Title: FINAL RULE--Loan Policies and Operations; Lending Limits--12 CFR Part 614
Issue Date: 07/28/1993
Agency: FCA
Federal Register Cite: 58 FR 40311
___________________________________________________________________________
FARM CREDIT ADMINISTRATION

12 CFR Part 614

RIN 3052-AB35

Loan Policies and Operations; Lending Limits


ACTION: Final rule.

[*40311]

SUMMARY: The Farm Credit Administration (FCA), by the Farm Credit Administration Board (Board), adopts final regulations relating to lending limits. The Agricultural Credit Act of 1987 n1 (1987 Act), authorized the creation of new corporate entities from mandatory and voluntary mergers and the transfer of long-term real estate lending authorities from Farm Credit Banks (FCBs) to certain associations and directed the FCA to reconcile the authorities of the resulting institutions. These changes required amendments to FCA regulations to reflect the structural changes and the lending authorities of the new entities. Other provisions of the regulations are amended to make conforming changes and to eliminate a number of FCA prior approvals including provisions relating to lending limits

n1 Pub. L. No. 100-233, 101 Stat. 1568 (1988).

The final regulations on lending limits contain a limit on extensions of credit to a single borrower of 25 percent of capital for all Farm Credit System (FCS or System) direct lender institutions, except banks for cooperatives (BCs). It provides for exceptions to the lending limitation and rules for the attribution of loans to separate but related borrowers for the purpose of making "single borrower" determinations. The FCA believes that limiting the amount that can be lent to any one borrower or a group of related borrowers is an effective way to control concentrations of risk in a lending institution and limit the amount of risk to an institution's capital arising from losses incurred by large "single credits."

EFFECTIVE DATE: These final regulations shall become effective on January 1, 1994, or upon the expiration of 30 days after publication during which either or both Houses of Congress are in session, whichever is later. Notice of the effective date will be published in the Federal Register.

FOR FURTHER INFORMATION CONTACT:

Dennis K. Carpenter, Senior Policy Analyst, Regulation Development Division, Office of Examination, Farm Credit Administration, McLean, VA 22102-5090, (703) 883-4498, TDD (703) 883-4444,

or

Gary L. Norton, Assistant General Counsel, Regulatory Operations Division, Office of General Counsel, Farm Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TDD (703) 883-4444.

SUPPLEMENTARY INFORMATION:

I. General

Lending limit regulations were originally included as part of the Eligibility/Lending Authorities regulations proposed on November 3, 1988, 53 FR 44438. The amendments were removed from the regulations prior to their adoption and were reproposed, along with appraisal and loan purchase and sale regulations, on January 23, 1991, 56 FR 2452. The comment period on the reproposed regulations ended on March 25, 1991. The FCA received approximately 430 letters in response to the published reproposed regulations. A substantial number of the comment letters expressed concern about the potential impact of the lending limits and appraisal requirements of the reproposed regulations. The FCA published a Notice of Public Hearings on May 10, 1991, 56 FR 21637, to provide an opportunity for System borrowers, institutions, and other interested parties to state their views and to offer constructive suggestions on issues of concern in the reproposed regulations. The Notice of Public Hearings contained a solicitation of comments on specific topics. It also clarified the application of specific rules relating to attribution ( 614.4358(a)(1)) and nonconforming loans ( 614.4359) that were used to compute lending limits under the reproposed regulations. Testimony was presented by 121 individuals during the 4 days of the public hearings; 94 comment letters responded to questions raised in the Notice and at the hearings; and 85 additional letters were received during the public hearing comment period which ended on July 31, 1991. Subsequent to the close of the public hearing comment period the loan purchase and sale and collateral evaluation requirement portions of the reproposed regulations were separated from the lending limit regulations and later adopted by the FCA Board as final regulations (57 FR 38237, August 24, 1992) and (57 FR 54683, November 20, 1992).

All comments received after publication of the reproposed regulations, as well as all documents, testimony, and comments relating to the public hearings, were considered by the FCA in the development of the final regulations. The significant changes to the reproposed regulations, including any comments received on the subject matter, are explained below in the Summary of Comments and in the Section-by-Section Discussion of Changes preceding the affected part of title 12 of the Code of Federal Regulations. Finally, the FCA made technical corrections to the regulations designed to shorten them and enhance their readability.

The FCA Board recognizes the importance of this topic to the business operations of the institutions and acknowledges the high level of concern about the content of these final regulations. Some commentors have continued to request that the Board repropose rather than adopt the regulations in the form published today. The Board desires to be responsive to the concerns of the FCS institutions, yet must be aware of the time and costs involved in reproposing the regulations and the operational constraints that could be placed on the institutions in the absence of the final regulations. The Board has established an effective date for these regulations of January 1, 1994. The Board believes that with the delayed effective date the public will have ample opportunity to further review the regulations and bring any observations to the Board's attention prior to the effective date of the regulations. As always, the Board will [*40312] consider requests for further clarification or amendments to the regulations prior to or after their effective date.

II. Other Financial Institutions (OFIs)

Several OFIs inquired as to whether they were required to comply with the provisions of the lending limits regulations. The OFIs stated that such compliance would be detrimental to their ability to do business. Alternatively, comments were received from several production credit associations (PCAs) objecting to the OFIs not being subject to the requirements of the lending limits regulations.

The FCA noted during its public hearings that the lending limits regulations do not apply to the OFIs. The OFIs obtain their financing under arrangements with FCBs. The FCA has authority to regulate the discount relationship between the OFIs and the FCBs. However, unlike its regulatory authority over the FCS associations, the FCA does not have direct regulatory authority over the OFIs. It is the FCA's position that an OFI's lending limit should be addressed in the financing agreement between the FCB and the OFI. The FCB, under its lending policies and the terms and conditions of the financing agreement, may require lending criteria to comply with the requirements of the FCA's lending limits regulations. FCBs are subject to the lending limits regulations and, therefore, are restricted by the regulations from extending more than the percent of their lending limit base established in the regulations to any "single borrower," whether such loans are discounted from an association or an OFI.

III. Subpart J-Lending Limits

A. Summary of Comments

1. Computation of Lending Limits

The reproposed regulations based the calculation of lending limits on permanent capital, eliminating any double-counted capital and including stock protected under section 4.9A of the Farm Credit Act of 1971, as amended (Act), until January 1, 1998. The final regulations have substituted the term "lending limit base" for the term "capital" throughout the regulations, to avoid confusion regarding the base against which institutions can extend credit. There is no significant difference in the net computation between the existing and the final regulations.

The lending limit base is comprised of an institution's permanent capital, as defined in 615.5201(h) of this chapter. As defined, permanent capital includes all capital except stock and other equities that may be retired on the repayment of the holder's loan or otherwise at the option of the holder. For the purposes of the lending limits regulations, stock protected under section 4.9A of the Act may be included in the lending limit base until January 1, 1998. A new 614.4351, entitled "Computation of lending limit," has been added to the final regulations, describing how the lending limit base should be adjusted for equity eliminations.

One FCB supported basing the calculation of the lending limits on permanent capital. The American Bankers' Association (ABA) also supported the use of permanent capital, but objected to including protected stock in the lending limit base. The ABA claimed that the inclusion would artificially inflate capital levels for FCS institutions.

The FCA continues to believe that for a limited period of time stock protected under section 4.9A of the Act should be included as capital for lending limit purposes. Excluding this stock from the computation of lending limits could have an immediate negative impact on the size of the loans some institutions can make. The FCA believes that it would not be justifiable or fair to remove protected borrower stock from the lending limit base while some institutions still have considerable amounts of such stock outstanding, but recognizes that the level of protected stock is declining. Therefore, the final regulation provides that after January 1, 1998, such stock will no longer be counted for lending limit purposes.

Several associations commented that the elimination of the FCBs' investments in the associations required under the permanent capital regulations would have a negative effect on their lending limits. The FCA recognizes that the lending limits of direct lender associations may be negatively impacted by equity allocations that assign the equity to the bank, as was required under the original permanent capital regulations. However, recent and pending changes to the capital regulations provide the associations with an opportunity to reach an agreement with the bank on the allocation of equities. Therefore, the FCA does not believe that the regulatory requirements are overly restrictive or impose an undue hardship on the associations.

The FCA's position is based on the following rationale: (a) The double counting of capital should be eliminated; (b) the double counting of capital is inappropriate for calculating lending limits; and (c) the capital must be counted for lending limit purposes where it is counted for capital purposes. When an association's investment in a bank is counted as the bank's capital, then the bank, not the association, is considered to have control over the capital. The bank is considered to have complete discretion, within its operating authorities, to invest or use the funds as it sees fit. It would not be prudent for an association to loan against capital over which it has no direct control. Accordingly, the final regulations continue to reflect the FCA's belief that it is important to count capital where control is vested.

