FR Doc 04-12998

[Federal Register: June 14, 2004 (Volume 69, Number 113)]
[Proposed Rules]
[Page 32905-32922]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr14jn04-24]

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Proposed Rules
Federal Register
________________________________________________________________________

This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.

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[[Page 32905]]

FARM CREDIT ADMINISTRATION

12 CFR Parts 620, 621, 650, 651, 652, 653, 654, and 655

RIN 3052-AC18

Disclosure to Shareholders; Accounting and Reporting
Requirements; Federal Agricultural Mortgage Corporation General
Provisions; Federal Agricultural Mortgage Corporation Governance;
Federal Agricultural Mortgage Corporation Funding and Fiscal Affairs;
Federal Agricultural Mortgage Corporation Disclosure and Reporting
Requirements

AGENCY: Farm Credit Administration.

ACTION: Proposed rule.

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SUMMARY: The Farm Credit Administration (FCA, our, or we) proposes
regulations governing the Federal Agricultural Mortgage Corporation
(Farmer Mac or the Corporation) in the areas of non-program investments
and liquidity. We are proposing the regulations to ensure that Farmer
Mac holds only high-quality, liquid investments to maintain a
sufficient liquidity reserve, invest surplus funds, and manage
interest-rate risk, while not holding excessive amounts of non-program
investments considering Farmer Mac's status as a Government-sponsored
enterprise.

DATES: Please send comments to the FCA by September 13, 2004.

ADDRESSES: You may send comments by electronic mail to
reg-comm@fca.gov, through the ``Pending Regulations'' section of FCA's Web

site, http://www.fca.gov, or through the Governmentwide www.regulations.gov

portal. You may also send comments to Thomas G. McKenzie, Director,
Office of Secondary Market Oversight, Farm Credit Administration, 1501
Farm Credit Drive, McLean, Virginia 22102-5090 or by facsimile to (703)
734-5784. You may review copies of all comments we receive in our
office in McLean, Virginia.

FOR FURTHER INFORMATION CONTACT: Thomas G. McKenzie, Director, Office
of Secondary Market Oversight, Farm Credit Administration, McLean, VA
22102-5090, (703) 883-4280; TTY (703) 883-4434; or Jennifer A. Cohn,
Senior Attorney, Office of General Counsel, Farm Credit Administration,
McLean, VA 22102-5090, (703) 883-4020, TTY (703) 883-2020.

SUPPLEMENTARY INFORMATION:

I. Objectives

The primary objectives of our proposal are to ensure the safety and
soundness and continuity of Farmer Mac operations by:
Establishing minimum liquidity standards that would
require Farmer Mac to hold sufficient high-quality, marketable
investments to provide adequate liquidity to fund maturing obligations
and operational expenses for a minimum of 60 days;
Specifying the type, quality, and maximum amount (or
limit) of non-program investments \1\ that may be held by Farmer Mac;
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\1\ Pursuant to title VIII of the Farm Credit Act of 1971, as
amended (Act), Farmer Mac issues debt in order to buy (invest in)
``program'' assets under the Corporation's core programs known as
the Farmer Mac I Program and the Farmer Mac II Program. Under these
programs, Farmer Mac purchases, or commits to purchase, ``qualified
loans,'' as that term is defined in section 8.0(9) of the Act.
Generally, ``qualified loans'' consist of loans on agricultural real
estate or portions of loans guaranteed by the United States
Department of Agriculture. Under section 8.0(1) of the Act,
``agricultural real estate'' includes both land used to produce
agricultural commodities or products and single family, moderately-
priced principal residential dwellings located in rural areas. In
this preamble, we refer to loans made on this latter type of real
estate as ``rural housing mortgages.'' We propose to define
investments other than those in (1) ``qualified loans,'' or (2)
securities collateralized by ``qualified loans'' as ``non-program''
investments.
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Establishing diversification requirements, including
portfolio limits on specific types of investments and counterparty
exposure limits; and
Requiring Farmer Mac's board of directors to approve
liquidity and non-program investment management policies and implement
appropriate internal controls to oversee the investment and liquidity
management of the Corporation.
Another objective of this proposal is to better organize current
regulatory sections pertaining to Farmer Mac, details of which are
discussed in section XIV. below.

II. Background

Congress established Farmer Mac in 1988 as part of its effort to
resolve the agricultural crisis of the 1980s. Congress expected that a
secondary market for agricultural and rural housing mortgages would
increase competitively priced mortgage credit to America's farmers,
ranchers, and rural homeowners.
As originally structured, market demand for Farmer Mac services was
low and the Corporation's ability to thrive and develop an active
secondary market for long-term agricultural real estate loans was
challenged. In 1996, statutory changes \2\ by Congress made Farmer
Mac's programs more attractive, but Farmer Mac still had difficulty in
building and maintaining recognition in the secondary market. In early
1997, Farmer Mac adopted a new ``debt issuance strategy'' and
consequently built its non-program investment portfolio to relatively
high levels when compared to program assets. Farmer Mac's rationale for
its debt issuance strategy was to increase its presence in the capital
markets to attract more investors to its debt and mortgage-backed
securities and reduce its borrowing and securitization costs.
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\2\ The Farm Credit System Reform Act of 1996 (Pub. L. 104-105)
amendments authorized Farmer Mac to purchase agricultural real
estate and rural housing mortgages directly, as a pooler, and to
guarantee securities backed by those loans without a 10-percent
``subordinated interest'' or provision for private sector assumption
of first losses.
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Farmer Mac now has about $4.4 billion in assets, which includes
about $1.7 billion in non-program investments. Also, Farmer Mac has
over $4.0 billion in liabilities. (For comparison, 5 years ago
liabilities totaled $1.6 billion, and 10 years ago liabilities totaled
$452 million.) In addition to on-balance assets and liabilities, Farmer
Mac now has in excess of $3.3 billion in off-balance sheet obligations
associated with Long-Term Standby Purchase Commitments (LTSPC)\3\ and
Farmer Mac Guaranteed Securities (FMGS).\4\
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\3\ An LTSPC is a commitment by Farmer Mac to purchase specified
eligible loans on one or more undetermined future dates. In
consideration for Farmer Mac's assumption of the credit risk on the
specified loans underlying an LTSPC, Farmer Mac receives an annual
commitment fee on the outstanding balance of those loans in monthly
installments based on the outstanding balance of those loans.
\4\ Periodically, Farmer Mac transfers agricultural mortgage
loans into trusts that are used as vehicles for the securitization
of the transferred assets and the beneficial interests in the trusts
are sold to third-party investors as FMGS. Farmer Mac guarantees the
timely payment of principal and interest on the certificates issued
by the trusts, regardless of whether the trusts actually receive
scheduled payments on the related underlying loans. As consideration
for Farmer Mac's assumption of the credit risk on these mortgage
pass-through certificates, Farmer Mac receives an annual guarantee
fee that is based upon the outstanding balance of the FMGS.

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[[Page 32906]]

We are proposing these regulations because, as Farmer Mac continues
to grow, its exposure to various business risks, including liquidity
risk, also can be anticipated to grow. In addition, excessive or
inappropriate use of non-program investments is not consistent with the
Corporation's status as a Government-sponsored enterprise (GSE). This
proposal balances safety and soundness concerns with the program focus
of the Corporation.
These proposed regulations do not address Farmer Mac's program
investments. We will continue to monitor those investments for safety
and soundness and other purposes through our examination, and off-site
monitoring activities, of the Corporation.

III. Arrangement of This Proposal

The following preamble material is a section-by-section analysis of
the subsequent proposed rule text. This arrangement allows FCA to
provide additional details or rationale for our proposal. Also, in
section XIV., we discuss how we propose to better organize our rules
pertaining to Farmer Mac.

IV. Section 652.1--Purpose

This proposed section provides the user with a basic understanding
of the contents and purpose of this subpart. We state that the purpose
of this subpart is to ensure safety and soundness, continuity of
funding, and appropriate use of non-program investments considering
Farmer Mac's status as a GSE. It also highlights responsibilities of
Farmer Mac's board of directors and management.

V. Section 652.5--Definitions

This proposed section alphabetically lists words or phrases that
are applicable to this subpart and will help the user more fully
understand the subpart and our requirements. Most of the definitions
are self explanatory, but one definition will benefit from explanation.
The proposed definition of ``Government-sponsored agency'' includes
Government-sponsored enterprises such as Fannie Mae and Farmer Mac, as
well as Federal agencies, such as the Tennessee Valley Authority, that
issue obligations that are not explicitly guaranteed by the Government
of the United States' full faith and credit.

VI. Section 652.10--Investment Management and Requirements

Farmer Mac, like any financial institution, must establish and
follow certain fundamental practices to effectively manage risks in its
investment portfolio. An effective risk management process for
investments requires financial institutions to establish: (1) Policies;
(2) risk limits; (3) a mechanism for identifying, measuring, and
reporting risk exposures; and (4) a strong system of internal controls.
Accordingly, proposed Sec. 652.10 requires Farmer Mac's board of
directors to adopt written policies that establish risk limits and
guide the decisions of investment managers. More specifically, board
policies must establish objective criteria so investment managers can
prudently manage credit, market, liquidity, and operational risks.
Additionally, proposed Sec. 652.10 establishes other controls that are
consistent with sound business practices, such as:
(1) Clear delegation of responsibilities and authorities to
investment managers;
(2) Separation of duties;
(3) Timely and effective security valuation practices; and
(4) Routine reports on investment performance.

A. Responsibilities of the Board of Directors

Proposed Sec. 652.10(a) outlines the basic responsibilities of the
board of directors regarding Farmer Mac's non-program investment
activities. The proposed rule requires the board to adopt written
policies for managing those activities. The board must also ensure that
management complies with the written policies and that appropriate
internal controls are in place to prevent loss. The board, or a
designated subcommittee of the board, must review the Corporation's
investment policies at least annually. Any changes to the policies must
be adopted by the board of directors and reported to FCA within 10 days
of adoption.

B. Investment Policies

Proposed Sec. 652.10(b) requires Farmer Mac's investment policies
to address the purposes and objectives of investments, risk tolerance,
delegations of authority, exception parameters, securities valuation,
internal controls, and reporting requirements. Furthermore, the
policies must address the means for reporting, and approvals needed
for, exceptions to established policies. A general explanation of the
board's investment objectives, expectations, and performance goals is
necessary to guide investment managers. The proposed rule further
requires that the investment policies must be sufficiently detailed,
consistent with, and appropriate for the amounts, types, and risk
characteristics of Farmer Mac's investments.

