Title: PROPOSED RULE--Funding and Fiscal Affairs, Loan Policies and Operations, and Funding Operations--12 CFR Part 615
Issue Date: 09/02/1988
Agency: FCA
Federal Register Cite: 53 FR 34109
___________________________________________________________________________

FARM CREDIT ADMINISTRATION

12 CFR Part 615

Funding and Fiscal Affairs, Loan Policies and Operations, and Funding Operations


ACTION: Proposed rule.

SUMMARY: The Farm Credit Administration (FCA) withdraws proposed amendments to 12 CFR Part 615 published for comment on October 16, 1986 (51 FR 36824), and proposes for comment amendments to 12 CFR Part 615, Subparts I, J, K, L, M, and N relating to the adoption of capitalization bylaws, the issuance and retirement of equities thereunder and related disclosure requirements, and the unallocated surplus of banks for cooperatives. The proposed regulations set forth requirements for capitalization bylaws, requirements that must be met in order for equities issued thereunder to qualify as permanent capital, requirements designed to ensure implementation of cooperative principles, disclosure requirements for the issuance and retirement of equities, requirements for the retirement of equities, and requirements for additions to unallocated surplus in banks for cooperatives. The proposed amendments reflect changes in the capitalization provisions of the Farm Credit Act of 1971 (1971 Act), 12 U.S.C. 2001 et seq., made by the Agricultural Credit Act of 1987 (1987 Act), Pub. L. 100-233. Upon the adoption in final form of these proposed regulations as well as the proposed capital adequacy regulations published for comment on May 12, 1988 (53 FR 16948), the FCA would rescind Capital Directive No. 1. The effect of the proposed regulations would be to give Farm Credit System (System) institutions greater flexibility in determining their capital structures and to provide guidance to such institutions in the adoption of capitalization bylaws that will enable them to meet minimum permanent capital standards established by the FCA, as required by the 1987 Act.

DATE: Comments must be submitted on or before September 16, 1988.

ADDRESSES: Written comments may be mailed (in triplicate) to Anne E. Dewey, General Counsel, Farm Credit Administration, 1501 Farm Credit Drive, McLean, Va. 22102-5090. Copies of all communications received will be available for examination by interested parties in the Office of General Counsel, Farm Credit Administration.

FOR FURTHER INFORMATION CONTACT:

William G. Dunn, Chief, Financial Analysis and Standards Division, 1501 Farm Credit Drive, McLean, VA 22102-5090, (703) 883-4402
or
Dorothy J. Acosta, Senior Attorney, Office of General Counsel, Farm Credit Administration, 1501 Farm Credit Drive, McLean, VA 22102-5090, (703) 883-4020, TDD (703) 883-4444

SUPPLEMENTARY INFORMATION: On July 23, 1986, the Farm Credit Administration (FCA) published for comment proposed regulations (51 FR 26402) relating to capital adequacy and minimum capital standards for Farm Credit System (System) institutions pursuant to section4.3(a) of the Farm Credit Act of 1971 (1971 Act), 12 U.S.C. 2154. On October 16, 1986, the FCA published for comment proposed amendments to Parts 614 and 615 of Title 12 of the Code of Federal Regulations that were referred to as "capital adequacy related regulations." Before final action had been taken on these proposals, the Agricultural Credit Act of 1987 (1987 Act) was enacted on January 6, 1988, substantially amending, among other things, the capitalization provisions of the 1971 Act and directing the FCA to adopt regulations setting minimum "permanent capital" standards that take into account risk factors. As a result of the statutory changes the FCA, on April 5, 1988, (published May 12, 1988, at 53 FR 16948) withdrew the proposal of July 23, 1986, and published for comment a regulation setting forth a minimum permanent capital standard expressed as a ratio of permanent capital to risk-adjusted assets. In that proposal, the FCA announced its intention to propose amendments to the capital adequacy related regulations necessary to conform the regulations to the statutory changes made by the 1987 Act. The capital adequacy regulations proposed on May 12, 1988, were the subject of a public hearing on June 9, 1988. The FCA is considering the comments submitted during the comment period and the testimony given at the public hearing and will be adopting a final capital adequacy regulation in the near future. The FCA is also considering what changes to the proposed amendments to Part 614 published on October 16, 1986, are appropriate and will be taking into action on that proposal in the near future. The FCA withdraws the proposed amendments to Part 615 published on October 16, 1986, and publishes for comment proposed amendments that reflect changes made by the 1987 Act in the capitalization provisions of the 1971 Act. Upon the adoption in final form of these proposed regulations and the proposed capital adequacy regulations published on May 12, 1988, the FCA's Capital Directive No. 1 would be rescinded.

I. Statutory Changes

Prior to the 1987 Act, the 1971 Act contained detailed and specific provisions relating to the issuance and retirement of equities of System institutions and the distribution of their earnings. Also boards of directors of System institutions were empowered to adopt bylaws without shareholder approval and the FCA was empowered to issue and amend bylaws. FCA had in fact prescribed model bylaws and required FCA approval for any deviation therefrom. As a result of the detailed statutory provisions and required FCA approvals, System institutions had limited discretion in the issuance and retirement of equities and the distribution of earnings. Only production credit associations could issue stock to persons other than eligible borrowers, and this was rarely done. Borrowers were required to purchase stock in an amount equal to a specified percentage of their loan. The Federal land bank and the Federal land bank associations were required to retire the borrower's stock upon repayment of the loan, and borrowers from other System institutions had expectations that their stock would be retired soon after repayment of a loan or on some revolving cycle based on board policy or custom and practice. Transfer rights were restricted.