Several associations and a FCB commented that the allowance for loan losses should be included in the capital calculation. They said this argument was particularly compelling in the case of the PCAs, which were required by law to maintain an allowance equal to 3.50 percent of loan assets even though that would exceed the allowance required under generally accepted accounting principles (GAAP). They also pointed out that commercial banks are permitted to include the allowance for loan losses in the capital base when determining lending limits. To assure equitable treatment, they urged that the allowance be included as permanent capital for lending limit calculations.

With regard to the PCA allowance, following the expiration of the comment period the Act was amended to delete the required 3.50 percent allowance requirement. n2 As amended, the law now requires all System institutions, including PCAs, to maintain their allowance in accordance with GAAP, therefore the PCA allowance is no longer an issue.

n2 Farm Credit Banks and Associations Safety and Soundness Act of 1992 (Pub. L. 102-552), 106 Stat. 4102.

Contrary to the comments received and the practices of commercial banks, the FCA continues to believe that the allowance for loan losses computed in accordance with GAAP should be excluded from the definition of the lending limit base. Such funds already represent specifically known risk exposure and generally anticipated risk of loss. It would be inappropriate for an institution to expose funds already earmarked to cover losses to increased risk of loss by including them in the lending limit base. Therefore, the final regulation continues to exclude the amount of the allowance for losses required by GAAP from the lending limit base. [*40313]

The BCs commented that changing the basis of the calculation of lending limits from net worth to permanent capital, would adversely affect their lending limits. They said this would require the smaller BCs to participate more loans with CoBank. This adverse impact stems from the regulatory treatment of investments in other institutions due to participation of loans.

Under existing regulation, 614.4354(d), a BC purchasing a participation interest in another BC's loan would calculate its lending limit by subtracting from its net worth the amount of any capital that the originating BC is required to have in the purchasing bank. Thus, when CoBank purchases a participation from the other BCs, it deducts from its net worth the amount of investment in CoBank owned by the other BCs. For example, assume that the originating bank has a net worth of $ 50 million and that its investment in the purchasing bank is $ 20 million. Further assume that the purchasing bank's net worth is $ 500 million. Under existing regulations, the purchasing bank can participate a seasonal and term loan with the originating bank up to 35 percent of its $ 480 million net worth, or $ 168 million. The originating bank can loan up to 35 percent of its $ 50 million net worth, or $ 17.5 million.

The reproposed regulation revised this elimination and required the originating bank to deduct from its capital the investment in the purchasing bank that the originating bank was required to purchase. Therefore, under the reproposed regulation, if the Springfield or St. Paul BCs sold a participation to CoBank, they would have to deduct from their capital the amount of their investment in CoBank in order to determine their lending limit. At the same time, if CoBank were to purchase a participation from the other BCs, it would not have to deduct from its capital the amount of investments owned by the other BCs.

In light of these comments, FCA has reconsidered this provision of the reproposed regulations and determined that the regulation should revert back to the computation originally provided in the proposed regulations. It was determined that the reproposed regulation would have adversely impacted the lending limit of the two smaller BCs, and the FCA is prohibited by statute from setting more restrictive lending limits for the BCs than are currently in effect. FCA believes that application of this method of computation will not create a safety and soundness concern for the FCBs and associations and therefore should also be applicable to these institutions in order to provide a consistent methodology for computing lending limits.

Accordingly, for purposes of capitalizing participation interests, the final regulations have revised the manner in which the investment in other institutions is eliminated. Section 614.4351(c) of the final regulations requires the investment to be deducted from the purchasing institution's lending limit base rather than from the originating institution's lending limit base.

2. Computation of Obligations

The reproposed regulations allow an institution to exclude loans that are discharged in bankruptcy or that are legally unenforceable because of judicial decision or the expiration of the statute of limitations when making a determination if loans to a borrower are within the lending limit. The Farm Credit Council (FCC) commented that the regulation should be broadened to exclude those portions of a loan where the lender cannot legally enforce payment because of formal restructuring or similar actions. One FCB suggested that the phrase "because of judicial decision or the expiration of the statute of limitations" be deleted. The FCB maintained that an institution should not be required to obtain a judicial decision or to postpone extending credit during the statute of limitations period for otherwise qualified eligible borrowers. The FCB argued that the provision is excessively restrictive and would inhibit the restructuring of loans authorized by the Act.

One FCB also commented that charged-off loans should not be included in a borrower's total obligations when determining whether additional credit can be extended. The FCB asserted that the conditions under which previous indebtedness was charged off may have little similarity to the borrower's present financial condition and that each extension of credit requires a credit decision that takes into account existing credit factors.

The FCA agrees that all payments that are determined to be legally unenforceable are no longer considered to be a loan for lending limit purposes and should be excluded from a borrower's obligations. The final regulation has been clarified accordingly. The final regulation continues to include chargeoffs in the calculation of a borrower's total obligations because chargeoffs do not affect the borrower's legal obligation to repay the debt unless the institution has modified the obligating instruments. If the borrower's present financial condition has improved to the point that the institution wishes to extend additional credit, the institution should first make every effort to collect previous extensions of credit from which the borrower has not been legally released.

3. Timing of Determinations

Several comments were received requesting clarification as to when a loan or commitment is considered to have been made for the purpose of determining whether a borrower's indebtedness exceeds the lending limit. In addition, one association commented that lending limits should be based solely on the outstanding principal balance and should not include undisbursed commitments.

To ensure uniformity concerning the point in time when the lending determination is made, the definition of "commitment" has been revised. Under the final regulations, a commitment is effective at the time it becomes a legal obligation. Since commitments are contractual obligations of the institution when they are made, they must be combined with any other outstanding debts of a borrower in determining lending limits. Therefore, before an institution makes a loan commitment, it shall ensure that the commitment, together with all loans and commitments outstanding and attributed to that borrower, is within the lending limits or is able to be participated.

4. Attribution Rules

The attribution rules are intended to identify all loans to a single borrower or related borrowers which must be combined with the borrower's loan when calculating the borrower's lending limit. The criteria for attributing one borrower's loan to another is set forth in the final regulations to allow all FCS institutions to identify "single credit risks" before making a loan or commitment to lend.

A number of comments were received from FCS institutions, individual borrowers, the FCC, and other interested parties regarding the reproposed attribution rules. A majority of the comments were from BCs and their borrowers. The commentors were primarily concerned with how the regulations would impact loans to regional and local cooperatives. The BCs and their customers were concerned that the rules of attribution in the reproposed regulations would restrict the BCs' lending activities. Additional [*40314] comments were received from the FCC with similar concerns.

Existing regulation 614.4354(e) requires FCA prior approval to treat related BC borrowers as separate credit risks. The reproposed attribution rules apply to all FCS borrowers and were based on the same criteria that FCA has used internally in the past in determining whether to approve exceptions for those BC borrowers who were determined to be independently viable. These criteria were included in order to eliminate the prior approval requirement and allow all institutions to make their own determinations of "single credit risk."

In response to the comments the FCA reconsidered the reproposed regulations and the underlying rationale. The FCA also conducted a study of the various cooperative ownership structures found in the BCs lending portfolios as well as the ownership structures and borrowing relationships found in the FCBs' and associations' loan portfolios. Based on this analysis, the attribution rules have been modified in the final regulations. As modified, the attribution rules will not create a more restrictive application of lending limits on the BCs than already existed. Following the completion of the study, FCA confirmed that no existing BC borrowing relationship would have been required to be attributed that would not also have been required to be attributed, upon identification, under the existing regulations.

Under the final regulations, the issue of whether a related borrower's loan needs to be combined with the borrower's loans, when calculating the borrower's lending limit, will depend on whether the borrower either exerts corporate control over the related borrower's operation or is a primary source of repayment on the related borrower's loan(s). In cases where the borrower is obligated to repay or has the ability to influence the repayment of the related borrower's loan, the related borrower's debt must be attributed to the borrower and combined with the borrower's debt for lending limit purposes.

The following is a discussion of the specific changes to the regulations.

(a) "Named" and "subject" borrower. Under the rules of attribution in the reproposed regulations, loans to a borrower (named borrower) were required to be combined with and attributed to another borrower (subject borrower) when any one of five conditions occurred. Considerable comment was received stating that the terms "subject" and "named" borrower were confusing, making it difficult to determine how the rules of attribution should be applied. In response to these comments, the final regulations have been revised by deleting all reference to subject and named borrower. For the purposes of applying the lending limits to the indebtedness of an applicant for a loan, the applicant, previously referred to as the subject borrower is referred to as the borrower in the final regulations. A loan in the name of another borrower, previously referred to as "named" borrower, is referred to as the "related" borrower.