C. Risk Tolerance

Proposed Sec. 652.10(c) requires Farmer Mac's board of directors
to establish within its investment policies risk limits and
diversification requirements for the various classes of eligible
investments and for the entire investment portfolio. The policies must
ensure that Farmer Mac maintains prudent diversification of its
investment portfolio. Risk limits must be based on Farmer Mac's
objectives, capital position, and risk tolerance capabilities. Risk
tolerance can be expressed through several parameters such as duration,
convexity, sector distribution, yield curve distribution, credit
quality, risk-adjusted return, portfolio size, total return volatility,
or value-at-risk.\5\ Farmer Mac should use a combination of parameters
to appropriately limit its exposure to credit and market risk. Farmer
Mac's policies must identify the types and quantity of investments that
the Corporation will hold to achieve its objectives and control credit,
market, liquidity, and operational risks. Farmer Mac must establish
risk limits for those four types of risk.
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\5\ Generically, duration is a measure of a bond's or
portfolio's price sensitivity to a change in interest rates.
Convexity measures the rate of change in duration with respect to a
change in interest rates. A sector refers to a broad class of
investments with similar characteristics or industry classification.
Yield curve distribution refers to the distribution of the
portfolio's investments in short-, intermediate-, or long-term
investments. Value-at-risk is a methodology used to measure market
risk in an investment portfolio.
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1. Credit Risk
Credit risk generally refers to the risk that an issuer, obligor,
or other counterparty will default on its obligation to pay the
investor under the terms of the security or instrument. Farmer Mac's
investment policies must establish standards for addressing credit
risk.
Credit risk is based on, among other factors, the ability of
counterparties to honor their obligations and commitments. Farmer Mac
should consider appropriate credit risk limits after fully considering
its position with regard to a well-diversified investment portfolio.
Accordingly, proposed Sec. 652.10(c)(1)(i) requires Farmer Mac's

[[Page 32907]]

investment policies to establish credit quality standards, limits on
counterparty risk, and risk diversification standards that limit
concentrations based on a single or related counterparty(ies), a
geographical area, industries, or obligations with similar
characteristics.
The selection of dealers, brokers, and investment bankers
(collectively, securities firms) is an important aspect of effective
management of counterparty credit risk. Proposed Sec. 652.10(c)(1)(ii)
requires Farmer Mac's investment policies to establish criteria for
selecting securities firms. A satisfactory approval process includes a
review of each firm's financial statements and an evaluation of its
ability to honor its commitments, including an inquiry into the general
reputation of the securities firm. Farmer Mac should also review
information from Federal or state securities regulators and industry
self-regulatory organizations, such as the National Association of
Securities Dealers, concerning any formal enforcement actions against
the security firm, its affiliates, or associated personnel.
In addition, to further diversify Farmer Mac's exposure to credit
risk, the proposed rule requires Farmer Mac to buy and sell eligible
investments with more than one securities firm. Moreover, the proposed
rule requires the board of directors or a designated subcommittee of
the board, as part of its annual review of its investment policies, to
review the criteria for selecting securities firms and determine
whether to continue Farmer Mac's existing relationships with them. Any
changes to the criteria or securities firms must be approved by the
board of directors.
Proposed Sec. 652.10(c)(1)(iii) requires Farmer Mac to establish
appropriate collateral margin requirements on repurchase agreements.\6\
The FCA is proposing this requirement because it is prudent, as a means
of managing potential counterparty credit risk, for Farmer Mac to
establish appropriate collateral margin requirements based on the
quality of the collateral and the terms of the agreement. Farmer Mac
must also manage its exposure to loss on repurchase agreements by
regularly marking the collateral to market and ensuring appropriate
controls are maintained over collateral held.
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\6\ In general, whether a given agreement is termed a
``repurchase agreement'' or a ``reverse repurchase agreement''
depends largely on which party initiated the transaction. Market
participants typically view the transaction from the dealer's
perspective. In this preamble and the proposed regulation, the FCA
uses the term ``repurchase agreement'' regardless of the perspective
from which the transaction is viewed.
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2. Market Risk
Market risk is the risk to a financial institution's financial
condition resulting from adverse changes in the value of its holdings
arising from movements in interest rates or prices. From a safety and
soundness perspective, it is crucial for a financial institution's
board and management to fully understand the market risks associated
with investment securities prior to acquisition and on an ongoing
basis. The most significant market risk of investment activities is
interest rate risk. Proposed Sec. 652.10(c)(2) would require Farmer
Mac's board to set market risk limits for specific types of
investments, and for the investment portfolio or for Farmer Mac
generally.
To manage market risk exposure, this proposal would require Farmer
Mac to evaluate how individual instruments and the investment portfolio
as a whole affect the Corporation's overall interest rate risk profile.
We also expect that Farmer Mac would timely monitor the price
sensitivity of its investment portfolio and specify Corporation-wide
interest rate risk limits.
In addition, we believe prudently managed financial institutions
should establish interest rate risk limits on their investment
portfolios and on certain types of securities. Accordingly, risk
parameters should be commensurate with Farmer Mac's ability to measure,
manage, and absorb risk. The board should consider Farmer Mac's level
of capital and earnings and its tolerance for market risk exposure when
setting risk parameters. Farmer Mac must document in its records or
minutes any analyses used in formulating its policy or amendments to
the policy. Market risk limits should be established in a manner that
is consistent with all relevant regulations, policies, and guidance
issued by the FCA.
3. Liquidity Risk
Liquidity risk may exist at both the investment and the
institutional level. At the investment level, liquidity risk is the
risk that Farmer Mac would not be able to sell or liquidate an
investment quickly at a fair price. This inability may be due to
inadequate market depth or market disruption.
At the institutional level, liquidity risk is the risk that Farmer
Mac could encounter a liquidity crisis if it is unable to fund
operations at reasonable rates because access to the capital markets is
impeded. This impediment may result from a market disruption or real or
perceived credit, operational, public policy, or business problems.
FCA expects Farmer Mac to manage liquidity risk at both the
investment and the institutional levels. Accordingly, proposed Sec.
652.10(c)(3) requires Farmer Mac's investment policies to describe the
liquidity characteristics of eligible investments that it will hold to
meet its liquidity needs and institutional objectives. Farmer Mac's
investment policies must also require the Corporation to maintain
sufficient quantities of liquid investments to comply with the
liquidity reserve requirements of Sec. 652.20.
Pursuant to Sec. 652.25, the amount of Farmer Mac's non-program
investments is subject to certain limitations so that its GSE status
and preferred market access privileges are not abused through excessive
amounts of non-program investments. FCA expects Farmer Mac's policies
to strike an appropriate balance among the need for a liquidity
reserve, the management of interest rate risk, and the investment of
surplus funds as it strives to accomplish its institutional objectives
and its public purpose as a GSE.
4. Operational Risk
Operational risk occurs when deficiencies in internal controls or
information systems result in unexpected loss to a financial
institution. Operational risk may arise from inadequate procedures,
human error, information system failure, or fraud. Internal controls
that effectively detect and prevent operating risks are an integral
part of prudent investment management. The ability of management to
accurately assess and control operating risks is frequently one of the
greatest challenges that a financial institution faces with regard to
investment activities. Therefore, proposed Sec. 652.10(c)(4) would
require Farmer Mac's investment policies to address operating risks,
including delegations of authority and internal controls, in accordance
with paragraphs (d) and (e) of Sec. 652.10.
Farmer Mac also may be exposed to other sources of operating risks,
such as legal risk that may result from contracts that are not legally
enforceable. FCA expects Farmer Mac to adequately assess, control, and
minimize operating risks relating to investment activities.
Accordingly, we expect Farmer Mac to clearly define documentation
requirements for securities transactions, retention and safekeeping of
documents, and possession and control of purchased investment
instruments.

[[Page 32908]]

D. Delegation of Authority

Prudent management of investment activities requires an
organizational structure that clearly delineates responsibility and
accountability for all investment management functions, including risk
measurement, and oversight. Accordingly, proposed Sec. 652.10(d)
specifically provides that all delegations of authority to specified
personnel or committees must state the extent of management's authority
and responsibilities for investments. Farmer Mac should periodically
review the Corporation's organizational structure to reveal conflicts
of interest or inadequate checks and balances.

E. Internal Controls

Proposed Sec. 652.10(e) sets forth internal control requirements
for investment management of Farmer Mac. Proposed Sec. 652.10(e)(1)
would require Farmer Mac to establish appropriate internal controls to
detect and prevent loss, fraud, embezzlement, conflicts of interest,
and unauthorized investments.
Proposed Sec. 652.10(e)(2) would require a separation of duties
and supervision between personnel executing investment transactions and
those responsible for approving, revaluating, and overseeing the
investments. Separation of duties promotes integrity, accuracy, and
prudent business practices that reduce the risk of loss. Senior
management must ensure that Farmer Mac's investment practices and risk
exposure are regularly reviewed and evaluated by personnel who are
independent from those responsible for executing investment
transactions. Also, we consider separate and independent valuation of
computer model assumptions and data used by investment managers a
necessary part of these regular reviews.
Proposed Sec. 652.10(e)(3) would require Farmer Mac to maintain
records and management information systems that are appropriate for the
level and complexity of its investment activities. This requirement is
especially important as investment instruments become increasingly
complex and internal controls depend on adequacy and accuracy of
corporate records. Internal quantitative models, computer software, and
management expertise must be adequate and fully integrated to
adequately analyze individual investment instruments, the investment
portfolio, and the effect investments have on Farmer Mac's cashflows,
earnings, and capital.

