of the exposure.
(2) For a security (that is not a securitization exposure, equity
exposure, or preferred stock classified as an equity security under
GAAP) classified as available-for-sale or held-to-maturity, the System
institution's carrying value (including net accrued but unpaid interest
and fees) for the exposure less any net unrealized gains on the
exposure and plus any net unrealized losses on the exposure.
(3) For available-for-sale preferred stock classified as an equity
security under GAAP, the System institution's carrying value of the
exposure less any net unrealized gains on the exposure that are
reflected in such carrying value but excluded from the System
institution's regulatory capital components.
(4) For the off-balance sheet component of an exposure (other than
an OTC derivative contract; a repo-style transaction or an eligible
margin loan for which the System institution calculates the exposure
amount under Sec. 628.37; a cleared transaction; or a securitization
exposure), the notional amount of the off-balance sheet component
multiplied by the appropriate credit conversion factor (CCF) in Sec.
628.33.
(5) For an exposure that is an OTC derivative contract, the
exposure amount determined under Sec. 628.34.
(6) For an exposure that is a cleared transaction, the exposure
amount determined under Sec. 628.35.
(7) For an exposure that is an eligible margin loan or repo-style
transaction for which the bank calculates the exposure amount as
provided in Sec. 628.37, the exposure amount determined under Sec.
628.37.
(8) For an exposure that is a securitization exposure, the exposure
amount determined under Sec. 628.42.
Farm Credit Act means the Farm Credit Act of 1971, as amended (12
U.S.C. 2001 et seq.).
Federal Deposit Insurance Act means the Federal Deposit Insurance
Act (12 U.S.C. 1813).
Federal Deposit Insurance Corporation Improvement Act means the
Federal Deposit Insurance Corporation Improvement Act of 1991 (12
U.S.C. 4401).
Financial collateral means collateral:
(1) In the form of:
(i) Cash on deposit at a depository institution or Federal Reserve
Bank (including cash held for the System institution by a third-party
custodian or trustee);
(ii) Gold bullion;
(iii) Long-term debt securities that are not resecuritization
exposures and that are investment grade;
(iv) Short-term debt instruments that are not resecuritization
exposures and that are investment grade;
(v) Equity securities that are publicly traded;
(vi) Convertible bonds that are publicly traded; or
(vii) Money market fund shares and other mutual fund shares if a
price for the shares is publicly quoted daily; and
(2) In which the System institution has a perfected, first-priority
security interest or, outside of the United States, the legal
equivalent thereof (with the exception of cash on deposit at a
depository institution or Federal Reserve Bank and notwithstanding the
prior security interest of any custodial agent).
First-lien residential mortgage exposure means a residential
mortgage exposure secured by a first lien.
[[Page 52880]]
Foreign bank means a foreign bank as defined in Sec. 211.2 of the
Federal Reserve Board's Regulation K (12 CFR 211.2) (other than a
depository institution).
Forward agreement means a legally binding contractual obligation to
purchase assets with certain drawdown at a specified future date, not
including commitments to make residential mortgage loans or forward
foreign exchange contracts.
GAAP means generally accepted accounting principles as used in the
United States.
Gain-on-sale means an increase in the equity capital of a System
institution (as reported on the Call Report) resulting from a
traditional securitization (other than an increase in equity capital
resulting from the System institution's receipt of cash in connection
with the securitization or reporting of a mortgage servicing asset on
the Call Report).
General obligation means a bond or similar obligation that is
backed by the full faith and credit of a public sector entity (PSE).
Government-sponsored enterprise (GSE) means an entity established
or chartered by the U.S. Government to serve public purposes specified
by the U.S. Congress but whose debt obligations are not explicitly
guaranteed by the full faith and credit of the U.S. Government. For
purposes of part 628, this definition excludes System institutions.
Guarantee means a financial guarantee, letter of credit, insurance,
or other similar financial instrument (other than a credit derivative)
that allows one party (beneficiary) to transfer the credit risk of one
or more specific exposures (reference exposure) to another party
(protection provider).
High volatility commercial real estate (HVCRE) exposure means a
credit facility that, prior to conversion to permanent financing,
finances or has financed the acquisition, development, or construction
(ADC) of real property, unless the facility finances:
(1) One- to four-family residential properties;
(2) Real property that:
(i) The FCA has authorized as an investment pursuant to Sec.
615.5140(e) of this chapter; and
(ii) [Reserved];
(3) The purchase or development of agricultural land, which
includes all land known to be used or usable for agricultural purposes
(such as crop and livestock production), provided that the valuation of
the agricultural land is based on its value for agricultural purposes
and the valuation does not take into consideration any potential use of
the land for non-agricultural commercial development or residential
development; or
(4) Commercial real estate projects in which:
(i) The loan-to-value ratio is less than or equal to the maximum
loan-to-value ratio set forth in Sec. 614.4200(b) of this chapter;
(ii) The borrower has contributed capital to the project in the
form of cash or unencumbered readily marketable assets (or has paid
development expenses out-of-pocket) of at least 15 percent of the real
estate's appraised ``as completed'' value; and
(iii) The borrower contributed the amount of capital required by
paragraph (4)(ii) of this definition before the System institution
advances funds under the credit facility, and the capital contributed
by the borrower, or internally generated by the project, is
contractually required to remain in the project throughout the life of
the project. The life of a project concludes only when the credit
facility is converted to permanent financing or is sold or paid in
full. Permanent financing may be provided by the System institution
that provided the ADC facility as long as the permanent financing is
subject to the System institution's underwriting criteria for long-term
mortgage loans.
Home country means the country where an entity is incorporated,
chartered, or similarly established.
Insurance company means an insurance company as defined in section
201 of the Dodd-Frank Act (12 U.S.C. 5381).
Insurance underwriting company means an insurance company as
defined in section 201 of the Dodd-Frank Act (12 U.S.C. 5381) that
engages in insurance underwriting activities.
Insured depository institution means an insured depository
institution as defined in section 3 of the Federal Deposit Insurance
Act.
Interest rate derivative contract means a single-currency interest
rate swap, basis swap, forward rate agreement, purchased interest rate
option, when-issued securities, or any other instrument linked to
interest rates that gives rise to similar counterparty credit risks.
International Lending Supervision Act means the International
Lending Supervision Act of 1983 (12 U.S.C. 3907).
Investment fund means a company:
(1) Where all or substantially all of the assets of the company are
financial assets; and
(2) That has no material liabilities.
Investment grade means that the entity to which the System
institution is exposed through a loan or security, or the reference
entity with respect to a credit derivative, has adequate capacity to
meet financial commitments for the projected life of the asset or
exposure. Such an entity or reference entity has adequate capacity to
meet financial commitments if the risk of its default is low and the
full and timely repayment of principal and interest is expected.
Junior-lien residential mortgage exposure means a residential
mortgage exposure that is not a first-lien residential mortgage
exposure.
Member means a borrower or former borrower from a System
institution that holds voting or nonvoting common cooperative equities
of the institution.
Money market fund means an investment fund that is subject to 17
CFR 270.2a-7 or any foreign equivalent thereof.
Mortgage servicing assets (MSAs) means the contractual rights owned
by a System institution to service for a fee mortgage loans that are
owned by others.
Multilateral development bank (MDB) means the International Bank
for Reconstruction and Development, the Multilateral Investment
Guarantee Agency, the International Finance Corporation, the Inter-
American Development Bank, the Asian Development Bank, the African
Development Bank, the European Bank for Reconstruction and Development,
the European Investment Bank, the European Investment Fund, the Nordic
Investment Bank, the Caribbean Development Bank, the Islamic
Development Bank, the Council of Europe Development Bank, and any other
multilateral lending institution or regional development bank in which
the U.S. Government is a shareholder or contributing member or which
the FCA determines poses comparable credit risk.
National Bank Act means the National Bank Act (12 U.S.C. 24).
Netting set means a group of transactions with a single
counterparty that are subject to a qualifying master netting agreement
or a qualifying cross-product master netting agreement. For purposes of
calculating risk-based capital requirements using the internal models
methodology in subpart E of this part, this term does not cover a
transaction:
(1) That is not subject to such a master netting agreement; or
(2) Where the System institution has identified specific wrong-way
risk.
Nonqualified allocated equities means retained patronage refunds
paid in the form of stock or surplus that are distributed to a borrower
and that a System institution does not deduct from
[[Page 52881]]
its taxable income according to the Internal Revenue Code Sec. Sec.
1382(b) and 1383.\3\
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\3\ Nonqualified allocated equities also include surplus in a
tax-exempt institution or subsidiary. When a System institution
redeems a nonqualified allocation, the System institution deducts
the allocation from its taxable income, if any, and the borrower
generally recognizes the tax liability, if any, as ordinary income.
System institutions distribute two types of nonqualified allocated
equities through written notices of allocation to the borrowers: (1)
Those subject to redemption and (2) those not subject to redemption.
The second type for GAAP purposes is considered an equivalent of
unallocated surplus and consolidated with unallocated surplus on
externally prepared shareholder reports.
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N\th\-to-default credit derivative means a credit derivative that
provides credit protection only for the n\th\-defaulting reference
exposure in a group of reference exposures.
Operating entity means a company established to conduct business
with clients with the intention of earning a profit in its own right
and that generally produces goods or provides services beyond the
business of investing, reinvesting, holding, or trading in financial
assets. All System banks, associations, and service corporations, and
all UBEs, are operating entities.
Original maturity with respect to an off-balance sheet commitment
means the length of time between the date a commitment is issued and:
(1) For a commitment that is not subject to extension or renewal,
the stated expiration date of the commitment; or
(2) For a commitment that is subject to extension or renewal, the
earliest date on which the System institution can, at its option,
unconditionally cancel the commitment.
Originating System institution, with respect to a securitization,
means a System institution that:
(1) Directly or indirectly originated the underlying exposures
included in the securitization; or
(2)[Reserved]
Other financing institution (OFI) means any entity referred to in
section 1.7(b)(1)(B) of the Farm Credit Act.
Over-the-counter (OTC) derivative contract means a derivative
contract that is not a cleared transaction.
Participation certificates means borrower stock held by a borrower
that does not have voting rights.
Patronage refund means a declared distribution of capital to
borrowers based on a System institution's net income and allocated to
borrowers based on business conducted with the cooperative pursuant to
the Internal Revenue Code section 1381(a). Patronage refunds may be
distributed as cash, allocated equity (stock or surplus), or a
combination of cash and allocated equity.
Performance standby letter of credit (or performance bond) means an
irrevocable obligation of a System institution to pay a third-party
beneficiary when a customer (account party) fails to perform on any
contractual nonfinancial or commercial obligation. To the extent
permitted by law or regulation, performance standby letters of credit
include arrangements backing, among other things; subcontractors' and
suppliers' performance, labor; and materials contracts, and
construction bids.
Protection amount (P) means, with respect to an exposure hedged by
an eligible guarantee or eligible credit derivative, the effective
notional amount of the guarantee or credit derivative, reduced to
reflect any currency mismatch, maturity mismatch, or lack of
restructuring coverage (as provided in Sec. 628.36).
Publicly traded means traded on:
(1) Any exchange registered with the Securities and Exchange
Commission (SEC) as a national securities exchange under section 6 of
the Securities Exchange Act; or
(2) Any non-U.S.-based securities exchange that:
(i) Is registered with, or approved by, a national securities
regulatory authority; and
(ii) Provides a liquid, two-way market for the instrument in
question.
Public sector entity (PSE) means a state, local authority, or other
governmental subdivision below the sovereign level.
Qualified allocated equities means patronage refunds distributed to
a borrower, in the form of stock or surplus, that a System institution
can exclude from its taxable income and that the borrower has agreed to
include in its taxable income.\4\
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\4\ A System institution must pay at least 20 percent of a
qualified patronage refund in cash to borrowers. A System
institution must provide the borrowers with a qualified written
notice of allocation when they distribute qualified patronage
refunds pursuant to the Internal Revenue Code Sec. Sec. 1381(b) and
1388(c). A System institution redeems qualified allocated equities
according to a board-approved plan.
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Qualifying central counterparty (QCCP) means a central counterparty
that:
(1)(i) Is a designated financial market utility (FMU), as defined
in section 803 of the Dodd-Frank Act;
(ii) If not located in the United States, is regulated and
supervised in a manner equivalent to a designated FMU; or
(iii) Meets the following standards:
(A) The central counterparty requires all parties to contracts
cleared by the counterparty to be fully collateralized on a daily
basis;
(B) The System institution demonstrates to the satisfaction of the
FCA that the central counterparty:
(1) Is in sound financial condition;
(2) Is subject to supervision by the Board, the CFTC, or the
Securities Exchange Commission (SEC), or, if the central counterparty
is not located in the United States, is subject to effective oversight
by a national supervisory authority in its home country; and
(3) Meets or exceeds the risk-management standards for central
counterparties set forth in regulations established by the Board, the
CFTC, or the SEC under title VII or title VIII of the Dodd-Frank Act;
or if the central counterparty is not located in the United States,
meets or exceeds similar risk-management standards established under
the law of its home country that are consistent with international
standards for central counterparty risk management as established by
the relevant standard setting body of the Bank of International
Settlements; and
(2)(i) Provides the System institution with the central
counterparty's hypothetical capital requirement or the information
necessary to calculate such hypothetical capital requirement, and other
information the System institution is required to obtain under Sec.
628.35(d)(3);
(ii) Makes available to the FCA and the CCP's regulator the
information described in paragraph (2)(i) of this definition; and
(iii) Has not otherwise been determined by the FCA to not be a QCCP
due to its financial condition, risk profile, failure to meet
supervisory risk management standards, or other weaknesses or
supervisory concerns that are inconsistent with the risk weight
assigned to qualifying central counterparties under Sec. 628.35.
(3) A QCCP that fails to meet the requirements of a QCCP in the
future may still be treated as a QCCP under the conditions specified in
Sec. 628.3(f).
Qualifying master netting agreement means a written, legally
enforceable agreement provided that:
(1) The agreement creates a single legal obligation for all
individual transactions covered by the agreement upon an event of
default, including upon an event of receivership, insolvency,
liquidation, or similar proceeding, of the counterparty;
(2) The agreement provides the System institution the right to
accelerate, terminate, and close-out on a net basis all transactions
under the agreement and to liquidate or set-off collateral promptly
upon an event of
[[Page 52882]]
default, including upon an event of receivership, insolvency,
liquidation, or similar proceeding, of the counterparty, provided that,
in any such case, any exercise of rights under the agreement will not
be stayed or avoided under applicable law in the relevant
jurisdictions, other than in receivership, conservatorship, resolution
under the Federal Deposit Insurance Act, title II of the Dodd-Frank
Act, under any similar insolvency law applicable to GSEs, or under the
Farm Credit Act;
(3) The agreement does not contain a walkaway clause (that is, a
provision that permits a non-defaulting counterparty to make a lower
payment than it otherwise would make under the agreement, or no payment
at all, to a defaulter or the estate of a defaulter, even if the
defaulter or the estate of the defaulter is a net creditor under the
agreement); and
(4) In order to recognize an agreement as a qualifying master
netting agreement for purposes of this subpart, a System institution
must comply with the requirements of Sec. 628.3(d) with respect to
that agreement.
Repo-style transaction means a repurchase or reverse repurchase
transaction, or a securities borrowing or securities lending
transaction, including a transaction in which the System institution
acts as agent for a customer and indemnifies the customer against loss,
provided that:
(1) The transaction is based solely on liquid and readily
marketable securities, cash, or gold;
(2) The transaction is marked-to-fair value daily and subject to
daily margin maintenance requirements;
(3)(i) The transaction is a ``securities contract'' or ``repurchase
agreement'' under section 555 or 559, respectively, of the Bankruptcy
Code (11 U.S.C. 555 or 559) or a qualified financial contract under
section 11(e)(8) of the Federal Deposit Insurance Act; or
(ii) If the transaction does not meet the criteria set forth in
paragraph (3)(i) of this definition, then either:
(A) The transaction is executed under an agreement that provides
the System institution the right to accelerate, terminate, and close-
out the transaction on a net basis and to liquidate or set-off
collateral promptly upon an event of default, including upon an event
of receivership, insolvency, liquidation, or similar proceeding, of the
counterparty, provided that, in any such case, any exercise of rights
under the agreement will not be stayed or avoided under applicable law
in the relevant jurisdictions, other than in receivership,
conservatorship, resolution under the Federal Deposit Insurance Act,
title II of the Dodd-Frank Act, under any similar insolvency law
applicable to GSEs, or under the Farm Credit Act; or
(B) The transaction is:
(1) Either overnight or unconditionally cancelable at any time by
the System institution; and
(2) Executed under an agreement that provides the System
institution the right to accelerate, terminate, and close-out the
transaction on a net basis and to liquidate or set-off collateral
promptly upon an event of counterparty default; and
(4) In order to recognize an exposure as a repo-style transaction
for purposes of this subpart, a System institution must comply with the
requirements of Sec. 628.3(e) of this part with respect to that
exposure.
Resecuritization means a securitization which has more than one
underlying exposure and in which one or more of the underlying
exposures is a securitization exposure.
Resecuritization exposure means:
(1) An on- or off-balance sheet exposure to a resecuritization; or
(2) An exposure that directly or indirectly references a
resecuritization exposure.
Residential mortgage exposure means an exposure (other than a
securitization exposure or equity exposure) that is:
(1) An exposure that is primarily secured by a first or subsequent
lien on one-to-four family residential property, provided that the
dwelling (including attached components such as garages, porches, and
decks) represents at least 50 percent of the total appraised value of
the collateral secured by the first or subsequent lien; or
(2)[Reserved]
Revenue obligation means a bond or similar obligation that is an
obligation of a PSE, but which the PSE is committed to repay with
revenues from the specific project financed rather than general tax
funds.
Savings and loan holding company means a savings and loan holding
company as defined in section 10 of the Home Owners' Loan Act (12
U.S.C. 1467a).
Securities and Exchange Commission (SEC) means the U.S. Securities
and Exchange Commission.
Securities Exchange Act means the Securities Exchange Act of 1934
(15 U.S.C. 78).
Securitization exposure means:
(1) An on-balance sheet or off-balance sheet credit exposure
(including credit-enhancing representations and warranties) that arises
from a traditional securitization or synthetic securitization
(including a resecuritization); or
(2) An exposure that directly or indirectly references a
securitization exposure described in paragraph (1) of this definition.
Securitization special purpose entity (securitization SPE) means a
corporation, trust, or other entity organized for the specific purpose
of holding underlying exposures of a securitization, the activities of
which are limited to those appropriate to accomplish this purpose, and
the structure of which is intended to isolate the underlying exposures
held by the entity from the credit risk of the seller of the underlying
exposures to the entity.
Senior officer means the Chief Executive Officer, the Chief
Operations Officer, the Chief Financial Officer, the Chief Credit
Officer, and the General Counsel, or persons in similar positions; and
any other person responsible for a major policy-making function.
Servicer cash advance facility means a facility under which the
servicer of the underlying exposures of a securitization may advance
cash to ensure an uninterrupted flow of payments to investors in the
securitization, including advances made to cover foreclosure costs or
other expenses to facilitate the timely collection of the underlying
exposures.
Small Business Act means the Small Business Act (15 U.S.C. 632).
Small Business Investment Act means the Small Business Investment
Act of 1958 (15 U.S.C. 682).
Sovereign means a central government (including the U.S.
Government) or an agency, department, ministry, or central bank of a
central government.
Sovereign default means noncompliance by a sovereign with its
external debt service obligations or the inability or unwillingness of
a sovereign government to service an existing loan according to its
original terms, as evidenced by failure to pay principal and interest
timely and fully, arrearages, or restructuring.
Sovereign exposure means:
(1) A direct exposure to a sovereign; or
(2) An exposure directly and unconditionally backed by the full
faith and credit of a sovereign.
