Federal Agricultural Mortgage Corporation Funding and Fiscal Affairs; Risk-Based Capital Requirements

AGENCY:

Farm Credit Administration.

ACTION:

Proposed rule.

SUMMARY:

The Farm Credit Administration (FCA, Agency, us, or we) proposes to amend our regulations on the Risk-Based Capital Stress Test (RBCST or model) used by the Federal Agricultural Mortgage Corporation (Farmer Mac or the Corporation). We propose to update the model to address recent additions to Farmer Mac's program authorities, specifically the authority for Farmer Mac to finance rural utility loans. We are also proposing to revise the existing treatment of risk mitigations of general obligations for the AgVantage Plus program and related structures, as established in Version 3.0 of the model. Finally, we propose revising the treatment of counterparty risk on non-program investments in the model by adjusting the haircuts applied to those investments to keep the model consistent with statutory requirements for calculating Farmer Mac's regulatory minimum capital level.

DATES:

You may send us comments by March 8, 2010.

ADDRESSES:

We offer a variety of methods for you to submit comments on this proposed rule. For accuracy and efficiency reasons, commenters are encouraged to submit comments by e-mail or through the Agency's Web site. As facsimiles (fax) are difficult for us to process and achieve compliance with section 508 of the Rehabilitation Act, we are no longer accepting comments submitted by fax. Regardless of the method you use, please do not submit your comment multiple times via different methods. You may submit comments by any of the following methods:

• E-mail: Send us an e-mail at reg-comm@fca.gov.
• FCA Web site: http://www.fca.gov. Select “Public Commenters,” then “Public Comments,” and follow the directions for “Submitting a Comment.”
• Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments.
• Mail: Joseph T. Connor, Associate Director for Policy and Analysis, Office of Secondary Market Oversight, Farm Credit Administration, 1501 Farm Credit Drive, McLean, VA 22102-5090.

You may review copies of all comments we receive at our office in McLean, Virginia, or on our Web site at http://www.fca.gov. Once you are in the Web site, select “Public Commenters,” then “Public Comments,” and follow the directions for “Reading Submitted Public Comments.” We will show your comments as submitted, but for technical reasons we may omit items such as logos and special characters. Identifying information that you provide, such as phone numbers and addresses, will be publicly available. However, we will attempt to remove e-mail addresses to help reduce Internet spam.

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

Laura McFarland, 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 proposed rule is to ensure that the RBCST for Farmer Mac continues to determine regulatory capital requirements in a manner that remains consistent with statutory requirements.

II. Background

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 utility loans as well as to facilitate capital markets funding for USDA-guaranteed farm program and rural development loans. Farmer Mac's Class C non-voting and Class A voting common stocks are listed on the New York Stock Exchange under the symbols AGM and AGM.A, respectively. FCA, an independent agency in the executive branch of the Federal Government, is the safety and soundness regulator of Farmer Mac. FCA regulates Farmer Mac through the Office of Secondary Market Oversight (OSMO).

Section 5406 of the Food, Conservation and Energy Act of 2008 (2008 Farm Bill) amended the definition of “qualified loan” in Title VIII of the Farm Credit Act of 1971, as amended, (Act) to include rural utility loans. This change gave Farmer Mac the authority to purchase and guarantee securities backed by loans to rural electric and telephone utility cooperatives as program business. The 2008 Farm Bill further directed FCA to estimate the credit risk on the portfolio covered by this new authority at a rate of default and severity reasonably related to the risks in rural electric and telephone facility loans.

The existing RBCST (Version 3.0) for Farmer Mac is contained in subpart B of part 652, and is used to determine the minimum level of regulatory capital Farmer Mac must hold to maintain positive capital during a 10-year period, as characterized by stressful credit and interest rate conditions. Version 3.0 of the RBCST was developed according to the provisions of section 8.32 of the Act before Farmer Mac was given rural utility authority and thus lacks a component to directly recognize the credit risk on such loans. At the time of the Farm Bill's enactment, Farmer Mac held approximately $1.3 billion of such loans in its non-program investment portfolio. At the end of the first quarter 2009, Farmer Mac held $1.4 billion in loans to rural electric cooperatives in its program loan portfolio.