The 1987 Act provided a mechanism for Federal assistance to financially troubled System institutions by providing for the establishment of the Farm Credit System Assistance Board (Assistance Board) and the Farm Credit System Financial Assistance Corporation (FAC). Upon certification by the Assistance Board, the FAC was authorized to purchase preferred stock in System institutions. The 1987 Act provided assurance that stock issued prior to the 1987 amendments and during a brief transitional period thereafter would be retired at par, regardless of its book value. However, the 1987 Act also significantly changed the capitalization of System institutions prospectively by adding a new section4.3A to the 1971 Act, which directs System institutions to adopt shareholder-approved capitalization bylaws that meet certain statutory requirements and that will enable the institution to meet minimum permanent capital standards established by the FCA. These statutory requirements have the effect of assuring that stock and participation certificates issued by the System institutions after the adoption of the new bylaws will be true "at risk" equity investments that can only be retired at the discretion of the board of directors (providing the minimum permanent capital standards established by FCA are met). Section4.3A also allows equities, except for voting stock, to be issued to non-borrowers.

Although the 1987 Act allowed for the consolidation of all of the banks for cooperatives (BCs) into a national bank for cooperatives, the statutory provisions relating to the capitalization and distribution of earnings of BCs in Title III of the 1971 Act were generally unchanged except that a number of required FCA prior approvals were deleted. However, BCs are subject to the requirements of new section4.3A of the Act.

On the other hand, the 1987 Act mandated the merger of the Federal land bank (FLB) and the Federal intermediate credit bank (FICB) in each district into a Farm Credit Bank (FCB) within 6 months of enactment, and enacted a new Title I and Title II under which such banks and their related associations are to operate. The 1987 Act authorized the merger of Federal land bank associations (FLBAs) and production credit associations (PCAs) into associations having the combined powers of an FLBA and a PCA (agricultural credit associations, or ACAs). The 1987 Act also allows FLBAs to become direct lenders. The extensive statutory provisions governing capitalization and distribution of earnings under which the FLB, FICB, FLBAs and PCAs operated were repealed by the 1987 Act, effective 6 months from enactment. Under the new Title I, the boards of directors of FCBs are authorized to "provide in accordance with section4.3A, through bylaws and subject to FCA regulations, for the capitalization of the bank and the manner in which bank stock is issued, held, transferred and retired and the bank earnings distributed." Associations are similarly authorized under new Title II.
Section4.3A of the 1971 Act, as amended, requires institutions to adopt shareholder-approved capitalization bylaws that meet the following statutory requirements:

(1) Issuance of voting stock must be restricted to farmers, ranchers, producers or harvesters of aquatic products, eligible cooperatives, and System associations and banks for cooperatives;

(2) Borrowers must be required to purchase stock in an amount that cannot be less than 2 percent of the loan amount or $1,000, whichever is less;

(3) Voting stock must be converted to nonvoting stock within 2 years after the loan of a borrower is repaid in full;

(4) Holders of stock and participation certificates issued before the adoption of the capitalization bylaws must be required to exchange a portion of such stock (which is protected from impairment under section4.9A of the 1971 Act, as amended) for new stock (which is not protected);

(5) Stock must be retireable solely at the discretion of the board (provided the minimum permanent capital standards established by the FCA are met);

(6) Stock must be transferable to persons eligible to hold it; and

(7) The bylaws must enable the institution to meet capital adequacy standards established by the FCA.

The FCA's authority to issue and amend bylaws was deleted by the 1987 Act. The FCA's primary regulatory interests in the capitalization of Farm Credit Banks after the 1987 amendment of the 1971 Act are: (1) To set minimum capital standards for safe and sound operation and the protection of investors; (2) to assure that capitalization bylaws enable institutions to meet minimum capital standards; (3) to assure that capitalization bylaws are consistent with law and cooperative principles (including one-person-one-vote and equitable treatment); (4) to assure that adequate disclosure is made to purchasers of equities of individual System institutions; and (5) to assure that obligations under joint and several liability can be met. The proposed regulations are deemed to be necessary and appropriate to achieve those ends. The details of capitalization are otherwise left to the boards of directors of the institutions and their shareholders.

II. Proposed Regulation

Subpart I -- Issuance of Equities

The current provisions of Subpart I relate to debt-to-capital ratios, which will be superseded by the minimum permanent capital standards proposed on May 12, 1988, when they are adopted in a final regulation. Therefore, the FCA proposes to amend Subpart I to set forth the statutory requirements for the bylaws, requirements designed to assure that the bylaws are consistent with law and with cooperative principles and that equities issued thereunder will enable the institution to meet minimum permanent capital standards established by the FCA, and disclosure requirements for the issuance and retirement of equities by individual System institutions.

