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Daily Rules, Proposed Rules, and Notices of the Federal Government

FARM CREDIT ADMINISTRATION

12 CFR Part 652

RIN 3052-AC56

Federal Agricultural Mortgage Corporation Funding and Fiscal Affairs; Farmer Mac Investment Management

AGENCY: Farm Credit Administration.
ACTION: Final rule.
SUMMARY: The Farm Credit Administration (FCA, Agency, us, or we) issues this final rule amending our regulations governing investment management practices of the Federal Agricultural Mortgage Corporation (Farmer Mac or Corporation). This final rule will help ensure that Farmer Mac maintains safe and sound non-program investment management practices in accordance with clearly articulated board-established guidance, streamlines the process for handling investments that fail to meet the eligibility criteria after purchase, and modifies the allowable purposes of Farmer Mac's non-program investments to include investments that would complement Farmer Mac's program activities. We are also finalizing the significant reorganization of these regulations that we proposed to make the regulations easier to follow.
DATES: This regulation will be effective 30 days after publication in theFederal Registerduring which either or both Houses of Congress are in session. We will publish a notice of the effective date in theFederal Register.
FOR FURTHER INFORMATION CONTACT: Joseph T. Connor, Associate Director for Policy and Analysis, Office of Secondary Market Oversight, Farm Credit Administration, McLean, VA 22102-5090, (703) 883-4280, TTY (703) 883-4434; or Jennifer A. Cohn, Senior Counsel, Office of the General Counsel, Farm Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703) 883-4020.
SUPPLEMENTARY INFORMATION: I. Objective

The objective of this final rule is to ensure that Farmer Mac has appropriate Board policies and operational procedures in place to manage its non-program investment portfolio safely and soundly with appropriate consideration of its public mission as a Government-sponsored enterprise (GSE). This final rule will:

• Revise the permissible purposes of non-program investments;

• Revise board policy requirements, including stress-testing requirements;

• Modify the non-program investment portfolio limit;

• Reduce the regulatory burden associated with investments that fail to meet eligibility criteria after purchase; and

• Reorganize the regulations to make them easier to follow.

II. History of Rule

On May 19, 2010, we published an Advanced Notice of Proposed Rulemaking that considered revisions to Farmer Mac's non-program investment and liquidity requirements.1 On November 18, 2011, we published a Notice of Proposed Rulemaking (NPRM) that would have revised these non-program investment and liquidity requirements.2 After considering the comments we received on the NPRM, we now plan to finalize the proposed provisions contained in the NPRM in phases.

175 FR 27951.

276 FR 71798.

This first phase of final regulations will substantively revise the following regulations:

• § 652.10—Investment Management • § 652.15—Non-Program Investment Purposes and Limitation (renumbered from § 652.25) • § 652.25—Management of Ineligible Investments and Reservation of Authority to Require Divestiture (renumbered from § 652.45) • § 652.30—Interest Rate Risk Management (renumbered from § 652.15) • § 652.45—Temporary Regulatory Waivers or Modifications for Extraordinary Situations (renumbered from § 652.30)

These revisions will help ensure that Farmer Mac maintains safe and sound non-program investment management practices in accordance with clearly articulated board-established guidance. They also streamline the process for handling investments that fail to meet the eligibility criteria after purchase and modify the allowable purposes of Farmer Mac's non-program investments to include investments that would complement Farmer Mac's program activities.

We are also making minor technical changes to the following provisions:

• § 652.1—Purpose • § 652.5—Definitions • § 652.20—Eligible Non-Program Investments (renumbered from § 652.35)

In addition, we are deleting existing § 652.40, entitled “Stress Tests forMortgage Securities,” and incorporating its provisions into § 652.10(f).

Lastly, we are finalizing the proposed reorganization of the investment management and liquidity regulations to make the sequence of the issues covered more logical.

We intend to address in one or more future rulemakings regulations covering all the areas of the proposed rule not covered in this final rule, including liquidity management and requirements and investment eligibility (including revised creditworthiness requirements). The regulations that we proposed to revise but that we are not issuing as final at this time (except to renumber them and, in some instances, to make minor technical changes) include:

• § 652.5—Definitions • § 652.20—Eligible Non-Program Investments (renumbered from § 652.35) • § 652.35—Liquidity Reserve Management and Requirements (renumbered from § 652.20) III. Guiding Principle of Rule

The FCA is an independent agency in the executive branch of the Federal Government that serves as the regulator of Farmer Mac, as well as of the other institutions of the Farm Credit System (System) including, in pertinent part, Farm Credit banks and direct lender associations. The FCA regulates Farmer Mac through the Office of Secondary Market Oversight (OSMO). Farmer Mac is a stockholder-owned instrumentality of the United States, chartered by Congress to establish a secondary market for agricultural real estate, rural housing mortgage loans, and rural utilities loans. Farmer Mac also provides a secondary market for USDA-guaranteed farm program and rural development loans.