Based on the provisions of the 2008 Farm Bill, we are proposing to amend the RBCST (Version 3.0) to account for Farmer Mac's new authority to finance rural electric and telephone utility cooperatives. We are also proposing to address the existing adjustment factors for recognizing the risk-mitigating effects of an issuer's general obligation to Farmer Mac by applying increases (or “haircuts”) to the historical default rates by whole-letter credit rating. In our rule published in June 2008, we established a method to recognize the risk-mitigating effects of the issuer's general obligation to Farmer Mac under the product referred to as “AgVantage Plus.” RBCST Version 3.0 recognized the risk mitigation provided by the general obligation by reducing the age-adjusted dollar losses estimated on the subject loans by a General Obligation Adjustment (GOA) factor derived from average historical default rates of corporate bond issuers with similar whole-letter credit ratings as reported by a nationally recognized statistical rating organization (NRSRO). We now propose to apply stress generally to the current GOA factors and to further discount them to recognize the level of concentration risk associated with an individual counterparty's general obligation.

We are also proposing conforming changes to the haircuts on non-program investments. Our existing rule applies a method to account for counterparty risk on non-program investments by applying a discount (or “haircut”) to the yields of non-program investments, scaled according to average credit ratings, with a 10-year phase-in. We are proposing modifications to the haircut levels applied to non-program investments to increase the severity of the haircuts.

III. Section-by-Section Analysis

The purpose of this proposed rule is to revise the risk-based capital regulations that apply to Farmer Mac to reflect changes in Farmer Mac's financing authorities, operations, and business practices. The issues addressed in this proposed rule include: (1) Treatment of program loan volume in the rural utility cooperative sector; (2) modification of the GOA factors (initially established in RBCST Version 3.0) to reflect greater prudence in the assumptions regarding the relationship between risk and pricing of Farmer Mac's exposure to certain structures known as “AgVantage Plus” and other similar arrangements that may arise in the future; and (3) modification of haircuts on non-program investments to retain consistency with the risk levels recognized by whole-letter rating category in the proposed modifications to GOA factors discussed in item “2” above. We refer to the version of the model proposed here as “Version 4.0 (proposed).”

A. Credit Loss Estimation on Rural Utility Loans [§§ 652.50 and 652.65(b); Appendix A to Part 652]

1. Guarantee Fee

We propose to amend § 652.50 by adding a definition for guarantee fees charged on rural utility loans to distinguish treatment of these fees from those assessed against all other loans guaranteed by Farmer Mac. Guarantee fees are made up of Farmer Mac's estimate of likely long-term average annual losses on the investment, plus fee loads to cover operating costs and return-on-equity requirements. Section 8.10 of the Act establishes a limit on the guarantee fees Farmer Mac may charge, but the 2008 Farm Bill, when establishing the authority for Farmer Mac to deal in rural utility loans as program business, stated that this authority be handled in a manner reasonably related to the risks specific to rural utility loans. Based on this, we propose adding a “rural utility guarantee fee” definition to § 652.50 to clarify that rural utility guarantee fees are distinguished from those guarantee fees discussed in section 8.10 of the Act. Unlike all other fees under section 8.10 of the Act, we propose that the model use rural utility guarantee fees as a component of its loss estimation calculation. We also propose that the definition differentiate between on-balance sheet and off-balance sheet rural utility volume to recognize that on-balance sheet guarantee fee rates may need to be imputed from Farmer Mac's earnings spread, while off-balance sheet guarantee fee rates would always be contractually explicit. In each case, the intent is to isolate the earnings rate on the volume. In structuring the definition in this manner, we want to be clear that whether that earnings rate an explicitly set guarantee fee in a contract or not, we would apply the proposed credit risk multiple to Farmer Mac's net cash flow rate, i.e., either the contractual guarantee fee rate (in the case of off-balance sheet rural utility exposure) or Farmer Mac's earnings spread (in the case of on-balance sheet rural utility exposure). The earnings spread is the in-coming cash flow rate (as a percent of outstanding principal) minus Farmer Mac's total funding rate on that volume.

As a conforming technical change, we propose amending sections 1.0.a., 4.1.b., 4.2.b.(2), and 4.2.b.(3) of the model in Appendix A of part 652 to add rural utility guarantee fees.