Section615.5220 Issuance of Equities

Section615.5220 of proposed Subpart I would require the capitalization bylaws to set forth:

(1) The classes of stock authorized to be issued and the manner in which they can be issued, transferred, converted, and retired;

(2) For each class of stock, classes of persons to whom it 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 stock authorized to be issued for each class of stock other than stock required to be purchased as a condition for obtaining a loan (which may be authorized in unlimited amounts to permit loan volume to increase without shareholder approval);

(4) The percentage amount of stock that will be required to be purchased as a condition for obtaining a loan (which may be more than but must not be less than 2 percent of the loan amount or $1,000, whichever is less);

(5) The amount of stock protected under section4.9A of the 1971 Act, as amended, that will be required to be exchanged for voting stock issued under the new capitalization bylaws; and

(6) A statement that such equities are retireable at the sole discretion of the board of directors;

(7) The manner in which earnings will be allocated and distributed, including the basis on which patronage refunds will be made, which shall be consistent with cooperative principles; and

(8) The manner of allocating the capital requirements of the FCB among its owners and periodically equalizing the allocation.

Section615.5230 of the proposed Subpart I would require the bylaws to reflect the cooperative principles of one-person-one-vote and equitable treatment of patrons. Under the proposed paragraph (a), Farm Credit associations would be required to accord each holder of voting stock one vote regardless of the number of shares owned, except when voting on the issuance of preferred stock. In FCBs, each association/shareholder vote would be required to be weighted according to the number of the association's voting shareholders. This requirement would assure that the bank is cooperatively controlled by its ultimate owners, the borrowers. In addition, the bylaws of the FCBs would be required to reflect a weighting plan that would not discriminate against ACAs, which result from the merger of FLBAs and PCAs. The bylaws of both banks and associations would be required to permit every shareholder be entitled to vote in the election of each director.

Proposed paragraph (b) would require that the bylaws provide for the equitable treatment of all equityholders and would set forth provisions that must be included in the bylaws to assure such equitable treatment. The proposed regulation would require the issuance of preferred stock to be authorized by a majority vote of the shares of each class of stock affected by the preference, whether or not its members are otherwise entitled to vote. This modification of cooperative voting principles is necessary to protect the interests of holders of common stock and participation certificate holders. The proposed regulation would also require that shareholders be treated equitably with respect to the distribution of earnings and priority upon liquidation. Dividends would be required to be on a per share basis and without preference between holders of stock and holders of participation certificates, between members of a class, and between classes of common stock except that a class of common stock that resulted from the conversion of allocated surplus may be subordinate to other classes of common stock.
n1

n1 In the recent mandatory merger of the Federal land banks and Federal intermediate credit banks, some institutions converted allocated surplus into a separate class of common stock which is not dividend bearing and continues to have the same subordinate position upon liquidation as the allocated surplus had. The FCA believes System institutions should have the flexibility to discontinue the practice of allocating surplus to members if they choose and thinks it appropriate that stock that results from conversions of allocated surplus retain the subordinate position allocated surplus had.

Section615.5240 of the proposed regulation sets forth the statutory requirement that the capitalization bylaws must enable the institution to meet the minimum permanent capital standards established by the FCA. Proposed paragraph (a) sets forth requirements that would have to be met in order for equities issued under the bylaws to qualify as permanent capital. These requirements are designed to assure that the equities issued under the bylaws are at risk and to distinguish them from debt. All equities would be required to be retireable at no more than book value and only at the discretion of the board (provided minimum permanent capital standards established by Subpart H of this Part are met) and not on a date certain or upon the happening of an event, such as repayment of the loan, or pursuant to an automatic retirement or revolvement plan. Dividends would be required to be payable only at the discretion of the board. Cumulative dividends could be paid only on preferred stock and only if they could be indefinitely deferred and any obligation to pay such dividends subordinated to the right of the holders of common stock and participation certificates to have their equities retired at book value not to exceed par upon liquidation. Disclosure of the nature of the equities as an investment at risk would have to be made pursuant to proposed 615.5250.

Paragraph (b) of proposed 615.5240 would require the capitalization bylaws of the FCB to allow the FCB, with the prior approval of the FCA, to require its owners to subscribe for additional capital when needed to honor the FCB's obligations under joint and several liability or to meet the FCB's capital requirements under Subpart H. The FCB would be required to take into account the financial condition of its owners in making such capital calls. This provision is similar to provisions in existing regulations for the FICB (currently found in 615.5270), which mirror statutory provisions of the 1971 Act that were eliminated by the 1987 Act. However, since the 1987 Act did not change the basic nature of the relationship between the funding bank and direct lender association, the FCA believes that the owners of the FCB have an obligation to assure that the FCB has access to sufficient capital resources to honor its obligations under joint and several liability and meet its capital standards. The FCA believes that such a regulatory provision is necessary and appropriate to implement the joint and several liability provisions of section4.4 of the 1971 Act, which allocates residual liability on the basis of assets. Since loans and discounts to direct lenders constitute a large portion of the FCBs' assets, such an allocation would be meaningless unless the FCBs have some access to the capital of their owners in the event the FCBs are unable to meet their statutory obligations from their own capital resources. The FCA proposes to require FCA approval for such capital calls to assure that the interests of the owners of the FCB are protected and that any such subscription requirements are equitably allocated.

