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Letters to Regulators

Scope & Eligibility Notice of Proposed Rule Making (Non-Farm Lending)

October 29, 2003

Mr. Robert Coleman
Director, Regulation and Policy Division
Office of Policy and Analysis
Farm Credit Administration,
1501 Farm Credit Drive,
McLean, Virginia 22102-5090

Re: Scope & Eligibility Notice of Proposed Rule Making (Non-Farm Lending)

Dear Mr. Coleman:

We are sending this letter on behalf of the Independent Community Bankers of America (ICBA) and its 5,000 community bank members. ICBA is the nation's largest national banking trade association and exclusively represents the interests of the nation's community banks. Our comments pertain to the Farm Credit Administration's (FCA) notice of proposed rule making (NPRM) in which the FCA asks members of the public to respond to several questions that relate to the Farm Credit System's (FCS) scope and eligibility authorities. These authorities help focus the FCS's lending in terms of who is eligible to borrow and for what purposes.

Background of Proposed Rule Making

The impetus for considering changes to FCA scope and eligibility regulations came from one FCS institution and the Washington D.C. lobbying arm of the FCS, the Farm Credit Council. Representatives of these two groups requested FCA change its regulations to allow for a fundamental shift in the FCS's focus, namely, shifting away from serving farmers and ranchers to unconditionally embrace providing credit for non-farm lending purposes including to individuals who have little, if any, real farming activities. Included in this extraordinary proposal was a request to allow the "local" boards of directors of FCS associations to make their own decisions on who is eligible to borrow and for what purposes.

The FCA wisely sought public input on this request to fundamentally and dramatically refocus the lending activities of the FCS. FCA conducted a public meeting to gather a better explanation of what specifically the two FCS entities were urging its members to request from the FCA - and the taxpayers of America who are the ultimate back-stop to any future failure of the FCS - in terms of these broad new lending powers.

FCA also published a NPRM explaining the current scope and eligibility regulations relating to loans to "bona-fide" farmers and then posed four categories of questions from which the agency sought input from the public. ICBA appreciates the FCA taking time to consider all views on this major proposal by FCS and we urge FCA not to adopt this loosely defined, arbitrary and capricious proposal.

Analogy of Why Proposal Lacks Merit

A proposed rule should not proceed on the proposal because it lacks sufficient justification and is without merit. Adopting a regulation on this proposal, for example, would be similar to the OCC allowing the boards of directors of community banks to make their own determinations regarding which banking regulations they deem important enough to follow and which banking or non-products, services and activities they wish to pursue.

For example, the OCC could propose that in determining the definition of a "town of 5,000", in which banks are allowed to establish insurance agencies, the bank's directors should be able to define a community's population by using their own arbitrary standards. The arbitrary standards proposed could include:

  • not counting residents who earn income from employment or activities outside of the community;

  • not counting residents who have property located outside the community;

  • not counting residents whose original families came from or reside outside the community;

  • not counting residents who do not plan to permanently reside in the community such as those who plan to retire elsewhere

  • not counting residents who have indicated an interest in eventually seeking employment in another community;

  • not counting residents who have attended a university outside of the community since they would have temporarily resided elsewhere; and

  • not counting individuals who may have deposits, investments, or insurance policies in financial institutions located in other places, such as insurance with a company headquartered in a larger city.

The explanation for these exemptions would be that these activities or conditions indicate for financial, insurance, and other purposes that these individuals do not consider themselves wholly committed to the community's financial life and may have an eventual basis for residency elsewhere.

The essence of the attempted argument would be to undermine the actual meaning of the normal and expected definition of who would have been considered a "resident". Similarly, the FCS representatives seek to undermine the normal and expected definition of what it means to be a "bona fide farmer", the legal requirement to determine who is eligible to borrow from the FCS.

In many respects, the request to dramatically shift the FCS's lending activities based on arbitrary determinations of eligibility by boards of directors is equally unreasonable, if not more so, than the example provided above regarding who would be considered actual "residents" of a place of 5,000. Both the example provided and the request by FCS are simply ways to sidestep the legal requirements of what institutions are entitled to do and who they are entitled to serve under the specific and narrow legal parameters imposed upon them by their federal enabling statutes.

Both of these instances are simply opposite sides of the same eligibility coin - in one instance efforts would have been made to exclude those who would influence eligibility and in the other instance efforts are being made to include those who would influence eligibility.

Congress did allow banks greater leeway to become involved in insurance-related activities through the Graham/Leach/Bliley Act. However, the 'towns of 5000' rule still applies to national banks who want to offer insurance as they must utilize a holding company structure to do so. Changes resulting from the GLB Act came through the legislative process and not by agency fiat or an agency initiated rulemaking process. The FCS's proposal goes well beyond what Congress ever intended and represents dramatic change for the System that would allow it to transform itself into a network of specially privileged GSE entities with commercial bank powers. Such revolutionary issues should be left to Congress to decide based upon whether there is a legitimate need to pursue an action which, in our view, would crowd out private sector lenders from rural financial markets and therefore reduce credit choices to rural consumers.