F. Securities Valuations

Accurate and frequent securities valuation is essential to
measuring risk and monitoring compliance with a financial institution's
objectives and risk parameters. Prudent business practices dictate that
a financial institution must understand the value and price sensitivity
of its investments prior to purchase and on an ongoing basis.
Appropriate securities valuation practices by the financial institution
enable managers to fully understand the risks and cashflow
characteristics of its investments. Farmer Mac should rely on valuation
methodologies that take into account all the risk elements in a
security to determine its price. Proposed Sec. 652.10(f) establishes
the basic requirements for securities valuations by Farmer Mac and
generally requires Farmer Mac to perform an analysis of the credit and
market risks on investments prior to purchase and on an ongoing basis.
The primary objective of this provision is to ensure that management
understands and the board appropriately oversees the risks and cashflow
characteristics of any investment that Farmer Mac purchases.
Managers must have a reasonable and adequate basis for investment
purchases, supported by appropriate analysis, for the Corporation's
investment decisions, and must maintain adequate documentation
regarding the decisions. We believe this is especially relevant to
Farmer Mac given its status as a GSE. We expect the analysis to
describe the basic risk characteristics of the investment and include a
balanced discussion of risks involved in purchasing the investment. In
preparing the analysis, investment managers should consider the current
rate of return or yield, expected total return, and annual income. We
also expect investment managers to consider the degree of uncertainty
associated with the cashflows, and the investment's marketability,
liquidity, credit risk, and market risk. For investments that have
unusual, leveraged, or highly variable cashflows, investment managers
must exercise extraordinary diligence and thoroughness in making
investment decisions. The depth of analyses and documentation of such
decisions must be commensurate with the investment risk.
A fundamental component of sound investment management is the
independent verification of securities prices. Accordingly, proposed
Sec. 652.10(f)(1) requires Farmer Mac, before it purchases a security,
to evaluate its credit quality and price sensitivity to changes in
market interest rates. We also propose to require Farmer Mac to
evaluate and document the size and liquidity of the secondary market
for the security at the time of purchase. In addition, we expect Farmer
Mac to monitor and update this information as market conditions change.
While Farmer Mac must support its credit evaluations by using the most
recent credit rating given to a security by a Nationally Recognized
Statistical Rating Organization (NRSRO) in accordance with the
requirements of Sec. 652.35, the Corporation may not rely exclusively
on NRSRO ratings prior to purchasing investments. An independent and
timely evaluation performed by Farmer Mac is needed because there may
be a lag before an adverse event is reflected in the credit rating.
Therefore, Farmer Mac's analysis must indicate whether the security's
risk has changed subsequent to the most recent NRSRO rating.
Proposed Sec. 652.10(f)(1) also requires Farmer Mac to verify the
value of a security that it plans to purchase, other than a new issue,
with a source that is independent of the broker, dealer, counterparty,
or other intermediary to the transaction. Independent verification of
price can be as simple as obtaining a price from an industry-recognized
information provider. Farmer Mac may satisfy this requirement by
independently verifying the price of a security with an online market
reporting service, such as Bloomberg, Telerate, or Reuters. Although
price quotes from information providers are not actual market prices,
they confirm whether the broker's price is reasonable. In the event
that Farmer Mac is unable to obtain a second price quote on a
particular security, a price quote may be obtained on a security with
substantially similar characteristics. However, such an alternative
method increases analysis and documentation requirements and must be
available for independent internal and external evaluators to assess.
In addition, Farmer Mac may use internal valuation models to verify the
reasonableness of prices it pays or receives for securities.
Finally proposed Sec. 652.10(f)(1) requires the board's investment
policies to fully address the extent of the prepurchase analysis that
management needs to perform for various classes of instruments. For
example, Farmer Mac should specifically describe the stress tests in
Sec. 652.40 that must be performed on various types of mortgage
securities.
Proposed Sec. 652.10(f)(2) would require Farmer Mac to determine,
at least monthly, the fair market value of each security in its
portfolio and the fair market value of its investment portfolio as a
whole. We propose this provision to ensure that management and the

[[Page 32909]]

board have the necessary information to assess the performance of
Farmer Mac's investment portfolio. This requirement enables management
to provide accurate and timely reports to the board of directors in
accordance with proposed Sec. 652.10(g) and manage market risks.
In satisfying the above requirements, proposed Sec. 652.10(f)(2)
would also require Farmer Mac to evaluate the credit quality and price
sensitivity to the change in market interest rates of each security in
Farmer Mac's portfolio and its whole investment portfolio. The
substance and form of the evaluations are likely to vary depending on
the type of instrument. Relatively simple or standardized instruments
with readily identifiable risks require significantly less analysis
than more volatile or complex instruments. (Proposed Sec. 652.40
contains specific stress test guidance for evaluating the price
sensitivity of mortgage securities.)
Other eligible investments that have uncertain cashflows as a
result of embedded options (such as call options, caps, or floors) may
require similar analytical techniques to appropriately evaluate the
instruments. For example, prior to investing in asset-backed securities
(ABS), the FCA expects Farmer Mac to conduct or obtain an evaluation of
the collateral (including type, aging of the assets, and the credit
quality of the underlying loans) and an analysis of the securities'
structure and cashflows.
Proposed Sec. 652.10(f)(3) requires Farmer Mac, before it sells a
security, to verify its value with a source that is independent of the
broker, dealer, counterparty, or other intermediary to the transaction.
We reiterate, independent verification of price can be as simple as
obtaining a price from an industry-recognized information provider,
which will verify whether the broker's price is reasonable. In the
event that Farmer Mac is unable to obtain a second price quote on a
particular security, a price quote may be obtained on a security with
substantially similar characteristics as explained and qualified above
so long as the analysis is adequately documented and appropriately
supports the security's value.

G. Reports to the Board of Directors

Adequate reporting will help ensure the Farmer Mac board properly
carries out its fiduciary responsibilities and provides an essential
element of internal controls. Management reports must communicate
effectively to the board the nature of the risks inherent in Farmer
Mac's investment activities. Reporting should occur frequently so that
the board has timely, accurate, and sufficient information in order to
adequately oversee changes in the investment portfolio and Farmer Mac's
risk profile.
Proposed Sec. 652.10(g) requires management, at least quarterly,
to report to the board, or a designated subcommittee of the board, on
the performance and risk of each class of investments and the entire
investment portfolio. The report must identify all gains and losses
that Farmer Mac incurs during the quarter on individual securities it
sells before maturity and why such securities were liquidated. Reports
also must identify potential risk exposure to changes in market
interest rates and any other factors (such as credit deterioration)
that may affect the value of Farmer Mac's investment holdings. In
addition, the regulation would require management's report to discuss
how Farmer Mac's investments affect its overall financial condition and
to evaluate whether the performance of the investment portfolio
effectively achieves the objectives established by the board of
directors. The report must specifically identify deviations from the
board's policies and seek board approval for any deviations.

VII. Section 652.15--Interest Rate Risk Management and Requirements

Because interest rate risk management is such an important part of
investment management, we propose in Sec. 652.15 certain
responsibilities of Farmer Mac's board of directors and management as
well as policy requirements to address more generally the management of
interest rate risk exposure. The proposed regulations outline our
minimum expectations for the management of interest rate risk exposure.
The potentially adverse effect that interest rate risk may have on
net interest income and the market value of Farmer Mac's equity is of
particular importance. Unless properly measured and managed, interest
rate changes can have significant adverse effects on Farmer Mac's
ability to generate earnings, build net worth, and maintain liquidity.
Proposed Sec. 652.15(a) requires Farmer Mac's board of directors
to be responsible for providing effective oversight (direction,
controls, and supervision) to the interest rate risk management program
and to be knowledgeable of the nature and level of interest rate risk
taken by Farmer Mac.
Proposed Sec. 652.15(b) requires Farmer Mac's management to be
responsible for ensuring that interest rate risk is properly managed on
both a long-range and a day-to-day basis.
Proposed Sec. 652.15(c) requires Farmer Mac's board of directors
to adopt an interest rate risk management policy. At least annually,
the board of directors, or a designated subcommittee of the board, must
review the policy. Any changes to the policy must be approved by the
board and reported to FCA within 10 days of adoption.
Proposed Sec. 652.15(d) requires Farmer Mac's interest rate
management policy, at a minimum, to:
(1) Address the purpose and objectives of interest rate risk
management;
(2) Identify and analyze the causes of interest rate risks within
its existing balance sheet structure;
(3) Require Farmer Mac to measure the potential impact of these
risks on projected earnings and market values by conducting interest
rate shock tests and simulations of multiple economic scenarios at
least quarterly;
(4) Describe and implement actions needed to obtain its desired
risk management objectives;
(5) Document the objectives that Farmer Mac is attempting to
achieve by purchasing eligible investments that are authorized by Sec.
652.35;
(6) Require Farmer Mac to evaluate and document, at least
quarterly, whether these investments have actually met the objectives
stated under paragraph (4) above;
(7) Identify exception parameters and post approvals needed for any
exceptions to the policy's requirements;
(8) Describe delegations of authority; and
(9) Describe reporting requirements, including exceptions to policy
limits.
Proposed Sec. 652.15(e) requires Farmer Mac's management to
report, at least quarterly, to the Corporation's board of directors, or
a designated subcommittee of the board, describing the nature and level
of interest rate risk exposure. It also would require that any
deviations from the board's policy on interest rate risk must be
specifically identified in the report and approved by the board, or
designated subcommittee of the board.

VIII. Liquidity Reserve Management and Requirements

As discussed in section VI., Farmer Mac is subject to liquidity
risk at both the investment and institutional levels. Farmer Mac must
manage risk at both of these levels.
In making this proposal, we recognize Farmer Mac's long-term
liquidity is dependent on its ability to obtain funding from the
securities markets. To

[[Page 32910]]

aid in assuring market access, temporary sources of highly liquid and
low-risk investments are needed in the event of market disruptions or
aberrations. Accordingly, we propose liquidity requirements in Sec.
652.20 that address minimum reserves, policies, periodic and special
reporting requirements, and high quality unencumbered investments as
follows.

A. Minimum Daily Liquidity Reserve Requirement

The minimum daily liquidity reserve requirement in proposed Sec.
652.20(a) will ensure that Farmer Mac has a pool of cash, eligible non-
program investments, and/or securities backed by portions of Farmer Mac
program assets (loans) that are guaranteed by the United States
Department of Agriculture as described in section 8.0(9)(B) of the Act
(subject to certain discounts) to fund its operations for a minimum of
60 days, if its access to the capital markets becomes impeded or
otherwise threatened. The Farmer Mac program assets described above are
held under a program known as the Farmer Mac II Program.
We believe the significance of maintaining an ample supply of
liquid funds for safety and soundness reasons outweigh any burdens
created by the minimum daily liquidity reserve requirement.
This proposed regulation will permit Farmer Mac sufficient time to
make adjustments to the liquidity portfolio and any associated
restructuring of Farmer Mac's maturing debt. We propose that within 24
months of this rule becoming effective, and thereafter, the minimum
daily liquidity reserve requirement will be 60 days.
We seek comment on whether the 60-day minimum daily liquidity
reserve requirement is too much or too little. We also seek comment on
whether it is appropriate to include securities backed by portions of
Farmer Mac program assets (loans) that are guaranteed by the United
States Department of Agriculture (Farmer Mac II program assets) in the
minimum daily liquidity reserve requirement.

B. Free of Lien

At Sec. 652.20(b), we propose that all investments held for the
purpose of meeting the minimum daily liquidity reserve requirement of
this section must be free of liens or other encumbrances.

C. Discounts

We propose to subject some of the investments in the liquidity pool
to certain discounts as they may exhibit somewhat less liquidity in
adverse market conditions. Those investments include money market
instruments, floating and fixed rate debt securities, diversified
investment funds, and securities backed by portions of Farmer Mac
program assets (loans) that are guaranteed by the United States
Department of Agriculture as described in section 8.0(9)(B) of the Act.
Additionally, we reserve the authority to modify or determine the
appropriate discount for any investments used to meet the minimum daily
liquidity reserve requirement. For example, if an adverse credit event
or other adverse event caused an eligible investment to exhibit less
liquidity, we might increase the discount associated with that
investment.