Paragraph (c) of the proposed regulation would require that the capitalization bylaws to require that until minimum permanent capital standards established by the FCA are met, stock required to be purchased as a condition of obtaining a loan be purchased from the institution. The FCA believes such a requirement is necessary and appropriate to carry out the purposes of the 1987 amendment of the 1971 Act. Since stock is now transferable, it is possible for prospective borrowers to purchase their required number of qualifying shares from borrowers who have paid off their loans. Such a practice would make it even more difficult for institutions that do not meet the minimum standard to do so, since increasing volume without increasing stock levels would decrease the minimum permanent capital ratio. Such a practice could operate as a circumvention of the statutory prohibition against reducing permanent capital by retiring stock or distributing earnings, since stock that could not be retired because minimum permanent capital standards are not met could be transferred and allowed to count as qualifying shares. While the FCA has no objection to such a practice if capital standards are met, allowing it when they are not would exacerbate an already difficult situation for System institutions.

Section615.5250 of the proposed regulation sets forth disclosure requirements for the issuance of equities, both for equities required to be purchased as a condition of obtaining a loan and for other sales of equities. For equities required to be purchased as a condition of obtaining a loan, the institution would be required to give the purchaser, prior to the loan closing, a copy of the institution's latest annual and quarterly reports to shareholders, a copy of the institution's capitalization bylaws, and a written description of the equity that describes the terms and conditions under which it is issued and its nature as an investment at risk and not a compensating balance. Similar disclosure would be required when a borrower is required to exchange protected stock for new at-risk stock issued under the new capitalization bylaws, except that no annual and quarterly reports would be required since borrowers will have already received a copy of these reports. For other sales of equities, the institution would be required to submit a disclosure statement to the FCA for review and clearance 45 days prior to the proposed sale. Under the proposed regulation, no equities could be sold except through the use of such a statement that has been reviewed and cleared by the FCA. The disclosure would be required to contain all of the information required by 12 CFR Part 620 for the annual and quarterly reports to shareholders, as well as a description of the equity and the intended use of the proceeds of the sale and a copy of the institution's capitalization bylaws. The most recent annual and quarterly reports filed under Part 620 could be incorporated by reference in partial satisfaction of the disclosure requirements. The proposed regulation would allow the FCA to waive any or all of the disclosure requirements when the sale is to a single investor in a denomination of $100,000 or more if the sophistication of the investor warrants, provided the certificate evidencing the investment bears a legend that prohibits dividing the equity into smaller denominations without FCA approval. All disclosures would be required to include a statement that the equity may be retired only at the discretion of the board.

These proposed sections would replace existing 615.5220, 615.5230, and 615.5240 of Subpart I and 615.5250 of Subpart J.

Subpart J

Subpart J would be retitled, "Retirement of equities" to reflect its narrower focus after amendment. All of the provisions of Subpart J except 615.5255 would be deleted, as they either are no longer appropriate after the 1987 Act, duplicative of statutory provisions, or incorporated into the proposed regulation. Section615.5255 would be redesignated as 615.5280, amended as described below and retitled, "Retirement in event of default." Although the specific equalization provisions of 615.5270 and 615.5280 would be deleted, the FCA would expect the FCBs to continue to treat associations equitably. In view of the different types of association that may evolve in a district under the 1987 amendments of the 1971 Act, the FCA believes that the method of equalization is a matter that is best left to the board and shareholders of each institution and their capitalization bylaws.

Section615.5260 of the proposed regulation would set forth provisions related to the retirement of "eligible borrower stock," which is defined in proposed paragraph (a) as equities that are protected under section4.9A of the 1971 Act, as amended, and any equities for which such equities are exchanged in connection with a merger, consolidation, or other reorganization, or a transfer of territory. Proposed paragraph (a) would also set forth definitions of "eligible borrower stock," "retirement in the ordinary course of business," and "par value." For the purposes of the proposed regulations, "retirement in the ordinary course of business" would be defined to mean: (1) Retirement upon repayment of a loan or retirement under a retirement or revolvement plan in effect prior to January 6, 1988, or, for stock issued after that date, at the time the loan was made; and (2) retirements in the event of the borrower's default pursuant to 615.5280. "Par value" would have the meaning set forth in section4.9A of the Act.

Paragraph (b) of proposed 615.5260 would restate the statutory requirements for an institution to retire eligible borrower stock at par (even if its book value is less than par) and to coordinate with the Assistance Board and the FAC when retiring eligible borrower stock that is impaired, as determined in accordance with generally accepted accounting principles (GAAP).

Paragraph (c) of proposed 615.5260 would require FCB pass-through equities that are retired solely to enable an FLBA to retire eligible borrower stock, to be retired at par, and, if they are impaired, to coordinate their retirement with the Assistance Board and the FAC.

Paragraph (d) of proposed 615.5260 would require the approval of the FCA for any out-of-the-ordinary-course-of-business retirement of eligible borrower stock.