2. Credit Risk

We propose to amend the model in Appendix A of part 652 to include rural utility program volume. We propose clarifying the applicability of individual sections of the model to the rural utility portfolio. We also propose adding new sections 2.6, 4.1.e., and 4.3.e. to calculate losses for rural utility loans. This proposed rule applies a stylized approach to characterizing credit risk for rural utility program volume by multiplying the dollar-weighted average rural utility guarantee fee by a factor of two to characterize average annual loss rates. A data set suitable to build a reliable default probability loss function was not available due to the fact that historical losses in the electric cooperative sub-sector of the utilities industry have been extremely rare. The industry is characterized by low frequency of default and instances of default appear largely unrelated to specific underwriting decisions. Further, even among that small proportion of historical instances of nonperforming loans in the data we obtained, restructured credit defaults have in many instances become more profitable with deferred obligations carried at accumulating rates higher than the loan interest rates. For that reason, an empirical frequency-based analog for estimating credit risk, as was used to arrive at the model's approach to estimating agricultural loan risks, is not feasible.

If there were no alternative but to use the available data set, rural utility loans' unique features (e.g., few loans, very large loan sizes, often with unique individual project features) would compel us to adjust for extreme value possibilities. Extreme value theory (EVT) employs methods to assign probability to possible outcomes in ranges beyond those included in the data. EVT provides a means to limit the relative probability assigned to sample outcomes and the probability assigned to ranges beyond the most extreme observed values. In such cases, simply relying on the empirical maximum loss value is not acceptable. For example, EVT is often applied by hydrologists who, when designing levees, are not satisfied with building protection against historical high-water marks when the maximum severity of water level in the historical data is not an acceptable level of protection to attain. Rather, they must protect against more severe high-water scenarios. However, in an EVT context, the wide divergence in the character of rural utility losses in the available data may have resulted in an even less reliable estimate of the “worst case” through a constructed limit under EVT theory. Therefore, we also rejected the EVT approach.

We next considered a cash-flow divergence (CFD) approach. A CFD approach would focus on losses related to the stress associated with delayed receipts of cash flows expected under the original amortization schedule. Even if the loan is ultimately profitable due to a restructuring, the CFD model would reflect the stress associated with funding the loan during the workout period. However, CFD models did not offer a reliable measure of loss experience that was significantly correlated with observable differences in loan underwriting characteristics in the data set.

Rather than basing the estimate of credit risk on data deemed unsuitable for reasons stated above, we propose to base a credit risk characterization on rural utility guarantee fees charged by Farmer Mac. We believe that the Farmer Mac rural utility guarantee fee represents the best available reference point, or benchmark, for quantifying credit risk because an alternative approach deemed acceptable for depicting the probability measures associated with default was not available. Version 4.0 (proposed) would impose stressed annual credit loss rates on loans in the rural utility portfolio by multiplying the dollar-weighted average rural utility guarantee fee by a factor of two. We discuss the rationale behind the selection of a factor of two in section III.C. of this preamble.

Farmer Mac bases its fees on an evaluation of credit-related variables associated with the loans and the interrelations among those variables, as well as the counterparties' access to alternative forms of liquidity through the capital markets (i.e., an analysis of return opportunities related to what the market will bear). Among the credit-related variables are the modified debt service coverage ratios, long-term, debt-to-net utility plant ratio, debt-to-equity ratio, guaranteed supply contracts in place (if any), the level of discretion the borrower has to set electric rates, and the level of diversification in the borrower's customer base. The guarantee fee is, in part, Farmer Mac's estimate of the long-term average annual credit losses, i.e., its assessment of average net credit risk embedded in those variables.