D. Liquidity Reserve Policy

At Sec. 652.20(d), we propose requirements that Farmer Mac's board
must address when setting a liquidity reserve policy. We also propose
that proper internal controls be put in place, and that the board of
directors, or a designated subcommittee of the board, review and
validate the policy's adequacy at least annually. Any changes to the
policy must be approved by the board of directors, and Farmer Mac must
provide a copy of the revised policy to FCA within 10 days of adoption.
At Sec. 652.20(e), we propose the minimum contents of the policy.
The policy must include a statement of the purpose and objectives of
liquidity reserves; a listing of specific assets, debt, and
arrangements that can be used to meet liquidity objectives;
diversification requirements of Farmer Mac's liquidity reserve
portfolio; exception parameters and post approvals needed; delegations
of authority; and reporting requirements.
In addition, we propose the policy establish maturity limits and
credit quality standards for non-program investments used to meet the
minimum daily liquidity reserve requirement of Sec. 652.20(a).
Furthermore, we propose that the policy establish minimum and
target amounts of liquidity. For example, the policy could establish an
internal liquidity minimum such as 75 days (in addition to the 60-day
regulatory minimum), or it could set an optimum liquidity requirement
such as 90 days of liquidity to be met 80 percent of the time (in
addition to the 60-day regulatory minimum reserve requirement).
Finally, we propose the policy include the maximum amount of non-
program investments that can be held for meeting Farmer Mac's liquidity
needs, as expressed as a percentage of program assets and off-balance
sheet obligations.

E. Liquidity Reserve Reporting

To ensure appropriate internal control and accountability, we
propose at Sec. 652.20(f) to require that Farmer Mac's management
report specific information to its board of directors or a designated
subcommittee at least quarterly. The reports would describe liquidity
reserve compliance with policy and other requirements of this section.
Any deviations from the board's liquidity reserve policy must be
specifically identified in the report and approved by the board of
directors.
At Sec. 652.20(g), we propose special reporting requirements for
Farmer Mac. Farmer Mac's management must immediately report to its
board of directors if any violation of board policy requirements at
Sec. 652.20(e) occurs. We believe this will allow sufficient time for
Farmer Mac's board of directors to understand the ramifications of any
breach and take corrective measures to prevent violations of our
minimum daily liquidity reserve requirement as proposed in Sec.
652.20(a). The Farmer Mac board must report to FCA within 3 days of
receiving a report of any noncompliance with board policy requirements
that are specified in Sec. 652.20(e).
Additionally, Farmer Mac must immediately report to the FCA when
the regulatory minimum daily liquidity reserve requirement at Sec.
652.20(a) are breached.

IX. Section 652.25--Non-Program Investment Purposes and Limitations

Proposed Sec. 652.25 lists authorized purposes for Farmer Mac non-
program investments and imposes limitations on those investments. Our
proposal seeks to reasonably relate investments made by Farmer Mac to
its program purpose of establishing a secondary market arrangement for
agricultural and rural housing mortgages. In making this proposal, we
recognize non-program investments provide for a blend of Farmer Mac
needs; most fundamental of these needs is to provide highly liquid
assets to meet immediate funding needs associated with Farmer Mac's
business in agricultural and rural housing mortgages. Farmer Mac also
uses non-program investments in managing interest rate risk and
providing flexibility in responding to fluctuating liquidity and
economic conditions. Any non-program investments not appropriately
related to the above needs warrant specific attention and
justification. We recognize that

[[Page 32911]]

investment fund management and prediction of changes in the market are
very complex and fully support Farmer Mac's ability to respond
appropriately in times of adversity. Therefore, holding adequate levels
of highly liquid assets to meet funding needs during market disruptions
is a fundamental safety and soundness matter. At the same time, Farmer
Mac's powers to make non-program investments cannot result in
inappropriate use of its GSE charter.
At Sec. 652.25(a), we provide that non-program investments are
authorized to comply with interest rate risk and liquidity reserve
requirements and to manage surplus short-term funds.
At Sec. 652.25(b), we propose that non-program investments cannot
exceed the greater of $1.5 billion or the aggregate of the following:
(1) Thirty (30) percent of total assets; and (2) a reasonable estimate
of off-balance sheet loans covered by guarantees or commitments that
Farmer Mac likely will be required to purchase during the upcoming 12-
month period, not to exceed 15 percent of total off-balance sheet
obligations.
In proposing the limitations, we recognized that Farmer Mac's
liquidity needs are unique and considered such issues as off-balance
sheet contingency funding needs and how those needs could fluctuate in
times of sector or geographic adversity. We recognized that Farmer
Mac's need for market presence and penetration is also unique.
Additionally, we considered that in certain circumstances, Farmer Mac
may borrow up to $1.5 billion from the U.S. Treasury to fulfill the
guarantee obligations of the Corporation.
We seek comment on whether the $1.5 billion component or the
aggregation component is too much or too little in relation to our
proposed minimum daily liquidity reserve requirement set forth in Sec.
652.20(a). In addition, should off-balance sheet obligations be
permitted or not be permitted in determining the maximum levels of non-
program investments? Finally, should we consider other issues pertinent
to Farmer Mac's non-program investment needs or practices such as its
``debt issuance strategy''?

X. Section 652.30--Temporary Regulatory Waivers or Modifications for
Extraordinary Situations

Proposed Sec. 652.30 provides that the FCA may waive or modify
restrictions on the size of Farmer Mac's investment portfolio and/or
the liquidity reserve during times of economic stress, financial
stress, or other extraordinary situations. As waivers or modifications
are approved, we may impose certain expirations, plans to return to
compliance, or other limitations. The flexibility of this provision
enables the agency to tailor specific remedies for particular problems
or particular circumstances that might arise.
Examples of extraordinary situations include, but are not
necessarily limited to: (1) Disrupted access to capital markets due to
financial, economic, agricultural, or national defense crises; and (2)
situations specific to Farmer Mac that necessitate modified liquidity
reserves, other investments, or other measures for continued market
access.

XI. Section 652.35--Eligible Non-Program Investments

The proposed rule provides Farmer Mac with a broad array of
eligible high-quality, liquid investments while providing a regulatory
framework that can readily accommodate innovations in financial
products and analytical tools. Similar classes of investments, such as
full faith and credit obligations of Federal and state governments and
short-term money market instruments, are grouped together in a table.
Our proposed rule provides definitions for many of those investments in
Sec. 652.5.
Farmer Mac may purchase and hold the eligible non-program
investments listed in Sec. 652.35 to maintain liquidity reserves,
manage interest rate risk, and invest surplus short-term funds. Only
investments that can be promptly converted into cash without
significant loss are suitable for achieving these objectives. For this
reason, the eligible investments listed in Sec. 652.35 generally have
short terms to maturity and high credit ratings from NRSROs.
Furthermore, all eligible investments are either traded in active and
universally recognized secondary markets or are valuable as collateral.
To enhance safety and soundness, for many of the investments, we
propose that they comprise certain maximum percentages of the total
non-program investment portfolio. We propose these portfolio caps to
limit credit risk exposures, to promote diversification, and to curtail
investments in securities that may exhibit considerable price
volatility, price risk, or liquidity risks. We also propose obligor
limits to help reduce exposure to counterparty risk.

A. Obligations of the United States

We propose to authorize Farmer Mac to invest in Treasuries and
other obligations (except mortgage securities) fully insured or
guaranteed by the United States Government or a Government agency.
Farmer Mac may, for example, hold deposits that are insured by the
Federal Deposit Insurance Corporation or portions of loans that are
guaranteed by the Small Business Administration.

B. Obligations of Government-Sponsored Agencies

We propose to authorize Farmer Mac to invest in Government-
sponsored agency securities (except mortgage securities) and other
obligations (except mortgage securities) fully insured or guaranteed by
Government-sponsored agencies. However, because Farmer Mac is also a
Government-sponsored agency, we believe counterparty exposures should
be limited. Accordingly, we propose that Farmer Mac may not invest more
than 100 percent of its total capital in any single Government-
sponsored agency. This limitation does not apply to Farmer Mac's own
securities (e.g., agricultural mortgage-backed securities issued by
Farmer Mac and retained in its portfolio).

C. Municipal Securities

We propose to authorize investment in the general obligations of
state and municipal governments. We also propose to authorize
investment in revenue bonds of state and municipal governments;
however, we propose to limit revenue bonds to 15 percent or less of the
total investment portfolio.

D. International and Multilateral Development Bank Obligations

We propose to authorize obligations of international and
multilateral development banks, provided the United States is a voting
shareholder. Examples of eligible banks include the International Bank
for Reconstruction and Development (World Bank), Inter-American
Development Bank, and the North American Development Bank. Other highly
rated banks working in concert with the World Bank to promote
development in various countries are also eligible, subject to the
shareholder-voting requirement above.

E. Money Market Instruments

We propose to authorize investments in Federal funds, negotiable
certificates of deposit, bankers acceptances, and prime commercial
paper. These money market instruments have high credit quality and
short maturities and can be sold on active secondary markets prior to
maturity. Therefore, we place no portfolio limits on these investments.
We propose to authorize investments in noncallable term Federal
funds and Eurodollar time deposits. However, we propose to limit these
investments to 20 percent or less of the total investment portfolio and
require maturities of 100 days or less to control concentration risk in
these non-negotiable instruments.

[[Page 32912]]

We propose to authorize investments in Master Notes that have
maturities of 270 days or less, but Master Notes cannot comprise more
than 20 percent of the total investment portfolio.
We propose to authorize investments in repurchase agreements
collateralized by eligible investments or marketable securities rated
in the highest credit rating category by an NRSRO. We propose to
require that repurchase agreements have maturities of 100 days or less.
In addition, if the counterparty defaults, Farmer Mac must divest
itself of noneligible securities as required under proposed Sec.
652.45.