Section615.5270 of the proposed regulation would set forth the requirements for the retirement of equities other than eligible borrower stock. Proposed paragraph (a) would require equities other than eligible borrower stock to be retireable at not more than their book value, and only in the discretion of the board and not on a date certain and not upon the happening of an event (such as repayment of a loan) or pursuant to an automatic retirement or revolvement plan. This paragraph reflects the FCA's judgment that the effect of the capitalization provisions of the 1987 Act is to require that all equities issued after October 5, 1988, be issued in such a manner as to qualify as permanent capital. Proposed paragraph (b) would prohibit the retirement of such other equities if after their retirement the institution would not meet minimum permanent capital standards established under Subpart H of this part.

Section615.5280 of the proposed regulation would set forth the current provisions of 615.5255 relating to the retirement of equities when the borrower's loan is in default and would incorporate a similar provision currently found in 615.5260 for BCs. A new paragraph (a) would be added to incorporate the requirement to retire eligible borrower stock at par and a new paragraph (c) would be added to incorporate the BC provision. Subsequent paragraphs would be renumbered accordingly. Paragraph (b) of exiting 615.5255 would be redesignated as paragraph (c) and amended to delete the reference to production credit associations and to exclude Federal land bank associations that are direct lenders. This paragraph currently requires that any retirements in event of default by Federal land bank associations and production credit associations be made with the specific prior approval of or in accordance with procedures prescribed by the district Federal land bank and Federal intermediate credit bank, respectively. The FCA believes that the effect of the 1987 amendments is to allow associations that are direct lenders more autonomy. FLBAs that are not direct lenders, on the other hand, appear to be more in the nature of branch lending offices and the application of borrower stock to the borrower's indebtedness at the association level may in some cases require a retirement of bank stock. However, since retirement of bank stock may not always be required, the proposed revision would allow the FCBs, at their option, to require that such retirements either have the FCB's prior approval or be made pursuant to the procedures prescribed by the FCB.

Existing paragraphs (c) and (d) would be unchanged, but would be redesignated as paragraph (e) and (f), respectively. The FCA has previously proposed to add paragraphs (e), (f), and (g) to existing 615.5255 in connection with its borrower rights regulations (53 FR 16937), and will be taking action on that proposal in the near future. If that proposal is adopted in final form, the adoption of this proposed amendment would redesignate paragraphs (e), (f), and (g) as paragraphs (g), (h), and (i), respectively.

Subpart K -- Surplus and Reserves

The FCA proposes to delete all of the existing provisions of Subpart K. Most of the deleted provisions relate to requirements to establish allowances for loan losses, which duplicate either the statutory provisions or the requirement under GAAP and 12 CFR Part 621 of FCA regulations to maintain an adequate allowance for losses.

The FCA proposes to revise 615.5330 to require BCs to add at least 10 percent of net earnings after taxes to unallocated surplus each year until such surplus reaches 50 percent of the minimum permanent capital required by Subpart H of this part. Since it has been the practice of most banks for cooperatives to revolve nearly all capital out over a 5 to 7 year period, the resulting level of capital not allocated to individual borrowers is relatively small in relation to the potential unreserved loss on many individual loans. An unexpected loss may impair the allocated equities of a BC and have an immediate effect on the balance sheet of its members. This could have a pronounced effect on the confidence in the bank and result in borrower flight. The proposed regulatory requirement would be lower than equivalent standards adopted for the System by the FCCA. The Systemwide Financial Standards adopted by the FCCA set a standard for return on average total assets of 75 percent, and a maximum debt-to-capital ratio of 12 to 1. For banks, the standard for contributions to unallocated surplus is one-tenth of 1 percent of average assets until the unallocated surplus reaches an amount equal to stock and allocated surplus. If the standard return on assets is achieved, this would translate into an addition to unallocated surplus of approximately 15 percent of net earnings. In addition, many BCs have already embraced a 10 percent addition standard and in fact maintained such a minimum addition in 1987. The regulatory requirement would be lower and would apply regardless of the return on assets achieved by the institution.

Subpart L -- Distribution of Earnings

The FCA proposes to delete all of the provisions of Subpart L and reserve the section. The deleted provisions relate to the payment of patronage, and in the case of the FLB and FLBAs are based on statutory provisions eliminated by the 1987 Act. The FCA believes that under the 1971 Act as amended by the 1987 Act, the payment of patronage is a matter that is more appropriately left to an institution's board of directors and its shareholders in the capitalization bylaws, subject to proposed FCA regulations requiring that such payments be made in accordance with cooperative principles, including the principle that all patrons should be treated equitably. In addition, section4.3A(d) of the 1971 Act, as amended, prohibits the payment of patronage if it would reduce the institution's permanent capital below the minimum permanent capital standards established by the FCA. The FCA believes that this statutory prohibition, the minimum permanent capital standards established by the FCA, and the proposed regulations requiring equitable treatment of patrons provide sufficient guidance in this area.

In the case of BCs, the statutory basis for the regulations is unchanged except for deletions of FCA prior approvals. The FCA believes the statutory provisions, the minimum permanent capital standards, the proposed regulations requiring equitable treatment of patrons, and the proposed Subpart K will provide adequate guidance for BCs.