Proposal Moves System Away Form its Historical Mission

In many ways the very credibility or lack thereof of the Farm Credit System and its mission and purpose are at stake. If the FCS seeks to become essentially a network of commercial banks, and if the FCA allows such a development, then the very "purpose for being" of the FCS would be called into question.

In such an instance, the FCS would move from meeting the charge of their mission and charter — serving the needs of farmers and ranchers — into a completely different charter arena, namely acting like commercial banks. The obvious question that commercial banks and Congress and the public would then ask is whether the FCS has outlived its usefulness and should be privatized. Only by keeping the FCS focused on its mission to legitimately serve farmers and ranchers can the FCS and FCA state with credibility that there is still an actual need for keeping this GSE in existence as a retail lender since commercial banks are now able to provide an ample variety of credit products and services to farmers and non-farmers.

We believe it is essential to not lose site of the fact that the FCS is a government sponsored enterprise with special tax and funding advantages. The special privileges, low-cost funding and tax exemptions that result from being a government sponsored enterprise are largely unavailable to community banks, which are private-sector, tax-paying institutions committed to their local communities that rely primarily on the expensive, but limited mechanism of taking deposits for their major funding source.

Providing FCS lenders with what for all practical purposes would be the same scope and eligibility parameters as rural community banks, combined with recent efforts to operate outside the statute's intent by offering deposit-like accounts, while also avoiding many of the tax obligations community banks face, would create an un-level playing field and would undermine the viability of rural community banks. Community banks would strenuously object to such a controversial proposal.

No Need Established for FCS Non-Farm Lending

FCA Should Share Economic Impact Statement — We point out that the FCA has released no economic data that details there is a need for the FCS to expand into non-farm lending. While FCA is required to do an economic impact statement on their proposals, FCA has released no economic data to state what the amount of economic harm will be to community banks and other rural credit providers. To suggest the impact will be less than $100 million is inconceivable. If FCA believes otherwise ICBA requests that FCA release their economic impact statement so that it can be reviewed.

FCA Should Show Need for This Dramatic Policy Shift — We also request that FCA show in their analysis that there is a need for the dramatic policy shift in FCA regulations and FCS lending to the non-farm sector, given that rural America has numerous sources of credit already available from the private sector for both farm and non-farm credit.

In addition, this proposal is not necessary to enhance the viability of the FCS, which has been growing quite rapidly in recent years making record net income, growing their customer base and witnessing significant growth in lending volumes and market share. When FCA considered a similar proposal in 1996 it was argued that the non-farm lending authorities were necessary to help FCS keep up with a rapidly changing agricultural environment.

However, USDA data indicates that since a similar proposal was considered by FCA in 1996, outstanding FCS loan volumes for short-and intermediate-term loans and for long-term real estate loans have grown by over 50 percent! USDA also reports that, with the exception of a single year, FCS non-real estate lending has witnessed annual increases between six to twelve percent since 1993. FCS non-real estate lending has increase well over 100 percent since 1988!

In fact, a recent internal study by FCA showed in recent years that out of 103 System institutions, 63 grew over 10 percent; 34 grew over 15 percent; and 9 grew over 20 percent! Clearly the FCS already has ample loan authorities and is growing quite rapidly and this proposal is unnecessary in terms of the System's own interests in achieving growth.

Not a Customer Oriented Proposal — If there are no legitimate needs for this proposal in terms of an unmet credit demand by rural customers, then it becomes clear that the FCS's request is not customer-oriented, but rather is (FCS) institution oriented in terms of serving their own desires for growth. We can find no explanation given that the proposal would serve customers who do not now have access to credit in rural America.

Proposal Based on Flawed Logic

Increasing Credit When No Need Exists Doesn't Enhance Economic Opportunity - FCS's request to engage in unlimited non-farm lending lacks merit on a number of fronts. We note that simply increasing the supply of subsidized credit, especially where no need exists and where ample credit is already in abundance from the private sector, can be very reckless and destructive.

Simply supplying more credit to people in rural America who already have access to ample supplies of credit doesn't create new jobs and doesn't increase economic opportunities. In this case, it simply allows for a government sponsored enterprise to drive out private sector lenders and thus undermines access to credit — especially for those who may be marginally credit-worthy and not be in the categories of non-farm loans deemed worthy enough by the FCS to cherry-pick away from private commercial lenders.

Farmers Already Have Ample Access to Credit — We note that USDA has stated there is already an ample supply of credit for farmers for short, medium-term, and long-term credit needs (see below). This proposal is supposedly aimed at "farmers" - bona-fide farmers - but USDA reports indicate there is no need for such provision of credit to "bona-fide" farmers.

