Appendix A to Subpart B of Part 652 - Risk-Based Capital Stress Test
12:7.0.1.2.33.2.11.14.6 : Appendix A
Appendix A to Subpart B of Part 652 - Risk-Based Capital Stress
Test 1.0 Introduction. 2.0 Credit Risk. 2.1 Loss-Frequency and
Loss-Severity Models for All Types of Loans, Except Rural Utility
Loans. 2.2 Loan-Seasoning Adjustment for All Types of Loans, Except
Rural Utility Loans. 2.3 Example Calculation of Dollar Loss on One
Loan for All Types of Loans, Except Rural Utility Loans. 2.4
Treatment of Loans Backed by an Obligation of the Counterparty and
Loans for Which Pledged Loan Collateral Volume Exceeds Farmer
Mac-Guaranteed Volume. 2.5 Calculation of Loss Rates for Use in the
Stress Test for All Types of Loans, Except Rural Utility Loans. 2.6
Calculation of Loss Rates on Rural Utility Volume for Use in the
Stress Test. 3.0 Interest Rate Risk. 3.1 Process for Calculating
the Interest Rate Movement. 4.0 Elements Used in Generating
Cashflows. 4.1 Data Inputs. 4.2 Assumptions and Relationships. 4.3
Risk Measures. 4.4 Loan and Cashflow Accounts. 4.5 Income
Statements. 4.6 Balance Sheets. 4.7 Capital. 5.0 Capital
Calculations. 5.1 Method of Calculation. 1.0 Introduction
a. Appendix A provides details about the risk-based capital
stress test (stress test) for Farmer Mac. The stress test
calculates the risk-based capital level required by statute under
stipulated conditions of credit risk and interest rate risk. The
stress test uses loan-level data from Farmer Mac's agricultural
mortgage portfolio or proxy data as described in section 4.1 d.(3)
below, as well as quarterly Call Report and related information to
generate pro forma financial statements and calculate a risk-based
capital requirement. The stress test also uses historic
agricultural real estate mortgage performance data, rural utility
guarantee fees, relevant economic variables, and other inputs in
its calculations of Farmer Mac's capital needs over a 10-year
period.
b. Appendix A establishes the requirements for all components of
the stress test. The key components of the stress test are:
Specifications of credit risk, interest rate risk, the cashflow
generator, and the capital calculation. Linkages among the
components ensure that the measures of credit and interest rate
risk pass into the cashflow generator. The linkages also transfer
cashflows through the financial statements to represent values of
assets, liabilities, and equity capital. The 10-year projection is
designed to reflect a steady state in the scope and composition of
Farmer Mac's assets.
2.0 Credit Risk
Loan loss rates are determined by applying the loss-frequency
equation and the loss-severity factor to Farmer Mac loan-level
data. Using this equation and severity factor, you must calculate
loan losses under stressful economic conditions assuming Farmer
Mac's portfolio remains at a “steady state.” Steady state assumes
the underlying characteristics and risks of Farmer Mac's portfolio
remain constant over the 10 years of the stress test. Loss rates
discussed in this section apply to all loans, unless otherwise
indicated. Loss rates are computed from estimated dollar losses for
use in the stress test. The loan volume subject to loss throughout
the stress test is then multiplied by the loss rate. Lastly, the
stress test allocates losses to each of the 10 years assuming a
time pattern for loss occurrence as discussed in section 4.3, “Risk
Measures.”
2.1 Loss-Frequency and Loss-Severity Models for All Types of Loans,
Except Rural Utility Loans
a. Credit risks are modeled in the stress test using historical
time series loan-level data to measure the frequency and severity
of losses on agricultural mortgage loans. The model relates loss
frequency and severity to loan-level characteristics and economic
conditions through appropriately specified regression equations to
account explicitly for the effects of these characteristics on loan
losses. Loan losses for Farmer Mac are estimated from the resulting
loss-frequency equation combined with the loss-severity factor by
substituting the respective values of Farmer Mac's loan-level data
or proxy data as described in section 4.1 d.(3) below, and applying
stressful economic inputs.
b. The loss-frequency equation and loss-severity factor were
estimated from historical agricultural real estate mortgage loan
data from the Farm Credit Bank of Texas (FCBT). Due to Farmer Mac's
relatively short history, its own loan-level data are
insufficiently developed for use in estimating the default
frequency equation and loss-severity factor. In the future,
however, expansions in both the scope and historic length of Farmer
Mac's lending operations may support the use of its data in
estimating the relationships.
c. To estimate the equations, the data used included FCBT loans,
which satisfied three of the four underwriting standards Farmer Mac
currently uses (estimation data). The four standards specify: (1)
The debt-to-assets ratio (D/A) must be less than 0.50, (2) the
loan-to-value ratio (LTV) must be less than 0.70, (3) the
debt-service-coverage ratio (DSCR) must exceed 1.25, (4) and the
current ratio (current assets divided by current liabilities) must
exceed 1.0. Furthermore, the D/A and LTV ratios were restricted to
be less than or equal to 0.85.
d. Several limitations in the FCBT loan-level data affect
construction of the loss-frequency equation. The data contained
loans that were originated between 1979 and 1992, but there were
virtually no losses during the early years of the sample period. As
a result, losses attributable to specific loans are only available
from 1986 through 1992. In addition, no prepayment information was
available in the data.
e. The FCBT data used for estimation also included as performing
loans, those loans that were re-amortized, paid in full, or merged
with a new loan. Including these loans may lead to an
understatement of loss-frequency probabilities if some of the
re-amortized, paid, or merged loans experience default or incur
losses. In contrast, when the loans that are re-amortized, paid in
full, or merged are excluded from the analysis, the loss-frequency
rates are overstated if a higher proportion of loans that are
re-amortized, paid in full, or combined (merged) into a new loan
are non-default loans compared to live loans. 1
1 Excluding loans with defaults, 11,527 loans were active and
7,515 loans were paid in full, re-amortized or merged as of 1992. A
t-test 2 of the differences in the means for the group of defaulted
loans and active loans indicated that active loans had
significantly higher D/A and LTV ratios, and lower current ratios
than defaulted loans where loss occurred. These results indicate
that, on average, active loans have potentially higher risk than
loans that were re-amortized, paid in full, or merged.
f. The structure of the historical FCBT data supports estimation
of loss frequency based on origination information and economic
conditions. Under an origination year approach, each observation is
used only once in estimating loan default. The underwriting
variables at origination and economic factors occurring over the
life of the loan are then used to estimate loan-loss frequency.
g. The final loss-frequency equation is based on origination
year data and represents a lifetime loss-frequency model. The final
equation for loss frequency is:
p = 1/(1 + exp(−(BX)) Where: BX = (−12.62738) + 1.91259 · X1 +
(−0.33830) · X2 / (1 + 0.0413299)Periods + (−0.19596) · X3 +
4.55390 · (1−exp((−0.00538178) · X4) + 2.49482 · X5 Where: • p is
the probability that a loan defaults and has positive losses (Pr (Y
= 1 | x)); • X1 is the LTV ratio at loan origination raised to the
power 5.3914596; 2
2 Loss probability is likely to be more sensitive to changes in
LTV at higher values of LTV. The power function provides a
continuous relationship between LTV and defaults.
• X2 is the largest annual percentage decline in FCBT farmland
values during the life of the loan dampened with a factor of
0.0413299 per year; 3
3 The dampening function reflects the declining effect that the
maximum land value decline has on the probability of default when
it occurs later in a loan's life.