A guiding principle for FCA in establishing regulations governing Farmer Mac is to maintain an appropriate balance between the Corporation's mission achievement and risk. We aim to ensure continuity of operations so that Farmer Mac can fulfill its mission during stressful economic conditions that may require sufficient access to secondary sources of liquidity. This final rule is intended to provide a high degree of certainty that Farmer Mac will be able to continue to serve its customers under a wide range of market or economic conditions without the need to issue debt to the Department of Treasury or seek any other form of Government financial assistance.3

3Under certain specific adverse circumstances, Farmer Mac is authorized to issue debt to the Department of the Treasury to meet obligations on guarantees.Seesection 8.13 of the Farm Credit Act of 1971, as amended (Act) (12 U.S.C. 2279aa-13).

IV. Discussion of Comments and Section-by-Section Analysis of Rule

We received comment letters from Farmer Mac and from the Farm Credit Council (Council), which, in addition to submitting a comment letter directly responding to the NPRM, also asked us to consider, wherever applicable, comments it had submitted on FCA's similar proposed rule pertaining to System banks and associations.4

4 See76 FR 51289, Aug. 18, 2011.

In addition to its comments on specific proposed regulation provisions, the Council generally encouraged us to adapt this rule to more closely mirror the requirements for System banks and associations. Although the two final rules continue to differ where appropriate, changes were made to both this rule and the System banks and associations rule to make the requirements more similar.5

5In the interests of consistency, the FCA Board adopted the final rule governing the investment management of System banks and associations at the same time it adopted this final rule. That final rule is also published in today's issue of theFederal Register.

We will address each specific comment received in our discussion of the regulation provision to which the comment relates. Some of the minor changes we proposed received no comment. Unless otherwise discussed in this preamble, we are finalizing those provisions as proposed without further explanation. Interested persons are directed to our NPRM for a discussion of those changes. Throughout this regulation, we make minor technical, clarifying, and non-substantive language changes that we do not specifically discuss in this preamble.

A. Reorganization of Rule

We are finalizing the rule's reorganization much the way we proposed it. We provide the following table to orient the reader to the reorganization. The left column of the table contains the existing rule's section headings, and the right column contains the proposed reorganization of section sequence and heading changes.

Existing regulations Final reorganization § 652.1Purpose § 652.1Purpose. § 652.5Definitions § 652.5Definitions. § 652.10Investment management and requirements § 652.10Investment management. § 652.15Interest rate risk management and requirements § 652.15Non-program investment purposes and limitation. § 652.20Liquidity reserve management and requirements § 652.20Eligible non-program investments. § 652.25Non-program investment purposes and limitation § 652.25Management of ineligible investments. § 652.30Temporary regulatory waivers or modifications for extraordinary situations § 652.30Interest rate risk management. § 652.35Eligible non-program investments § 652.35Liquidity reserve management and requirements. § 652.40Stress tests for mortgage securities § 652.40[Reserved]. § 652.45Divestiture of ineligible non-program investments § 652.45Temporary regulatory waivers or modifications for extraordinary situations.

Generally, the reorganization is meant to address sequentially and as completely as possible the three major categories of management governed in the rule: Investment management; interest rate risk management; and liquidity management.

B. Section 652.1—Purpose

We received no comments on our proposal to delete the first sentence of this section as unnecessary, and we adopt the revision as proposed.

C. Section 652.5—Definitions

Many of the definitions we proposed relate to revisions to regulations that will not be finalized until a later installment of this rulemaking, and we will not finalize those definitions until we finalize the regulations to which they relate. We received no commentson the proposed technical clarification to the definition of FCA or the proposed definition of OSMO as FCA's Office of Secondary Market Oversight that we proposed, and we adopt these revisions as proposed.

We proposed technical clarifications to the definitions of “Government agency” and “Government-sponsored agency.” We are finalizing definitions for these terms with additional technical clarifications.

The Council commented that our existing definition of non-program investments, which we did not propose to revise, is overly broad and allows for the holding of investments beyond the regulatory objectives of ensuring safety and soundness and continuity of funding as outlined in § 652.1. It suggested that we modify the definition to clarify that non-program investments are those held for the investment purposes authorized by revised and renumbered § 652.25. We note that as proposed and as discussed above, this final rule deletes the sentence in § 652.1 to which the comment refers. Moreover, the definition of non-program investments does not itself allow for the holding of investments. Rather, Farmer Mac may hold non-program investments only for the permissible investment purposes. Accordingly, we do not change this definition.

D. Section 652.10—Investment Management

Farmer Mac commented that several of the proposed changes to the rule go well beyond establishing a framework for safety and soundness and instead impose FCA's judgment on proper business operations. Our general response is that we revised some of the proposed requirements in the final rule to make them less prescriptive but that we retain some of the proposed requirements, with clarifications. We respond to the comments on specific provisions below.

The Council requested that FCA follow a similar structure and approach for Farmer Mac as it proposed for the System banks and associations in their investment management rule. In the final rule, we revise the structure and approach of this rule. In addition, the structure and approach of the rule governing System banks and associations has also been revised. We believe the structure and approach of the two rules are now more similar; although, where appropriate, differences still exist.

1. § 652.10(a)—Responsibilities of the Board of Directors

The Council commented that the proposed requirement that the board must annually review and “affirmatively validate” the sufficiency of its investment policies is overly prescriptive, burdensome, and unclear. We agree that a requirement of annual board review is sufficient and delete “affirmatively validate” from the final rule. With the exception of a few minor technical, clarifying, and non-substantive changes, this paragraph is unchanged from the existing rule.