We propose a multiple of two be applied to the rural utility guarantee fees to represent stressed rural utility loan losses and to place the amount generally in the tail of the distribution (discussed more fully in section III.C. of this preamble). The multiple of two in this case is less than the value chosen to apply stress in the case of modifications to the GOA factors for general obligation risk mitigation on AgVantage Plus counterparties because in the case of the GOA factors we have good information on the historical average default rates—which we do not have in the case of rural utility loans. We propose using a multiple of the Farmer Mac rural utility guarantee fee as a proxy for loss rates because of the unsuitability of the data as discussed above. We recognize that the use of this loss rate proxy results in a different factor than in the case of the GOA factors. Our intent is to stress rural utility loss rates only and, since the proportion of the guarantee fees attributable to expected average annual losses will vary due to the necessarily coarse level of precision targeted in this treatment, we elected not to propose some portion of the guarantee fee as the assumed average credit risk coverage component. Such an approach would have added a level of calculation complexity that is disproportionate to the coarse level of precision achievable given data limitations. Therefore, we reduced the multiple we would have applied to a more precise average credit loss component of the guarantee fee (i.e., some percentage of the total fee times three) down to two times the entire guarantee fee. We believe the proposed approach is consistent with the statutory credit risk target for agricultural loans since it targets a range meant to approximate a reasonable but stylized worst-case scenario.

By basing the loss estimate on a factor that Farmer Mac controls (rural utility guarantee fee), Farmer Mac could manipulate its minimum capital requirement through its guarantee fee pricing. However, the natural alignment of incentives to build capital and grow earnings renders the scenario implausible. If Farmer Mac were capital constrained, the incentive to take on large volumes of significantly underpriced rural utility loan exposure is more than offset by counterbalancing pressures from the continuing level of the proposed loss proxy relative to any guarantee fee regardless of whether it is abnormally low (i.e., double that rate). For this reason, we view as extremely unlikely the scenario where Farmer Mac would reduce its guarantee fee below a level that might be appropriate for purposes of pricing the risk Farmer Mac assumes in the transaction in order to reduce the regulatory capital minimum requirement calculated on that volume. Further, additional offsetting pressures to this scenario can be found in the statutory leverage maximum requirements and ongoing oversight and supervisory risk monitoring by FCA, as well as Farmer Mac's internal control structures (also monitored by FCA).

Additionally, we note that while no new regulatory language is necessary, implicit in section 2.4 of the Appendix, is the proposal that if the contractual terms of an AgVantage Plus rural utility investment include overcollateral, it be treated in a manner consistent with the model's current treatment of such overcollateral in AgVantage Plus structures. Also consistent with current RBCST treatment, we propose that when rural utility loan pools submitted to Farmer Mac include overcollateral that is not contractually required, all submitted loans be modeled and the total pool loss estimate factored down proportionately. We further propose to apply no age adjustment to rural utility loss estimates because, unlike other credit loss estimates in the RBCST, rural utility loss rates are already characterized as average annual loss rates, not lifetime loss rates. Therefore, any aging affects are considered to be subsumed into that annual average. Finally, consistent with the proposed revisions to the GOA factors discussed below, we propose those GOA factors applied to rural utility AgVantage Plus volume be revised to reflect the relative concentration of rural utility loans in the portfolio of the issuer.

The proposed amendments to the model in Appendix A of part 652 discussed above includes amending the table of contents and section headings 2.1, 2.2, 2.3 and 2.5; adding new sections 2.6, 4.1.e., and 4.3.e.; and amending the contents of sections 2.0 and 4.2.b.(1)(A) to reflect the treatment of the rural utility authority. As conforming technical changes, we propose redesignating existing paragraphs (b)(5) and (b)(6) as (b)(6) and (b)(7) and adding a new paragraph (b)(5) to § 652.65 to indicate that the model in Appendix A of part 652 is to be used to calculate credit loss rates for rural utility loans.

B. Modification of the Treatment of Loans Backed by an Obligation of the Counterparty and Loans for Which Pledged Loan Collateral Volume Exceeds Farmer Mac-Guaranteed Volume [§§ 652.50 and 652.65(d); Appendix A to Part 652]

We propose to amend sections 2.4.b.3, 2.4.b.4, 4.1.f., and 4.2.b. of the model in Appendix A of part 652 to increase the GOA factors, address counterparty concentration risks, and ensure AgVantage Plus volume maturities are recognized in the model.