Standardized total risk-weighted assets means:
(1) The sum of:
(i) Total risk-weighted assets for general credit risk as
calculated under Sec. 628.31;
(ii) Total risk-weighted assets for cleared transactions as
calculated under Sec. 628.35;
(iii) Total risk-weighted assets for unsettled transactions as
calculated under Sec. 628.38;
[[Page 52883]]
(iv) Total risk-weighted assets for securitization exposures as
calculated under Sec. 628.42;
(v) Total risk-weighted assets for equity exposures as calculated
under Sec. Sec. 628.52 and 628.53; and
(vi) [Reserved]; minus
(2) Any amount of the System institution's allowance for loan
losses that is not included in tier 2 capital.
Subsidiary means, with respect to a company, a company controlled
by that company.
System bank means a Farm Credit bank as defined in Sec. 619.9140
of this chapter, which includes Farm Credit Banks, agricultural credit
banks, and banks for cooperatives.
System institution means a System bank, an association of the Farm
Credit System, Farm Credit Leasing Services Corporation, and their
successors, and any other institution chartered by the FCA that the FCA
determines should be considered a System institution for the purposes
of this part. Synthetic exposure means an exposure whose value is
linked to the value of an investment in the System institution's own
capital instrument.
Synthetic securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more underlying
exposures is retained or transferred to one or more third parties
through the use of one or more credit derivatives or guarantees (other
than a guarantee that transfers only the credit risk of an individual
retail exposure);
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different levels
of seniority;
(3) Performance of the securitization exposures depends upon the
performance of the underlying exposures; and
(4) All or substantially all of the underlying exposures are
financial exposures (such as loans, commitments, credit derivatives,
guarantees, receivables, asset-backed securities, mortgage-backed
securities, other debt securities, or equity securities).
Tier 1 capital means the sum of common equity tier 1 capital and
additional tier 1 capital.
Tier 2 capital is defined in Sec. 628.20(d).
Total capital means the sum of tier 1 capital and tier 2 capital.
Traditional securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more underlying
exposures is transferred to one or more third parties other than
through the use of credit derivatives or guarantees;
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different levels
of seniority;
(3) Performance of the securitization exposures depends upon the
performance of the underlying exposures;
(4) All or substantially all of the underlying exposures are
financial exposures (such as loans, commitments, credit derivatives,
guarantees, receivables, asset-backed securities, mortgage-backed
securities, other debt securities, or equity securities);
(5) The underlying exposures are not owned by an operating entity;
(6) The underlying exposures are not owned by a rural business
investment company described in 7 U.S.C. 2009cc et seq.;
(7) The underlying exposures are not owned by a firm an investment
in which is authorized by the FCA under Sec. 615.5140(e)of this
chapter;
(8) The FCA may determine that a transaction in which the
underlying exposures are owned by an investment firm that exercises
substantially unfettered control over the size and composition of its
assets, liabilities, and off-balance sheet exposures is not a
traditional securitization based on the transaction's leverage, risk
profile, or economic substance;
(9) The FCA may deem a transaction that meets the definition of a
traditional securitization, notwithstanding paragraph (5), (6), or (7)
of this definition, to be a traditional securitization based on the
transaction's leverage, risk profile, or economic substance; and
(10) The transaction is not:
(i) An investment fund;
(ii) A collective investment fund (as defined in [12 CFR 9.18
(national bank) and 12 CFR 151.40 (Federal saving association) (OCC);
12 CFR 208.34 (Board)];
(iii) An employee benefit plan (as defined in paragraphs (3) and
(32) of section 3 of ERISA), a ``governmental plan'' (as defined in 29
U.S.C. 1002(32)) that complies with the tax deferral qualification
requirements provided in the Internal Revenue Code, or any similar
employee benefit plan established under the laws of a foreign
jurisdiction;
(iv) A synthetic exposure to the capital of a System institution to
the extent deducted from capital under Sec. 628.22; or
(v) Registered with the SEC under the Investment Company Act of
1940 (15 U.S.C. 80a-1) or foreign equivalents thereof.
Tranche means all securitization exposures associated with a
securitization that have the same seniority level.
Two-way market means a market where there are independent bona fide
offers to buy and sell so that a price reasonably related to the last
sales price or current bona fide competitive bid and offer quotations
can be determined within 1 day and settled at that price within a
relatively short timeframe conforming to trade custom.
Unallocated retained earnings (URE) means accumulated net income
that a System institution has not allocated as patronage refunds.
Unallocated retained earnings (URE) equivalents means nonqualified
allocated surplus not subject to retirement except upon dissolution or
liquidation. URE equivalents does not include equities allocated by a
System institution to other System institutions.
Unconditionally cancelable means, with respect to a commitment that
a System institution may, at any time, with or without cause, refuse to
extend credit under the commitment (to the extent permitted under
applicable law).
Underlying exposures means one or more exposures that have been
securitized in a securitization transaction.
U.S. Government agency means an instrumentality of the U.S.
Government whose obligations are fully guaranteed as to the timely
payment of principal and interest by the full faith and credit of the
U.S. Government.
Sec. 628.3 Operational requirements for certain exposures.
For purposes of calculating risk-weighted assets under subpart D of
this part:
(a) Cleared transaction. In order to recognize certain exposures as
cleared transactions pursuant to paragraph (1)(ii), (1)(iii) or (1)(iv)
of the definition of ``cleared transaction'' in Sec. 628.2, the
exposures must meet all of the requirements set forth in this
paragraph.
(1) The offsetting transaction must be identified by the CCP as a
transaction for the clearing member client.
(2) The collateral supporting the transaction must be held in a
manner that prevents the System institution from facing any loss due to
an event of default, including from a liquidation, receivership,
insolvency, or similar proceeding of either the clearing member or the
clearing member's other clients. Omnibus accounts established under 17
CFR parts 190 and 300 satisfy the requirements of this paragraph.
(3) The System institution must conduct sufficient legal review to
[[Page 52884]]
conclude with a well-founded basis (and maintain sufficient written
documentation of that legal review) that in the event of a legal
challenge (including one resulting from a default or receivership,
insolvency, liquidation, or similar proceeding) the relevant court and
administrative authorities would find the arrangements of paragraph
(a)(2) of this section to be legal, valid, binding and enforceable
under the law of the relevant jurisdictions.
(4) The offsetting transaction with a clearing member must be
transferable under the transaction documents and applicable laws in the
relevant jurisdiction(s) to another clearing member should the clearing
member default, become insolvent, or enter receivership, insolvency,
liquidation, or similar proceedings.
(b) Eligible margin loan. In order to recognize an exposure as an
eligible margin loan as defined in Sec. 628.2, a System institution
must conduct sufficient legal review to conclude with a well-founded
basis (and maintain sufficient written documentation of that legal
review) that the agreement underlying the exposure:
(1) Meets the requirements of paragraph (1)(iii) of the definition
of ``eligible margin loan'' in Sec. 628.2, and
(2) Is legal, valid, binding, and enforceable under applicable law
in the relevant jurisdictions.
(c) [Reserved]
(d) Qualifying master netting agreement. In order to recognize an
agreement as a qualifying master netting agreement as defined in Sec.
628.2, a System institution must:
(1) Conduct sufficient legal review to conclude with a well-founded
basis (and maintain sufficient written documentation of that legal
review) that:
(i) The agreement meets the requirements of paragraph (2) of the
definition of ``qualifying master netting agreement'' in Sec. 628.2;
and
(ii) In the event of a legal challenge (including one resulting
from default or from receivership, insolvency, liquidation, or similar
proceeding) the relevant court and administrative authorities would
find the agreement to be legal, valid, binding, and enforceable under
the law of the relevant jurisdictions; and
(2) Establish and maintain written procedures to monitor possible
changes in relevant law and to ensure that the agreement continues to
satisfy the requirements of the definition of ``qualifying master
netting agreement'' in Sec. 628.2.
(e) Repo-style transaction. In order to recognize an exposure as a
repo-style transaction as defined in Sec. 628.2, a System institution
must conduct sufficient legal review to conclude with a well-founded
basis (and maintain sufficient written documentation of that legal
review) that the agreement underlying the exposure:
(1) Meets the requirements of paragraph (3) of the definition of
``repo-style transaction'' in Sec. 628.2, and
(2) Is legal, valid, binding, and enforceable under applicable law
in the relevant jurisdictions.
(f) Failure of a QCCP to satisfy the rule's requirements. If a
System institution determines that a CCP ceases to be a QCCP due to the
failure of the CCP to satisfy one or more of the requirements set forth
in paragraph (2)(i) through (2)(iii) of the definition of a ``QCCP'' in
Sec. 628.2, the System institution may continue to treat the CCP as a
QCCP for up to 3 months following the determination. If the CCP fails
to remedy the relevant deficiency within 3 months after the initial
determination, or the CCP fails to satisfy the requirements set forth
in paragraph (2)(i) through (2)(iii) of the definition of a QCCP
continuously for a 3-month period after remedying the relevant
deficiency, a System institution may not treat the CCP as a QCCP for
the purposes of this part until after the System institution has
determined that the CCP has satisfied the requirements in paragraph
(2)(i) through (2)(iii) of the definition of a QCCP for 3 continuous
months.
Sec. Sec. 628.4--628.9 [Reserved]
Subpart B--Capital Ratio Requirements and Buffers
Sec. 628.10 Minimum capital requirements.
(a) Computation of regulatory capital ratios. A System
institution's regulatory capital ratios are determined on the basis of
the financial statements of the institution prepared in accordance with
GAAP using average daily balances for the most recent 3 months.
(b) Minimum capital requirements. A System institution must
maintain the following minimum capital ratios:
(1) A common equity tier 1 (CET1) capital ratio of 4.5 percent.
(2) A tier 1 capital ratio of 6 percent.
(3) A total capital ratio of 8 percent.
(4) A tier 1 leverage ratio of 5 percent, of which at least 1.5
percent must be composed of URE and URE equivalents.
(5) [Reserved]
(6) A permanent capital ratio of 7 percent.
(c) Capital ratio calculations. A System institution's regulatory
capital ratios are as follows:
(1) CET1 capital ratio. A System institution's CET1 capital ratio
is the ratio of the System institution's CET1 capital to total risk-
weighted assets;
(2) Tier 1 capital ratio. A System institution's tier 1 capital
ratio is the ratio of the System institution's tier 1 capital to total
risk-weighted assets;
(3) Total capital ratio. A System institution's total capital ratio
is the ratio of the System institution's total (tier 1 and tier 2)
capital to total risk-weighted assets; and
(4) Tier 1 leverage ratio. A System institution's leverage ratio is
the ratio of the institution's tier 1 capital to the institution's
average total consolidated assets as reported on the institution's Call
Report minus amounts deducted from tier 1 capital under Sec. Sec.
628.22(a), (c) and (d), and 628.23.
(5) Permanent capital ratio. A System institution's permanent
capital ratio must be calculated in accordance with the regulations in
part 615, subpart H, of this chapter.
(d) [Reserved]
(e) Capital adequacy. (1) Notwithstanding the minimum requirements
in this part, a System institution must maintain capital commensurate
with the level and nature of all risks to which the System institution
is exposed. FCA may evaluate a System institution's capital adequacy
and require that institution to maintain higher minimum regulatory
capital ratios using the factors listed in Sec. 615.5350 of this
chapter.
(2) A System institution must have a process for assessing its
overall capital adequacy in relation to its risk profile and a
comprehensive strategy for maintaining an appropriate level of capital
under Sec. 615.5200 of this chapter.
Sec. 628.11 Capital conservation buffer amount.
(a) Capital conservation buffer--(1) Composition of the capital
conservation buffer. The capital conservation buffer is composed solely
of CET1 capital.
(2) Definitions. For purposes of this section, the following
definitions apply:
(i) Eligible retained income. The eligible retained income of a
System institution is the System institution's net income for the 4
calendar quarters preceding the current calendar quarter, based on the
System institution's quarterly Call Reports, net of any capital
distributions and associated tax effects not already reflected in net
income.
(ii) Maximum payout ratio. The maximum payout ratio is the
percentage of eligible retained income that a System institution can
pay out in the form of capital distributions and discretionary bonus
payments during the current calendar quarter. The maximum payout ratio
is based on the
[[Page 52885]]
System institution's capital conservation buffer, calculated as of the
last day of the previous calendar quarter, as set forth in Table 1 to
Sec. 628.11.
(iii) Maximum payout amount. A System institution's maximum payout
amount for the current calendar quarter is equal to the System
institution's eligible retained income, multiplied by the applicable
maximum payout ratio, as set forth in Table 1 to Sec. 628.11.
(iv) [Reserved]
(v) Capital distribution means:
(A) A reduction of tier 1 capital through the repurchase or
redemption of a tier 1 capital instrument or by other means, except
when a System institution, within the same quarter when the repurchase
is announced, fully replaces a tier 1 capital instrument it has
repurchased by issuing another capital instrument that meets the
eligibility criteria for:
(1) A CET1 capital instrument if the instrument being repurchased
was part of the System institution's CET1 capital; or
(2) A CET1 or AT1 capital instrument if the instrument being
repurchased was part of the System institution's tier 1 capital;
(B) A reduction of tier 2 capital through the repurchase, or
redemption prior to maturity, of a tier 2 capital instrument or by
other means, except when a System institution, within the same quarter
when the repurchase or redemption is announced, fully replaces a tier 2
capital instrument it has repurchased by issuing another capital
instrument that meets the eligibility criteria for a tier 1 or tier 2
capital instrument;
(C) A dividend declaration or payment on any tier 1 capital
instrument;
(D) A dividend declaration or interest payment on any tier 2
capital instrument if the System institution has full discretion to
permanently or temporarily suspend such payments without triggering an
event of default;
(E) A cash patronage refund declaration or payment;
(F) A patronage refund declaration in the form of allocated
equities that did not qualify as tier 1 or tier 2 capital;\5\ or
---------------------------------------------------------------------------
\5\ A patronage refund declaration or payment in the form of
allocated equities that qualifies as tier 1 capital is not a
reduction in tier 1 capital. It is just a reclassification from one
tier 1 capital element into a different tier 1 capital element.
---------------------------------------------------------------------------
(G) Any similar transaction that the FCA determines to be in
substance a distribution of capital.
(3) Calculation of capital conservation buffer. (i) A System
institution's capital conservation buffer is equal to the lowest of the
following ratios, calculated as of the last day of the previous
calendar quarter based on the System institution's most recent Call
Report:
(A) The System institution's CET1 capital ratio minus the System
institution's minimum CET1 capital ratio requirement under Sec.
628.10;
(B) The System institution's tier 1 capital ratio minus the System
institution's minimum tier 1 capital ratio requirement under Sec.
628.10; and
(C) The System institution's total capital ratio minus the System
institution's minimum total capital ratio requirement under Sec.
628.10; or
(ii) Notwithstanding paragraphs (a)(3)(i)(A) through (C) of this
section, if the System institution's CET1, tier 1 or total capital
ratio is less than or equal to the System institution's minimum CET1,
tier 1 or total capital ratio requirement under Sec. 628.10,
respectively, the System institution's capital conservation buffer is
zero.
(4) Limits on capital distributions and discretionary bonus
payments. (i) A System institution must not make capital distributions
or discretionary bonus payments or create an obligation to make such
capital distributions or payments during the current calendar quarter
that, in the aggregate, exceed the maximum payout amount.
(ii) A System institution with a capital conservation buffer that
is greater than 2.5 percent is not subject to a maximum payout amount
under this section.
(iii) Negative eligible retained income. Except as provided in
paragraph (a)(4)(iv) of this section, a System institution may not make
capital distributions or discretionary bonus payments during the
current calendar quarter if the System institution's:
(A) Eligible retained income is negative; and
(B) Capital conservation buffer was less than 2.5 percent as of the
end of the previous calendar quarter.
(iv) Prior approval. Notwithstanding the limitations in paragraphs
(a)(4)(i) through (a)(4)(iii) of this section, FCA may permit a System
institution to make a capital distribution or discretionary bonus
payment upon a request of the System institution, if FCA determines
that the capital distribution or discretionary bonus payment would not
be contrary to the purposes of this section, or to the safety and
soundness of the System institution. In making such a determination,
FCA will consider the nature and extent of the request and the
particular circumstances giving rise to the request.
Table 1 to Sec. 628.11--Calculation of Maximum Payout Amount
------------------------------------------------------------------------
Maximum payout
ratio (as a
percentage of
Capital conservation buffer eligible
retained
income)
------------------------------------------------------------------------
> 2.500 percent......................................... No limitation
<= 2.500 percent, and > 1.875 percent................... 60
<= 1.875 percent, and > 1.250 percent................... 40
<= 1.250 percent, and > 0.625 percent................... 20
<= 0.625 percent........................................ 0
------------------------------------------------------------------------
(v) Other limitations on capital distributions. Additional
limitations on capital distributions may apply to a System institution
under subpart C of this part and under part 615, subparts L and M.
(b) [Reserved]
Sec. Sec. 628.12--628.19 [Reserved]
Subpart C--Definition of Capital
Sec. 628.20 Capital components and eligibility criteria for
regulatory capital instruments other than permanent capital.
(a) Regulatory capital components. A System institution's
regulatory capital components are:
(1) CET1 capital;
(2) AT1 capital; and
(3) Tier 2 capital.
(b) CET1 capital. CET1 capital is the sum of the CET1 capital
elements in paragraph (b) of this section, minus regulatory adjustments
and deductions in Sec. 628.22. The CET1 capital elements are:
(1) Any common cooperative equity instrument issued by a System
institution that meets all of the following criteria:
(i) The instrument is issued directly by the System institution and
represents a claim subordinated to general creditors, subordinated debt
holders, and preferred stock holders in a receivership, insolvency,
liquidation, or similar proceeding of the System institution;
(ii) The holder of the instrument is entitled to a claim on the
residual assets of the System institution, the claim will be paid only
after all creditors, subordinated debt holders, and preferred stock
claims have been satisfied in a receivership, insolvency, liquidation,
or similar proceeding;
(iii) The instrument has no maturity date, can be redeemed only at
the discretion of the System institution and with the prior approval of
FCA, and
[[Page 52886]]
does not contain any term or feature that creates an incentive to
redeem;
(iv) The System institution did not create, through any action or
communication, an expectation that it will buy back, cancel, revolve,
or redeem the instrument, and the instrument does not include any term
or feature that might give rise to such an expectation, except that the
establishment of a revolvement period of 10 years or more, or the
practice of revolving or redeeming the instrument no less than 10 years
after issuance or allocation, will not be considered to create such an
expectation;
(v) Any cash dividend payments on the instrument are paid out of
the System institution's net income or unallocated retained earnings,
and are not subject to a limit imposed by the contractual terms
governing the instrument;
(vi) The System institution has full discretion at all times to
refrain from paying any dividends without triggering an event of
default, a requirement to make a payment-in-kind, or an imposition of
any other restrictions on the System institution;
(vii) Dividend payments and other distributions related to the
instrument may be paid only after all legal and contractual obligations
of the System institution have been satisfied, including payments due
on more senior claims;
(viii) The holders of the instrument bear losses as they occur
before any losses are borne by holders of preferred stock claims on the
System institution and holders of any other claims with priority over
common cooperative equity instruments in a receivership, insolvency,
liquidation, or similar proceeding;
(ix) The instrument is classified as equity under GAAP;
(x) The System institution, or an entity that the System
institution controls, did not purchase or directly or indirectly fund
the purchase of the instrument, except that where there is an
obligation for a member of the institution to hold an instrument in
order to receive a loan or service from the System institution, an
amount of that loan equal to the minimum borrower stock requirement
under section 4.3A of the Act will not be considered as a direct or
indirect funding where:
(A) The purpose of the loan is not the purchase of capital
instruments of the System institution providing the loan; and
(B) The purchase or acquisition of one or more member equities of
the institution is necessary in order for the beneficiary of the loan
to become a member of the System institution;
(xi) The instrument is not secured, not covered by a guarantee of
the System institution, and is not subject to any other arrangement
that legally or economically enhances the seniority of the instrument;
(xii) The instrument is issued in accordance with applicable laws
and regulations and with the institution's capitalization bylaws;
(xiii) The instrument is reported on the System institution's
regulatory financial statements separately from other capital
instruments; and
(xiv) The System institution's capitalization bylaws provide that
it will not offset the instrument against a member's loan in default,
that it will not redeem the instrument for a period of at least 10
years after issuance, or if allocated equities at least 10 years after
allocation to a member, or reduce the original revolvement period to
less than 10 years without the prior approval of the FCA, except that
the minimum statutory borrower stock described under paragraph
(b)(1)(x) of this section may be redeemed without a minimum period
outstanding after issuance and without the prior approval of the FCA.