• X3 is the DSCR at loan origination; • X4 is 1 minus the
exponential of the product of negative 0.00538178 and the original
loan balance in 1997 dollars expressed in thousands; and • X5 is
the D/A ratio at loan origination.
h. The estimated logit coefficients and p-values are: 4
4 The nonlinear parameters for the variable transformations were
simultaneously estimated using SAS version 8e NLIN procedure. The
NLIN procedure produces estimates of the parameters of a nonlinear
transformation for LTV, dampening factor, and loan-size variables.
To implement the NLIN procedure, the loss-frequency equation and
its variables are declared and initial parameter values supplied.
The NLIN procedure is an iterative process that uses the initial
parameter values as the starting values for the first iteration and
continues to iterate until acceptable parameters are solved. The
initial values for the power function and dampening function are
based on the proposed rule. The procedure for the initial values
for the size variable parameter is provided in an Excel spreadsheet
posted at http://www.fca.gov. The Gauss-Newton method is the
selected iterative solving process. As described in the preamble,
the loss-frequency function for the nonlinear model is the negative
of the log-likelihood function, thus producing maximum likelihood
estimates. In order to obtain statistical properties for the
loss-frequency equation and verify the logistic coefficients, the
estimates for the nonlinear transformations are applied to the FCBT
data and the loss-frequency model is re-estimated using the SAS
Logistic procedure. The SAS procedures, output reports and Excel
spreadsheet used to estimate the parameters of the loss-frequency
equation are located on the Web site http://www.fca.gov.
Coefficients
p-value
Intercept
−12.62738
<0.0001
X1: LTV
variable
1.91259
0.0001
X2: Max land value
decline variable
0.33830
<0.0001
X3: DSCR
−0.19596
0.0002
X4: Loan size
variable
4.55390
<0.0001
X5: D/A ratio
2.49482
<0.0000
i. The low p-values on each coefficient indicate a highly
significant relationship between the probability ratio of loan-loss
frequency and the respective independent variables. Other
goodness-of-fit indicators are:
Hosmer and
Lemeshow goodness-of-fit p-value
0.1718
Max-rescaled R
2
0.2015
Concordant
85.2%
Disconcordant
12.0%
Tied
2.8%
j. These variables have logical relationships to the incidence
of loan default and loss, as evidenced by the findings of numerous
credit-scoring studies in agricultural finance. 5 Each of the
variable coefficients has directional relationships that
appropriately capture credit risk from underwriting variables and,
therefore, the incidence of loan-loss frequency. The frequency of
loan loss was found to differ significantly across all of the loan
characteristics and lending conditions. Farmland values represent
an appropriate variable for capturing the effects of exogenous
economic factors. It is commonly accepted that farmland values at
any point in time reflect the discounted present value of expected
returns to the land. 6 Thus, changes in land values, as expressed
in the loss-frequency equation, represent the combined effects of
the level and growth rates of farm income, interest rates, and
inflationary expectations - each of which is accounted for in the
discounted, present value process.
5 Splett, N.S., P. J. Barry, B. Dixon, and P. Ellinger. “A Joint
Experience and Statistical Approach to Credit Scoring,”
Agricultural Finance Review, 54(1994):39-54.
6 Barry, P. J., P. N. Ellinger, J. A. Hopkin, and C. B. Baker.
Financial Management in Agriculture, 5th ed., Interstate
Publishers, 1995.
k. When applying the equation to Farmer Mac's portfolio, you
must get the input values for X1, X3, X4, and X5 for each loan in
Farmer Mac's portfolio on the date at which the stress test is
conducted, using either submitted data or proxy data as described
in section 4.1 d.(3) below. For the variable X2, the stressful
input value from the benchmark loss experience is −23.52 percent.
You must apply this input to all Farmer Mac loans subject to loss
to calculate loss frequency under stressful economic conditions. 7
The maximum land value decline from the benchmark loss experience
is the simple average of annual land value changes for Iowa,
Illinois, and Minnesota for the years 1984 and 1985. 8
7 On- and off-balance sheet Farmer Mac I agricultural mortgage
program assets booked after the 1996 Act amendments are subject to
the loss calculation.
8 While the worst-case losses, based on origination year,
occurred during 1983 and 1984, this benchmark was determined using
annual land value changes that occurred 2 years later.
l. Forecasting with data outside the range of the estimation
data requires special treatment for implementation. While the
estimation data embody Farmer Mac values for various loan
characteristics, the maximum farmland price decline experienced in
Texas was −16.69 percent, a value below the benchmark experience of
−23.52 percent. To control for this effect, you must apply a
procedure that restricts the slope of all the independent variables
to that observed at the maximum land value decline observed in the
estimation data. Essentially, you must approximate the slope of the
loss-frequency equation at the point −16.69 percent in order to
adjust the probability of loan default and loss occurrence for data
beyond the range in the estimating data. The adjustment procedure
is shown in step 4 of section 2.3 entitled, “Example Calculation of
Dollar Loss on One Loan.”
m. Loss severity was not found to vary systematically and was
considered constant across the tested loan characteristics and
lending conditions. Thus, the simple weighted average by loss
volume of 20.9 percent is used in the stress test. 9 You must
multiply loss severity with the probability estimate computed from
the loss-frequency equation to determine the loss rate for a
loan.
9 We calculated the weighted-average loss severity from the
estimation data.
n. Using original loan balance results in estimated
probabilities of loss frequency over the entire life of a loan. To
account for loan seasoning, you must reduce the loan-loss exposure
by the cumulative probability of loss already experienced by each
loan as discussed in section 2.2 entitled, “Loan-Seasoning
Adjustment.” This subtraction is based on loan age and reduces the
loss estimated by the loss-frequency and loss-severity equations.
The result is an age-adjusted lifetime dollar loss that can be used
in subsequent calculations of loss rates as discussed in section
2.4, “Calculation of Loss Rates for Use in the Stress Test.”
2.2 Loan-Seasoning Adjustment for All Types of Loans, Except Rural
Utility Loans
a. You must use the seasoning function supplied by FCA to adjust
the calculated probability of loss for each Farmer Mac loan for the
cumulative loss exposure already experienced based on the age of
each loan. The seasoning function is based on the same data used to
determine the loss-frequency equation and an assumed average life
of 14 years for agricultural mortgages. If we determine that the
relationship between the loss experience in Farmer Mac's portfolio
over time and the seasoning function can be improved, we may
augment or replace the seasoning function.
b. The seasoning function is parameterized as a beta
distribution with parameters of p = 4.288 and q = 5.3185. 10 How
the loan-seasoning distribution is used is shown in Step 7 of
section 2.3, “Example Calculation of Dollar Loss on One Loan.”
10 We estimated the loan-seasoning distribution from portfolio
aggregate charge-off rates from the estimation data. To do so, we
arrayed all defaulting loans where loss occurred according to the
time from origination to default. Then, a beta distribution, β(p,
q), was fit to the estimation data scaled to the maximum time a
loan survived (14 years).
2.3 Example Calculation of Dollar Loss on One Loan for All Types of
Loans, Except Rural Utility Loans
Here is an example of the calculation of the dollar losses for
an individual loan with the following characteristics and input
values: 11
11 In the examples presented we rounded the numbers, but the
example calculation is based on a larger number of significant
digits. The stress test uses additional digits carried at the
default precision of the software.
