Federal Register: July 26, 2000 (Volume 65, Number 144)

DOCID: FR Doc 00-18873

SUBJECT CATEGORY:

Loan Policies and Operations; Definitions; Loan Purchases and Sales

DATES: You may send us comments by September 25, 2000.

DOCUMENT SUMMARY:

We propose revisions to our regulations on loan participations to allow Farm Credit System (System or FCS) institutions greater flexibility to buy loan participations from nonSystem lenders under certain conditions. We propose to remove the existing 10percent retention requirement when loan servicing remains with a nonSystem seller. We also propose removing two restrictive definitions of ``loan participation'' in order to enable System institutions to use their full statutory authority for loan participations. Also, we are proposing technical and clarifying changes related to System institutions' participation authorities.

SUMMARY:

Loan policies and operations—; Loan purchases and sales; definitions,

SUPPLEMENTAL INFORMATION

I. Objective

The objective of this proposed rule is to increase the availability and efficiency of providing agricultural credit by providing greater flexibility for System institutions to engage in loan participations with other System institutions and nonSystem lenders. We expect that the proposed rule will promote more cooperative alliances and business ventures with commercial banks and other lenders.

This proposed rule is part of our efforts to carry out the Board's Philosophy Statement of July 14, 1998. Added regulatory flexibility should increase the efficient flow of funds to agriculture and rural America while helping ensure the continued availability of adequate and competitive agricultural credit. The proposed changes should also contribute to diversification of the portfolios of individual System institutions and nonSystem lenders, enabling them to better withstand stress conditions in agriculture.

II. Summary

The proposed rule would enable FCS institutions to use existing statutory authorities to support rural America through loan participation agreements with System and nonSystem lenders. The Farm Credit Act of 1971, as amended (Act) does not define the terms ``participate'' or ``participation,'' other than in a special definition contained in section 3.1(11)(B)(iv) of the Act. We have broad authority to define terms used in the Act, and used our authority to provide a general regulatory definition of the term ``loan participation'' in present Secs. 614.4325(a)(4) and 619.9195. However, the two regulatory definitions contained in Secs. 614.4325(a)(4) and 619.9195 are more restrictive than the Act requires. The proposed rule would remove these restrictive definitions and enable System institutions to use their full statutory authority for loan participations with System and nonSystem lenders.

Other Federal bank regulators have, over the past several years, effectively defined loan participations to include 100percent interests in loans. In addition, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision adopted an interagency statement providing guidance for 100percent participations.\1\ We propose removing our restrictive definitions to ensure that System institutions have the flexibility to interpret their loan participation authorities in the context of current banking practices. Therefore, we propose removing the existing regulatory definitions of ``loan participation'' contained in parts 614 and 619. We do not propose any change in the regulatory definition of ``participate'' and ``participation'' in Sec. 613.3300(a), which reflects the definition contained in section 3.1(11)(B)(iv) of the Act, pertaining to the ``similar entity'' participation authorities. \1\ ``Interagency Statement on Sales of 10% Loan

Participations'' (April 10, 1997).]

In addition, we propose removing a 10percent retention requirement that applies to System institutions buying participations from nonFCS institutions when the seller keeps the servicing rights of the loans. Finally, we propose clarifying the authorities for participation agreements between the Federal Agricultural Mortgage Corporation (Farmer Mac) and other FCS institutions or other lenders.

III. Revised Definitions of Participations

The Act does not provide a specific definition of a loan participation other than that contained in section 3.1(11)(B)(iv), concerning ``similar entity'' participations. Nevertheless, we previously provided more narrow regulatory definitions than required by the statute.

Our prior view was that a loan participation had to be a ``fractional'' undivided interest, something less than 100 percent.\2\ On review of the statutory provisions on participations, we have concluded that the Act does not require this result. Section 1.5 of the Act
[[Page 45932]]
provides that Farm Credit Banks, ``subject to regulation by the Farm Credit Administration, shall have power to . . . make, participate in, and discount loans'' and may ``participate with'' other financial institutions in loans authorized under the Act. There are no limitations on the percentage of a loan in which a bank may participate. Similarly, sections 2.2 and 3.1 of the Act provide, respectively, that a production credit association ``may make and participate in loans'' and a bank for cooperatives may ``participate in loans,'' subject to regulation by the FCA. Nowhere does the Act provide that a participation interest must be less than 100 percent. \2\ We expressed this position in the preamble of the proposed Lending Authorities regulations of January 1991 (56 FR 2452, Jan. 23, 1991).