(2) Unallocated retained earnings.
(3) [Reserved]
(4) [Reserved]
(5) [Reserved]
(c) AT1 capital. AT1 capital is the sum of additional tier 1
capital elements and related surplus, minus the regulatory adjustments
and deductions in Sec. Sec. 628.22 and 628.23. AT1 capital elements
are:
(1) Instruments and related surplus, other than common cooperative
equities, that meet the following criteria:
(i) The instrument is issued and paid-in;
(ii) The instrument is subordinated to general creditors and
subordinated debt holders of the System institution in a receivership,
insolvency, liquidation, or similar proceeding;
(iii) The instrument is not secured, not covered by a guarantee of
the System institution and not subject to any other arrangement that
legally or economically enhances the seniority of the instrument;
(iv) The instrument has no maturity date and does not contain a
dividend step-up or any other term or feature that creates an incentive
to redeem;
(v) If callable by its terms, the instrument may be called by the
System institution only after a minimum of 5 years following issuance,
except that the terms of the instrument may allow it to be called
earlier than 5 years upon the occurrence of a regulatory event that
precludes the instrument from being included in AT1 capital, or a tax
event. In addition:
(A) The System institution must receive prior approval from FCA to
exercise a call option on the instrument.
(B) The System institution does not create at issuance of the
instrument, through any action or communication, an expectation that
the call option will be exercised.
(C) Prior to exercising the call option, or immediately thereafter,
the System institution must either replace the instrument to be called
with an equal amount of instruments that meet the criteria under
paragraph (b) of this section or this paragraph (c),\6\ or demonstrate
to the satisfaction of FCA that following redemption, the System
institution will continue to hold capital commensurate with its risk;
---------------------------------------------------------------------------
\6\ Replacement can be concurrent with redemption of existing
AT1 capital instruments.
---------------------------------------------------------------------------
(vi) Redemption or repurchase of the instrument requires prior
approval from FCA;
(vii) The System institution has full discretion at all times to
cancel dividends or other distributions on the instrument without
triggering an event of default, a requirement to make a payment-in-
kind, or an imposition of other restrictions on the System institution
except in relation to any distributions to holders of common
cooperative equity instruments or other instruments that are pari passu
with the instrument;
(viii) Any distributions on the instrument are paid out of the
System institution's net income, unallocated retained earnings, or
surplus related to other AT1 capital instruments and are not subject to
a limit imposed by the contractual terms governing the instrument;
(ix) The instrument does not have a credit-sensitive feature, such
as a dividend rate that is reset periodically based in whole or in part
on the System institution's credit quality, but may have a dividend
rate that is adjusted periodically independent of the System
institution's credit quality, in relation to general market interest
rates or similar adjustments;
(x) The paid-in amount is classified as equity under GAAP;
(xi) The System institution did not purchase or directly or
indirectly fund the purchase of the instrument;
(xii) The instrument does not have any features that would limit or
discourage additional issuance of capital by the System institution,
such as provisions that require the System institution to compensate
holders of the
[[Page 52887]]
instrument if a new instrument is issued at a lower price during a
specified timeframe;
(xiii) [Reserved]; and
(xiv) The System institution's capitalization bylaws provide that
it will not redeem the instrument without the prior approval of the
FCA;
(2) [Reserved];
(3) [Reserved];
(4) Notwithstanding the criteria for AT1 capital instruments
referenced above:
(i) [Reserved];
(ii) An instrument with terms that provide that the instrument may
be called earlier than 5 years upon the occurrence of a rating agency
event does not violate the criterion in paragraph (c)(1)(v) of this
section provided that the instrument was issued and included in a
System institution's core surplus capital prior to the effective date
of the final rule, and that such instrument satisfies all other
criteria under this Sec. 628.20(c).
(d) Tier 2 Capital. Tier 2 capital is the sum of tier 2 capital
elements and any related surplus minus regulatory adjustments and
deductions in Sec. Sec. 628.22 and 628.23. Tier 2 capital elements
are:
(1) Instruments (plus related surplus) that meet the following
criteria:
(i) The instrument is issued and paid-in, is a common cooperative
equity, or is member equity purchased in accordance with paragraph
(d)(1)(viii) of this section;
(ii) The instrument is subordinated to general creditors of the
System institution;
(iii) The instrument is not secured, not covered by a guarantee of
the System institution and not subject to any other arrangement that
legally or economically enhances the seniority of the instrument in
relation to more senior claims;
(iv) The instrument has a minimum original maturity of at least 5
years. At the beginning of each of the last 5 years of the life of the
instrument, the amount that is eligible to be included in tier 2
capital is reduced by 20 percent of the original amount of the
instrument (net of redemptions) and is excluded from regulatory capital
when the remaining maturity is less than 1 year. In addition, the
instrument must not have any terms or features that require, or create
significant incentives for, the System institution to redeem the
instrument prior to maturity; \7\
---------------------------------------------------------------------------
\7\ An instrument that by its terms automatically converts into
a tier 1 capital instrument prior to 5 years after issuance complies
with the 5-year maturity requirement of this criterion.
---------------------------------------------------------------------------
(v) The instrument, by its terms, may be called by the System
institution only after a minimum of 5 years following issuance, except
that the terms of the instrument may allow it to be called sooner upon
the occurrence of an event that would preclude the instrument from
being included in tier 2 capital, or a tax event. In addition:
(A) The System institution must receive the prior approval of FCA
to exercise a call option on the instrument.
(B) The System institution does not create at issuance, through
action or communication, an expectation the call option will be
exercised.
(C) Prior to exercising the call option, or immediately thereafter,
the System institution must either: replace any amount called with an
equivalent amount of an instrument that meets the criteria for
regulatory capital under this section; \8\ or demonstrate to the
satisfaction of FCA that following redemption, the System institution
would continue to hold an amount of capital that is commensurate with
its risk;
---------------------------------------------------------------------------
\8\ A System institution may replace tier 2 capital instruments
concurrent with the redemption of existing tier 2 capital
instruments.
---------------------------------------------------------------------------
(vi) The holder of the instrument must have no contractual right to
accelerate payment of principal, dividends, or interest on the
instrument, except in the event of a receivership, insolvency,
liquidation, or similar proceeding of the System institution;
(vii) The instrument has no credit-sensitive feature, such as a
dividend or interest rate that is reset periodically based in whole or
in part on the System institution's credit standing, but may have a
dividend rate that is adjusted periodically independent of the System
institution's credit standing, in relation to general market interest
rates or similar adjustments;
(viii) The System institution has not purchased and has not
directly or indirectly funded the purchase of the instrument, except
that where common cooperative equity instruments are held by a member
of the institution in connection with a loan, and the institution funds
the acquisition of such instruments, that loan shall not be considered
as a direct or indirect funding where:
(A) The purpose of the loan is not the purchase of capital
instruments of the System institution providing the loan;
(B) The purchase or acquisition of one or more capital instruments
of the institution is necessary in order for the beneficiary of the
loan to become a member of the System institution; and
(C) The capital instruments are in excess of the statutory minimum
stock purchase amount.
(ix) [Reserved]
(x) Redemption of the instrument prior to maturity or repurchase is
at the discretion of the System institution and requires the prior
approval of the FCA;
(xi) If the instrument is a common cooperative equity, the System
institution's capitalization bylaws provide that it will not, except
with the prior approval of the FCA, redeem such equity included in tier
2 capital for a period of at least 5 years after allocating it to a
member.
(2) [Reserved]
(3) ALL up to 1.25 percent of the System institution's total risk-
weighted assets not including any amount of the ALL.
(4) [Reserved]
(5) [Reserved]
(6) [Reserved]
(e) FCA approval of a capital element. (1) A System institution
must receive FCA prior approval to include a capital element (as listed
in this section) in its CET1 capital, AT1 capital, or tier 2 capital
unless the element is equivalent, in terms of capital quality and
ability to absorb losses with respect to all material terms, to a
regulatory capital element FCA determined may be included in regulatory
capital pursuant to paragraph (e)(3) of this section.
(i) [Reserved]
(ii) [Reserved]
(2) [Reserved]
(3) After determining that a regulatory capital element may be
included in a System institution's CET1 capital, AT1 capital, or tier 2
capital, FCA will make its decision publicly available.
(f) FCA prior approval of capital redemptions and dividends
included in tier 1 and tier 2 capital. (1) Subject to the provisions of
paragraph (f)(5) of this section, a System institution must obtain the
prior approval of the FCA before paying cash dividends or patronage
refunds or redeeming equities included in tier 1 or tier 2 capital,
other than term equities redeemed on their maturity date.
(2) At least 30 days prior to the intended action, the System
institution must submit a request for approval to the FCA. The FCA's
30-day review period begins on the date on which the FCA receives the
request.
(3) The request is deemed to be granted if the FCA does not notify
the System institution to the contrary before the end of the 30-day
review period.
(4)(i) A System institution may request advance approval to cover
several anticipated redemptions and dividend and patronage payments,
[[Page 52888]]
provided that the institution projects sufficient current net income
during those periods to support the amount of the dividends declared,
patronage refunds and redemptions. In determining whether to grant
advance approval, the FCA will consider:
(A) The reasonableness of the institution's request, including its
historical and projected patronage refunds, redemptions and dividend
payments;
(B) The institution's historical trends and current projections for
capital growth through earnings retention;
(C) The overall condition of the institution, with particular
emphasis on current and projected capital adequacy as described in
Sec. 628.10(e); and
(D) Any other information that the FCA deems pertinent to reviewing
the institution's request.
(ii) After considering these standards, the FCA may grant prior
approval for an institution's patronage refunds, redemptions and
dividends request in advance of the periods in which the patronage
refunds, redemptions and dividends will be declared. Notwithstanding
any such approval, an institution may not declare or pay a patronage
refund, redeem equities or declare or pay a dividend if, after making
the patronage refunds, redemptions or dividend payments, the
institution would not meet its regulatory capital requirements set
forth in parts 615 and 628.
(5) Subject to any capital distribution restrictions specified in
Sec. 628.11, a System institution is deemed to have FCA prior approval
for cash payments of dividends, patronage refunds, or revolvements and
redemptions of common cooperative equities provided that:
(i) For revolvements or redemptions of common cooperative equities
included in CET1 capital other than a member's statutory minimum
borrower stock purchase requirement described in Sec. 628.20(b)(1)(x),
the institution issued or allocated such equities at least 10 years
ago;
(ii) For revolvements or redemptions of common cooperative equities
included in Tier 2 capital, the institution issued or allocated such
equities at least 5 years ago;
(iii) After such cash distributions the dollar amount of the System
institution's CET1 capital equals or exceeds the dollar amount of CET1
capital on the same date in the previous calendar year; and
(B) The System institution continues to comply with all regulatory
capital requirements and supervisory or enforcement actions.
Sec. 628.21 [Reserved]
Sec. 628.22 Regulatory capital adjustments and deductions.
(a) Regulatory capital deductions from CET1 capital. A System
institution must deduct from the sum of its CET1 capital elements the
items set forth in this paragraph:
(1) Goodwill, net of associated deferred tax liabilities (DTLs) in
accordance with paragraph (e) of this section;
(2) Intangible assets, other than mortgage servicing assets (MSAs),
net of associated DTLs in accordance with paragraph (e) of this
section;
(3) Deferred tax assets (DTAs) that arise from net operating loss
and tax credit carryforwards net of any related valuation allowances
and net of DTLs in accordance with paragraph (e) of this section; \9\
---------------------------------------------------------------------------
\9\ See Sec. 628.30(a) for DTAs arising from temporary
differences that a System institution could not realize through net
operating loss carrybacks.
---------------------------------------------------------------------------
(4) Any gain-on-sale in connection with a securitization exposure;
(5) Any defined benefit pension fund net asset, net of any
associated DTL in accordance with paragraph (e) of this section;
(6) The System institution's allocated equity investment in another
System institution;
(7) [Reserved]; and
(8) If, without the required prior FCA approval, during the 12
previous quarters, the System institution redeemed or revolved
allocated equities included in its CET1 capital that it had allocated
during the previous 10 years or retired purchased stock that it had
issued in the previous 10 years, the institution must deduct 30 percent
of its purchased and allocated equities for 3 years otherwise
includable in CET1 capital. However, no deduction will be made of
allocated equities that are URE equivalents unless the institution
redeemed or revolved URE equivalents.
(b) [Reserved]
(c) Deductions from regulatory capital.\10\
---------------------------------------------------------------------------
\10\ The System institution must calculate amounts deducted
under Sec. Sec. 628.22(c) through (f) and 628.23 after it
calculates the amount of ALL includable in tier 2 capital under
Sec. 628.20(d)(3).
---------------------------------------------------------------------------
(1) [Reserved]
(2) Corresponding deduction approach. For purposes of subpart C of
this part, the corresponding deduction approach is the methodology used
for the deductions from regulatory capital related to purchased equity
investments in another System institution (as described in paragraph
(c)(5) of this section). Under the corresponding deduction approach, a
System institution must make deductions from the component of capital
for which the underlying instrument would qualify if it were issued by
the System institution itself. If the System institution does not have
a sufficient amount of a specific component of capital to effect the
required deduction, the shortfall must be deducted according to
paragraph (f) of this section.
(i) [Reserved]
(ii) [Reserved]
(iii) [Reserved]
(3) [Reserved]
(4) [Reserved]
(5) Purchased equity investments in another System institution.
System institutions must deduct all purchased equity investments in
another System institution, service corporation, or the Funding
Corporation by applying the corresponding deduction approach. \11\ The
deductions described in this section are net of associated DTLs in
accordance with paragraph (e) of this section.
---------------------------------------------------------------------------
\11\ With prior written approval of FCA, for the period
stipulated by FCA, a System institution is not required to deduct an
investment in the capital of another institution in distress if such
investment is made to provide financial support to the System
institution as determined by FCA.
---------------------------------------------------------------------------
(d) [Reserved]
(e) Netting of DTLs against assets subject to deduction. (1) The
netting of DTLs against assets that are subject to deduction under
Sec. 628.22 is required, if the following conditions are met:
(i) The DTL is associated with the asset; and
(ii) The DTL would be extinguished if the associated asset becomes
impaired or is derecognized under GAAP.
(2) A DTL may only be netted against a single asset.
(3) [Reserved]
(4) [Reserved]
(5) [Reserved]
(f) Insufficient amounts of a specific regulatory capital component
to effect deductions. Under the corresponding deduction approach, if a
System institution does not have a sufficient amount of a specific
component of capital to effect the required deduction after completing
the deductions required under Sec. 628.22(c), the System institution
must deduct the shortfall from the next higher (that is, more
subordinated) component of regulatory capital.
(g) Treatment of assets that are deducted. A System institution
must exclude from total risk-weighted assets any item deducted from
regulatory capital under paragraphs (a) and (c) of this section.
(h) [Reserved]
[[Page 52889]]
Sec. 628.23 Limits on third-party capital.
(a) Limit on inclusion of third-party capital in tier 1 capital.
The combined amount of third-party capital instruments that a System
institution may include in tier 1 capital is equal to the greater of
the following:
(1) The then existing limit, if any, or
(2) One third of the average of the previous 4 quarters for the
previous year of the tier 1 capital reported on its Call Report filed
with FCA less any amounts of third-party capital reported in tier 1
capital.
(b) Limit on inclusion of third-party capital in total (tier 1 and
tier 2) capital. The combined amount of third-party capital instruments
that a System institution may include in its total (tier 1 and tier 2)
capital is equal to the lesser of the following:
(1) An amount equal to 40 percent of its total capital outstanding,
or
(2) An amount equal to 100 percent of its tier 1 capital
outstanding.
(c) Treatment of assets that are deducted. A System institution
must exclude from total risk-weighted assets any item deducted from
regulatory capital under this section.
Sec. Sec. 628.24-628.29 [Reserved]
Subpart D--Risk-Weighted Assets--Standardized Approach
Sec. 628.30 Applicability.
(a) This subpart sets forth methodologies for determining risk-
weighted assets for purposes of the generally applicable risk-based
capital requirements for all System institutions.
(b) [Reserved]
Risk-Weighted Assets for General Credit Risk
Sec. 628.31 Mechanics for calculating risk-weighted assets for
general credit risk.
(a) General risk-weighting requirements. A System institution must
apply risk weights to its exposures as follows:
(1) A System institution must determine the exposure amount of each
on-balance sheet exposure, each OTC derivative contract, and each off-
balance sheet commitment, trade and transaction-related contingency,
guarantee, repo-style transaction, financial standby letter of credit,
forward agreement, or other similar transaction that is not:
(i) An unsettled transaction subject to Sec. 628.38;
(ii) A cleared transaction subject to Sec. 628.35;
(iii) [Reserved];
(iv) A securitization exposure subject to Sec. Sec. 628.41 through
628.45; or
(v) An equity exposure (other than an equity OTC derivative
contract) subject to Sec. Sec. 628.51 through 628.53.
(2) The System institution must multiply each exposure amount by
the risk weight appropriate to the exposure based on the exposure type
or counterparty, eligible guarantor, or financial collateral to
determine the risk-weighted asset amount for each exposure.
(b) Total risk-weighted assets for general credit risk equals the
sum of the risk-weighted asset amounts calculated under this section.
Sec. 628.32 General risk weights.
(a) Sovereign exposures--(1) Exposures to the U.S. Government. (i)
Notwithstanding any other requirement in this subpart, a System
institution must assign a 0-percent risk weight to:
(A) An exposure to the U.S. Government, its central bank, or a U.S.
Government agency; and
(B) The portion of an exposure that is directly and unconditionally
guaranteed by the U.S. Government, its central bank, or a U.S.
Government agency. This includes a deposit or other exposure, or the
portion of a deposit or other exposure, that is insured or otherwise
unconditionally guaranteed by the Federal Deposit Insurance Corporation
or National Credit Union Administration.
(ii) A System institution must assign a 20-percent risk weight to
the portion of an exposure that is conditionally guaranteed by the U.S.
Government, its central bank, or a U.S. Government agency. This
includes an exposure, or the portion of an exposure, that is
conditionally guaranteed by the Federal Deposit Insurance Corporation
or National Credit Union Administration.
(2) Other sovereign exposures. In accordance with Table 1 to Sec.
628.32, a System institution must assign a risk weight to a sovereign
exposure based on the Country Risk Classification (CRC) applicable to
the sovereign or the sovereign's Organization for Economic Cooperation
and Development (OECD) membership status if there is no CRC applicable
to the sovereign.
Table 1 to Sec. 628.32--Risk Weights for Sovereign Exposures
------------------------------------------------------------------------
Risk weight
(in percent)
------------------------------------------------------------------------
CRC:
0-1................................................. 0
2................................................... 20
3................................................... 50
4-6................................................. 100
7................................................... 150
OECD Member with no CRC................................. 0
Non-OECD Member with no CRC............................. 100
Sovereign Default....................................... 150
------------------------------------------------------------------------
(3) Certain sovereign exposures. Notwithstanding paragraph (a)(2)
of this section, a System institution may assign to a sovereign
exposure a risk weight that is lower than the applicable risk weight in
Table 1 to Sec. 628.32 if:
(i) The exposure is denominated in the sovereign's currency;
(ii) The System institution has at least an equivalent amount of
liabilities in that currency; and
(iii) The risk weight is not lower than the risk weight that the
sovereign allows banking organizations under its jurisdiction to assign
to the same exposures to the sovereign.
(4) Exposures to a non-OECD member sovereign with no CRC. Except as
provided in paragraph (a)(3), (a)(5), and (a)(6) of this section, a
System institution must assign a 100-percent risk weight to a sovereign
exposure if the sovereign does not have a CRC.