1. GOA Factors—Treatment of Loan Volume

In Version 3.0 of the RBCST, we established a treatment for program loan volume backed by the obligation of a counterparty under a general obligation (e.g., AgVantage Plus). The derivation and application of the GOA factors in the current version of the RBCST can be summarized as follows: (1) Five levels of credit ratings from “AAA” to “below BBB and unrated” that are mapped to the various NRSRO rating categories, which include pluses (“+”) and minuses (“−”) to the whole-letter categories; (2) apply default rate factors equal to the average cumulative issuer-weighted 10-year corporate default rates by whole letter category from 1920 through the most recent year, as published by Moody's Investor Services; (3) apply a factor equal to the 10-year corporate default rates on Speculative-Grade bonds published in the same report for issuers that are rated below BBB or are unrated; (4) adjust the rate to obtain an estimated loss rate related to a general obligation of the AgVantage Plus counterparty, with a given credit rating by considering the loss-severity rate as implied by senior unsecured bond recovery rates published in the same annual Moody's report (i.e., 1 minus recovery rate).

We now propose revising the GOA factors by stressing the historical corporate bond loss rates to levels intended to represent stressed conditions instead of average conditions. The proposed rule would modify the adjustment factors through the application of increases (or “haircuts”) to the estimated historical loss rates by whole-letter credit rating category. Currently, Version 3.0 effectively assumes that there is no relationship between agricultural stress and major stress on the issuer's overall financial condition (i.e., in industry sectors unrelated to agriculture to which the issuer also has significant exposure). Thus, the average corporate bond default and recovery rates are currently assumed to represent an appropriate degree of stress to that component of the model.

While we remain convinced of the appropriateness of the existing overall approach, we believe using the average default and recovery rates is not sufficiently conservative. A conclusion that, while not driven by it, is nevertheless underscored by the recent crisis in the financial services sector. Our proposed revisions to the GOA factor would change existing assumptions in Version 3.0 to recognize the potential scenario that agricultural stress and major stress on the issuer's overall financial condition could occur at the same time. That is, the proposed changes to the GOA factors would assume a degree of positive correlation between the financial strength of the issuer and the loans underlying AgVantage Plus issuance. A resulting assumption would be that an individual firm's default and recovery experience likely differs from the average experience of similarly rated firms across average historic conditions. The result would be a model representing a stressed loss scenario, not an average loss scenario.

The proposed treatment is consistent with a scenario under which Farmer Mac's risk increases as the value of the issuer's general obligation declines simultaneously with the value of the underlying loan collateral. The revised factors and their components are set forth in the table below:

As the table illustrates, we propose to increase the historical loss rates by a factor of three. As in the current RBCST version, these figures would be updated annually, or as an updated version of the Moody's report on Default and Recovery Rates of Corporate Bond Issuers becomes available. We discuss the rationale behind the selection of the factor in section III.C. of this preamble.

2. GOA Factors—Concentration Ratios

We also propose modifying GOA factors to recognize the risk associated with a counterparty's (also referred to as the AgVantage Plus issuer) loan portfolio concentration in the industry sector used in an AgVantage Plus issuance. We believe we should recognize a reduction in the risk-mitigating value of a counterparty's general obligation due specifically to its loan portfolio concentration in the same industry sector as the loans underlying an AgVantage Plus pool. We are proposing to estimate that by reducing the value of the GOA factors proportionate to the counterparty's exposure to that sector in its total portfolio. The proposed revision would recognize conditions that stress the underlying assets, as well as the counterparty's financial position generally. The proposed change is expected to simultaneously reduce the risk-mitigating value of both the underlying portfolio and the general obligation.

We further propose that the Director of OSMO (Director) make final determinations of concentration ratios on a case-by-case basis. These determinations would define industry sectors broadly when there is limited availability of concentration data of a given counterparty. Specifically, we propose modifying section 2.4.b.3.A. of Appendix A to allow the Director to make final determinations of concentration ratios on a case-by-case basis by using publicly reported data on counterparty portfolios, nonpublic data submitted and certified by Farmer Mac as part of its RBCST submissions, and generally recognizing two rural utility sectors-rural electric cooperatives and rural telephone cooperatives. The following are two illustrative examples of how the Director would generally arrive at such determinations. First, if the underlying AgVantage Plus portfolio were rural electric utility cooperative loans and the counterparty's loan and lease portfolio were publicly reported to contain 25-percent electric utility loans, the Director would likely determine the concentration ratio at 25 percent, absent any other unique aspects of the counterparty's business. Second, if an AgVantage Plus underlying portfolio of agricultural loans has a counterparty whose portion of agricultural loans is not disaggregated from some larger portfolio segment in its publicly available disclosures, the Director would use the most appropriate publicly disclosed aggregated portfolio data to set the concentration ratio. In this final example, Farmer Mac could obtain the disaggregated portfolio information and certify to its accuracy in its quarterly RBCST submission in lieu of the Director relying on publicly disclosed aggregated portfolio data.