2. § 652.10(b)—Investment Policies—General Requirements

The Council commented that the requirement (an existing requirement for Farmer Mac that had been proposed for System banks and associations) that Farmer Mac must document in its “records or minutes” any analyses used in formulating investment policies or amendments is burdensome and does not enhance the investment management process. We agree that specifying minutes as a possible location for this documentation is unnecessary. Accordingly, we are deleting “or minutes” from the final rule.

We are moving the requirement (most of which is contained in existing § 652.10(f)(1)) that Farmer Mac's investment policies must fully address the extent of pre-purchase analysis that management must perform for various types, classes, and structure of investments from proposed § 652.10(f)(1)(i) to this paragraph because it is a more logical location.

With these exceptions, we are adopting § 652.10(b) as proposed, including several minor technical and clarifying changes. A discussion of these minor changes may be found in the preamble to the proposed rule.6

6 See76 FR 71801, Nov. 18, 2011.

3. § 652.10(c)—Investment Policies—Risk Tolerance

Proposed § 652.10(c) would have required Farmer Mac's investment policies to ensure that the Corporation maintains prudent diversification of its investment portfolio and that its asset allocations and investment portfolio strategies do not expose its capital or earnings to excessive risk of loss. In final § 652.10(c), we revise this requirement to provide that Farmer Mac's investment policies must include concentration limits to ensure prudent diversification of credit, market, and liquidity risks in its investment portfolio. We believe this language is more specific, better reflects requirements that are necessary for safety and soundness, and provides consistency with the rule governing System banks and associations. We emphasize, however, that the objective of this requirement remains ensuring that Farmer Mac's asset allocations and investment portfolio strategies do not expose its capital or earnings to excessive risk of loss.

In addition, our proposed rule, as well as our existing rule, provides that risk limits must be based on Farmer Mac's objectives, capital position, and risk tolerance. In the final rule, we further specify that risk limits must be based on all relevant factors, including Farmer Mac's objectives, capital position, earnings, and quality and reliability of risk management systems.

Existing § 652.10(c)(1)(ii) requires Farmer Mac's board (or a designated subcommittee) to review annually the criteria for selecting securities firms and the board to approve any changes to the criteria. It also requires that the board (or subcommittee) review annually the existing relationships with securities firms and be notified before any changes to securities firms are made.

In our NPRM, we proposed clarifying changes to these requirements but did not intend a significant change in the meaning. Both Farmer Mac and the Council objected to the existing requirement that the board must review existing relationships and be notified before changes are made to these relationships. The Council commented that this requirement is confusing, creates an excessive burden, and results in an unnecessary distraction for the board.

We agree that as long as Farmer Mac's board (or a designated committee) reviews the selection criteria on an annual basis, and the board approves any changes to the criteria, the board does not need to be involved in the approval of relationships. Accordingly, we have deleted the existing and proposed requirement that the board (or a subcommittee) must review existing relationships and be notified before changes are made to these relationships.

We adopt several other minor technical, clarifying, and non-substantive changes in this paragraph.

4. § 652.10(e)—Internal Controls

Existing § 652.10(e)(2) requires Farmer Mac to establish and maintain a separation of duties and supervision between personnel who execute investment transactions and personnel who approve, revaluate, and oversee investments. Proposed § 651.10(e)(2) would have added to the list ofpersonnel whose duties and supervision would have had to be separated from personnel who execute investment transactions. These additional personnel would have been those who post accounting entries, reconcile trade confirmations, and report compliance with investment policy.

Both Farmer Mac and the Council objected to this proposed revision as overly prescriptive. Rather than itemizing all of the possible personnel functions, final § 652.10(e)(2) provides that Farmer Mac must establish and maintain a separation of duties between personnel who supervise or execute investment transactions and personnel who supervise or engage in all other investment-related functions. These other investment-related functions include those itemized in the list in the proposed rule, as well as any other functions that are investment related. This regulation does not prohibit one person from performing or supervising more than one investment-related function (other than executing, or supervising the execution of, investment transactions), if appropriate controls are in place as warranted by the complexity and risk of Farmer Mac's investment operations.

Proposed section 652.10(e)(4) would have added a new requirement that Farmer Mac must implement an effective internal audit program to review, at least annually, its investment controls, processes, and compliance with FCA regulations and other regulatory guidance. The internal audit program would have had to specifically include a review of its process for ensuring all investments were eligible and suitable for purchase under its board's investment policies.

Both Farmer Mac and the Council commented that this requirement was too prescriptive and eliminated the flexibility that is necessary for Farmer Mac's internal auditors to establish their own risk-based approach to audits. Final § 652.10(e)(4) requires Farmer Mac to implement an effective internal audit program to review, at least annually, its investment management functions, controls, processes, and compliance with FCA regulations. The scope of the annual review must be appropriate for the size, risk, and complexity of the investment portfolio.

5. § 652.10(f)—Due Diligence

We made a number of minor technical and non-substantive changes throughout this paragraph to clarify the requirements and to more closely match up with the language of the rule governing the System banks and associations. We do not identify these minor changes here. Below we discuss our responses to the comments we received, including the changes we make in response to those comments.