FCS Proposal Hurts Bona Fide Farmers — FCS has suggested that the proposal is necessary to help "bona fide" farmers meet their farming needs by enhancing their non-farm activities and income. However, drastically increasing the amount of subsidized credit can have a very detrimental impact in rural economies. For example, USDA's recent Ag Income and Finance Outlook report noted that much of the recent gains in farmland value have been fueled by "non-farm investors" and not by farmers. In many cases land values have been bid higher than agricultural-use values would indicate valid. The effect is to drive up land values for local farmers and increases their tax assessments and tax burdens, thus decreasing their net farm income.

FCS Proposal Hurts YBS Farmers — Further, by putting economic incentives in place to drive up land values through easy access to subsidized credit for those who essentially are not engaged in farming, this proposal drives up prices that real farmers pay for land, the largest collateral item that farmers have. This makes it even more difficult for young, beginning and small farmers to enter agriculture, a goal that the FCS and the FCA are supposedly seeking to achieve. It is unclear whether FCA's economic impact statement factored in these types of destructive economic consequences and again request FCA make it publicly available.

Existing Authorities Already Over-Liberalized — We point out that there is already sufficient credit for non-farm lending. Any credit-worthy candidate can already obtain credit from a commercial banking institution, of which there are several thousand in rural America. In fact, USDA's Agricultural Income & Finance Outlook (March 11, 2003) report states:

"A fast growing component of the short-and intermediate-term loan category continues to be (FCS) loans to farm-related businesses and marketing and processing businesses. The FCA has liberalized regulations in this area, making it easier for these types of businesses to be eligible for FCS loans."

FCS lenders can already make loans for farm-related business financing. The authority allows:

  • Financing all of a business if a majority of the firm's income is related to agriculture;

  • Financing a proportional amount of a business's credit needs if less than one-half of its income is agriculturally related.

USDA also comments on other ways FCS can reach beyond the farm gate:

Total loan participation volume with non-FCS lenders grew by 19 percent during the 12 months ending September 30, 2002, with much of the increase coming from participation on loans to borrowers who would not otherwise be eligible to borrow directly from the FCS ("similar entity" loans). The increase in participations allows FCS lenders to diversify the risk in their portfolios, use their at-risk capital more efficiently, and increase lending volume."

These comments suggest several conclusions.

  • First, FCS already has means to make loans to businesses proportional to the businesses' farm related income.

  • Second, there are already ways for the FCS to be involved in non-farm lending within fixed parameters designed to keep the FCS focused on agriculture.

  • Third, the FCS proposal is a wholesale attempt to get into non-farm lending in an effort to become the equivalent of commercial banks when they have not shown any need or justification to do so.

  • Fourth, Congress implemented the "similar entity" authorities, with the cooperation of the banking industry. In doing so, Congress specifically recognized that specific lending restraints are in place and should be kept in place for FCS's scope and eligibility parameters. FCS's proposal seeks to completely undermine the measured actions of Congress in passing a limited expansion of lending authorities. FCS's proposal, in addition to establishing arbitrary and capricious standards for scope and eligibility purposes, would be inconsistent with the Act, its intent and its legislative history.

Summary Response to FCA's Questions

Bona-Fide Farmer Definition — The crux of the "eligibility" argument FCS has asked FCA to consider centers on who is really a real, or bona-fide, farmer. Common dictionary definitions of the word bona fide include: real, true, authentic, genuine and actual. These common sense designations suggest what ninety-nine percent of the public would believe that they suggest in terms of applying to "farmers", namely that these farmers are earning their income from agricultural production and activities as an important source of their livelihood or are attempting to do so.

However, FCA's current definition of who is a "bona fide" farmer is far too negligible in that it allows people to simply own land to qualify. This means they may not ever produce an ag commodity or have any agricultural sales. It is questionable whether the current FCA definition of a bona fide farmer adheres to congressional statute and legislative intent without relaxing the definition further.

Obviously, the FCS's proposal is intended to allow FCS lenders to serve all of the business and consumer credit needs of those who may or may not be real farmers. This raises a number of troubling scenarios of the types of abuses likely to occur:

  • For example, if a doctor in a small rural community wants financing for his medical practice, he may decide (or be told by the local FCS lender) that he qualifies as a bona fide farmer if he buys a couple acres of pasture land. He will then have his entire non-agricultural medical facility financed by the "Farm" Credit System.

  • Likewise, a dentist may decide to also buy an acre of pasture land and a steer and receive all the financing he needs for his practice from the FCS.

  • A county hospital decides to request financing from the FCS on the basis that it owns a couple acres of land that it may decide to rent at some point in the future for vegetable production if the community ever establishes a 'farmers' market. The hospital decides that it will therefore seek to have its entire facility financed by the FCS.