Loan Origination
Year
1996
Loan Origination
Balance
$1,250,000
LTV at
Origination
0.5
D/A at
Origination
0.5
DSCR at
Origination
1.3984
Maximum Percentage
Land Price Decline (MAX)
−23.52
Step 1: Convert 1996 Origination Value to 1997 dollar
value (LOAN) based on the consumer price index and transform as
follows:
Step 2: Calculate the default probabilities using −16.64
percent and −16.74 percent land value declines as follows: 12
12 This process facilitates the approximation of slope needed to
adjust the loss probabilities for land value declines greater than
observed in the estimation data.
Where: Z1 = (−12.62738) + 1.91259 · LTV5.3914596 − 0.33830 ·
(−16.6439443) − 0.19596 · DSCR + 4.55390 · 0.998972 + 2.49482 · DA
= (−1.428509) Default Loss Frequency at (−16.64%) = 1 / 1 +
exp−(−1.428509) = 0.19333111 And Z1 = (−12.62738) + 1.91259 ·
LTV5.3914596 − 0.33830 · (−16.7439443) − 0.19596 · DSCR + 4.55390 ·
0.998972 + 2.49482 · DA = (−1.394679) Loss Frequency Probability at
(−16.74%) = 1 / 1 + exp−(−1.394679) = 0.19866189
Step 3: Calculate the slope adjustment. You must
calculate slope by subtracting the difference between
“Loss-Frequency Probability at −16.64 percent” and “Loss-Frequency
Probability at −16.74 percent” and dividing by −0.1 (the difference
between −16.64 percent and −16.74 percent) as follows:
0.05330776 = (0.19333111 − 0.19866189) / −0.1
Step 4: Make the linear adjustment. You make the
adjustment by increasing the loss-frequency probability where the
dampened stressed farmland value input is less than −16.69 percent
to reflect the stressed farmland value input, appropriately
discounted. As discussed previously, the stressed land value input
is discounted to reflect the declining effect that the maximum land
value decline has on the probability of default when it occurs
later in a loan's life. 13 The linear adjustment is the difference
between −16.69 percent land value decline and the adjusted stressed
maximum land value decline input of −23.52 multiplied by the slope
estimated in Step 3 as follows:
13 The dampened period is the number of years from the beginning
of the origination year to the current year (i.e., January 1, 1996
to January 1, 2000 is 4 years).
Loss Frequency at −16.69 percent = Z1 = (−12.62738) +
(1.91259)(LTV5.3914596) − (0.33830)(−16.6939443) − (0.19596)(DSCR)
+ (4.55390)(0.998972) + (2.49482)(DA) = −1.411594 And 1 / 1 +
exp−(−1.411594) = 0.19598279 Dampened Maximum Land Price Decline =
(−20.00248544) = (−23.52)(1.0413299)−4 Slope Adjustment =
0.17637092 = 0.053312247 · (−16.6939443 − (−20.00248544)) Loan
Default Probability = 0.37235371 = 0.19598279 + 0.17637092
Step 5: Multiply loan default probability times the
average severity of 0.209 as follows:
0.077821926 = 0.37235371 · 0.209
Step 6: Multiply the loss rate times the origination loan
balance as follows:
$97,277 = $1,250,000 · 0.077821926
Step 7: Adjust the origination based dollar losses for 4
years of loan seasoning as follows:
$81,987 = $97,277 − $97,277 · (0.157178762) 14
14 The age of adjustment of 0.157178762 is determined from the
beta distribution for a 4-year-old loan.
2.4 Treatment of Loans Backed by an Obligation of the Counterparty
and Loans for Which Pledged Loan Collateral Volume Exceeds Farmer
Mac-Guaranteed Volume
You must calculate the age-adjusted loss rates for these loans
that include adjustments to scale losses according to the
proportion of total submitted collateral to the guaranteed amount
as provided for in the “Dollar Losses” column of the transformed
worksheets in the Credit Loss Module based on new data inputs
required in the “Coefficients” worksheet of the Credit Loss Module.
Then, you must adjust the calculated loss rates as follows.
a. For loans in which the seller retains a subordinated
interest, subtract from the total estimated age-adjusted dollar
losses on the pool the amount equal to current unpaid principal
times the subordinated interest percentage.
b. Some pools of loans underlying specific transactions could
include loan collateral volume pledged to Farmer Mac in excess of
Farmer Mac's guarantee amount (“overcollateral”). Overcollateral
can be either: (i) Contractually required according to the terms of
the transaction, or (ii) not contractually required, but pledged in
addition to the contractually required amount at the discretion of
the counterparty, often for purposes of administrative convenience
regarding the collateral substitution process, or (iii) both (i)
and (ii).
1. If a pool of loans includes collateral pledged in excess of
the guaranteed amount, you must adjust the age-adjusted, loan-level
dollar losses by a factor equal to the ratio of the guarantee
amount to total submitted collateral. For example, consider a pool
of two loans serving as security for a Farmer Mac guarantee on a
note with a total issuance face value of $2 million and on which
the counterparty has submitted 10-percent overcollateral. The two
loans in the example have the following characteristics and
adjustments.
2. If a pool of loans includes collateral pledged in excess of
the guaranteed amount that is required under the terms of the
transaction, you must further adjust the dollar losses as follows.
Calculate the total losses on the subject portfolio of loans after
age adjustments and any adjustments related to total submitted
overcollateral as described in “1.” above. Calculate the total
dollar amount of contractually required overcollateral in the
subject pool. Subtract the total dollars of contractually required
overcollateral from the adjusted total losses on the subject pool.
If the result is less than or equal to zero, input a loss rate of
zero for this transaction pool in the Data Inputs worksheet of the
RBCST. A new category must be created for each such transaction in
the RBCST. If the loss rate after subtracting contractually
required overcollateral is greater than zero, proceed to additional
adjustment for the risk-reducing effects of the counterparty's
general obligation described in “3.” below.
3. Loans with a positive loss estimate remaining after
adjustments in “1.” and “2.” above are further adjusted for the
security provided by the general obligation of the counterparty. To
make this adjustment in our example, multiply the estimated dollar
losses remaining after adjustments in “1.” and “2.” above by the
appropriate general obligation adjustment (GOA) factor based on the
counterparty's whole-letter issuer credit rating by a nationally
recognized statistical rating organization (NRSRO) and the ratio of
the counterparty's concentration of risk in the same industry
sector as the loans backing the AgVantage Plus volume, as
determined by the Director.
A. The Director will make final determinations of concentration
ratios on a case-by-case basis by using publicly reported data on
counterparty portfolios, non-public data submitted and certified by
Farmer Mac as part of its RBCST submissions, and will generally
recognize rural electric cooperatives and rural telephone
cooperatives as separate rural utility sectors. The following table
sets forth the GOA factors and their components by whole-letter
credit rating (Adjustment Factor = Default Rate × Severity Rate ×
3), which may be further adjusted for industry sector concentration
by the Director. 15
15 Emery, K., Ou S., Tennant, J., Kim F., Cantor R., “Corporate
Default and Recovery Rates, 1920 - 2007,” published by Moody's
Investors Service, February 2008 - the most recent edition as of
March 2008; Default Rates, page 24, Recovery Rates (Severity Rate =
1 minus Senior Unsecured Average Recovery Rate) page 20.