Subpart M -- Payment of Dividends

The FCA proposes to delete and reserve Subpart M. So long as an institution has adequate capital, the FCA's primary regulatory interest in the payment of dividends is focused on dividend rights and preferences insofar as they have some bearing on the status of equities as permanent capital and the safety and soundness of the institution, and the equitable treatment of shareholders and participation certificate holders. These concerns are addressed in proposed Subpart I.

Subpart N -- Association Supervision

The FCA proposes to delete and reserve Subpart N. This section directs bank boards to prescribe policies and regulations and guidelines necessary for the banks to discharge their supervisory responsibilities over the financial and fiscal affairs of the associations and to monitor compliance with such policies, regulations and guidelines. Because the 1987 Act encourages greater autonomy on the part of associations that are direct lenders and provides an opportunity for all associations to become direct lenders, the FCA believes that the FCBs and associations should have greater flexibility to work out an effective relationship between them under the provisions of the 1971 Act as amended by the 1987 Act.

List of Subjects in 12 CFR Part 615

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

For the reasons stated in the preamble, Part 615 of Chapter VI of Title 12 of the Code of Federal Regulations is proposed to be amended as follows:

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

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

Authority: Secs. 4.3, 5.9, 5.17, 6.20, 6.26; 12 U.S.C. 2154, 2243, 2252, 2278b, 2278b-6.

2. Subpart I is revised to read as follows:

Subpart I -- Issuance of Equities

Sec.

615.5220 Capitalization Bylaws.

615.5230 Implementation of cooperative principles.

615.5240 Permanent capital requirements.

615.5250 Disclosure requirements.

Subpart I -- Issuance of Equities

615.5220 Capitalization Bylaws.

The board of directors of each Farm Credit institution shall, pursuant to section4.3A of the Farm Credit Act of 1971, adopt capitalization bylaws, subject to the approval of a majority of its voting shareholders present and voting, or voting by written proxy, at a duly authorized shareholders' meeting, that set forth:

(a) Classes of equities and the manner in which they shall be issued, transferred, converted and retired;

(b) 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;

(c) The number of shares and par value of equities authorized to be issued for each class of equities, except that equities that are required to be purchased as a condition of obtaining a loan may be authorized to be issued in unlimited amounts;

(d) The percentage amount of equities that will be required to be purchased from the institution as a condition for obtaining a loan, which may be more than, but shall be not less than, 2 percent of the loan amount or $1,000, whichever is less;

(e) The amount of stock protected under section4.9A of the Act that existing borrowers will be required to exchange for stock issued under capitalization bylaws adopted pursuant to section4.3A of the Act;

(f) The manner in which stock will be retired, including a provision stating that equities other than those protected under section4.9A 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;

(g) The manner in which earnings will be allocated and distributed, including the basis on which patronage refunds will be made, which shall be in accord with cooperative principles; and

(h) The manner in which the capitalization requirements of the Farm Credit Bank shall be allocated and equalized from time to time among its owners.

615.5230 Implementation of cooperative principles.

(a) The bylaws shall provide for voting rights based upon cooperative principles, except as otherwise required by statute or regulation, and shall include, at a minimum, the following provisions:

(1) For associations --

(i) A provision according each voting shareholder one vote, except as modified by paragraph (b) of this section.

(ii) A provision according each voting shareholder the right to vote in the election of each director.

(2) For Farm Credit Banks --

(i) A provision according the vote of each association a weight proportional to the number of the association's voting shareholders in a manner that does not discriminate against agricultural credit associations that have resulted from the merger or consolidation of Federal land bank associations and production credit associations; and

(ii) A provision according each voting shareholder the right to cast its vote in the election of each director.

(b) Bylaw provisions shall provide for the equitable treatment of all shareholders and participation certificate holders. To assure such equitable treatment, the bylaws shall, at a minimum, provide for the following:

(1) The authorization to issue preferred stock other than preferred stock to be issued to the Farm Credit System Financial Assistance Corporation shall be approved by a majority of the shares of each class of stock affected by the preference, voting as a class, whether or not such classes are otherwise authorized to vote;

(2) Any dividends paid to the holders of common stock shall be on a per share basis and without preference between classes of common stock, between classes of participation certificates, between classes of common stock and classes of participation certificates, or between holders of the same class of stock or participation certificates, except that any class of common stock that results from the conversion of allocated surplus may be subordinated to other classes of common stock in the payment of dividends.

(3) Patronage refunds may be paid, consistent with cooperative principles, on a proportionate basis determined by the board of directors in accordance with the capitalization bylaws, provided that any earning pools that may be established for the payment of patronage shall be established on a rational and equitable basis and shall ensure that each patron of the institution receives its fair share of all of the earnings of the institution and bears its fair share of the expenses of the institution.

(4) All classes of common stock and participation certificates (except those resulting from a conversion of allocated surplus) must be accorded the same priority with respect to impairment and restoration of impairment and have the same rights and priority upon liquidation.

615.5240 Permanent capital requirements.

The capitalization bylaws shall enable the institution to meet the minimum permanent capital adequacy standards established under Subpart H of this Part and the total capital standard established by the board of directors of the institution.

(a) In order to qualify as permanent capital, equities issued under the bylaws must meet the following requirements:

(1) For common stock and participation certificates --

(i) Retirement must be solely at the discretion of the board of directors and not upon a date certain or upon the happening of any event, such as repayment of the loan, and not pursuant to any automatic retirement or revolvement plan adopted by the board of directors.

