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Legal Opinion Summary
Topic:Incidental Authority/Risk Management: May a Farm Credit System association enter into a credit default swap with a special purpose vehicle established and owned by a third party in order to transfer credit risk on a portion of its long-term mortgage loan portfolio?
ID Number:02-03
Issue Date:05/14/2002

Although Farm Credit System associations are not expressly authorized to manage credit risk or other risks, risk management is without question an incidental power that is "necessary . . . to carry on the business of the association," which is making loans. See Farm Credit Act (Act) 2.2(20), 2.12(20) (12 U.S.C. 2073(20), 2093(20)). The primary means of managing credit risk is an informed evaluation of the borrower's operations and the industry in which the borrower operates. An additional, newer way to manage credit risk is to use derivative products that limit the potential loss on a loan. A credit default swap transaction is such a derivative product and is the equivalent of purchasing default insurance on the reference portfolio, which the FCA has previously determined to be a permissible activity. Therefore, OGC concluded that a credit default swap is a permissible risk management tool that an association may use under its incidental authority to carry on its business.

OGC also concluded that the “special purpose vehicle” (SPV), as proposed, does not implicate statutory or regulatory provisions governing service corporations. Section 4.25 and 4.28A of the Act (12 U.S.C. 2211 and 2214a) permit an association to "organize a corporation or corporations for the purpose of performing functions and services for or on behalf of the organizing [institution] that the [institution] may perform pursuant to this Act . . . ." As long as the System association does not establish, sponsor, or own equity in the SPV, OGC does not consider the SPV to be a service corporation. Because such issues are fact specific, we expect institutions to consult with us before proceeding.