A
B
C
D
E
F
G
Whole-letter
rating
Default rate
(percent)
Severity rate
(percent)
V3.0 GOA factor
(percent)
V4.0 GOA
factors (D × 3)
(percent)
Concentration
ratio (e.g., 25%)
(percent)
Factor with
concentration
adjustment 1−
((1−E) × (1−F))
(percent)
AAA
0.897
54
0.48
1.41
25.00
26.06
AA
2.294
54
1.24
3.70
25.00
27.78
A
2.901
54
1.57
5.13
25.00
28.84
BBB
7.061
54
3.82
11.48
25.00
33.61
Below BBB and
Unrated
26.827
54
14.50
44.52
25.00
58.39
B. The adjustment factors will be updated annually as Moody's
annual report on Default and Recovery Rates of Corporate Bond
Issuers becomes available, normally in January or February of each
year. In the event that there is an interruption of Moody's
publication of this annual report, or FCA determines that the
format of the report has changed enough to prevent or call into
question the identification of updated factors, the prior year's
factors will remain in effect until FCA revises the process through
rulemaking.
4. Continuing the previous example, the pool contains two loans
on which Farmer Mac is guaranteeing a total of $2 million and with
total submitted collateral of 110 percent of the guaranteed amount.
Of the 10-percent total overcollateral, 5 percent is contractually
required under the terms of the transaction. The pool consists of
two loans of slightly over $1 million. Total overcollateral is
$200,000 of which $100,000 is contractually required. The
counterparty has a single “A” credit rating, a 25-percent
concentration ratio, and after adjusting for contractually required
overcollateral, estimated losses are greater than zero. The net
loss rate is calculated as described in the steps in the table
below.
Loan A
Loan B
1 Guaranteed
Volume
$2,000,000
2 Origination
Balance of 2-Loan Portfolio
$1,080,000
$1,120,000
3 Age-Adjusted
Loss Rate
7%
5%
4 Estimated
Age-Adjusted Losses
$75,600
$56,000
5 Guarantee Volume
Scaling Factor
90.91%
90.91%
6 Losses Adjusted
for Total Overcollateral
$68,727
$50,909
7 Contractually
Required Overcollateral on Pool (5%)
$100,000
8 Net Losses on
Pool Adjusted for Contractually Required Overcollateral
$19,636
9 GOA Factor for
“A” Issuer with 25% Concentration Ratio
28.84%
10 Losses Adjusted
for “A” General Obligation
$5,664
11 Loss Rate Input
in the RBCST for this Pool
0.28%
A. The net, fully adjusted losses are distributed over time on a
straight-line basis. When a transaction reaches maturity within the
10-year modeling horizon, the losses are distributed on a
straightline over a timepath that ends in the year of the
transaction's maturity.
B. [Reserved]
2.5 Calculation of Loss Rates for Use in the Stress Test for All
Types of Loans, Except Rural Utility Loans
a. You must compute the loss rates by state as the dollar
weighted average seasoned loss rates from the Cash Window and
Standby loan portfolios by state. The spreadsheet entitled, “Credit
Loss Module.XLS” can be used for these calculations. This
spreadsheet is available for download on our Web site,
www.fca.gov, or will be provided upon request. The blended
loss rates for each state are copied from the “Credit Loss Module”
to the stress test spreadsheet for determining Farmer Mac's
regulatory capital requirement.
b. The stress test use of the blended loss rates is further
discussed in section 4.3, “Risk Measures.”
2.6 Calculation of Loss Rates on Rural Utility Volume for-Use in
the Stress Test
You must submit the outstanding principal, maturity date of the
loan, maturity date of the AgVantage Plus contract (if applicable),
and the rural utility guarantee fee percentage for each loan in
Farmer Mac's rural utility loan portfolio on the date at which the
stress test is conducted. You must multiply the rural utility
guarantee fee by two to calculate the loss rate on rural utility
loans under stressful economic conditions and then multiply the
loss rate by the total outstanding principal. To arrive at the net
rural utility loan losses, you must next apply the steps “5”
through “11” of section 2.4.b.4 of this Appendix. For loans under
an AgVantage Plus-type structure, the calculated losses are
distributed over time on a straight-line basis. For loans that are
not part of an AgVantage Plus-type structure, losses are
distributed over the 10-year modeling horizon, consistent with
other non-AgVantage Plus loan volume.
3.0 Interest Rate Risk
The stress test explicitly accounts for Farmer Mac's
vulnerability to interest rate risk from the movement in interest
rates specified in the statute. The stress test considers Farmer
Mac's interest rate risk position through the current structure of
its balance sheet, reported interest rate risk shock-test results,
16 and other financial activities. The stress test calculates the
effect of interest rate risk exposure through market value changes
of interest-bearing assets, liabilities, and off-balance sheet
transactions, and thereby the effects to equity capital. The stress
test also captures this exposure through the cashflows on
rate-sensitive assets and liabilities. We discuss how to calculate
the dollar impact of interest rate risk in section 4.6, “Balance
Sheets.”
16 See paragraph c. of section 4.1 entitled, “Data Inputs,” for
a description of the interest rate risk shock-reporting
requirement.
3.1 Process for Calculating the Interest Rate Movement
a. The stress test uses the 10-year Constant Maturity Treasury
(10-year CMT) released by the Federal Reserve in HR. 15, “Selected
Interest Rates.” The stress test uses the 10-year CMT to generate
earnings yields on assets, expense rates on liabilities, and
changes in the market value of assets and liabilities. For stress
test purposes, the starting rate for the 10-year CMT is the 3-month
average of the most recent monthly rate series published by the
Federal Reserve. The 3-month average is calculated by summing the
latest monthly series of the 10-year CMT and dividing by three. For
instance, you would calculate the initial rate on June 30, 1999,
as:
Month end
10-year CMT monthly
series
04/1999
5.18
05/1999
5.54
06/1999
5.90
Average
5.54
b. The amount by which the stress test shocks the initial rate
up and down is determined by calculating the 12-month average of
the 10-year CMT monthly series. If the resulting average is less
than 12 percent, the stress test shocks the initial rate by an
amount determined by multiplying the 12-month average rate by 50
percent. However, if the average is greater than or equal to 12
percent, the stress test shocks the initial rate by 600 basis
points. For example, determine the amount by which to increase and
decrease the initial rate for June 30, 1999, as follows:
Month end
10-year CMT monthly
series
07/1998
5.46
08/1998
5.34
09/1998
4.81
10/1998
4.53
11/1998
4.83
12/1998
4.65
01/1999
4.72
02/1999
5.00
03/1999
5.23
04/1999
5.18
05/1999
5.54
06/1999
5.90
12-Month
Average
5.10
Calculation of shock
amount
12-Month Average
Less than 12%
Yes.
12-Month
Average
5.10.
Multiply the
12-Month Average by
50%.
Shock in basis
points equals
255.
c. You must run the stress test for two separate changes in
interest rates: (i) An immediate increase in the initial rate by
the shock amount; and (ii) immediate decrease in the initial rate
by the shock amount. The stress test then holds the changed
interest rate constant for the remainder of the 10-year stress
period. For example, at June 30, 1999, the stress test would be run
for an immediate and sustained (for 10 years) upward movement in
interest rates to 8.09 percent (5.54 percent plus 255 basis points)
and also for an immediate and sustained (for 10 years) downward
movement in interest rates to 2.99 percent (5.54 percent minus 255
basis points). The movement in interest rates that results in the
greatest need for capital is then used to determine Farmer Mac's
risk-based capital requirement.