(5) Exposures to an OECD member sovereign with no CRC. Except as
provided in paragraph (a)(6) of this section, a System institution must
assign a 0-percent risk weight to an exposure to a sovereign that is a
member of the OECD if the sovereign does not have a CRC.
(6) Sovereign default. A System institution must assign a 150-
percent risk weight to a sovereign exposure immediately upon
determining that an event of sovereign default has occurred, or if an
event of sovereign default has occurred during the previous 5 years.
(b) Certain supranational entities and multilateral development
banks (MDBs). A System institution must assign a 0-percent risk weight
to an exposure to the Bank for International Settlements, the European
Central Bank, the European Commission, the International Monetary Fund,
or an MDB.
(c) Exposures to Government-sponsored enterprises (GSEs). (1) A
System institution must assign a 20-percent risk weight to an exposure
to a GSE other than an equity exposure or preferred stock.
(2) A System institution must assign a 100-percent risk weight to
preferred stock issued by a GSE.
(d) Exposures to depository institutions, foreign banks, and credit
unions--(1) Exposures to U.S.
[[Page 52890]]
depository institutions and credit unions. A System institution must
assign a 20-percent risk weight to an exposure to a depository
institution or credit union that is organized under the laws of the
United States or any state thereof, except as otherwise provided in
this paragraph. This risk weight applies to an exposure a System bank
has to an other financing institution (OFI) that is a depository
institution or credit union organized under the laws of the United
States or any state thereof or owned and controlled by such an entity
that guarantees the exposure. If the OFI exposure does not satisfy
these requirements, it must be assigned a risk weight as a corporate
exposure pursuant to paragraph (f)(2) of this section.
(2) Exposures to foreign banks. (i) Except as otherwise provided
under paragraphs (d)(2)(iv) of this section, a System institution must
assign a risk weight to an exposure to a foreign bank, in accordance
with Table 2 to Sec. 628.32, based on the CRC rating that corresponds
to the foreign bank's home country or the OECD membership status of the
foreign bank's home country if there is no CRC applicable to the
foreign bank's home country.
Table 2 to Sec. 628.32--Risk Weights for Exposures to Foreign Banks
------------------------------------------------------------------------
Risk weight
(in percent)
------------------------------------------------------------------------
CRC:....................................................
0-1................................................. 20
2................................................... 50
3................................................... 100
4-7................................................. 150
OECD Member with No CRC................................. 20
Non-OECD with No CRC.................................... 100
Sovereign Default....................................... 150
------------------------------------------------------------------------
(ii) A System institution must assign a 20-percent risk weight to
an exposure to a foreign bank whose home country is a member of the
OECD and does not have a CRC.
(iii) A System institution must assign a 100-percent risk weight to
an exposure to a foreign bank whose home country is not a member of the
OECD and does not have a CRC, with the exception of self-liquidating,
trade-related contingent items that arise from the movement of goods,
and that have a maturity of 3 months or less, which may be assigned a
20-percent risk weight.
(iv) A System institution must assign a 150-percent risk weight to
an exposure to a foreign bank immediately upon determining that an
event of sovereign default has occurred in the bank's home country, or
if an event of sovereign default has occurred in the foreign bank's
home country during the previous 5 years.
(3) [Reserved]
(e) Exposures to public sector entities (PSEs).--(1) Exposures to
U.S. PSEs. (i) A System institution must assign a 20-percent risk
weight to a general obligation exposure to a PSE that is organized
under the laws of the United States or any state or political
subdivision thereof.
(ii) A System institution must assign a 50-percent risk weight to a
revenue obligation exposure to a PSE that is organized under the laws
of the United States or any state or political subdivision thereof.
(2) Exposures to foreign PSEs. (i) Except as provided in paragraphs
(e)(1) and (e)(3) of this section, a System institution must assign a
risk weight to a general obligation exposure to a foreign PSE, in
accordance with Table 3 to Sec. 628.32, based on the CRC that
corresponds to the PSE's home country or the OECD membership status of
the PSE's home country if there is no CRC applicable to the PSE's home
country.
(ii) Except as provided in paragraphs (e)(1) and (e)(3) of this
section, a System institution must assign a risk weight to a revenue
obligation exposure to a foreign PSE, in accordance with Table 4 to
Sec. 628.32, based on the CRC that corresponds to the PSE's home
country; or the OECD membership status of the PSE's home country if
there is no CRC applicable to the PSE's home country.
(3) A System institution may assign a lower risk weight than would
otherwise apply under Tables 3 and 4 to Sec. 628.32 to an exposure to
a foreign PSE if:
(i) The PSE's home country supervisor allows banks under its
jurisdiction to assign a lower risk weight to such exposures; and
(ii) The risk weight is not lower than the risk weight that
corresponds to the PSE's home country in accordance with Table 1 to
Sec. 628.32.
Table 3 to Sec. 628.32--Risk Weights for Non-U.S. PSE General
Obligations
------------------------------------------------------------------------
Risk weight
(in percent)
------------------------------------------------------------------------
CRC:
0-1................................................. 20
2................................................... 50
3................................................... 100
4-7................................................. 150
OECD Member with No CRC................................. 20
Non-OECD Member with No CRC............................. 100
Sovereign Default....................................... 150
------------------------------------------------------------------------
Table 4 to Sec. 628.32--Risk Weights for Non-U.S. PSE Revenue
Obligations
------------------------------------------------------------------------
Risk weight
(in percent)
------------------------------------------------------------------------
CRC:
0-1................................................. 50
2-3................................................. 100
4-7................................................. 150
OECD Member with No CRC................................. 50
Non-OECD Member with No CRC............................. 100
Sovereign Default....................................... 150
------------------------------------------------------------------------
(4) Exposures to PSEs from an OECD member sovereign with no CRC.
(i) A System institution must assign a 20-percent risk weight to a
general obligation exposure to a PSE whose home country is a OECD
member sovereign with no CRC.
(ii) A System institution must assign a 50-percent risk weight to a
revenue obligation exposure to a PSE whose country is an OECD member
sovereign with no CRC.
(5) Exposures to PSEs whose home country is not an OECD member
sovereign with no CRC. A System institution must assign a 100-percent
risk weight to an exposure to a PSE whose home country is not a member
of the OECD and does not have a CRC.
(6) A System institution must assign a 150-percent risk weight to a
PSE exposure immediately upon determining that an event of sovereign
default has occurred in a PSE's home country or if an event of
sovereign default has occurred in the PSE's home country during the
previous 5 years.
(f) Corporate exposures. A System institution must assign a 100-
percent risk weight to all its corporate exposures. Assets assigned a
risk weight under this provision include:
(1) Borrower loans such as agricultural loans and consumer loans,
regardless of the corporate form of the borrower, unless those loans
qualify for different risk weights under other provisions of this
subpart D;
(2) System bank exposures to OFIs that do not satisfy the
requirements for a 20-percent risk weight pursuant to paragraph (d)(1)
of this section; and
(3) Premises, fixed assets, and other real estate owned.
(g) Residential mortgage exposures. (1) A System institution must
assign a 50-percent risk weight to a first-lien residential mortgage
exposure that:
(i) Is secured by a property that is either owner-occupied or
rented;
(ii) Is made in accordance with prudent underwriting standards
suitable for residential property, including standards relating to the
loan amount as
[[Page 52891]]
a percent of the appraised value of the property;
(iii) Is not 90 days or more past due or carried in nonaccrual
status; and
(iv) Is not restructured or modified.
(2) A System institution must assign a 100-percent risk weight to a
first-lien residential mortgage exposure that does not meet the
criteria in paragraph (g)(1) of this section, and to junior-lien
residential mortgage exposures.
(3) For the purpose of this paragraph (g), if a System institution
holds the first-lien and junior-lien(s) residential mortgage exposures,
and no other party holds an intervening lien, the System institution
must combine the exposures and treat them as a single first-lien
residential mortgage exposure.
(4) A loan modified or restructured solely pursuant to the U.S.
Treasury's Home Affordable Mortgage Program is not modified or
restructured for purposes of this section.
(h) [Reserved]
(i) [Reserved]
(j) High-volatility commercial real estate (HVCRE) exposures. A
System institution must assign a 150-percent risk weight to an HVCRE
exposure.
(k) Past due exposures. Except for a sovereign exposure or a
residential mortgage exposure, a System institution must determine a
risk weight for an exposure that is 90 days or more past due or in
nonaccrual status according to the requirements set forth in this
paragraph.
(1) A System institution must assign a 150-percent risk weight to
the portion of the exposure that is not guaranteed or that is not
secured by financial collateral.
(2) A System institution may assign a risk weight to the guaranteed
portion of a past due exposure based on the risk weight that applies
under Sec. 628.36 if the guarantee or credit derivative meets the
requirements of that section.
(3) A System institution may assign a risk weight to the portion of
a past due exposure that is collateralized by financial collateral
based on the risk weight that applies under Sec. 628.37 if the
financial collateral meets the requirements of that section.
(l) Other assets. (1) A System institution must assign a 0-percent
risk weight to cash owned and held in all offices of the System
institution, in transit, or in accounts at a depository institution or
a Federal Reserve Bank; to gold bullion held in a depository
institution's vaults on an allocated basis, to the extent the gold
bullion assets are offset by gold bullion liabilities; and to exposures
that arise from the settlement of cash transactions (such as equities,
fixed income, spot foreign exchange (FX) and spot commodities) with a
central counterparty where there is no assumption of ongoing
counterparty credit risk by the central counterparty after settlement
of the trade.
(2) A System institution must assign a 20-percent risk weight to
cash items in the process of collection.
(3) A System institution must assign a 100-percent risk weight to
deferred tax assets (DTAs) arising from temporary differences that the
System institution could realize through net operating loss carrybacks.
(4) A System institution must assign a 100-percent risk weight to
all MSAs.
(5) A System institution must assign a 100-percent risk weight to
all assets that are not specifically assigned a different risk weight
under this subpart and that are not deducted from tier 1 or tier 2
capital pursuant to Sec. 628.22.
(6) [Reserved]
(m) System institution exposure to other System institutions. A
System bank must assign a 20-percent risk weight to loans made to an
association.
Sec. 628.33 Off-balance sheet exposures.
(a) General. (1) A System institution must calculate the exposure
amount of an off-balance sheet exposure using the credit conversion
factors (CCFs) in paragraph (b) of this section.
(2) Where a System institution commits to provide a commitment, the
System institution may apply the lower of the two applicable CCFs.
(3) Where a System institution provides a commitment structured as
a syndication or participation, the System institution is only required
to calculate the exposure amount for its pro rata share of the
commitment.
(4) Where a System institution provides a commitment, enters into a
repurchase agreement, or provides a credit enhancing representation and
warranty, and such commitment, repurchase agreement, or credit-
enhancing representation and warranty is not a securitization exposure,
the exposure amount shall be no greater than the maximum contractual
amount of the commitment, repurchase agreement, or credit-enhancing
representation and warranty, as applicable.
(5) The exposure amount of a System bank's commitment to an
association is the difference between the association's maximum credit
limit with the System bank (as established by the general financing
agreement or promissory note, as required by Sec. 614.4125(d)) and the
amount the association has borrowed from the System bank.
(b) Credit conversion factors--(1) Zero-percent (0%) CCF. A System
institution must apply a 0-percent CCF to the unused portion of a
commitment that is unconditionally cancelable by the System
institution.
(2) Twenty-percent (20%) CCF. A System institution must apply a 20-
percent CCF to the amount of:
(i) Commitments with an original maturity of 14 months or less that
are not unconditionally cancelable by the System institution.
(ii) Self-liquidating, trade-related contingent items that arise
from the movement of goods, with an original maturity of 14 months or
less.
(3) Fifty-percent (50%) CCF. A System institution must apply a 50-
percent CCF to the amount of:
(i) Commitments with an original maturity of more than 14 months
that are not unconditionally cancelable by the System institution.
(ii) Transaction-related contingent items, including performance
bonds, bid bonds, warranties, and performance standby letters of
credit.
(4) One hundred-percent (100%) CCF. A System institution must apply
a 100-percent CCF to the following off-balance sheet items and other
similar transactions:
(i) Guarantees;
(ii) Repurchase agreements (the off-balance sheet component of
which equals the sum of the current fair values of all positions the
System institution has sold subject to repurchase);
(iii) Credit-enhancing representations and warranties that are not
securitization exposures;
(iv) Off-balance sheet securities lending transactions (the off-
balance sheet component of which equals the sum of the current fair
values of all positions the System institution has lent under the
transaction);
(v) Off-balance sheet securities borrowing transactions (the off-
balance sheet component of which equals the sum of the current fair
values of all non-cash positions the System institution has posted as
collateral under the transaction);
(vi) Financial standby letters of credit; and
(vii) Forward agreements.
Sec. 628.34 OTC derivative contracts.
(a) Exposure amount--(1) Single OTC derivative contract. Except as
modified by paragraph (b) of this section, the exposure amount for a
single OTC derivative contract that is not subject to a qualifying
master netting agreement is equal to the sum of the System
institution's current credit exposure and potential future credit
exposure (PFE) on the OTC derivative contract.
[[Page 52892]]
(i) Current credit exposure. The current credit exposure for a
single OTC derivative contract is the greater of the mark-to-fair value
of the OTC derivative contract or 0.
(ii) PFE. (A) The PFE for a single OTC derivative contract,
including an OTC derivative contract with a negative mark-to-fair
value, is calculated by multiplying the notional principal amount of
the OTC derivative contract by the appropriate conversion factor in
Table 1 to Sec. 628.34.
(B) For purposes of calculating either the PFE under this paragraph
or the gross PFE under paragraph (a)(2) of this section for exchange
rate contracts and other similar contracts in which the notional
principal amount is equivalent to the cash flows, notional principal
amount is the net receipts to each party falling due on each value date
in each currency.
(C) For an OTC derivative contract that does not fall within one of
the specified categories in Table 1 to Sec. 628.34, the PFE must be
calculated using the appropriate ``other'' conversion factor.
(D) A System institution must use an OTC derivative contract's
effective notional principal amount (that is, the apparent or stated
notional principal amount multiplied by any multiplier in the OTC
derivative contract) rather than the apparent or stated notional
principal amount in calculating PFE.
(E) The PFE of the protection provider of a credit derivative is
capped at the net present value of the amount of unpaid premiums.
Table 1 to Sec. 628.34--Conversion Factor Matrix for Derivative Contracts \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Credit Credit (non-
Foreign (investment investment Precious
Remaining maturity \2\ Interest rate exchange rate grade grade Equity metals Other
and gold reference reference (except gold)
asset) \3\ asset)
--------------------------------------------------------------------------------------------------------------------------------------------------------
One (1) year or less.................... 0.00 0.01 0.05 0.10 0.06 0.07 0.10
Greater than one (1) year and less than 0.005 0.05 0.05 0.10 0.08 0.07 0.12
or equal to five (5) years.............
Greater than five (5) years............. 0.015 0.075 0.05 0.10 0.10 0.08 0.15
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ For a derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the
derivative contract.
\2\ For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that
the fair value of the contract is 0, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract with a
remaining maturity of greater than 1 year that meets these criteria, the minimum conversion factor is 0.005.
\3\ A System institution must use the column labeled ``Credit (investment-grade reference asset)'' for a credit derivative whose reference asset is an
outstanding unsecured long-term debt security without credit enhancement that is investment grade. A System institution must use the column labeled
``Credit (non-investment-grade reference asset)'' for all other credit derivatives.
(2) Multiple OTC derivative contracts subject to a qualifying
master netting agreement. Except as modified by paragraph (b) of this
section, the exposure amount for multiple OTC derivative contracts
subject to a qualifying master netting agreement is equal to the sum of
the net current credit exposure and the adjusted sum of the PFE amounts
for all OTC derivative contracts subject to the qualifying master
netting agreement.
(i) Net current credit exposure. The net current credit exposure is
the greater of the net sum of all positive and negative mark-to-fair
values of the individual OTC derivative contracts subject to the
qualifying master netting agreement or 0.
(ii) Adjusted sum of the PFE amounts. The adjusted sum of the PFE
amounts, Anet, is calculated as
Anet = (0.4xAgross) +
(0.6xNGRxAgross), where:
(A) Agross = the gross PFE (that is, the sum of the PFE amounts
(as determined under paragraph (a)(1)(ii) of this section for each
individual derivative contract subject to the qualifying master
netting agreement); and
(B) Net-to-gross Ratio (NGR) = the ratio of the net current
credit exposure to the gross current credit exposure. In calculating
the NGR, the gross current credit exposure equals the sum of the
positive current credit exposures (as determined under paragraph
(a)(1)(i) of this section) of all individual derivative contracts
subject to the qualifying master netting agreement.
(b) Recognition of credit risk mitigation of collateralized OTC
derivative contracts. (1) A System institution may recognize the credit
risk mitigation benefits of financial collateral that secures an OTC
derivative contract or multiple OTC derivative contracts subject to a
qualifying master netting agreement (netting set) by using the simple
approach in Sec. 628.37(b).
(2) Alternatively, if the financial collateral securing a contract
or netting set described in paragraph (b)(1) of this section is marked-
to-fair value on a daily basis and subject to a daily margin
maintenance requirement, a System institution may recognize the credit
risk mitigation benefits of financial collateral that secures the
contract or netting set by using the collateral haircut approach in
Sec. 628.37(c).
(c) Counterparty credit risk for OTC credit derivatives--(1)
Protection purchasers. A System institution that purchases an OTC
credit derivative that is recognized under Sec. 628.36 as a credit
risk mitigant is not required to compute a separate counterparty credit
risk capital requirement under Sec. 628.32 provided that the System
institution does so consistently for all such credit derivatives. The
System institution must either include all or exclude all such credit
derivatives that are subject to a qualifying master netting agreement
from any measure used to determine counterparty credit risk exposure to
all relevant counterparties for risk-based capital purposes.
(2) Protection providers. (i) A System institution that is the
protection provider under an OTC credit derivative must treat the OTC
credit derivative as an exposure to the underlying reference asset. The
System institution is not required to compute a counterparty credit
risk capital requirement for the OTC credit derivative under Sec.
628.32, provided that this treatment is applied consistently for all
such OTC credit derivatives. The System institution must either include
all or exclude all such OTC credit derivatives that are subject to a
qualifying master netting agreement from any measure used to determine
counterparty credit risk exposure.
[[Page 52893]]
(ii) The provisions of paragraph (c)(2) of this section apply to
all relevant counterparties for risk-based capital purposes.
(d) Counterparty credit risk for OTC equity derivatives. (1) A
System institution must treat an OTC equity derivative contract as an
equity exposure and compute a risk-weighted asset amount for the OTC
equity derivative contract under Sec. Sec. 628.51 through 628.53.
(2) [Reserved]
(3) If the System institution risk weights the contract under the
Simple Risk-Weight Approach (SRWA) in Sec. 628.52, the System
institution may choose not to hold risk-based capital against the
counterparty credit risk of the OTC equity derivative contract, as long
as it does so for all such contracts. Where the OTC equity derivative
contracts are subject to a qualified master netting agreement, a System
institution using the SRWA must either include all or exclude all of
the contracts from any measure used to determine counterparty credit
risk exposure.
(e) [Reserved]
Sec. 628.35 Cleared transactions.
(a) General requirements--(1) Clearing member clients. A System
institution that is a clearing member client must use the methodologies
described in paragraph (b) of this section to calculate risk-weighted
assets for a cleared transaction.
(2) [Reserved]
(b) Clearing member client System institutions--(1) Risk-weighted
assets for cleared transactions. (i) To determine the risk-weighted
asset amount for a cleared transaction, a System institution that is a
clearing member client must multiply the trade exposure amount for the
cleared transaction, calculated in accordance with paragraph (b)(2) of
this section, by the risk weight appropriate for the cleared
transaction, determined in accordance with paragraph (b)(3) of this
section.
(ii) A clearing member client System institution's total risk-
weighted assets for cleared transactions is the sum of the risk-
weighted asset amounts for all its cleared transactions.