Proposed § 652.10(f)(1)(i) would have required Farmer Mac, before it purchased an investment, to conduct sufficient due diligence to determine whether the investment was eligible and suitable under its board-approved investment policies and to document this determination.

This proposed requirement is retained in new § 652.10(f)(1)(i), with minor clarifications. Since we had used the term “suitable” to mean an investment complied with Farmer Mac's board-approved investment policies, we simplify the regulation by eliminating that term and instead requiring Farmer Mac to determine whether an investment complies with those policies. We also clarify that Farmer Mac must determine whether an investment is for an authorized purpose.

The Council commented that eligibility and the other pre-purchase assessments are often established for a class or segment of securities by specifying the criteria (credit risk, liquidity, market risk, etc.) that make a class of securities eligible and suitable per se, and it requested clarification that these pre-purchase assessments may be defined for segments or classes of securities that meet appropriate criteria rather on a security-by-security basis. We note that the regulation does not prohibit Farmer Mac from establishing criteria for various classes or segments of investments; nonetheless, Farmer Mac must continue to adequately document its evaluation and assessments of investments being purchased.

We also added a sentence to § 652.10(f)(1)(i) specifically authorizing Farmer Mac, with board approval, to hold investments that do not comply with its investment policies. This addition recognizes that such decisions are within the discretion of the board's business judgment. We emphasize that this provision does not authorize the board to approve investments that do not comply with our regulatory eligibility requirements and purpose limitations.

Existing § 652.10(f)(1) 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. We proposed to relocate this requirement to § 652.10(f)(1)(ii) but proposed no substantive changes to the requirement.7

7The proposed requirement read: “Prior to purchase, you must verify the value of the investment (unless it is a new issue) with a source that is independent of the broker, dealer, counterparty, or other intermediary to the transaction.”

Both Farmer Mac and the Council objected to this existing requirement. The Council commented that verifying value from an independent source is not realistic for investments of tranches of collateralized mortgage obligations (CMOs), including planned amortization class (PAC) bonds, purchased in the primary market. The Council stated that these securities are generally unique in nature and their value, when newly created, will be impossible to verify with a third party prior to purchase.

In response, we reiterate that the third-party, pre-purchase valuation requirement explicitly excludes new issues. Accordingly, Farmer Mac need not seek third-party, pre-purchase valuation for new issues.

Proposed § 652.10(f)(1)(iii) would have contained extensive risk-assessment evaluation and documentation requirements. Both Farmer Mac and the Council objected to these requirements. The Council commented that the detail and prescriptiveness of this paragraph was unnecessary, burdensome, and redundant to the proposed investment policy requirements. The Council also stated that the proposed rule governing System banks and associations, while still excessive, was more “streamlined” and consistent with the overall objectives of the regulations.

In response, we have revised the requirements of final § 652.10(f)(1)(iii) to be much less detailed than those in the NPRM as well as more similar, but not identical, to those in the final rule governing System banks and associations. The final rule specifies the risks that must be assessed but, other than stress-testing requirements, which are discussed below, it does not specify how these risks must be assessed. We explain in this preamble our expectations for how Farmer Mac should assess its risk. These expectations were stated as requirements in the proposed rule.

In its assessment of credit risk, Farmer Mac should consider the nature and type of underlying collateral, credit enhancements, complexity of the structure, and any other available indicators of the risk of default.

In its assessment of liquidity risk, Farmer Mac should consider the investment structure, depth of the market, and ability to liquidate theposition under a variety of economic scenarios and market conditions.

In its assessment of market risk, Farmer Mac should consider how various market stress scenarios including, at a minimum, potential changes in interest rates and market conditions (such as changes in market perceptions of creditworthiness), are likely to affect the cash flow and price of the instrument.

The proposed rule would have required Farmer Mac, in conducting its market risk assessment, to use reasonable and appropriate methodologies for stress testing for the type or class of instrument to ensure the investment complies with risk limits established in its investment and interest rate risk policies. Although we intended that this stress-testing requirement would encompass structured instruments and those with uncertain cash flows, such as mortgage-backed securities and asset-backed securities, the proposed rule did not expressly specify what types or classes of instruments must be stress tested.

The Council commented that this proposal was more lenient than the provisions that were proposed for System banks and associations, which would have expressly required stress testing of all instruments prior to purchase. In response to the Council's comment, and to clarify our intentions in our proposed regulation, final § 651.10(f)(1)(iii) expressly requires Farmer Mac to stress test all investments that are structured or that have uncertain cash flows, including specifically mortgage-backed securities and asset-backed securities, prior to their purchase. The stress test must be commensurate with the risk and complexity of the investment.

Existing § 652.10(f)(2) requires Farmer Mac, at least monthly, to determine the fair market value of each security in its portfolio and the fair market value of its whole investment portfolio. In doing so, Farmer Mac must also evaluate the credit quality and price sensitivity to the change in market interest rates of each security in its portfolio and its whole investment portfolio. We had proposed to delete the entire second sentence. Final § 652.10(f)(3) requires Farmer Mac to establish and maintain processes to monitor and evaluate changes in the credit quality of each security in its portfolio and its whole investment portfolio on an ongoing basis. We delete the price sensitivity evaluation requirement because that is addressed in our final interest rate risk management regulation at § 652.30(c)(3).