4.0 Elements Used in Generating Cashflows
a. This section describes the elements that are required for
implementation of the stress test and assessment of Farmer Mac
capital performance through time. An Excel spreadsheet named FAMC
RBCST, available at http://www.fca.gov, contains the stress
test, including the cashflow generator. The spreadsheet contains
the following seven worksheets:
(1) Data Input;
(2) Assumptions and Relationships;
(3) Risk Measures (credit risk and interest rate risk);
(4) Loan and Cash Flow Accounts;
(5) Income Statements;
(6) Balance Sheets; and
(7) Capital.
b. Each of the components is described in further detail below
with references where appropriate to the specific worksheets within
the Excel spreadsheet. The stress test may be generally described
as a set of linked financial statements that evolve over a period
of 10 years using generally accepted accounting conventions and
specified sets of stressed inputs. The stress test uses the initial
financial condition of Farmer Mac, including earnings and funding
relationships, and the credit and interest rate stressed inputs to
calculate Farmer Mac's capital performance through time. The stress
test then subjects the initial financial conditions to the first
period set of credit and interest rate risk stresses, generates
cashflows by asset and liability category, performs necessary
accounting postings into relevant accounts, and generates an income
statement associated with the first interval of time. The stress
test then uses the income statement to update the balance sheet for
the end of period 1 (beginning of period 2). All necessary capital
calculations for that point in time are then performed.
c. The beginning of the period 2 balance sheet then serves as
the departure point for the second income cycle. The second
period's cashflows and resulting income statement are generated in
similar fashion as the first period's except all inputs
(i.e., the periodic loan losses, portfolio balance by
category, and liability balances) are updated appropriately to
reflect conditions at that point in time. The process evolves
forward for a period of 10 years with each pair of balance sheets
linked by an intervening set of cashflow and income statements. In
this and the following sections, additional details are provided
about the specification of the income-generating model to be used
by Farmer Mac in calculating the risk-based capital
requirement.
4.1 Data Inputs
The stress test requires the initial financial statement
conditions and income generating relationships for Farmer Mac. The
worksheet named “Data Inputs” contains the complete data inputs and
the data form used in the stress test. The stress test uses these
data and various assumptions to calculate pro forma financial
statements. For stress test purposes, Farmer Mac is required to
supply:
a. Call Report Schedules RC: Balance Sheet and RI: Income
Statement. These schedules form the starting financial position
for the stress test. In addition, the stress test calculates basic
financial relationships and assumptions used in generating pro
forma annual financial statements over the 10-year stress period.
Financial relationships and assumptions are in section 4.2,
“Assumptions and Relationships.”
b. Cashflow Data for Asset and Liability Account
Categories. The necessary cashflow data for the
spreadsheet-based stress test are book value, weighted average
yield, weighted average maturity, conditional prepayment rate,
weighted average amortization, and weighted average guarantee fees
and rural utility guarantee fees. The spreadsheet uses this
cashflow information to generate starting and ending account
balances, interest earnings, guarantee fees, rural utility
guarantee fees, and interest expense. Each asset and liability
account category identified in this data requirement is discussed
in section 4.2 “Assumptions and Relationships.”
c. Interest Rate Risk Measurement Results. The stress
test uses the results from Farmer Mac's interest rate risk model to
represent changes in the market value of assets, liabilities, and
off-balance sheet positions during upward and downward
instantaneous shocks in interest rates of 300, 250, 200, 150, and
100 basis points. The stress test uses these data to calculate a
schedule of estimated effective durations representing the market
value effects from a change in interest rates. The stress test uses
a linear interpolation of the duration schedule to relate a change
in interest rates to a change in the market value of equity. This
calculation is described in section 4.4 entitled, “Loan and
Cashflow Accounts,” and is illustrated in the referenced worksheet
of the stress test.
d. Loan-Level Data for all Farmer Mac I Program
Assets.
(1) The stress test requires loan-level data for all Farmer Mac
I program assets to determine lifetime age-adjusted loss rates. The
specific loan data fields required for running the credit risk
component are:
Farmer Mac I Program Loan Data Fields Loan Number Ending Scheduled
Balance Group Pre/Post Act Property State Product Type Origination
Date Loan Cutoff Date Original Loan Balance Original Scheduled
P&I Original Appraised Value Loan-to-Value Ratio Debt-to-Assets
Ratio Current Assets Current Liabilities Total Assets Total
Liabilities Gross Farm Revenue Net Farm Income Depreciation
Interest on Capital Debt Capital Lease Payments Living Expenses
Income & FICA Taxes Net Off-Farm Income Total Debt Service
Guarantee/Commitment Fee Seasoned Loan Flag
(2) From the loan-level data, you must identify the geographic
distribution by state of Farmer Mac's loan portfolio and enter the
current loan balance for each state in the “Data Inputs” worksheet.
The lifetime age-adjustment of origination year loss rates was
discussed in section 2.0, “Credit Risk.” The lifetime age-adjusted
loss rates are entered in the “Risk Measures” worksheet of the
stress test. The stress test application of the loss rates is
discussed in section 4.3, “Risk Measures.”
(3) Under certain circumstances, described below, you must
substitute the following data proxies for the variables LTV, DSCR,
and D/A: LTV = 0.70, DSCR = 1.25, and D/A = 0.50. The substitution
must be done whenever any of these data are missing, i.e., cells
are blank, or one or more of the conditions in the following table
is true.
Condition
Apply
1. Total Assets =
0
Proxy D/A.
2. Total
Liabilities = 0
Proxy D/A.
3. Total assets
less total liabilities <0
Proxy D/A.
4. Total debt
service = 0 or not calculable
Proxy DSCR.
5. Net farm income
= 0
Proxy DSCR.
6. LTV ratio =
0
Proxy LTV.
7. Total assets
less than original appraised value
Proxy LTV, D/A.
8. Total
liabilities less than the original loan amount
Proxy D/A.
9. Total debt
service is less than original scheduled principal and interest
payment
Proxy DSCR.
10. Depreciation,
interest on capital debt, capital lease payments, or living
expenses are reported as less than zero
Proxy DSCR.
11. Original
Scheduled Principal and Interest is greater than Total Debt
Service
Proxy DSCR.
12. Calculated LTV
(original loan amount divided by original appraised value) does not
equal the submitted LTV ratio
The greater of the two LTV
ratios.
13. Any of the
fields referenced in “1.” through “12.” above are blank or contain
spaces, periods, zeros, negative amounts, or fonts formatted to any
setting other than numbers
Proxy all related ratios.
In addition, the following loan data adjustments must be made in
response to the situations listed below:
Situation
Data adjustment
Original loan
balance is less than scheduled loan balance
Substitute scheduled balance
for origination.
Purchase
(commitment) date (a.k.a. “cutoff” date) field and Origination date
field are both blank
Insert the quarter end “as of”
date of the RBCST submission.
Origination date
field is blank
Model based on Cutoff
date.
Seasoned Standby
loans that include loan data
Proxy data applied.*
* Application of proxy data recognizes that
underwriting data on seasoned Standby loans are not reviewed by
Farmer Mac in favor of other criteria and frequently not
origination data.
Further, because it would not be possible to compile an
exhaustive list of loan data anomalies, FCA reserves the authority
to require an explanation on other data anomalies it identifies and
to apply the loan data proxies on such cases until the anomaly is
adequately addressed by the Corporation.
e. Loan-Level Data for All Rural Utility Program Volume.
The stress test requires loan-level data for all rural utility
program volume. The specific loan data fields required for
calculating the credit risk are outstanding principal, maturity
date of the loan, maturity date of the AgVantage Plus contract (if
applicable), and the rural utility guarantee fee percentage for
each loan in Farmer Mac's rural utility loan portfolio on the date
at which the stress test is conducted.
f. Weighted Haircuts for Non-Program Investments. For
non-program investments, the stress test adjusts the weighted
average yield data referenced in section 4.1.b. to reflect
counterparty risk. Non-program investments are defined in § 652.5.