F. Mortgage Securities

We propose to authorize investments in mortgage securities that are
issued or guaranteed by the United States or a Government agency.
Farmer Mac must perform the stress testing described in proposed Sec.
652.40 on these securities.
We propose to authorize investments in mortgage securities issued
by a Government-sponsored agency. Farmer Mac must perform the stress
testing described in proposed Sec. 652.40 on these securities. In
addition, the combined amount of the securities cannot comprise more
than 50 percent of Farmer Mac's total investment portfolio. We propose
to authorize investments in non-Government agency or Government-
sponsored agency securities that comply with 15 U.S.C. 77(d)5 or 15
U.S.C. 78c(a)(41). Farmer Mac must perform the stress testing described
in proposed Sec. 652.40 on these securities. In addition, the
securities must maintain the highest credit rating by an NRSRO. These
types of mortgage securities are typically issued by private sector
entities and are mostly comprised of securities that are collateralized
by ``jumbo'' mortgages with principal amounts that exceed the maximum
limits of Fannie Mae or Freddie Mac programs.\7\ The securities must
meet: (1) The requirements of 15 U.S.C. 77d(5) that pertain to mortgage
securities that are offered and sold pursuant to section 4(5) of the
Securities Act of 1933; or (2) the requirements of 15 U.S.C. 78c(a)(41)
that pertain to residential mortgage-related securities within the
meaning of section 3(a)(41) of the Securities Exchange Act of 1934.
Generally speaking, this means the securities are secured by a first
lien on a single parcel of real estate (residential or mixed
residential and commercial properties) and originated by a qualifying
financial institution. Additionally, we propose to require that these
securities comprise 15 percent or less of Farmer Mac's total investment
portfolio because they are not explicitly or implicitly guaranteed by
the United States, typically require credit enhancements to receive a
high NRSRO credit rating, and are dependent upon a myriad of factors
(collateral, terms, and originators) to achieve satisfactory credit
quality and liquidity.
---------------------------------------------------------------------------

\7\ Other asset classes in the non-Government agency security
class exist, including (1) Housing and Urban Development paper; (2)
high loan-to-value loans; (3) Community Reinvestment Act loans; and
(4) loans to borrowers with conforming loan balances with other
features that prevent agency securitization, such as low
documentation, self-employment, and unique property features.
---------------------------------------------------------------------------

We propose to authorize investment in commercial mortgage-backed
securities (CMBS),\8\ which are collateralized by mortgages on
commercial properties, such as apartment buildings, shopping centers,
office buildings, and hotels. CMBS typically have yield-maintenance
provisions or other features that provide greater prepayment protection
to investors than residential mortgage securities. However, the
structures of CMBS can vary widely and the more unique structures may
contain additional risks that need to be thoroughly evaluated.
Investment managers must fully understand the cashflow characteristics
and price sensitivity of CMBS investments. Nonetheless, with
appropriate safety and soundness controls, CMBS may provide Farmer Mac
with greater investment portfolio diversification. Therefore, we
propose to authorize investments in the securities provided that: (1)
The security has the highest NRSRO credit rating; (2) the security is
backed by a minimum of 100 loans; (3) loans from a single mortgagor
cannot exceed 5 percent of the mortgage security pool; and (4) the
mortgage security pool is geographically diversified and complies with
Farmer Mac board policy. In addition, Farmer Mac must perform the
stress testing described in proposed Sec. 652.40 on these securities.
---------------------------------------------------------------------------

\8\ ``CMBS'' refers only to securities backed by mortgages on
commercial real estate. This term does not cover Fannie Mae mortgage
securities on mixed residential and commercial properties or
mortgage securities on commercial real estate that the Small
Business Administration issues or guarantees.
---------------------------------------------------------------------------

G. Asset-Backed Securities (ABS)

We propose to allow investment in ABS secured by credit card
receivables, automobile loans, home equity loans, wholesale automobile
dealer loans, student loans, equipment loans, and manufactured housing
loans. Under this proposal, securities collateralized by home equity
loans qualify as ABS, not mortgage securities.
Investments in ABS must have the highest NRSRO credit rating and
cannot comprise more than 20 percent of Farmer Mac's total investment
portfolio. Furthermore, if a fixed or floating rate ABS is at its
contractual interest rate cap, it must have a 5-year weighted average
life (WAL),\9\ or less.
---------------------------------------------------------------------------

\9\ Generally, the WAL is the average amount of time required
for each dollar of invested principal to be repaid, based on the
cashflow structure of an ABS and an assumed level of prepayments.
Nearly all ABS are priced and traded on the basis of their WAL, not
their final maturity dates.
---------------------------------------------------------------------------

H. Corporate Debt Securities

We propose to allow investment in corporate debt securities with
maturities up to 5 years and one of the two highest NRSRO credit
ratings. Additionally, the securities cannot be convertible to equity
securities and cannot comprise more than 20 percent of Farmer Mac's
total investment portfolio.

I. Diversified Investment Funds

We propose to authorize investment in shares of any investment
company that is registered under section 8 of the Investment Company
Act of 1940, 15 U.S.C. 80a-8, as long as the investment company's
portfolio consists solely of investments that are authorized by Sec.
652.40. Prior to investing in a particular investment company, Farmer
Mac would be required to evaluate the investment company's risk and
return objectives. As part of this evaluation, Farmer Mac should
determine whether the investment company's use of derivatives is
consistent with FCA guidance and Farmer Mac's investment policies. For
instance, we would generally view it an unsafe and unsound practice for
Farmer Mac to invest in an investment company that uses financial
derivatives for speculative purposes rather than as a risk management
tool. Farmer Mac must maintain appropriate documentation on each
investment, including a prospectus and analysis, so its investment and
selection process can be independently and objectively audited and
examined. If Farmer Mac's shares in each investment company comprise 10
percent or less of Farmer Mac's total investment portfolio, no maximum
portfolio limits are triggered. However, if Farmer Mac's shares in a
particular investment company comprise more than 10 percent of Farmer
Mac's total investment portfolio, then the pro rata interest in an
asset class of security in an investment company must be added to the
same asset class of Farmer Mac's other investments to determine
investment portfolio limits. For example, if Farmer Mac has 12 percent
of its total

[[Page 32913]]

investment portfolio (i.e., more than 10 percent) in Diversified
Investment Company Alpha (Alpha), then Farmer Mac would have to
determine the composition of investments in Alpha's portfolio. The pro
rata dollar amount of corporate debt securities (one example of the
many asset classes) in Alpha would have to be added to Farmer Mac's
corporate debt securities, and that combined amount would have to be 20
percent or less of Farmer Mac's total investment portfolio. Again,
corporate debt securities are used only as an example. Any asset class
in Farmer Mac's portfolio with an investment portfolio limit would have
to be computed the same way.

J. Rating of Foreign Countries

We want to ensure that investments from outside the United States
are of minimal risk to Farmer Mac, a GSE. For that reason, at Sec.
652.35(b) we propose that whenever the obligor or issuer of an eligible
investment is located outside the United States, the host country must
maintain the highest sovereign rating for political and economic
stability by an NRSRO.

K. Marketable Investments

Marketability without significant loss is one of the key components
of liquidity. Proposed Sec. 652.40(c) requires that all eligible
investments, except money market instruments, must be readily
marketable. We note that an eligible investment is marketable if Farmer
Mac can sell it promptly at a price that closely reflects its fair
value in an active and universally recognized secondary market. We also
propose to require Farmer Mac to evaluate and document the size and
liquidity of the secondary market for the investment at time of
purchase.

L. Obligor Limits

Previously, we discussed the risks of investment concentrations and
the benefits of a well diversified and high quality investment
portfolio. In proposed Sec. 652.35(d)(1), we prohibit Farmer Mac from
investing more than 20 percent of its total capital in eligible
investments issued by any single entity, issuer, or obligor. However,
the obligor limit would not apply to Government agencies or Government-
sponsored agencies. Instead, we propose that Farmer Mac may not invest
more than 100 percent of its total capital in any one Government-
sponsored agency. There are no obligor limits for Government agencies.
Also, at proposed Sec. 652.35(d)(2), we require Farmer Mac to
count securities that it holds through an investment company towards
the obligor limits of this section unless the investment company's
holdings of the security of any one issuer do not exceed 5 percent of
the investment company's total portfolio.

M. Investments in Preferred Stock of Farm Credit System Institutions
and Other Investments Approved by FCA

With our prior written approval, Farmer Mac may purchase non-
program investments in preferred stock issued by Farm Credit System
(System) institutions and in other non-program investments that are not
expressly authorized by FCA regulations.
Proposed Sec. 652.35(e) requires that Farmer Mac request our
approval to invest in preferred stock issued by System institutions. We
propose this requirement to enhance our oversight of the flow of
capital and investments between System institutions and Farmer Mac.
Farmer Mac presently owns preferred stock in two System
institutions. An increasing number of System institutions are issuing
preferred stock for a variety of valid reasons, including meeting long-
term capital objectives and supporting growth. However, as the safety
and soundness regulator for System banks and associations and Farmer
Mac, we have concerns that continued and expanded preferred stock
investments could potentially reduce the quality of System institution
and Farmer Mac capital. Concentration and systemic risks concerns arise
from Farmer Mac's ability to invest in unlimited amounts of preferred
stock issued by System institutions, and potentially in the future,
vice-versa.\10\
---------------------------------------------------------------------------

\10\ On April 22, 2004, the FCA Board adopted a provision, in
another proposed rule, that would require System institutions to
obtain FCA approval when investing in Farmer Mac preferred stock.
---------------------------------------------------------------------------

As we noted previously, for any investment that does not fit wholly
within one of the investment categories that we describe or provide
for, we reserve the authority to determine an appropriate discount as
the investment is considered in meeting the minimum daily liquidity
reserve requirement of proposed Sec. 652.20(a).
Similar to our rules for Farm Credit banks and associations,
proposed Sec. 652.35(f) requires that Farmer Mac receive FCA approval
for any investments that are not specifically included in this section
as eligible non-program investments.
Farmer Mac's request for FCA approval to invest in the preferred
stock of System institutions or other non-program investments must
explain the risk characteristics of the investment and the purpose and
objective for making the investment.

XII. Stress Tests for Mortgage Securities

A. Overview/Reason for Proposal

For several reasons, stress testing is an essential risk management
practice for Farmer Mac to perform on mortgage securities in its
investment portfolio. Stress testing is essential when the cashflows
from investments or assets of financial institutions change in response
to fluctuations in market interest rates. For example, although credit
risk on highly rated mortgage securities is minimal, mortgage
securities may expose investors to significant interest rate risk.
Since borrowers may prepay their mortgages, investors may not receive
the expected cashflows and returns on these securities. Prepayments on
these securities are affected by the spread between market rates and
the actual interest rates of mortgages in the pool, the path of
interest rates, and the unpaid balances and remaining terms to maturity
on the mortgage collateral. The price behavior of a mortgage security
also depends on whether the security was purchased at a premium or at a
discount.
To better control and manage these factors, we propose that Farmer
Mac employ appropriate analytical techniques and methodologies to
measure and evaluate interest rate risk inherent in mortgage
securities. More specifically, prudent risk management practices
require Farmer Mac to examine the performance of each mortgage security
under a wide array of possible interest rate scenarios.
We propose in Sec. 652.40 to allow Farmer Mac to accomplish this
performance analysis by developing stress tests that measure the price
sensitivity of mortgage instruments over different interest rate/yield
curve scenarios.
The methodology that Farmer Mac uses to analyze mortgage securities
must be appropriate for the complexity of the instrument's structure
and cashflows. Prior to purchase and each quarter thereafter, Farmer
Mac must use stress tests to determine that the risk in the mortgage
securities is within the risk limits of Farmer Mac's board investment
policies. The stress tests must be able to determine at the time of
purchase and each subsequent quarter that the mortgage security does
not expose Farmer Mac's capital or earnings to excessive risks.