(b) Liability. Under the reproposed regulations, any loan for which the borrower is primarily or secondarily liable would be combined with the total debt of that borrower. Numerous commentors stated that the rules of attribution should only apply to the portion of the loan being guaranteed by the borrower. The FCA agrees with the commentors and has modified the regulations accordingly. While the final regulation continues to require attribution when the borrower has primary or secondary liability for a loan made to the related borrower, it clarifies that the amount of such loan attributable to the borrower is limited to the amount of the borrower's liability.

The FCA notes that guarantees are presumed to be taken in support of the credit decision and not out of an abundance of caution. Only when an institution documents in the appropriate loan files that the guarantee is not a necessary factor in the credit decision may the abundance of caution exception be taken. If the documentation fails to provide such support, then the portion of the loan that is guaranteed must be combined with the borrower's other debt for lending limit purposes. If this results in the loan to the borrower exceeding the lending limit the excess amount of the loan would be subject to the provisions of 614.4359 of this subpart.

A substantial number of the comments continued to reflect the impression that loans guaranteed by a borrower must be attributed to both the borrower and the related borrower under the reproposed rules of attribution. The FCA had previously attempted to clarify this issue in its Notice of Public Hearings relating to the reproposed lending limit regulation (56 FR 21638, May 10, 1991). The reproposed regulations were intended to require all loans which the borrower guaranteed to be combined with the borrower's other loans when calculating the borrower's lending limit. As stated in the Notice, a loan guaranteed by a borrower would be combined with the loans outstanding to that borrower. However, loans outstanding to the guarantor would not be combined with and attributed to the related borrower whose loan is being guaranteed. For example, assume cooperative A (borrower) has a $ 100 million loan, and provides a full guarantee on cooperative B's (related borrower) $ 50 million loan. Because of the guarantee, cooperative B's loan would be attributed to the guarantor, cooperative A, and combined with cooperative A's outstanding loan. Cooperative A's total debt for lending limit purposes would be $ 150 million. Cooperative B's debt remains at $ 50 million for lending limit purposes.

A Comment received on behalf of the BCs expressed concern that the reproposed attribution rules would disallow the exception for "look-through" notes contained in 614.4354(a)(2) of the existing regulation. This exception was not removed in the reproposed regulation and continues under the final regulation. Under the Liability section of the final attribution rules in 614.4358(a), look-through notes are exempt from the lending limit provisions for the BCs, provided the notes meet all the criteria of 614.4356.

(c) Financial interdependence. The reproposed regulations required attribution if two borrowers' operations were so intertwined that viability could not be independently determined. A number of comments were received regarding this section of the reproposed regulations and the terms used to determine when borrowers are financially interdependent. As discussed below, the financial interdependence section of the final regulations has been reorganized and modified to clarify the application of the regulation.

A number of commentors expressed concern that the attribution rule would be difficult to apply because the terms "intertwined" and "viability" were vague. The FCA agrees with the commentors and has modified the final regulations by deleting these terms and incorporating this concept under 614.4358(a)(2). Under this section, the borrower's loan should be combined with and attributed to another borrower's loan when their operations are so financially interdependent that the economic survival of one operation will materially affect the economic survival and repayment capacity of the other operation.

A substantial number of comments received from the BCs and their borrowers regarded the source of repayment criteria used in the reproposed regulation. A majority of commentors did not object to the use of [*40315] the gross receipts standard but requested that the percentage be raised to 50 percent, stating that the higher percentage would result in less frequent consolidation of credits of different borrowers and provide more flexibility in addressing the credit risk associated with interdependence.

In response to these comments, the FCA analyzed the potential impact of the reproposed regulation on the BCs and their borrowers and in particular the various cooperative ownership structures and the use of the 30-percent gross receipts in the repayment criteria. Based on the results of its analysis, the FCA has modified the final regulations to increase the percentage of gross receipts from 30 to 50 percent. Under the final regulations, a borrower is considered to be the primary source of repayment if the borrower is obligated to supply 50 percent or more of the related borrower's annual gross receipts, and reliance on the income from one another is such that, regardless of the solvency and liquidity of the borrower's operations, the debt service obligation of the related borrower could not be met if income flow is interrupted or terminated. Gross receipts include, but are not limited to, revenues, intercompany loans, dividends, and capital contributions.

Under the final regulation, financial interdependence is not limited to borrowers who supply 50 percent or more of the related borrower's gross receipts. Borrowers will also be considered to be financially interdependent and required to combine their debts, when the assets or operations of the borrowers are commingled to such an extent that they cannot be separated without materially impacting the repayment capacity of each borrower. Therefore, even if a borrower supplies less than 50 percent of the gross receipts, the related borrower's loans must be attributed to the borrower if their assets or operations are so commingled.

The reproposed regulation provided that the gross receipts rule did not apply to "integrated operations." FCA received comments requesting clarification of the scope of this exception and its applicability to contract growers. The exception was intended to identify those relationships where one borrower could reasonably continue to do business or service its debt without a continuing, ongoing relationship with the other borrower. Those often involve contractual relationships that can easily be replaced in the marketplace without adversely affecting the viability or repayment ability of the related borrower. The final regulations were revised so that the source of repayment rule would apply the same criteria to all borrowers instead of attempting to specifically exclude a particular class of borrower, such as integrated operations from the attribution rules. As an example, the final rule would not require attribution for integrated operations where the integrator had choices as to which contract operators the integrator would have under contract. At the same time, the individual contract operators' loans would not be required to be consolidated as long as they have reasonable contract replacement alternatives and their viability or repayment ability is not jeopardized.

The reproposed regulations required attribution when the proceeds of loans to the related borrower are used by or for the direct benefit of the borrower. Direct benefit was deemed to have occurred when the proceeds of the loan were either transferred to or used to purchase an asset that was transferred to the borrower without a reasonably equivalent exchange of value. Several commentors objected to this direct benefit rule, asserting that it was difficult for institutions to measure or monitor. They also questioned why loans must be attributed solely because of loan purpose. The FCA agrees with the commentors and has deleted the direct benefit rule from the final attribution rules. The FCA believes that risk will be contained by focusing on financial interdependence and control rather than on loan purpose.

Contrary to a number of comments received from local and regional cooperatives who borrow from the BCs, the borrowers' loans are generally not required to be attributed to a related borrower for the purpose of calculating the related borrower's lending limit. FCA has modified the final regulation to further clarify this point. Under the final regulation, the only time the borrower's loan would be attributed to the "related" borrower would be if the related borrower controls repayment of the borrowers' loans.

(d) Control. The reproposed regulation required attribution when the borrower directly or indirectly controls or is controlled by the related borrower. Control was defined as exercising a controlling influence over the affairs of another borrower or operating under common control with another borrower. The criteria used to determine control included any one of the following: (1) Ownership or the power to vote 25 percent or more of the voting securities in another; (2) control of the election of a majority of directors of another; (3) the power to exercise a controlling influence over the management of another's operations; or (4) the sharing of a common directorate or management with another.

Comments regarding the definition of control came primarily from the BCs, BC borrowers, and the FCC. Several commentors stated that using 25-percent ownership as a basis for control was not consistent with established principles for operating on a cooperative basis because one characteristic of traditional cooperative structures is that one borrower equals one vote. They stated that the reproposed regulations presumed that 25-percent ownership could be translated into voting control. They felt that by using 25-percent stock ownership the FCA was equating stock ownership in cooperatives to stock ownership in corporations. The FCC and other commentors suggested that 614.4350(d)(1) be revised to require attribution when a borrower has the power to vote 50 percent or more of the voting securities in another.

The FCC also stated that 614.4350(d)(3), which defined "control" to include the authority to exercise a controlling influence over the management of another's operations was vague and should be deleted. Finally, the FCC recommended that 614.4350(d)(4), regarding when a borrower shares a common directorate or management with another, be improved by establishing a more objective standard.

The FCA acknowledges that cooperative ownership structures may differ significantly from non-cooperative corporate ownership structures. Generally, in a cooperative, each member has only one vote regardless of the amount of stock owned while in a corporation, voting rights typically correspond to the amount of stock owned. The FCA also realizes that the nature of cooperative relationships is undergoing a transition to more capital-based ownership structures and has chosen to include the percentage of stock ownership as one of the criteria for determining control. The final regulations have been revised to reflect these distinctions and to incorporate both traditional and nontraditional cooperative structures.

The final regulations provide that, for purposes of lending limits, where a borrower owns 50 percent or more of the stock of another, direct control exists and attribution is required. Where a borrower owns or controls 25 percent of the voting stock, attribution will be required if at least one of three management control conditions is also present. By combining stock ownership with managerial control, the FCA has [*40316] addressed the concern that the control criterion is unduly subjective and restrictive for traditional cooperative relationships. At the same time, the regulation continues to require attribution in those instances where the borrower may indirectly control the stock, but plays a major role in the related borrower's operations.