The Corporation must calculate the haircut to be applied to each
investment based on the lowest whole-letter credit rating the
investment received from an NRSRO using the haircut levels in
effect at the time. Haircut levels shall be the same amounts
calculated for the GOA factor in section 2.4.b.3 above. The first
table provides the mappings of NRSRO ratings to whole-letter
ratings for purposes of applying haircuts. Any “ + ” or “−” signs
appended to NRSRO ratings that are not shown in the table should be
ignored for purposes of mapping NRSRO ratings to FCA whole-letter
ratings. The second table provides the haircut levels by
whole-letter rating category.
FCA Whole-Letter Credit Ratings Mapped to
Rating Agency Credit Ratings
FCA Ratings
Category
AAA
AA
A
BBB
Below BBB and Unrated.
Standard & Poor's
Long-Term
AAA
AA
A
BBB
Below BBB and Unrated.
Fitch
Long-Term
AAA
AA
A
BBB
Below BBB and Unrated.
Standard & Poor's
Short-Term
A-1 +
SP-1 +
A-1
SP-1
A-2
SP-2
A-3
SP-3, B, or Below and
Unrated.
Fitch
Short-Term
F-1 +
F-1
F-2
F-3
Below F-3 and Unrated.
Moody's
Prime-MIG12
VMIg1
Prime-2 MIG2 VMIG2
Prime-3 MIG3 VMIG3
Not Prime, SG and
Unrated.
Fitch Bank
Ratings
A
B
A/B
C
B/C
D
C/D
E.
D/E.
Moody's Bank
Financial Strength Rating
A
B
C
D
E.
Farmer Mac RBCST Maximum Haircut by Ratings
Classification
1. Certain special cases will receive the following treatment.
For an investment structured as a collateralized obligation backed
by the issuer's general obligation and, in turn, a pool of
collateral, reference the Issuer Rating or Financial Strength
Rating of that issuer as the credit rating applicable to the
security. Unrated securities that are fully guaranteed by
Government-sponsored enterprises (GSE) such as the Federal National
Mortgage Corporation (Fannie Mae) will receive the same treatment
as AAA securities. Unrated securities backed by the full faith and
credit of the U.S. Government will not receive a haircut. Unrated
securities that are not fully guaranteed by a GSE will receive the
haircut level in place at that time for “Below BBB and Unrated”
investments unless the Director, at the Director's discretion,
determines to apply a lesser haircut. In making this determination,
the Director will consider the risk characteristics associated with
the structure of individual instruments.
2. If portions of investments are later sold by Farmer Mac
according to their specific risk characteristics, the Director will
take reasonable measures to adjust the haircut level applied to the
investment to recognize the change in the risk characteristics of
the retained portion. The Director will consider relevant similar
methods for dealing with capital requirements adopted by other
Federal financial institution regulators in similar situations.
3. Individual investment haircuts must then be aggregated into
weighted-average haircuts by investment category and submitted in
the “Data Inputs” worksheet. The spreadsheet uses these inputs to
reduce the weighted-average yield on the investment category to
account for counterparty insolvency according to a 10-year linear
phase-in of the haircuts. Each asset account category identified in
this data requirement is discussed in section 4.2, “Assumptions and
Relationships.”
4.2 Assumptions and Relationships
a. The stress test assumptions are summarized on the worksheet
called “Assumptions and Relationships.” Some of the entries on this
page are direct user entries. Other entries are relationships
generated from data supplied by Farmer Mac or other sources as
discussed in section 4.1, “Data Inputs.” After current financial
data are entered, the user selects the date for running the stress
test. This action causes the stress test to identify and select the
appropriate data from the “Data Inputs” worksheet. The next section
highlights the degree of disaggregation needed to maintain
reasonably representative financial characterizations of Farmer Mac
in the stress test. Several specific assumptions are established
about the future relationships of account balances and how they
evolve.
b. From the data and assumptions, the stress test computes pro
forma financial statements for 10 years. The stress test must be
run as a “steady state” with regard to program balances (with the
exception of AgVantage Plus volume, in which case maturities are
recognized by the model), and where possible, will use information
gleaned from recent financial statements and other data supplied by
Farmer Mac to establish earnings and cost relationships on major
program assets that are applied forward in time. As documented in
the stress test, entries of “1” imply no growth and/or no change in
account balances or proportions relative to initial conditions with
the exception of pre-1996 loan volume being transferred to
post-1996 loan volume. The interest rate risk and credit loss
components are applied to the stress test through time. The
individual sections of that worksheet are:
(1) Elements related to cashflows, earnings rates, and
disposition of discontinued program assets.
(A) The stress test accounts for earnings rates by asset class
and cost rates on funding. The stress test aggregates investments
into the categories of: Cash and money market securities;
commercial paper; certificates of deposit; agency mortgage-backed
securities and collateralized mortgage obligations; and other
investments. With FCA's concurrence, Farmer Mac is permitted to
further disaggregate these categories. Similarly, we may require
new categories for future activities to be added to the stress
test. Loan items requiring separate accounts include the
following:
(i) Farmer Mac I program assets post-1996 Act;
(ii) Farmer Mac I program assets post-1996 Act Swap
balances;
(iii) Farmer Mac I program assets pre-1996 Act;
(iv) Farmer Mac I AgVantage securities;
(v) Loans held for securitization;
(vi) Farmer Mac II program assets; and
(vii) Rural Utility program volume on balance sheet.
(B) The stress test also uses data elements related to
amortization and prepayment experience to calculate and process the
implied rates at which asset and liability balances terminate or
“roll off” through time. Further, for each category, the stress
test has the capacity to track account balances that are expected
to change through time for each of the above categories. For
purposes of the stress test, all assets are assumed to maintain a
“steady state” with the implication that any principal balances
retired or prepaid are replaced with new balances. The exceptions
are that expiring pre-1996 Act program assets are replaced with
post-1996 Act program assets and AgVantage Plus volume maturities
are recognized by the model.
(2) Elements related to other balance sheet assumptions
through time. As well as interest earning assets, the other
categories of the balance sheet that are modeled through time
include interest receivable, guarantee fees receivable, rural
utility guarantee fees receivable, prepaid expenses, accrued
interest payable, accounts payable, accrued expenses, reserves for
losses (loans held and guaranteed securities), and other
off-balance sheet obligations. The stress test is consistent with
Farmer Mac's existing reporting categories and practices. If
reporting practices change substantially, the above list will be
adjusted accordingly. The stress test has the capacity to have the
balances in each of these accounts determined based upon existing
relationships to other earning accounts, to keep their balances
either in constant proportions of loan or security accounts, or to
evolve according to a user-selected rule. For purposes of the
stress test, these accounts are to remain constant relative to the
proportions of their associated balance sheet accounts that
generated the accrued balances.
(3) Elements related to income and expense assumptions.
Several other parameters that are required to generate pro forma
financial statements may not be easily captured from historic data
or may have characteristics that suggest that they be individually
supplied. These parameters are the gain on agricultural
mortgage-backed securities (AMBS) sales, miscellaneous income,
operating expenses, reserve requirement, guarantee fees, rural
utility guarantee fees, and loan loss resolution timing.
(A) The stress test applies the actual weighted average gain
rate on sales of AMBS over the most recent 3 years to the dollar
amount of AMBS sold during the most recent four quarters in order
to estimate gain on sale of AMBS over the stress period.
(B) The stress test assumes miscellaneous income at a level
equal to the average of the most recent 3-year's actual
miscellaneous income as a percent of the sum of; cash, investments,
guaranteed securities, and loans held for investment.