Therefore, we are proposing to remove the regulatory definitions of loan participation in Secs. 614.4325(a)(4) and 619.9195 to provide more flexibility to System institutions to make better use of existing statutory participation authorities. With this proposed rule we recognize the banking industry's understanding of loan participations as including all or some portion of a loan.

In 1984 the OCC issued a banking circular \3\ that provides that loan participations can include 100 percent of a loan. The OCC issued its banking circular to address safety and soundness concerns associated with loan purchases and participations. In the circular, the OCC described a loan participation as an arrangement in which a bank makes a loan to a borrower and then sells all or a portion of that loan to a purchasing bank. The circular distinguished a participation from a multibank loan transaction (syndicated loan).
\3\ OCCBC181 ``Purchases of Loans in Whole or in Part

Participations'' (August 2, 1984).

The other Federal banking regulators issued an interagency statement on sales of 100percent participations on April 10, 1997. The interagency statement discussed the features of 100percent loan participations in light of a 1992 court decision \4\ that concluded that such participations did not involve the sale of securities under federal securities laws. The interagency statement also identified and discussed related safety and soundness concerns such as heightened legal, reputation, and compliance risks.
\4\ Banco Espanol De Credito v. Security Pacific National Bank, 973 F.2d 51 (2nd Cir. 1992).

The OCC's banking circular contained loan participation guidelines addressing safety and soundness concerns. We have adopted similar guidelines, including the requirement that a buying participant exercise an independent credit judgment as part of our general regulatory guidance for loan purchases and participations.

IV. Proposal Removes 10Percent Retention Requirement

Section 614.4330(b) generally requires that any nonSystem lender that sells a loan participation to a System institution but continues to service the loan must retain at least 10 percent of the principal amount of the loan, or the seller's legal lending limit, whichever is less. We imposed this regulatory requirement to ensure the nonSystem seller and servicer would maintain appropriate controls for loans sold to System participants.

Because of changes in the financial markets, the System's growing experience with loan participations, and to enable FCS institutions to effectively use their existing statutory participation authorities, we now propose removing this retention requirement. This change will facilitate the use of 100percent participations and allow the participation agreement to provide for loan servicing. However, compensating management controls will be needed to mitigate possible increased risk the added flexibility offers.
V. Characteristics of Typical Participations and Loan Purchases A. Participations and Loan Purchases

Participations are commonly used when a lender makes a loan and then wishes to sell all of or a portion of the loan. In a
participation, the originating lender typically sets up the lending relationship with the borrower and obtains the promissory note, loan agreement and supporting security documents in its name. The participating lender receives an interest in the loan and its collateral through a loan participation agreement and participation certificate.

In contrast, in a typical loan purchase, the buyer, through the purchase agreement, is assigned all rights included in the legal documents, security instruments, and rights to collateral. The buyer assumes the legal lender relationship with the borrower and arranges loan repayment, servicing, and as necessary collection, either directly with the borrower or contractually through an agent.

In typical loan participations all documentation for the loan is between the borrower and the originating lender, and the originating lender has the sole contact with the borrower. The borrower and participant have no direct relationship and there is no contract between the two parties. Therefore, the participant normally must rely on the seller to enforce the terms of the documents between the originating lender and the borrower.

B. Advantages of Participations

Some of the principal advantages of participations are:

Lending limit relief for the seller,

Increased liquidity for the seller,

Reduced concentration risk for both the buyer and seller through greater portfolio diversification,

Increased fee income opportunities,

Access to external credit expertise and new and diverse markets,

Improved capital adequacy management for both the buyer and seller, and

Better use of the buyer's excess funds.

C. Controlling Risk of Participations

There are risk control issues that can arise with loan participations. Some of these are typical of any credit arrangement. However, expanding the definition of a loan participation to include 100percent participations can increase certain types of risks if not controlled and managed appropriately.

Therefore, we believe that System institutions should take extra care in developing the policies and procedures for their participation programs if they intend to buy 100percent participations. An institution's policies and procedures and participation agreements should, at a minimum, address the following risks:

1. Credit riskThe participant depends on the originating lender to obtain, develop, and evaluate the relevant information about the borrower and the structure of the credit.

2. Legal riskThe originating lender typically prepares the documentation for the loan and perfects any security interests. The participant generally has a share of the rights of the originating lender. If deficiencies exist, the participant's rights may be limited.

3. Administrative riskTypically, the participant must rely on the originating lender to (a) service, monitor, and control the credit relationship with the borrower, (b) provide information about the borrower, and (c) remit payments received from the borrower. However, all of the aforementioned administrative actions must be addressed in the participation agreement as well as the parties' duties and responsibilities.