(2) Trade exposure amount. (i) For a cleared transaction that is
either a derivative contract or netting set of derivative contracts,
the trade exposure amount equals:
(A) The exposure amount for the derivative contract or netting set
of derivative contracts, calculated using the current exposure method
(CEM) for OTC derivative contracts under Sec. 628.34, plus
(B) The fair value of the collateral posted by the clearing member
client System institution and held by the central counterparty (CCP),
clearing member, or custodian in a manner that is not bankruptcy
remote.
(ii) For a cleared transaction that is a repo-style transaction,
the trade exposure amount equals:
(A) The exposure amount for the repo-style transaction calculated
using the collateral haircut methodology under Sec. 628.37(c), plus
(B) The fair value of the collateral posted by the clearing member
client System institution and held by the CCP or a clearing member in a
manner that is not bankruptcy remote.
(3) Cleared transaction risk weights. (i) For a cleared transaction
with a qualifying CCP (QCCP), a clearing member client System
institution must apply a risk weight of:
(A) Two (2) percent if the collateral posted by the System
institution to the QCCP or clearing member is subject to an arrangement
that prevents any losses to the clearing member client System
institution due to the joint default or a concurrent insolvency,
liquidation, or receivership proceeding of the clearing member and any
other clearing member clients of the clearing member; and the clearing
member client System institution has conducted sufficient legal review
to conclude with a well-founded basis (and maintains sufficient written
documentation of that legal review) that in the event of a legal
challenge (including one resulting from default or from liquidation,
insolvency, or receivership proceeding) the relevant court and
administrative authorities would find the arrangements to be legal,
valid, binding and enforceable under the law of the relevant
jurisdictions; or
(B) Four (4) percent if the requirements of paragraph (b)(3)(i)(A)
of this section are not met.
(ii) For a cleared transaction with a CCP that is not a QCCP, a
clearing member client System institution must apply the risk weight
appropriate for the CCP according to Sec. 628.32.
(4) Collateral. (i) Notwithstanding any other requirements in this
section, collateral posted by a clearing member client System
institution that is held by a custodian (in its capacity as custodian)
in a manner that is bankruptcy remote from the CCP, the custodian,
clearing member and other clearing member clients of the clearing
member, is not subject to a capital requirement under this section.
(ii) A clearing member client System institution must calculate a
risk-weighted asset amount for any collateral provided to a CCP,
clearing member, or custodian in connection with a cleared transaction
in accordance with the requirements under Sec. 628.32.
(c) [Reserved]
(d) [Reserved]
Sec. 628.36 Guarantees and credit derivatives: substitution
treatment.
(a) Scope--(1) General. A System institution may recognize the
credit risk mitigation benefits of an eligible guarantee or eligible
credit derivative by substituting the risk weight associated with the
protection provider for the risk weight assigned to an exposure, as
provided under this section.
(2) This section applies to exposures for which:
(i) Credit risk is fully covered by an eligible guarantee or
eligible credit derivative; or
(ii) Credit risk is covered on a pro rata basis (that is, on a
basis in which the System institution and the protection provider share
losses proportionately) by an eligible guarantee or eligible credit
derivative.
(3) Exposures on which there is a tranching of credit risk
(reflecting at least two different levels of seniority) generally are
securitization exposures subject to Sec. Sec. 628.41 through 628.45.
(4) If multiple eligible guarantees or eligible credit derivatives
cover a single exposure described in this section, a System institution
may treat the hedged exposure as multiple separate exposures each
covered by a single eligible guarantee or eligible credit derivative
and may calculate a separate risk-weighted asset amount for each
separate exposure as described in paragraph (c) of this section.
(5) If a single eligible guarantee or eligible credit derivative
covers multiple hedged exposures described in paragraph (a)(2) of this
section, a System institution must treat each hedged exposure as
covered by a separate eligible guarantee or eligible credit derivative
and must calculate a separate risk-weighted asset amount for each
exposure as described in paragraph (c) of this section.
(b) Rules of recognition. (1) A System institution may only
recognize the credit risk mitigation benefits of eligible guarantees
and eligible credit derivatives.
(2) A System institution may only recognize the credit risk
mitigation benefits of an eligible credit derivative to hedge an
exposure that is different from the credit derivative's reference
exposure used for determining the derivative's cash settlement value,
[[Page 52894]]
deliverable obligation, or occurrence of a credit event if:
(i) The reference exposure ranks pari passu with, or is
subordinated to, the hedged exposure; and
(ii) The reference exposure and the hedged exposure are to the same
legal entity, and legally enforceable cross-default or cross-
acceleration clauses are in place to ensure payments under the credit
derivative are triggered when the obligated party of the hedged
exposure fails to pay under the terms of the hedged exposure.
(c) Substitution approach--(1) Full coverage. If an eligible
guarantee or eligible credit derivative meets the conditions in
paragraphs (a) and (b) of this section and the protection amount (P) of
the guarantee or credit derivative is greater than or equal to the
exposure amount of the hedged exposure, a System institution may
recognize the guarantee or credit derivative in determining the risk-
weighted asset amount for the hedged exposure by substituting the risk
weight applicable to the guarantor or credit derivative protection
provider under Sec. 628.32 for the risk weight assigned to the
exposure.
(2) Partial coverage. If an eligible guarantee or eligible credit
derivative meets the conditions in Sec. Sec. 628.36(a) and 628.37(b)
and the protection amount (P) of the guarantee or credit derivative is
less than the exposure amount of the hedged exposure, the System
institution must treat the hedged exposure as two separate exposures
(protected and unprotected) in order to recognize the credit risk
mitigation benefit of the guarantee or credit derivative.
(i) The System institution may calculate the risk-weighted asset
amount for the protected exposure under Sec. 628.32, where the
applicable risk weight is the risk weight applicable to the guarantor
or credit derivative protection provider.
(ii) The System institution must calculate the risk-weighted asset
amount for the unprotected exposure under Sec. 628.32, where the
applicable risk weight is that of the unprotected portion of the hedged
exposure.
(iii) The treatment provided in this section is applicable when the
credit risk of an exposure is covered on a partial pro rata basis and
may be applicable when an adjustment is made to the effective notional
amount of the guarantee or credit derivative under paragraphs (d), (e),
or (f) of this section.
(d) Maturity mismatch adjustment. (1) A System institution that
recognizes an eligible guarantee or eligible credit derivative in
determining the risk-weighted asset amount for a hedged exposure must
adjust the effective notional amount of the credit risk mitigant to
reflect any maturity mismatch between the hedged exposure and the
credit risk mitigant.
(2) A maturity mismatch occurs when the residual maturity of a
credit risk mitigant is less than that of the hedged exposure(s).
(3) The residual maturity of a hedged exposure is the longest
possible remaining time before the obligated party of the hedged
exposure is scheduled to fulfill its obligation on the hedged exposure.
If a credit risk mitigant has embedded options that may reduce its
term, the System institution (protection purchaser) must use the
shortest possible residual maturity for the credit risk mitigant. If a
call is at the discretion of the protection provider, the residual
maturity of the credit risk mitigant is at the first call date. If the
call is at the discretion of the System institution (protection
purchaser), but the terms of the arrangement at origination of the
credit risk mitigant contain a positive incentive for the System
institution to call the transaction before contractual maturity, the
remaining time to the first call date is the residual maturity of the
credit risk mitigant.
(4) A credit risk mitigant with a maturity mismatch may be
recognized only if its original maturity is greater than or equal to 1
year and its residual maturity is greater than 3 months.
(5) When a maturity mismatch exists, the System institution must
apply the following adjustment to reduce the effective notional amount
of the credit risk mitigant: Pm = E x [(t-0.25)/(T-0.25)],
where:
(i) Pm = effective notional amount of the credit risk mitigant,
adjusted for maturity mismatch;
(ii) E = effective notional amount of the credit risk mitigant;
(iii) t = the lesser of T or the residual maturity of the credit
risk mitigant, expressed in years; and
(iv) T = the lesser of 5 or the residual maturity of the hedged
exposure, expressed in years.
(e) Adjustment for credit derivatives without restructuring as a
credit event. If a System institution recognizes an eligible credit
derivative that does not include as a credit event a restructuring of
the hedged exposure involving forgiveness or postponement of principal,
interest, or fees that results in a credit loss event (that is, a
charge-off, specific provision, or other similar debit to the profit
and loss account), the System institution must apply the following
adjustment to reduce the effective notional amount of the credit
derivative: Pr = Pm x 0.60,
where:
(1) Pr = effective notional amount of the credit risk mitigant,
adjusted for lack of restructuring event (and maturity mismatch, if
applicable); and
(2) Pm = effective notional amount of the credit risk mitigant
(adjusted for maturity mismatch, if applicable).
(f) Currency mismatch adjustment. (1) If a System institution
recognizes an eligible guarantee or eligible credit derivative that is
denominated in a currency different from that in which the hedged
exposure is denominated, the System institution must apply the
following formula to the effective notional amount of the guarantee or
credit derivative: Pc = Pr x (1-Hfx),
where:
(i) Pc = effective notional amount of the credit risk mitigant,
adjusted for currency mismatch (and maturity mismatch and lack of
restructuring event, if applicable);
(ii) Pr = effective notional amount of the credit risk mitigant
(adjusted for maturity mismatch and lack of restructuring event, if
applicable); and
(iii) Hfx = haircut appropriate for the currency mismatch between
the credit risk mitigant and the hedged exposure.
(2) A System institution must set Hfx equal to 8 percent.
(3) A System institution must adjust Hfx calculated in paragraph
(f)(2) of this section upward if the System institution revalues the
guarantee or credit derivative less frequently than once every 10
business days using the following square root of time formula:
[GRAPHIC] [TIFF OMITTED] TP04SE14.011
where TM equals the greater of 10 or the number of days between
revaluation.
Sec. 628.37 Collateralized transactions.
(a) General. (1) To recognize the risk-mitigating effects of
financial collateral, a System institution may use:
(i) The simple approach in paragraph (b) of this section for any
exposure.
(ii) The collateral haircut approach in paragraph (c) of this
section for repo-style transactions, eligible margin loans,
collateralized derivative contracts, and single-product netting sets of
such transactions.
(2) A System institution may use any approach described in this
section that is valid for a particular type of exposure or transaction;
however, it must use the same approach for similar exposures or
transactions.
[[Page 52895]]
(b) The simple approach--(1) General requirements.
(i) A System institution may recognize the credit risk mitigation
benefits of financial collateral that secures any exposure.
(ii) To qualify for the simple approach, the financial collateral
must meet the following requirements:
(A) The collateral must be subject to a collateral agreement for at
least the life of the exposure;
(B) The collateral must be revalued at least every 6 months; and
(C) The collateral (other than gold) and the exposure must be
denominated in the same currency.
(2) Risk-weight substitution. (i) A System institution may apply a
risk weight to the portion of an exposure that is secured by the fair
value of financial collateral (that meets the requirements of paragraph
(b)(1) of this section) based on the risk weight assigned to the
collateral under Sec. 628.32. For repurchase agreements, reverse
repurchase agreements, and securities lending and borrowing
transactions, the collateral is the instruments, gold, and cash the
System institution has borrowed, purchased subject to resale, or taken
as collateral from the counterparty under the transaction. Except as
provided in paragraph (b)(3) of this section, the risk weight assigned
to the collateralized portion of the exposure may not be less than 20
percent.
(ii) A System institution must apply a risk weight to the unsecured
portion of the exposure based on the risk weight assigned to the
exposure under this subpart.
(3) Exceptions to the 20-percent risk-weight floor and other
requirements. Notwithstanding paragraph (b)(2)(i) of this section:
(i) A System institution may assign a 0-percent risk weight to an
exposure to an OTC derivative contract that is marked-to-fair on a
daily basis and subject to a daily margin maintenance requirement, to
the extent the contract is collateralized by cash on deposit.
(ii) A System institution may assign a 10-percent risk weight to an
exposure to an OTC derivative contract that is marked-to-fair value
daily and subject to a daily margin maintenance requirement, to the
extent that the contract is collateralized by an exposure to a
sovereign that qualifies for a 0-percent risk weight under Sec.
628.32.
(iii) A System institution may assign a 0-percent risk weight to
the collateralized portion of an exposure where:
(A) The financial collateral is cash on deposit; or
(B) The financial collateral is an exposure to a sovereign that
qualifies for a 0-percent risk weight under Sec. 628.32, and the
System institution has discounted the fair value of the collateral by
20 percent.
(c) Collateral haircut approach -- (1) General. A System
institution may recognize the credit risk mitigation benefits of
financial collateral that secures an eligible margin loan, repo-style
transaction, collateralized derivative contract, or single-product
netting set of such transactions by using the standard supervisory
haircuts in paragraph (c)(3) of this section.
(2) Exposure amount equation. A System institution must determine
the exposure amount for an eligible margin loan, repo-style
transaction, collateralized derivative contract, or a single-product
netting set of such transactions by setting the exposure amount equal
to max {0, [([Sigma]E--[Sigma]C) + [Sigma](Es x
Hs) + [Sigma](Efx x Hfx)]{time} ,
where:
(i)(A) For eligible margin loans and repo-style transactions and
netting sets thereof, [Sigma]E equals the value of the exposure (the
sum of the current fair values of all instruments, gold, and cash
the System institution has lent, sold subject to repurchase, or
posted as collateral to the counterparty under the transaction (or
netting set)); and
(B) For collateralized derivative contracts and netting sets
thereof, [Sigma]E equals the exposure amount of the OTC derivative
contract (or netting set) calculated under Sec. 628.34(c) or (d).
(ii) [Sigma]C equals the value of the collateral (the sum of the
current fair values of all instruments, gold and cash the System
institution has borrowed, purchased subject to resale, or taken as
collateral from the counterparty under the transaction (or netting
set));
(iii) Es equals the absolute value of the net position in
a given instrument or in gold (where the net position in the
instrument or gold equals the sum of the current fair values of the
instrument or gold the System institution has lent, sold subject to
repurchase, or posted as collateral to the counterparty minus the
sum of the current fair values of that same instrument or gold the
System institution has borrowed, purchased subject to resale, or
taken as collateral from the counterparty);
(iv) Hs equals the fair value price volatility haircut
appropriate to the instrument or gold referenced in Es;
(v) Efx equals the absolute value of the net position of
instruments and cash in a currency that is different from the
settlement currency (where the net position in a given currency
equals the sum of the current fair values of any instruments or cash
in the currency the System institution has lent, sold subject to
repurchase, or posted as collateral to the counterparty minus the
sum of the current fair values of any instruments or cash in the
currency the System institution has borrowed, purchased subject to
resale, or taken as collateral from the counterparty); and
(vi) Hfx equals the haircut appropriate to the mismatch
between the currency referenced in Efx and the settlement currency.
(3) Standard supervisory haircuts. (i) A System institution must
use the haircuts for fair value price volatility (Hs) provided in Table
1 to Sec. 628.37, as adjusted in certain circumstances in accordance
with the requirements of paragraphs (c)(3)(iii) and (iv) of this
section:
Table 1 to Sec. 628.37--Standard Supervisory Market Price Volatility Haircut 1
--------------------------------------------------------------------------------------------------------------------------------------------------------
Haircut (in percent) assigned based on
------------------------------------------------------------------------------ Investment
Sovereign issuers risk weight under Non-sovereign issuers risk weight grade
Residual maturity Sec. 628.3 \2\ under Sec. 628.32 securization
------------------------------------------------------------------------------ exposures
Zero 20% or -50% 100% 20% 50% 100% (in percent)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than or equal to 1 year................................ 0.5 1.0 15.0 1.0 2.0 25.0 4%
Greater than 1 years and less than and equal to 5 years..... 2.0 3.0 15.0 4.0 6.0 25.0 12%
Greater than 5 years........................................ 4.0 6.0 15.0 8.0 12.0 25.0 24%
-------------------------------------------------------------------------------------------
Main index equities (including convertible bonds) and gold 15%
Other publically traded equities (including convertible bonds) 25%
[[Page 52896]]
Mutual funds Highest haircut applicable to any security in
which the fund can invest
Cash collateral 0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The market price volatility haircut in Table 1 to Sec. 628.37 are based on 10-day holding period.
\2\ Includes a foreign PSE that receives a 0-percent risk weight.
(ii) For currency mismatches, a System institution must use a
haircut for foreign exchange rate volatility (Hfx) of 8 percent, as
adjusted in certain circumstances under paragraphs (c)(3)(iii) and (iv)
of this section.
(iii) For repo-style transactions, a System institution may
multiply the standard supervisory haircuts provided in paragraphs
(c)(3)(i) and (ii) of this section by the square root of \1/2\ (which
equals 0.707107).
(iv) If the number of trades in a netting set exceeds 5,000 at any
time during a quarter, a System institution must adjust the supervisory
haircuts provided in paragraphs (c)(3)(i) and (ii) of this section
upward on the basis of a holding period of 20 business days for the
following quarter except in the calculation of the exposure amount for
purposes of Sec. 628.35. If a netting set contains one or more trades
involving illiquid collateral or an OTC derivative that cannot be
easily replaced, a System institution must adjust the supervisory
haircuts upward on the basis of a holding period of 20 business days.
If over the 2 previous quarters more than two margin disputes on a
netting set have occurred that lasted more than the holding period,
then the System institution must adjust the supervisory haircuts upward
for that netting set on the basis of a holding period that is at least
two times the minimum holding period for that netting set. A System
institution must adjust the standard supervisory haircuts upward using
the following formula:
[GRAPHIC] [TIFF OMITTED] TP04SE14.016
where
(A) TM equals a holding period of longer than 10 business days for
eligible margin loans and derivative contracts or longer than 5
business days for repo-style transactions;
(B) HS equals the standard supervisory haircut; and
(C) TS equals 10 business days for eligible margin loans and
derivative contracts or 5 business days for repo-style transactions.
(v) If the instrument a System institution has lent, sold subject
to repurchase, or posted as collateral does not meet the definition of
financial collateral in Sec. 628.2, the System institution must use a
25-percent haircut for fair value price volatility (Hs).
(4) [Reserved]
Risk-Weighted Assets for Unsettled Transactions
Sec. 628.38 Unsettled transactions.
(a) Definitions. For purposes of this section:
(1) Delivery-versus-payment (DvP) transaction means a securities or
commodities transaction in which the buyer is obligated to make payment
only if the seller has made delivery of the securities or commodities
and the seller is obligated to deliver the securities or commodities
only if the buyer has made payment.
(2) Payment-versus-payment (PvP) transaction means a foreign
exchange transaction in which each counterparty is obligated to make a
final transfer of one or more currencies only if the other counterparty
has made a final transfer of one or more currencies.
(3) A transaction has a normal settlement period if the contractual
settlement period for the transaction is equal to or less than the fair
value standard for the instrument underlying the transaction and equal
to or less than 5 business days.
(4) Positive current exposure of a System institution for a
transaction is the difference between the transaction value at the
agreed settlement price and the current fair value price of the
transaction, if the difference results in a credit exposure of the
System institution to the counterparty.
(b) Scope. This section applies to all transactions involving
securities, foreign exchange instruments, and commodities that have a
risk of delayed settlement or delivery. This section does not apply to:
(1) Cleared transactions that are marked-to-fair value daily and
subject to daily receipt and payment of variation margin;
(2) Repo-style transactions, including unsettled repo-style
transactions;
(3) One-way cash payments on OTC derivative contracts; or
(4) Transactions with a contractual settlement period that is
longer than the normal settlement period (which are treated as OTC
derivative contracts as provided in Sec. 628.34).
(c) System-wide failures. In the case of a system-wide failure of a
settlement, clearing system or central counterparty, the FCA may waive
risk-based capital requirements for unsettled and failed transactions
until the situation is rectified.
(d) Delivery-versus-payment (DvP) and payment-versus-payment (PvP)
transactions. A System institution must hold risk-based capital against
any DvP or PvP transaction with a normal settlement period if the
System institution's counterparty has not made delivery or payment
within 5 business days after the settlement date. The System
institution must determine its risk-weighted asset amount for such a
transaction by multiplying the positive current exposure of the
transaction for the System institution by the appropriate risk weight
in Table 1 to Sec. 628.38.