(C) The stress test assumes that short-term cost of funds is
incurred in relation to the amount of defaulting loans purchased
from off-balance sheet pools. The remaining unpaid principal
balance on this loan volume is the origination amount reduced by
the proportion of the total portfolio that has amortized as of the
end of the most recent quarter. This volume is assumed to be funded
at the short-term cost of funds and this expense continues for a
period equal to the loan loss resolution timing period (LLRT)
period minus 1. We will calculate the LLRT period from Farmer Mac
data. In addition, during the LLRT period, all guarantee income
associated with the loan volume ceases.
(D) The stress test generates no interest income on the
estimated volume of defaulted on-balance sheet loan volume required
to be carried during the LLRT period, but continues to accrue
funding costs during the remainder of the LLRT period.
(E) You must update the LLRT period in response to changes in
the Corporation's actual experience with each quarterly
submission.
(F) Operating costs are determined in the model using weighted
moving average of operating expenses as a percentage of the sum of
on-balance sheet assets and off-balance sheet program activities
over the previous four quarters inclusive of the current submission
date. The share will then be applied forward to the balances of the
same categories throughout the 10-year period of the RBCST model.
As additional data accumulate, the specification will be
re-examined and modified if we deem changing the specification
results in a more appropriate representation of operating
expenses.
(G) The reserve requirement as a fraction of loan assets can
also be specified. However, the stress test is run with the reserve
requirement set to zero. Setting the parameter to zero causes the
stress test to calculate a risk-based capital level that is
comparable to regulatory capital, which includes reserves. Thus,
the risk-based capital requirement contains the regulatory capital
required, including reserves. The amount of total capital that is
allocated to the reserve account is determined by GAAP. The stress
test applies quarterly updates of the weighted average guarantee
rates for post-1996 Farmer Mac I assets, pre-1996 Farmer Mac I
assets, and Farmer Mac II assets.
(4) Elements related to earnings rates and funding
costs.
(A) The stress test can accommodate numerous specifications of
earnings and funding costs. In general, both relationships are tied
to the 10-year CMT interest rate. Specifically, each investment
account, each loan item, and each liability account can be
specified as fixed rate, or fixed spread to the 10-year CMT with
initial rates determined by actual data. The stress test calculates
specific spreads (weighted average yield less initial 10-year CMT)
by category from the weighted average yield data supplied by Farmer
Mac as described earlier. For example, the fixed spread for Farmer
Mac I program post-1996 Act mortgages is calculated as follows:
Fixed Spread = Weighted Average Yield less 10-year CMT 0.014 =
0.0694 - 0.0554
(B) The resulting fixed spread of 1.40 percent is then added to
the 10-year CMT when it is shocked to determine the new yield. For
instance, if the 10-year CMT is shocked upward by 300 basis points,
the yield on Farmer Mac I program post-1996 Act loans would change
as follows:
(C) The adjusted yield is then used for income calculations when
generating pro forma financial statements. All fixed-spread asset
and liability classes are computed in an identical manner using
starting yields provided as data inputs from Farmer Mac. The
fixed-yield option holds the starting yield data constant for the
entire 10-year stress test period. You must run the stress test
using the fixed-spread option for all accounts except for
discontinued program activities, such as Farmer Mac I program loans
made before the 1996 Act. For discontinued loans, the fixed-rate
specification must be used if the loans are primarily fixed-rate
mortgages.
(5) Elements related to interest rate shock test. As
described earlier, the interest rate shock test is implemented as a
single set of forward interest rates. The stress test applies the
up-rate scenario and down-rate scenario separately. The stress test
also uses the results of Farmer Mac's shock test, as described in
paragraph c. of section 4.1, “Data Inputs,” to calculate the impact
on equity from a stressful change in interest rates as discussed in
section 3.0 titled, “Interest Rate Risk.” The stress test uses a
schedule relating a change in interest rates to a change in the
market value of equity. For instance, if interest rates are shocked
upward so that the percentage change is 262 basis points, the
linearly interpolated effective estimated duration of equity is
−6.7405 years given Farmer Mac's interest rate measurement results
at 250 and 300 basis points of −6.7316 and 76.7688 years,
respectively found on the effective duration schedule. The stress
test uses the linearly interpolated estimated effective duration
for equity to calculate the market value change by multiplying
duration by the base value of equity before any rate change from
Farmer Mac's interest rate risk measurement results with the
percentage change in interest rates.
4.3 Risk Measures
a. This section describes the elements of the stress test in the
worksheet named “Risk Measures” that reflect the interest rate
shock and credit loss requirements of the stress test.
b. As described in section 3.1, the stress test applies the
statutory interest rate shock to the initial 10-year CMT rate. It
then generates a series of fixed annual interest rates for the
10-year stress period that serve as indices for earnings yields and
cost of funds rates used in the stress test. (See the “Risk
Measures” worksheet for the resulting interest rate series used in
the stress test.)
c. The Credit Loss Module's state-level loss rates, as described
in section 2.4 entitled, “Calculation of Loss Rates for Use in the
Stress Test,” are entered into the “Risk Measures” worksheet and
applied to the loan balances that exist in each state. The
distribution of loan balances by state is used to allocate new
loans that replace loan products that roll off the balance sheet
through time. The loss rates are applied both to the initial volume
and to new loan volume that replaces expiring loans. The total life
of loan losses that are expected at origination are then allocated
through time based on a set of user entries describing the
time-path of losses.
d. The loss rates estimated in the credit risk component of the
stress test are based on an origination year concept, adjusted for
loan seasoning. All losses arising from loans originated in a
particular year are expressed as lifetime age-adjusted losses
irrespective of when the losses actually occur. The fraction of the
origination year loss rates that must be used to allocate losses
through time are 43 percent to year 1, 17 percent to year 2, 11.66
percent to year 3, and 4.03 percent for the remaining years. The
total allocated losses in any year are expressed as a percent of
loan volume in that year to reflect the conversion to exposure
year.
e. The credit loss exposure on rural utility volume, described
in section 2.6, “Calculation of Loss Rates on Rural Utility Volume
for Use in the Stress Test,” is entered into the “Risk Measures”
worksheet applied to the volume balance. All losses arising from
rural utility loans are expressed as annual loss rates and
distributed over the weighted average maturity of the rural utility
AgVantage Plus Volume, or as annual loss across the full 10-year
modeling horizon in the case of rural utility Cash Window
loans.
4.4 Loan and Cashflow Accounts
The worksheet labeled “Loan and Cashflow Data” contains the
categorized loan data and cashflow accounting relationships that
are used in the stress test to generate projections of Farmer Mac's
performance and condition. The steady-state formulation results in
account balances that remain constant except for the effects of
discontinued programs, maturing AgVantage Plus positions, and the
LLRT adjustment. For assets with maturities under 1 year, the
results are reported for convenience as though they matured only
one time per year with the additional convention that the
earnings/cost rates are annualized. For the pre-1996 Act assets,
maturing balances are added back to post-1996 Act account balances.
The liability accounts are used to satisfy the accounting identity,
which requires assets to equal liabilities plus owner equity. In
addition to the replacement of maturities under a steady state,
liabilities are increased to reflect net losses or decreased to
reflect resulting net gains. Adjustments must be made to the long-
and short-term debt accounts to maintain the same relative
proportions as existed at the beginning period from which the
stress test is run with the exception of changes associated with
the funding of defaulted loans during the LLRT period. The primary
receivable and payable accounts are also maintained on this
worksheet, as is a summary balance of the volume of loans subject
to credit losses.