Instead of requiring attribution if any one of the four criteria in the reproposed regulations are met, the final regulation at 614.4358(a)(3) requires attribution when the borrower owns 50 percent or more of the stock of the related borrower or the borrower owns or has the power to vote 25 percent or more of the voting stock of a related borrower and meets at least one of the following three management control criteria. These three criteria were contained in the reproposed regulations and the way in which they are applied to the question of attribution has been modified in the final regulations. They are:

(1) The borrower shares a common directorate or management with a related borrower. A common directorate is deemed to exist when a majority of the directors, trustees, or other persons performing similar functions of one borrower also serves the other borrower in a like capacity. A common management is deemed to exist if any employee of the borrower holds the position of chief executive officer, chief operating officer, chief financial officer, or an equivalent position in the related borrower's organization.

(2) The borrower controls in any manner the election of a majority of directors of a related borrower.

(3) The borrower exercises or has the power to exercise a controlling influence over management of a related borrower's operations through the provisions of management placement or marketing agreements, or providing services such as insurance carrier or bookkeeping. An example of the test for determining borrower control under this condition would be where the related borrower's ability to make independent decisions is limited by the actions of the borrower.

5. Transition Period

A number of comments were received regarding the transition period provisions of the reproposed regulations. The reproposed regulations required loans that were made prior to the effective date of the regulations which became nonconforming solely because of a change in the regulations to be retired or liquidated over a reasonable period, not to exceed 7 years. Several commentors requested this requirement be deleted, because institutions cannot unilaterally change existing terms of loan contracts that exceed the 7-year period. Some commentors also argued that institutions should not be penalized for retroactively failing to comply with new regulations. The FCC urged that the new lending limits be applied prospectively and that all existing loans be "grandfathered" unless subsequent loan servicing results in a material change in the contract terms allowing the institution to bring the loan into conformance with the new lending limits. One institution noted that loans maturing or renewing much earlier than 18 months, combined with the added restrictions on participations and the lowering of the lending limits, would create an undue burden. Several borrowers expressed concern that they would have to refinance their loans at the end of the 18-month period and that they might be forced to seek financing elsewhere if their loans were not within the institution's new lending limit.

The FCA recognizes that the term of some existing loans might exceed 7 years and that institutions cannot change the term of a loan contract to comply with their new regulatory lending limit. To address these concerns, the final regulations provide a "grandfather" provision for all loans on the books on the date these regulations become effective. Furthermore, after careful consideration of the comments expressing concern that institutions would not have ample time to conform to the new regulations, the FCA has chosen to delay the effective date of the regulations until January 1, 1994, or upon the expiration of 30 days after publication in the Federal Register during which either or both Houses of Congress are in session, whichever is later. Since this date marks the beginning of a new year and quarter, the FCA believes it will be easier for institutions to calculate and comply with the new lending limits.

All new loans or commitments entered into after the regulations become effective must conform to the new regulations. A grandfathered loan will be considered a new loan if funds are advanced to the borrower in excess of existing commitments, the terms and conditions of the loan are materially changed, a different borrower is substituted for an original borrower who is released, or an additional person is added to the loan contract. Also, for purposes of this subpart, when a renewal or reamortization involves the capitalization of interest, new funds would be considered to have been advanced and the entire loan must then be within the lending limit.

The transition section of the reproposed regulations also allowed commitments made prior to the effective date of the regulations to be funded. If the commitment would result in a lending limit violation when fully funded, then no additional funds in excess of the commitment amount may be advanced. The FCC commented that 614.4360(b) could be read as prohibiting the advance of additional funds under an existing commitment if the advance would result in a nonconforming loan. This was not the intent of the regulations and the final regulations were amended to eliminate any ambiguity.

6. Lending Limit Violations

The reproposed regulations contained a section governing "nonconforming" loans, which were defined as loans or commitments that were within the lending limit when made, but which subsequently exceeded the limits. The FCC and several other FCS institutions requested clarification of the nonconforming loan designation and its impact on the institutions.

The final regulations were reorganized and clarified to emphasize that all loans which exceed the lending limit, except "grandfathered" loans, are lending limit violations. However, the final regulation also provides an exception for those loans which were previously categorized as "nonconforming" and clarifies that these excepted loans are not required to be removed from an institution's collateral base. In addition, the final regulation adds an exception for loans which exceed the lending limits due to mergers and acquisitions.

The FCA recognizes that if the loan or commitment was legal at the time it was made, then the institution has not knowingly violated the lending limit regulations. Therefore, under the final regulations, if a loan or commitment, when combined with all other loans and commitments outstanding and attributed to the borrower, was within the lending limit when made, the loan may continue to be funded and advances can be made under the commitment even if: (a) The institution experiences a decline in capital and thus its lending limit base; or (b) the borrower's operations are merged with another borrower resulting in total consolidated loans in excess of the institution's lending limit.

To ensure that institutions make every effort to bring loans which violate the lending limit into conformance, the reproposed regulations required nonconforming loans to have a written plan prescribing specific actions that [*40317] will be taken by the institution and the borrower to bring the loan into conformance with the legal lending limit. The FCC and several FCBs urged that this requirement be revised to remove any requirement for corrective action by the borrower. They asserted that this change was necessary since an institution cannot amend the borrower's contractual rights in order to bring a loan into conformance with the institution's lending limits. The FCC also suggested that the written plan is unnecessary because it will simply state that the loan will be retired in an orderly fashion in accordance with the loan contract.

The FCA continues to believe that a written plan to resolve lending limit violations is necessary. The plan should serve as the institution's vehicle to resolve the violation and should be used by the board and management to monitor both the level of loans in excess of the lending limit and the length of time such loans remain on its books. However, the FCA agrees with the commentors that the borrower has no control over the institution's lending limit and should not be obligated in the plan to an accelerated repayment schedule. The final regulations have been modified by deleting the requirements for corrective action by the borrower.

The FCA notes that there are options other than retiring a loan according to the loan contract that can cure a lending limit violation. For instance, where undisbursed commitments are consistently held in excess of a borrower's peak credit requirements the need for such excess commitments should be reviewed in terms of the loan's conformance with the institution's legal lending limits. In addition, if an institution has a loan which exceeds the lending limits, it is in the institution's best interest to try to participate the loan or commitment, particularly if it anticipates a request for additional credit from the borrower or a decline in capital.

The FCA is aware that the business environment in which FCS borrowers operate is changing, and such changes may impact the ability of FCS institutions to provide their borrowers with continuing credit. Therefore, 614.4359(b)(3) of the final regulation includes an exception to the lending limit violations which addresses those instances where a merger or acquisition of a corporate borrower results in a combined lending relationship in excess of the legal lending limits. Where one borrower merges with, or the borrower's operations are acquired by, another borrower and the resulting consolidation of debt results in a total indebtedness in excess of the lending limit prior to a loan maturity or renewal, then the institution can renew or extend the maturity of a loan for a period of not more than 1 year from the date of the merger. During this waiver period, the institution may advance and/or re-advance funds under the same terms, conditions, and amounts as previously existed prior to the merger or acquisition. At the end of the maximum 1-year waiver, any remaining balances and undisbursed commitments in excess of the applicable lending limit will be considered lending limit violations.

7. Monthly Reporting Requirement

The reproposed regulations required lending limits to be calculated on a monthly basis. The FCC and several FCS institutions asked for additional clarification on this requirement. They expressed concern that participations would need to be adjusted monthly as loan balances and lending limits fluctuate, necessitating a new independent credit judgment. They urged that adjustments to the lending limit be calculated on a quarterly or semiannual basis.

The FCA continues to believe that lending limits should be calculated on a monthly basis as of the preceding month end. Institutions currently prepare monthly financial statements, therefore, this requirement should not be burdensome. If participations are shared on a last-in-first-out basis, then balances will be required to be adjusted as lending limits fluctuate. The loan purchase and sale regulations, 614.4325(e), require an independent credit judgment be made prior to the purchase of the participation interest and prior to each servicing action that changes the terms of the contract under which the asset was purchased. The agreement or contract between the participating institutions must state the amount each institution is willing to lend. Therefore, a shift in balances among participating institutions would not constitute a servicing action which changes the terms and conditions and a new credit judgment would not be necessary every month.

8. Lending Limit Percentage

The reproposed regulations lowered the lending limit for all direct lender associations to 20 percent of capital. All banks, except the BCs, remained at the existing 20-percent level. Lending limits for BCs continued to vary according to the type of loan, with 25 percent for term debt, 35 percent for seasonal debt, and an overall limit of 35 percent of capital in most circumstances. Numerous comments were received from FCS institutions concerning the reproposed lending limit. Three FCBs fully supported the reproposed lending limit. One of the FCBs commented that they would strongly oppose lending limits in excess of the 20-percent level. This commentor stated that the limitation of risk concentration is an essential component in assuring safety and soundness of the System as a whole, as well as for individual institutions. Another FCB commented that the 20-percent lending limit is sound and quite appropriate, but only when considered in concert with a reasonable definition of loans, rules of attribution, and the permanent capital standards. The ABA supported the adoption of the reproposed regulations in the interest of competitive equality.