A participant's administrative risk increases when the originating lender has no direct financial interest in the loan. The proposed removal of the 10percent retention requirement increases this risk. The participation agreement should specifically address whether the [[Page 45933]]
seller has the ability, and under what circumstances, to transfer or sell the note or agreement to a third party without concurrence by the participant.

D. Managing Portfolio Risk

Our current regulations require each System institution involved in loan participation activities to develop and implement policies and procedures for such programs, including establishing appropriate portfolio limits to control portfolio risk.

While participations offer a number of advantages to an institution's portfolio (especially as risk diversification tools) they also carry additional risks not common to a normal borrower/lender relationship. We believe policy direction from a System institution's board of directors becomes even more important with these proposed changes. Portfolio limitations should be reviewed by the institution's board to ensure loan participations are appropriately integrated into the institution's overall business plan and risk management strategies. VI. Farmer Mac Related Participation Authorities

In response to a question raised by Farmer Mac,\5\ we propose a change in the authorities contained in part 614, subpart A, of the regulations. The Act provides that banks and associations can enter into participation arrangements with other System institutions, which by definition includes Farmer Mac. However, our present regulations do not reflect this fact. Farmer Mac was given authority to buy, sell, hold, or assign loans after the present regulations were written. Therefore, we propose to revise the authority regulations in part 614, subpart A, to clarify the loan participation authorities of System banks and associations and Farmer Mac.
\5\ Farmer Mac, in a letter dated October 26, 1999, requested that we modify our regulations to recognize Farmer Mac authority to sell loan participations to System Institutions.

VII. Technical and Conforming Changes

We are also proposing certain technical and conforming changes to the regulations.
List of Subjects

12 CFR Part 614

Agriculture, Banks, Banking, Flood insurance, Foreign trade, Reporting and recordkeeping requirements, Rural areas.
12 CFR Part 619

Agriculture, Banks, Banking, Rural areas.

For the reasons stated in the preamble, we propose to amend parts 614 and 619 of chapter VI, title 12 of the Code of Federal Regulations as follows:

PART 614LOAN POLICIES AND OPERATIONS

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

Authority: 42 U.S.C. 4012a, 4104a, 4104b, 4106, and 4128; secs. 1.3, 1.5, 1.6, 1.7, 1.9, 1.10, 1.11, 2.0, 2.2, 2.3, 2.4, 2.10, 2.12, 2.13, 2.15, 3.0, 3.1, 3.3, 3.7, 3.8, 3.10, 3.20, 3.28, 4.12, 4.12A, 4.13, 4.13B, 4.14, 4.14A, 4.14C, 4.14D, 4.14E, 4.18, 4.18A, 4.19, 4.25, 4.26, 4.27, 4.28, 4.36, 4.37, 5.9, 5.10, 5.17, 7.0, 7.2, 7.6, 7.8, 7.12, 7.13, 8.0, 8.5 of the Farm Credit Act (12 U.S.C. 2011, 2013, 2014, 2015, 2017, 2018, 2019, 2071, 2073, 2074, 2075, 2091, 2093, 2094, 2097, 2121, 2122, 2124, 2128, 2129, 2131, 2141, 2149, 2183, 2184, 2199, 2201, 2202, 2202a, 2202c, 2202d, 2202e, 2206, 2206a, 2207, 2211, 2212, 2213, 2214, 2219a, 2219b, 2243, 2244, 2252, 2279a, 2279a2, 2279b, 2279c1, 2279f, 2279f1, 2279aa, 2279aa5); sec. 413 of Pub. L. 100233, 101 Stat. 1568, 1639.
Subpart ALending Authorities

2. Amend Sec. 614.4000 as follows:

a. Remove the word ``and'' at the end of paragraph (d)(1);

b. Remove the ``.'' and add ``; and'' at the end of paragraph (d)(2); and

c. Add paragraph (d)(3) to read as follows:
Sec. 614.4000 Farm Credit Banks.
* * * * *
(d)(3) The Federal Agricultural Mortgage Corporation to the extent provided in Sec. 614.4055.
* * * * *

3. Amend Sec. 614.4010 as follows:

a. Remove the word ``and'' at the end of paragraph (e)(1);

b. Remove the ``.'' and add ``; and'' at the end of paragraph (e)(2); and

c. Add paragraph (e)(3) to read as follows:
Sec. 614.4010 Agricultural credit banks.
* * * * *
(e)(3) The Federal Agricultural Mortgage Corporation to the extent provided in Sec. 614.4055.
* * * * *

4. Amend Sec. 614.4020 as follows:

a. Remove the ``.'' and add ``; and'' at the end of paragraph (b)(2); and

b. Add paragraph (b)(3) to read as follows:
Sec. 614.4020 Banks for cooperatives.
* * * * *
(b)(3) The Federal Agricultural Mortgage Corporation to the extent provided in Sec. 614.4055.