Final § 652.10(f)(4)(i) requires Farmer Mac to stress test its entire investment portfolio, including stress tests of all investments individually and stress tests of the portfolio as a whole, at the end of each quarter. The stress test must enable Farmer Mac to determine that its investment securities, both individually and on a portfolio-wide basis, do not expose its capital, earnings, or liquidity to risks that exceed the risk tolerance specified in its investment policies. These requirements combine and clarify the existing § 652.40(a) requirement that Farmer Mac be able to identify individual securities that expose it to a high level of risk with the portfolio-wide stress testing required by proposed § 652.10(f)(3)(i).

The Council commented that the stress-testing requirements in proposed § 652.10(f)(3)(ii) differed in subtle but important ways from what was proposed for System banks and associations, and it stated that this inconsistency was not supported by any business difference between Farmer Mac and System banks and associations. The Council did not, however, either specify the differences or explain why the differences were important. We have made a few minor changes in the final rule. We believe the final rule is substantially similar to the final rule governing the System banks and associations; any differences are not intended to be material.

6. § 652.10(g)—Reports to the Board of Directors

Farmer Mac commented that the board reporting requirements in proposed § 652.10(g) go beyond establishing a framework for safety and soundness and instead effectively supplant Farmer Mac's business judgment with FCA's, but the Corporation provided no specific comments on the requirements. The Council, commenting on the proposed rule governing System banks and associations—which was somewhat more detailed than the proposed rule governing Farmer Mac—stated that the board reporting requirements were exceedingly prescriptive and limiting of the board's authority to direct management, and it requested that the provisions be generalized and simply require that the board receive a quarterly report containing information on the investment portfolio as the board deems appropriate.

We are finalizing § 651.10(g) as proposed. We believe this level of reporting is necessary to ensure the board has the information it needs about Farmer Mac's investments.

E. Section 652.15—Non-Program Investment Purposes and Limitation

We are finalizing our proposal to renumber existing § 652.25 as § 652.15.

We proposed in § 652.15(a) to add a new permissible purpose for Farmer Mac's non-program investments—investments that complement program business activities. In the preamble to the proposed rule, we stated that this purpose would recognize that certain investments, such as investments with a rural focus that are backed by the full faith and credit of the United States Government, could advance Farmer Mac's mission by complementing its program business activities. We believe that even if an investment is not held for the purposes of complying with interest rate risk management requirements, complying with liquidity requirements, or managing surplus short-term funds, mission advancement could nevertheless be an appropriate purpose for which to hold investments.8

8FCA has also approved mission-related investments for System banks and associations on a case-by-case basis.

Section 8.3(c)(12) of the Act permits Farmer Mac to “purchase or sell any securities or obligations * * * necessary and convenient to the business of the Corporation.” We believe this proposed broadening of investment purposes is compatible with Farmer Mac's statutory mandate and consistent with congressional intent.

We emphasized in the preamble to the proposed rule that this provision would not add any new eligible investments to our authorized list; Farmer Mac would still need to seek FCA's prior approval for any investments not explicitly authorized on the list of eligible investments.

In addition, we stated in the preamble to the proposed rule that neither the proposed purpose nor any of the three existing purposes authorize Farmer Mac to accumulate investment portfolios for arbitrage activities or to engage in trading for speculative or primarily capital gains purposes. We stated that realizing gains on sales before investments mature is not a regulatory violation as long as the profits are incidental to the specified permissible investment purposes. And we emphasized that Farmer Mac's internal controls must ensure that eligible investments clearly fulfill one or more of the authorized investment purposes.

The Council strongly objected to the proposed purpose, stating that FCA “specifically states” that the purpose will allow Farmer Mac to use non-program investments as a business strategy to enhance returns for investors.The Council stated that this purpose would authorize Farmer Mac to assume additional risk in its non-program investments and that Farmer Mac's authorized investment purposes should be the same as those for System banks. The Council also expressed concern that FCA did not define what constitutes “business activities.” The Council asked us to delete this proposed purpose entirely.

We adopt this provision as proposed. We specifically state that this new purpose is to advance Farmer Mac's mission by complementing Farmer Mac's program business activities—not to enhance returns to investors. Positive returns are permissible only if they are incidental to this purpose or to one of the three existing purposes. FCA will use its supervisory authorities to ensure that all investments held for this purpose actually do complement Farmer Mac's program business activities and that the risk and return characteristics of such investments are appropriate.

As stated above, Farmer Mac may hold only investments that are already on the list of eligible investments unless it seeks FCA's prior approval. In determining whether to grant approval, FCA will consider the risk of the investment and whether it actually does complement Farmer Mac's program business activities; where appropriate, we may impose conditions on the approval. Although System banks do not have such a purpose authorized by regulation, FCA has approved many mission-related investments for System banks and associations. We further emphasize that Farmer Mac's investments held for any of the four permissible purposes will be subject to the 35-percent investment limit in § 652.15(b). We believe this limitation will help ensure that Farmer Mac's mission achievement continues to be centered on providing a source of liquidity and credit support for agriculture and rural lenders directly through its secondary market and guarantee programs. Investments that complement program business activities should have an agricultural or rural focus.