Table 1 to Sec. 628.38--Risk Weights for Unsettled DvP and PvP
Transactions
------------------------------------------------------------------------
Risk weight
to be
applied to
positive
Number of business days after contractual settlement date current
exposure
(in
percent)
------------------------------------------------------------------------
From 5 to 15............................................... 100.0
From 16 to 30.............................................. 625.0
From 31 to 45.............................................. 937.5
[[Page 52897]]
46 or more................................................. 1,250.0
------------------------------------------------------------------------
(e) Non-DvP/non-PvP (non-delivery-versus-payment/non-payment-
versus-payment) transactions. (1) A System institution must hold risk-
based capital against any non-DvP/non-PvP transaction with a normal
settlement period if the System institution has delivered cash,
securities, commodities, or currencies to its counterparty but has not
received its corresponding deliverables by the end of the same business
day. The System institution must continue to hold risk-based capital
against the transaction until the System institution has received its
corresponding deliverables.
(2) From the business day after the System institution has made its
delivery until 5 business days after the counterparty delivery is due,
the System institution must calculate the risk-weighted asset amount
for the transaction by treating the current fair value of the
deliverables owed to the System institution as an exposure to the
counterparty and using the applicable counterparty risk weight under
Sec. 628.32.
(3) If the System institution has not received its deliverables by
the 5th business day after counterparty delivery was due, the System
institution must assign a 1,250-percent risk weight to the current fair
value of the deliverables owed to the System institution.
(f) Total risk-weighted assets for unsettled transactions. Total
risk-weighted assets for unsettled transactions is the sum of the risk-
weighted asset amounts of all DvP, PvP, and non- DvP/non-PvP
transactions. >Sec. Sec. 628.39 through 628.40 [Reserved]
Risk-Weighted Assets for Securitization Exposures
Sec. 628.41 Operational requirements for securitization exposures.
(a) Operational criteria for traditional securitizations. A System
institution that transfers exposures it has originated or purchased to
a third party in connection with a traditional securitization may
exclude the exposures from the calculation of its risk-weighted assets
only if each condition in this section is satisfied. A System
institution that meets these conditions must hold risk-based capital
against any credit risk it retains in connection with the
securitization. A System institution that fails to meet these
conditions must hold risk-based capital against the transferred
exposures as if they had not been securitized and must deduct from CET1
capital, pursuant to Sec. 628.22, any after-tax gain-on-sale resulting
from the transaction. The conditions are:
(1) The exposures are not reported on the System institution's
consolidated balance sheet under GAAP;
(2) The System institution has transferred to one or more third
parties credit risk associated with the underlying exposures;
(3) Any clean-up calls relating to the securitization are eligible
clean-up calls; and
(4) The securitization does not:
(i) Include one or more underlying exposures in which the borrower
is permitted to vary the drawn amount within an agreed limit under a
line of credit; and
(ii) Contain an early amortization provision.
(b) Operational criteria for synthetic securitizations. For
synthetic securitizations, a System institution may recognize for risk-
based capital purposes the use of a credit risk mitigant to hedge
underlying exposures only if each condition in this paragraph is
satisfied. A System institution that meets these conditions must hold
risk-based capital against any credit risk of the exposures it retains
in connection with the synthetic securitization. A System institution
that fails to meet these conditions or chooses not to recognize the
credit risk mitigant for purposes of this section must instead hold
risk-based capital against the underlying exposures as if they had not
been synthetically securitized. The conditions are:
(1) The credit risk mitigant is:
(i) Financial collateral;
(ii) A guarantee that meets all criteria set forth in the
definition of ``eligible guarantee'' in Sec. 628.2, except for the
criteria in paragraph (3) of that definition; or
(iii) A credit derivative that meets all criteria as set forth in
the definition of ``eligible credit derivative'' in Sec. 628.2, except
for the criteria in paragraph (3) of the definition of ``eligible
guarantee'' in Sec. 628.2.
(2) The System institution transfers credit risk associated with
the underlying exposures to one or more third parties, and the terms
and conditions in the credit risk mitigants employed do not include
provisions that:
(i) Allow for the termination of the credit protection due to
deterioration in the credit quality of the underlying exposures;
(ii) Require the System institution to alter or replace the
underlying exposures to improve the credit quality of the pool of
underlying exposures;
(iii) Increase the System institution's cost of credit protection
in response to deterioration in the credit quality of the underlying
exposures;
(iv) Increase the yield payable to parties other than the System
institution in response to a deterioration in the credit quality of the
underlying exposures; or
(v) Provide for increases in a retained first loss position or
credit enhancement provided by the System institution after the
inception of the securitization;
(3) The System institution obtains a well-reasoned opinion from
legal counsel that confirms the enforceability of the credit risk
mitigant in all relevant jurisdictions; and
(4) Any clean-up calls relating to the securitization are eligible
clean-up calls.
(c) Due diligence requirements. (1) Except for exposures that are
deducted from CET1 capital (pursuant to Sec. 628.22) and exposures
subject to Sec. 628.42(h), if a System institution is unable to
demonstrate to the satisfaction of the FCA a comprehensive
understanding of the features of a securitization exposure that would
materially affect the performance of the exposure, the System
institution must assign the securitization exposure a risk weight of
1,250 percent. The System institution's analysis must be commensurate
with the complexity of the securitization exposure and the materiality
of the exposure in relation to its capital.
(2) A System institution must demonstrate its comprehensive
understanding of a securitization exposure under paragraph (c)(1) of
this section for each securitization exposure by:
(i) Conducting an analysis of the risk characteristics of a
securitization exposure prior to acquiring the exposure, and
documenting such analysis within 3 business days after acquiring the
exposure, considering:
(A) Structural features of the securitization that would materially
impact the performance of the exposure, for example, the contractual
cash flow waterfall, waterfall-related triggers, credit enhancements,
liquidity enhancements, fair value triggers, the performance of
organizations that service the exposure, and deal-specific definitions
of default;
(B) Relevant information regarding the performance of the
underlying credit
[[Page 52898]]
exposure(s), for example, the percentage of loans 30, 60, and 90 days
past due; default rates; prepayment rates; loans in foreclosure;
property types; occupancy; average credit score or other measures of
creditworthiness; average loan-to-value (LTV) ratio; and industry and
geographic diversification data on the underlying exposure(s);
(C) Relevant market data of the securitization, for example, bid-
ask spread, most recent sales price and historic price volatility,
trading volume, implied market rating, and size, depth and
concentration level of the market for the securitization; and
(D) For resecuritization exposures, performance information on the
underlying securitization exposures, for example, the issuer name and
credit quality, and the characteristics and performance of the
exposures; and
(ii) On an on-going basis (no less frequently than quarterly),
evaluating, reviewing, and updating as appropriate the analysis
required under paragraph (c)(1) of this section for each securitization
exposure.
Sec. 628.42 Risk-weighted assets for securitization exposures.
(a) Securitization risk weight approaches. Except as provided
elsewhere in this section or in Sec. 628.41:
(1) A System institution must deduct from CET1 capital any after-
tax gain-on-sale resulting from a securitization (as provided in Sec.
628.22) and must apply a 1,250-percent risk weight to the portion of a
credit-enhancing interest-only strip (CEIO) that does not constitute
after-tax gain-on-sale.
(2) If a securitization exposure does not require deduction under
paragraph (a)(1) of this section, a System institution may assign a
risk weight to the securitization exposure using the simplified
supervisory formula approach (SSFA) in accordance with Sec. 628.43(a)
through (d) and subject to the limitation under Sec. 628.42(e).
Alternatively, a System institution may assign a risk weight to the
purchased securitization exposure using the gross-up approach in
accordance with Sec. 628.43(e), provided however, that such System
institution must apply either the SSFA or the gross-up approach
consistently across all of its securitization exposures, except as
provided in paragraphs (a)(1), (a)(3), and (a)(4) of this section.
(3) If a securitization exposure does not require deduction under
paragraph (a)(1) of this section and the System institution cannot or
chooses not to apply the SSFA or the gross-up approach to the exposure,
the System institution must assign a risk weight to the exposure as
described in Sec. 628.44.
(4) If a securitization exposure is a derivative contract (other
than protection provided by a System institution in the form of a
credit derivative) that has a first priority claim on the cash flows
from the underlying exposures (notwithstanding amounts due under
interest rate or currency derivative contracts, fees due, or other
similar payments), a System institution may choose to set the risk-
weighted asset amount of the exposure equal to the amount of the
exposure as determined in paragraph (c) of this section.
(b) Total risk-weighted assets for securitization exposures. A
System institution's total risk-weighted assets for securitization
exposures equals the sum of the risk-weighted asset amount for
securitization exposures that the System institution risk weights under
Sec. Sec. 628.41(c), 628.42(a)(1), and 628.43, 628.44, or 628.45,
except as provided in Sec. 628.42(e) through (j) of this section, as
applicable.
(c) Exposure amount of a securitization exposure.
(1) [Reserved]
(2) On-balance sheet securitization exposures (available-for-sale
or held-to-maturity securities). The exposure amount of an on-balance
sheet securitization exposure that is an available-for-sale or held-to-
maturity security is the System institution's carrying value (including
net accrued but unpaid interest and fees), less any net unrealized
gains on the exposure and plus any net unrealized losses on the
exposure.
(3) Off-balance sheet securitization exposures. (i) Except as
provided in paragraph (j) of this section, the exposure amount of an
off-balance sheet securitization that is not a repo-style transaction,
an eligible margin loan, a cleared transaction (other than a credit
derivative), or an OTC derivative contract (other than a credit
derivative) is the notional amount of the exposure.
(ii) [Reserved]
(iii) [Reserved]
(4) Repo-style transactions, eligible margin loans, and derivative
contracts. The exposure amount of a securitization exposure that is a
repo-style transaction, an eligible margin loan, or a derivative
contract (other than a credit derivative) is the exposure amount of the
transaction as calculated under Sec. 628.34 or Sec. 628.37 as
applicable.
(d) Overlapping exposures. If a System institution has multiple
securitization exposures that provide duplicative coverage to the
underlying exposures of a securitization, the System institution is not
required to hold duplicative risk-based capital against the overlapping
position. Instead, the System institution may apply to the overlapping
position the applicable risk-based capital treatment that results in
the highest risk-based capital requirement.
(e) Implicit support. If a System institution provides support to a
securitization in excess of the System institution's contractual
obligation to provide credit support to the securitization (implicit
support):
(1) The System institution must include in risk-weighted assets all
of the underlying exposures associated with the securitization as if
the exposures had not been securitized and must deduct from CET1
capital (pursuant to Sec. 628.22) any after-tax gain-on-sale resulting
from the securitization; and
(2) The System institution must disclose publicly:
(i) That it has provided implicit support to the securitization;
and
(ii) The risk-based capital impact to the System institution of
providing such implicit support.
(f) Undrawn portion of an eligible servicer cash advance facility.
(1) Notwithstanding any other provision of this subpart, a System
institution that is a servicer under an eligible servicer cash advance
facility is not required to hold risk-based capital against potential
future cash advance payments that it may be required to provide under
the contract governing the facility.
(2) For a System institution that acts as a servicer, the exposure
amount for a servicer cash advance facility that is not an eligible
cash advance facility is equal to the amount of all potential future
cash payments that the System institution may be contractually required
to provide during the subsequent 12-month period under the governing
facility.
(g) Interest-only mortgage-backed securities. Regardless of any
other provisions of this subpart, the risk weight for a non-credit-
enhancing interest-only mortgage-backed security may not be less than
100 percent.
(h) Small-business loans and leases on personal property
transferred with retained contractual exposure. (1) Regardless of any
other provisions of this subpart, a System institution that has
transferred small-business loans and leases on personal property
(small-business obligations) must include in risk-weighted assets only
its contractual exposure to the small-business obligations if all the
following conditions are met:
(i) The transaction must be treated as a sale under GAAP.
[[Page 52899]]
(ii) The System institution establishes and maintains, pursuant to
GAAP, a non-capital reserve sufficient to meet the System institution's
reasonably estimated liability under the contractual obligation.
(iii) The small business obligations are to businesses that meet
the criteria for a small-business concern established by the Small
Business Administration under section 3(a) of the Small Business Act.
(iv) [Reserved]
(2) The total outstanding amount of contractual exposure retained
by a System institution on transfers of small-business obligations
receiving the capital treatment specified in paragraph (h)(1) of this
section cannot exceed 15 percent of the System institution's total
capital.
(3) If a System institution exceeds the 15-percent capital
limitation provided in paragraph (h)(2) of this section, the capital
treatment under paragraph (h)(1) of this section will continue to apply
to any transfers of small-business obligations with retained
contractual exposure that occurred during the time that the System
institution did not exceed the capital limit.
(4) [Reserved]
(i) [Reserved]; and
(ii) [Reserved]
(i) N\th\-to-default credit derivatives. (1) Protection provider. A
System institution must assign a risk weight to an N\th\-to-default
credit derivative in accordance with FCA guidance.
(2) [Reserved]
(3) [Reserved]
(4) Protection purchaser -- (i) First-to-default credit
derivatives. A System institution that obtains credit protection on a
group of underlying exposures through a first-to-default credit
derivative that meets the rules of recognition of Sec. 628.36(b) must
determine its risk-based capital requirement for the underlying
exposures as if the System institution synthetically securitized the
underlying exposure with the smallest risk-weighted asset amount and
had obtained no credit risk mitigant on the other underlying exposures.
A System institution must calculate a risk-based capital requirement
for counterparty credit risk according to Sec. 628.34 for a first-to-
default credit derivative that does not meet the rules of recognition
of Sec. 628.36(b).
(ii) Second-or-subsequent-to-default credit derivatives. (A) A
System institution that obtains credit protection on a group of
underlying exposures through a N\th\-to-default credit derivative that
meets the rules of recognition of Sec. 628.36(b) (other than a first-
to-default credit derivative) may recognize the credit risk mitigation
benefits of the derivative only if:
(1) The System institution also has obtained credit protection on
the same underlying exposures in the form of first-through-(n-1)-to-
default credit derivatives; or
(2) If n-1 of the underlying exposures have already defaulted.
(B) If a System institution satisfies the requirements of paragraph
(i)(4)(ii)(A) of this section, the System institution must determine
its risk-based capital requirement for the underlying exposures as if
the System institution had only symetically securitized the underlying
exposure with the N\th\ smallest risk-weighted asset amount and had
obtained no credit risk mitigant on the underlying exposures.
(C) A System institution must calculate a risk-based capital
requirement for counterparty credit risk according to Sec. 628.34 for
a N\th\ -to-default credit derivative that does not meet the rules of
recognition of Sec. 628.36(b).
(j) Guarantees and credit derivatives other than N\th\ - to-default
credit derivatives -- (1) Protection provider. For a guarantee or
credit derivative (other than an N\th\-to-default credit derivative)
provided by a System institution that covers the full amount or a pro
rata share of a securitization exposure's principal and interest, the
System institution must risk weight the guarantee or credit derivative
in accordance with FCA guidance.
(2) Protection purchaser. (i) A System institution that purchases a
guarantee or OTC credit derivative (other than an N\th\ -to-default
credit derivative) that is recognized under Sec. 628.45 as a credit
risk mitigant (including via collateral recognized under Sec. 628.37)
is not required to compute a separate credit risk capital requirement
under Sec. 628.31, in accordance with Sec. 628.34(c).
(ii) If a System institution cannot, or chooses not to, recognize a
purchased credit derivative as a credit risk mitigant under Sec.
628.45, the System institution must determine the exposure amount of
the credit derivative under Sec. 628.34.
(A) If the System institution purchases credit protection from a
counterparty that is not a securitization special purpose entity (SPE),
the System institution must determine the risk weight for the exposure
according to general risk weights under Sec. 628.32.
(B) If the System institution purchases the credit protection from
a counterparty that is a securitization SPE, the System institution
must determine the risk weight for the exposure according to Sec.
628.42, including Sec. 628.42(a)(4) for a credit derivative that has a
first priority claim on the cash flows from the underlying exposures of
the securitization SPE (notwithstanding amounts due under interest rate
or currency derivative contracts, fees due, or other similar payments).
Sec. 628.43 Simplified supervisory formula approach (SSFA) and the
gross-up approach.
(a) General requirements for the SSFA. To use the SSFA to determine
the risk weight for a securitization exposure, a System institution
must have data that enables it to assign accurately the parameters
described in paragraph (b) of this section. Data used to assign the
parameters described in paragraph (b) of this section must be the most
currently available data; if the contract governing the underlying
exposures of the securitization require payment on a monthly or
quarterly basis, the data used to assign the parameters described in
paragraph (b) of this section must be no more than 91 calendar days
old. A System institution that does not have the appropriate data to
assign the parameters described in paragraph (b) of this section must
assign a risk weight of 1,250 percent to the exposure.
(b) SSFA parameters. To calculate the risk weight for a
securitization exposure using the SSFA, a System institution must have
accurate information on the following five inputs to the SSFA
calculation:
(1) KG is the weighted-average (with unpaid principal used as the
weight for each exposure) total capital requirement of the underlying
exposures calculated using this subpart. KG is expressed as a decimal
value between 0 and 1 (that is, an average risk weight of 100 percent
represents a value of KG equal to .08).
(2) Parameter W is expressed as a decimal value between 0 and 1.
Parameter W is the ratio of the sum of the dollar amounts of any
underlying exposures within the securitized pool that meet any of the
criteria as set forth in paragraphs (b)(2)(i) through (vi) of this
section to the balance, measured in dollars, of underlying exposures:
(i) Ninety (90) days or more past due;
(ii) Subject to a bankruptcy or insolvency proceeding;
(iii) In the process of foreclosure;
(iv) Held as real estate owned;
(v) Has contractually deferred interest payments for 90 days or
more, other than principal or interest payments deferred on:
(A) Federally guaranteed student loans, in accordance with the
terms of those guarantee programs; or
[[Page 52900]]
(B) Consumer loans, including non-federally guaranteed student
loans, provided that such payments are deferred pursuant to provisions
included in the contract at the time funds are disbursed that provide
for periods(s) of deferral that are not initiated based on changes in
the creditworthiness of the borrower; or
(vi) Is in default.
(3) Parameter A is the attachment point for the exposure, which
represents the threshold at which credit losses will first be allocated
to the exposure. Except as provided in Sec. 628.42(i) for
nth -to-default credit derivatives, parameter A equals the
ratio of the current dollar amount of underlying exposures that are
subordinated to the exposure of the System institution to the current
dollar amount of underlying exposures. Any reserve account funded by
the accumulated cash flows from the underlying exposures that is
subordinated to the System institution's securitization exposure may be
included in the calculation of parameter A to the extent that cash is
present in the account. Parameter A is expressed as a decimal value
between 0 and 1.
(4) Parameter D is the detachment point for the exposure, which
represents the threshold at which credit losses of principal allocated
to the exposure would result in a total loss of principal. Except as
provided in Sec. 628.42(i) for nth-to-default credit
derivatives, parameter D equals parameter A plus the ratio of the
current dollar amount of the securitization exposures that are pari
passu with the exposure (that is, have equal seniority with respect to
credit risk) to the current dollar amount of the underlying exposures.
Parameter D is expressed as a decimal value between 0 and 1.
(5) A supervisory calibration parameter, p, is equal to 0.5 for
securitization exposures that are not resecuritization exposures and
equal to 1.5 for resecuritization exposures.
(c) Mechanics of the SSFA. Kg and W are used to
calculate KA, the augmented value of Kg, which reflects the
observed credit quality of the underlying pool of exposures. KA is
defined in paragraph (d) of this section. The values of parameters A
and D, relative to KA determine the risk weight assigned to
a securitization exposure as described in paragraph (d) of this
section. The risk weight assigned to a securitization exposure, or
portion of a exposure, as appropriate, is the larger of the risk weight
determined in accordance with this paragraph (d) of this section and a
risk weight of 20 percent.
(1) When the detachment point, parameter D, for a securitization
exposure is less than or equal to KA the exposure must be assigned a
risk weight of 1,250 percent.