This proposed approach would continue to accept that the GOA factors should recognize that there are two levels of risk mitigation provided to Farmer Mac by the AgVantage Plus structure: the issuer's general obligation to Farmer Mac and the value of the underlying loan collateral. The revised approach would further recognize the relative difference in an induced correlation between the parent obligor and the underlying collateral that is likely to arise through portfolio concentrations. It would also scale the GAO factors for counterparty portfolio concentrations to reflect the Agency's view that the correlation between a significant decline in a highly concentrated issuer's overall financial condition and the underlying AgVantage Plus loan portfolio is likely to be high relative to a more diversified counterparty.

3. Technical Changes

We propose to amend § 652.50 by adding a definition for “AgVantage Plus” to clarify that, while “AgVantage Plus” is a product name used by Farmer Mac, we propose applying it throughout this subpart to refer both specifically to AgVantage Plus volume currently in Farmer Mac's portfolio as well as other similarly structured program volume that Farmer Mac might finance in the future under other names. We also propose conforming changes to the model at Appendix A of part 652 to replace the term “Off-Balance Sheet AgVantage” with “AgVantage Plus.”

Since the introduction of the AgVantage product, volume has accumulated through a few very large individual deals as opposed to a constant, steady deal-flow. However, we do not believe it is reasonable to assume that such volume would backfill on a steady-state basis because there has not been sufficient historical experience demonstrating the incidence of AgVantage Plus volume renewing into similar structures at the termination of existing deals. Therefore, as additional clarifying changes, we propose adding to paragraph (d)(2) of § 652.65 a statement that AgVantage Plus volume is not replaced when it matures. We also propose explaining in the parenthetical of section 4.2.b. of the Appendix A that, while the stress test is run as a “steady state,” AgVantage Plus volume maturities will be recognized by the model.

C. Using Two Different Multiples of Externally Referenced Benchmarks To Represent Stressed Default Risk

In two of the proposed revisions, we use multiples of external points of reference (or “benchmark measurements”) of average expected loss. Those revisions are: (1) Establishing a representation of rural utility credit losses, and (2) adjusting the GOA factors by stressing the historical corporate bond loss rates to levels intended to represent worst-case stress conditions. In both cases, the multiples were selected on the basis of the availability of historical information related to credit losses (or lack thereof in the case of rural utility loans) and the Agency's overarching intent to represent losses in a reasonable worst-case context. We refer to that targeted worst-case scenario as the level of loss “in the tail” of any given probability distribution. The statistical vernacular “in the tail” represents a level of loss severity sufficiently extreme that it would be a very low probability event. Targeting a low probability loss event (i.e., a scenario of very high losses, relatively) can be equivalently thought of as a high probability of capital adequacy (i.e., Farmer Mac's solvency) even under severe loss conditions. While the relative terms “high” and “low” remain unquantified targets thus far in the discussion, we now provide a generalized probabilistic description of the Agency's view of capital adequacy for purposes of these proposed revisions.

The proposed revisions reflect the Agency's targeting a high confidence level (i.e., it has been noted that AA ratings often are used interchangeably with concepts like a 99.7 percent confidence level, or the level of probability below which an insolvency scenario would not be expected to occur). We refer to this description as “generalized” because the calculation of the relevant probabilities is entirely dependent on the amount of information and data available to the Agency, and overreliance on a highly variable measure can induce unintended modeling variability and error. When the information and data are insufficient to draw specific inferences from the data, we can still use statistical theory to make generalized statements about probability if certain conditions are met. In the present context, the proposed multiples are used with the intent to target loss events that could be reasonably viewed as being “in the tail” of the distribution, without providing a false sense of accuracy based on data whose characteristics could be overly sensitive to small changes in experiences or assumptions. We believe our approach places the post-haircut corporate bond loss estimate in a range that provides a meaningfully stressful representation, consistent with possibly limited data, and reflects generally accepted statistical principles and relationships. If, for example, the coefficient of variation were equal to one, placement of the haircut loss rate estimate would be at a point on the distribution that generally corresponds to three standard deviations from the mean, which also corresponds to the 99.7-percent confidence level. Targeting the placement in this range is meant to be consistent with the Act's credit risk targets for agricultural loans, which directs us to focus on not less than a 2-year worst-case historical loss experience in agricultural lending.