One FCB encouraged the FCA to re-examine whether the same lending limit is appropriate for both associations and banks. The FCB urged the FCA to adopt lending limits of 20 percent for associations, an overall limit of 35 percent for FCBs, with term or real estate loans not to exceed 25 percent. They asserted that such limits for FCBs would be comparable to the limits applicable to the BCs. Since the FCB's role has moved toward that of participant and pooler, the FCB believed that a 35-percent limit would be large enough to avoid unnecessary participations with other districts or lenders outside the System. The FCB also asserted that the higher 35-percent limit would provide all banks, including BCs, more equal treatment. One FCB suggested that each bank be authorized to establish a lending limit up to 50 percent for its affiliated associations. Another FCB suggested a limit of no less than 35 percent, stating that the 20-percent limit would be overly restrictive, and result in a loss of income to originating institutions as well as a loss of an appreciable share of the market. This FCB also felt exceptions could be incorporated into the limits, including exceptions based on the quality and quantity of collateral.

Several associations commented that the reproposed limit of 20 percent was overly restrictive and would reduce their ability to carry larger loans and thereby decrease earnings. One association requested that the FCA incorporate certain exceptions to the lending limit. It claimed that State banks, who are their primary competitors, have a limit of 20 percent and are allowed exceptions similar to those provided to national banks. The association suggested a 40-percent lending limit. A federation established [*40318] to represent the PCAs in Texas urged the FCA to adopt a lending limit of no less than 35 percent. They asserted that the incorporation of certain exceptions to the lending limit would not be difficult to apply. The federation expressed concerns that the lower lending limit would increase participations. They claimed that as a number of institutions make independent credit decisions, credit service would be unacceptably delayed to borrowers whose loans exceed the lower lending limits.

The FCA has carefully considered the comments claiming that the reproposed lending limit would competitively disadvantage FCS institutions when compared to the lending limits for national and State banks. A review of lending limit regulations for State banks indicates that the lending limits for State banks vary widely. Many States closely align their regulations to those governing national banks, limiting loans to 15 percent of capital. Regulations of both national and State banks typically incorporate some exceptions into their lending limits, which increase the limits for many types of loans. However, a loan must be fully secured before any of the exceptions can be applied. Therefore, while the general limitation for national banks and some State banks is 15 percent of capital, an institution may lend a greater percentage of capital for certain types of fully collateralized loans.

In addition, the FCA reviewed the specific lending limits established by other Federal regulatory agencies such as the Office of the Comptroller of the Currency (OCC). The OCC's base lending limit is 15 percent with various exceptions provided. For instance, the OCC provides that loans that are fully secured by either short-term assets or real estate and/or are for the purpose of financing livestock operations are subject to a 25-percent lending limit. In comparison, a large majority of the loans financed by the FCS institutions would fall within the 25-percent lending limit used by the OCC.

Based on the comments received, an analysis of the lending limits of other regulators, and the results of an internal study completed on a representative sample of direct lender associations, the FCA believes that 25 percent of capital lending limit is the most appropriate. This lending limit will be applicable for all banks and direct lender associations operating under title I or title II authorities of the Act, respectively. In establishing the lending limit, the FCA has balanced the agency's safety and soundness concerns with the institutions' concerns of being able to service the credit needs of creditworthy, eligible borrowers.

FCA believes that a 25-percent lending limit will address the FCA's concerns of single credit concentrations and yet not impose a significant burden on any specific bank or district structure. In addition, due to the grandfathering provision of the final regulations, no existing loan would be forced to leave the System or be participated.

However, future loan structures may require further evaluation in light of the new limits. While a few individual associations may need to participate a portion of some of their loans to other institutions in the future, there is every reason to believe this can be done with minimum negative effects. Through the expanded loan participation authorities adopted by the FCA on September 10, 1992, no loans would be forced outside of the Farm Credit System solely on the basis of the final regulations. The association also has the opportunity to replace such participated loans with other loan interests purchased through participations from other FCS institutions. The 25-percent limit for the banks would allow the association's funding bank to fully carry any participation of existing loans resulting from these regulations.

The FCA considered the request of some FCBs to have lending limits that were at 35 or 50 percent in order to be comparable with the BCs. Because the FCBs direct lending authority is limited to long-term loans, the 25-percent limit in the final regulation is in fact comparable to the BCs 25-percent limit for long-term loans, as well as the limits for commercial banks. Finally, a 25-percent lending limit would place all institutions in the System, with the exception of BC seasonal loans, on a level playing field.

Exceptions are granted in 614.4357 of the final regulations for government-guaranteed loans and loans fully secured by obligations fully guaranteed by the United States government. These loans were not exempt from lending limits under existing regulations.

FCA considered, but did not adopt exceptions based on the type and quantity of collateral supporting the loan. FCA concluded that such exceptions would be difficult and time-consuming to apply and administer while providing very little real advantage to FCS borrowers. For example, allowing exceptions based on collateral could disadvantage some institutions that do not extend loans secured by accepted collateral. Furthermore, the FCA does not wish to encourage institutions to place undue reliance upon collateral as a basis for extending credit above the 25-percent lending limit.

The FCA does not agree with the commentors that participations will prove onerous, disrupt credit service, and decrease earnings. In many cases, the borrower will not even be aware that the institution has participated the loan. While an institution might need to sell a portion of a loan that exceeds the lending limit, it can also buy loans from other FCS institutions to compensate for lost volume.

One FCB argued for a 5-year phase-in of the lending limits to allow institutions time to build capital. It maintained that immediate compliance with the lower lending limits would disadvantage its affiliated associations, forcing them to participate loans of their larger customers, thereby decreasing income. Another FCB and an association also supported a gradual implementation of the reduction in lending limits to 25 percent over a 5-year period. The FCB argued that the reduction in direct lender association lending limits would have a major detrimental impact on operations and earnings and hinder the associations' ability to service large customers.

The FCA does not believe that it is necessary or in the best interest of the System to phase-in the lending limits. The reproposed regulations were published in the Federal Register on January 23, 1991, putting institutions on notice of an intended change to the lending limits. In fact, several districts have used the time since publication to lower lending limits in anticipation of publication of the final lending limit regulations. The final regulations specifically address the institutions' concerns regarding immediate implementation of the lending limits through the transition criteria. In addition, the effective date of the lending limit regulations has been delayed until January 1, 1994, to provide institutions ample time to conform to the new regulations.

Two FCBs commented that single credit concentrations are safety and soundness issues that should be controlled by the FCA through its examination, supervision, and enforcement actions rather than through the regulatory establishment of lending limits. One association maintained that risk could be controlled through the association's lending agreement with the FCB. The association also believed that dynamic credit administration and proper management of loans would provide more risk protection than the regulation of loan size. Another association believed that the existing 50-percent [*40319] limit should remain in place and that the FCB should oversee the size of an association's loans. It stated that restricting loan size would result in significant earnings reduction, which would negatively impact the financial position of the institution more than the increased risk from large loans. Another association recommended that each FCB establish an association's lending limit based on demonstrated performance and quality of the association's loan portfolio.

The FCA believes that the safety and soundness of FCS institutions are maintained, not controlled, through examination and supervision. Enforcement actions are taken to implement corrective action in situations where safety and soundness have been jeopardized. The examination and supervision of institutions are retroactive, allowing corrective action only after the credit has been extended. In setting these lending limits, the FCA is attempting to reduce "single borrower" concentration risk to the financial position of an institution resulting from losses on loans disproportionate to their capital base before that risk is reflected on the institution's balance sheet. In addition, FCBs are encouraged to establish in-house lending limits which are less than the regulatory limit. Such in-house limits should be addressed as part of the bank/association lending relationship controlled by the terms and conditions of the general financing agreement.

FCA notes that these lending limits only address single borrower risks and are not intended to address the risks associated with industry concentrations, faulty credit administration, poor management practices, poor accounting practices, etc. While the regulations do not impose lending limits based on industry concentrations or direct loans to associations the institutions are encouraged to address such risk factors. Generally such risks can be addressed within the institution's capital requirements and the general allowance for loan loss allocations.

Comments were received from the FCC, an FCB, and several associations on the lending limits in relation to the permanent capital requirements. Commentors noted that permanent capital standards were issued when the lending limits were much higher. The FCA's justification for the level of permanent capital was the risk involved in single-industry lending. The commentors claimed that the FCA has not adequately explained why safety and soundness concerns dictate lower lending limits when minimum permanent capital standards are higher than those established for other federally regulated financial institutions.