(2) When the attachment point, parameter A, for a securitization
exposure is greater than or equal to KA the System institution must
calculate the risk weight in accordance with paragraph (d) of this
section.
(3) When A is less than KA and D is greater than KA, the risk
weight is a weighted average of 1,250 percent and 1,250 percent times
KSSFA calculated in accordance with paragraph (d) of this section. For
the purpose of this weighted-average calculation:
[GRAPHIC] [TIFF OMITTED] TP04SE14.012
(d) SSFA equation.
(1) The System institution must define the following parameters:
[GRAPHIC] [TIFF OMITTED] TP04SE14.013
[[Page 52901]]
e=2.71828 , the base of the natural logarithms.
(2) Then the System institution must calculate KSSFA according to
the following equation:
[GRAPHIC] [TIFF OMITTED] TP04SE14.014
(3) The risk weight for the exposure (expressed as a percent) is
equal to KSSFA x 1,250.
(e) Gross-up approach -- (1) Applicability. A System institution
may apply the gross-up approach set forth in this section instead of
the SSFA to determine the risk weight of its securitization exposures,
provided that it applies the gross-up approach to all of its
securitization exposures, except as otherwise provided for certain
securitization exposures in Sec. Sec. 628.44 and 628.45.
(2) To use the gross-up approach, a System institution must
calculate the following four inputs:
(i) Pro rata share A, which is the par value of the System
institution's securitization exposure X as a percent of the par value
of the tranche in which the securitization exposure resides Y; A=\X/Y\
expressed as a percent;
(ii) Enhanced amount B, which is the value of tranches that are
more senior to the tranche in which the System institution's
securitization resides; are more senior to the tranche in which the
System institution's securitization resides;
(iii) Exposure amount of the System institution's securitization
exposure calculated under Sec. 628.42(c) C=carrying value of exposure;
and
(iv) Risk weight (RW) which is the weighted-average risk weight of
underlying exposures in the securitization pool as calculated under
this subpart. For example, RW for an asset-backed security with
underlying car loans would be 100 percent.
(3) Credit equivalent amount (CEA). The CEA of a securitization
exposure under this section equals the sum of:
(i) The exposure amount C of the System institution's
securitization exposure, plus
(ii) the pro rata share A multiplied by the enhanced amount B, each
calculated in accordance with paragraph (e)(2) of this section.
CEA = C + (A x B)
(4) Risk-weighted assets (RWA). To calculate RWA for a
securitization exposure under the gross-up approach, a System
institution must apply the RW calculated under paragraph (e)(2) of this
section to the CEA calculated in paragraph (e)(3) of this section.
RWA = RW x CEA
(f) Limitations. Notwithstanding any other provision of this
section, a System institution must assign a risk weight of not less
than 20 percent to a securitization exposure.
Sec. 628.44 Securitization exposures to which the SSFA and gross-up
approach do not apply.
(a) General requirement. A System institution must assign a 1,250-
percent risk weight to all securitization exposures to which the System
institution does not apply the SSFA or the gross up approach under
Sec. 628.43.
(b) [Reserved]
(c) [Reserved]
Sec. 628.45 Recognition of credit risk mitigants for securitization
exposures.
(a) General. (1) An originating System institution that has
obtained a credit risk mitigant to hedge its exposure to a synthetic or
traditional securitization that satisfies the operational criteria
provided in Sec. 628.41 may recognize the credit risk mitigant under
Sec. Sec. 628.36 or 628.37, but only as provided in this section.
(2) An investing System institution that has obtained a credit risk
mitigant to hedge a securitization exposure may recognize the credit
risk mitigant under Sec. Sec. 628.36 or 628.37, but only as provided
in this section.
(b) Mismatches. A System institution must make any applicable
adjustment to the protection amount of an eligible guarantee or credit
derivative as required in Sec. 628.36(d), (e), and (f) for any hedged
securitization exposure. In the context of a synthetic securitization,
when an eligible guarantee or eligible credit derivative covers
multiple hedged exposures that have different residual maturities, the
System institution must use the longest residual maturity of any of the
hedged exposures as the residual maturity of all hedged exposures.
Sec. Sec. 628.46 through 628.50 [Reserved]
Risk-Weighted Assets for Equity Exposures
Sec. 628.51 Introduction and exposure measurement.
(a) General. (1) To calculate its risk-weighted asset amounts for
equity exposures that are not equity exposures to an investment fund, a
System institution must use the Simple Risk-Weight Approach (SRWA)
provided in Sec. 628.52. A System institution must use the look-
through approaches provided in Sec. 628.53 to calculate its risk-
weighted asset amounts for equity exposures to investment funds.
(2) [Reserved]
(3) [Reserved]
(b) Adjusted carrying value. For purposes of Sec. Sec. 628.51
through 628.53, the adjusted carrying value of an equity exposure is:
(1) For the on-balance sheet component of an equity exposure (other
than an equity exposure that is classified as available-for-sale), the
System institution's carrying value of the exposure;
(2) For the on-balance sheet component of an equity exposure that
is classified as available-for-sale, the System institution's carrying
value of the exposure less any net unrealized gains on the exposure
that are reflected in such carrying value but excluded from the System
institution's regulatory capital components;
(3) For the off-balance sheet component of an equity exposure that
is not an equity commitment, the effective notional principal amount of
the exposure, the size of which is equivalent to a hypothetical on-
balance sheet position in the underlying equity instrument that would
evidence the same change in fair value (measured in dollars) given a
small change in the price of the underlying equity instrument, minus
the adjusted carrying value of the on-balance sheet component of the
exposure as calculated in paragraph (b)(1) of this section; and
(4) For a commitment to acquire an equity exposure (an equity
commitment), the effective notional principal amount of the exposure is
multiplied by the following conversion factors (CFs):
(i) Conditional equity commitments with an original maturity of 14
months or less receive a CF of 20 percent.
(ii) Conditional equity commitments with an original maturity of
over 14 months receive a CF of 50 percent.
(iii) Unconditional equity commitments receive a CF of 100 percent.
Sec. 628.52 Simple risk-weight approach (SRWA).
(a) General. Under the SRWA, a System institution's total risk-
weighted assets for equity exposures equals the sum of the risk-
weighted asset amounts for each of the System institution's individual
equity exposures (other than equity exposures to an investment fund) as
determined under this section and the risk-weighted asset amounts for
each of the System institution's individual equity exposures to an
investment fund as determined under Sec. 628.53.
(b) SRWA computation for individual equity exposures. A System
institution must determine the risk-weighted asset amount for an
individual equity
[[Page 52902]]
exposure (other than an equity exposure to an investment fund) by
multiplying the adjusted carrying value of the equity exposure or the
effective portion and ineffective portion of a hedge pair (as defined
in paragraph (c) of this section) by the lowest applicable risk weight
in this paragraph.
(1) Zero-percent (0%) risk weight equity exposures. An equity
exposure to a sovereign, the Bank for International Settlements, the
European Central Bank, the European Commission, the International
Monetary Fund, an MDB, and any other entity whose credit exposures
receive a 0-percent risk weight under Sec. 628.32 may be assigned a 0-
percent risk weight.
(2) Twenty-percent (20%) risk weight equity exposures. An equity
exposure to a PSE or the Federal Agricultural Mortgage Corporation
(Farmer Mac) must be assigned a 20-percent risk weight.
(3) One hundred-percent (100%) risk weight equity exposures. The
equity exposures set forth in this paragraph (b)(3) must be assigned a
100-percent risk weight:
(i) Certain equity exposures authorized under Sec. 615.5140(e) of
this chapter. An equity exposure that the FCA has authorized pursuant
to Sec. 615.5140(e) for a purpose other than those specified in Sec.
615.5132(a) (for System banks) or Sec. 615.5142 (for associations) of
this chapter, unless the equity exposure is assigned a different risk
weight under this section.
(ii) Effective portion of hedge pairs. The effective portion of a
hedge pair.
(iii) Non-significant equity exposures. Equity exposures, excluding
exposures to an investment firm that would meet the definition of a
traditional securitization in Sec. 628.2 were it not for the
application of paragraph (8) of that definition and has greater than
immaterial leverage, to the extent that aggregate adjusted carrying
value of the exposures does not exceed 10 percent of the System
institution's total capital.
(A) Equity exposures subject to paragraph (b)(3)(iii) of this
section include:
(1) Equity exposures to unconsolidated unincorporated business
entities and equity exposures held through consolidated unincorporated
business entities, as authorized by subpart J of part 611 of this
chapter;
(2) Equity exposures that the FCA has authorized pursuant to Sec.
615.5140(e) for a purpose specified in Sec. 615.5132(a) (for System
banks) or Sec. 615.5142 (for associations) of this chapter, unless the
equity exposures are assigned a different risk weight under this
section; and
(3) Equity exposures to an unconsolidated rural business investment
company and equity exposures held through a consolidated rural business
investment company described in 7 U.S.C. 2009cc et seq.
(B) To compute the aggregate adjusted carrying value of a System
institution's equity exposures for purposes of this section, the System
institution may exclude equity exposures described in paragraphs
(b)(1), (b)(2), (b)(3)(i), and (b)(3)(ii) of this section, the equity
exposure in a hedge pair with the smaller adjusted carrying value, and
a proportion of each equity exposure to an investment fund equal to the
proportion of the assets of the investment fund that are not equity
exposures or that meet the criterion of paragraph (b)(3)(i) of this
section. If a System institution does not know the actual holdings of
the investment fund, the System institution may calculate the
proportion of the assets of the fund that are not equity exposures
based on the terms of the prospectus, partnership agreement, or similar
contract that defines the fund's permissible investments. If the sum of
the investment limits for all exposure classes within the fund exceeds
100 percent, the System institution must assume for purposes of this
section that the investment fund invests to the maximum extent possible
in equity exposures.
(C) When determining which of a System institution's equity
exposures qualify for a 100-percent risk weight under this paragraph, a
System institution first must include equity exposures to
unconsolidated rural business investment companies or held through
consolidated rural business investment companies described in 7 U.S.C.
2009cc et seq.; then must include equity exposures that the FCA has
authorized pursuant to Sec. 615.5140(e) for a purpose specified in
Sec. 615.5132(a) (for System banks) or Sec. 615.5142 (for
associations) of this chapter (unless the equity exposures are assigned
a different risk weight under this section); then must include equity
exposures to unconsolidated unincorporated business entities and equity
exposures held through consolidated unincorporated business entities,
as authorized by subpart J of part 611 of this chapter; then must
include publicly traded equity exposures (including those held
indirectly through investment funds); and then must include non-
publicly traded equity exposures (including those held indirectly
through investment funds).
(4) Other equity exposures. The risk weight for any equity exposure
that does not qualify for a risk weight under paragraph (b)(1),
paragraph (b)(2), paragraph (b)(3), or paragraph (b)(7) of this section
will be determined by the FCA.
(5) [Reserved]
(6) [Reserved]
(7) Six hundred-percent (600%) risk weight equity exposures. An
equity exposure to an investment firm must be assigned a 600-percent
risk weight, provided that the investment firm:
(i) Would meet the definition of a traditional securitization in
Sec. 628.2 were it not for the application of paragraph (8) of that
definition; and
(ii) Has greater than immaterial leverage.
(c) Hedge transactions--(1) Hedge pair. A hedge pair is two equity
exposures that form an effective hedge so long as each equity exposure
is publicly traded or has a return that is primarily based on a
publicly traded equity exposure.
(2) Effective hedge. Two equity exposures form an effective hedge
if the exposures either have the same remaining maturity or each has a
remaining maturity of at least 3 months; the hedge relationship is
formally documented in a prospective manner (that is, before the System
institution acquires at least one of the equity exposures); the
documentation specifies the measure of effectiveness (E) the System
institution will use for the hedge relationship throughout the life of
the transaction; and the hedge relationship has an E greater than or
equal to 0.8. A System institution must measure E at least quarterly
and must use one of three alternative measures of E as set forth in
this paragraph (c):
(i) Under the dollar-offset method of measuring effectiveness, the
System institution must determine the ratio of value change (RVC). The
RVC is the ratio of the cumulative sum of the changes in value of one
equity exposure to the cumulative sum of the changes in the value of
the other equity exposure. If RVC is positive, the hedge is not
effective and E equals 0. If RVC is negative and greater than or equal
to -1 (that is, less than 0 and greater than or equal to -1), then E
equals the absolute value of RVC. If RVC is negative and less than -1,
then E equals 2 plus RVC.
(ii) Under the variability-reduction method of measuring
effectiveness:
[[Page 52903]]
[GRAPHIC] [TIFF OMITTED] TP04SE14.015
(A) Xt = At - Bt,
(B) At = the value at time t of one exposure in a hedge
pair; and
(C) Bt = the value at time t of the other exposure in a hedge pair.
(iii) Under the regression method of measuring effectiveness, E
equals the coefficient of determination of a regression in which the
change in value of one exposure in a hedge pair is the dependent
variable and the change in value of the other exposure in a hedge pair
is the independent variable. However, if the estimated regression
coefficient is positive, then E equals 0.
(3) The effective portion of a hedge pair is E multiplied by the
greater of the adjusted carrying values of the equity exposures forming
a hedge pair.
(4) The ineffective portion of a hedge pair is (1-E) multiplied by
the greater of the adjusted carrying values of the equity exposures
forming a hedge pair.
Sec. 628.53 Equity exposures to investment funds.
(a) Available approaches. (1) Unless the exposure meets the
requirements for an equity exposure under Sec. 628.52(b)(3)(i), a
System institution must determine the risk-weighted asset amount of an
equity exposure to an investment fund under the full look-through
approach described in paragraph (b) of this section, the simple
modified look-through approach described in paragraph (c) of this
section, or the alterative modified look-through approach described
paragraph (d) of this section, provided, however, that the minimum risk
weight that may be assigned to an equity exposure under this section is
20 percent.
(2) The risk-weighted asset amount of an equity exposure to an
investment fund that meets the requirements for an equity exposure in
Sec. 628.52(b)(3)(i) is its adjusted carrying value.
(3) If an equity exposure to an investment fund is part of a hedge
pair and the System institution does not use the full look-through
approach, the System institution must use the ineffective portion of
the hedge pair as determined under Sec. 628.52(c) as the adjusted
carrying value for the equity exposure to the investment fund. The
risk-weighted asset amount of the effective portion of the hedge pair
is equal to its adjusted carrying value.
(b) Full look-through approach. A System institution that is able
to calculate a risk-weighted asset amount for its proportional
ownership share of each exposure held by the investment fund (as
calculated under this subpart as if the proportional ownership share of
the adjusted carrying value of each exposure were held directly by the
System institution) may set the risk-weighted asset amount of the
System institution's exposure to the fund equal to the product of:
(1) The aggregate risk-weighted asset amounts of the exposures held
by the fund as if they were held directly by the System institution;
and
(2) The System institution's proportional ownership share of the
fund.
(c) Simple modified look-through approach. Under the simple
modified look-through approach, the risk-weighted asset amount for a
System institution's equity exposure to an investment fund equals the
adjusted carrying value of the equity exposure multiplied by the
highest risk weight that applies to any exposure the fund is permitted
to hold under the prospectus, partnership agreement, or similar
agreement that defines the fund's permissible investments (excluding
derivative contracts that are used for hedging rather than speculative
purposes and that do not constitute a material portion of the fund's
exposures).
(d) Alternative modified look-through approach. Under the
alternative modified look-through approach, a System institution may
assign the adjusted carrying value of an equity exposure to an
investment fund on a pro rata basis to different risk weight categories
under this subpart based on the investment limits in the fund's
prospectus, partnership agreement, or similar contract that defines the
fund's permissible investments. The risk-weighted asset amount for the
System institution's equity exposure to the investment fund equals the
sum of each portion of the adjusted carrying value assigned to an
exposure type multiplied by the applicable risk weight under this
subpart. If the sum of the investment limits for all exposure types
within the fund exceeds 100 percent, the System institution must assume
that the fund invests to the maximum extent permitted under its
investment limits in the exposure type with the highest applicable risk
weight under this subpart and continues to make investments in order of
the exposure type with the next highest applicable risk weight under
this subpart until the maximum total investment level is reached. If
more than one exposure type applies to an exposure, the System
institution must use the highest applicable risk weight. A System
institution may exclude derivative contracts held by the fund that are
used for hedging rather than for speculative purposes and do not
constitute a material portion of the fund's exposures.
Sec. Sec. 628.54 through 628.60 [Reserved]
Disclosures.
Sec. 628.61 Purpose and scope.
Sections 628.62 and 628.63 of this subpart establish public
disclosure requirements for each System bank related to the capital
requirements contained in this part.
Sec. 628.62 Disclosure requirements.
(a) A System bank must provide timely public disclosures each
calendar quarter of the information in the applicable tables in Sec.
628.63. The System bank must make these disclosures in its quarterly
and annual reports to shareholders required in part 620 of this
chapter. The System bank need not make these disclosures in the format
set out in the applicable tables or all in the same location in a
report, as long as a summary table specifically indicating the
location(s) of all such disclosures is provided. If a significant
change occurs, such that the most recent reported amounts are no longer
reflective of the System bank's capital adequacy and risk profile, then
a brief discussion of this change and its likely impact must be
disclosed as soon as practicable thereafter. This disclosure
requirement may be satisfied by providing a notice under Sec. 620.15
of this chapter. Qualitative disclosures that typically do not change
each quarter (for example, a general summary of the System bank's risk
management objectives and policies, reporting system, and definitions)
may be disclosed annually after the end of the 4th calendar quarter,
provided that any
[[Page 52904]]
significant changes are disclosed in the interim.
(b) A System bank must have a formal disclosure policy approved by
the board of directors that addresses its approach for determining the
disclosures it makes. The policy must address the associated internal
controls and disclosure controls and procedures. The board of directors
and senior management are responsible for establishing and maintaining
an effective internal control structure over financial reporting,
including the disclosures required by this subpart, and must ensure
that appropriate review of the disclosures takes place. The chief
executive officer, the chief financial officer (CFO), and a designated
board member must attest that the disclosures meet the requirements of
this subpart.
(c) If a System bank concludes that disclosure of specific
proprietary or confidential commercial or financial information that it
would otherwise be required to disclose under this section would
compromise its position, then the System bank is not required to
disclose that specific information pursuant to this section, but must
disclose more general information about the subject matter of the
requirement, together with the fact that, and the reason why, the
specific items of information have not been disclosed.
Sec. 628.63 Disclosures.
(a) Except as provided in Sec. 628.62, a System bank must make the
disclosures described in Tables 1 through 10 of this section. The
System bank must make these disclosures publicly available for each of
the last 3 years (that is, 12 quarters) or such shorter period
beginning on the effective date of this subpart D of this part.
(b) A System bank must publicly disclose each quarter the
following:
(1) CET1 capital, AT1 capital, tier 2 capital, tier 1 and total
capital ratios, including the regulatory capital elements and all the
regulatory adjustments and deductions needed to calculate the numerator
of such ratios;
(2) Total risk-weighted assets, including the different regulatory
adjustments and deductions needed to calculate total risk-weighted
assets;
(3) Regulatory capital ratios during the transition period,
including a description of all the regulatory capital elements and all
regulatory adjustments and deductions needed to calculate the numerator
and denominator of each capital ratio during the transition period; and
(4) A reconciliation of regulatory capital elements as they relate
to its balance sheet in any audited consolidated financial statements.
Table 1 to Sec. 628.63--Scope of Application
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures.............. (a) The name of the top corporate
entity in the group to which
subpart D of this part
applies.\1\
(b) A brief description of the
differences in the basis for
consolidating entities \2\ for
accounting and regulatory
purposes, with a description of
those entities:
(1) That are fully
consolidated;
(2) That are deconsolidated
and deducted from total
capital;
(3) For which the total
capital requirement is
deducted; and
(4) That are neither
consolidated nor deducted
(for example, where the
investment in the entity is
assigned a risk weight in
accordance with this
subpart).
(c) Any restrictions, or other
major impediments, on transfer
of funds or total capital within
the group.