(ii) Retirement must be at not more than book value.

(iii) Disclosure must have been made pursuant to 615.5250 of the nature of the investment and the terms and conditions under which it is issued, and the rights, if any, to share in any patronage distributions that may be made.

(iv) Dividends must be payable only at the discretion of the board and must be noncumulative.

(2) For preferred stock issued to persons other than the Farm Credit System Financial Assistance Corporation --

(i) Retirement must be solely at the discretion of the board of directors and not upon a date certain or upon the happening of any event, such as repayment of the loan, and not pursuant to any automatic retirement or revolvement plan adopted by the board of directors.

(ii) Retirement must be at not more than book value.

(iii) Dividends must be payable only in the discretion of the board, and may be cumulative, provided the obligation to pay can be indefinitely deferred so long as no dividends are paid to holders of common stock and participation certificates or patronage refunds paid to patrons, and provided further that such obligation is subordinated to the rights of the holders of common stock and participation certificates to have their stock or participation certificates retired at book value not to exceed par upon liquidation.

(iv) Disclosure must have been made pursuant to 615.5250 of the nature of the investment and the terms and conditions under which it is issued.

(b) The capitalization bylaws of the Farm Credit Bank shall allow the Farm Credit Bank, with the prior approval of the Farm Credit Administration, to require the holders of its common stock and participation certificates to subscribe for such additional capital as may be needed by the Farm Credit Bank to meet its capital requirements under Subpart H of this part or its joint and several liabilities under section4.4 of the Act. In making such a capital call, the Farm Credit Bank shall take into account the financial condition of the holders of its common stock and participation certificates.

(c) The capitalization bylaws of the banks for cooperatives and associations shall require that until the institution meets the minimum permanent capital standard established by the FCA, all equities required to be purchased as a condition for obtaining a loan shall be purchased from the institution.

615.5250 Disclosure requirements.

(a) Equities purchased as a condition for obtaining a loan. Prior to loan closing, the institution shall provide the prospective borrower with the following:

(1) The institution's most recent annual report filed under 12 CFR Part 620;

(2) The institution's most recent quarterly filed under 12 CFR Part 620, 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, including an express disclosure that the equity is retireable only at the discretion of the board of directors and is an investment that is at risk and not a compensating balance.

(b) Prior to any mandatory exchange of eligible borrower stock, as defined in 615.5260(a)(1), for stock issued under capitalization bylaws required under 615.5220, equity holders shall be provided with the disclosures required by paragraph (a)(3) and (4) of this section.

(c) Other equities.

(1) No stock or participation certificates other than those required to be purchased as a condition of obtaining a loan may be offered for sale except pursuant to a disclosure statement containing all of the information required by 12 CFR Part 620 in the annual report to shareholders as of a date within 135 days of the proposed sale, which disclosure statement must have been reviewed and cleared by the Farm Credit Administration.

(2) At least 45 days prior to the proposed sale of such equities, the institution shall submit the disclosure statement required by paragraph (b)(1) of this section to the Farm Credit Administration for review and clearance. The most recent annual report to shareholders and the most recent quarterly report filed with the Farm Credit Administration may be incorporated by reference into the disclosure statement in satisfaction of this requirement. In addition, the disclosure statement shall include items (3) and (4) of paragraph (a) of this section and a discussion of the intended use of the sale proceeds.

(3) Within 30 days of the receipt of such disclosure statement and any clarifying information the Farm Credit Administration may request, the Farm Credit Administration shall inform the institution whether the Farm Credit Administration will consider the issuance permanent capital for the purpose of meeting the minimum permanent capital standards established under Subpart H and shall inform the institution of any required changes or additions to the disclosure materials.

(4) No officer, director, employee, or agent of a System institution shall make any disclosure, through the disclosure statement or otherwise, in connection with the sale of equities that is inaccurate or misleading, or omit to make any statement needed to make other disclosures made by such person not misleading.

(5) The Farm Credit Administration may waive any or all of the disclosure requirements of this paragraph (b) when a single investor acquires $100,000 or more of a single class of equity if the sophistication of the purchaser warrants, provided that any certificate that may be issued evidencing such an equity states on its face in boldface type "The denomination of this equity may not be reduced to less than $100,000 without the prior approval of the Farm Credit Administration."

(c) The requirements of this section shall not apply to the sale of Farm Credit System institution equities to other Farm Credit System institutions or other financing institutions having a discount or lending relationship with the selling Farm Credit System institution.

3. Subpart J is revised to read as follows:

Subpart J -- Retirement of Equities

Sec.

615.5260 Retirement of eligible borrower stock.

615.5270 Retirement of other equities.

615.5280 Retirement in event of default.

Subpart J -- Retirement of Equities

615.5260 Retirement of eligible borrower stock.

(a) Definitions. For the purpose of this Subpart the following definitions shall apply:

(1) "Eligible borrower stock" means:

(i) Stock, participation certificates or allocated equities outstanding on January 6, 1988, or purchased as a condition of obtaining a loan prior to the earlier of the date of shareholder approval of capitalization bylaws under section4.3A of the Act or October 5, 1988; and

(ii) Any stock, participation certificates or allocated equities for which such eligible borrower stock is exchanged in connection with a merger, consolidation, or other reorganization or transfer of territory. "Eligible borrower stock" does not include equities for which eligible borrower stock is required to be exchanged pursuant to the bylaws adopted under section4.3A or equities for which eligible borrower stock is voluntarily exchanged in consideration of a benefit to the shareholder, such as early retirement.