We adopt as final our proposal to change the current regulatory maximum non-program investment parameters in paragraph (b) to delete the alternate maximum of a fixed $1.5 billion. While we continue to believe that excessive or inappropriate use of non-program investments is not consistent with the Corporation's statutory mission and status as a Government-sponsored enterprise (GSE), we believe the maximum investment parameter of 35 percent of program volume alone is sufficient and that there is no longer a need for the $1.5-billion ceiling on that maximum calculation. This change is based on Farmer Mac's growth since the $1.5 billion ceiling was established in 2005. We received no comment on this proposal.

Also in paragraph (b), we adopt as final our proposal to permit Farmer Mac to exclude investments pledged to meet margin requirements for derivative transactions (collateral) when calculating the 35-percent investment limit under paragraph (b).9 We note that investments that are pledged as collateral do not count toward Farmer Mac's compliance with its liquidity requirements.10 We make this change because the Dodd-Frank Act may result in additional margin requirements for Farmer Mac, and we want to avoid the unintended consequence of discouraging the use of derivatives as an appropriate risk management tool. We received positive comments on this proposal from the Council.

9Paragraph (b) permits Farmer Mac to hold eligible non-program investments, for specified purposes, up to 35 percent of program volume.

10Under new § 652.35(b) (renumbered from existing § 652.20(b)), all investments held for the purpose of meeting the liquidity reserve requirement must be free of liens or other encumbrances.

The Council requested that we also exclude various other investments from the investment limit calculation. The Council requested that we exclude securities purchased and designated for the primary purpose of posting collateral for derivative positions, even if the collateral is returned or the securities are never posted. The Council stated that including these securities in the limit would require Farmer Mac to maintain a cushion under the limit to accommodate the possibility of return, thereby limiting the amount of other investments it can hold to manage its liquidity position and derivative counterparty exposures.

Both Farmer Mac and the Council asked that Treasury securities also be excluded from the 35-percent limit. Farmer Mac stated that the proposed rule would require it to hold significant amounts of Treasury securities to meet FCA's liquidity requirements, thereby utilizing a large portion of its liquidity and investment portfolio capacity. The Council stated that the 35-percent limit creates an economic constraint and disincentive to holding Treasury securities, even though they are the most liquid and marketable investment.

Finally, the Council also requested that investment securities pledged in secured borrowing relationships be excluded from the 35-percent limit. The Council cited State Ag-Linked lending programs and repurchase agreements as examples of these secured borrowing relationships. Under both arrangements, according to the Council, the pledging of securities acts as an alternative means of obtaining cash for operations. Under § 652.35(b) (renumbered from § 652.20(b)), these investments may not be counted in the liquidity reserve because they are not unencumbered. The Council asserts that excluding securities pledged in secured borrowing relationships from the 35-percent limit would be consistent with use of the securities as an alternative method to secure financing and their treatment under the FCA regulatory liquidity measurement.

We decline to exclude these investments from the investment limit. We view these types of transactions as part of Farmer Mac's normal cash management operations. Thus, under normal conditions, we expect Farmer Mac to manage the level of its investments within FCA's portfolio size limits to ensure regulatory compliance. If, in unusual business environments, Farmer Mac were to experience the unexpected need for a significant increase in pledgeable assets, and that increase could result in a short-term need for regulatory flexibility regarding the 35-percent maximum limit, § 652.45 of this regulation provides for FCA discretion to allow that flexibility.

F. Section 652.20—Eligible Non-Program Investments

As proposed, we renumber existing § 652.35, Eligible Non-Program Investments, as § 652.20. We delete the reference to divestiture that was contained in § 652.35(a)(5), because we no longer require divestiture of investments that were eligible when purchased, and the treatment of investments that were ineligible when purchased is specified in § 652.25(a). We also delete the references to stress-testing mortgage securities that were contained in § 652.35(a)(6), because new § 652.10(f) sets forth stress-testing requirements for investments. We are reprinting this provision because of these changes, but we are making no other changes to the provision.

G. Section 652.25—Management of Ineligible Investments and Reservation of Authority To Require Divestiture

As proposed, we delete existing § 652.45 and replace it with new § 652.25. Existing § 652.45(a)(2) requires Farmer Mac to dispose of an investment that is ineligible11 within 6 monthsunless we approve, in writing, a plan that authorizes divestment over a longer period of time. An acceptable divestiture plan generally must require Farmer Mac to dispose of the ineligible investment as quickly as possible without substantial financial loss. Until it actually disposes of the ineligible investment, Farmer Mac must report on specified matters to its board of directors and to FCA at least quarterly.

11Under existing § 652.35.

New § 652.25(b) no longer requires Farmer Mac to divest of (or to receive approval of a divestiture plan for) an investment that was eligible12 when purchased but that no longer satisfies the eligibility criteria.13 Rather, Farmer Mac would be required to notify the OSMO within 15 calendar days of determining that the investment no longer satisfies the eligibility criteria, and the investment would be subject to specified requirements that are discussed below. This approach provides the Corporation with greater flexibility to manage its position and mitigate losses as compared with a forced divestiture during a specific time period (or the need to devote resources to developing and submitting a divestiture plan for FCA to consider).