Quantitative Disclosures............. (d) [Reserved]
(e) The aggregate amount by which
actual total capital is less
than the minimum total capital
requirement in all subsidiaries,
with total capital requirements
and the name(s) of the
subsidiaries with such
deficiencies.
------------------------------------------------------------------------
\1\ The System bank is the top corporate entity.
\2\ Entities include any subsidiaries authorized by the FCA, including
operating subsidiaries, service corporations, and unincorporated
business entities.
Table 2 to Sec. 628.63--Capital Structure
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures.............. (a) Summary information on the
terms and conditions of the main
features of all regulatory
capital instruments.
Quantitative Disclosures............. (b) The amount of common equity
tier 1 capital, with separate
disclosure of:
(1) Common cooperative
equities
a. Statutory minimum
borrower stock;
b. Other required member
stock;
c. Allocated equity (stock
or surplus);
(2) Unallocated retained
earnings (URE) and URE
equivalents; and
(3) Regulatory adjustments and
deductions made to common
equity tier 1 capital.
(c) The amount of tier 1 capital,
with separate disclosure of:
(1) Additional tier 1 capital
elements; and
(2) Regulatory adjustments and
deductions made to tier 1
capital.
(d) The amount of total capital,
with separate disclosure of:
(1) Common cooperative
equities not included in
common equity tier 1 capital
(2) Tier 2 capital elements,
including tier 2 apital
instruments; and
(3) Regulatory adjustments and
deductions made to total
capital.
------------------------------------------------------------------------
Table 3 to Sec. 628.63--Capital Adequacy
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures.............. (a) A summary discussion of the
System bank's approach to
assessing the adequacy of its
capital to support current and
future activities.
Quantitative disclosures............. (b) Risk-weighted assets for:
(1) Exposures to sovereign
entities;
(2) Exposures to certain
supranational entities and
MDBs;
(3) Exposures to GSEs;
[[Page 52905]]
(4) Exposures to depository
institutions, foreign banks,
and credit unions, including
OFI exposures that are risk
weighted as exposures to U.S.
depository institutions and
credit unions;
(5) Exposures to PSEs;
(6) Corporate exposures,
including borrower loans
(including agricultural and
consumer loans) and OFI
exposures that are risk
weighted as corporate
exposures;
(7) Residential mortgage
exposures;
(8) HVCRE exposures;
(9) Past due exposures;
(10) Exposures to other
assets;
(11) Loans from System banks
to associations;
(12) Cleared transactions;
(13) Unsettled transactions;
(14) Securitization exposures;
and
(15) Equity exposures.
(c) [Reserved]
(d) Common equity tier 1, tier 1
and total risk-based capital
ratios for the System bank.
(e) Total standardized risk-
weighted assets.
------------------------------------------------------------------------
Table 4 to Sec. 628.63--Capital Conservation Buffer
------------------------------------------------------------------------
------------------------------------------------------------------------
Quantitative Disclosures............. (a) At least quarterly, the
System bank must calculate and
publicly disclose the capital
conservation buffer as described
under Sec. 628.11.
(b) At least quarterly, the
System bank must calculate and
publicly disclose the eligible
retained income of the System
bank, as described under Sec.
628.11.
(c) At least quarterly, the
System bank must calculate and
publicly disclose any
limitations it has on
distributions and discretionary
bonus payments resulting from
the capital conservation buffer
framework described under Sec.
628.11, including the maximum
payout amount for the quarter.
------------------------------------------------------------------------
(c) General qualitative disclosure requirement. For each separate
risk area described in Tables 5 through 10, the System bank must
describe its risk management objectives and policies, including:
Strategies and processes; the structure and organization of the
relevant risk management function; the scope and nature of risk
reporting and/or measurement systems; policies for hedging and/or
mitigating risk and strategies and processes for monitoring the
continuing effectiveness of hedges/mitigants.
Table 5 to Sec. 628.63\1\--Credit Risk: General Disclosures
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures.............. (a) The general qualitative
disclosure requirement with
respect to credit risk
(excluding counterparty credit
risk disclosed in accordance
with Table 6), including the:
(1) Policy for determining
past due or delinquency
status;
(2) Policy for placing loans
in nonaccrual status;
(3) Policy for returning loans
to accrual status;
(4) Definition of and policy
for identifying impaired
loans (for financial
accounting purposes);
(5) Description of the
methodology that the System
bank uses to estimate its
allowance for loan losses,
including statistical methods
used where applicable;
(6) Policy for charging-off
uncollectible amounts; and
(7) Discussion of the System
bank's credit risk management
policy.
Quantitative Disclosures............. (b) Total credit risk exposures
and average credit risk
exposures, after accounting
offsets in accordance with GAAP,
without taking into account the
effects of credit risk
mitigation techniques (for
example, collateral and netting
not permitted under GAAP), over
the period categorized by major
types of credit exposure. For
example, System banks could use
categories similar to that used
for financial statement
purposes. Such categories might
include, for instance:
(1) Loans, off-balance sheet
commitments, and other non-
derivative off-balance sheet
exposures;
(2) Debt securities; and
(3) OTC derivatives.\2\
(c) Geographic distribution of
exposures, categorized in
significant areas by major types
of credit exposure.\3\
(d) Industry or counterparty type
distribution of exposures,
categorized by major types of
credit exposure.
(e) By major industry or
counterparty type:
(1) Amount of impaired loans
for which there was a related
allowance under GAAP;
(2) Amount of impaired loans
for which there was no
related allowance under GAAP;
(3) Amount of loans past due
90 days and in nonaccrual
status;
(4) Amount of loans past due
90 days and still accruing;
\4\
(5) The balance in the
allowance for loan losses at
the end of each period
according to GAAP; and
(6) Charge-offs during the
period.
(f) Amount of impaired loans and,
if available, the amount of past
due loans categorized by
significant geographic areas
including, if practical, the
amounts of allowances related to
each geographical area,\5\
further categorized as required
by GAAP.
(g) Reconciliation of changes in
allowances for loan losses.\6\
[[Page 52906]]
(h) Remaining contractual
maturity delineation (for
example, one year or less) of
the whole portfolio, categorized
by credit exposure.
------------------------------------------------------------------------
\1\ Table 5 does not cover equity exposures, which should be reported in
Table 9.
\2\ See, for example, ASC Topic 815-10 and 210, as they may be amended
from time to time.
\3\ A System bank can satisfy this requirement by describing the
geographic distribution of its loan portfolio by State or other
significant geographic division, if any.
\4\ A System bank is encouraged also to provide an analysis of the aging
of past-due loans.
\5\ The portion of the general allowance that is not allocated to a
geographical area should be disclosed separately.
\6\ The reconciliation should include the following: a description of
the allowance; the opening balance of the allowance; charge-offs taken
against the allowance during the period; amounts provided (or
reversed) for estimated probable loan losses during the period; any
other adjustments (for example, exchange rate differences, business
combinations, acquisitions and disposals of subsidiaries), including
transfers between allowances; and the closing balance of the
allowance. Charge-offs and recoveries that have been recorded directly
to the income statement should be disclosed separately.
Table 6 to Sec. 628.63--General Disclosure for Counterparty Credit
Risk-Related Exposures
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures.............. (a) The general qualitative
disclosure requirement with
respect to OTC derivatives,
eligible margin loans, and repo-
style transactions, including a
discussion of:
(1) The methodology used to
assign credit limits for
counterparty credit
exposures;
(2) Policies for securing
collateral, valuing and
managing collateral, and
establishing credit reserves;
(3) The primary types of
collateral taken; and
(4) The impact of the amount
of collateral the System bank
would have to provide given
deterioration in the System
bank's own creditworthiness.
Quantitative Disclosures............. (b) Gross positive fair value of
contracts, collateral held
(including type, for example,
cash, government securities),
and net unsecured credit
exposure.\1\ A System bank also
must disclose the notional value
of credit derivative hedges
purchased for counterparty
credit risk protection and the
distribution of current credit
exposure by exposure type.\2\
(c) Notional amount of purchased
credit derivatives used for the
System bank's own credit
portfolio.
------------------------------------------------------------------------
\1\ Net unsecured credit exposure is the credit exposure after
considering both the benefits from legally enforceable netting
agreements and collateral arrangements without taking into account
haircuts for price volatility, liquidity, etc.
\2\ This may include interest rate derivative contracts, foreign
exchange derivative contracts, equity derivative contracts, credit
derivatives, commodity or other derivative contracts, repo-style
transactions, and eligible margin loans.
Table 7 to Sec. 628.63--Credit Risk Mitigation \1\ \2\
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures.............. (a) The general qualitative
disclosure requirement with
respect to credit risk
mitigation, including:
(1) Policies and processes for
collateral valuation and
management;
(2) A description of the main
types of collateral taken by
the System bank;
(3) The main types of
guarantors/credit derivative
counterparties and their
creditworthiness; and
(4) Information about (market
or credit) risk
concentrations with respect
to credit risk mitigation.
Quantitative Disclosures............. (b) For each separately disclosed
credit risk portfolio, the total
exposure that is covered by
eligible financial collateral,
and after the application of
haircuts.
(c) For each separately disclosed
portfolio, the total exposure
that is covered by guarantees/
credit derivatives and the risk-
weighted asset amount associated
with that exposure.
------------------------------------------------------------------------
\1\ At a minimum, a System bank must provide the disclosures in Table 7
in relation to credit risk mitigation that has been recognized for the
purposes of reducing capital requirements under this subpart. Where
relevant, System banks are encouraged to give further information
about mitigants that have not been recognized for that purpose.
\2\ Credit derivatives that are treated, for the purposes of this
subpart, as synthetic securitization exposures should be excluded from
the credit risk mitigation disclosures and included within those
relating to securitization (Table 8).
Table 8 to Sec. 628.63--Securitization \1\
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures.............. (a) The general qualitative
disclosure requirement with
respect to a securitization
(including synthetic
securitizations), including a
discussion of:
(1) The System bank's
objectives for securitizing
assets, including the extent
to which these activities
transfer credit risk of the
underlying exposures away
from the System bank to other
entities and including the
type of risks assumed and
retained with
resecuritization activity;
\2\
(2) The nature of the risks
(e.g. liquidity risk)
inherent in the securitized
assets;
(3) The roles played by the
System bank in the
securitization process \3\
and an indication of the
extent of the System bank's
involvement in each of them;
(4) The processes in place to
monitor changes in the credit
and market risk of
securitization exposures
including how those processes
differ for resecuritization
exposures;
(5) The System bank's policy
for mitigating the credit
risk retained through
securitization and
resecuritization exposures;
and
(6) The risk-based capital
approaches that the System
bank follows for its
securitization exposures
including the type of
securitization exposure to
which each approach applies.
(b) [Reserved]
(c) Summary of the System bank's
accounting policies for
securitization activities,
including:
(1) Whether the transactions
are treated as sales or
financings;
(2) Recognition of gain-on-
sale;
(3) Methods and key
assumptions applied in
valuing retained or purchased
interests;
[[Page 52907]]
(4) Changes in methods and key
assumptions from the previous
period for valuing retained
interests and impact of the
changes;
(5) Treatment of synthetic
securitizations;
(6) How exposures intended to
be securitized are valued and
whether they are recorded
under subpart D of this part;
and
(7) Policies for recognizing
liabilities on the balance
sheet for arrangements that
could require the System bank
to provide financial support
for securitized assets.
(d) An explanation of significant
changes to any quantitative
information since the last
reporting period.
Quantitative Disclosures............. (e) The total outstanding
exposures securitized by the
System bank in securitizations
that meet the operational
criteria provided in Sec.
628.41 (categorized into
traditional and synthetic
securitizations), by exposure
type.4
(f) For exposures securitized by
the System bank in
securitizations that meet the
operational criteria in Sec.
628.41:
(1) Amount of securitized
assets that are impaired/past
due categorized by exposure
type; \5\ and
(2) Losses recognized by the
System bank during the
current period categorized by
exposure type.\6\
(g) The total amount of
outstanding exposures intended
to be securitized categorized by
exposure type.
(h) Aggregate amount of:
(1) On-balance sheet
securitization exposures
retained or purchased
categorized by exposure type;
and
(2) Off-balance sheet
securitization exposures
categorized by exposure type.
(i)(1) Aggregate amount of
securitization exposures
retained or purchased and the
associated capital requirements
for these exposures, categorized
between securitization and
resecuritization exposures,
further categorized into a
meaningful number of risk weight
bands and by risk-based capital
approach (e.g., SSFA); and
(2) Exposures that have been
deducted entirely from tier 1
capital, CEIOs deducted from
total capital (as described
in Sec. 628.42(a)(1)), and
other exposures deducted from
total capital should be
disclosed separately by
exposure type.
(j) Summary of current year's
securitization activity,
including the amount of
exposures securitized (by
exposure type), and recognized
gain or loss on sale by exposure
type.
(k) Aggregate amount of
resecuritization exposures
retained or purchased
categorized according to:
(1) Exposures to which credit
risk mitigation is applied
and those not applied; and
(2) Exposures to guarantors
categorized according to
guarantor creditworthiness
categories or guarantor name.
------------------------------------------------------------------------
\1\ A System bank is not authorized to perform every role in a
securitization, and nothing in these capital rules authorizes a System
bank to engage in activities relating to securitizations that are not
otherwise authorized.
\2\ The System bank should describe the structure of resecuritizations
in which it participates; this description should be provided for the
main categories of resecuritization products in which the System bank
is active.
\3\ Roles in securitizations generally could include originator,
investor, servicer, provider of credit enhancement, sponsor, liquidity
provider, or swap provider. As noted in footnote 1, however, a System
bank is not authorized to perform all of these roles.
\4\ ``Exposures securitized'' include underlying exposures originated by
the System bank, whether generated by them or purchased, and
recognized in the balance sheet, from third parties, and third-party
exposures included in sponsored transactions. Securitization
transactions (including underlying exposures originally on the System
bank's balance sheet and underlying exposures acquired by the System
bank from third-party entities) in which the originating System bank
(as an originating System institution) does not retain any
securitization exposure should be shown separately but need only be
reported for the year of inception. System banks are required to
disclose exposures regardless of whether there is a capital charge
under this part.
\5\ Include credit-related other than temporary impairment (OTTI).
\6\ For example, charge-offs/allowances (if the assets remain on the
System bank's balance sheet) or credit-related OTTI of interest-only
strips and other retained residual interests, as well as recognition
of liabilities for probable future financial support required of the
System bank with respect to securitized assets.
Table 9 to Sec. 628.63--Equities
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative Disclosures.............. (a) The general qualitative
disclosure requirement with
respect to equity risk:
(1) Differentiation between
holdings on which capital gains
are expected and those taken
under other objectives including
for relationship and strategic
reasons; and
(2) Discussion of important
policies covering the
valuation of and accounting
for equity. This includes the
accounting techniques and
valuation methodologies used,
including key assumptions and
practices affecting valuation
as well as significant
changes in these practices.
Quantitative Disclosures............. (b) Value disclosed on the
balance sheet of investments, as
well as the fair value of those
investments; for securities that
are publicly traded, a
comparison to publicly quoted
share values where the share
price is materially different
from fair value.
(c) The types and nature of
investments, including the
amount that is:
(1) Publicly traded; and
(2) Non-publicly traded.
(d) The cumulative realized gains
(losses) arising from sales and
liquidations in the reporting
period.
(e)(1) Total unrealized gains
(losses).\1\
(2) Total latent revaluation
gains (losses).\2\
(3) Any amounts of the above
included in tier 1 or tier 2
capital.
(f) [Reserved]
------------------------------------------------------------------------
\1\ Unrealized gains (losses) recognized on the balance sheet but not
through earnings.
\2\ Unrealized gains (losses) not recognized either on the balance sheet
or through earnings.
[[Page 52908]]
Table 10 to Sec. 628.63--Interest Rate Risk for Non-Trading Activities
------------------------------------------------------------------------
------------------------------------------------------------------------
Qualitative disclosures.............. (a) The general qualitative
disclosure requirement,
including the nature of interest
rate risk for non-trading
activities and key assumptions,
including assumptions regarding
loan prepayments and behavior of
non-maturity deposits, and
frequency of measurement of
interest rate risk for non-
trading activities.
Quantitative disclosures............. (b) The increase (decline) in
earnings or economic value (or
relevant measure used by
management) for upward and
downward rate shocks according
to management's method for
measuring interest rate risk for
non-trading activities,
categorized by currency (as
appropriate).
------------------------------------------------------------------------
Sec. Sec. 628.64 through 628.99 [Reserved]
Subpart E--[Reserved]
Subpart F--[Reserved]
Subpart G--Transition Provisions
Sec. 628.300 Transitions.
(a) Capital conservation buffer.
(1) [Reserved]
(2) Beginning January 1, 2016 through December 31, 2018 a System
institution's maximum payout ratio must be determined as set forth in
Table 1 to Sec. 628.300.
Table 1 to Sec. 628.300
------------------------------------------------------------------------
Maximum payout
ratio (as a
Transition period Capital conservation percentage of
buffer eligible
retained income)
------------------------------------------------------------------------
Calendar year 2016............ > 0.625 percent....... No limitation.
<= 0.625 percent, and 60 percent.
> 0.469 percent.
<= 0.469 percent, and 40 percent.
> 0.313 percent.
<= 0.313 percent, and 20 percent.
> 0.156 percent.
<= 0.156 percent...... 0 percent.
Calendar year 2017............ > 1.25 percent........ No limitation.
<= 1.25 percent, and > 60 percent.
0.938 percent.
<= 0.938 percent, and 40 percent.
> 0.625 percent.
<= 0.625 percent, and 20 percent.
> 0.313 percent.
<= 0.313 percent...... 0 percent.
Calendar year 2018............ > 1.875 percent....... No limitation
<= 1.875 percent, and 60 percent.
> 1.406 percent.
<= 1.406 percent, and 40 percent.
> 0.938 percent.
<= 0.938 percent, and 20 percent.
> 0.469 percent.
<= 0.469 percent...... 0 percent.
------------------------------------------------------------------------
(b) through (e) [Reserved]
Sec. 628.301 Initial compliance and reporting requirements.
(a) A System institution that fails to satisfy one or more of its
minimum applicable CET1, AT1, tier 1, tier 2, or total capital ratios
at the end of the quarter in which these regulations become effective
shall report its initial noncompliance to the FCA within 20 days
following such quarterend and shall also submit a capital restoration
plan for achieving and maintaining the standards, demonstrating
appropriate annual progress toward meeting the goal, to the FCA within
60 days following such quarterend. If the capital restoration plan is
not approved by the FCA, the FCA will inform the institution of the
reasons for disapproval, and the institution shall submit a revised
capital restoration plan within the time specified by the FCA.
(b) Approval of compliance plans. In determining whether to approve
a capital restoration plan submitted under this section, the FCA shall
consider the following factors, as applicable:
(1) The conditions or circumstances leading to the institution's
falling below minimum levels, the exigency of those circumstances, and
whether or not they were caused by actions of the institution or were
beyond the institution's control;
(2) The overall condition, management strength, and future
prospects of the institution and, if applicable, affiliated System
institutions;
(3) The institution's capital, adverse assets (including nonaccrual
and nonperforming loans), ALL, and other ratios compared to the ratios
of its peers or industry norms;
(4) How far an institution's ratios are below the minimum
requirements;
(5) The estimated rate at which the institution can reasonably be
expected to generate additional earnings;
(6) The effect of the business changes required to increase
capital;
(7) The institution's previous compliance practices, as
appropriate;
(8) The views of the institution's directors and senior management
regarding the plan; and
(9) Any other facts or circumstances that the FCA deems relevant.
(c) An institution shall be deemed to be in compliance with the
regulatory capital requirements of this subpart if it is in compliance
with a capital restoration plan that is approved by the FCA within 180
days following the end of the quarter in which these regulations become
effective.
Dated: August 8, 2014.
Dale L. Aultman,
Secretary, Farm Credit Administration Board.
[FR Doc. 2014-19179 Filed 9-3-14; 8:45 am]
BILLING CODE 6705-01-P