  • A car dealership owns a couple acres of land, part of which is used to store its inventory of used cars but which may one day, perhaps 10 to 15 years from now, be converted to range for cattle grazing. The dealership applies for and receives credit to finance the daily activities of its dealership.

  • Ted Turner decides to buy thousands of acres of rural pasture land and seeks financing from an FCS association.

  • Wal-Mart, realizing it owns land in rural areas, decides to apply for FCS subsidized credit on the basis it qualifies under FCA regulations as a "bona fide farmer". Wal-Mart proceeds to utilize FCS financing for construction of new Wal-Marts in rural areas, and the financing of its ongoing operations including payroll, inventory, and assets.

Under FCA regulations and FCS's proposal, all of these abuses and many, many more could occur. None of these examples really involve bona fide farming operations, yet they would be considered to be just that under FCA regulations. All of these examples are illustrative of how businesses would seek subsidized FCS financing and displace private sector lenders without serving the credit needs of bona fide farmers. And they all illustrate the arbitrary and capricious nature of the proposed regulations.

Why should the FCS be financing businesses that are not actually involved in bona fide farming activities? On its face, the FCS request makes no practical sense.

ICBA bankers made several suggestions as part of their presentations for FCA's public meeting on this issue in June. Bona fide farmers should be considered to be those who are actually and significantly engaged in a farm operation to produce ag commodities and earn income for their livelihood. Bona fide farmers are not hobby farmers. They file schedule F tax returns. They contribute their time and resources to the farm operation. If changes are made, we request FCA tighten the definition of a bona fide farmer to include these elements and not allow someone who simply owns land to qualify.

FCA regulations do, however, attempt to keep the focus of FCS lending on agriculture by requiring the FCS loan product be primarily agricultural in nature and requiring credit to become restricted to only agricultural lending the further away the FCS borrower moves from having a full-time farming operation. These basic and fundamental requirements should be kept in place.

Therefore, we suggest that if FCA makes any changes to current regulations, that regulations be tightened to ensure applicants actually produce significant agricultural commodities or receive significant agricultural income and that they intend to be full-time farmers as evidenced on their Schedule F tax return. They also need to earn a majority of their income from farming or show they intend farming to be their main occupation. They should also contribute significant land, labor or capital. All of these criteria should be included in the definition of a bona fide farmer.

It is instructive to look at how other federal agencies interpret who an actual farmer is. In order to qualify for USDA's Farm Service Agency's guaranteed loan programs, the applicant must be actively involved in the day-to-day management of the farm operation. FSA guaranteed operating and farm ownership loans may only be used to finance items directly related to the farm operation such as farm equipment, livestock, purchasing farmland, constructing or repairing buildings and other fixtures on the farm. Applications for FSA guaranteed loans of $125,000 or more must include: a loan narrative describing the farming operation including the types of enterprise; key personnel; management structure; the short-term and long-term business goals of the operation; and a description of the farmland, using for example, FSA farm numbers. An FSA guaranteed loan application includes 3 years of production history.

Similarly, the IRS also looks at specific, verifiable criteria to determine if someone is actually engaged in farming in an authentic (bona fide) manner. For example, the IRS considers the time and effort an individual spends on farming, whether individuals depend on income from farming for their livelihood; and whether an actual profit is made from farming in at least 3 of the last 5 tax years.

Using real, verifiable standards, such as those described above in use by the USDA and IRS - which like FCA are also federal agencies — is the only legitimate way to verify if the congressional intent is being met of targeting FCS credit to authentic, verifiable, bona fide farmers. Otherwise, FCA is allowing completely arbitrary methods to be used to determine who meets the definition of a bona fide farmer.

Interpreting the Term "Other Credit Needs" — The crux of the "scope" aspect FCS is asking FCA to consider involves the purpose of FCS lending. The statute states that the credit FCS provides should be "directly related to the farming operation." The FCS, however, is requesting the wording "and other credit needs" be lifted out of the context of the sentence where these words are actually located. FCS then creatively suggests that the Farm Credit Act (Act) allows their lenders to provide an unlimited amount of credit for non-agricultural purposes unrelated to any farming activities. Such a novel interpretation turns the Act and its legislative history completely on its head!

Anyone taking words out of context from any sentence can distort the meaning of the sentence. FCA should not reward efforts to misrepresent the intent and plain wording of the statute by the FCS. Rather, we suggest that FCA has an obligation to fidelity in terms of applying the Act as Congress intended it be applied. While Congress may have given the FCA some flexibility as the independent, arms-length, regulator to oversee that the ongoing operational aspects of the FCS are carried out in a safe and sound manner and to ensure FCS operates within its legislatively defined narrow constraints, this flexibility was intended to keep the FCS focused on providing credit for agricultural purposes, not non-agricultural purposes! Especially since the private sector already provides ample credit for both farm and off-farm financing needs.