12Under renumbered § 652.20.

13Such an investment would no longer be considered “ineligible.”

The proposed rule would have required Farmer Mac to notify the OSMO “promptly” if an investment no longer satisfied the eligibility criteria. Farmer Mac commented that the term “prompt” leaves significant room for interpretation as to practical application, and it requested a specific timeframe. The Council commented that it was unsure what “prompt” meant in the context of the rule, and it stated that notification is redundant and unnecessary given the requirements of the regulation and the ongoing nature of FCA's examination function. If FCA retained this requirement, the Council suggested a 60-calendar-day notice period.

In response to these comments, we make the notification period 15 calendar days after Farmer Mac determines that the investment no longer satisfies the eligibility criteria. We believe this notification period is adequate, since the timeframe does not begin until Farmer Mac makes the determination. Moreover, notification can be as simple as a telephone call or an email.

The proposed rule would also have required notification to the OSMO when an investment that satisfied the regulatory eligibility criteria was not suitable because it did not satisfy the risk tolerance established in the institution's required board policy, and the investment would have been subject to the same specified requirements discussed below. We are deleting this notification requirement from the final rule because we do not want to create a disincentive for Farmer Mac to establish a risk tolerance that is stricter than FCA's regulatory eligibility criteria. Under the final rule, Farmer Mac does not have to notify the OSMO when an investment that satisfies FCA's regulatory eligibility criteria does not satisfy its own risk tolerance, nor is the investment subject to the other specified requirements discussed below.

As we proposed, final § 652.25(a) provides that an investment that does not satisfy the regulatory eligibility criteria at the time of purchase is ineligible. Under the final rule (as under the existing regulation), Farmer Mac may not purchase ineligible investments. If Farmer Mac does purchase an ineligible investment, it must notify the OSMO within 15 calendar days after determining that the investment was ineligible and must divest of the investment no later than 60 calendar days after the determination unless we approved, in writing, a plan that authorizes divestiture over a longer period of time.

Although it is not stated in the regulation, we clarify here that an acceptable divestiture plan would have to require Farmer Mac to dispose of the investment as quickly as possible without substantial financial loss. The plan would also have to contain sufficient analysis to support continued retention of the investment, including its effect on the institution's capital, earnings, liquidity, and collateral position. Our decision would not be based solely on financial loss and would include consideration of all circumstances surrounding the purchase. Until Farmer Mac divests of the investment, it would be subject to the same specified requirements discussed below.

Furthermore, we emphasize that any purchase of an ineligible investment would indicate weaknesses in Farmer Mac's internal controls and due diligence and would trigger increased FCA oversight if it occurs. We expect such a purchase to occur rarely, if ever. For this reason, we are retaining the divestiture requirement from the existing and proposed rules, despite the Council's request that we treat investments that are ineligible when purchased in the same manner as we treat investments that are eligible when purchased but that subsequently fail to meet the eligibility criteria. Furthermore, in response to the Council's comment that this provision essentially authorizes Farmer Mac to purchase ineligible investments that could be held for 60 calendar days, we emphasize that this provision does not authorize such a purchase. As stated, if Farmer Mac makes such a purchase, it should expect increased FCA oversight of its internal controls and due diligence process, as well as other enforcement actions as appropriate.

The specified requirements that apply to investments retained by Farmer Mac that are ineligible or that no longer satisfy the eligibility requirements are specified in § 652.25(c). We believe these specified requirements are warranted by safety and soundness concerns.

Section 652.25(c)(1) contains reporting requirements. Each quarter, Farmer Mac is required to report to FCA and to its board on the status of all such investments. The report must demonstrate the effect that the investments may have on the Corporation's capital, earnings, and liquidity position. Additionally, the report must address how the Corporation plans to reduce its risk exposure from these investments or exit the position.

Section 652.25(c)(2) provides that the investments may not be used to satisfy Farmer Mac's liquidity requirement(s) in § 652.40 and that they must continue to be included in the investment portfolio limit calculation established in § 652.15(b).

Finally, § 652.25(d) reserves FCA's authority to require Farmer Mac to divest of any investment at any time for failure to comply with § 652.15(a) or for safety and soundness purposes. Although we did not propose failure to comply with the permissible investment purposes specified in § 652.15(a) as a basis for requiring divestiture, this change makes explicit our authority to require divestiture of an investment that does not comply with our investment regulations. The timeframe FCA sets would consider the expected loss on the transaction (or transactions) and the effect on Farmer Mac's financial condition and performance. Because the final rule does not require automatic divestiture of any investment that was eligible when purchased, FCA is making express our authority to require divestiture of investments when necessary.

H. Section 652.30—Interest Rate Risk Management

We renumber existing § 652.15 as § 652.30. No comments were received on the proposed revisions to this section, and we finalize them asproposed, with a minor, non-substantive change. The preamble to our proposed rule explains our changes.

I. Section 652.35—Liquidity Reserve Management and Requirements

As proposed, we renumber existing § 652.20, Liquidity Reserve Management and Requirements, as § 652.35. We are reprinting this provision because of this renumbering, but we are making no other changes to the provision.