Mathematical identification and reliability issues limit our ability to make specific statements regarding how to represent the loss probability. However, we can place some limits on the probability distances in any loss distribution through statistical relationships such as Chebychev's theorem—which holds that the proportion of observations within some number of standard deviations from the mean must be at least some specific percentage, regardless of the shape of the distribution. This allows us to draw conclusions (though at a fairly coarse level) about the probability of events, even when we do not know the mean or the level of variation around the mean (or both) of the event we are trying to model.

The multiple of three was selected for the GOA factors based on the recognition that the average historical default and recovery rates within each whole-letter rating category as reported by Moody's provide a measure of central tendency that summarizes the varied individual experiences of investors who purchased bonds within each rating category at each point in time. If we were to apply a multiple using implications of Chebchev's theorem to the GOA factor, the specific quantitative proportions involved in Chebychev's theorem would require a multiple of 19 or perhaps even higher in order to achieve the targeted confidence level (99.7 percent). We deemed this approach too conservative. However, if we assume the distribution is normal with a ceofficient of variation of 1, then a multiple of 3 is required to achieve the targeted confidence level. While we cannot directly observe the variation of default rates within each rating category (or recovery rates among senior secured borrowers within each year), the coefficients of variation of the time series of annual default rates in Moody's 2008 report vary from roughly two to three within the range of ratings AA to the speculative grade group through time. Like Chebychev's theorem, we can also reasonably assume that the time series variation provides a lower bound on the cross sectional variation, were it observable, and that the proposed multiple is therefore not particularly aggressive.

D. Revise Haircuts on Non-Program Investments [Appendix A to Part 652]

We propose changing the haircut levels for non-program investments in existing section 4.1.e. of Appendix A, renumbering the section as 4.1.f. Specifically, we propose revising these haircut levels to the same loss rate adjustment factors proposed for application on loans underlying guaranteed notes (i.e., AgVantage Plus) as discussed in section III.B.1 of this preamble. The proposed investment haircuts to recognize counterparty risk are as follows:

We likewise propose to update these figures annually, or as an updated version of the Moody's report on Default and Recovery Rates of Corporate Bond Issuers becomes available, just as we proposed for loss rate adjustment factors on loans underlying guaranteed notes.

IV. Impact of the Proposed Revisions on Required Capital

We have evaluated the impact of the proposed changes to Version 3.0 of the model. Our review indicates that changes related to the reclassification of rural utility volume as program business and the associated required application of worst-case credit risk, along with the recognition of more limited risk-mitigation in the counterparty's general obligation, would have the most significant impact on risk-based capital calculated by the model. The table below provides an indication of the impacts of the revisions in the quarter ended March 31, 2009.

As the table shows, the individual estimated impacts do not have an additive relationship to the total impact on the model output. This is due to the interrelationship of the changes with one another when they are combined in Version 4.0 (proposed). It is worth noting that the marginal effects are also not constant rate effects, but depend on the starting conditions and earnings spread of Farmer Mac and the magnitude of the effect considered. For example, as the volume in the rural utility category is increased, the rate of increase in the marginal minimum risk-based capital requirement begins to increase as the downward-pressure on that rate exerted by earnings from other activities are further diluted as those earnings become increasingly smaller in proportion to total estimated losses. The same effect is evident in other ways as risk increases and the offsetting effect of earnings is diminished relative to increased risk. For example, this effect would be observed, all else equal, with lower initial earnings spreads or higher AgVantage Plus counterparty concentrations, updated (and higher) Moody's base corporate bond default rates, or ratings downgrades. Thus, the values in the table above are illustrative of the relative effects of the proposals in this rulemaking, given the conditions at March 2009, but can be materially affected by changes in starting conditions or risk compositions through time.

V. Regulatory Flexibility Act

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

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 proposed to be 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.

Subpart B—Risk-Based Capital Requirements

2. Amend § 652.50 by adding alphabetically the following definitions: