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Return to Comments
Capital - Tier1/Tier 2 Regulatory Capital Framework Proposed Rule
Type: Regulation
Federal Register Document Type: Proposed
Description:
Request that Board approve a new part 628 to FCA's regulations and amend parts 607, 614, 615 and 620 to modify the regulatory capital requirements for System Banks and associations


Text of Comment Letter
Alan Hess
22162B Hessdale Road
Alma, KS 66401-8034


February 12, 2015

Barry F Mardock
Office of Regulatory Policy, Farm Credit Administration
1501 Farm Credit Drive
McLean, VA 22102-5090


Dear Barry Mardock:

Mr. Barry Mardock
Deputy Director, Office of Regulatory Policy
Farm Credit Administration
1501 Farm Credit Drive
McLean, Virginia 22102-5090


Dear Mr. Mardock:

Thank you for the opportunity to comment on Farm Credit Administration's
proposed capital rule.  The Agency's efforts to modernize Farm Credit
System (FCS) capital requirements will result in a framework that is
consistent with Basel III standards applied to other financial
institutions.  I believe that adopting Basel III standards for the FCS
will enhance investor understanding of the FCS's financial strength and
increase marketability of third-party capital and debt securities,
especially in periods of stress, thereby enabling the FCS to fulfill its
mission.  

I appreciate the Agency's efforts to carefully consider and accommodate
the FCS's cooperative structure in developing the proposed capital
framework.  While FCA has done an admirable job in drafting the proposed
capital rule, I am concerned that it does not strike the appropriate
balance between supporting and protecting the cooperative structure on
which Congress based the FCS and aligning with the Basel III concepts
written for joint stock companies.  Unfortunately, parts of the Agency's
proposal undermine the cooperative structure.  As a result, I ask that FCA
revise the proposed rule as outlined below to make it workable and
supportive of the FCS's Congressionally mandated cooperative structure:

1. Eliminate the requirement that FCS institutions obtain shareholder
votes on the capitalization bylaw changes required by the proposed rule. 
This requirement results in a meaningless vote that puts the institution
and its member-customers in an impossible situation.  If member-customers
do not approve the bylaw changes, the institution faces capitalization
challenges.  If member-customers approve the bylaw changes, they undermine
the institutions's ability to function consistent with cooperative
principles.  I appreciate FCA's desire to ensure that the capital plan
features of each FCS institution are effectively communicated to their
member-owners.  However, rather than direct capitalization bylaw changes,
the FCA could rely on board policies, directives, loan documentation or
capital plans for such communication.  Structurally, a board directive or
similar document can accomplish the same outcome as a capitalization bylaw
vote.  Board direction, along with shareholder disclosures, is more than
sufficient to implement FCA's proposed Basel III framework.

2. Reduce the proposed revolvement period for Common Equity Tier 1 (CET1)
to 7 years and permit the normal revolving features of loan-based
cooperative equity plans.  There is no basis in Basel III for the proposed
10-year revolvement cycle of an individual share, and it is overly
stringent and fundamentally inconsistent with cooperative principles.  It
is also unnecessary given the other proposed capital controls.  The
proposed rule limits distributions to current year earnings unless
specifically approved by FCA.  FCA also proposes additional limits if
capital levels fall below the proposed conservation buffer that is far
above minimum standards.  These controls and FCA prior approval eliminate
any possible member-customer expectations for the distribution of income
or retirement of stock and effectively makes cooperative shares permanent.
 Given these controls, a 7-year revolvement cycle on a loan basis is
easily justified.  For cooperative capital, the length of time a share is
outstanding is irrelevant to permanence.  Rather, permanence is determined
by member-customers' clear understanding that their shares are at-risk and
committed to the long-term financial stability of their cooperative. 

3. Eliminate the concept of 10-year revolvement cycles for association
investments in their funding bank to qualify for CET1.  Within the closed
FCS cooperative structure, requiring a revolvement cycle for
association-held bank equities is unnecessary, inefficient, ineffective,
and without any discernible benefit.  Each affiliated association's
investment is understood and legally structured as a permanent capital
contribution to the bank that is fully at risk and available to absorb
losses.   The law requires affiliated associations to capitalize and
obtain funding from a Farm Credit Bank, which means they need to maintain
a permanent investment in the bank.  The ability to adjust this investment
is critical for ensuring associations share proportionately and
appropriately in bank capitalization and risk of loss.  It is unnecessary
and unworkable to require each association's individual bank shares to be
outstanding for 10-years to qualify as CET1.  This requirement means that
the bank will be unable to function as a cooperative or equalize capital
investments.  It is critical FCA understand that the permanence of the
bank capital is entirely unaffected by how capital is equalized among
affiliated associations.  I ask that FCA provide flexibility for banks to
equalize capital investment among affiliated associations without
compromising CET1 treatment.