The FCA wanted to allow time to implement the final capital adequacy regulations and to review the restructuring of institutions before making changes to the lending limits. The lending limits regulations originally proposed setting lending limits at the level applicable to the individual banks or associations prior to the mergers required or allowed by the 1987 Act. The reproposed regulations addressed the FCA's concerns with the level of risk associated with the existing lending limits and the problems that have arisen in the past due to such single borrower concentrations. The reproposed regulations were designed to address the lending limits after many institutions had completed mergers and capital between the banks and associations had been adjusted. The capital regulations were designed to address the institutions' overall financial strength and their ability to safely fund and manage their loan portfolios. As stated earlier, it is expected that the institutions will address issues such as general portfolio risks and industry concentrations through means such as their capital plans and allowance requirements. The lending limits are intended to address single borrower loan concentrations and limit the risk to an institution's capital associated with potential losses incurred by these large loans. After reviewing the comments and completing the associated impact studies, the FCA believes that the lending limits in the final regulations are appropriate for FCS institutions and adequately take into consideration all of the safety and soundness concerns of the agency.

B. Section-by-Section Discussion of Changes

1. Section 614.4350-Definitions

This section of the reproposed regulations contained the definitions used throughout subpart J. The final regulations have clarified several of the definitions, and moved the definition of "control" to the attribution rules contained in 614.4358. The definition of "commitment" has been expanded to clarify when a commitment becomes effective. The term "capital" has been deleted from the definition section and has been replaced by a discussion of the computation of the "lending limit base" contained in 614.4351. The identification of when an institution makes a loan has been broadened under the definition of "loan" to include when it enters into a commitment to lend.

2. Section 614.4351-Computation of Lending Limit Base

This section of the reproposed regulations contained the lending limits for all banks, except BCs. The lending limits for banks are now contained in 614.4352. Under the final regulations, 614.4351 contains the adjustments and eliminations required to be made to permanent capital (as defined in 615.5201(h) of this chapter) for purposes of computing an institution's lending limit base. Under the reproposed regulations, the definition of "capital" required eliminations and adjustments according to 615.5210(d)(1) through (d)(4) of this chapter. Section 614.4351 has been revised so that the investment resulting from loan participations is deducted from the purchasing institution's capital to determine its lending limit base, which is the same as required by existing lending limit regulations for BCs.

3. Section 614.4352-Farm Credit Banks and Agricultural Credit Banks

Under the reproposed regulations this section applied to direct lender associations. In the final regulations, this section sets forth the lending limit for FCBs and agricultural credit banks (ACBs) which is increased from the 20 percent contained in the reproposed regulations to 25 percent in the final regulations for the FCBs and for ACB loans made under the authority of title I of the Act. For ACBs making loans under the authority of title III of the Act the lending limits governing BCs as described in 614.4355, would apply.

4. Section 614.4353-Direct Lender Associations

Section 614.4353 of the reproposed regulations addressed the endorsement liability limit of Federal land bank associations (FLBAs). Under the final regulations, 614.4353 has been renumbered to 614.4354. Section 614.4353 of the final regulations addresses the lending limit for all direct lender associations, which includes PCAs.

5. Section 614.4354-Federal Land Bank Associations

Section 614.4354 of the reproposed regulations detailed the lending limits applicable to BCs. Under the final regulations, most of this section has been renumbered to 614.4355, while 614.4354(a)(2) of the existing regulation has been renumbered as 614.4356. Under the final regulations, 614.4354 addresses the endorsement liability of FLBAs. [*40320]

6. Section 614.4355-Banks for Cooperatives

Section 614.4355 under the final regulations sets forth the lending limits for the BCs. The reproposed and final regulations amend the existing regulations for the BCs, 614.4354(a), by requiring lending limits to be calculated on a monthly basis, instead of semiannually. The final regulations do not change the BC lending limits contained in paragraph (a)(1) of the existing regulations and redesignate paragraph (a)(2) as 614.4356 in the final regulations.

The attribution rules in 614.4358 of the final regulations continue to exempt loans satisfying the criteria of existing 614.4354(a)(2). Section 614.4354(a)(3) has been removed because it is no longer necessary to compute the total BCs' lending limit base under the final regulations. In addition, 614.4354(a)(4) is removed. Paragraph (b) of 614.4354 has been removed as the final regulations do not contain a requirement for a systemwide BC lending limit. The FCA believes this requirement is not necessary since the lending limit percentages applied to CoBank are nearly as large as the percentages applied to the combined net worth of the previous 13 individual BCs.

Paragraph (c) of 614.4354, relating to the Central Bank for Cooperatives, has been removed because it is no longer appropriate. The lending limits contained in 614.4355(a)(1) of the final regulations are applicable to all BCs. Paragraph (d) of 614.4354 has also been removed. The content of this paragraph is addressed in the final regulations in 614.4351 relating to the computation of the lending limit base. Paragraph (e) of 614.4354 has been removed since the manner in which "one borrower" is determined is set forth in 614.4358 in the final regulations relating to rules of attribution. Paragraph (f) of 614.4354 has been removed in the final regulations.

7. Section 614.4356-Banks for Cooperatives Look-Through Notes

Section 614.4356 is a new section of the final regulations which incorporates the provisions of the existing 614.4354(a)(2).

8. Section 614.4357-Computation of Obligations

Section 614.4357 of the final and reproposed regulations relates to the computation of obligations, parts of which were contained in 614.4360 of the existing regulations. Section 614.4357 has been expanded and details what loans must be included in a borrower's total loans outstanding and what loans may be excluded. The exclusion for loans guaranteed by a FCS institution, contained in existing regulations 614.4360(c), continues to apply and is set forth in the final regulations in 614.4357(b)(2).

Paragraph (a) of 614.4360 of the existing regulations, relating to participation loans, is addressed in the final regulations in paragraph (a)(2) of 614.4357. The final regulations provide that loans sold with recourse must still be included in a borrower's total indebtedness. Section 614.4357(a)(1) of the final regulations has expanded the computation of borrower indebtedness to include the total amount of outstanding commitments in addition to the total unpaid principal balance, contained in 614.4360(b) of existing regulations. The exemption from the indebtedness computation in paragraph (b) of existing 614.4360 is no longer applicable.

9. Section 614.4358-Attribution Rules

The rules of attribution are contained in 614.4358 in both the reproposed regulations and the final regulations. However, the contents of the reproposed regulations set forth in 614.4358(a)(1) through (a)(5) were reorganized and clarified in 614.4358(a)(1) through (a)(3) of the final regulations. Section 614.4358(a)(1) of the reproposed regulations remains unchanged except for some minor clarification. Section 614.4358(a)(2) through (a)(4) of the reproposed regulations was modified in response to comments received and was combined under 614.4358(a)(2) of the final regulations. Section 614.4358(a)(5) of the reproposed regulations was expanded in the final regulations to clarify the control criteria and to incorporate the definition of "control" previously set forth in 614.4350(d).

In the reproposed regulations, "control" was defined in 614.4350(d)(1) through (d)(4) as exercising a controlling influence on the affairs of another borrower or operating under common control with another borrower. In the final regulations, control criteria are set forth in the attribution rules under 614.4358(a)(3).

10. Section 614.4359-Lending Limit Violations

Section 614.4359 of the reproposed regulations discussed "nonconforming" loans and is not contained in the existing regulations. The final regulations have been revised to reduce their complexity and simplify their application. As revised, the final regulations recognize that any loan which exceeds the lending limit, except loans on the books on the effective date of these regulations (grandfathered loans), is a violation, but provide exceptions for loans that were originally designated as "nonconforming" in the reproposed regulations. The exceptions include a discussion of those situations where a loan would violate the lending limit because of a lending limit base reduction or as a result of a merger or acquisition. Other changes included deleting the statement under paragraph (c) of the reproposed regulation, concerning the guarantor's inability to pay the guaranteed loan. This statement was considered unnecessary as the guarantor is the United States government. Paragraph (c) of the final regulation deleted the requirement that the borrower correct nonconformance because such a requirement was considered unenforceable.

11. Section 614.4360-Transition Period

Section 614.4360 of the reproposed regulations deals with the transition period for implementing the new lending limits prescribed by the final regulations. Paragraph (a) of the reproposed regulations, which required all loans to be brought into conformance with the new regulations by the earlier of the next maturity date, loan servicing action, or a period not to exceed 18 months, is no longer necessary. Under 614.4360(a) of the final regulation, loans or commitments which exceed the lending limits because of a regulatory change in the lending limits will be grandfathered until the current contract expires. Once the contract expires on such loans and commitments, funds advanced will be considered new loans and must conform with the lending limit rules. The content of paragraph (c) of the reproposed regulations requiring a written plan to bring loans into conformance is included in paragraph (c) of 614.4359 of the final regulations and does not apply to those loans "grandfathered" by 614.4360.

IV. Subpart H-Loan Purchases and Sales

Section 614.4325(g) of the existing loan purchases and sales regulations, addressing exclusions from the lending limits, has been deleted and the language of the existing paragraph has been moved to 614.4357(b)(4), Computation of obligations.

List of Subjects in 12 CFR Part 614

Agriculture, Banks, banking, Foreign trade, Reporting and recordkeeping requirements, Rural areas.

For reasons stated in the preamble, part 614 of chapter VI, title 12 of the [*40321] Code of Federal Regulations is amended as follows:

PART 614-LOAN POLICIES AND OPERATIONS

1. The authority citation for part 614 continues to read as follows:

Authority: Secs. 1.3, 1.5, 1.6, 1.7, 1.9, 1.10, 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, 4.13, 4.13B, 4.14, 4.14A, 4.14C, 4.14D, 4.14E, 4.18, 4.19, 4.36, 4.37, 5.9, 5.10, 5.17, 7.0, 7.2, 7.6, 7.7, 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, 2071, 2073, 2074, 2075, 2091, 2093, 2094, 2096, 2121, 2122, 2124, 2128, 2129, 2131, 2141, 2149, 2183, 2184, 2199, 2201, 2202, 2202a, 2202c, 2202d, 2202e, 2206, 2207, 2219a, 2219b, 2243, 2244, 2252, 2279a, 2279a-2, 2279b, 2279b-1, 2279b-2, 2279f, 2279f-1, 2279aa, 2279aa-5; sec. 413 of Pub. L. 100-233, 101 Stat. 1568, 1639.

Subpart H-Loan Purchases and Sales

614.4325 -- [Amended]

2. Section 614.4325 is amended by removing paragraph (g) and redesignating existing paragraph (h) as new paragraph (g).

3. Subpart J is revised to read as follows:

Subpart J-Lending Limits

Sec.

614.4350 Definitions.

614.4351 Computation of lending limit base.

614.4352 Farm Credit Banks and agricultural credit banks.

614.4353 Direct lender associations.

614.4354 Federal land bank associations.

614.4355 Banks for cooperatives.

614.4356 Banks for cooperatives look-through notes.

614.4357 Computation of obligations.

614.4358 Attribution rules.

614.4359 Lending limit violations.

614.4360 Transition.

Subpart J-Lending Limits

614.4350 -- Definitions.

For purposes of this subpart, the following definitions shall apply:

(a) Borrower means an individual, partnership, joint venture, trust, corporation, or other business entity (except a Farm Credit System association or other financing institution, as defined in 614.4540 of this part) to which an institution has made a loan or a commitment to make a loan either directly or indirectly.

(b) Commitment means a legally binding obligation to extend credit, enter into lease financing, purchase or participate in loans or leases, or pay the obligation of another, which becomes effective at the time such commitment is made.

(c) Loan means any extension of, or commitment to extend, credit authorized under the Act whether it results from direct negotiations between a lender and a borrower or is purchased from or discounted for another lender, including participation interests. The term "loan" includes loans outstanding, obligated but undisbursed commitments, contracts of sale, notes receivable, other similar obligations, guarantees, and lease financing. An institution "makes a loan" when it enters into a commitment to lend, advances new funds, substitutes a different borrower for a borrower who is released, or where any other person's liability is added to the outstanding loan or commitment.

(d) Primary liability means an obligation to repay that is not conditioned upon an unsuccessful prior demand on another party.

(e) Secondary liability means an obligation to repay that only arises after an unsuccessful demand on another party.

614.4351 -- Computation of lending limit base.

(a) Lending limit base. An institution's lending limit base is comprised of the permanent capital of the institution, as defined in 615.5201(h) of this chapter, with the adjustments provided for in 615.5210(d)(1), (d)(2) and (d)(4) of this chapter, and paragraphs (a)(1) and (a)(2) of this section.

(1) Where one institution invests in another institution in order to capitalize a participation interest, the amount of investment in the purchasing institution that is owned by the originating institution shall be deducted from the purchasing institution's capital.

(2) Stock protected under section 4.9A of the Act may be included in permanent capital until January 1, 1998.

(b) Timing of calculation. The lending limit base will be calculated on a monthly basis as of the preceding month end.

614.4352 -- Farm Credit Banks and agricultural credit banks.

(a) Farm Credit Banks. No Farm Credit Bank may make or discount a loan to a borrower, if the consolidated amount of all loans outstanding and undisbursed commitments to that borrower exceed 25 percent of the bank's lending limit base.

(b) Agricultural credit banks. (1) No agricultural credit bank may make or discount a loan to a borrower under the authority of title I of the Act, if the consolidated amount of all loans outstanding and undisbursed commitments to that borrower exceeds 25 percent of the bank's lending limit base.

(2) No agricultural credit bank may make or discount a loan to a borrower under the authority of title III of the Act, if the consolidated amount of all loans outstanding and undisbursed commitments to that borrower exceeds the lending limits prescribed in 614.4355 of this subpart.

614.4353 -- Direct lender associations.

No association may make a loan to a borrower, if the consolidated amount of all loans outstanding and undisbursed commitments to that borrower exceeds 25 percent of the association's lending limit base.

614.4354 -- Federal land bank associations.

No Federal land bank association may assume endorsement liability on any loan if the total amount of the association's endorsement liability on loans outstanding and undisbursed commitments to that borrower would exceed 25 percent of the association's lending limit base.

614.4355 -- Banks for cooperatives.

No bank for cooperatives may make a loan if the consolidated amount of all loans outstanding and undisbursed commitments to that borrower exceeds the following percentages of the lending limit base of the bank:

(a) Basic lending limit. (1) Term loans to eligible cooperatives: 25 percent.

(2) Term loans to foreign and domestic parties: 10 percent.

(3) Lease loans qualifying under 614.4020(a)(3) and applying to the lessee: 25 percent.

(4) Standby letters of credit qualifying under 614.4810: 35 percent.

(5) Guarantees qualifying under 614.4800: 35 percent.

(6) Seasonal loans exclusive of seasonal loans qualifying under 614.4231: 35 percent.

(7) Foreign trade receivables qualifying under 614.4700: 50 percent.

(8) Bankers' acceptances held qualifying under 614.4710 and seasonal loans qualifying under 614.4231: 50 percent.

(9) Export and import letters of credit qualifying under 614.4321: 50 percent.

(b) Total lending limit. (1) The sum of term and seasonal loans exclusive of seasonal loans qualifying under 614.4231: 35 percent.

(2) The sum of paragraphs (a)(1) through (a)(9) of this section: 50 percent.

614.4356 -- Banks for cooperatives look-through notes.

Where a bank for cooperatives makes a loan to an eligible borrower that is [*40322] secured by notes of individuals or business entities, the basic lending limits provided in 614.4355 may be applied to each original notemaker rather than to the loan to the eligible borrower, if:

(a) Each note is current and carries a full recourse endorsement or unconditional guarantee by the borrower;

(b) The bank determines the financial condition, repayment capacity, and other credit factors of the loan to the original maker reasonably justify the credit granted by the endorser; and

(c) The loans are fully supported by documented loan files, which include, at a minimum:

(1) A credit report supporting the bank's finding that the financial condition, repayment capacity, and other factors of the maker of the notes being pledged justify the credit extended by the bank and/or endorser;

(2) A certification by a bank officer designated for that purpose by the loan or executive committee that the financial responsibility of the original notemaker has been evaluated by the loan committee and the bank is relying primarily on each such maker for the payment of the obligation; and

(3) Other credit information normally required of a borrower when making and administering a loan.

614.4357 -- Computation of obligations.

(a) Inclusions. The computation of total loans to each borrower for the purpose of computing their lending limit shall include:

(1) The total unpaid principal of all loans and the total amount of undisbursed commitments except as excluded by paragraph (b) of this section. This amount shall include loans that have been charged off on the books of the institution in whole or in part but have not been collected, except to the extent that such amounts are not legally collectible;

(2) Purchased interests in loans, including participation interests, to the extent of the amount of the purchased interest, including any undisbursed commitment;

(3) Loans attributed to a borrower in accordance with 614.4358.

(b) Exclusions. The following loans when adequately documented in the loan file, may be excluded from loans to a borrower subject to the lending limit:

(1) Any loan or portion of a loan that carries a full faith and credit performance guaranty or surety of any department, agency, bureau, board, commission, or establishment of the United States government, provided there is no evidence to suggest that the guaranty has become unenforceable and the institution can demonstrate that it is in compliance with the terms and conditions of the guaranty.

(2) Any loan or portion of a loan guaranteed by a Farm Credit System institution, pursuant to the provisions of 614.4345 on guaranty agreements. This exclusion does not apply to the institution providing the guaranty.

(3) Any loan or portion of a loan that is secured by bonds, notes, certificates of indebtedness, or Treasury bills of the United States or by other obligations guaranteed as to principal and interest by the United States government, provided the loans are fully secured by the current market value of such obligations. If the market value of the collateral declines to below the balance of the loan, and the entire loan, individually, or when combined with other loans and undisbursed commitments to or attributed to the borrower, causes the borrower's total indebtedness to exceed the institution's lending limit, the institution shall have 5 business days to bring the loan into conformance before it shall be deemed to be in violation of the lending limit.