5. Amend Sec. 614.4030 as follows:

a. Remove the word ``and'' at the end of paragraph (b)(1);

b. Remove the ``.'' and add ``; and'' at the end of paragraph (b)(2); and

c. Add paragraph (b)(3) to read as follows:
Sec. 614.4030 Federal land credit associations.
* * * * *
(b)(3) The Federal Agricultural Mortgage Corporation to the extent provided in Sec. 614.4055.
* * * * *

6. Amend Sec. 614.4040 as follows:

a. Remove the word ``and'' at the end of paragraph (b)(1);

b. Remove the ``.'' and add ``; and'' at the end of paragraph (b)(2); and

c. Add paragraph (b)(3) to read as follows:
Sec. 614.4040 Production credit associations.
* * * * *
(b)(3) The Federal Agricultural Mortgage Corporation to the extent provided in Sec. 614.4055.
* * * * *

7. Amend Sec. 614.4050 as follows:

a. Remove the word ``and'' at the end of paragraph (c)(1);

b. Remove the ``.'' and add ``; and'' at the end of paragraph (c)(2); and

c. Add paragraph (c)(3) to read as follows:
Sec. 614.4050 Agricultural credit associations.
* * * * *
(c)(3) The Federal Agricultural Mortgage Corporation to the extent provided in Sec. 614.4055.
* * * * *

8. Add a new Sec. 614.4055 to read as follows:
Sec. 614.4055 Federal Agricultural Mortgage Corporation loan participations.

Subject to the requirements of subpart H of this part 614: (a) Any Farm Credit System bank or direct lender association may buy from, and sell to, the Federal Agricultural Mortgage Corporation, participation interests in ``qualified loans.''
(b) The Federal Agricultural Mortgage Corporation may buy from, and sell to, any Farm Credit System bank or direct lender association, or lender that is not a Farm Credit System institution, participation interests in ``qualified loans.''
(c) For purposes of this section, ``qualified loans'' means qualified loans as defined in section 8.0(9) of the Act.
Subpart HLoan Purchases and Sales

9. Amend Sec. 614.4325 by:

a. Removing paragraph (a)(4);

[[Page 45934]]

b. Redesignating paragraphs (a)(5), (a)(6), and (a)(7) as paragraphs (a)(4), (a)(5), and (a)(6), respectively; and revising newly designated paragraph (a)(4) to read as follows:
Sec. 614.4325 Purchase and sale of interests in loans.
* * * * *
(a)(4) Participating institution means an institution that purchases a participation interest in a loan originated by another lender.
* * * * *
Sec. 614.4330 [Amended]

10. Amend Sec. 614.4330 as follows:

a. Remove the words ``an undivided'' and add in their place the words ``a participation'' in paragraph (a)(9); and

b. Remove paragraph (b) and redesignate existing paragraph (c) as paragraph (b).
Subpart JLending and Leasing Limits
Sec. 614.4358 [Amended]

11. Amend Sec. 614.4358 as follows:

a. Remove paragraph (b)(4)(i); and

b. Redesignate paragraphs (b)(4)(ii) and (b)(4)(iii) as paragraphs (b)(4)(i) and (b)(4)(ii), respectively.

PART 619DEFINITIONS

12. The authority citation for part 619 continues to read as follows:

Authority: Secs. 1.7, 2.4, 4.9, 5.9, 5.12, 5.17, 5.18, 7.0, 7.6, 7.7, 7.8 of the Farm Credit Act (12 U.S.C. 2015, 2075, 2160, 2243, 2246, 2252, 2253, 2279a, 2279b, 2279b1, 2279b2).
Sec. 619.9195 [Removed and Reserved]

13. Remove and reserve Sec. 619.9195.

Dated: July 20, 2000.
Kelly Mikel Williams,
Secretary, Farm Credit Administration Board.
[FR Doc. 0018873 Filed 72500; 8:45 am] BILLING CODE 670501P

FOR FURTHER INFORMATION CONTACT

Dennis K. Carpenter, Senior Policy Analyst, Office of Policy and Analysis, Farm Credit Administration, McLean, VA 221025090, (703) 883 4498, TDD (703) 8834444,
or
James M. Morris, Senior Counsel, Office of General Counsel, Farm Credit Administration, McLean, VA 221025090, (703) 8834020, TDD (703) 883 4444.

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