J. Section 642.40—Stress Tests for Mortgage Securities

As proposed, we remove this standalone section from our regulations and incorporate its requirements into § 652.10(f), as discussed above.

K. Section 652.45—Temporary Regulatory Waivers or Modifications for Extraordinary Situations

We adopt the proposed revisions to § 652.45. We relocate existing § 652.30, which authorizes FCA to modify or waive regulatory investment management and liquidity management requirements in extraordinary situations, to new § 652.45. We believe this location is more appropriate for this provision.

In addition to the existing specific modifications and waivers the provision authorizes, we amend § 652.45 to authorize FCA to take other actions as deemed appropriate. This added authority will give FCA additional flexibility to address extraordinary situations.

We received no comments on this revision, and the Council was supportive of similar changes in the proposed rule governing System banks.

V. 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. 601et seq.), the FCA hereby certifies that the final rule will not have a significant economic impact on a substantial number of small entities.

List of Subjects in 12 CFR Part 652

Agriculture, Banks, banking, Capital, Investments, Rural areas.

For the reasons stated in the preamble, part 652 of chapter VI, title 12 of the Code of Federal Regulations is amended as follows:

PART 652—FEDERAL AGRICULTURAL MORTGAGE CORPORATION FUNDING AND FISCAL AFFAIRS 1. The authority citation for part 652 continues 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.

2. Subpart A, consisting of §§ 652.1 through 652.45, is revised to read as follows: Subpart A—Investment Management Sec. 652.1 Purpose. 652.5 Definitions. 652.10 Investment management. 652.15 Non-program investment purposes and limitation. 652.20 Eligible non-program investments. 652.25 Management of ineligible investments and reservation of authority. 652.30 Interest rate risk management. 652.35 Liquidity reserve management and requirements. 652.40 [Reserved] 652.45 Temporary regulatory waivers or modifications for extraordinary situations. Subpart A—Investment Management
§ 652.1 Purpose.

The purpose of this subpart is to ensure safety and soundness, continuity of funding, and appropriate use of non-program investments considering the Federal Agricultural Mortgage Corporation's (Farmer Mac or Corporation) 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.

§ 652.5 Definitions.

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

Affiliatemeans any entity established under authority granted to the Corporation under section 8.3(c)(14) of the Farm Credit Act of 1971, as amended.

Asset-backed securities (ABS)mean 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 depositmeans 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 yourmeans the Federal Agricultural Mortgage Corporation and its affiliates.

FCA, our, us, or wemeans the Farm Credit Administration.

Final maturitymeans 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 obligationsof 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 agencymeans the United States or an agency, instrumentality, or corporation of the United States Government whose obligations are fully and explicitly insured or guaranteed as to the timely repayment of principal and interest by the full faith and credit of the United States Government.

Government-sponsored agencymeans an agency, instrumentality, or corporation chartered or established to serve public purposes specified by the United States Congress but whose obligations are not fully and explicitly insured or guaranteed by the full faith and credit of the United States Government, including but not limited to any Government-sponsored enterprise.

Liquid investmentsare 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 outstandingbalance of those loans in monthly installments based on the outstanding balance of those loans.

Market riskmeans 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 obligationsmeans 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 securitiesmeans 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 investmentsmeans 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.”

OSMOmeans FCA's Office of Secondary Market Oversight.

Program assetsmeans on-balance sheet “qualified loans” as defined in section 8.0(9) of the Farm Credit Act of 1971, as amended.

Program obligationsmeans off-balance sheet “qualified loans” as defined in section 8.0(9) of the Farm Credit Act of 1971, as amended.

Regulatory capitalmeans your core capital plus an allowance for losses and guarantee claims, as determined in accordance with generally accepted accounting principles.

Revenue bondmeans 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.

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.

§ 652.10 Investment management.

(a)Responsibilities of the board of directors.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 committee of the board, must review the sufficiency of these investment policies. Any changes to the policies must be adopted by the board. You must report any changes to these policies to the OSMO within 10 business days of adoption.

(b)Investment policies—general requirements.Your investment policies must address the purposes and objectives of investments, risk tolerance, delegations of authority, internal controls, due diligence, and reporting requirements. Moreover, your investment policies must fully address the extent of pre-purchase analysis that management must perform for various types, classes, and structure of investments. Furthermore, the policies must include reporting requirements and approvals needed for exceptions to the board's policies. Investment policies must be sufficiently detailed, consistent with, and appropriate for the amounts, types, and risk characteristics of your investments. You must document in the Corporation's records any analyses used in formulating your policies or amendments to the policies.

(c)Investment policies—risk tolerance.Your investment policies must establish risk limits for the various types, classes, and sectors of eligible investments. These policies must include concentration limits to ensure prudent diversification of credit, market, and liquidity risks in the investment portfolio. Risk limits must be based on all relevant factors, including the Corporation's objectives, capital position, earnings, and quality and reliability of risk management systems. 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 in a single or related counterparty(ies), geographical areas, industry sectors, and asset classes 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 review of your investment policies required under paragraph (a) of this section, your board of directors, or a designated committee of the board, must review the criteria for selecting securities firms. Any changes to the criteria must be approved by the board.

(iii) Collateral margin requirements o