[[Page 32914]]

B. Other Considerations and Requirements of Stress Testing

Farmer Mac may consider the effect of a derivative hedge
transaction on the price sensitivity of instruments as part of its
evaluation of whether a particular mortgage security is a suitable
investment.
Under proposed Sec. 652.40(b), we require that Farmer Mac's
management:
(1) Rely on verifiable information to support all its assumptions,
including prepayment and interest rate volatility assumptions.
(2) Document the basis for all assumptions that are used to
evaluate the security and its underlying mortgages.
(3) Document all subsequent changes in Farmer Mac's assumptions.
(4) Report to the Corporation's board of directors in accordance
with Sec. 652.10(g) if at any time after purchase the mortgage
security no longer complies with the requirements of proposed Sec.
652.40.
We believe the proposals under Sec. 652.40 allow Farmer Mac the
latitude to consider a number of relevant factors when evaluating a
mortgage security's suitability while promoting overall safety and
soundness by not exposing Farmer Mac's capital and earnings to
excessive risk.

XIII. Divestiture of Ineligible Non-Program Investments

In Sec. 652.45 we propose that an ineligible non-program
investment or security must be divested within 6 months, unless FCA
approves, in writing, a plan that authorizes the investment or its
divesture over a longer period of time. An acceptable plan generally
requires Farmer Mac to divest of the ineligible investment or security
as quickly as possible without substantial financial loss. We propose
that until the ineligible investment or security is actually divested
of, Farmer Mac's investment manager must report at least quarterly to
Farmer Mac's board of directors and to FCA's Office of Secondary Market
Oversight about the status and performance of the ineligible
instrument, the reason why it remains ineligible, and the investment
manager's progress in divesting of the investment or security.

XIV. Better Organizing Rules That Apply to Farmer Mac

We propose moving some existing regulation sections that pertain
specifically to Farmer Mac to a centralized location in our regulations
so they can be more easily located and used. The following table
provides details of our proposal and shows where this proposed rule
would be located:

Proposed Organization of Farmer Mac Rules
----------------------------------------------------------------------------------------------------------------
Proposed new Proposed new part Proposed new Proposed new Proposed new
part name subpart subpart name sections From
----------------------------------------------------------------------------------------------------------------
650............ Federal ................ Receiver and Sec. Sec. Existing Part 650,
Agricultural Conservator. 650.1-650.80 Subpart C, Sec.
Mortgage Sec. 650.50 to
Corporation--Gene 650.68
ral Provisions.
651............ Federal ................ Conflicts of Sec. Sec. Existing Part 650,
Agricultural Interest. 651.1-651.4 Subpart A, Sec.
Mortgage Sec. 650.1 to
Corporation--Gove 650.4
rnance.
652............ Federal A............... Investment Sec. Sec. Newly proposed in
Agricultural Management. 652.1-652.45 this rule.
Mortgage
Corporation--Fund
ing and Fiscal
Affairs.
652............ Federal B............... Risk-Based Capital Sec. Sec. Existing Part 650,
Agricultural 652.50-652.105 Subpart B, Sec.
Mortgage Sec. 650.20 to
Corporation--Fund 650.31
ing and Fiscal
Affairs.
653............ Reserved.......... ................ .................. ................. ..................
654............ Reserved.......... ................ .................. ................. ..................
655............ Federal A............... Annual Report of Sec. 655.1 Existing Part 620,
Agricultural Condition of the Subpart G, Sec.
Mortgage Federal 620.40
Corporation--Disc Agricultural
losure and Mortgage
Reporting Corporation.
Requirements.
655............ Federal B............... Accounting and Sec. 655.50 Existing Part 621,
Agricultural Reporting Subpart E, Sec.
Mortgage Requirements. 621.20
Corporation--Disc
losure and
Reporting
Requirements.
----------------------------------------------------------------------------------------------------------------

XV. Regulatory Flexibility Act

Farmer Mac has assets and annual income in excess of the amounts
that would qualify it as a small entity. Therefore, Farmer Mac is not a
``small entity'' as defined in the Regulatory Flexibility Act. Pursuant
to section 605(b) of the Regulatory Flexibility Act (5 U.S.C. 601 et
seq.), the FCA hereby certifies that the proposed rule will not have a
significant economic impact on a substantial number of small entities.

List of Subjects

12 CFR Part 620

Accounting, Agriculture, Banks, banking, Reporting and
recordkeeping requirements, Rural areas.

12 CFR Part 621

Accounting, Agriculture, Banks, banking, Penalties, Reporting and
recordkeeping requirements, Rural areas.

12 CFR Part 650

Agriculture, Banks, banking, Conflicts of interest, Rural areas.

12 CFR Part 651

Agriculture, Banks, banking, Conflicts of interest, Rural areas.

12 CFR Part 652

Agriculture, Banks, banking, Rural areas, investments, capital.

12 CFR Part 655

Accounting, Agriculture, Banks, banking, Accounting and reporting
requirements, Disclosure and reporting requirements, Rural areas.

For the reasons stated in the preamble, we propose amending parts
620, 621, and 650 of chapter VI, adding parts 651, 652, and 655 to
chapter VI, and reserving parts 653 and 654 of chapter VI, title 12 of
the Code of Federal Regulations to read as follows:

[[Page 32915]]

PART 655--FEDERAL AGRICULTURAL MORTGAGE CORPORATION DISCLOSURE AND
REPORTING REQUIREMENTS

1. Add the heading for a new part 655 to read as set forth above.
2. Add the authority citation for new part 655 to read as follows:

Authority: Sec. 8.11 of the Farm Credit Act (12 U.S.C. 2279aa-
11).

PART 620--DISCLOSURE TO SHAREHOLDERS

3. The authority citation for part 620 continues to read as
follows:

Authority: Secs. 5.17, 5.19, 8.11 of the Farm Credit Act (12
U.S.C. 2252, 2254, 2279aa-11); sec. 424 of Pub. L. 100-233, 101
Stat. 1568, 1656.

Subpart G--Annual Report of Condition of the Federal Agricultural
Mortgage Corporation

Sec. 620.40 [Redesignated as Sec. 655.1]

4. Redesignate subpart G of part 620, consisting of Sec. 620.40 as
subpart A of new part 655, consisting of Sec. 655.1.

PART 621--ACCOUNTING AND REPORTING REQUIREMENTS

5. The authority citation for part 621 continues to read as
follows:

Authority: Secs. 5.17, 8.11 of the Farm Credit Act (12 U.S.C.
2252, 2279aa-11).

Subpart E--Reports Relating to Securities Activities of the Federal
Agricultural Mortgage Corporation

Sec. 621.20 [Redesignated as Sec. 655.50]

6. Redesignate subpart E of part 620, consisting of Sec. 621.20 as
subpart B of new part 655, consisting of Sec. 655.50.

PART 651--FEDERAL AGRICULTURAL MORTGAGE CORPORATION GOVERNANCE

7. Add the heading for a new part 651 to read as set forth above.
8. The authority citation for new part 651 is added to read as
follows:

Authority: Secs. 4.12, 5.9, 5.17, 8.11, 8.31, 8.32, 8.33, 8.34,
8.35, 8.36, 8.37, 8.41 of the Farm Credit Act (12 U.S.C. 2183, 2243,
2252, 2279aa-11, 2279bb, 2279bb-1, 2279bb-2, 2279bb-3, 2279bb-4,
2279bb-5, 2279bb-6, 2279cc); sec. 514 of Pub. L. 102-552, 106 Stat.
4102; sec. 118 of Pub. L. 104-105, 110 Stat. 168.

9. Add a new part 652 to read as follows:

PART 652--FEDERAL AGRICULTURAL MORTGAGE CORPORATION FUNDING AND
FISCAL AFFAIRS

Subpart A--Investment Management

Sec.
652.1 Purpose.
652.5 Definitions.
652.10 Investment management and requirements.
652.15 Interest rate risk management and requirements.
652.20 Liquidity reserve management and requirements.
652.25 Non-program investment purposes and limitations.
652.30 Temporary regulatory waivers or modifications for
extraordinary situations.
652.35 Eligible non-program investments.
652.40 Stress tests for mortgage securities.
652.45 Divestiture of ineligible non-program investments.

Subpart B--Risk-Based Capital Requirements [Reserved]

Subpart A--Investment Management

Sec. 652.1 Purpose.

This subpart contains the Farm Credit Administration's (FCA) rules
for governing liquidity and non-program investments held by the Federal
Agricultural Mortgage Corporation (Farmer Mac). The purpose of this
subpart is to ensure safety and soundness, continuity of funding, and
appropriate use of non-program investments considering Farmer Mac's
special status as a Government-sponsored enterprise (GSE). The subpart
contains requirements for Farmer Mac's board of directors to adopt
policies covering such areas as investment management, interest rate
risk, and liquidity reserves. The subpart also requires Farmer Mac to
comply with various reporting requirements.

Sec. 652.5 Definitions.

For purposes of this subpart, the following definitions will apply:
Affiliate means any entity established under authority granted to
the Corporation under section 8.3(b)(13) of the Farm Credit Act of
1971, as amended.
Asset-backed securities (ABS) means investment securities that
provide for ownership of a fractional undivided interest or collateral
interests in specific assets of a trust that are sold and traded in the
capital markets. For the purposes of this subpart, ABS exclude mortgage
securities that are defined below.
Eurodollar time deposit means a non-negotiable deposit denominated
in United States dollars and issued by an overseas branch of a United
States bank or by a foreign bank outside the United States.
Farmer Mac, Corporation, you, and your means the Federal
Agricultural Mortgage Corporation and its affiliates.
FCA, our, or we means the Farm Credit Administration.
Final maturity means the last date on which the remaining principal
amount of a security is due and payable (matures) to the registered
owner. It does not mean the call date, the expected average life, the
duration, or the weighted average maturity.
General obligations of a state or political subdivision means:
(1) The full faith and credit obligations of a state, the District
of Columbia, the Commonwealth of Puerto Rico, a territory or possession
of the United States, or a political subdivision thereof that possesses
general powers of taxation, including property taxation; or
(2) An obligation that is unconditionally guaranteed by an obligor
possessing general powers of taxation, including property taxation.
Government agency means an agency or instrumentality of the United
States Government whose obligations are fully and explicitly guaranteed
as to the timely repayment of principal and interest by the full faith
and credit of the United States Government.
Government-sponsored agency means an agency or instrumentality
chartered or established to serve public purposes specified by the
United States Congress but whose obligations are not explicitly
guaranteed by the full faith and credit of the United States
Government.
Liquid investments are assets that can be promptly converted into
cash without significant loss to the investor. A security is liquid if
the spread between its bid price and ask price is narrow and a
reasonable amount can be sold at those prices promptly.
Long-Term Standby Purchase Commitment (LTSPC) is a commitment by
Farmer Mac to purchase specified eligible loans on one or more
undetermined future dates. In consideration for Farmer Mac's assumption
of the credit risk on the specified loans underlying an LTSPC, Farmer
Mac receives an annual commitment fee on the outstanding balance of
those loans in monthly installments based on the outstanding balance of
those loans.

[[Page 32916]]

Market risk means the risk to your financial condition because the
value of your holdings may decline if interest rates or market prices
change. Exposure to market risk is measured by assessing the effect of
changing rates and prices on either the earnings or economic value of
an individual instrument, a portfolio, or the entire Corporation.
Maturing obligations means maturing debt and other obligations that
may be expected, such as buyouts of long-term standby purchase
commitments or repurchases of agricultural mortgage securities.
Mortgage securities means securities that are either:
(1) Pass-through securities or participation certificates that
represent ownership of a fractional undivided interest in a specified
pool of residential (excluding home equity loans), multifamily or
commercial mortgages, or
(2) A multiclass security (including collateralized mortgage
obligations and real estate mortgage investment conduits) that is
backed by a pool of residential, multifamily or commercial real estate
mortgages, pass-through mortgage securities, or other multiclass
mortgage securities.
(3) This definition does not include agricultural mortgage-backed
securities guaranteed by Farmer Mac itself.
Nationally recognized statistical rating organization (NRSRO) means
a rating organization that the Securities and Exchange Commission
recognizes as an NRSRO.
Non-program investments means investments other than those in:
(1) ``Qualified loans'' as defined in section 8.0(9) of the Farm
Credit Act of 1971, as amended; or
(2) Securities collateralized by ``qualified loans.''
Revenue bond means an obligation of a municipal government that
finances a specific project or enterprise, but it is not a full faith
and credit obligation. The obligor pays a portion of the revenue
generated by the project or enterprise to the bondholders.
Total capital means total capital in accordance with generally
accepted accounting principles.
Weighted average life (WAL) means the average time until the
investor receives the principal on a security, weighted by the size of
each principal payment and calculated under specified prepayment
assumptions.

Sec. 652.10 Investment management and requirements.

(a) Investment policies--board responsibilities. Your board of
directors must adopt written policies for managing your non-program
investment activities. Your board must also ensure that management
complies with these policies and that appropriate internal controls are
in place to prevent loss. At least annually, your board, or a
designated subcommittee of the board, must review these investment
policies. Any changes to the policies must be adopted by the board. You
must report any changes to these policies to FCA within 10 days of
adoption.
(b) Investment policies--general requirements. Your investment
policies must address the purposes and objectives of investments, risk
tolerance, delegations of authority, exception parameters, securities
valuation, internal controls, and reporting requirements.
Furthermore, the policies must address the means for reporting, and
approvals needed for, exceptions to established policies. Investment
policies must be sufficiently detailed, consistent with, and
appropriate for the amounts, types, and risk characteristics of your
investments.
(c) Investment policies--risk tolerance. Your investment policies
must establish risk limits and diversification requirements for the
various classes of eligible investments and for the entire investment
portfolio. These policies must ensure that you maintain prudent
diversification of your investment portfolio. Risk limits must be based
on the Corporation's objectives, capital position, and risk tolerance
capabilities. Your policies must identify the types and quantity of
investments that you will hold to achieve your objectives and control
credit, market, liquidity, and operational risks. Your policies must
establish risk limits for the following four types of risk:
(1) Credit risk. Your investment policies must establish:
(i) Credit quality standards, limits on counterparty risk, and risk
diversification standards that limit concentrations based on a single
or related counterparty(ies), a geographical area, industries or
obligations with similar characteristics.
(ii) Criteria for selecting brokers, dealers, and investment
bankers (collectively, securities firms). You must buy and sell
eligible investments with more than one securities firm. As part of
your annual review of your investment policies, your board of
directors, or a designated subcommittee of the board, must review the
criteria for selecting securities firms. Any changes to the criteria
must be approved by the board. Also, as part of your annual review, the
board, or a designated subcommittee of the board, must review existing
relationships with securities firms. Any changes to securities firms
must be approved by the board.
(iii) Collateral margin requirements on repurchase agreements. You
must regularly mark the collateral to market and ensure appropriate
controls are maintained over collateral held.
(2) Market risk. Your investment policies must set market risk
limits for specific types of investments, and for the investment
portfolio or for Farmer Mac generally. Your board of directors must
establish market risk limits in accordance with these regulations
(including, but not limited to, Sec. Sec. 652.15 and 652.40) and our
other policies and guidance. You must evaluate how individual
instruments and the investment portfolio as a whole affect the
Corporation's overall interest rate risk profile. You must document in
the Corporation's records or minutes any analyses used in formulating
your policies or amendments to the policies.
(3) Liquidity risk. Your investment policies must describe the
liquidity characteristics of eligible investments that you will hold to
meet your liquidity needs and the Corporation's objectives.
(4) Operational risk. Investment policies must address operational
risks, including delegations of authority and internal controls in
accordance with paragraphs (d) and (e) of this section.
(d) Delegation of authority. All delegations of authority to
specified personnel or committees must state the extent of management's
authority and responsibilities for investments.
(e) Internal controls. You must:
(1) Establish appropriate internal controls to detect and prevent
loss, fraud, embezzlement, conflicts of interest, and unauthorized
investments.
(2) Establish and maintain a separation of duties and supervision
between personnel who execute investment transactions and personnel who
approve, revaluate, and oversee investments.
(3) Maintain records and management information systems that are
appropriate for the level and complexity of your investment activities.
(f) Securities valuations.
(1) Before you purchase a security, you must evaluate its credit
quality and price sensitivity to changes in market interest rates. You
must also document the size and liquidity of the secondary market for
the security at the time of purchase. In addition, you must also verify
the value of a security that you plan to purchase, other than a new
issue, with a source that is independent of the broker, dealer,
counterparty, or other intermediary to the transaction.

[[Page 32917]]

Your investment policies must fully address the extent of the
prepurchase analysis that management needs to perform for various
classes of instruments. For example, you should specifically describe
the stress tests in Sec. 652.40 that must be performed on various
types of mortgage securities.
(2) At least monthly, you must determine the fair market value of
each security in your portfolio and the fair market value of your whole
investment portfolio. In doing so you must also evaluate the credit
quality and price sensitivity to the change in market interest rates of
each security in your portfolio and your whole investment portfolio.
(3) Before you sell a security, you must verify its value with a
source that is independent of the broker, dealer, counterparty, or
other intermediary to the transaction.
(g) Reports to the board of directors. At least quarterly, Farmer
Mac's management must report to the Corporation's board of directors,
or a designated subcommittee of the board:
(1) On the performance and risk of each class of investments and
the entire investment portfolio;
(2) All gains and losses that you incur during the quarter on
individual securities that you sold before maturity and why they were
liquidated;
(3) Potential risk exposure to changes in market interest rates and
any other factors that may affect the value of your investment
holdings;
(4) How investments affect your overall financial condition;
(5) Whether the performance of the investment portfolio effectively
achieves the board's objectives; and
(6) Any deviations from the board's policies. These deviations must
be formally approved by the board of directors.

Sec. 652.15 Interest rate risk management and requirements.

(a) The board of directors of Farmer Mac must provide effective
oversight (direction, controls, and supervision) to the interest rate
risk management program and must be knowledgeable of the nature and
level of interest rate risk taken by Farmer Mac.
(b) The management of Farmer Mac must ensure that interest rate
risk is properly managed on both a long-range and a day-to-day basis.
(c) The board of directors of Farmer Mac must adopt an interest
rate risk management policy that establishes appropriate interest rate
risk exposure limits based on the Corporation's risk-bearing capacity
and reporting requirements in accordance with paragraphs (b) and (c) of
this section. At least annually, the board of directors, or a
designated subcommittee of the board, must review the policy. Any
changes to the policy must be approved by the board of directors. You
must report any changes to the policy to FCA within 10 days of
adoption.
(d) The interest rate risk management policy must, at a minimum:
(1) Address the purpose and objectives of interest rate risk
management;
(2) Identify and analyze the causes of interest rate risks within
Farmer Mac's existing balance sheet structure;
(3) Require Farmer Mac to measure the potential impact of these
risks on projected earnings and market values by conducting interest
rate shock tests and simulations of multiple economic scenarios at
least quarterly;
(4) Describe and implement actions needed to obtain Farmer Mac's
desired risk management objectives;
(5) Document the objectives that Farmer Mac is attempting to
achieve by purchasing eligible investments that are authorized by Sec.
652.35 of this subpart;
(6) Require Farmer Mac to evaluate and document, at least
quarterly, whether these investments have actually met the objectives
stated under paragraph (d)(4) of this section;
(7) Identify exception parameters and post approvals needed for any
exceptions to the policy's requirements;
(8) Describe delegations of authority; and
(9) Describe reporting requirements, including exceptions to policy
limits.
(e) At least quarterly, Farmer Mac's management must report to the
Corporation's board of directors, or a designated subcommittee of the
board, describing the nature and level of interest rate risk exposure.
Any deviations from the board's policy on interest rate risk must be
specifically identified in the report and approved by the board, or a
designated subcommittee of the board.

Sec. 652.20 Liquidity reserve management and requirements.