Simply put, if FCA intends to truly adhere to the Act's actual wording and intent, it will keep the FCS primarily focused on agricultural lending and not grant the System's self-serving desire to lend to anyone living in rural America for any purpose, including purposes completely unrelated to agriculture.

USDA's Farm Service Agency farm loans also allow financing of "other credit needs". However, this financing is required to be "directly related to the farm" — the exact wording in the Farm Credit Act! As mentioned, examples include farm equipment, livestock, farmland, building repairs and other fixtures on the farm. These are the "other credit needs" that congress envisioned and FCA should spell out the same agriculturally related requirements for clarification if changes are made to current regulations. This would minimize confusion and adhere to the true intent of Congress while also recognizing that FCS, while not the "lender of last resort", should have in place standards that are at least as strong as the lender of last resort.

Congress and the FCA have already provided a remedy for System institutions to become general purpose lenders, which is by exiting the System and converting to a commercial lender status. If there are shortcomings pertaining to such termination activities, then FCA should pursue regulations to address these flaws. Simply granting regulatory fiat to dramatically and fundamentally alter the historical mission of the FCS, however, is inappropriate and legally unjustifiable.

The statute also states that credit provided by the FCS should be "necessary for efficient farming operations". FCS regulations do seek to fulfill this mandatory requirement by stipulating that FCS loans be increasingly conservative as an individual moves away from agriculture as his full-time occupation to the point where only agriculture credit is extended to those whose occupations are essentially other than farming. Again, FCS loans should be kept primarily agricultural in nature and be for the purpose of allowing a bona fide farmer to maintain an efficient farming operation.

Off-Farm Income Criteria — FCA's focus from a regulatory standpoint should not include consideration of an off-farm income factor. Rather, in order to keep the System focused on agriculture, FCA's regulatory approach needs to center on whether the individual has sufficient agriculturally oriented income and activities to qualify as a true, bona fide farmer.

The System cannot be focused on agriculture, its historical mission and purpose, when criteria for scope of lending is unlimited in its focus on non-agricultural events. As stated previously there is no need nor justification for doing so. There is also no basis from the statute for applying a non-farm income category as a qualification to receive FCS loans, which again, are intended to be for bona fide farmers.

USDA research on off-farm income suggests that the vast majority of people who have off-farm jobs do so as a career choice - in other words — they're not trying to be bona fide farmers as their principal source of livelihood — they have other career choices in mind! USDA also states, "A long-held belief was that farmers take off-farm work to support the farm business. National survey results show that as many as one-third of operators worked off-farm prior to becoming a farmer!"

Nearly 500,000 spouses reported an off-farm occupation, with 80 percent indicating that off-farm work was their career choice.

Nearly 80 percent of retired households' off-farm income comes from unearned sources", (e.g. interest, dividends, social security and other public programs.) Limited-resource or low sales farms receive about half of their off-farm income from these sources, reflecting the advanced age of many of the operators in these groups.

Approximately 32 percent of limited resource operators and 46 percent of low-sales farmers are age 65 or more. While 70 percent of rural residential farms report off-farm jobs, 90 percent of these work 35 hours a week. USDA states, "This suggests that individuals who likely do not consider farming as their primary occupation run many of these small operations. USDA adds, "only 4 percent of operators of rural residential farms reported farming as their primary occupation." USDA further adds, "Households operating the remaining family farms. . . on average have positive earnings from farming."

People earn non-farm income for a variety of reasons. Sometimes people get off-farm jobs to have access to health care benefits. Much non-farm income is passive in nature, like dividends, interest or social security. Many rural people work for the government and our schools and yet may have a few acres of land or a big back yard. Yet these individuals wouldn't be considered "bona fide farmers" just because they have off-farm income. Certainly, some people use off-farm income to help repay farm debt. However, given the above information, painting with a sweeping and broad brush and suggesting that anyone who has off-farm income should receive unlimited FCS financing would set in place eligibility criteria that are arbitrary, capricious and inappropriate and would serve no justifiable purpose given FCS's historical mission.

USDA's annual Agricultural Income and Finance Outlook Report (March 11, 2003) makes these comments:

"Agricultural lenders have sufficient loanable funds available in 2003 for qualified farm borrowers";

"Farm lenders are expected to have an adequate supply of short-, intermediate-, and long-term credit available ".

These comments show there is no need for FCA and FCS to focus on non-farm income since bona bide farmers already have access to the credit they need for their farms. FCS needs to focus on serving bona fide farmers in their agricultural pursuits.

Full-Time & Part-Time Farmer Distinctions — Consistent with keeping the FCS focused on serving agriculture, we believe the FCA needs to keep its current distinction between full-time and part-time farmers, again ensuring that all loans are primarily agricultural and that as individuals move further away from farming as their livelihood, they should only get restricted credit that is agricultural in nature. Part-time farmers should not receive an unlimited amount of non-farm credit for any purpose that is completely unrelated to their farms, as the latter would not make any sense for a special purpose GSE created to serve only agriculture.

Current regulations already have extremely liberalized flexibility to meet needs of part-time farmers. The regulations already state part-time farmers, "who need to seek off-farm employment to supplement their farm income" can access credit to meet their "family needs in a preferred position with full-time farmers".

The regulations at least partially attempt to reflect the "Objectives" section of the Act by making clear that as an individual moves away from farming, credit is to be reduced, "to the point where agricultural needs only will be financed for the applicant whose business is essentially other than farming." This is the very least that should be asked of FCS, since ALL applicable sections of the law mention lending is to target bona fide farmers.

It is appropriate to distinguish between full time farmers and part-time farmers to keep the FCS focused on serving agriculture. However, the loans made to part-time farmers should also be primarily agricultural in nature and credit should become more restricted as individuals have vocations outside of agriculture. Agriculture, on-farm income, and the pursuit of full time farming activities as one's primary vocation need to be the fundamental, underlying foundation for receiving credit from the FCS, given its subsidized GSE status.

Moderately Priced Rural Housing - FCA should provide the public detailed information on what FCS lenders are now doing under this lending category. Such information should include the amount of mortgage loans FCS is providing by institution; in what state the loans are being made and what percent of each association's portfolio consists of home loans. Most bankers are aware of the advertisements for financing "country estates" and large and new homes that are clearly not moderately priced rural homes.

Current regulations supposedly limit FCS financing to the 75th percentile of housing prices in the local area and require the homes to be "modestly priced". But FCS is financing luxury homes in rural areas. An explanation should be provided to the public as to why FCS is able to apparently skirt current regulations in this area.

FCA Historically Recognizes Limited FCS Scope & Eligibility

We have made the point numerous times in this letter that the FCS scope & eligibility proposal - which in essence is a non-farm lending proposal — is inappropriate for the FCS which has a narrow charter as a GSE and advantages over community banks due to their GSE status. The FCA has acknowledged these arguments as being valid in previous agency regulatory decisions. The following are quotes from an FCA Final Rule issued in 1993 on FCS eligible investment activities:

"The proposed limitation on total investment holdings is also designed to prevent FCBs, BCs, and ACBs from engaging in arbitrage activities that are incompatible with their status as a government-sponsored enterprise (GSE), which finances agriculture. (Emphasis added in all quotes)

"Farm Credit banks, as instrumentalities of the United States government, generally have access to the money and capital markets at lower interest rates than their private sector competitors.

"All FCS commentors, except Farmer Mac, advised the FCA not to impose any regulatory restrictions on the size of bank investment portfolios. These commentors implied that this matter should be left to the discretion of the bank's board of directors. If this approach is followed through to its logical conclusion, any Farm Credit bank, at the discretion of its board, could hold most of its assets in investments that are unrelated to agricultural credit.

"The FCA rejects this option because it is fundamentally incompatible with the charter, status, and purpose of the FCS. Congress enacted the Federal Farm Loan Act of 1916 after it concluded that commercial banks were unable to furnish adequate credit to America's farmers on a sustainable basis. Congress acknowledged that its efforts to address the credit needs of farmers through the Federal Reserve Act of 1913 were largely unsuccessful, and agricultural credit was scarce because commercial banks primarily loaned money to borrowers who basically had different credit requirements than farmers.

"Although the scope of the FCS expanded over the years, its fundamental mission of meeting the credit needs of agricultural producers has never changed.

"In fact, section 1.1(a) of the Act declares that the policy of Congress is to promote a farmer-owned cooperative banking system that furnishes sound, adequate, and constructive credit to agricultural producers.

"The FCA is also unable to reconcile the commentors' proposal with the FCS's cooperative principles. Cooperatives, by law, conduct most of their business with their members, and earn most of their income from such transactions.

"From the FCA's perspective, a Farm Credit bank is not using its charter primarily to serve the credit needs of agricultural producers and rural communities once agricultural loans to its borrower-members no longer comprise a majority of its assets.

"On the funding side of the equation, the commentors' proposal also conflicts with the GSE status of the FCS. Farm Credit banks borrow money on the capital markets to fund their assets. According to recent reports by the United States Treasury Department and the General Accounting Office (GAO), GSE status significantly enhances the creditworthiness of the FCS. Without GSE status, System banks would incur a substantially higher cost of funds. Under these circumstances, the FCA believes that it is inappropriate for System banks, as GSEs, to borrow funds at favorable rates, and then invest most of the money in assets other than agricultural loans.

"The FCA interprets the Act and its legislative history as requiring each Farm Credit bank to hold a majority of its assets in agricultural loans. Pursuant to its authorities under sections 5.17(a) (4) and (9) of the Act, 12 U.S.C. 2252(a)(4) and (9), the FCA determines that a regulatory limit on investments ensures that Farm Credit banks abide by their: (1) Statutory mission of financing agriculture; and (2) cooperative principles.