4. Revise the proposed "safe harbor" provision that authorizes limited
distributions, including stock retirements, without FCA prior approval to
be consistent with similar provisions implemented by European bank
regulators.  The proposed limit of no reduction in CET1 provides no
reasonable room for boards to manage capital without first seeking FCA
prior approval.  This burdensome requirement is far more restrictive than
the approach taken by foreign bank regulators that implemented Basel III
for the cooperatives under their jurisdiction.  FCA should follow the same
standards as these regulators and allow up to a 2% reduction in CET1 as
long as capital ratios remain above the conservation buffer.  In addition,
the "haircut deduction" for early distributions is punitive and should be
eliminated from the proposed regulations and handled through examination
as there is no basis for this in Basel III.

5. Eliminate or refine the unallocated retained earnings (URE) sub-limit
embedded within the proposed Tier 1 leverage requirement.  The proposed
sub-limit implies URE is of higher quality than CET1.  There is no basis
for this within Basel III either directly or in the context of a minimum
URE standard embedded within CET1.  Basel III did not see a safety and
soundness need to establish URE as a "superior" class of CET1 and FCA has
no basis for deviating from Basel III in this area.  It is also
significantly more stringent than FCA's current URE requirement given it
is measured on total, unweighted assets.  I ask that FCA authorize FCS
institutions' boards to manage the components of CET1, including URE.  If
FCA sees a need for a URE standard, it should simply follow its current
requirements and calculate the URE ratio on a risk-adjusted basis.    

6. Reduce the proposed Tier 1 leverage requirement to 4% to be consistent
with Basel III standards implemented by regulators across the globe.  From
my perspective, the proposed 5% standard is an arbitrary and capricious
deviation from Basel III.  There is simply no quantitative analysis or
loss experience that justifies a 5% Tier 1 leverage ratio for the FCS
while all other regulated financial institutions regardless of structure
are subject to a 4% requirement.  It is clear to me that FCA's proposal is
excessive, unsupported, creates an unnecessary inconsistency with Basel
III and would result in higher borrowing costs to the member-customers. 
This inconsistency with Basel III and with the approach taken by
regulators around the globe will raise questions about the FCS's risk
profile compared to other lending institutions.  Such questions will
irreparably harm the FCS and its mission achievement.  I ask FCA to
establish a 4%Tier 1 leverage ratio consistent with the Basel III guidance.

7. Maintain the 50% and 20% risk-weight treatment of rural electric
cooperative assets consistent with the current regulatory treatment. 
There has been no change in the unique characteristics and low risk
profile of the electric cooperative industry.  As FCA previously
acknowledged, loans to this industry have lower risk because of: (1) the
financial strength and stability of the underlying member systems; (2) the
ability to establish user rates with limited third-party oversight; and
(3) the exclusive service territories.  These unique characteristics
insulate the rural electric cooperative industry from many of the
credit-related risks experienced by utility providers.  I strongly
encourage FCA to continue the 50% and 20% risk-weight treatment so the FCS
can continue to fulfill its mission to finance the rural electric industry
as it does today.  If FCA does not make this change, the proposed rule
will adversely affect the FCS's capital capacity to serve this industry
and place it at a competitive disadvantage compared to other lenders who
finance this industry. 

I am confident that the refinements described above would make the
proposed capital rule workable and effective from a safety and soundness
perspective and consistent with the implementation of Basel III by other
regulators.  Most importantly, the refinements I ask FCA to make ensure
that the FCS can function consistent with cooperative principles for the
benefit of its member-customers as Congress clearly intended. 

I feel that it is my responsibility as a director to protect the System's
cooperative structure.  This cooperative structure sets us apart from
other financial institutions and it has given us the ability to fulfill
our mission for nearly 100 years. 

I appreciate the opportunity to comment on this proposed rule and FCA's
willingness to consider my feedback.   

Sincerely,


Alan J. Hess
7857653786


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