Title: ADVANCE NOTICE OF PROPOSED RULEMAKING--Funding and Fiscal Affairs, Loan Policies and Operations, and Funding Operations; Capital Adequacy of Farm Credit System Institutions--12 CFR Part 615
Issue Date: 02/17/1988
Agency: FCA
Federal Register Cite: 53 FR 4642

12 CFR Part 615

Funding and Fiscal Affairs, Loan Policies and Operations, and Funding Operations; Capital Adequacy of Farm Credit System Institutions

ACTION: Advance Notice of Proposed Rulemaking.

SUMMARY: Notice is hereby given that the Farm Credit Administration (FCA) intends to develop regulations that establish minimum capital adequacy standards under section 4.3(a) of the Farm Credit Act of 1971, as required by section 301 of the Agricultural Credit Act of 1987 (Pub. L. 100-233) (1987 Act).

The FCA previously issued for public comment proposed regulations for capital adequacy and minimum capital requirements on July 23, 1986 (51 FR 26402), and capital adequacy related regulations on October 27, 1986 (51 FR 36824). The substantial changes made to the Farm Credit Act of 1971 by the 1987 Act requires the FCA to alter the approach to regulating Farm Credit System (System) capital embodied in those proposed regulations. Accordingly, the FCA is requesting comment on possible approaches the FCA Board should consider in issuing proposed capital adequacy regulations.

DATE: Comments should be received on or before March 1, 1988.

ADDRESS: Submit any comments in writing (in triplicate) to Anne E. Dewey, General Counsel, Farm Credit Administration, 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.


William G. Dunn, Chief, Financial Analysis and Standards Division, Farm Credit Administration, McLean, VA 22102-5090, (703) 883-4402
Dorothy J. Acosta, Senior Attorney, Office of General Counsel, McLean, Virginia 22102-5090, (703) 883-4000

TEXT: SUPPLEMENTARY INFORMATION: Section 4.3(a) of the Farm Credit Act of 1971 (1971 Act), codified at 12 U.S.C. 2154, authorizes the FCA to establish such minimum levels of capital for System institutions as it shall deem necessary or appropriate in light of the particular circumstances of the System institution. Section 301 and other provisions of the 1987 Act substantially alters the nature of capital stock issued to member-borrowers and gives System institutions greater flexibility in determining their capital structure and the methods by which they will increase capital. The institutions are also given greater control over the payment of dividends and distribution of earnings, provided the institutions meet minimum capital adequacy standards established by the FCA.

In addition, the 1987 Act makes a distinction between "permanent capital" and capital that is either not at risk or can be retired by the holder upon repayment of the loan or otherwise at the discretion of the borrower. The FCA is required within 120 days of the January 6, 1988 enactment to issue regulations under Section 4.3(a) of the Farm Credit Act of 1971, 12 U.S.C. 2154(a), that establish minimum permanent capital adequacy standards for System institutions.

The 1987 Act adds a new Section 4.3A, which defines permanent capital as " * * * current year retained earnings, allocated and unallocated earnings, all surplus (less allowance for losses), and stock issued by System institutions, except stock that --

(A) May be retired by the holder thereof on payment of the holder's loan, or otherwise at the option or request of the holder; or

(B) Is protected under Section 4.9B [probably intended to refer to 4.9A] or is otherwise not at risk."

The capital standards must specify fixed ratios of permanent capital to assets taking into consideration relative risk factors. Additionally, capital must be computed using financial statements prepared in accordance with generally accepted accounting principles.