"Since an investment ceiling enforces compliance with the Act, the FCA rejects System arguments that only compelling safety and soundness reasons can justify restrictions on the size of bank investment portfolios.

"For the same reason, the FCA cannot accept the claim that an investment ceiling constitutes an unwarranted interference by the regulator in the business affairs of System banks.

"The mission of the FCS is to finance agriculture and other specified rural credit needs.

"Since the FCS operates on cooperative principles, loans to member-borrowers are supposed to be the primary source of income to Farm Credit institutions.

"The United States Budget for fiscal year 1992 contained a section that focused on the role of GSEs in providing credit to specific sectors of the American economy, and the financial risk they pose to the Federal government. . . Some institutions have over 400 percent of the liquidity required by the Funding Corporation. . . . This implies that some institutions are creating arbitrage profits from the issuance of federally backed FCS debt.

There are numerous conclusions that can be drawn from FCA's own comments including:

  • The FCA itself recognized that the legislative history and the statute itself provides a limited mission for the FCS to provide targeted funding for agriculture to assist farmers and ranchers and other purposes that are clearly specified;

  • FCS's GSE status provide FCS institutions with cost of funds advantages and an advantage in the interest rates it can charge compared to private sector lenders;

  • Allowing local boards of directors to supposedly make scope & eligibility determinations (although clearly this would likely be done by FCS managers, not boards of directors) leads to the logical conclusion that FCS associations could end up with most of their loans being unrelated to agricultural credit;

  • The impetus for creating the FCS in 1916 was the conclusion that farmers had unique needs that differed from other credit consumers and a specialized entity was desired to target financing to the farm sector, because commercial banks could adequately meet the non-unique needs of non-farmers;

  • The FCS's fundamental mission of serving agriculture has not changed over the years. The FCS's current proposal, by focusing on providing non-ag credit, would be a dramatic departure from its historical mission;

  • To maintain its' cooperative principals, FCS needs to loan to its farmer-owners. Allowing anyone to loosely be considered a farmer and receive credit from the FCS dilutes the real farmer-ownership of the FCS and could easily lead to its sharp departure from providing credit to American agriculture;

  • As FCA stated, FCS would no longer be using its charter primarily to serve the credit needs of agricultural producers once agricultural loans to its borrower-members no longer comprise a majority of its assets.

  • It is indeed inappropriate for System institutions, as GSEs, to borrow funds at favorable rates, and then pursue credits with the inevitable result being that most FCS loans are other than agricultural loans.

  • We agree with the FCA's interpretation: "the Act and its legislative history as requiring each Farm Credit bank to hold a majority of its assets in agricultural loans", and note the proposal to engage in unrestrained non-farm loans undermines both the Act and its history.

  • Having adequate and verifiable restrictions and standards in place to limit FCS lending for primarily agricultural purposes is appropriate since these restrictions and standards help ensure compliance with the Act. Further, the argument that only safety and soundness considerations should determine whether there are any restrictions and standards in place is without merit or logic based on the statute and its history.

  • As FCA stated, "for the same reason, the FCA cannot accept" the claim that current regulations, with their minimal restrictions, constitute an unwarranted interference by the regulator in the business affairs of System institutions.

  • Since the FCS operates on cooperative principles, loans to member-borrowers are supposed to be the primary source of income to Farm Credit institutions, not loans for non-agricultural purposes to individuals who may not really be bona fide farmers.

Proposal Raises Safety & Soundness & Farmer Control Concerns

The FCS's proposal is clearly designed to allow FCS institutions to cherry-pick non-agricultural loans from private sector lenders. Neither the FCS nor the FCA explained in any written materials how the proposal would provide credit to those who supposedly cannot now obtain credit. We would argue, as would most agricultural economists, that credit worthy borrowers in rural America have access to ample credit options. Therefore, the proposal would serve no new borrowers nor is there a requirement in the proposal that it would serve new borrowers.

By pushing private sector lenders out of the marketplace, the FCS reduces its own options to pursue participations and similar entity financing with commercial lenders, a quickly growing market for FCS lenders. This would consequently reduce the ability of the FCS to diversify its loan portfolios and spread risk among other creditors, suggesting greater risk-taking by FCS institutions.

USDA has recently pointed out that:

"Whereas 20 years ago a typical FCS association covered a small geographic area of several counties and specialized either in land loans or farm production loans, the typical FCS association of today covers large regions, delivers a wide range of farm and rural credit programs and financial services, and has an extensive loan portfolio. As of September 30, 2002, 16 associations had loan portfolios exceeding $1 billion."

USDA noted the consolidation trends within the System raise issues such as local office access, less specialized product choices and the loss of local borrower control of lending policies.

As FCS institutions become increasingly large in terms of assets, they become increasingly more complex financial institutions to regulate. Allowing rapid growth of FCS institutions even beyond the rapid growth they are now experiencing poses risks both to System institutions and the ability of the FCA to regulate these larger, more complex financial organizations.

As the FCA Chairman stated in a speech earlier this year:

"The system is experiencing a period of rapid loan growth. . . . it should also serve as a yellow flag of caution. . . . unbridled growth has the potential to place significant stress on internal control systems of an institution and lead to asset quality problems several years down the line if not handled very skillfully."

There are also numerous risks pertaining to the use of non-farm credit by those who may actually be bona fide farmers. For example, seeking to support their farm activities (operations, expansion, etc.) individuals may seek to venture into business lines they have no experience in. The failure of new small businesses is quite common. Failures in these businesses could also wipe out producers' equity in their farming operations and ruin a lifetime of hard work. This scenario also would cause loan losses to increase for FCS lenders.


We believe this proposal should not be allowed to proceed. If FCA decides to change its current regulations, they should be tightened to comply with the Act and its legislative history, not further loosened. In fact, if the proposed regulation were to proceed, it would bring into question the credibility of the FCA and the FCS.

As FCA Chairman Mike Reyna stated in a speech earlier this year:

"An 'arms-length' regulator is independent, in other words it is not unduly influenced nor is it controlled or governed by the entities that it regulates. Such a regulator also is objective or, in other words fair and balanced in its decision-making. A regulator that is not both independent and objective really has no credibility and cannot truly speak with authority."

FCA comments from the June 26th public meeting on scope & eligibility pertaining to non-farm lending included the following:

"Government-sponsored enterprises, like the Farm Credit System, are established to serve a specific public purpose, rather than a general public purpose. . . Commercial and community banks, in contrast, are chartered to serve a more general public purpose."

"Public costs, for example, result from a GSE's reduced or limited tax liability, or when more serious situations arise at GSEs that threaten to undercut the trust and confidence of investors."

We urge FCA not to change existing regulations regarding scope and eligibility by allowing the System to lend to anyone loosely defined as a farmer for any non-agricultural credit need. Some System advocates apparently want to become commercial banks while still enjoying the privileges of being a government sponsored enterprise.

FCS needs to focus on serving real, bona fide farmers. If FCS wants to expand their powers so they operate like commercial banks then the FCA can streamline current termination procedures so that institutions that want broader powers can leave the System and operate in the world of commercial banks.

The proposal would displace community banks throughout rural America. This is not the role Congress intended for the FCS. It raises numerous safety and soundness risks as they venture into new types of lending and would lead to many abuses. It also shifts FCS's focus away from agriculture as the farmer owners become those without real agricultural interests. By establishing an arbitrary framework with loose or minimal standards for non-farm lending, FCA would also be setting the stage for a massive shift of current lending from the private sector, which pays significant taxes, to tax-advantaged GSE lenders, thus resulting in a massive loss of income from the tax base of many rural economies. This will hurt rural communities and their infrastructures and services that are financed by their existing tax bases.

The current regulations are already looser than what the statute says they should be, but they do, in a very minimal way, at least attempt to keep the System focused on its mission-to provide sound, adequate, and constructive credit . . .necessary for efficient farm operations.

ICBA appreciates the FCA taking time to gather public input on this major proposal. However, we feel it would be a major expansion of FCS powers related to scope and eligibility based on very arbitrary and capricious guidelines that would take the FCS well beyond anything Congress had ever intended and well beyond what the statute allows.

The proposal would have many harmful and destructive consequences to our rural communities and to rural community banks. We urge the FCA not to proceed with this proposal.

When a similar previous proposed rule to expand FCS powers was considered, former House Banking Committee Chairman Jim Leach wrote FCA regarding FCS's role in fulfilling a narrow lending charter. He noted,

"At issue is a new dimension to the 'crowding out' problem. When Government-Sponsored enterprises are allowed to expand the scope of their activities, they 'crowd out' the private sector and compete against the very people who are taxed to provide their subsidies. The question in the final measure is whether one prefers a free market or a governmentally-tilted one. To opt for a tilt demands the presentation of a compelling case that the people in the areas affected lack alternative, competitive professional services."

Farmers and ranchers in rural areas may have lacked access to sufficient credit options early in the previous century when the FCS was created. However, that is no longer the case, as was alluded to by FCA during the June 26th public hearing. FCA, in its role as an independent and professional federal regulator, should put a halt to the FCS's incessant appetite for new powers and greater profits that result in no new customers being served. Please discontinue consideration of this proposal.

Thank you for considering our views. If you need further information please contact Mark Scanlan, ICBA's director of agricultural finance at 202-659-8111.


Ken Guenther
President & CEO

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