(4) Interests in loans sold, including participation interests, when the sale agreement meets the following requirements:

(i) The interest sold must be an undivided interest in the principal amount of the loan and in the collateral securing the loan; and

(ii) The interest must be sold without recourse; and

(iii) The agreement under which the interest is sold must provide for the sharing of all payments of principal, collection expenses, collateral proceeds, and risk of loss on a pro rata basis according to the percentage interest in the principal amount of the loan. Agreements that provide for the pro rata sharing to commence at the time of default or similar event, as defined in the agreement under which the interest is sold, shall be considered to be pro rata agreements, notwithstanding the fact that advances are made and payments are distributed on a basis other than pro rata prior to that time.

(5) Loans sold in their entirety to a pooler certified by the Federal Agricultural Mortgage Corporation, if an interest in a pool of subordinated participation interests is purchased to satisfy the requirements of title VIII of the Act.

614.4358 -- Attribution rules.

(a) For the purpose of applying the lending limit to the indebtedness of a borrower, loans to a related borrower shall be combined with loans outstanding to the borrower and attributed to the borrower when any one of the following three conditions exist:

(1) Liability. (i) The borrower has primary or secondary liability on a loan made to the related borrower. The amount of such loan attributable to the borrower is limited to the amount of the borrower's liability.

(ii) This section does not require attribution of a guarantee taken out of an abundance of caution. To qualify for the abundance of caution exception to the requirements of this subpart, the institution must document in the loan file that the loan, when evaluated on the credit factors set forth in 614.4160 of this part without considering the guarantee, would support the credit decision under the same basic terms and conditions.

(iii) For the banks for cooperatives and agricultural credit banks operating under title III authorities of the Act, look-through notes are exempt from the lending limit provisions provided they meet the criteria of 614.4356.

(2) Financial interdependence. The operations of a borrower and related borrower are financially interdependent. Financial interdependence exists if the borrower is the primary source of repayment for a related borrower's loan, or if the operations of the borrower and the related borrower are commingled.

(i) The borrower shall be considered the primary source of repayment on the loan to the related borrower if the borrower is obligated to supply 50 percent or more of the related borrower's annual gross receipts, and reliance on the income from one another is such that, regardless of the solvency and liquidity of the borrower's operations, the debt service obligation of the related borrower could not be met if income flow from the borrower is interrupted or terminated. For the purpose of this paragraph, gross receipts include, but are not limited to, revenues, intercompany loans, dividends and capital contributions.

(ii) The assets or operations of the borrower and related borrower are considered to be commingled if they cannot be separated without materially impacting the economic survival of the individual operations and their ability to repay their loans.

(3) Control. The borrower directly or indirectly controls the related borrower. A borrower is deemed to control a related borrower if either paragraph (a)(3)(i) or (a)(3)(ii) of this section exist:

(i) The borrower, directly or acting through one or more other persons, owns 50 percent or more of the stock of the related borrower; or [*40323]

(ii) The borrower, directly or acting through one or more other persons, owns or has the power to vote 25 percent or more of the voting stock of a related borrower, and meets at least one of the following three conditions:

(A) The borrower shares a common directorate or management with a related borrower. A common directorate is deemed to exist when a majority of the directors, trustees, or other persons performing similar functions of one borrower also serves the other borrower in a like capacity. A common management is deemed to exist if any employee of the borrower holds the position of chief executive officer, chief operating officer, chief financial officer, or an equivalent position in the related borrower's organization.

(B) The borrower controls in any manner the election of a majority of directors of a related borrower.

(C) The borrower exercises or has the power to exercise a controlling influence over management of a related borrower's operations through the provisions of management placement or marketing agreements, or providing services such as insurance carrier or bookkeeping.

(b) Each institution shall make provisions for appropriately designating loans to a related borrower that are combined with the borrower's loan and attributed to the borrower to ensure that loans to the borrower are within the lending limits.

(c) Attribution rules table. For the purposes of applying the lending limit to the indebtedness of a borrower, loans to a related borrower shall be combined with loans outstanding to the borrower and attributed to the borrower when any one of three attribution rules are met as outlined in Table 1.
Table 1

Attribute rule
Criteria per Sec. 614.4358
Attribute
(A)Liability...............................................
*to the extent of the borrower's liability...

(B) Financial Interdependence..............
(Economic survival of the borrower's operation will materially impact economic survival of the related borrowers operation).



(C) Control ..............................................
(The borrower, directly or indirectly, controls the related borrower).
Borrower has primary or secondary liability .........................................................
Borrower's liability is taken out of an abundance of caution................................
Look-through notes (BC only) ............................................................................
Source of Repayment:
Borrower is obligated to supply 50 percent or more of related borrower's annual gross receipts, and reliance on the income from one another is such that the debt service of the related borrower could not be met if income flow from the borrower is interrupted or terminated.
Commingled Operations:
Assets or operations of the borrowers are commingled and cannot be separated without materially impacting the borrowers' repayment capacity
The borrower owns 50 percent or more of the stock of the related borrower.........
The borrower owns or has the power to vote 25 percent or more
of the voting stock of a related borrower, and
(1) Shares a common directorate or management with a related borrower, or
(2) Controls the election of a majority of directors of a related borrower, or
(3) Exercises a controlling influence over management of a related borrower's operations through the provisions of management placement or marketing agreements, or providing services such as insurance carrier or bookkeeping
Yes.*
No.*
No.

Yes.



    Yes.

    Yes.
    Yes.

    614.4359 -- Lending limit violations.

    (a) Each loan, except loans that are grandfathered under the provisions of 614.4360, shall be in compliance with the lending limit on the date the loan is made, and at all times thereafter. Except as provided for in paragraph (b) of this section, loans which are in violation of the lending limit shall comply with the provisions of 615.5090 of this chapter.

    (b) Under the following conditions a loan that violates the lending limit shall be exempt from the provisions of 615.5090 of this chapter:

    (1) A loan in which the total amount of principal outstanding and undisbursed commitments exceed the lending limit because of a decline in permanent capital after the loan was made.

    (2) Loans on which funds are advanced pursuant to a commitment that was within the lending limit at the time the commitment was made, even if the lending limit subsequently declines.

    (3) A loan that exceeds the lending limit as a result of the consolidation of the debt of two or more borrowers as a consequence of a merger or the acquisition of one borrower's operations by another borrower. Such a loan may be extended or renewed, for a period not to exceed 1 year from the date of such merger or acquisition, during which period the institution may advance and/or readvance funds not to exceed the greater of:

    (i) 110 percent of the advances to the borrower in the prior calendar year; or

    (ii) 110 percent of the average of the advances to the borrower in the past 3 calendar years.

    (c) For all lending limit violations except those exempted under 614.4359(b)(3), within 90 days of the identification of the violation, the institution must develop a written plan prescribing the specific actions that will be taken by the institution to bring the total amount of loans and commitments outstanding or attributed to that borrower within the new lending limit, and must document the plan in the loan file.

    (d) Nothing in this section limits the authority of the FCA to take administrative action, including, but not limited to, monetary penalties, as a result of lending limit violations.

    614.4360 -- Transition.

    (a) A loan (not including a commitment) made or attributed to a borrower prior to the effective date of this subpart, which does not comply with the limits contained in this subpart, will not be considered a violation of the lending limits during the existing contract terms of such loans. A new loan must conform with the rules set forth in this subpart. A new loan includes but is not limited to:

    (1) Funds advanced in excess of existing commitment;

    (2) A different borrower is substituted for a borrower who is subsequently released; or

    (3) An additional person becomes an obligor on the loan.

    (b) A commitment made prior to the effective date of these regulations which exceeds the lending limit may be funded to the full extent of the legal commitment. Any advances that exceed [*40324] the lending limit are subject to the provisions prescribed in 614.4359.

    Subpart M-Loan Approval Requirements

    614.4470 -- [Amended]

    4. Section 614.4470 is amended by removing the reference " 614.4360(b)" and adding in its place "subpart J of this part" in paragraph (c).

    Subpart Q-Bank for Cooperatives Financing International Trade

    614.4710 -- [Amended]

    5. Section 614.4710 is amended by removing the reference " 614.4350, 614.4354, and 614.4360" and adding in its place "subpart J" in the second sentence of the introductory paragraph; and by removing the reference " 614.4354" and adding " 614.4355" in the introductory paragraph at the second place it appears and in paragraphs (a)(2), (a)(3), and (b)(1).

    Dated: July 20, 1993.

    Curtis M. Anderson,

    Secretary, Farm Credit Administration Board.

    [FR Doc. 93-17917 Filed 7-27-93; 8:45 am]

    BILLING CODE 6705-01-P