Purpose of Capital

The FCA believes that institutions must maintain capital sufficient to protect investors, minimize the risk of insolvency, and provide for current and future needs. Some risks are predictable and recurring, for example, loan losses. These risks can be estimated and provided for on the balance sheet through sufficient loan loss allowances or reserves. However, capital must also be sufficient to protect against other financial and economic risks. Concentrated single-industry lending, especially in fixed geographic territories, is inherently riskier than diversified multi-industry, multi-product lending. In addition, most System institutions carry proportionately more risk assets (particularly loans) on their balance sheets than do more diversified financial institutions. As a result the agency intends to propose standards for System institutions' permanent capital which, on a comparable basis, are likely to be higher than standards set or proposed for those more diversified financial institutions.
The FCA is presently considering whether one capital adequacy ratio should apply to all System institutions or whether different ratios should be established for different System institutions. Should different standards be decided upon, such standards would be set proportionate to the different levels of risk inherent in the operations of different institutions (for example, one could argue that more diversified banks for cooperatives may have lower capital requirements than production credit associations).

Any standard chosen is expected to be applied on the basis of daily average balances of the relevant accounts for each calendar quarter.

Capital Adequacy Measures

The 1987 Act requires that the capital adequacy standards both specify fixed ratios of capital to assets, and take into consideration relative risk factors. In developing capital adequacy regulations, the FCA is considering adoption of a risk-based capital program similar to that recently proposed by the other Federal financial regulators, but modified to reflect the relative risk factors inherent in the System institution, and the unique nature of permanent capital, as defined by the 1987 Act.

Under this approach, each distinct type of asset would be categorized by the degree of risk inherent in the asset. Each category would be assigned a weight ranging from 0 to 100 percent and the weight would determine the relative amount of capitalization required for the asset. For example, cash would be assigned the lowest risk category. Loans expose an institution to relatively greater risk and would therefore be assigned to a higher risk category. Assets assigned a weight of 0 would not require capitalization. Assets assigned a weight of 100 would require full capitalization at the specified fixed ratio level.

The risks incurred by a financial institution include certain types of off balance sheet items that require capital support. The FCA believes that contingent liabilities that could affect risk or which represent actual risk taken should be supported by capital. Such items might include undisbursed commitments, loss-sharing guarantees, letters of credit, and similar obligations. The FCA intends to propose individual weight categories for each such item.

Phase-In Period

The FCA is required to phase in the standards over a 5-year period. The FCA intends to propose interim target ratios which will be greater each year until the fifth year, when the minimum standards must be met. However until the fifth year minimum capital adequacy standards are met, the FCA intends to prohibit institutions from taking any of the actions set forth in Section 4.3A(d)(1) of the amended act that could result in a reduction of capital. For taxable institutions, the prohibition would not extend to certain minimum payments of noncash patronage refunds or cash distributions required by the Internal Revenue Code to qualify as a deductible patronage refund -- provided the remaining portion of the refund paid qualifies as permanent capital.

The FCA is considering proposing that, during the phase-in period, each institution be required to develop and implement long- and short-term financial and operating plans which show how they plan to met both the interim targets and the final minimum capital adequacy standards. The adequacy of the plans and the institution's performance in meeting the plans would be subject to examination and supervision.

Treatment of Equities

The 1987 Act treats allocated equities differently in different System institutions. To the extent that these equities are at risk, they may be treated as permanent capital. However, for equities that will be paid to borrowers in accordance with revolvement policies that entitle the shareholder to a specific payout at a specific time, the FCA is considering eliminating such equities from consideration as permanent capital.

The regulation contemplated would recognize each dollar of permanent capital as support for risk in only one institution. The use of "double duty" dollars as capital support to two different System institutions would be eliminated. Such funds would be counted as capital where the primary risk to those funds is recognized.

Other Related Regulations

The FCA may propose other related regulations and amendments to, or deletions of, existing related regulations that may be inconsistent with the capitalization provisions of the 1987 Act and such capital adequacy regulations as may be adopted under Section 4.3(a) of the 1971 Act.

The FCA invites comment on these issues and any other issues related to capital adequacy. The FCA also requests comment concerning whether a public hearing would contribute to the agency's consideration of the issues involved in these regulations and, if so, what particular issues should be addressed at the hearing.

Dated: February 10, 1988.

David A. Hill,

Secretary, Farm Credit Administration Board.

[FR Doc. 88-3319 Filed 2-16-88; 8:45 am]