(2) "Retirement in the ordinary course of business" means:

(i) Retirement upon repayment of a loan or under a retirement or revolvement plan in effect prior to January 6, 1988, and for eligible borrower stock issued after that date, at the time the loan was made; and

(ii) Retirement pursuant to 615.5280.

(3) "Par value" means:

(i) In the case of stock, par value;

(ii) In the case of participation certificates and other equities (except equities unable to be retired in connection with a liquidation occurring after January 1, 1983, and before January 1, 1988), face or equivalent value; or

(iii) In the case of participation certificates and allocated surplus subject to retirement under a revolving cycle and retired out or order pursuant to 615.5280 or otherwise under the Act, par or face value discounted at a rate determined by the institution to reflect the present value of the equity as of the date of such retirement.

(b) When an institution retires eligible borrower stock in the ordinary course of business, such equities shall be retired at par, even if book value is less than par. If the book value is less than par, such retirement shall be coordinated with the Farm Credit System Assistance Board and the Farm Credit System Financial Assistance Corporation.

(c) When a Farm Credit Bank retires stock for the sole purpose of enabling an association to retire eligible borrower stock that was issued in connection with a long term real estate loan, such stock shall be retired at par even if its book value is less than par. If the book value is less than par, such retirement shall be coordinated with the Farm Credit System Assistance Board and the Farm Credit System Financial Assistance Corporation.

(d) No eligible borrower stock shall be retired other than in the ordinary course of business without the prior approval of the Farm Credit Administration.

615.5270 Retirement of other equities.

(a) Equities other than eligible borrower stock shall be retireable only in the discretion of the board and not on a date certain or upon the happening of an event such as repayment of a loan, or pursuant to an automatic retirement or revolvement plan, and shall be retired at not more than their book value.
(b) No equities shall be retired unless after the retirement the institution would continue to meet the minimum permanent capital standards (including interim standards) established under Subpart H of this part.

615.5280 Retirement in event of default.

(a) When the debt of a holder of eligible borrower stock issued by a production credit association, Federal land bank association or agricultural credit association is in default, such institution may, but shall not be required to, retire at par eligible borrower stock owned by such borrower in total or partial liquidation of the debt.

(b) When the debt of a holder of stock, participation certificates or other equities issued by a production credit association, Federal land bank association, or agricultural credit association is in default, such institution may, but shall not be required to, retire such stock, participation certificates or other equities, other than eligible borrower stock as defined in 615.5260(a)(1), at book value not to exceed par, all or part of the equity owned by such borrower in total or partial liquidation of the debt.

(c) When the debt of a holder of eligible borrower stock issued by a bank for cooperatives is in default, the bank for cooperatives may, but shall not be required to retire such stock, in total or partial liquidation of the debt. If such stock qualifies as eligible borrower stock, it shall be retired at par, as defined in 615.5260(a)(3). All other stock shall be retired at fair market value.

(d) Any retirements made under this section by a Federal land bank association that is not a direct lender shall be made only upon the specific approval of or in accordance with approval procedures issued by the district Farm Credit Bank.

(e) Prior to making any retirement pursuant to this section, except retirements pursuant to paragraph (c) of this section, the institution shall provide the borrower with written notice of the following matters:

(1) A statement that the association has declared the borrower's loan to be in default;

(2) A statement that the association will retire all or part of the equities of the borrower in total or partial liquidation of his or her loan;

(3) A description of the effect of the retirement on the relationship of the borrower to the association;

(4) A statement of the amount of the outstanding debt that will be owed to the association after the retirement of the borrower's equities; and

(5) The date on which the association will retire the equities of the borrower.

(f) The notice required by this section shall be provided in person at least 10 days prior to the retirement of any equities of a holder, or by mailing a copy of the notice by first class mail to the last known address of the equity holder at least 13 days prior to the retirement of such person's equities.

4. Subpart K is revised to read as follows:

Subpart K -- Surplus and Reserves

Sec.

615.5330 Banks for cooperatives.

Subpart K -- Surplus and Reserves

615.5330 Banks for cooperatives.

Each bank for cooperatives shall add to the unallocated surplus account annually an amount not less than 10 percent of net earnings after taxes until such time as the unallocated surplus equals half of the minimum permanent capital requirements established under Subpart H of this part.

615.5350-615.5370 (SUBPART L) [RESERVED]

615.5390-615.5430 (SUBPART M) [RESERVED]

615.5440 (SUBPART N) [RESERVED]

5. Subparts L, M, and N are removed and reserved.

Date: August 30, 1988.

David A. Hill,

Secretary, Farm Credit Administration Board.

[FR Doc. 88-20046 Filed 9-1-88; 8:45 am]

BILLING CODE 6705-01-M