4.5 Income Statements
a. Information related to income performance through time is
contained on the worksheet named “Income Statements.” Information
from the first period balance sheet is used in conjunction with the
earnings and cost-spread relationships from Farmer Mac supplied
data to generate the first period's income statement. The same set
of accounts is maintained in this worksheet as “Loan and Cashflow
Accounts” for consistency in reporting each annual period of the
10-year stress period of the test with the exception of the line
item labeled “Interest reversals to carry loan losses” which
incorporates the LLRT adjustment to earnings from the “Risk
Measures” worksheet. Loans that defaulted do not earn interest or
guarantee and commitment fees during LLRT period. The income from
each interest-bearing account is calculated, as are costs of
interest-bearing liabilities. In each case, these entries are the
associated interest rate for that period multiplied by the account
balances.
b. The credit losses described in section 2.0, “Credit Risk,”
are transmitted through the provision account, as is any change
needed to re-establish the target reserve balance. For determining
risk-based capital, the reserve target is set to zero as previously
indicated in section 4.2. Under the income tax section, it must
first be determined whether it is appropriate to carry forward tax
losses or recapture tax credits. The tax section then establishes
the appropriate income tax liability that permits the calculation
of final net income (loss), which is credited (debited) to the
retained earnings account.
4.6 Balance Sheets
a. The worksheet named “Balance Sheets” is used to construct pro
forma balance sheets from which the capital calculations can be
performed. As can be seen in the Excel spreadsheet, the worksheet
is organized to correspond to Farmer Mac's normal reporting
practices. Asset accounts are built from the initial financial
statement conditions, and loan and cashflow accounts. Liability
accounts including the reserve account are likewise built from the
previous period's results to balance the asset and equity
positions. The equity section uses initial conditions and standard
accounts to monitor equity through time. The equity section
maintains separate categories for increments to paid-in-capital and
retained earnings and for mark-to-market effects of changes in
account values. The process described below in the “Capital”
worksheet uses the initial retained earnings and paid-in-capital
account to test for the change in initial capital that permits
conformance to the statutory requirements. Therefore, these
accounts must be maintained separately for test solution
purposes.
b. The market valuation changes due to interest rate movements
must be computed utilizing the linearly interpolated schedule of
estimated equity effects due to changes in interest rates,
contained in the “Assumptions & Relationships” worksheet. The
stress test calculates the dollar change in the market value of
equity by multiplying the base value of equity before any rate
change from Farmer Mac's interest rate risk measurement results,
the linearly interpolated estimated effective duration of equity,
and the percentage change in interest rates. In addition, the
earnings effect of the measured dollar change in the market value
of equity is estimated by multiplying the dollar change by the
blended cost of funds rate found on the “Assumptions &
Relationships” worksheet. Next, divide by 2 the computed earnings
effect to approximate the impact as a theoretical shock in the
interest rates that occurs at the mid-point of the income cycle
from period t 0 to period t 1. The measured dollar change in the
market value of equity and related earnings effect are then
adjusted to reflect any tax-related benefits. Tax adjustments are
determined by including the measured dollar change in the market
value of equity and the earnings effect in the tax calculations
found in the “Income Statements” worksheet. This approach ensures
that the value of equity reflects the economic loss or gain in
value of Farmer Mac's capital position from a change in interest
rates and reflects any immediate tax benefits that Farmer Mac could
realize. Any tax benefits in the module are posted through the
income statement by adjusting the net taxes due before calculating
final net income. Final net income is posted to accumulated
unretained earnings in the shareholders' equity portion of the
balance sheet. The tax section is also described in section 4.5
entitled, “Income Statements.”
c. After one cycle of income has been calculated, the balance
sheet as of the end of the income period is then generated. The
“Balance Sheet” worksheet shows the periodic pro forma balance
sheets in a format convenient to track capital shifts through
time.
d. The stress test considers Farmer Mac's balance sheet as
subject to interest rate risk and, therefore, the capital position
reflects mark-to-market changes in the value of equity. This
approach ensures that the stress test captures interest rate risk
in a meaningful way by addressing explicitly the loss or gain in
value resulting from the change in interest rates required by the
statute.
4.7 Capital
The “Capital” worksheet contains the results of the required
capital calculations as described below, and provides a method to
calculate the level of initial capital that would permit Farmer Mac
to maintain positive capital throughout the 10-year stress test
period.
5.0 Capital Calculation
a. The stress test computes regulatory capital as the sum of the
following:
(1) The par value of outstanding common stock;
(2) The par value of outstanding preferred stock;
(3) Paid-in capital;
(4) Retained earnings; and
(5) Reserve for loan and guarantee losses.
b. Inclusion of the reserve account in regulatory capital is an
important difference compared to minimum capital as defined by the
statute. Therefore, the calculation of reserves in the stress test
is also important because reserves are reduced by loan and
guarantee losses. The reserve account is linked to the income
statement through the provision for loan-loss expense (provision).
Provision expense reflects the amount of current income necessary
to rebuild the reserve account to acceptable levels after loan
losses reduce the account or as a result of increases in the level
of risky mortgage positions, both on- and off-balance sheet.
Provision reversals represent reductions in the reserve levels due
to reduced risk of loan losses or loan volume of risky mortgage
positions. The liabilities section of the “Balance Sheets”
worksheet also includes separate line items to disaggregate the
Guarantee and commitment obligation related to the Financial
Accounting Standards Board Accounting Standards Codification Topic
460, Guarantees. This item is disaggregated to permit accurate
calculation of regulatory capital post-adoption of FIN 45. When
calculating the stress test, the reserve is maintained at zero to
result in a risk-based capital requirement that includes reserves,
thereby making the requirement comparable to the statutory
definition of regulatory capital. By setting the reserve
requirement to zero, the capital position includes all financial
resources Farmer Mac has at its disposal to withstand risk.
5.1 Method of Calculation
a. Risk-based capital is calculated in the stress test as the
minimum initial capital that would permit Farmer Mac to remain
solvent for the ensuing 10 years. To this amount, an additional 30
percent is added to account for managerial and operational risks
not reflected in the specific components of the stress test.
b. The relationship between the solvency constraint
(i.e., future capital position not less than zero) and the
risk-based capital requirement reflects the appropriate earnings
and funding cost rates that may vary through time based on initial
conditions. Therefore, the minimum capital at a future point in
time cannot be directly used to determine the risk-based capital
requirement. To calculate the risk-based capital requirement, the
stress test includes a section to solve for the minimum initial
capital value that results in a minimum capital level over the 10
years of zero at the point in time that it would actually occur. In
solving for initial capital, it is assumed that reductions or
additions to the initial capital accounts are made in the retained
earnings accounts, and balanced in the debt accounts at terms
proportionate to initial balances (same relative proportion of
long- and short-term debt at existing initial rates). Because the
initial capital position affects the earnings, and hence capital
positions and appropriate discount rates through time, the initial
and future capital are simultaneously determined and must be solved
iteratively. The resulting minimum initial capital from the stress
test is then reported on the “Capital” worksheet of the stress
test. The “Capital” worksheet includes an element that uses Excel's
“solver” or “goal seek” capability to calculate the minimum initial
capital that, when added (subtracted) from initial capital and
replaced with debt, results in a minimum capital balance over the
following 10 years of zero.
[71 FR 77253, Dec. 26, 2006, as amended at 73 FR 31940, June 5,
2008; 76 FR 23467, Apr. 27, 2011; 78 FR 21037, Apr. 9, 2013]