(a) Minimum daily liquidity reserve requirement. Within 24 months
of this rule becoming effective, and thereafter, Farmer Mac must hold
cash, eligible non-program investments under Sec. 652.35 of this
subpart, and/or securities backed by portions of Farmer Mac program
assets (loans) that are guaranteed by the United States Department of
Agriculture as described in section 8.0(9)(B) of the Act (in accordance
with the requirements of paragraphs (b) and (c) of this section), to
maintain sufficient daily liquidity to fund a minimum of 60 days of
maturing obligations, interest due, and operating expenses. You must
maintain sufficient documentation to demonstrate that you meet this
minimum liquidity reserve requirement on a daily basis.
(b) Free of lien. All investments held for the purpose of meeting
the liquidity reserve requirement of this section must be free of liens
or other encumbrances.
(c) Discounts. The amount that may be counted to meet the minimum
daily liquidity reserve requirement is as follows:
(1) For cash and overnight investments, multiply the cash and
investments by 100 percent;
(2) For money market instruments and floating rate debt securities,
multiply the instruments and securities by 95 percent of market value;
(3) For diversified investment funds, multiply the individual
securities in the funds by the discounts that would apply to the
securities if held separately;
(4) For fixed rate debt securities, multiply the securities by 90
percent of market value;
(5) For securities backed by portions of Farmer Mac program assets
(loans) guaranteed by the United States Department of Agriculture as
described in section 8.0(9)(B) of the Act, multiply the securities by
50 percent; and
(6) We reserve the authority to modify or determine the appropriate
discount for any investments used to meet the minimum daily liquidity
reserve requirement.
(d) Liquidity reserve policy--board responsibilities. Farmer Mac's
board of directors must adopt a liquidity reserve policy. The board
must also ensure that management uses adequate internal controls to
ensure compliance with the liquidity reserve policy standards,
limitations, and reporting requirements established pursuant to this
paragraph and to paragraphs (e), (f), and (g) of this section. At least
annually, the board of directors or a designated subcommittee of the
board must review and validate the liquidity policy's adequacy. The
board of directors must approve any changes to the policy. You must
provide a copy of the revised policy to FCA within 10 days of adoption.
(e) Liquidity reserve policy--content. Your liquidity reserve
policy must contain at a minimum the following:
(1) The purpose and objectives of liquidity reserves;
(2) A listing of specific assets, debt, and arrangements that can
be used to meet liquidity objectives;
(3) Diversification requirements of your liquidity reserve
portfolio;
(4) Maturity limits and credit quality standards for non-program
investments

[[Page 32918]]

used to meet the minimum daily liquidity reserve requirement of
paragraph (a) of this section;
(5) The minimum and target (or optimum) amounts of liquidity that
the board believes are appropriate for Farmer Mac;
(6) The maximum amount of non-program investments that can be held
for meeting Farmer Mac's liquidity needs, as expressed as a percentage
of program assets and off-balance sheet obligations;
(7) Exception parameters and post approvals needed;
(8) Delegations of authority; and
(9) Reporting requirements.
(f) Liquidity reserve reporting--periodic reporting requirements.
At least quarterly, Farmer Mac's management must report to the
Corporation's board of directors or a designated subcommittee of the
board describing, at a minimum, liquidity reserve compliance with the
Corporation's policy and this section. Any deviations from the board's
liquidity reserve policy (other than requirements specified in Sec.
652.20(e)(5)) must be specifically identified in the report and
approved by the board of directors.
(g) Liquidity reserve reporting--special reporting requirements.
Farmer Mac's management must immediately report to its board of
directors any noncompliance with board policy requirements that are
specified in Sec. 652.20(e)(5). The Farmer Mac board must report to
FCA within 3 days of receiving a report of any noncompliance with board
policy requirements that are specified in Sec. 652.20(e)(5). Farmer
Mac must immediately report to the FCA when the minimum daily liquidity
reserve requirement at Sec. 652.20(a) is breached.

Sec. 652.25 Non-program investment purposes and limitations.

(a) Farmer Mac is authorized to hold eligible non-program
investments listed under Sec. 652.35 for the purposes of complying
with the interest rate risk requirements of Sec. 652.15, complying
with the liquidity reserve requirements of Sec. 652.20, and managing
surplus short-term funds.
(b) Non-program investments cannot exceed the greater of $1.5
billion or the aggregate of the following:
(1) Thirty (30) percent of total assets; and
(2) A reasonable estimate of off-balance sheet loans covered by
guarantees or commitments that Farmer Mac likely will be required to
purchase during the upcoming 12-month period, not to exceed 15 percent
of total off-balance sheet obligations.

Sec. 652.30 Temporary regulatory waivers or modifications for
extraordinary situations.

Whenever the FCA determines that an extraordinary situation exists
that necessitates a temporary regulatory waiver or modification, the
FCA may, in its sole discretion:
(a) Modify or waive the minimum daily liquidity reserve requirement
in Sec. 652.20 of this subpart; and/or
(b) Increase the amount of eligible investments that you are
authorized to hold pursuant to Sec. 652.25 of this subpart.

Sec. 652.35 Eligible non-program investments.

(a) You may hold only the types, quantities, and qualities of non-
program investments listed in the following Non-Program Investment
Eligibility Criteria Table. These investments must be denominated in
United States dollars.
BILLING CODE 6705-01-P

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[[Page 32920]]

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[[Page 32921]]

(b) Rating of foreign countries. Whenever the obligor or issuer of
an eligible investment is located outside the United States, the host
country must maintain the highest sovereign rating for political and
economic stability by an NRSRO.
(c) Marketable investments. All eligible investments, except money
market instruments, must be readily marketable. An eligible investment
is marketable if you can sell it promptly at a price that closely
reflects its fair value in an active and universally recognized
secondary market. You must evaluate and document the size and liquidity
of the secondary market for the investment at time of purchase.
(d) Obligor limits. (1) You may not invest more than 20 percent of
your total capital in eligible investments issued by any single entity,
issuer or obligor. This obligor limit does not apply to Government-
sponsored agencies or Government agencies. You may not invest more than
100 percent of your total capital in any one Government-sponsored
agency. There are no obligor limits for Government agencies.
(2) Obligor limits for your holdings in an investment company. You
must count securities that you hold through an investment company
towards the obligor limits of this section unless the investment
company's holdings of the security of any one issuer do not exceed 5
percent of the investment company's total portfolio.
(e) Preferred stock and other investments approved by the FCA. (1)
You may purchase non-program investments in preferred stock issued by
other Farm Credit System institutions only with our written prior
approval. You may also purchase non-program investments other than
those listed in the Non-Program Investment Eligibility Criteria Table
at paragraph (a) of this section only with our written prior approval.
(2) Your request for our approval must explain the risk
characteristics of the investment and your purpose and objectives for
making the investment.
(3) We reserve the authority to determine an appropriate discount
for any investment that does not fit wholly within one of the
investment categories that we describe or provide for as the investment
is considered in meeting the minimum daily liquidity reserve
requirement of Sec. 652.20(a).

Sec. 652.40 Stress tests for mortgage securities.

(a) You must perform stress tests to determine how interest rate
changes will affect the cashflow and price of each mortgage security
that you purchase and hold, except for adjustable rate mortgage
securities that reprice at intervals of 12 months or less and are tied
to an index. You must also use stress tests to gauge how interest rate
fluctuations on mortgage securities affect your capital and earnings.
The stress tests must be able to measure the price sensitivity of
mortgage instruments over different interest rate/yield curve scenarios
and be consistent with any asset liability management and interest rate
risk policies. The methodology that you use to analyze mortgage
securities must be appropriate for the complexity of the instrument's
structure and cashflows. Prior to purchase and each quarter thereafter,
you must use the stress tests to determine that the risk in the
mortgage securities is within the risk limits of your board's
investment policies. The stress tests must enable you to determine at
the time of purchase and each subsequent quarter that the mortgage
security does not expose your capital or earnings to excessive risks.
(b) You must rely on verifiable information to support all your
assumptions, including prepayment and interest rate volatility
assumptions. You must document the basis for all assumptions that you
use to evaluate the security and its underlying mortgages. You must
also document all subsequent changes in your assumptions. If at any
time after purchase, a mortgage security no longer complies with
requirements in this section, Farmer Mac's management must report to
the Corporation's board of directors in accordance with Sec.
652.10(g).

Sec. 652.45 Divestiture of ineligible non-program investments.

(a) Divestiture requirements. You must divest of an ineligible non-
program investment or security within 6 months unless we approve, in
writing, a plan that authorizes you to divest the instrument over a
longer period of time. An acceptable plan generally would require you
to divest of the ineligible investment or security as quickly as
possible without substantial financial loss.
(b) Reporting requirements. Until you divest of the ineligible non-
program investment or security, the manager of your investment
portfolio must report at least quarterly to your board of directors and
to FCA's Office of Secondary Market Oversight about the status and
performance of the ineligible instrument, the reasons why it remains
ineligible, and the manager's progress in divesting of the investment.

Subpart B--Risk-Based Capital Requirements [Reserved]

PART 650--FEDERAL AGRICULTURAL MORTGAGE CORPORATION GENERAL
PROVISIONS

10. The authority citation for part 650 continues to read as
follows:

Sec. Sec. 650.1 through 650.68 [Redesignated]

12. Redesignate Sec. Sec. 650.1 through 650.68 as follows:

------------------------------------------------------------------------
Old section New section
------------------------------------------------------------------------
650.1, subpart........................... A 651.1.
650.2, subpart A......................... 651.2.
650.3, subpart A......................... 651.3.
650.4, subpart A......................... 651.4.
650.20, subpart B........................ 652.50, subpart B.
650.21, subpart B........................ 652.55, subpart B.
650.22, subpart B........................ 652.60, subpart B.
650.23, subpart B........................ 652.65, subpart B.
650.24, subpart B........................ 652.70, subpart B.
650.25, subpart B........................ 652.75, subpart B.
650.26, subpart B........................ 652.80, subpart B.
650.27, subpart B........................ 652.85, subpart B.

[[Page 32922]]

650.28, subpart B........................ 652.90, subpart B.
650.29, subpart B........................ 652.95, subpart B.
650.30, subpart B........................ 652.100, subpart B.
650.31, subpart B........................ 652.105, subpart B.
Appendix A to Subpart B of Part 650...... Appendix A to Subpart B of
Part 652.
650.50, subpart C........................ 650.1.
650.51, subpart C........................ 650.5.
650.52, subpart C........................ 650.10.
650.55, subpart C........................ 650.15.
650.55, subpart C........................ 650.15.
650.56, subpart C........................ 650.20.
650.57, subpart C........................ 650.25.
650.58, subpart C........................ 650.30.
650.59, subpart C........................ 650.35.
650.60, subpart C........................ 650.40.
650.61, subpart C........................ 650.45.
650.62, subpart C........................ 650.50.
650.63, subpart C........................ 650.55.
650.64, subpart C........................ 650.60.
650.65, subpart C........................ 650.65.
650.66, subpart C........................ 650.70.
650.67, subpart C........................ 650.75.
650.68, subpart C........................ 650.80.
------------------------------------------------------------------------

Subpart A--General Provisions

Sec. 650.75 [Amended]

13. Amend newly designated Sec. 650.75 by removing the reference
``Sec. 620.40'' and adding in its place, the reference ``Sec. 655.1''
in paragraph (c).

PART 653--[ADDED AND RESERVED]

PART 654--[ADDED AND RESERVED]

14. Add and reserve parts 653 and 654.

Dated: May 27, 2004.
Jeanette C. Brinkley,
Secretary, Farm Credit Administration Board.
[FR Doc. 04-12998 Filed 6-10-04; 8:45 am]

BILLING CODE 6705-01-P